Management

31 Jan, 2005 By: Robert Green Cadalyst

### Use ROI methods to bolster your budget.

Sooner or later every CAD manager has to submit a budget. One of the most common complaints I hear from CAD managers is that when they do, they have a hard time getting it approved by management. Like it or not, you must be able to set priorities and present your budget in a way that management can understand for it to survive the budget gauntlet.

The good news is that ROI (return on investment) metrics can help prioritize your budget and show how management views your budget at the same time. By taking the time to back up your budget with ROI analysis, you'll be astonished at how much better your budget will be received. Your management team has many budget requests to consider, so it's up to you to show them why yours should be approved.

## ROI Defined

Before we look at sample problems and comparative ROI numbers, let's go through the basic formula for calculating ROI. Luckily, computing ROI is simple.

#1. Frame your budget request for any item in terms of potential savings and costs. If you are requesting a new piece of design software, think about the potential time savings the software could generate and then tally up allthe costs associated with buying and installing the softwre and training users.

#2. Determine a detailed number for the savings you can achieve. Do this by calculating the amount of time saved in hours and multiplying that by the hourly labor rate of the person who is saving the time. Project all savings to an annual basis by assuming 48 work weeks per year.

#3. Determine a detailed number for the costs you will incur. Add purchase prices of software, support contracts, training costs and lost user productivity during training. For capital items such as software and plotters, compute all costs for the first year of operation (when you actually buy the item) and then the costs of maintaining the item (support and maintenance) over the useful life of the item.

#4. Divide the savings (second item) by the costs (third item) and express in percentage form.

#5. Compute the payback interval by determining how many years it will take for the savings to cover the costs. This calculation is very important for capital items such as software and equipment that have high upfront costs. Businesses are much more likely to invest in items that achieve payback quickly, especially in applications such as CAD where technology changes so fast that long time spans can't be reliably predicted.

## Example 1: Buy a New Modeler?

Let's work a quick example so you can see how an ROI computation works, then we'll interpret the results.

We've determined that we can save a \$50-an-hour tooling engineer 60 hours per year by purchasing a new design modeling system. The software costs \$4,000 to purchase and install and \$1,000 per year to maintain. The required training will cost \$1,000 and require the engineer to be away from work for three days and incur \$800 in travel expenses. In subsequent years, it's estimated that the engineer will need a half-day of self-study to stay current with each upgrade.

Savings. Because the tooling engineer will realize 60 hours of time savings and his billable rate is \$50 per hour, total savings realized will be \$3,000 per year.

Costs. Total costs in the first year will be the software purchase cost (\$4,000) plus the training cost and lost time (3 days at \$50 per hour = \$1,200) and expenses (\$800) the tooling engineer racks up while at training. Total cost for the first year is \$7,000. Each year thereafter, the total cost will be \$1,000 for the software maintenance fee plus \$200 (a half-day at \$50 per hour). Total cost for each additional year is \$1,200.

ROI. For the first year, the ROI is 43% (\$3,000 savings divided by \$7,000 cost). For each additional year, the ROI is 250% (\$3,000 savings divided by \$1,200 cost).

Payback. In this case, a \$3,000 savings per year contrasted with a \$7,000 year-one cost and \$1,200 annual costs thereafter will achieve payback shortly after the third year begins. After three years, \$9,400 will have been spent while only \$9,000 in labor will have been saved.

## What it Means

This first example illustrates so many ROI concepts for the CAD manager that we must analyze them individually. As you read through my analysis, try to think like your management team and you'll start to understand how your budget is viewed. You may even understand why companies don't like to install new software.

Savings potential. This example illustrates how a software application can save money by saving a particular user's time, or does it? The key to this example is to realize that saving a user's time saves the company money only if the user can apply the time saved to other tasks.

If we spend \$7,000 to save a user 60 hours a year, only to have that person routinely sit around without enough work to keep busy, there really isn't any savings gained. Conclusion: Software that saves time is useful only when it allows your company to get more done with the same number of people.

