Traditionally, call centers have acquired new technology and funded new initiatives with capital dollars. However, more and more technology is now being offered “in the cloud” as a subscription-based service rather than a premise-based technology solution. When evaluating these pay-as-yougo subscription-based services, it’s important to understand not just the technical pros and cons of the new model, but the financial tradeoffs, as well. This article provides an overview of the concept of net present value and how to apply this time value of money when evaluating whether to purchase your own premise-based technology or subscribe to that technology as an ongoing service offering.
Model for Decision Making
Cost justification, or the calculation of savings/benefits, can be accomplished several ways. The two most common methods are return on investment (ROI) and payback period. To be calculated accurately, both these models require the calculation of net present value (NPV). NPV takes into account the time value of money (interest and inflation impacts) and is the model that your CFO uses to evaluate whether an investment is worthwhile enough to warrant the use of the company’s money.
It’s important to be able to calculate payback period and ROI using NPV so you can evaluate vendor proposals of technology payback. Some vendor proposals may not use NPV in their calculations, either because the salesperson doesn’t know how to use it, or more likely because the true payback period will be longer if calculated correctly using the NPV assumption.
Payback and ROI Example
Let’s take the example of a 300-seat call center purchasing a workforce management (WFM) software system. The WFM package costs $225,000 to purchase (including cost of software and required hardware and system costs). We anticipate it will make staffing and scheduling much more productive and actually save headcount by more efficient use of staff and reduce current overtime charges. The savings anticipated in the first year are $75,000, and $120,000 each year after that (after paying maintenance costs). With a simplified payback calculation, we simply divide the purchase price by the savings per month to determine the number of months it would take to pay for the system. In this example, the payback period would be 27 months.
If we evaluate the return on the investment over three years (a common timeframe for evaluating technology investment returns), then the savings would be $315,000 compared to an investment of $225,000 for a return of 140%. However, these calculations of payback period and ROI ignore the time value of money. Now let’s take a look at a more accurate method of calculating this payback based on a calculation of net present value.
Net Present Value Calculation
The basic concept behind NPV is that a dollar in the future is generally worth less than a dollar today because people generally prefer present consumption to future consumption, inflation decreases the value of currency over time, investment of today’s dollar can increase its value, and any uncertainty or risk associated with future money reduces its value.
If $1 is invested at an interest rate of 5%, then at the end of the year it should be $1.05. On the other hand, if $1 is buried in a can in the back yard and inflation is running at 5%, then at the end of the year, the $1 has only $0.95 in buying power. Therefore, the time value of money works in both directions. If I earn $1 today, it is worth $1. But if I don’t receive it until a year from now, it isn’t worth as much as $1 today due to the impact of inflation. Exhibit 1 shows the present value of a dollar over 10 years at rates of 4% to 10%.
Exhibit 2 shows the calculation of NPV on an investment of $225,000 for a new WFM system. The company has forecast net savings in agent labor costs after maintenance costs are paid. There is a savings (or positive net cash flow) each year, which increases as use of the WFM system is optimized after the first year. This example assumes a 5% rate. Notice that even though the savings projected for years 2 through 4 is the same $120,000, the NPV of each year is successively less due to the impact of inflation on the value of that money.
The savings and return depend upon the length of the analysis period. If a 3-year analysis is done, the savings ($284,040) will pay for the $225,000 investment, with the investment covered after 29 months (as compared to 27 months in our simpler vendor payback estimate). The ROI calculation would compare savings to the initial investment for a 3-year ROI of 126%. The total NPV of the savings over 4 years looks better with a net return of $157,764 or 170%. If the analysis is done for more than four years, it will look even better than the savings shown here. Therefore, the sensitivity of the timeframe for the analysis is an important consideration and should be based in part on how long the technology is likely to be in place.
Purchase vs. Subscription
NPV should also be used to compare two ways of paying for a solution such as a purchase versus a “lease” or “subscription” to that same service or technology. Since the outflows will vary between the two payment methods, but the savings are likely to be similar, the NPV is a good way to see the impact of paying less upfront but more each year for the lease alternative.
In the analysis above (Exhibits 3 and 4), the subscription-based cost of $9 per person per month for a 300-seat center ($2700 per month or $32,400 per year) are compared to the same premise-based technology solution discussed above. We have also assumed a cost of $50,000 for implementation services and customer project management in year one. The net annual savings is increased over the purchase analysis due to the lack of a separate maintenance fee assumed to be 18% of the purchase price or approximately $40,000 per year in years 2 through 4.
This additional calculation allows us to compare the two financing options over a 4-year period. While the purchase seems better based on the cumulative NPV, there is still another step to consider in the analysis. In the purchase, the original investment of $225,000 must still be accounted for while the subscription costs are all included in the annual figures in the analysis. Therefore, in this example, the net savings of the purchase over the 4 years is $157,764, while the net savings of the subscription is $323,882. There is a payback for the subscription in month 13, as well, given the lower upfront investment.
In summary, it is important to consider all the costs and savings potentials in the analysis of alternatives, especially when the payment process is quite different among the choices. Net present value is a key element to the analysis and setting the rate to be used should be done with the advice of your finance department. They will also provide guidance on the number of years to be considered in the analysis and may recommend that two sets of numbers be developed to bracket the potential useful life of the system and depreciation options. Having your numbers right will earn considerable credibility with the senior management team that is reviewing your recommendations. Once all of the financial elements have been considered, there are still the technological analyses and the review of the vendors’ capabilities to be included in your final decision.
Maggie Klenke is a Founding Partner of The Call Center School, a provider of education and training solutions for contact center professionals.
– Reprinted with permission from Contact Center Pipeline, www.contactcenterpipeline.com