ReliaSoft’s Reliability ROI

ReliaSoft's Reliability Return on Investment(RRROI or R3OI)

Traditional ROI

First, traditional Return On Investment (ROI) is a performance measure used to evaluate the efficiency of an investment, or to compare the efficiency of a number of different investments. In general to calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; and the result is expressed as a percentage or a ratio.  Equation (1) that follows illustrates this.

[math]\displaystyle{ ROI=\frac{Gain\,from\,Investment\,-\,Cost\,of\,Investment}{Cost\,of\,Investment} }[/math]

(1)

In this formula "gains from investment" refers to the revenue or proceeds obtained the investment of interest.

Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken. Reliability ROI, is similarly computed by looking at the investment as the the investment in improving the reliability.

Reliability ROI (R³OI)

To illustrate consider the case of ACME and their best selling product the ACME's Widgets. The current design has had less than stellar reliability performance in the field, yielding ACME a 10% market share. ACME offers the same warranty as it's competitors (1 year) and prices it's product similarly. Some high level specifics are given below in Table 1.

Table 1. ACME's Widget Specifics

Units Sold	100,000
Warranty Returns Per year	6%
Market Share	10%
Sales Price Per Unit	$200
Cost to produce a Unit	$100

ACME's management believes that they can, and should, build a more reliable widget, and by doing so reduce both warranty costs and increase market share. Based on some preliminary studies they believe that they can reduce the warranty returns to 2% per year. Additionally, and by building a better product they also believe that they can more than double their market share.

ACME Numbers

  Before we continue lets quickly examine the costs and revenue for ACME. Table 2 provides these numbers.  Note that for the warranty cost per unit a fixed $400 per incident was assumed for associated overhead plus the cost of a new unit ($140).

 

Table 2: Revenue & Costs for ACME

[math]\displaystyle{ Sales\,Revenue= }[/math]	[math]\displaystyle{ 100,000\cdot \$200= }[/math]	[math]\displaystyle{ \$20,000,000 }[/math]
[math]\displaystyle{ Production\,Costs= }[/math]	[math]\displaystyle{ 100,000 \cdot \$140= }[/math]	[math]\displaystyle{ \$14,000,000 }[/math]
[math]\displaystyle{ Other\,FixedCosts= }[/math]		[math]\displaystyle{ \$1,000,000 }[/math]
[math]\displaystyle{ Expected\,Returns= }[/math]	[math]\displaystyle{ 100,000 \cdot 0.06= }[/math]	[math]\displaystyle{ 6,000\, }[/math]
[math]\displaystyle{ Warranty\,Cost\,Per\,Unit= }[/math]	[math]\displaystyle{ \$140+\$400= }[/math]	[math]\displaystyle{ \$540 }[/math]
[math]\displaystyle{ Total\,Warranty\,Costs= }[/math]	[math]\displaystyle{ 6,000 \cdot \$540= }[/math]	[math]\displaystyle{ \$3,240,000 }[/math]
[math]\displaystyle{ Gross\,Profit= }[/math]	[math]\displaystyle{ \$20,000,000-\$14,000,000 }[/math]
	[math]\displaystyle{ -\$1,000,000-\$3,240,000= }[/math]	[math]\displaystyle{ \$1,760,000 }[/math]

Based on this the Widget product line generates a gross profit of $1,760,000.

Now improving reliability will come at a cost. These costs are going to be fixed costs (investments in tools, facilities and people to improve the reliability) and variable (per unit cost) for better material etc.For this example lets assume that this will result in a 10% increase in the production costs per unit. Furthermore they estimate an upfront investment of $500,000 . Then based on these numbers:

Current
New Design

With an increase in reliability then

[math]\displaystyle{ \text{Sales Revenue}=250,000\cdot \$200=\$50,000,000 }[/math]

[math]\displaystyle{ \text{Production Costs}=250,000 \cdot \$154=\$38,500,000 }[/math]

[math]\displaystyle{ \text{Other Fixed Costs}=\$1,000,000 }[/math]

[math]\displaystyle{ \text{Expected Returns}=250,000 \cdot 0.02=5,000 }[/math]

[math]\displaystyle{ \text{Warranty Cost Per Unit}=\$154+\$400=\$554 }[/math]

[math]\displaystyle{ \text{Total Warranty Costs}=5,000 \cdot \$554=\$2,770,000 }[/math]

[math]\displaystyle{ \text{Gross Profit}=\$50,000,000-\$38,500,000-\$1,000,000-\$2,770,000=\$7,730,000 }[/math]

Our only costs not counted in was the initial investment of $500,000. The gain from the investment was

[math]\displaystyle{ \$7,730,000-\$1,760,000=\$5,970,000 }[/math]

R3OI

Then

[math]\displaystyle{ \text{R3OI}=\frac{Gain\,from\,Investment\,-\,Cost\,of\,Investment}{Cost\,of\,Investment} }[/math]

[math]\displaystyle{ \text{R}^3\text{OI}=\frac{\$5,970,000-\$500,000}{\$500,000}=10.94=1094\% }[/math]