Building a Successful Business Case Around an ROI Calculation
Demonstrating a good ROI is essential to persuading leadership
A calculation of return on investment, or ROI, is a fundamental tool used in determining the value of a business investment. At its most basic, an ROI calculation will demonstrate that the company will receive more in financial gains than the cost of the investment. Use of an ROI calculation in a business proposal is a necessary but not independently sufficient element of a successful business case. Whether or not your proposal gets funded is determined by that ROI, but also on the validity of the assumptions used to calculate that ROI. This article will demonstrate how to use an ROI calculation in creating a compelling business case for investment.
The basics of an ROI calculation
An ROI calculation is actually a very simple mathematical formula. Your goal is to demonstrate that the investment you are proposing will return a financial gain above the amount of money needed to make the investment. This return is usually presented as a percentage gain: ROI = (gain from investment-cost of investment) / cost of investment * 100. A simple internet search will return a number of online ROI calculators.1
This simple calculation can be used in discussion of a wide range of investments. Companies routinely use ROI in discussing their plans for investments, such as acquisitions, starting a new business line, or building a new facility. In the lab, an ROI calculation should be a routine part of the business case for investment in lab equipment. It can also be used to support the hiring of personnel. Any time money is spent in a for-profit enterprise, there should be a discussion about how this expenditure contributes to profitability.
For example, if you want to purchase a new instrument that costs $100,000 and you determine that the gain from that investment after five years of operation is $125,000, then the ROI is 25 percent. On an annualized basis, the gain is 4.56 percent. Is that a good investment? Your finance group can tell you what level of ROI is considered a good investment but as with most calculations, the devil is in the details—and the assumptions.
The importance of assumptions
While the mathematics are quite simple, the difficulty in making an ROI calculation lies with the assumptions made about the inputs. “Gain from investment” could be revenue, EBITDA (earnings before interest, taxes, depreciation, and amortization), or net income. What type of value you use here is determined by your company standards. Additionally, you must make a number of assumptions to calculate “gain.” Even the “cost of investment” number requires making a number of assumptions. There are several methodologies you can use to articulate and test these assumptions, such as Discovery-Driven Planning.2 Fundamentally, an effective methodology will lead you through the process of articulating and then testing the assumptions you must make to create an ROI calculation. Whether or not your project gets funded is often determined by how aggressive your assumptions are, how believable those assumptions are, and the plans you articulate to ensure the validity of those assumptions.
Building a business case: an example
The best way to illustrate this process is through an example. Let’s use the example of the purchase of that $100,000 instrument alluded to earlier. The business case we will build contains several parts that support the presentation of the ROI. At this point, you would have already discussed the ROI calculation with someone in finance to understand which measures are used to define “gain” and “cost” as well as an understanding of what levels of ROI are considered a good investment by the company.
Let’s begin with the “cost” side of the equation. What are all the costs that must be included and detailed in the plan? Besides the invoice cost of the instrument, you must include any installation costs charged by the vendor as well as any internal costs required to make the space ready to accept and install the new instrument. You should include an estimate of the annual consumables cost for running the instrument as well as personnel cost. Include personnel even if you don’t need to hire anyone new. There is an opportunity cost associated with employees spending time on this instrument and associated data analysis versus somewhere else in the lab. Finally, you should include an estimate of overhead costs—a percentage of facility costs as well as management and support personnel. Most important, detail those assumptions. If you are stating that annual consumables will be around $10,000, what assumptions did you make around number of tests per annum and consumables per test? Are there wear items that need to be replaced regularly? What is the cost of annual service (either a service contract or expected maintenance costs)? Others with the right experience can help you validate those assumptions, particularly if you have another instrument with similar needs.
The “gain” side of the equation is particularly tricky and requires careful attention to articulating assumptions. In defending your proposal, you will most likely get the most questions around your “gain” assumptions. An effective approach to outlining “gain” assumptions begins with articulating which market segment this instrument allows you to service. Is this a new market segment for the group or an existing segment that you will be able to service more effectively? Define a range of revenue, or revenue gain, that having this capability will generate. What are you assuming about the overall market size, what percentage you believe you can capture, and, if possible, particular customers. Address the pricing for the service and the profitability per test, perhaps showing improving profitability as business grows. Are there other services from the lab that would see an increase in usage due to the availability of the capabilities this new instrument provides? Include that in your gain calculation.
Your business case needs to include the articulation of these assumptions with any supporting information that demonstrates how you have, or could, validate those assumptions. This part of the proposal is where you capture support you would need from other parts of the company or even outside the company to ensure success of the proposed outcome. These are costs which are typically not included in the proposal and activities that you often don’t control but that you see as critical to delivering your commitment. Securing this type of support not only will improve your chances of success but also gives others a stake in the successful outcome.
Whether or not your proposal gets funded often is determined by the confidence leaders have in both the thoroughness of your assumptions (“You have thought of everything”) and the validity of the assumptions (“This sounds realistic”). Providing a range of inputs from conservative to aggressive is also a good approach. Your conservative case still needs to pass the bar of acceptable ROI, but providing a more aggressive case can also set the stage for additional investment.
The power of ROI
The return on investment calculation is a powerful tool to win support for investments of all kinds. A solid ROI, supported by articulated assumptions that are thorough and reasonable, gives leaders confidence that resources devoted to this investment will pay off. A strong track record of providing business cases that prove correct will further strengthen support for your ideas. Learn to use—and leverage—this tool.
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