ECM technology has been maturing for the past few years – and with this maturation comes a wider range of price points and expertise allowing for the benefits of ECM to be utilized by smaller companies and to truly encompass ever smaller business processes and departments within an enterprise. Regardless of the size of the ECM project, each will be scrutinized by some type of cost/benefit analysis to determine whether to proceed with the project.
Today, we’re going to talk specifically about costs and the flip side of the coin – benefits or cost reductions. More specifically, I hope that the following information will increase your comfort level in dealing with ‘he/she who holds the purse strings’ – from RFP stage through negotiations that ensue regarding the trade-offs between scope, resources (costs) and timeframe on your project.
The expectation of an ECM project manager is that he/she is knowledgeable about CM technology and can communicate with all levels of IT people. Additionally we’re also now expected to be able to understand business processes within AP, AR, HR and effectively manage projects merging technology into business solutions and/or process improvements. What we’re not doing and in most cases not expected to do – is to be able to communicate in finance speak with ‘he/she who holds the purse strings’. Essentially this means that we lose control of our RFP or project change requests – and rely on others because we’re not expected to be able to talk dollars and cents.
Again, I hope the following will allow you to feel more comfortable in talking dollars and cents.
So what do the words variable, fixed, average, and marginal all have in common? Perhaps you recognize these as a few of the myriad adjectives describing different types of costs. Let’s wade into the types of costs that CFOs look at when they’re evaluating your project and determining whether the $1 of benefits you’ve promised really equates to 4 quarters to their bottom line.
Variable cost – there is an old saying in economics that all costs are fixed in the short-term and variable in the long term. A good example of a variable cost would be postage. There is a perfect relationship between how many documents you mail and how much postage you have to pay. A variable cost is any cost that varies directly with an activity.
Fixed cost – these are costs that are fixed at least in the short term. The key question here is how long is short term? The answer will differ from company to company, and project to project. Most likely you’ll need to meet with someone in the finance or accounting department to determine how projects are evaluated. Let’s assume the CFO tells you that all projects must have a payback period of less than two years. (In Part II – we’ll talk about different ways companies evaluate projects.) So we can use this information to determine what costs are fixed/variable in the two year period. Union labor contracts, real-estate leases, etc., lock in costs – making them fixed perhaps for the entire project payback period. If you can’t break a lease or sublet freed storage space in the two year payback period – then it is unlikely the CFO will allow you to include any benefits from reducing storage costs.
Looking at many of the costs in your life – you recognize that many have both a fixed and a variable component. For example if you budget for food costs – there is some minimal level that you can’t fall below without risk to your health or well being. This fixed component will vary depending on whether you can maintain your happiness with Budweiser or require 20 year old scotch. When you own a car there are fixed cost components such as insurance or your car payment, and variable components such as gasoline, tire wear, depreciation or even maintenance. Just remember that in the short-term our ECM project can only provide savings that fall in the variable cost category.
Average cost – You’re working on an ECM project for an AP department – and a typical question you would ask during discovery would be, ‘How much does it cost your company to process an invoice?’ The well-informed AP manager will proudly come back and give you a figure somewhere between $20 and $50. What you’ve just been given is an average cost. The AP manager took all costs associated with the AP department including salaries, benefits, rent, postage, AP’s portion of utilities, janitorial costs, perhaps IT support, license costs for their payables system etc., and divided this number by the number of invoices processed. By now you recognize that these costs include both fixed and variable components. If your ECM project successfully eliminated all manual invoice costs – do you think the CFO believes that the benefits you’ve penciled in are true savings? Of course not.
Marginal cost – Let’s go back to the AP department one more time to understand marginal costs, and ask the AP manager a slightly different question, “How much would it cost for you to process 1 more invoice today?” The AP manager will most likely give you a blank look and repeat the same answer of $20-$50. So, you sit down with the AP clerk and time them on how long it takes to process an invoice, you then add time/costs for invoice approval, for creating a payment document, and perhaps for postage, mailing, invoice retention – and for some reason your cost comes in at a fraction of the $20-$50. What you’ve just done is determined the marginal cost of processing one more invoice or conversely the cost savings associated with the elimination of manual processing for one invoice. Look carefully at the costs you’ve included – you should recognize these as the sum of all the variable cost components associated with invoice processing.
So if average cost is incorrect – is marginal cost the correct figure to use when calculating ECM benefits? From the scenario above – does this mean marginal cost is the same as variable cost? The answer to both questions is no. The reason is that we’re making an assumption if we extrapolate the savings/costs associated with one invoice to many invoices. If an AP clerk can process 100 invoices per day then potentially we can reduce the salary costs associated with one AP clerk if we can eliminate manual processing for 100 invoices per day. If we’re able to replace a number of AP clerks, perhaps next year when the AP manager retires – we can replace him/her with an AP supervisor. If the number of AP users decline significantly – then next year we can negotiate a lower license cost with our AP software vendor.
What margin really means is that all costs are variable. At some point in the AP process we run into constraints where fixed costs are impacted. For example, if every single AP clerk is working as hard and efficiently as possible and working all the overtime allowed by the company – then adding one more invoice would force the company to hire one more AP clerk. In such a case the marginal cost of that one invoice could be $2000 and not $2. What if there wasn’t any room in the AP department for one more desk/person? In such a case the AP department might be forced to add a new shift of workers. Adding in the cost of a shift manager and other restructuring necessary – the marginal cost of that one invoice may now be in the $100,000 range.
The point is that over the life of your ECM projects benefit period – you can expect to convert some of the fixed costs to variable costs that can then be reduced or eliminated. If any part of this benefit period fits within the payback period of your project then you could and should include those benefits as project benefits.
My final point in understanding these costs is credibility with your customer’s ultimate decision maker.
As an ECM project manager, you’ve easily won over the IT department with your technical expertise in ECM hardware/software. You’ve wowed the business users with a list of successful implementations. What you don’t want to do is diminish your credibility with the CFO when they’re evaluating your project on a cost/benefit basis. Spend time understanding your customer’s cost structure; how they evaluate projects – and present accurate numbers that truly depict realistic benefits. If you do – you will have won over the most important person in the decision making process.
Part II in a few weeks will look at different financial methods that companies use to evaluate projects – and how to structure your project within those methodologies.
Steve Kissinger
