Wednesday, March 11, 2009
What is the Probability of acheiving my ROI target?
ROI: Will this investment meet my ROI requirements? This question comes up every day in business. Every vendor has their version of the compelling ROI. The question the buyer should ask is the probability of a given ROI scenario.
Many corporate purchasers think of ROI in terms of hard dollar v. soft dollar savings. Hard dollar savings are those things that reduce my weekly, monthly or quarterly cash flow. Soft dollar savings do not. A classic example is 'you will save 5 man days per month of labor on this process'.
Many buyers use only hard dollar savings in their ROI calculations. The soft dollar benefits are just the icing on the cake. A typical target is to have a 12 month payback only counting the hard dollar savings.
With uncertainty management, it is straightforward to learn the probability of each scenario. In the chart above, we can see there is an 83% chance that the hard dollar ROI will be under our acceptable limit of 12 months. It is nice to also see that the worst case scenarios go out to about 18 months. Also we can see that if everything goes our way, then the payback could be as short as 4-6 months.
As a seller, you can be very persuasive to a buyer with this kind of analysis. As a buyer, it is essential to ask for this risk assessment to understand the probability of a vendor-generated ROI.