ROI Calculators in Manufacturing Engineering: Good, Bad or Both?
A Step-by-Step Guide to Comparing ROI Calculators
ROI calculators can save you money and help you make informed decisions - if you know how to use them correctly.
By Sandia Harrison, Director of Marketing, FPE Automation
Lately, return on investment (ROI) calculators have been popping up everywhere. It usually goes something like this: the account rep for one of your suppliers contacts you and requests a meeting. They want to sit down with you and run some numbers to show you how you can save money. Sounds good, so you agree to listen. They arrive, tablet or laptop in hand, and plug numbers that you provide into an app. Initial investment, revenue, time period...
The formula looks like this.
While the specific term "Return on Investment" and its formalized mathematical formula have been widely used for a long time, the modern understanding and application of ROI gained prominence in the mid to late 20th century. The development of financial management practices and tools, along with the growth of corporate finance as a discipline, contributed to the increased focus on metrics like ROI.
Today, the vast majority would agree - ROI is a crucial metric for businesses and investors to evaluate the efficiency and profitability of their investments.
Enter the ROI Calculator
With this powerful information in hand, it wasn't long before companies started asking about ROI before they made big purchases. That prompted the sellers of the capital equipment to develop tools for calculating ROI.
ROI calculators are apps. Computer programs that allow you to enter numbers and calculate your return on investment.
As their popularity increased, gray areas began to appear. You might have noticed that the results these calculators return are usually positive. Smart manufacturers began to question how that could always be true. If you receive two positive results for two very different approaches, how does that help you decide? How do you spot unreliable data or other pitfalls? How do you compare the results of two or more separate ROI calculators?
Head-to-Head: Decoding ROI Calculators for Sound Decision-Making
As you might have guessed, there is no straightforward answer. The good news is, that by using this guide, you can leverage the results of ROI calculators to help you make the best and most informed decision.
Potential Pitfalls and How To Avoid Them
Let's assume your inbox is full of reports generated by ROI calculators. The next step is to determine the best course of action for you. More often than not, there is very useful data in the results. Here are some things to consider as you read through the results.
✔️ Watch Out for Simplification of Complex Scenarios
ROI calculators tend to simplify complex business scenarios into a set of inputs and outputs. This simplicity might overlook nuances, dependencies, or unique factors that could impact the actual ROI. For example, it might tell you which solution is superior. However, what if the best answer is a different solution altogether? Or, it may take labor costs into consideration where there is no real savings to be had. If an employee has other job functions that can't be eliminated by the solution, then all you're really getting is a productivity loss. Have you factored in availability and lead time?
✔️ Beware Assumption Sensitivity
Assumption sensitivity is a complex theory that can be explained simply: Changing market dynamics, even the smallest fluctuation in the numbers, can change the results dramatically. Many ROI calculators rely on assumptions, and small changes in these assumptions can lead to significant variations in the calculated ROI. Be aware of the sensitivity of the results to changes in input values.
✔️ Make Sure the Scope is not Limited
Just like the simplification of complex scenarios, ROI calculators may focus on specific aspects of ROI, such as cost savings or revenue generation, without considering the broader picture. They might not account for potential hidden costs or benefits. Ask questions about downtime, repair costs, upgrades, durability, product end-of-life, spare parts, sustainability, training, and more.
✔️ Caveat Emptor
While I don't doubt that most equipment suppliers have your best interest in mind, I would be remiss if I didn't include the good old "Buyer Beware" or "Caveat Emptor adages here. Some ROI calculators are developed by vendors to support their sales efforts. Users should be cautious and seek independent validation to ensure objectivity in the calculations.
✔️ Look Beyond the Numbers
Gather concrete facts. What is it about solution A that causes it to outperform solution B? Are there independent reports that verify the claims? Are there design patents that exist, making the engineering inherently superior to other similar products on the market?
✔️ Consider Hidden Opportunity Costs
ROI calculations do not account for opportunity costs — the potential benefits foregone by choosing one investment over another. It's crucial to consider alternative investments and their potential returns.
✔️ Watch for Linear Assumptions that Don't Hold Up
ROI calculators continue to improve every day. There is one important thing they can't yet do. In manufacturing, a linear assumption about costs might imply a direct relationship between production output and total costs. For instance, doubling production is assumed to double the costs. In reality, manufacturing costs are non-linear. Initially, there may be economies of scale, resulting in decreasing costs per unit with increased production. Yet, as production continues to grow, diminishing returns or increased costs might occur due to factors like capacity limitations and resource constraints. Assume that the numbers produced by an ROI calculator risk oversimplifying cost-output dynamics. Neglecting the non-linear aspects of manufacturing costs could lead to inaccurate ROI predictions. Be aware of these complexities and consider the nuances in their cost structures when relying on ROI calculations for decision-making.
✔️ Check and Re-check Your Data Quality
Remember that one figure you didn't have when the supplier was sitting with you? You contacted accounting. They returned a number, which you gave to the supplier. They punched it into the appropriate column on the ROI calculator screen. You both moved on. Weeks or months passed.
The time comes for you to evaluate the various ROI reports you received and make a decision. How you arrived at that particular number is long forgotten. I'm sure you know where this is headed... the accuracy of ROI calculations heavily depends on the quality of the input data. Inaccurate or incomplete data can lead to unreliable results.
You've Got This!
Using this guide will help you eliminate many of the pitfalls you can encounter if you take ROI calculators at face value. This information will better allow you to use their many benefits to increase your profits
The biggest advantage, however, will always be you and your own team. Utilize your own, unique knowledge of the production environment around you to interpret the numbers before you make capital equipment purchases to minimize risk and ensure success.
