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entigral whitepaper Calculating ROI for an RFID Asset Tracking System www.entigral.com | 877.822.0200 Calculating ROI for an RFID Asset Tracking System It can be difficult putting a credible number on the ROI for an RFID deployment, however, without it, you’ll likely meet with a lot of resistance from the CFO when you try to get your RFID project funded. This white paper provides the guidance on how to compute and present the ROI business case for an RFID deployment. It discusses how to go about calculating the cost of operations for your existing processes and how to compute the potential ROI from deploying an RFID asset tracking or inventory tracking system to determine if one makes sense for an organization. It covers how to estimate the costs to a corporation for not having a tracking system, based on lost assets and time usage to address the lost assets. Radio Frequency Identification (RFID) systems hold tremendous promise for organizations that have trouble with properly accounting for their various assets and/or inventory items. By placing tiny radio transponders on the items in question, the movement of these items can be detected; physical inventories can be accomplished in a fraction of the time; theft and loss can be prevented; processes can be monitored and tracked; and critical items can be located and utilized more efficiently. It is no wonder then that RFID continues to gain traction in industries such as manufacturing, retail, healthcare, transportation, and energy. Any company that needs to keep track of a highly valued asset or a large volume of “things” must certainly evaluate the merits of RFID. Despite the intuitive benefits perceived from having greater visibility over one’s assets, companies struggle with discerning if there is truly a financial benefit to implementing RFID and, if so, how much? Certainly some sort of Return On Investment (ROI) calculation is in order. Yet many companies struggle with how to properly determine this ROI due to the complex nature of their processes and, perhaps more specifically, the un-quantified costs of their existing situation. While several RFID ROI calculators can be found on the internet, most of them were developed for a particular application or company in mind, mostly in the retail space. Their guiding parameters may not be applicable to organizations with different concerns. Instead, potential users of RFID are forced to develop a calculation on their own that properly evaluates their unique issues. But how to best do this? This paper acts as a guideline to help answer that question and to aid those considering process improvements using RFID technology. 2 | www.entigral.com Quantifying The Current Situation The single most important aspect (and perhaps the one most challenging to ascertain) of any ROI calculation is determining the cost implications of the existing process. This should be the first step in any cost justification process. For example if solving the lost items issue is your objective, it is one thing to know that items can’t be found, it is another thing to know how frequently they get lost, and yet another to assign a realistic value to cost of finding those items when they are needed. In some cases the cost may not be limited to the wasted human labor of the person looking for the item, there may be impact on production efficiency or other opportunity costs. Having this information is imperative as it becomes the baseline against which all improvements are measured. So, how is this accomplished? Like all of the issues we will discuss in this paper, the answer depends greatly on the unique nature of the operation or process. Every company has different processes and different issues impacting them. The key is to discern what the most important of these are and to come up with a definable economic impact. If someone is evaluating RFID systems they should have, at least, a general idea of why they need one. The first step, then, is to quantify that need as best as possible. The best way to do that is to ask a series of questions that helps ferret out the information. Some examples are: 1. What are the items that matter and require better accountability? This should be as specific as possible. If, for example, the answer is “tools,” is it all tools or only tools of a certain value? Is it only the tools that need to be calibrated? Is it only the tools used by a particular department or assigned to a certain project? Is it all of the above? 2. What is the current visibility accuracy on these items? Quantify, as best as possible, the inventory accuracy. If a recent audit has been performed, that is a good start. But other ways to address this are to ask “How many times per day/week/month can something not be located out of all of the times that it is needed?” Or, “How frequently are items in short supply and typically by how much?” 3. What is the Intrinsic Value of these items? The actual cost of a data tape may be $50. But the cost of losing its sensitive information could be millions of dollars. When assigning monetary figures to anything, ask “What would be the cost impact of losing or not being able to find this item?” In some cases (e.g., a human life), the item may be priceless. 