Making the Case for Investment in Service

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1 Making the Case for Investment in Service

2 Making the Case for Investment in Service Cloud computing and SaaS can help to relieve some of the operational burdens and allow service staff to raise their game. The techniques of investment appraisal have long been used in IT to evaluate the business benefits of spend on development projects, which are mostly regarded as value-adding but usually discretionary. However, such techniques are rarely applied by IT services departments because the linkage between investment levels, Return on Investment (ROI) and the ongoing cost of delivery has not been properly articulated. This is a pity, because the benefits of formal appraisal will often yield as much value from careful investment in service capability as it will from yet another new product system. This paper sets out the methods used to determine the economic value of discretionary investments, explains the context within which a business case should be presented and shows some real examples of service propositions that successfully articulated and delivered - their benefits. Background A major survey 1 carried out on 2,600 service projects in 550 different companies returned some surprising results. Over 75% of these projects were completed in order to improve customer service, and yet only 12% of them had yielded any form of financial benefit. MAKING THE CASE FOR INVESTMENT IN SERVICE A FRUITION PARTNERS WHITEPAPER 2

3 As most projects will take some time to deliver the intended return, account must be taken of the changing value of money Of course, not all projects will show a financial return, although it could be argued that the cost of poor service will lead to loss of custom and therefore addressing this concern will show a benefit but the organisations concerned did not generally take this into account in their submissions. Many of these projects were felt to have some financial justification, although there was little or no evidence provided of a detailed, robust or consistent ROI process to demonstrate the value. Despite this, measurement of the value derived from these projects was seen to be important in 37% of the companies surveyed. The context for ROI Investment appraisal is carried out in order to provide realistic estimates of the economic value of individual projects. In so doing, it will take into account both the costs and benefits in financial terms over a set period, working on the cost of funds, the prevailing interest rates and any risk associated with realisation of the claimed benefits. In a company with limited access to funds, either for capital borrowing or by drawing from reserves depending on the liquidity status, all projects need to compete against each other for management consideration. The main purpose of any investment decision is to obtain a return on investment greater than the initial outlay. As most projects will take some time to deliver the intended return, account must be taken of the changing value of money because 1000 benefit in 5 years time will not have the same value as 1000 today. This is taken into account by means of a Discounted Cash Flow (DCF) approach which converts the future benefits and costs to a common date using either Net Present Value (NPV) or an Internal Rate of Return (IRR). Whilst this may seem complex, the process is simplified by means of standard accounting routines used by most Finance departments and in reality, you need to provide a surprisingly small amount of information but it has to be accurate and it has to yield an attractive benefit or else the exercise is pointless. NPV applies a rate of discount based on the marginal cost of funds for future cash flows to rebase them back to the present day. The figure used will depend on the rate which your organisation can access funds, which will fluctuate with both base rate and the company s external credit rating as determined by agencies such as Standard & Poor s or Moody s, which banks consult when making lending decisions. MAKING THE CASE FOR INVESTMENT IN SERVICE A FRUITION PARTNERS WHITEPAPER 3

4 Worked example The way in which NPV is calculated is by use of the formula for compound interest, which is worked backwards to provide a Present Value for a future benefit based on the notional rate of interest at which you borrow funds. P = Benefit (1+r)n Where P = Present Value, r = interest rate and n = time period So if we wish to achieve a benefit of 16,000 in year 5, this benefit will represent 11,956 in today s value terms assuming an annual rate of interest of 6%. This can be demonstrated as follows: P = = (1+.06)5 So let s assume that you can invest your company s funds at 6% for the next 5 years in a bank, or use the same funds to pay for a proposed project. To find out if your project is worthwhile, we need to adjust the returns achieved by your project by the interest rate we could get by the safe option and use this Discount Rate to modify both costs and benefits. If a service improvement project costs 100,000 in year 1 and returns an annual benefit stream of 25,000 for the next 4 years, would such an investment be worthwhile? To decide this, we adjust the cash flows investment and returns by the interest rate and which will yield, in this example, Discount Factors of in year 1, in year 2, in year 3, in year 4 and in year 5. Calculating the Net Present Value for this project means multiplying the investment level by and then adding in the subsequent year s benefits multiplied by the respective discount factors. In this example, the NPV result is negative at , meaning that the returns achieved by your project are worse than investing the money in a bank. MAKING THE CASE FOR INVESTMENT IN SERVICE A FRUITION PARTNERS WHITEPAPER 4

