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Formulas for calculating ROI on CRM technology purchases
Want to cause a cold sweat in a DMer? Tell him he has to incorporate the cost of technology into his return on investment equations. That's because most DMers calculate ROI by campaign.
“Traditionally, most marketing resource allocation decisions have focused on operating expenses,” says Steve Schultz, an executive vice president at Quaero Inc., Charlotte, NC. “CRM can be capital-intensive, requiring the building of databases and the purchasing of CRM software.” But marketers must “learn to speak the language of business” to get funding for new CRM initiatives, Schultz says. To do that, they have to include both major expense categories in their ROI analysis: investment costs, including hardware, software, consulting fees and internal resource costs; and noninvestment costs, such as the cost of developing a marketing piece, data overlays, and development and production charges. Both categories, he says, are part of the expenditure equation and should be part of the ROI analysis.
But a dollar spent in January will have a different value than one spent in December. To compensate, smart marketers calculate net present value (NPV), which provides a look at costs and revenue over time. The key part of NPV analysis is the discount rate assigned by the finance department, which allows the firm to estimate the value of future revenue or expenses in current dollars. How does NPV work? Schultz cites the case of a three-year CRM initiative, in which $225,000 is invested. Each order generates $85, and the cost of fulfilling each order is $62.50. In this scenario, the company gets 7,700 orders during the first year, generating $654,500. It paid out $706,250, meaning it now has a loss of $51,750. But that loss can be reduced $47,045 by using a 10% discount rate.
In the second year, sales go down by 50%, generating revenue of $327,250 (at a cost of $240,625). But since implementation costs were subtracted the first year, they don't need to be backed out again. The result? The firm realizes a net of $86,825 in the second year, spread out over the entire 12 months. With the 10% discount rate applied over two years, the NPV is $71,591. Subtract the loss reported in the first year and the project's cumulative NPV is $24,545, Schultz says. In the third year (assuming sales decline again by half), the cumulative NPV for the life of the three-year project is $57,087. The bottom line: A program with a negative NPV should set off warning bells in a marketer's head.
But NPV isn't the only formula for justifying technology expenditures. Another is cost displacement/cost avoidance analysis. This is a more subjective method, in which costs are weighed against benefits, according to CRM consultant Michael Meltzer. This method works well in the case of sales-force automation software. The manager can argue that the time saved by automation will enable the salesperson to focus on a wider range of prospects, or pay more attention to current customers. The danger is that this method may be misconstrued as “an invitation to prepare figmental projections that demean both those who produce them as well as those who accept them,” says Paul A. Strassman, an IT industry analyst.
The firm must also decide which justification is better — cost savings or revenue enhancement. Automation of a call center can result in increased efficiency due to salary savings, especially if the number of inbound calls remains static, according to Michael Panosh, director, Logical e-Business Solutions Group. For example, a 50-seat call center that pays roughly $35,000 for each rep can save $350,000 with new technology, Panosh argues in a paper titled “Counting the Cost of CRM.” How? The new software allows the firm to prioritize callers based on their worth to the company, or enables the rep to handle multiple calls at once. Assuming this results in a 25% higher service volume, the call center would be able to reassign 10 reps to other tasks, while providing customers with the same level of care, Panosh writes. He says that a CFO in this situation can comfortably sign off on any system that costs less than $8,750 a seat to implement — a figure that comes from dividing the cost savings by the number of employees left to do an equal amount of work.
But a Gartner study estimates such costs are more likely to hit $15,000-$35,000. A firm with a 40-seat call center should probably reconsider implementing this system because the benefits aren't high enough — unless the agents are highly paid tech support people.
