Your firm invests $100,000 in a federally insured bank account. The account will be worth $108,000 in one year. Your Return on Investment (ROI), of course, is 8%.
That’s not very complicated, is it? But what if your firm is investing $100,000 in a piece of equipment that will reduce your future labor costs? Let’s assume that you’ll be able to begin reducing your workforce in a year, and (at that time, in one year) the present value of the labor savings will be $108,000.
On the one hand, that’s still an 8% return. But if you need to “pull the trigger” on your $100,000 equipment investment today, it won’t be as easy to do so as the $100,000 cash investment.
Why? Because the return is not guaranteed. What if the equipment repeatedly malfunctions? Then you may be saddled with repair costs, as well as “workaround costs.” That could get expensive!
There may also be qualitative concerns. What if your employees become concerned about the stability of their jobs? Will they communicate their nervousness, explicitly or implicitly, to your customers? Will it then impact your sales volume?
You could try to reinforce your relationships with your employers through additional investments in benefit plans. But is that a better idea than not threatening their jobs to begin with? Likewise, you could develop attractive rewards programs for your customers. But to what extent can a few discounts or freebies rival the attractiveness of an attentive customer service representative?
A Web Of Factors
From a management accounting perspective, the challenge that underlies this equipment investment decision stems from the inherent uncertainty of the $108,000 labor cost savings metric. You can’t log onto your bank portal and see those savings sitting snugly in an account, waiting for you to withdraw it. It’s an estimate of the financial impact of a future scenario that may or may not come to pass.
Furthermore, the future scenario is reliant on a number of factors falling into place as expected. Even if you build a moderate amount of employee distress and customer unrest into your projections, you may still find that your forecast assumptions are too optimistic. Of course, other assumptions may be too pessimistic, and you may hope that the optimistic and pessimistic characteristics will off-set each other. Nevertheless, that may not necessarily occur.
Finally, you may need to contend with non-linearity when analyzing this web of inter-locking factors. A grumpy group of airline personnel, for instance, may not necessarily distress passengers on a pleasant spring day if the skies are clear, the flights are running on time, and the middle seats are all open.
But on a stormy day before Thanksgiving, when the flights are badly delayed and the planes are filled to capacity? Even slightly brusque flight personnel may leave their frustrated passengers fuming “I’ll never fly this airline again!”
This seems like a hopeless challenge, doesn’t it? But it doesn’t need to be so. The problem is a solvable one if you introduce non-financial metrics into your ROI evaluation.
The concept is a simple one. Some outcomes are quantitative and financial in nature. Some are quantitative but non-financial in nature. And some are both qualitative and non-financial in nature.
Invest $100,000 to receive $108,000? That’s a quantitative financial outcome. Invest the same amount in an employee benefit plan to increase worker satisfaction? Satisfaction can be quantified through surveys, so that’s a quantitative non-financial outcome.
But what about purely qualitative outcomes? Do they exist? Can an investment produce benefits that are not measurable in a quantitative sense?
Former New York City Mayor Michael Bloomberg popularized the following expression: “If you can’t measure it, you can’t manage it.” Most accountants would agree with his opinion, although some may argue that certain spiritual, artistic, or moral outcomes cannot be reduced to mere metrics.
What To Measure
Let’s assume that you’d like to measure the projected ROI on an enriched employee benefit plan. What would you do? Assuming that you agree with Mayor Bloomberg, how would you define your metrics?
You might wish to begin with the standards of the Global Reporting Initiative (GRI). Schlumberger’s 2018 Global Stewardship Report, for instance, lists several dozen GRI standards that are compiled on an annual basis.
The GRI promulgates several sets of standards involving investments in employees, including 401 Employment, 402 Labor Management Relations, 403 Occupational Health and Safety, 404 Training and Education, 405 Diversity and Equal Opportunity, 406 Non-Discrimination, and 407 Freedom of Association and Collective Bargaining.
The standards contain very few surprises. 401, for instance, requires disclosures regarding employee turnover, benefits provided to full-time employees that are not provided to temporary or part-time employees, and parental leave policies. Information regarding “actions are taken to determine and address situations of disguised employment relationships where workers in its supply chain are falsely considered to be self-employed or where there is no legally recognized employer” must also be disclosed.
Such items reflect contemporary news headlines about situations that generate immense employee dissatisfaction. Many of these factors also inflict reputational harm on customers and other stakeholders.
A Non-Financial ROI Illustration
So let’s assume that you decide to invest $100,000 in that new labor-saving equipment. And, out of concern for its potential impact on employee goodwill, you decide to enhance your employee benefit plans simultaneously.
How might you do that? First, you might recognize the credibility of the GRI. It’s hard to argue that your enhancement is meaningless if it is explicitly cited by a global standard-setting organization.
Next, select an enhancement category that is emphasized by the standards. New laptop computers may represent a potentially popular fringe benefit, but if parental leave is more important to the standard-setting organization, then that might represent a preferable option.
Then prepare to measure any declines in employee satisfaction as a result of the investment in the equipment, and any offsetting increases in employee satisfaction as a result of the new benefits policy. If you achieve your goals, you might end up with no net change in employee satisfaction at all, and thus perhaps no decline in customer satisfaction or sales.
And thus what will be your final outcome? You’ll make an investment in equipment, and the resulting labor savings will help you achieve your target financial ROI. You’ll also make an investment in a new employee benefit and the resulting satisfaction will help you achieve your target non-financial ROI.
You’ll also produce happier babies. That’s not a bad result, is it?
This is an article from TXCPA Houston's Online Magazine called the Forum. Read the full magazine here.
Michael Kraten, Ph.D., CPA specializes in the development of business strategies that stimulate the generation of long term sustainable value. He maintains areas of expertise in communication techniques, corporate social responsibility, decision analysis, enterprise risk management, entrepreneurship, financial modeling, forensic analysis, sustainability, and valuation. He is a senior Professor at Houston Baptist University (HBU), where he designed and now teaches the graduate courses in entrepreneurial finance, advanced international accounting, and accounting theory, and the undergraduate course in advanced financial accounting.