Cost-Benefit Analysis: Cost Centers Never Measure ROI
There seems to be some confusion about measuring learning’s impact upon business outcomes. While the confusion is not unusual, the approach to measuring it is often conflated with the need to prove a Return On Investment, or ROI. I’ve written about this in previous articles, but needless to say, clarity about what stakeholders expect isn’t what they are getting from practitioners.
For organizational leaders, allocating funding to various areas of the business depends upon what the business area is expected to deliver financially. It does sound like this is alluding to an ROI, but it depends on your leaders’ performance expectations. Simply put, these expectations are dependent on whether the activity is a profit center, a cost center, or an investment center.
Naturally each of these “centers” incur costs, but the question is about what the leaders expect those incurred cost to deliver for the benefit of the organization. Profit centers are well described and are expected to deliver a profit for the costs they incur. This is the same for investment centers, but for the purposes of simplicity, let’s focus on profit. By definition, a profit is a financial gain; it’s the difference between the amount earned and the amount spent in buying, operating, or producing something. This means that a profit is the difference between the revenue earned and the cost of the item in question.
Profit centers are typically areas where leaders make tangible investments. Furthermore, these are not frivolous investments. Every dollar spent, especially with investments, are expected to deliver long-term contributions, ensuring growth in the business’ profitability. This is literally what the term “return” in ROI means.
Now, unless your organization actually sells training for a profit, either to other divisions or as an actual training company, you’re training and learning efforts can’t, and should never be, measured using an ROI calculation. Ok then, so how do we answer and address the stakeholder’s concern about how money allocated to training is going to deliver value?
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To answer the “how”, we must first define what a cost center is, and then show how to demonstrate value. The term “cost center” is one of the most misunderstood areas of business. Instinctively, the word “cost” implies a negative feeling. But for decision-makers, cost is a business reality and there are specific expectations when using it.
Costs, in all forms, are expected to deliver value. As described, the value costs deliver in a profit center is to grow profitability. In a cost center, however, the value is more subtle and indirect. The cost center responsibility (activity) is to use their investments (costs) to support and enable the businesses profit responsibilities (activities). Investopedia.com defines a “cost center” as
A cost center is a department or function within an organization that does not directly add to profit but still costs the organization money to operate. Cost centers only contribute to a company’s profitability indirectly, unlike a profit center, which contributes to profitability directly through its actions.
Unfortunately, learning practitioners continue to take offense when their leaders refer to them as a cost center. Don’t be offended. The learning function isn’t the only cost center. You are in good company with other essential operational activities, such as production/manufacturing, marketing, finance/accounting, and human resources. Each of these, like learning, are cost centers without which the business wouldn’t be able to function properly.
Embrace the cost center label as it will reduce your stress about how to prove value for your efforts. Regretfully, like every other operational cost center, it won’t excuse you from demonstrating value either. For sure, it’s not about calculating a Return On Investment, unless it’s for learning technology and infrastructure (but that’s a topic for another time).
The question to ask when developing a learning initiative is what benefit, or benefits, it will deliver for the business. The answer should be more than “employees will learn new skills” or “participants enjoy the training.” The response should also demonstrate some relevant financial metrics, such as costs saved or measurable productivity improvement resulting from the decision to pursue the effort. Stakeholders describe this as a “cost-benefit analysis” or CBA. Investopedia.com defines a CBA
…a systematic process that businesses use to analyze which decisions to make and which to forgo. The analysis sums the potential rewards expected from a situation or action and then subtracts the total costs associated with taking that action.
Prudent decision-makers conduct a cost-benefit analysis to evaluate all potential costs and even the effect the initiative, albeit indirectly, will have on revenues from the effects of the initiative. The outcome of the analysis will determine whether the initiatives improvement of the qualitative performance elements translated into financial terms outweighs (shows a positive benefit) the tangible financial allocation it makes into the initiative. If so, then the benefit outweighs the cost of doing the initiative.
Decision-makers will construct various scenarios in a cost-benefit analysis, but they will also factor the opportunity cost into the decision-making process. Opportunity costs are alternative benefits that could have been realized when choosing one alternative over another. In other words, the opportunity cost is a forgone or missed financial opportunity as a result of a choosing to go with your learning effort.
The challenge is often around the financial quantification of the qualitative benefits. Sometimes costs are clear, such as the savings in material when reducing the percentage of defects or product returns. Other times, it can be more subjective, such as measuring employee work efficiency or improved customer satisfaction. These are the intangible costs of a decision and are equally relevant to your decision-makers.
This is why it’s essential to always involve those impacted by your proposal, along with those making the financial decisions, when evaluating their expectations. Since learning’s role is to improve the intangible operational elements, such as employee performance, you should always assess, then address how your effort will contribute to improving their need.
Conducting a cost-benefit analysis is more relevant and widely accepted by stakeholders. Doing so also demonstrates your credibility for showing the true value for your learning efforts. But operational activities within a business are not islands unto themselves; there are interdependencies. This means you must stop believing “if you build a learning effort, they will come.” They probably won’t, and you’ll be held accountable for wasting scarce resources. Never come to your own conclusions. Allow those affected by your proposal to dictate what they expect to receive, and then design your effort addressing these expectations.
Please share your thoughts and feedback with us. We would enjoy hearing about your efforts. And who knows, it may be the topic of our next eLearning Industry article. Also, please check out our LinkedIn Learning courses to learn more about developing business credibility for your learning efforts. Please share your thoughts and remember #alwaysbelearning!
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