Three ways to look beyond ROI and make better decisions
“How is the guy who is all about data looking at this decision on the basis of whether it will be fun?”
I was recently chatting with a colleague when she asked me this question about a meeting we had with a fellow consultant. The three of us were batting around the idea of collaborating together on a podcast or some other way of jointly promoting our services.
I let out a small chuckle. Her question caught me by surprise. For a moment, I too was surprised by the words that had come out of my mouth. Was I really assessing the potential of a new marketing strategy through a lens of enjoyment rather than some financial calculus?
I was.
But it was deeper than that. Over the course of my career, I’ve been an ardent student of data and the power of information to improve outcomes. And what I’ve come to love is how data is as much an art as it is a science. Knowing the context of what you’re assessing is as important as the analysis itself.
Take a Return on Investment (ROI) analysis for instance. It’s the gold standard for decision making for many in the business world. A simple way of determining if the benefit of an investment or decision will outweigh its cost.
This calculation works great when the variables are fairly certain and straight forward. For example, deciding whether to buy a new piece of equipment or whether to hire a stellar operations consultant (shameless plug) can be a relatively simple exercise. The costs are known and your estimation of the potential return can be reasonably certain. There’s precedent and track records to back it up.
But what about when you’re assessing something that doesn’t have a track record? Like building a new product or service offering, or creating a new strategic partnership? The likelihood is, your ROI estimation is nothing more than a guess. And we entrepreneurs can be pretty bad when it comes to predicting the success of our own ideas.
So what are we to do? When uncertainty is high, how can we overcome the entrepreneur’s bias to decide if a new idea is worth pursuing? Here are three ways to look beyond ROI and take your decision making to the next level.
The 5x Rule
Too often, I’ve seen business owners settle for any opportunity with a positive ROI, even if the return is small. The problem is, when uncertainty is high, having a positive ROI isn’t enough.
Let’s say you invest $10,000 on a new idea which yields you $12,000 in return. You might think $2,000 in profit is a great return! But what if you also invested $10,000 on another idea and lost $5,000? You would end up underwater.
When you’re pursuing new ideas and strategies - things you haven’t proven will work - you need to account for the fact that some of your ideas likely won’t pan out. In other words, if you want to come out ahead in the end, your winners need to cover for your losers.
When I was running an upstart energy efficiency company, it was full of creative people with a lot of ideas. And I mean a lot of ideas. When deciding whether to pursue a new opportunity, the decision making process often came down to whether it had the potential for a positive ROI. If we could squeeze out even a little bit more than what we would put in, the decision was often a yes.
But after years of this mindset without making much progress, I decided to take a look back at all the new ideas we had pursued over the past few years. The new service offerings we developed, the new marketing strategies we tried out, the RFP’s we pursued.
I was surprised by what I saw. Only about one in five had actually panned out.
With a 20% success rate on average, each new idea or strategy we pursued needed to at least return 5x our initial investment for us to break even in the end.
From that day on, we didn’t consider any new strategy that didn’t have the potential to return more than 5x the amount it would cost us to implement. This didn’t only save us money and improve our decision making. It got us to think bigger and come up with ideas that had greater potential to move the business forward.
It will do the same for your business. Whether you use a 3x, 5x, or 10x rule, the point is this - make sure your winning ideas cover for the ones that don’t work out.
Lower Your Entropy
Do you have a favorite law of physics? I do!
Mine is the 2nd law of thermodynamics. A byproduct of my education in mechanical engineering paired with eight years in the energy industry.
The 2nd law of thermodynamics is the entropy law. It tells us that over time, every system will fall apart. Many associate entropy with randomness, disorder, chaos, or decay. And what I love about it (and other laws of physics) is that it’s perfectly applicable to business.
In time, every system in your business will break down or fall apart. Your machines and equipment (physical systems). Your partnerships and teams (human systems). Your technology systems, operating processes, and even the business itself.
It takes work to counteract entropy and keep things from falling apart. We maintain and repair our equipment. We keep our teams productive with great management practices and team building activities. We keep our processes humming smoothly with quality control and a commitment to continuous improvement.
The higher the entropy in a system, the more work it takes to keep things together and running smoothly. So when deciding whether to invest in a new opportunity, we can’t only think about the initial cost. We also need to think about how much entropy it will introduce that will suck up energy and resources over time.
I think about the potential for entropy in terms of alignment. How well aligned will a new idea be with systems (physical, human, technological, etc.) that are already in place?
If you’re deciding whether to add someone new to your team, how well will that person align to your company’s culture and core values?
If you’re creating a new product or service offering, how well will it align with your capabilities and operating processes?
If you’re choosing a new piece of technology, does it align or integrate with the tools you already use?
The more aligned a new opportunity is with your business, the lower the entropy will be and the less work you’ll have to put in to ensure its success over time.
Returns Aren’t Only Monetary
Lex Sisney is a fellow business consultant and science nerd who started his company, Organizational Physics, after discovering that organizational success can be distilled to simple principles clearly explained by the laws of physics.
One of those principles is what he calls the “Universal Success Formula.” According to the formula, success comes down to the amount of energy that a system can extract from its environment (he calls this integration) compared to the amount of energy required to counteract entropy.
Credit: Lex Sisney of Organizational Physics
The energy available to a system will always flow to its entropy needs first. If there isn’t enough energy available, entropy will win out and the system will fail.
Profitability is a simple example of this. If the revenue a business brings in (integration) is less than the amount needed to cover its operating expenses (entropy), the business will fail.
On the flip side, if revenue is higher than the expenses, then there’s profit left over that can be deployed to do some really cool stuff.
I love how Lex describes integration as the energy a system can extract from the outside environment. Not money. Energy.
Energy is anything useful or desirable that can be made productive in the pursuit of success. Yes, money is certainly one of those things. But it’s not the only thing that can be made productive. Here’s some other examples:
Information
Resources
Time
Relationships
Brand Reputation
Joy
All of these things can be incredibly useful, perhaps even more so than the almighty dollar in some circumstances. Yet these things aren’t always quantifiable. They don’t fit neatly into an ROI calculation. But that doesn’t make them any less valid or valuable.
Making the Final Decision
When I told my colleague that I was deciding whether to collaborate together on the basis of whether it would be fun, I wasn’t dismissing systems thinking, I was leaning into it. I was thinking about the 5x rule and the universal success formula.
When the three of us were brainstorming, I was also observing. Were ideas flowing smoothly or would it take a lot of effort to create something together? How would the amount of work compare to benefits we’d gain in return? Was there 5x potential?
I was also assessing entropy. Were our goals aligned? Were we going after the same target audience? Would our working styles be compatible?
So where does the fun come in? Fun can be incredibly powerful. When you’re having it, work doesn’t feel like work. Your motivation is high and your energy seemingly boundless. I wanted the project to be fun in order to overcome any entropy and keep us motivated to build something together.
Ultimately, we chose not to collaborate and remain supportive of each other's individual pursuits instead. The potential for fun wasn’t high enough to overcome entropy and get to a 5x return. But the decision affirmed for me the importance of these principles that have been with me for years.
Use the 5x Rule.
Lower Your Entropy.
Returns Aren’t Only Monetary.