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Return on Effort

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Return on investment (ROI) is a familiar concept.  It usually has its greatest relevance when a big investment decision is soon to be made. Sometimes it goes by other names when applied to ongoing operations, like return on capital employed (ROCE), return on invested capital (ROIC) or return on equity (ROE).

Although such returns and return rates can be evaluated in isolation, for example in relation to the company’s cost of capital (which is a blended rate based on a combination of debt and equity), they are usually evaluated in relation to multiple investment alternatives, i.e., in the allocation of capital.

A number of years ago, I served on the Capital Appropriations Committee of a large public company where the disciplines associated with the allocation of capital to purchase or lease property and equipment were quite sophisticated and refined.  Each business unit needed to “compete” for their capital requirements and there was no assurance that the funds would be forthcoming, even if they had made a good case.  At the time, I was a little confused about the evaluation and approval process.  Even though volumes of data and extensive market validation of the concepts were put forward, there was very little consideration of the opportunities in terms of execution risk.  In other words, in my mind, the purchased or leased assets could only create value if they were properly put in place and used effectively, and there was usually minimal assurance that this would actually happen.  As a result, I talked to the committee chair and we decided to change the process to include this risk element.

…Whoa!  The push back was startling.  “Don’t you trust us?”  “Don’t you believe that we know what we’re doing?”  Well, maybe…  We hung in there and the results were incredible!  The presentations quickly started to reflect this change, with most everyone starting out with a description of their “impeccable” execution track record before they got into the “compelling” opportunity the expenditure would create.

At a later time, there were several similar opportunities to evaluate returns in relation to competing P&L expense initiatives, i.e., the multiple disbursement alternatives that could be characterized as an ongoing “investment” in our organic growth.  Although there were financial results and metrics in place to evaluate the outcomes from these expenditures, if something didn’t work, didn’t work well enough, or didn’t work fast enough, it was hard to determine whether it was a flaw in the initiative itself or effectiveness in its execution.  In my experience, well over half of the time the disappointment related to a lack of execution.  And, upon further evaluation and reflection, it was totally predictable!  …Nuts!  What we did was ignore the risk of things not getting done well, or we were in some state of denial about the risk, probably because we believed so strongly in the lift the initiative would give us.  We believed that it was so powerful, people would just naturally rise to the occasion… but they didn’t.  Sometimes it was a lack of real capability, but more often than not it was a lack of individual or team capacity.  There were too many other things to do.

I now require “return on investment” decisions to be accompanied by a list of “dangerous assumptions”.  One of which is who is going to be involved and what, where, and how I think things are going to play out.  Even with fact-based decision making and well planned execution steps, things can still go wrong.  There is still considerable execution risk.  To test these “dangerous assumptions”, and perhaps compensate for the associated risks, I now try to evaluate the effort involved… and I don’t just mean in terms of commitment, good intentions and hard work.  In fact, in terms of effort, I am much more inclined to favor nimbleness, creativity and innovation than aggressive pursuit and relentless perseverance, even though all of it is important.  That way, I believe we can get the best return… the best return on effort.