4. What are the current costs for managing these items? How are accountability issues handled today? If something is missing, how is it located? What is the cost impact of this – for example, 1 person spends 10 hours per week searching for items at a cost of $X per hour. Do replacements need to be ordered at expedited freight charges? What is that cost? Do physical audits need to be taken routinely to maintain accountability? Factor the overall costs of these? 5. What are the ancillary costs associated with the missing items? In addition to the direct costs of managing the items, what are the other costs associated with losing them? What is www.entigral.com | 3 the lost revenue associated with not having finished product available? What are the impacts to manufacturing when raw materials or tooling are not available? How does lack of visibility impact financial accountability for depreciation and Sarbanes-Oxley reporting? How does inventory inaccuracy impact other departments? Customers? There may be other cost factors associated with a particular situation. Be careful to consider them all. One of the challenges in calculating a return on any technology such as RFID is that the costs are often hard to describe monetarily. They may include items such as reduced customer satisfaction or diminished productivity, which certainly are of value, but are hard to relate to dollars. Still, these need to be calculated as best as possible to complete a full ROI analysis of the project. Assumptions may need to be made. Once these answers are established, a company can develop a basic understanding of its existing visibility situation. On the most basic level a calculation can be as follows where Visibility Inaccuracy is the percentage of total items that are lost, stolen, or cannot be found. The Annual Cost of Status Quo figure represents the problem’s total cost, and the potential costs savings if the problem is 100% solved. Once this is known, it is wise to set an improvement target. While everyone desires a 100% reduction in costs for any project, the reality is that the final result will most likely be something less than 100%. How would his effect the calculation? If, for example, inventory accuracy was improved to 98%, how would this impact the costs? Is there a dramatic savings? How much will the cost of management be reduced? The ancillary costs? Run the calculation at various percentages to determine various cost scenarios. These will be useful when calculating the formal ROI process. Often, there is still a tremendous cost savings even with a less than 100% improvement. Examining The Use Cases With knowledge of this basic formula, we will now examine the costs typically associated with some of the most popular use cases for RFID. 4 | www.entigral.com Number of Items Average Intrinsic Value x (Can use annual depreciation value) Total Item Value Visibility Inaccuracy (1 - accuracy %) Cost of Management/year Ancillary Costs/year Annual Cost of Status Quo x + + INTRINSIC VALUE The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. While there are many applications for the technology, at the core level most use cases typically can be categorized into one of two broad applications: 1) Inventory Accuracy, or 2) Asset Tracking. Inventory Accuracy Inventory is defined here as any item that is either produced or consumed in production by a company. Thus, this includes raw materials, finished goods, work in progress, supplies, etc. All of these items share the following characteristics: 1. They are all transient. They all move from place to place throughout the course of normal business operations. 2. They all have value. There is a definable cost for each item. 3. They all have a downstream process dependent on them (manufacturing, shipping, etc.) These characteristics create an environment where valuable items are moved from one place to another. Improper management results in not having the right things in the right place at the right time. A key contributor to this is shrinkage – the loss or theft of a certain percentage of the inventory. Shrinkage results in the actual quantity of items available being less than the expected quantity. There are several definable costs associated with shrinkage that implementing an RFID solution addresses: 1. Replacement costs. When inventory items go missing they need to be replaced. Often this is at a cost higher than the standard cost of the item as the order quantities are smaller and there are expedited shipping fees involved. If the inventory consists of finished goods, then the replacement cost translates into a cost of expedited sales, i.e., what are the costs of pulling inventory from a different location and expediting shipment? 2. Lost sales/miss-ships. Typically in a retail environment, if inventory is not available on the shelves, sales are lost as customers go elsewhere. For a manufacturer, what are the consequences (penalties, cancelled orders, etc.) of not meeting shipping deadlines due to lack of product, or for shipping the wrong products or quantity of product? 3. Increased downtime. Manufacturing lines are costly to run. Are machines sitting idle waiting on materials? Are forklift drivers often waiting for items that cannot be found? Calculate the total cost (wages, power/fuel, etc.) of waiting on needed materials. These costs can be reduced with accurate knowledge of material status. 