A lot of companies routinely use ROI (Return on Investment) to compare multiple projects competing for limited investment resource. But what do these same companies use during a bad economy when they’re trying to figure out where to make cuts? How do you compare multiple opportunities for cost cutting?
Recently I moderated a group discussion at an Atlanta SIM meeting on the topic “What do we do differently in IT as a result of a bad economy?” Early in the discussion, I asked the question, “What process do you use for determining the areas to cut?” but all of the answers I received were very general. It got me thinking that there ought to be a specific approach like ROI that can be used during a bad economy, so I set out to define such an alternative.
I decided that I’m looking for something that’s the opposite of ROI. ROI is essentially Return divided by Investment. The opposite of Return is Loss. In this situation we’re not trying to make money from a cost-cutting project — we’re trying to minimize our loss of existing capability. For example, we might want to cut back on our help desk, but we want to minimize the impact of the cuts on the people being supported. That impact is the Loss associated with this opportunity.
Looking at the other part of the ROI formula, the opposite of Investment is Savings. We’re not going to contribute additional funds to this effort — we’re looking to save money instead: we’ll reduce the amount of money we spend. In the help desk example, we want to cut the cost of the help desk, and that cost reduction is the Savings.
OK, so now we’ve got a ratio that compares Loss to Savings. But with ROI we know that a higher ROI is better — we get more return for our investment. With our bad economy formula, however, we want to maximize Savings and minimize Loss, so if you use a Loss/Savings ratio then a smaller number is better. To change this, we can swap the numerator and denominator in the formula, and instead of dividing Loss by Savings we can divide Savings by Loss. That gives us a number that — like ROI — gives a better result for a higher value.
Let’s plug some numbers into our formula to try it out. Suppose we can cut $100,000 out of our help desk budget and have a loss of service of only $50,000 (estimated by looking at the value of the time lost by help desk users who have to wait longer for a solution or who have to solve minor problems on their own). That would give us a Savings/Loss ratio of 2, which we can then compare to the Savings/Loss ratio of another cost-savings opportunity. Voilà! We now have a ratio that works like ROI — we can use it to compare multiple cost-saving opportunities. Opportunities with a higher Savings/Loss ratio offer better returns, and ratios less than 1 don’t offer enough Savings to make up for their Loss.
My Measure for Cost-Cutting Opportunities = Savings / Loss
Let me end with a few disclaimers. First, this new ratio has all of the limitations that ROI has. It gives you a deceptively precise result that’s based on the inaccurate estimates that are usually put together by people who have a vested interest in the outcome. It neglects any consideration of whether the losses and cost savings are strategic or non-strategic. It doesn’t consider interrelationships among multiple opportunities. And it ignores the impact of cost-cutting decisions on people — whether jobs are kept or lost.
What do we call our new ratio? If Return on Investment is called ROI then it seems logical that this new ratio should be called SOL, or Savings on Loss. And maybe that’s appropriate. Because when you decide what areas of your company to cut, you really are deciding which employees are SOL.
Despite the unfortunate name (feel free to use a different one), SOL is an interesting way to compare cost-cutting alternatives. And if you use the measure you’ll get a very solid benefit. Most people who look at ways to cut cost don’t consider the impact of cost-cutting on the customers of the organization being cut. Using SOL lets you take the needs of those customers into account, and so it considers both sides of each alternative.
Cut costs if you must, but make sure you’re cutting costs in a way that doesn’t just shift the cost onto your customer or into a different part of your business. Using SOL will allow you to compare the true impact of different cost-cutting alternatives, and select the most appropriate ones.
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