Cost profile. This example illustrates the high upfront costs of purchasing software and brings the concepts of training costs and lost productivity to light. The costs associated with purchasing software are doubly vexing as user productivity and company cash flow take a hit as the new software is purchased and implemented. Conclusion: Now you can see why companies are so hesitant to undertake new software implementations.

Payback period. With a payback interval of three years, this software will take a long time to pay for itself. Though we can forecast what business will be like for the next three years, we don't really know what economic and technical changes will emerge in that long a time span. The three-year payback interval makes this software purchase more of a gamble than something that pays back faster. Conclusion: You can see why a business can be wrongly accused of having a "short-term focus" when it's just trying to minimize the chance of making a long-term mistakes.

Let's work another quick example to serve as a contrast to our first example. We've determined that if we purchase a \$500 rendering utility, our \$40-per-hour sales engineer can create renderings and e-mail them to clients directly rather than using \$40-per-hour graphic artists. We've determined that an average sales engineer can save 30 hours per year based on the current workload and that the graphic artists' time can be better used by transferring them to the design department instead of sales. The software utility costs \$100 per year to keep on maintenance, and training for the sales engineer will take a half-day using a self-paced tutorial program supplied with the utility.

Savings. Because the sales engineer will realize 30 hours of time savings and the billable rate is \$40 per hour, the total savings realized will be \$1,200.

Costs. Total costs in the first year will be the software purchase cost (\$500) plus the lost time the sales engineer racks up while training (a half-day at \$40 per hour, \$160). Total cost for first year is therefore \$660. Each year thereafter the total cost will be the \$100 software maintenance fee plus \$160 (a half-day at \$40 per hour) for training. Total cost for each additional year is therefore \$260.

ROI. For the first year the ROI is 182% (\$1,200 savings divided by \$660 cost). Each additional year comes to 462% (\$1,200 savings divided by \$260 cost).

Payback. In this case, a \$1,200 savings per year contrasted with a \$660 first-year cost and \$260 annual costs thereafter means payback is achieved in only six months.

## What it Means

Our second example contrasts with the first example in a number of ways. I'll analyze various aspects and draw conclusions as I go. As you analyze this example, again, try to think like your management team to see how small, less technically intensive changes to your workplace can yield staggering savings.

Savings potential. In this case, a solid potential for savings exists that allows the sales engineer to get more done, and frees up time for the graphics artists to perform design tasks rather than supporting sales. The result of the savings will be that our sales engineer can do more in less time and respond better to customers while the high-level graphic talent can be used for more conceptual work in the design process. Conclusion: This is a win-win savings profile.

Cost profile. This example illustrates low upfront costs with no formal training costs and minimal loss of user productivity during implementation. Conclusion: Even if this software doesn't work out, it costs only a few hundred dollars to test it so the risk is low.

Payback period. With a payback interval of six months, it's easy to see that we can take full advantage of this software immediately and that we won't have to worry about technology obsolescence undermining our investment. For each year that we continue to use the software, we'll reap the benefit until circumstances make us change how we do business. Conclusion: This software is a no-brainer.

## ROI and Budgets

I've always found that ROI analysis of budgets is the best way to craft a tight budget that gets noticed and approved by management. I think ROI is going to be even more important in 2005 because productivity improvement and conservation of capital will continue to be a priority for management. When companies are watching their money, the projects with highest ROI will receive funding.

I hope that the sample calculations and analyses offered here get you thinking about how to quantify and substantiate your budget requests using ROI methods. Though it can take some time and thought to work through these ROI computations, it's the only way you'll really know how to prioritize the items in your budget. Going through your budget with an ROI magnifying glass will make you a better manager and help your budgets get approved.

For more examples of ROI problems and sample calculations, see my Web site at www.cad-manager.com/roi.htm.

Robert Green performs CAD programming and consulting throughout the United States and Canada. Reach him at rgreen@greenconsulting.com.

# About the Author: Robert Green

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