4. Inventory and search time. Many companies are often amazed at how much time is spent controlling inventory accuracy. How often are physical inventories taken? How long do these take? How many man hours are spent searching for missing inventory? Not only can RFID minimize www.entigral.com | 5 the need for periodically counting inventory, it can also reduce the time to do so. Calculate the amount of wages spent on these processes and how the time might be better spent. All of these costs should be factored into the basic calculation we looked at above. Not all inventory has the same shrinkage rate, so the items with the highest tendency for inaccuracy should be evaluated first. What is the accuracy of that inventory? Then quantify and add the related costs discussed here to complete the calculation. Example 1: An automotive supplies manufacturer loses 3% of finished parts inventory each year. This results in a periodic need to rush manufacturing and expedite shipments. Number of Items 50,000 / year Visibility Inaccuracy 0.03 Missing Inventory 1,500 / year Average Intrinsic Cost x $100 Lost Items Value $150,000 / year Cost of Management/year - Incremental replacement costs ($10 more / item) + $15,000 - Expedited shipping fees ($5 each replacement) + $7,500 - Search/audit costs (2 hrs./wk. @ $20) x52 + $2,080 / year Ancillary Costs/year - Penalties / Lost orders + $12,000 - Annual Inventory (80 man hours @ $20/hr.) + $1,600 Total Costs:$188,180 This reflects the current cost of operations. In comparison, examine the same scenario where an RFID system cuts shrinkage by two thirds (a conservative estimate) to 1% and eliminates the need for an annual inventory: Number of Items 50,000 / year Visibility Inaccuracy x 0.01 Missing Inventory 500 / year Average Intrinsic Cost x $100 Lost Items Value $50,000 / year Cost of Management/year - Incremental replacement costs ($10 more / item) + $5,000 - Expedited shipping fees ($5 each replacement) + $2,500 - Search/audit costs (1 hr./wk. @ $20/hr.) + $1,040 / year Ancillary Costs/year - Penalties / Lost orders + $6,000 Total Costs:$64,540 An annual savings of over $120,000, exclusive of the RFID system costs (which will be discussed later). The company can now determine if this cost savings is relevant enough to pursue an evaluation of RFID. 6 | www.entigral.com Asset Tracking: Assets differ from inventory in that they are permanently owned items that are used in the production or transit of inventory, or for the general running of the company. These could include tooling, containers, computers, molds, pallets, or files. They share the following characteristics: 1. They are capital items, often with a depreciation value. 2. Though they may move, they ultimately have a defined home location. 3. Their existence is essential for the running of the business. Although there are many types of fixed assets, those of particular concern are the ones with a high intrinsic value. These often need to be located for repeated use, and the inability to locate them or to determine where they have been can have serious production and financial impacts. Tools may need to be calibrated. A missing mold can halt production. A missing container can delay shipment. Missing computers and files may contain highly sensitive information. Among the definable costs: 1. Search costs: Since assets need to be utilized, they often need to be transported to various locations. Despite workers’ best intentions, asset movements are often not recorded, and even large assets can go missing – especially assets that have not been used for some time. The time spent searching for these items can be lengthy and may often be done by highly paid staff. Hospital nurses often spend 20% of their time searching for needed equipment. Manufacturing engineers can spend hours locating a particular tool. 2. Replacement Costs: Items that are never located need to be replaced, often at a higher cost as expedite fees are incurred. The old assets must be depreciated in full in accordance with Sarbanes Oxley rules, and the new assets acquired must be valued based on proper accounting requirements. 3. Increased downtime: As mentioned, manufacturing lines are costly to run. Are machines sitting idle waiting on proper tooling? Are shipments being delayed due to lack of shipping containers? It is important to calculate the total cost (wages, power/fuel, etc.) of waiting on needed items. These costs can be reduced with accurate knowledge of material status. With some fixed assets valued in excess of $1,000, the loss of even a few becomes costly. To determine if this is an issue, assess the assets 1) that have high intrinsic value, 2) that have high loss rates, and 3) that have the greatest impact on production cycles. Aggregating these will determine which assets have the highest associated cost. www.entigral.com | 7 Example 2: A manufacturer often spends hours searching for high value tools that are shared among various departments. Number of Tools 500 Average Intrinsic Costs x $1,000 Total Asset Value $500,000 Number of Items Permanently Lost / yr. 10 Number of man hours searching / week 20 Lost Items Replacement Costs $10,000 / year Cost of Management/year - Incremental replacement /expedite costs + $2,000 - Search/audit costs (20 man hrs./wk. @ $50/hr.) x52 + $52,000 / year Ancillary Costs/year - Production Idle Costs + $20,000 - Capital write off of lost assets (assume %20) + $ 2,000 Total Costs:$78,000 / year Now, if the searches and lost items were reduced