DaveTurbide.com

April 2010

For many years, companies purchased information technology primarily to foster cost savings. The main focus of these system projects was to reduce inventory, increase operational efficiency, reduce lead time and, generally, reduce waste (non value-adding activities) in all its forms.

Typically, a technology investment is fully justified by cost cutting savings, and most companies actually realize a good portion of the expected improvements. In other words, technology investments often do help reduce costs sufficient to justify the investment.

That’s undoubtedly one of the reasons why so many companies made the investment in these systems during the last 25 years. And most companies have gone through multiple rounds of cost-reduction efforts with and without the help of software.

Consequently, these companies may have reached the point of diminishing returns. The so-called low-hanging fruit has all been picked and further cost reduction opportunities are more difficult to find and even more difficult to obtain. Certainly, no company operates at 100 percent efficiency in all areas of its operations, but the investment required (money, time, effort, management attention) is now greater for a smaller potential return.

Given the above, it would seem that the focus of systems investments – and marketing – should switch to top line concerns; aimed more at increasing sales and revenue rather than reducing costs. Our ingrained predilection, however, is toward cost cutting.

Generally, it is easier to justify, say, a warehouse management system or a distribution management system whose potential return-on-investment (ROI) can be easily calculated on the basis of direct cost savings than it is to justify a customer-oriented information system that will potentially increase revenue.

Let’s look at a warehouse management system that costs $1 million and delivers a savings of $200,000 a year in labor and facilitates and inventory reduction of $1.5 million (15 percent of a $10 million inventory).  Assuming the annual cost of holding and handling inventory is 40 percent of its value (this is a middle-of-the-road estimate; trust me on this), the annual savings adds up to $800,000 yielding a payback period of about 15 months. Admittedly this is a very simplified calculation but it will do to make the point.

Now, let’s invest the same million dollars in something less tangible like a Customer Relationship Management (CRM) system that contributes to customer service and results in a 5 percent increase in sales revenue. Assuming that the company’s annual revenue is $100 million, the revenue increase is $5 million. Assuming the marginal cost to produce and ship those additional products is 80 percent of their selling price, the bottom line benefit is $1 million (20 percent of the $5 million increase in sales) with a payback period of 12 months. And that doesn’t even count any labor savings brought on by the new system.

Yet, most companies would choose the cost-saving warehouse system over the revenue-enhancing CRM system despite its lower calculated return. Why? First of all, few companies would do this kind of head-to-head comparison between such different projects. Secondly, long years of experience have taught us to look at cost savings for system justification – and that same attitude makes potential revenue enhancements less believable.

Today’s marketing challenge is to focus the prospect’s attention on the top line benefits (and what they contribute to the bottom line) rather than the diminishing potential for cost cutting-based savings.

This entry was posted on Tuesday, April 13th, 2010 at 4:59 pm.