How to Calculate the ROI of a Process Improvement Project
Having data is great. It’s important to be able to look at a data set and compare it against a benchmark to get your bearings. “We beat revenue goals by X%.” “We performed Y number of maintenance tasks this quarter.” “Downtime repairs cost us Z dollars.” These insights and more are invaluable.
But data by itself isn’t helpful; for data to have value, it needs context. Too often, manufacturers fall into the trap of paying for data and insights, without fully understanding how to use it or what it means. One example with a huge impact on businesses is not understanding return on investment (ROI).
A peek inside the importance of ROI
Let’s say your storeroom operations are a mess. You don’t know what you’re stocking or how much your static inventory is worth. Finding components and filling work orders takes forever. You know you can do better. So, you decide to commit $10,000 to completely rebuilding your storeroom inventory system. After it’s done, the storeroom looks great and functions smoothly.
Sounds great, right?
You may have anecdotal evidence that your $10,000 investment was a good one, but do you really know what your ROI is? Probably not, because you don’t have the data to calculate it. You have no way of really knowing the true value of your project.
How to Calculate ROI for Process Improvement Projects
Return of investment (ROI), or the ratio of the profit or loss of your business in a fiscal year is calculated like this:
Project Benefits – Project Costs = Return on Investment (ROI)
The final result is expressed as a ratio or percentage. There are actually two levels of ROI: immediate and long-term. Immediate ROI is measurable the moment a project is complete; long-term ROI is usually measured over 2-5 years or longer. Regardless of the timeframe, ROI is calculated in the same way.
Using our example from above, we know the project costs are $10,000, but that’s all we know. Without benchmarks in place to measure improvement, we can’t calculate the ROI.
Set the benchmarks and measure change
To measure project benefits, you need to measure change (good or bad). In the context of our storeroom example, you might measure the following in before and after capacities:
- The time it takes to fill a work request
- The amount of maintenance budget spent on parts not in stock
- Time spent locating specific components
Quantifying these variables before the process improvement will help you compare them after. More importantly, it provides context for calculating ROI. Understanding the cumulative rate of improvements and the cost savings affiliated with them provides context for the “Project Benefits” portion of the equation. For example, if the project benefits add up to $15,000, the ROI of the storeroom improvement project is $5,000, or a 50% return.
The value in knowing ROI
Calculating ROI is a big component of lean manufacturing. You can’t know if your improvements are paying for themselves unless you have a way to measure them. Because lean practices rely upon evidence-based decision-making, knowing ROI is imperative in informing future projects.
So, what level of ROI justifies process improvement? That depends. For some, any measurable ROI warrants the investment. For lean projects, 30% ROI is usually the standard for a worthwhile project, while 50% ROI is considered a very successful endeavor. Anything higher than 50% is above and beyond.
Where do your projects rate? How do you know? You can only tell if you know your ROI.