by 80% we would get… Number of Tools 500 Average Intrinsic Costs x $1,000 Total Asset Value $500,000 Number of Items Permanently Lost / yr. 2 Number of man hours searching / week 4 Lost Items Replacement Costs $2,000 / year Cost of Management/year - Incremental replacement /expedite costs + $400 - Search/audit costs (4 man hrs./wk. @ $50/hr.) x52 + $10,400 / year Ancillary Costs/year - Production Idle Costs + $4,000 - Capital write off of lost assets (assume %20) + $400 Total Costs:$15,200 / year In this example, a savings of over $60,000 per year. Again, while this does not include the RFID system costs, the proposed annual savings appear to be relevant. Examining RFID System Costs Once the cost savings are identified, it is time to calculate the cost of the proposed solution. RFID systems can vary greatly in configuration, but all are comprised of four primary components: Tags, Hardware, Software and Services. Likely, anyone considering an RFID system will seek out a specific price quotation from a qualified System Integrator, but we will examine the basic costs here to assist with ROI calculations. 8 | www.entigral.com RFID Tags: RFID tags and labels come in numerous varieties depending on their shape, size, and construction material. While the internal microchip may be the same, the different costs relate primarily to how the tag will be affixed to the items that need to be tracked. There are two major classifications of tags: peel and stick labels, and durable tags. Peel and stick labels are ideal for items where there is a flat, clean, non-metallic surface. Cardboard shipping cases and paper file folders are good examples. RFID labels are the most inexpensive form of RFID tag, with prices typically well under a dollar. Costs will vary by size and order quantity, but estimating a price of $0.15 - $0.40 each is certainly realistic even for modest quantities. Durable tags are designed for permanent mounting on metal and on items where the chip needs to be protected (tools, electronics, vehicles, high heat, etc.). Due to the specialized nature of the packaging materials these tags are more costly. Expect prices to vary between $1.00 and $5.00 per tag. And though a $5.00 tag may sound expensive, if it is tracking a $10,000 item the cost may be easily justified. RFID Hardware: There are three major hardware pieces to consider depending on the project: 1) fixed RFID readers/portals, 2) handheld or mobile RFID readers, and 3) RFID label printers. The exact mixture of these devices will depend upon your particular application. If you are using durable tags, you will likely not need a printer at all, as these tags either come pre-encoded or are encoded manually. Peel and stick labels typically go through a printer, and while there are units as low as $1,000, expect to pay between $3,000 and $5,000 for an industrial grade device. Fixed RFID readers are used to record tagged objects that pass by them and are typically used in doorways, on conveyor lines, or at other “choke points” where materials tend to travel. The typical reader can be mounted on a wall or ceiling and often supports 4-8 antennas. Free standing portals combine all of these elements into a single box which can often save deployment time and money. Their installation is much simpler due to the lack of antenna cables and installation of mounting brackets in walls, etc. In either case, one must also account for the cost of running an Ethernet cable to the reader location (and also power if the device does not support Power Over Ethernet). All told, it is reasonable to estimate each “choke point” to cost between $2,000 and $4,000. TCO BREAKDOWN Cost distribution over 3 year timeframe. www.entigral.com | 9 Handheld RFID readers have typically been developed as handheld computers complete with keypad, display, Wi-Fi connectivity, and an integrated RFID reader. Various form factors exist with costs ranging from $2,500 - $5,000. However, newer “reader only” handhelds are now emerging that contain no display or keypad and use Bluetooth to connect to a host device. These devices cost between $1,000 and $2,000. Which you choose will depend on your application, but make sure you factor in recharger and additional battery costs as well. RFID Software: The largest price variance comes with RFID software. Software solutions vary from as low as $5,000 to $150,000 depending on the functionality and complexity of the application, and the level of integration with your other business applications. While this may make calculating an ROI challenging without getting more precise information, there are some guidelines that can be followed. First, consider the system’s scope. If this new system is to be deployed Enterprise-wide with multiple read points and components, then surely it will require an investment approaching or even exceeding $100,000. Many software providers require a license for every fixed and portable reader in the system, so that may provide some aspect of scale. Interfacing with legacy systems (ERP, MES, WMS, etc.) typically carries a significant cost as well. Second, determine if the need is for a point solution or a platform. If the project is small and limited in scope, then a lower end system focused on that one task may suffice. In most cases, however, firms tend to grow their use of RFID and require that their RFID software grow with it. This lends itself to a platform