Calculating the Real Value of Process Improvement: Factoring in Intangible Benefits
Trying to calculate the value of your process improvement project? You should make sure you’re factoring in intangible benefits to the ROI, write contributors John W. Moran and Brynn Riley. Here’s why and how to do it.
Anytime you’re starting a process improvement (PI) project, it’s essential to have a clear and concise initial problem statement. When teams are unable to focus on the real issue, they lose valuable problem solving time. Team members become disenfranchised from the process since they seem to be going in circles without making any progress.
But just how do you determine where to start? And how can you analyze the true benefit of a given PI project?
It’s important to start small and focused. When developing the aim of the problem solving team, think in terms of concentric circles as shown in figure 1 below.
The concentric circles represent layers of decreasing control as you move away from the center, where the problem solving team is in complete control, to the periphery, where the team has little or no control or influence over events or resources. The farther away from the center, the more difficult it becomes to directly influence the immediate outcomes of an issue. Starting at the inner circle (i.e. the most focused) helps the problem solving team develop issues that are discrete, measurable, and time bound.
But how do you make sure that you’re focused on the area where you’ll get the biggest bang for your buck?
When it comes to adding muscle to business cases, there is an unjustified fear of measuring what are considered intangible benefits. But a more astute handling of intangibles—those goals that can’t be easily measured in dollar terms—can provide a big boost. We propose calculating both the tangible and intangible benefits as part of the initial steps of the PI problem solving process in order to focus the problem solving team on desired outcomes, help prioritize multiple projects, and quantitatively demonstrate success.
By including tangible and intangible benefits that are expected as a result of addressing the problem and comparing them to anticipated costs of undertaking the PI project, we can quantify the value of the project, measure its potential value, and use it to prioritize projects.
Focusing on Benefits and Costs:
Costs that are impacted as well as accrued by a problem solving team can fall into the following expense cost categories:
Variable – Variable costs are those that respond directly and proportionately to changes in activity level or volume, such as supplies, the rest of total cost, the part that varies as you produce more or less.
Semi-variable– costs are fixed for a set level of production or consumption, becoming variable after the level is exceeded
Fixed - Fixed Cost is the part of the budget that stays the same regardless of whether you produce a lot, a little bit, or even if you produce zero. Overhead, rent on buildings and interest on loans are examples of fixed cost.
When developing an AIM statement we urge teams to estimate which costs will be impacted that we have control over, and which ones we do not. Some questions to consider are:
If we implement a solution to this problem what are the potential cost categories that will be impacted and by how much? For example, a cost category might include additional resources the current process doesn’t need.
Is this cost category outside of our control and ability to influence?
How much will it cost to develop a solution and implement it?
What is the cost of doing nothing?
What is the cost of sustaining the solution?
Are there possible unintended consequences, and if so, what are the costs?
If we plan to use existing resources, what will we have to stop doing to divert resources to this problem/solution?
What are the Benefits?
During the development of the AIM statement we need to make an estimate of the tangible and intangible benefits that solving the problem will add to the organization and the community it serves.
Tangible benefits are defined as "a benefit produced by an investment that is immediately obvious and measurable." A tangible benefit can usually be expressed in terms of a monetary savings. An Intangible Benefit: "is an indirect benefit which cannot be felt or touched - such as saving time".
If we have a quantification of the tangible and intangible benefits, plus an estimate of the costs to achieve the savings we could calculate a Return on Investment. The classic business definition of Return on Investment is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio.The return on investment formula:
In the above formula "gains from investment", refers to the proceeds obtained from selling the investment of interest. Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken.
However, public health, where returns are often measured by improved health outcomes, would be a good example of somewhere that intangible benefits become an increasingly significant measure.
Accounting for intangible benefits will help improve the business case for undertaking a PI project but many managers have reservations when measuring intangible benefits. Managers may feel that the soft intangible benefits cannot be easily measured in dollar terms or, if they are, the benefits will not be viewed as valid. One reason that intangibles deserve more respect is that they are now a significant part of an organization’s and community's worth. More than 25 percent of the value of enterprises is now based on intangible assets, such as brand image and market share, according to economists. But decision-makers have not yet accepted this financial reality .
We need to give intangible benefits more respect in any ROI calculation since they are becoming a larger share of a business worth.
The problem we encounter is that most intangible benefits are not easily quantifiable. This problem is not unique... Ford Motor Company used a 4:1 ratio to help account for indirect benefits when they are identified to tangible benefits. This is a ratio that could be used in estimating the benefits of intangible benefits in any organization. But is 4:1 a sufficient scale or should we consider a more flexible and an increasing ratio scale to account for intangible benefits that may have more impact to our customers or community?
What is unique to many businesses is the need for a way to account for intangible benefits to the community being served. For example in public health a tangible benefits may be a decrease in the smoking rate, an increase in the immunization rate, reduced infant mortality, etc. An intangible benefit may be a program that contributes to increased self-esteem resulting in greater use of preventive services and adherence to an asthma management plan. There also are "intermediate" tangible benefits (benefits that are quantifiable, but do not necessarily directly impact a community’s health) such as increased access to preventive services, health education, and other types of community-wide programs.
The figure below proposes an Intangible Benefit Multiplier Pyramid for calculating the value of the internal and external intangible benefits from a PI project.
This approach builds in a multiplier for intangible benefits that each PI project can justify. The multiplier can vary from PI project to project since the impacts may be different. Each project’s multiplier must be justified through a process of identifying tangible and intangible benefits. A scenario analysis, a process that considers possible alternative outcomes, may be the best way to develop the case for intangible benefits since it examines the likelihood of achieving multiple potential intangible benefit outcomes. The ROI formula could be modified to be a Benefit Effective Ratio taking into account the impact of intangible project benefits.
The Benefit Effective Ratio formula is as follows:
Not all projects will have a positive Benefit Effectiveness Ratio but that does not mean they should not be undertaken. Many intangible benefits cannot be easily quantified or may be under estimated but the impact of the project may be substantial to the community served. The Benefit Effectiveness ratio is a guide and not a definitive decision making tool. It should be part of any prioritization process of project selection but just one of the criteria to quantify which projects may have a high return to an organization.
We have proposed a way to account for intangible benefits to improve the business case for undertaking a PI project by accounting for intangible benefits. We would like your feedback on the applicability of this approach, suggested modifications to the multipliers, or changes to the formula to make it more robust and improve the way to account for intangible benefits.
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http://www.investopedia.com/terms/r/returnoninvestment.asp#axzz1iUynchr1, accessed 1/4/2012
Expert Answers, Quality Progress, September 2010, PP. 8 and 9.