When faced with a decision about spending money, do you take the time to analyze the payback that you will get? If your overall goal is to save money, are you sure that the investment that you are about to make will save you money in the long run?
These questions occurred to me this week while watching a national newscast about the high price of gas. This particular segment caught my attention because a family was being interviewed at a Toyota dealership in Naperville, IL. My family and I lived in Naperville for 12 years before moving to our current home in the St. Louis, MO area about 11 years ago. So this was more than just another “price of gas” story to me.
The family being interviewed stated that they were buying a more fuel-efficient car so that they could drive their gas-guzzling SUV less, thereby, saving money on gas. My brain instinctively and immediately started doing the math. (This is either a blessing or a curse depending on who you talk to.) Somehow I knew that the numbers just didn’t add up.
To do this mental exercise I had to make some assumptions due to lack of information from the interview. The assumptions that I made are as follows:
• The SUV gets about 15 miles per gallon.
• The family drives about 15,000 miles per year.
• The new fuel-efficient car will get about 30 miles per gallon.
• The price of the fuel-efficient car is $20,000.
• The price of gas is $4.00 per gallon.
Now comes the fun part. Based on these assumptions the SUV will use 1,000 gallons of gas a year. The new fuel-efficient car will use 500 gallons per year. That is a savings of 500 gallons of gas a year. At $4.00 per gallon the family will save $2,000 a year. On the surface this sounds great. Who wouldn’t want to save $2,000 a year on gas? However, to get this savings, the family had to spend $20,000 for the new car. This means that it will take 10 years for this $20,000 investment to pay for itself.
The example above is an illustration of the process of doing a proper cost / benefit analysis. However, it does violate one of the key rules: NEVER MAKE ASSUMPTIONS! If you are doing this for your business or your personal life you would want to use facts. If some facts may be subject to change, such as the price of gas, use your best analysis of what the facts will be. If some of the above assumptions are changed: the family drives 30,000 miles per year; the new car gets 40 miles per gallon; the price of gas is $6.00 per gallon, the savings per year is $7,500, and the new car pays for itself in less than 3 years.
The key concept is: do the math and make fact based decisions. Avoid saving money in one account only to have overall expenses rise.
What a great point! We so often make assumptions about how the numbers will play out. I want a more fuel-efficient car too, but I’m holding out until there is something radically better – I don’t think 30mpg is it.
This played out for me in reverse the other day – we were doing some calculations on the cost of IT downtime (wasted productivity if people couldn’t work because their systems weren’t running). To my surprise, even the most conservative numbers generated a huge ROI for this company. 1 hour downtime x 10 people x $50 per hour burdened cost per employee (which is most certainly a low figure) = $500 wasted per hour of downtime. We’re looking at risk of a full day’s outage or more. To justify the new equipment they need that easily makes the business case.
Wendy
Thanks for your comments Wendy. You make a great point.
My experience has shown me that if any organization looks for “muda”, the Japanese word for waste, in their processes, the cost to prevent the “muda” is far less than the cost of the waste itself. Downtime, rework, excesses inventory are just a few examples of waste. Eliminating waste not only saves money, it speeds service to the customer. This is how a company can effectively reduce costs and improve service to their customers at the same time, creating a win-win situation for all involved.
Ed