ReliaSoft’s Reliability ROI

ReliaSoft's Reliability Return on Investment(RRROI or R[math]\displaystyle{ ^3 }[/math]OI)

Traditional ROI

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. The following equation illustrates this.

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

In this formula, "gains from investment" refers to the revenue or proceeds obtained from 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 return on the investment in improving reliability.

Reliability ROI (R³OI)

To illustrate, consider the case of ACME and their best selling product: 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 its competitors (1 year) and prices its product similarly. Some high level specifics are given below.

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	$140

ACME's management believes that they can and should build a more reliable widget. By doing so, they will both reduce 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, by building a better product, they also believe that they can more than double their market share to 25%.

ACME Numbers

Before we continue let's quickly examine the costs and revenue for ACME. The below provides these values. 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).

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.

The New Design

Of course, improving reliability will come at a cost. Some of these costs will be fixed (e.g., investments in tools, facilities and people to improve the reliability), and some will be variable (per unit cost), such as the cost of better material, etc. For this example, let's assume that this will result in a 10% increase in the production costs per unit. Furthermore we will assume an upfront investment of $500,000.

The profit calculation will be based on the below values.

[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]

Given these values, the New Widget product will generate a gross profit of $7,730,000.

Computing R3OI

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]

Thus

[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]