based approach where multiple applications can work together, often sharing the same database and control software. A single software platform solution can do both inventory and asset tracking as described above. In some case, new business logic may need to be created as requirements change, but a platform based approach provides the flexibility to adapt as usage grows. Finally, it is important to understand if the software in question is pre-built or customized. Pre-built, off the shelf, software often is less expensive initially but may be more expensive if and when changes need to be made. In some cases, the vendor may even refuse to make changes or do customization which may require the installation of a different package altogether for the new requirements. This duplicative effort may, in turn, create more internal cost and resources affecting the ROI. A pre-built system may also require you to alter your process to work within its framework. Custom built software can be costly up-front, but it is tailor made to the customer’s requirements and may be less expensive to operate in the long haul. Recently, over the past year or two, software that is a combination of these two approaches has become popular. This software may be 80% pre-built, with much of the core functionality already in place. The last 20% is then customized or personalized to meet your current processes and needed requirements. RFID Services: The final component deals with the costs associated with developing and installing the RFID system. These costs will vary, of course, based on the complexity of the system. The costs will also vary based on if they are performed in-house or by a System Integrator. The specific services you require may include 10 | www.entigral.com a formal site survey to assess the facility and to determine the proper placement of readers, antennas, etc. Tag evaluation services may be needed to determine the ideal tag and its best placement on the various items. Process re-engineering may be needed to ensure the optimal workflow for the system. And installation services to properly install and deploy the needed hardware and software components is a given. In most cases these are charged out on a daily basis at rates between $2,000 and $7,000 per day. Other service fees typical to large IT projects may also be incurred, such as, pilot management, system design, system training, project management, system warranties, consulting and the like. One should also factor in the man hours associated with internal staff planning and delivering the system. Determining The Proper ROI Calculation Once armed with the likely costs, the final question is to determine the proper ROI calculation to use. There are over a dozen accounting formulas that are used to quantify a certain return on an investment, and each has a unique value in its perspective. Briggs and Trigos in Analytics discussed various ROI calculations and how well they work with RFID technology. Their conclusion was that Net Present Value (NPV) was the best formula to use, being the most precise. NPV is defined as “the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.” The formula is: Where – the time period you want to evaluate (the life of the project) – the interest rate that could be earned on an investment in the financial markets with similar risk.) – the net cash flow i.e. cash inflow – cash outflow, at time . In short, it is a calculation where you determine if the projected financial benefits outweigh the projected costs. A positive result is favorable; a negative one is not. Determining the projected costs is rather simple. These include the depreciated costs of the hardware and software plus reoccurring costs such as tags, etc. as described above. The projected benefits equal the cost savings detailed in the previous Use Cases calculations – the difference between today’s costs and the anticipated future cost. If we use the asset tracking scenario in Example 2 above as our case study, we will make the following assumptions: • The cost of the required hardware, software, and services is $150,000 and fully depreciated evenly over five years ($30,000/yr.) • Reoccurring tag costs equal $5,000 per year. • Market interest rate is projected to average 7% over the 5 year project life. www.entigral.com | 1 1 Then the calculation would be: (The annual cost savings) – (The yearly system costs) x five years divided by the interest rate, or as follows: NPV = (($78,000 - $16,200) - $35,000) x 5 (1 + 0.07) 5 = $95,540 Thus, this project would have a positive benefit to the company, saving them $95,540 over five years (assuming the interest rate stays at 7%). This investment can then be compared against other investments to determine relative worth. Conclusion Calculating the value of an RFID system is not difficult as long as a true and clear understanding of the existing process costs can be determined. To accomplish this, the potential user must be open and honest about what their true current costs are and not oversell the value of the new RFID solution. Once existing costs are established and proposed costs savings can be estimated, it is a simple mathematical formula to determine the overall merit of the system and how it may positively or negatively impact the overall operation. 12 | www.entigral.com Tel Email Fax Web 877.822.0200 [email protected] 877.822.0200 www.entigral.com