5 You can make a better case by either spreading out the investment over more than one year, or by seeking to get either more benefits or achieving them sooner. And also do this before you seek formal approval, because having a project refused once does not bode well to get it evaluated again. Most companies will establish a hurdle rate below which investments are not considered viable. Of course, having a positive NPV does not show you what the actual return on investment is. This figure, the Internal Rate of Return, is calculated by finding the rate of investment earned throughout the life of the project. Let s assume that you have adjusted the benefits achieved by your project from 25,000 to 30,000 in years 2 to 4, which now gives an NPV of This is a positive result, which will be attractive to your accountants, but what does it mean in terms of return on investment? This is calculated in reverse by using the formula to achieve an NPV of zero in other words, what the ROI needs to be to break even compared to interest rates. So if a company can borrow funds at less than the internal rate of return from your project, you stand a better chance of getting investment approval. IRR can also be used to differentiate between two competing investment proposals with different cash flows, since the overall value would be used as the decision criteria and not the effect in any single year. In our example, the IRR becomes 7¾% and this can usefully be regarded as representing the ROI. A real case Most companies will establish a hurdle rate below which investments are not considered viable. This is because of the risk associated with the return of benefits in future years and also to help focus attention on projects with a high, rather than a mediocre, rate of return. Typical hurdle rates can be as low as 15% or as high as 50%, with 100% sometimes used when a company wants all its projects to pay back within one year, although this is unusual. Sophisticated investment appraisal models will also take account of expected future interest rates based on economic intelligence and so the maths can become complicated but IT people cope well with complexity! MAKING THE CASE FOR INVESTMENT IN SERVICE A FRUITION PARTNERS WHITEPAPER 5

6 Let s take a look at a real business case that established a new Help Desk. This organisation wanted to consolidate a number of separate help desks and at the same time increase the capability of its staff to answer customer queries. The benefits from this were seen in a reduction in internal costs by being able to handle more calls at first touch, which is cheaper than getting technical specialists involved, and by handling calls faster by use of a Knowledge Base containing the solutions to previously reported problems. They reduced the services headcount from 229 to 211 realising an annual payroll cost benefit of 0.75m - whilst achieving a 300% reduction in calls to the help desk. The total cost of the project was 2.1m, consisting of workstations, furniture, help desk software and all other project development costs such as relocation and staff training. Using a cost of funds of 10.5% and an evaluation period of 5 years yielded an NPV of + 404,000 with an internal rate of return of 17.5%. This was an attractive proposition that was approved on financial grounds; although of course what it also delivered was a standard of service that increased first time fix rates to 80% and which also yielded a commensurate improvement in customer satisfaction ratings. If a lower figure was used for the cost of funds based on more favourable interest rates, this project would have returned an even better result, so illustrating the fact that the same operational benefits could have been delivered for the same cost but with a higher NPV and better IRR so investment timing is critical. Another example of an effective improvement project is that from an organisation who decided to organise around best practice in order to streamline their service delivery function. By doing this, they reduced the services headcount from 229 to 211 realising an annual payroll cost benefit of 0.75m - whilst achieving a 300% reduction in calls to the help desk by the institution of Problem Management and an effective selfservice user portal. The 18 people released from routine service operations were quickly redeployed to discretionary work to allow the company to acquire and integrate two smaller organisations and absorb their help desk activity with no increase in manpower. Without this, the acquisitions may have failed. MAKING THE CASE FOR INVESTMENT IN SERVICE A FRUITION PARTNERS WHITEPAPER 6

7 Benefits realisation Once approval has been given to make the investment in service improvement, it is crucial to ensure the claimed benefits are delivered. Not only is this important for the project itself, but it ensures a level of credibility with your accountants for when next you raise a project idea. The standard way to do this is by means of a Post Implementation Review (PIR) that analyses the claimed benefits and costs versus the actual achievements. Of course, this presumes that the costs and benefits are tracked throughout the project, and although this is an essential management discipline, it is one that is sometimes overlooked. One way of ensuring benefits realisation is to publish the targets at project inception and revisit them regularly through the project life. In the Help Desk project example shown above, the PIR yielded an IRR of 29.6% and an NPV of + 720,000 because opportunities to deliver benefits earlier were taken by the project manager, the capital costs were lower than estimated due to good supplier negotiation and because fewer people than expected needed to relocate. Of course, it is not always the case that claimed benefits can be bettered but it is essential to track the project carefully to spot potential problems earlier as well as to show the progress. One way of ensuring benefits realisation is to publish the targets at project inception and revisit them regularly through the project life, using an external specialist say, an accountant to work the figures for you. This provides a degree of credibility to the claims you make for such benefits as well as ensuring that the right figures are used at the right time. Of critical importance, however, to the perceived success of any service improvement project is the customer experience, which needs to be measured at the start of the project and then again once it has finished. Being able to quantify service benefits will ensure customer support for future initiatives. MAKING THE CASE FOR INVESTMENT IN SERVICE A FRUITION PARTNERS WHITEPAPER 7

8 The bottom line So making a business case for a service improvement project is much the same as any other form of discretionary investment. The key differences between Systems and Services project are about management priorities and how staff can be deployed most effectively and once these are overcome, the rest is straight forward. Some key conclusions can be drawn from this: Be able to identify tangible benefits as well as the initial investment Find out the hurdle rate and other financial targets in your company Be able to quantify customer benefits in financial and service terms Manage staff utilisation and efficiency as well as your project spend Be as business minded in Service Delivery as your Systems colleagues For More Information: Contact Fruition Partners at or info@fruitionpartners.com. You can also browse some related resources on our website: ESM Showcase Case Studies Webinars MAKING THE CASE FOR INVESTMENT IN SERVICE A FRUITION PARTNERS WHITEPAPER 8

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