December 2005

Volume 6 Issue 11 December 2005

Software Savvy

What is Your Software ROI?
by Craig Yamauchi

As you do with any major investment, developing a return-on-investment (ROI) model to justify software investments is highly encouraged. The desirable financial benefits from software investments are seldom achieved when there are no measurable objectives.

Unlike investments in machinery, where the ROI is immediate and tangible, it is much more difficult to quantify and measure when it comes to software. The measurements of the investment may depend on how the software will be deployed and leveraged strategically.

For example, one company may implement a dealer software solution to enable it to enter into new strategic markets cost effectively. Another company may deploy the same dealer software solution to increase order accuracy and reduce the cost associated with having to re-key orders into its manufacturing system.

The objective of this article is to provide a framework you can use to identify and capture the key benefits and costs when developing a complete software Return on Investment (ROI) model. An ROI business model can ensure that you identify measurable objectives and benefits prior to making your long-term strategic software investment. Often, when creating an ROI model, your software selection criteria will become far more objective and will focus on what is in the best interest for your bottom-line (investment).

Types of Software
When creating a software ROI model, the first step will be to identify the type of software investment. These can be grouped into three broad categories:

• Enterprise-wide Application Software (ERP). These are the set of fully-integrated applications that support order processing, manufacturing, distribution and the financial process;
• Quoting and Ordering Software. These include quoting and order processing systems for the dealer, retailer, distributor and internally for new construction bidding (multi-home projects); and
• Enterprise Software Extensions. Unlike ERP software where integration is a requisite, these programs are often stand-alone applications. These include payroll, human resource, reporting/business intelligence, glass optimization, CRM and manufacturing execution software (MES).

Software ROI Benefits
The next step is to determine the benefits that your organization will derive from implementing the software. Benefits fall into two categories:

• Hard benefits result in a tangible cash benefit. Strong ROI models typically derive the majority of their benefits from hard dollar savings; and
• Soft benefits are not easily quantifiable in hard dollar terms. Although they don’t provide a cash benefit, soft benefits are important because they quantify other factors that may be important when evaluating whether to proceed with the investment.
The following example illustrates how to identify the benefits of a software investment. A manufacturer who is deciding whether to implement a new ERP system may identify the following hard quantifiable and measurable benefits:
• Reduced Head Count. Assuming a projected growth of 15 percent in 2006, the company will not have to increase ordering processing headcount due to improvements in order processing efficiencies. The net result is a 30-percent reduction in the cost of staffing in the companies customer service department. This benefit will be achieved six months after the company goes live and the five-year savings is $X; and
• Order Errors. A new software implementation that will eliminate the manual re-keying of sales orders is expected to reduce order errors by 60 percent. Sales order errors directly lead to increased administrative, production scrap, rework and service costs. The associated reduction in these downstream costs will save the company $X over five years.

Enterprise Software Deployment Costs
Whether you are evaluating the ROI on ERP, quoting and ordering software or enterprise extensions, the costs of implementation can be separated into the following cost buckets:

• Vendor license and/or development costs. These are the costs associated with the acquisition or custom development of application software programs;
• Vendor maintenance. If you purchase software from a vendor, maintenance costs are incurred often throughout the useful life of the software. Maintenance costs are usually calculated as a percentage of the initial license cost;
• Implementation services. These costs include the professional services costs associated with the training and deployment of packaged vendor software; and
• Hardware. These costs include expenditures associated with servers, network equipment, PC upgrades and other physical infrastructures that are required to deploy and maintain the software.

The combination of the above costs are referred to as the total cost of ownership (TCO) or sometimes referred to as the total cost of computing (TCC).

Putting it all Together
Assuming you have identified the benefits and costs of your software investment, you now have all the information to build the ROI model. I would suggest working with your organization’s financial resources to determine the useful life of the software, depreciation, cost of capital and quantification of risk.

Manufacturers need to better quantify benefits and costs when justifying any major software investments or when developing custom software internally. By applying the principles outlined in this article, you should be able to develop a complete software ROI model that contributes to a long-term successful strategic business case for your future software investments.

Craig Yamauchi is the president of Friedman Corp. in Deerfield, Ill. He may be reached at cyamauchi@friedman.com.