Every investment carries some level of risk. And when companies decide to make an investment, one of the key points to consider is how much money will be earned as a result of this decision. This metric is called Return on Investment or ROI. But what is Return on Investment? why is it important? In this article, we will explore the importance of ROI, the benefits of this metric & how you can calculate it.
What is the definition of Return on investment?
In simple terms, the Return on Investment (ROI) is a metric to measure how much money your business will make (or lose) with each investment. This metric is used to help a business understand if the investment is really worth it.
ROI takes into account all of the factors that can help generate a profit. This helps companies to understand the potential returns that, which in some cases, are not always so obvious.
This indicator can calculate, for example, the impact of marketing or sales actions, acquisition of management tools, new customer retention strategies. among others. In supply chain management, ROI can help us to understand the potential value & risk of buying a new warehouse, implementing a new demand planning tool or even rolling out a new range of products.
In this way, ROI can help identify the investments that give the best benefits while giving us the tools to analyse and optimize those investments that are already in place; all to improve performance.
What is the importance of ROI?
It is essential to understand the ROI of the different decisions your business makes to identify which are likely to be the most fruitful.
Furthermore, this indicator also allows companies to define their goals based on possible results they hope to achieve. By exploring expected performance and how long it will take before we see results, we can make business decisions with confidence. We can also use this insight to optimise our operations.
ROI is an effective indicator when it comes to calculating the monetary return of an action and can be applied to all investments, from those made in marketing campaigns and events, to improvements in the company’s infrastructure.
Therefore, keeping ROI is extremely important for helping customers answer questions about their business, such as:
- What are the company’s main sources of profit?
- What are the most effective communication channels?
- Are our initiatives, investments and decisions performing as expected?
- Is the sales process efficient?
- Does customer service contribute to customer loyalty?
- Are our processes efficient?
- Are we profitably fulfilling our customer’s expectations?
How to calculate ROI?
The easiest way to calculate ROI is by following this formula:
ROI = [(benefit – costs) / costs] x 100
The “benefits” in this formula are typically revenues generated from sales. The “costs” are the expenses necessary for the investment to be made.
The final result is a percentage. Therefore, it makes it easy to compare different actions and strategies both in terms of potential costs and income.
How do I measure the ROI of my supply chain project?
Let’s imagine we are reviewing a potential supply chain investment.
In terms of cost, we need to think about the following:
- Inventory costs
- Storage & logistics costs
- Waste costs
- Labour & admin costs
- Financial costs (e.g., the interest rates & insurance)
- Equipment & software costs
However, the benefits are a little more complicated. After all, while some benefits are easy to quantify, some are more difficult to put a number on.
Examples Tangible supply chain benefits
- Sales revenue increase attained through better availability
- Reduced purchasing & freight costs through making smarter order
- Reduction of working capital tied up in inventory
Examples of intangible supply chain benefits
- Reduced pressure on the planning team
- Greater internal collaboration
- Better supplier communication
Advantages of using ROI
Applying ROI in business planning and strategy can deliver some important benefits:
- Eliminate unnecessary expenses
Analysing ROI and acting on the data we have can help us make difficult or risky decisions with a higher degree of confidence. The practical effect of this evaluation is that it highlights which investments we need to keep. But more importantly, we can flag any tactics or investments that we need to stop.
2. Maximise chances of success
Cutting unnecessary expenses & preventing poor investment in the first place will help increase revenue and, in turn, profits. But let’s not stop there!
We must use our budget in the best possible way. For example, reallocating investment from ineffective tactics and reinvesting it into initiatives that do work. This can only result in one thing: increased profits. After all, we will have more resources and time to spend on the campaigns that are working. By taking steps to further optimise them, we can deliver the best possible results.
3. Ensure lasting results
It doesn’t make sense to achieve astronomical growth for a few months and then go back to a pattern of waste and bad investments, right? With that in mind, ROI tracking should be an ongoing process. Not something we do once and then forget about.
The ultimate goal is to be consistently profitable, no matter how much time passes. Once you get into the habit of doing this calculation, you can expect long-lasting results. The only thing necessary to achieve this is to maintain the follow-up cycle and take quick actions to correct any problems you find.
4. Increased self-esteem of the team
Who wouldn’t like to work in a successful company where projects work well and the established objectives are always achieved?
Well, this is the kind of environment you will create by keeping ROI in mind. Can you imagine the difference of having a motivated team working at full speed, compared to a team that has doubts about their potential?
How does Slimstock guarantee a positive ROI?
A stock optimisation project brings significant benefits to a business. However, we believe an investment only makes sense if it can provide an ROI within the first year. Therefore, Slimstock only starts a project once we can prove Return on Investment in less than 12 months.
To be successful, businesses must strike the right balance between customer satisfaction and optimal inventory cost. Find out how you can enhance your operations to achieve a better level of service.
