An Energy Trading and Risk Management (ETRM) system is specialized software that represents a serious investment. To justify a purchase, buyers and decision makers will create a business case including a calculation of the software’s return on investment (ROI), a specific calculation of an investment’s cost versus its benefit. This can be difficult in terms of identifying what is important and how to quantify the value. To get a better understanding, let’s look at those areas and some of the benefits that users may realize by using a comprehensive ETRM system: The Return on Investment of an ETRM solution.
ROI is a calculation that allows companies to describe the money derived from an investment and its cost. The ROI is a ratio that compares the gain or loss from an investment relative to its cost. The ROI for software quantifies the potential of a software application to deliver results for the business; increase revenue, decrease cost, or achieve operational efficiencies.
There are multiple methods for calculating ROI.
The most common method is:
ROI = (Gain or Benefit of Investment) - (Cost of Investment) / (Cost of Investment) x 100
In this case, the ROI is shown as a percentage instead of a ratio for ease of understanding: if the percentage is positive, the returns exceed the total cost. If the percentage is negative, the investment is generating a loss.
We will look at the two components of this calculation below and consider how they relate to ETRM software purchases. As part of the ROI assessment, one may want to establish a baseline by figuring out what the current costs are when not making any changes to the current processes.
Gain or Benefit of the Investment
The gain or benefit of investment is the amount of money you stand to gain from implementing the new ETRM system. The core of a next-generation ETRM system is that it brings value to either reduce pain or to enable to gain, i.e., allowing companies to take on new activities they could not do before. It earns its justification by increasing commercial competitiveness, reducing operating cost, improving process efficiency, risk mitigating, and creating opportunities for growth and transformation.
Below is a specific example of a commodity trader who implemented a CTRM system and identified the following areas of optimized business processes and improved operational efficiencies.
It may not always be easy to calculate the gain/benefit. When calculating, do this in relation to a specific time period, and consider applying a range to reflect an optimistic and pessimistic estimate of the gain/benefit.
One way of quantifying process optimization, risk mitigation or staying compliant with industry regulations and standards, is to approach this by looking what could go wrong when using spreadsheet or siloed systems, where data may not be current. Actual amounts would need to come from each individual company’s experience and the values below are just for illustration.
Per the example above, over a 4-5 year period the company would generate close to $4.0M in positive returns and cost savings as a result of better insight, control and process improvements.
Value may also be gained from a combination of process optimization and utilization of staff. For example, with an integrated ETRM system, the back-office will benefit from straight-through-processing and built-in workflow management - streamlining the contract-to-bill process. State-of-the-art back-office automation, improves leaving no money on the table and may result in substantial savings and efficiency gains, reducing the number of FTE’s or reassigning those to more value-add roles.
Other gains may come from:
Cost Of Investment
Before getting to the cost of new software, one may first assess what is being spent in the current situation. It may reveal that the company maybe spending a lot of money on maintaining and managing outdated and underperforming systems incapable of supporting the business and limiting growth. In other words, maintaining the status quo might be costly.
With that in mind, the cost of your investment is the amount of money you will spend on the acquisition of the software, the implementation, and the maintenance of the new ETRM system.
The most obvious costs are:
- One-time software license fee (Non-SaaS) or recurring subscription fee Software-as-a-Service (SaaS)
- 3rd party software or hardware as needed e.g. databases, servers, workstations
- Recurring maintenance and technical support cost (Non-SaaS)
- Professional services cost for implementation of the software including installation/provisioning, scoping, training, data migration, integration, and testing.
- Cost of external consultants helping with the procurement (or implementation) process
- Cost of for anticipated change requests for new or missing functionality (scoping, configuration, testing).
- Future upgrade cost
- Miscellaneous cost, such as escrow account
In addition to the actual identified costs above, think about the opportunity cost you're incurring. The time your staff spends on assisting with the procurement process (drafting or working with a 3rd party consultant on drafting requirements) as well their time allocation on the actual implementation project (consider 50% of their time), is time that could have spent elsewhere. You can also expect a period of diminished productivity while your staff adjusts.
After identifying and estimating the above costs and benefits on an annual basis, the next step is to calculate ROI. To calculate the potential ROI of your ETRM software, use the following formula to calculate your ROI multiple.
For example, if the combined gain of investment is $30M over 4 years (excluding the first year when the solution is implemented) and the combined cost of investment is $5M over 5 years, then implementing the new ETRM system is projected to yield 6 times the cost involved.
The classic question is ‘how much it is going to cost and how long it is going to take’. However, a new ETRM is not just a system installation, and the focus should be on value realization. Considering the ETRM implementation as an investment for ROI purposes would be the first step in a long-term system investment program. This also means it is not just about cost reduction and operational excellence but also about corporate innovation and sales growth.
Considering all the variables involved in an ETRM system's gain and cost is no easy task, especially because some of the real costs and benefits of an ETRM system may not be visible. But by taking the time to make a solid calculation, you'll be able to compare the merits of the acquisition of an ETRM system. It will help present a solid argument to stakeholders and decision-makers about why this choice is the best route forward for your company.
With Hitachi Energy, you not only invest in solutions that do what was done before better, faster, easier, and cheaper but also allow to extend and adapt for continued usage and ultimately resulting in a lower total cost of ownership over time.
Learn more about energy trading and risk management (ETRM) from Hitachi Energy.