This article has been contributed by Mark O’Connell a Senior Principal Consultant with Siwel
As an experienced SAM Manager in a new organization you’ll know how much you’re likely to save over the short to mid-term if you can obtain funding to implement a serious SAM plan. Or maybe you’ve been in the role for a while and want to secure additional investment. But just going to your stakeholders and saying you’ll find 30% savings probably won’t cut it.
You need to speak their language, and this article explains how to do this. We’ll look at applying Net Present Value (NPV) and the Internal Rate of Return (IRR) to quantify the benefits a SAM programme will have on operating expenses
The Net Present Value (NPV) as follows:
Net Present Value adjusts the gross benefits of a proposal (benefits minus costs) to take account of the time value of money and at a minimum rate of return. To calculate it you compile some estimated cost-reductions for the end of each of the next five years. Here’s a sample:
|Time||New Costs||Estimate New Benefits||Net Impact|
|Today||$100,000 initial setup||$0||-$100,000|
|By end of Year 1||$100,000||$25,000||-$75,000|
|By end of Year 2||$100,000||$100,000||+$0|
|By end of Year 3||$50,000||$200,000||+$150,000|
|By end of Year 4||$50,000||$300,000||+$250,000|
|By end of Year 5||$50,000||$400,000||+$350,000|
Sum $450,000 $1,025,000 +$575,000
Our expected discount rate in this scenario (the rate of return we expect on a project) = 10%.
Accuracy? These are your estimates of the likely costs and benefits. The costs you can directly calculate. The benefits might include things like avoiding procuring unnecessary software, attaining audit successes, avoiding legal and security problems etc. Each of these benefits can be fully vetted for accuracy with the correct department of the company, making them far more substantial than mere guesses. The time-frame of five years is somewhat arbitrary but is typically used in cases like this.
When critics challenge your estimates (and they will), you ask for their estimates. Usually they have none, including no estimate of the risk of doing nothing.
Anyway, with the above numbers you then can use EXCEL to calculate the NPV of this SAM project as follows:
=NPV(10%,-75000,0,150000,250000,350000) – 100000
Result = +$332,591.23
The NPV to your company today of this series of cash flows over five years, with an expectation of 10% annual return on money invested, is a positive $332,591 This is a more realistic (and Finance-friendly) assessment of total savings from your project, rather than stating “Net savings are $575k over 5 years”. This is a more realistic (and finance-friendly assessment) of total benefits from your SAM project, rather than just stating that Net Benefits are $575k over 5 years
Great! The project passed the test as a financially acceptable project (meaning: NPV > $0) and has all the other typically expected SAM benefits including:
All good stuff, right? Seems like a good idea, right? Let’s go!
But the top decision makers at your company might be more financially-oriented and less impressed by SAM benefits. There might be multiple projects pending with NPV>$0. They might want to compare your proposed investment in SAM against an investment in something totally unrelated, just to see which has the greater expected rate of return (RoR).
You may find yourself defending your proposed SAM rollout against another investment to buy automobiles that claims a 20% return. So even if your SAM Project has a positive NPV at the standard discount rate minimally expected of all company investments (maybe 5%? 10%?), that alone might not seem compelling compared to some other investment promising a far higher return.
So …. what to do?
Let’s compute the SAM project’s Internal Rate of Return (IRR). This treats your SAM project like any other company investment for comparison purposes.
Definition of IRR: The Discount Rate at which point the Net Present Value (NPV) of a project equals $0 is known as the project’s IRR (and also as the Break Even Point).
Create an EXCEL spreadsheet that looks like this:
Then in EXCEL click on
Fill-in the pop-up GOAL SEEK box as follows:
The result (in cell B1) will be 0.471 which means this project has an IRR of about 47%.
This IRR analysis (using these pretend numbers) enables you to say that in addition to all of the SAM PROJECT BENEFITS stated above, your SAM rollout has a 5-year FINANCIAL RATE OF RETURN of 47%!!!
While some in your company may not fully grasp the SAM technical benefits, the people who allocate budgets will understand the financial expected rate of return.
So let’s look at the various proposals that might be made by SAM Project Managers. Which is more likely to get funded?
By talking the same language as your stakeholders you immediately indicate that you’re not just “that geek from IT who understands licensing”. Now you just need to deliver on your promises!