How to Evaluate Prospective Vendors, Part III – Value as Return on Investment

This is the third post in a 3-part series on how to evaluate prospective vendors.

Evaluating Value as Return on Investment (ROI)

Another way to inform decisions about whether a vendor will be a good one is by quantifying the value the vendor delivers. You can measure this value in a few ways:

1) Ask. Just ask the vendor to tell you about what value they deliver to your company. If they can’t do it, that’s a red flag.
2) Calculate the Return on Investment (ROI). You can figure the ROI of a project before it starts to determine whether it’s worthwhile to invest.
3) Go with your gut. This is a subjective, gut-check measure. Does the vendor add to or alleviate stress and worry for you? Chances are, whatever you’re feeling now, you’ll feel even more in the future.

Companies often decide to move forward with projects based on subjective beliefs. They might ask for the price of the project and then measure that against some unknown and subjective number in their head about what they believe the project should cost. That’s not a great method. Yet business owners, C-suite leaders, and managers who usually make great decisions in other areas using objective reports and KPIs can sometimes decide to do a project such as a software fix without objective information.

Here’s what should be happening instead: they should evaluate the project cost against the expected benefits of the project measured in dollars and then discuss whether that return is appropriate. Calculating the ROI of a project is not difficult. ROI is calculated by dividing the cost of the project by the benefit of the project, with the final value expressed as a percentage (%):

ROI % = (Benefit – Cost of Investment) divided by the Cost of Investment x 100

The calculation does not need to be exact. Using reasonable educated guesses is far better than using no data measures at all. To value the benefits, you can factor in cost savings, Total Cost of Ownership (TCO), and potential revenue or profit growth. The project cost is provided by the vendor.

Let’s run through a quick example:

A high-level manager of a company currently spends 3 hours every morning manually manipulating data in Excel files to arrive at solid project schedules and resource plans. Let’s start by establishing the approximate value of those three hours of management time:

The manager’s annual salary with benefits is $150,000. Using 2,000 working hours per the year, we can calculate the value of the manager’s time at $75/hour. Multiply that by 3 hours a day, 5 days per week, 50 weeks per year. The result is roughly $56,000.

This value doesn’t even consider the value of other more valuable tasks not being performed by that same person that could be completed if they were freed up to the work. So that can also be calculated and added to the total. Maybe if the manager captured those 3 hours every day and was able to spend that time creating new enterprise customer relationships, the net of those potential projects could be $100,000. Adding that to the saved time value brings the total project benefit value to $156,000.

The vendor has quoted that the project will cost $50,000.

We can now calculate ROI, using the formula above:
ROI % = (Benefit – Cost of Investment) divided by the Cost of Investment x 100

(($156,000 – $50,000) / $50,000) x 100 = 212%

That’s a solid return on the investment for the first year, which is likely to improve in following years when costs of the solution should be lower while the benefits continue.

In summary, asking about, quantifying, and getting a feel for the value a vendor delivers on any given project are great ways to evaluate whether it is likely to be a successful client-vendor relationship. Great vendors are already having these discussions with their clients. That’s how they become true “partners”, and that’s the kind of vendor you should look for.

This is the third post in a 3-part series on how to evaluate prospective vendors.