By Pat Edmonds and Jeremy Hutton, Point B
Imagine you're in Vegas and have been gambling all night. There's $100,000 in the pot, and you're holding a royal flush. Everyone around the table lays down their hands while you struggle to keep a straight face. You calmly look at your cards, the dealer, the players, and that $100,000 pot.
You lay down your royal flush to reveal your winning hand. This is your moment. You pause to take in the looks of amazement around the table. Then you get up and walk away from the table, grinning from ear to ear—and leaving your $100,000 on the table.
Sound crazy? Yes. But that's what many process improvement practitioners do when leading capacity-saving projects. You identify opportunities to reduce the time and effort that go into executing a process, then walk away and leave your chips on the table by not quantifying and realizing the financial benefit.
It's generally easy for companies to calculate direct cost savings, which are defined as a reduction in a budget line item. You simply figure out how to save on budgeted overhead. In an IT services environment, examples of direct cost savings might be reduction in planned contractor expenses or decreased spend on expensed hardware components.
It's trickier, however, to estimate the expected value of indirect savings from a reduction in the time and effort required to complete a task—i.e., the saved capacity.
Many capacity-saving projects simply end with theoretical savings. You write down how many hours each employee or asset will theoretically save, put it on paper, and claim victory.
If you're a bit more sophisticated, you might take an average hourly labor rate and multiply it by the number of hours expected to be saved. For example, you might estimate that a process improvement would save 500 hours of tester time per quarter at a $50/hour rate, equating to $100,000 of capacity per year. If you take a shortsighted cost benefit and lay off 500 hours' worth of tester employees, this would represent a one-time direct cost savings from the labor budget. If you don't take this draconian step, then the $100,000 in estimated capacity savings will be no more than a figment of your imagination—unless you do something constructive to repurpose the freed-up time.
On paper, capacity savings feel good, but the benefit remains a fiction that provides no real value unless real action is taken to capitalize on it. Over time, leaders and participants question the value of process improvement activities that are long on talk but don't move the needle. Before long, support for capacity-saving efforts will vanish.
How do you take these capacity chips off the table and convert labor savings into cash? You could:
To estimate the expected financial gain due to capacity improvements, modify the Basic Net Present Value (NPV) calculation to reflect the expected increase in revenue or decrease in cost over time:
Capacity Gain NPV = (Δ1 / (1 + R)1) + (Δ2 / (1 + R)2) + ... + (Δn / (1 + R) n) – C where:
If you don't have a forecast against which to plot your improvements, take a few historical points and estimate what the near-term costs (or revenue), would be based on the most accurate historical data. Next, plot your expected improvements against these to calculate the Capacity Gain NPV. Use this method the next time you wrap up an improvement effort, and hold yourself accountable so you'll be positioned to cash in on those valuable chips.
There are usually significant opportunities to drive meaningful improvement throughout IT organizations. Don't walk away from a process improvement project until you have put financial value around the expected gain and tied that back to your organization's key financial metrics. When you score a winning hand, use these methods to ensure that all those chips make it into your pocket.
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