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How to Quantify Savings From a Data Collection System

There was a time when companies invested in computers for the sake of the technology. Management assumed that computerized systems were always more efficient. According to the Wall Street Journal, companies now demand to know the savings from all capital investments, including computer systems. Today, virtually all automation must be financially justified. Recent press indicates that attitudes may have even shifted to the opposite extreme in some companies. For example, a recent pull-out section in the Wall Street Journal on technology opens with: “It’s the morning after. For the past ten years companies have been on a blind-faith buying binge investing well over $1 trillion in new computer systems to embrace the future and gain a competitive edge. Now, many of them are awakening with a hangover and wondering: What was it all for, and where did we go wrong?”*

“Automated data collection technology is used to enter information into a business computer system. It relies on machine-readable bar code symbols to increase the speed and accuracy of collected data.”*

* The Wall Street Journal, Technology – Unleashing the Power, Dennis Knearle.
Getting Started
Begin by calculating the current cost of the tasks that you plan to automate. Then, estimate the cost
of the tasks under the proposed system. This is at the center of cost justification, so get this part right. The bad news is that quantifying savings can be challenging. Sometimes the benefits of the system are “soft”. How do you quantify better information or fewer errors?

The good news is that bar code systems really do save lots of money – this is not smoke and mirrors. Even skeptical, tight-fisted operations managers can understand the benefits of eliminating manual key strokes and errors. The benefits of being wireless are intuitive to an experienced warehouse manager.

As great as data collection is, do not oversell or over promise what your system will do for the com- pany. Be realistic and plan for the unexpected. Change – even positive change – causes uncertainty, so make allowances and be conservative in your estimates. You’ll achieve great success with the system if you keep the following formula in mind:

Happiness = Perceived Outcome – Expectations

Approach the project with a positive and confident frame of mind. At the same time, avoid overly optimistic statements and projections until the system is installed, accepted and working as planned. Productivity gains from automated data collection generally fit into two categories: “Hard” savings, or easily quantifiable savings, and “soft” or less tangible benefits.

Hard Expense Savings

Labor, including, taxes, benefits and variable costs
Operating Expenses
Fixed Asset Reductions such as reduced equipment needs or reduced equipment losses due to better equipment tracking. Reducing assets can save cash and make a dent in a company’s return on asset calculation.

Soft Benefits

Improved Sales due to better management information, reduced out-of-stock situations and up-to-date product availability information.
General Efficiency
Improved Employee Morale by automating boring tasks such as data entry, creating more enriching job opportunities for workers.
More Satisfied Customers due to higher quality, faster response and improved accuracy.

The most common area of savings from automated data collection is labor costs. When calculating labor savings, determine the variable cost of labor. The variable cost is the cash expense that varies in direct proportion to the hours worked. Do not include fixed burden or other overhead that will not be reduced if labor hours are cut. Variable costs generally include wages, payroll taxes and employee benefits.

Example: Let’s say you are installing a time and attendance system that will eliminate hand keying of payroll data. Currently, two people in the payroll department spend 1,040 hours each per year entering payroll data. The system will completely eliminate this task. Assuming that the average earnings of these data entry clerks is $8.65 per hour, plus taxes and benefits of 25%, the variable cost of this labor is $10.81 per hour. Total labor savings of this application is 2080 X 10.81 or $22,500 per year.

If your application is justified based on labor savings, then it’s crucial that you explain what the company will do with the people who are affected by automation. For instance, can the department reduce overtime or eliminate part time or contract positions? Can surplus employees be transferred to another department? Is normal turnover high enough that attrition will eliminate the problem? Or, will the company be faced with a layoff situation?
A second major category of savings is inventory. Warehouse managers will admit they would reduce inventory if they had better, quicker, and more reliable information about what’s in stock at any given time. Thousands of companies have used bar coding to improve inventory systems and give management better information.

We all know that reducing inventory saves money. As with labor, inventory savings should focus on the variable holding costs of inventory. When quantifying how much your inventory application will save, determine the variable holding costs of your inventory.

1. Financing: Interest
2. Warehouse Expense: Insurance, power, property taxes, physical inventory (a warehouse labor cost)
3. Holding Costs: Obsolescence, deterioration, scrap, shrinkage

Many companies have a rule-of-thumb they use to calculate the cost of carrying inventory. De- pending on the industry, these costs range from 15% to 35%. Find out if your company has a gen- erally accepted inventory carrying cost percentage. If not, ask your finance department and your warehouse manager to help you estimate your company’s variable cost of maintaining inventory. You cannot go wrong using a conservative figure such as 15%. Most companies use 25%.

Example: Assume that your warehouse maintains a finished goods inventory of $4 million per year. Included in the $4 million is a safety stock of $400 thousand (or 10%) that you maintain because of problems with out-of-stocks due to errors in data. The bar code system will improve inventory ac- curacy and thereby give the manufacturing and warehouse managers the confidence to reduce the safety stock from $400 thousand to $200 thousand. This saves the company:

Financing 10% X 200,000 = $20,000 per year

Warehouse expense 5% X $200,000 = $10,000
Holding costs 5% X $200,000 = $10,000
Total Savings $40,000 per year

As you reduce inventory you could very well reduce labor. One way would be to reduce the cost of the annual physical inventory count. These numbers are conservative and are on a variable basis. Do not include fixed costs, fixed overhead or sunk costs in your analysis. You’ll also realize the additional benefit of having more accurate information on a real time basis.
Soft Cost Benefits
Here’s where “soft costs” or intangible benefits from automated data collection come into play. Soft benefits include better information, fewer shipping errors, more customer satisfaction, and more efficient manufacturing operations.

Intangible benefits are important to your company and therefore should be highlighted in your proposal. At the same time, you may not want to quantify them. It all depends on the culture of your organization, and the nature of the key decision maker. If the decision maker is a “by the numbers” type of person, you probably should be painfully conservative with your assumptions and estimates of soft benefits.

There are ways to quantify soft costs if you believe it is necessary. The risk is that the reader may disagree with your assumptions or method and, instead of focusing on the benefit of the bar code system, criticize your approach. If you decide to quantify some intangible benefits, try to use conservative assumptions that are validated by well regarded people in your organization.
Quantifying Soft Cost Benefits
Some data collection applications can help increase a company’s income. Here is an example of a way to quantify a soft benefit:

Example: The VP of Sales, has documented that in the last two years twelve large orders totaling $1.2 million were lost because the company could not deliver product to customers on the needed date. In these cases the inventory system indicated the items were in stock, so the customer was given a promised delivery date. When the orders were scheduled to be picked, the product was not in the warehouse. The customers went elsewhere when the ship date was delayed. At an average gross margin of 20%, these missed opportunities cost the company $240,000.

If your system will reduce errors, and your company has determined the cost of an error, then use it to quantify the savings:

Example: Manufacturing engineering estimates that shipping errors cost the plant $50 each. Last year, out of 180,000 shipments there were 300 shipping errors. The $20,000 bar code system will reduce those errors by at least 75%, saving $11,250.

One of the real benefits to automated data collection is the information it makes available to man- agement. The caveat is that you must have management that is progressive enough to use the infor- mation. Data alone is not a benefit – information is only useful when applied to operating decisions.

Investigate real time data collection and asset management systems.