Client Value-Add (Generating Return-on-Investment)
The following is excerpted from William’s book: “90 Days to Success in Consulting”, Cengage Learning, 2009.
While this book will cover the “blocking and tackling” of the consulting profession, it is important not to lose sight of the prime mover when it comes to consulting success: your ability to delight the customer. Put another way, you need to be value-added to the client. How do you add value? Simply put, the client perceives they received more value than they paid.
Where it is applicable, you should absolutely use ROI to demonstrate the value added of your activity with the client. This is done ideally as a justification for the activity, and then after the fact as a measurement of the activity. Let me explain.
ROI is about accumulating all monetary returns and investments from an activity through to the ultimate desired results—all while considering the possible outcomes and their likelihood. Using ROI for justification is reducing the proposed net change in activities to their associated anticipated cash flow. Often, a cost of money is used to reflect in today’s numbers the present value of expected cashflows in the future.
Various ROIs can be computed for the justification of an anticipated project, showing the various potential outcomes distributed across their probability of occurrence—a probability distribution for the project. A probability distribution will use multiple ROI calculations and their likelihood of occurrence to come up with an overall ROI for justification. Mathematical ROI is not possible or relevant for all activities, but ROI as a mindset should be carried into every client situation.
*** Generate return-on-investment for your clients. ***
Consider Acme Speakers, a hypothetical prospect for your consulting services. Acme is cash-strapped, like many companies, and does not have money to throw away—as they are willing to tell you (and as you should always assume). They are considering adding Radio Frequency Identification (RFID) tags to their high-ticket items in stores to reduce theft, reduce the time it takes to take inventory, and get closer to just-in-time replenishment of their products. Your firm provides the consulting services they need.
As a high-value consultant, you will be helping them decide whether to adopt RFID. You will use ROI to show how RFID:
* Reduces theft. This is measured by a reduction in anticipated theft over the next three years.
* Reduces the time it takes to take inventory, thereby either reducing the client’s employee or contractor costs or freeing up employees to do more value-added activities. Regardless, you measure the value by cost reduction.
* Reduces the cost of inventory. This is a little trickier than the others, but it possibly improves sales by ensuring that items are available that customers want. There is also the possibility of a reduction in space required to store inventory.
For simplicity, the figure only considers the first benefit—fraud reduction. Fraud reduction shows as a cost reduction for Acme Speakers. Other categories of return could be for revenue increase and labor savings. Costs to implement are the costs for the three consultants you propose—Curly, Moe, and Larry. Other costs for hardware and software are ignored for now, but in reality, you would want to capture all client costs in the worksheet—those that are paid to your firm as well as to other vendors. (More on service planning in Chapter 6 and partnerships in Chapter 15.) We’re also ignoring client employee labor costs (again, for simplicity), but they could also be included.
We are anticipating no fraud reduction in Quarter 1 and $150,000 worth of fraud reduction in both Quarters 2 and 3. We are anticipating a total of $200,000 in costs in Quarter 1 and $40,000 in Quarters 2 and 3.
After returns and costs are reduced to cashflow by quarter, the cashflow is fed into the ROI calculations. Then, the math takes over.
The payback period is the simplest calculation and expresses the point in time at which the overall cashflow from the project turns positive. In this case, the project costs $200,000 in Quarter 1, but there is a net cashflow in Quarters 2 and 3 of $110,000 ($150,000 in returns minus $40,000 in costs). This means at some point in the third quarter, the client will be “in the black” on this project. The client must be willing to be in a net-negative position for two quarters to take on the project.
You may notice that the ROI calculations [(Returns – Costs)/Costs, using the discount rate to equate dollars to present values] look better and better as time goes on. That’s normal. So should you run these calculations out 10 years or so in order to get a hugely positive ROI? No, sorry—the project had better be more than paying for itself in the first year. Chief financial officers, the people who oversee these things, will generally only allow three years at the most in such calculations.
True Return on Investment considers the discount rate
The ROI calculations use a discount rate of 5% (not shown in the figure), which is the client’s “cost of money.” Consider if a guy named Eric were to offer you $100 today or $125 in one year. Assuming Eric is good for it, you would take the $125 in one year. (It’s 25% interest.) At some point ($110? $108? $105? $102?), you would lose interest in Eric’s interest, take the $100, and invest it yourself. Everybody’s point will be a little different. The same is true for companies. That breakpoint is called the company’s discount rate.
A discount rate is factored into the ROI calculations, but there’s no need to get too hung up on that now. As a matter of fact, you may hear the terms Net Present Value (NPV) and Internal Rate of Return (IRR). These are equivalent concepts to ROI and utilize the same cashflow and discount rate. (The worksheet, with all formulas, can be found at www.williammcknight.com.) Net Present Value (NPV) is the equivalent of what the cashflow stream would be if reduced to a single amount.
If the client already knows the benefits of the RFID project but is seeking qualified consultants to do the implementation, and the selection process is competitive, you will want to think in terms of a concept tangential to ROI called total cost of ownership (TCO). A TCO approach to solution-making is done with an eye to the client’s pocketbook. However, costs are seldom simply the implementation costs. There are long-term costs for staff training, support, maintenance, and upgrades. There are also potentially significant costs in integrating the product in with other client infrastructure.
ROI (all forms) will have its place, but the point of demonstrating it now is not because you are going to step into every client situation with the spreadsheet. It’s the mentality of ROI that you need to adopt to be successful. Many—perhaps most—of your client engagements will not involve doing the ROI math, but they will most assuredly involve generating value-added ROI to your client. By taking this approach to your engagements, you will be highly valued by your clients and generate references and repeat business. Produce ROI for your client, and you will be able to do all the things in this book. Don’t do it, and it will be at high peril to your consultancy.
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