Over the years, automation has proven to be beneficial in terms of throughput, ergonomics, and financials. There are various reasons to start an automation project. Still, there are times financial proof is necessary and requested by management. This article provides tips and two realistic scenarios to help you determine your payback period. As each project is unique and these calculations can become incredibly complicated we always advise requesting support from your system integrator, the project team, or your own financial department when calculating this model.
Why use this calculation?
Your reason for using this calculation depends on your position and the type of company. Financial backing might be required in your pitch to the management or board of directors. For smaller companies, the investment has a significant impact on their cash flow and their investment might depend on how quickly they can see returns. The calculations provided in this article work can be used for rough estimates and detailed reports, this all depends on your input.
We'll cover quite some ground in this article:
- The difference between ROI, TCO and PP
- Basic Payback Period Calculation
- Data that should be included
- Basic calculation: Feasible fashion
- Calculation with year-on-year growth: Logistic heroes
Let’s get one thing clear first. There are a few terms used in the market. These are not interchangeable, so let’s dive into the difference between the Return On Investment (ROI), the Payback Period (PP), and the Total Cost of Ownership (TCO).
Learn more to complete your business case for automation:
Return on investment
This is the annual return on investment. The calculation provides a percentage that is similar to interest at the bank. When the bank offers 1% interest, you know that with a €100,- deposit you will earn €1,- one year from now. This is a quite straightforward approach, but the output in percentages per year is often hard to understand when the project takes more than one year to start returning profit. You have to execute additional calculations to find out when you’ll actually start returning on the investment.
Total cost of ownership
TCO is the investment plus operation costs of an automation project. This helps companies to look at long-term investments. By including operation costs, this calculation provides a more realistic value for investment. In the long run, projects with a lower total cost of ownership provide a better return, given that the project has similar savings.
The Payback Period on the other hand is the time required for an investment to recover its costs. It provides an answer to the question: How many years will it take to recover the costs of this investment?
Basic Payback Period calculation
|Project investment||= Payback Period|
|Annual savings – annual costs|
The Payback Period is calculated by dividing the investment by the annual savings subtracted from annual costs. First, you’ll need the fixed costs from the investment. What will it cost to implement this investment? This includes the purchase costs, but also other one-off costs such as implementation costs, project team costs (also FTE), and any other cost necessary to realize the project.
Secondly, the related cash inflows are required. This can be calculated by taking the annual savings and subtracting the annual costs. Savings could include productivity gains, higher throughput with the same amount of FTE, savings in rental costs if expansion can be postponed, or fewer costs due to improved accuracy. For 3PL companies, there might be additional earnings involved if the sorter helps them acquire new customers.
Data that should be included
Let’s use a sorter as an example. When reviewing the earnings of a sorter, this could be reflected in savings. To calculate the earnings of a sorter you need two data sets. The first set includes historic productivity data. With this data, you can create a forecast of the required FTE with the current method. The second data set is required to predict the new situation. The same parameters are used, but this time with data from the new situation.
The bare minimum of data would be:
- Items per year
- Number of FTE required per method
- Cost per FTE
“Feasible Fashion” is a wholesaler of fashion items. Due to the continuing labor shortage, they are having difficulties attracting sufficient personnel for their increased throughput. Below we have a copy of their project investment and related costs.
|Project investment||Fixed costs|
|Sorter investment||€ 550.000,-|
|Internal project costs||€ 50.000,-|
|Annual costs||Yearly costs|
|Average FTE per year||16||4|
|FTE Costs per year||€ 560.000,-||€ 140.000,-|
Payback Period calculation
( 550.000 slide tray sorter + € 50.000,- project costs)
|= 1,6 years Payback Period|
(€ 420.000 savings – € 40.000)
Our second company is a 3PL player “Logistic heroes”. They expect an 80% growth in required throughput per year. Due to the limited expansion possibilities in the current building, they are looking to purchase a sorter that increases their throughput per FTE. This way they can stay in their current building while increasing their capacity. To find out this Payback Period the previous calculation is insufficient and a year-by-year calculation is required. Below we set up the example data of Logistic heroes:
|Key figures||Now||Year 1||Year 2||Year 3||Year 4||Year 5|
|Items per year||1.000.000||1.800.000||3.240.000||5.832.000||10.497.600||18.895.680|
|Average items / day||4.348||7.826||14.088||25.358||45.644||82.158|
|Average FTE per year||Now||Year 1||Year 2||Year 3||Year 4||Year 5|
|Current method #FTE||5||9||16||29||52||94|
|Current method €||€ 175.000,-||€ 315.000,-||€ 567.000,-||€ 1.020.600,-||€ 1.837.080,-||€ 3.306.744,-|
|New situation #FTE||1||2||3||6||11||20|
|New situation €||€ 0,-||€ 66.780,-||€ 120.204,-||€ 216.367,-||€ 389.460,-||€ 701.029,-|
|New situation||€ 1.000.000,-||€ 40.000,-|
|Savings||Now||Year 1||Year 2||Year 3||Year 4||Year 5|
|New situation||€ 0,-||€ 248.220,-||€ 446.796,-||€ 804.232,-||€ 1.447.619,-||€ 2.605.714,-|
|Savings||€ 0,-||€ 208.220,-||€ 615.016,-||€ 1.379.248,-||€ 2.786.867,-||€ 5.352.582,-|
|Investment||€ 1.000.000,-||€ 1.000.000,-||€ 1.000.000,-||€ 1.000.000,-||€ 1.000.000,-||€ 1.000.000,-|
|Cumulative cashflow||-€ 1.000.000,-||-€ 791.780,-||-€ 384.984,-||€ 379.248,-||€ 1.786.867,-||€ 4.352.582,-|
For this installation, the initial investment would be higher as it is built for future growth. However, with this solution, they might be able to stay in their current building longer. So in addition to productivity savings, you could also take the savings of a possible relocation or additional rental costs into account.
If anything, these examples show the diversity in challenges companies might face in calculating their Total Cost of Ownership, Return on Investment, or Payback Period. One thing is for certain, the right automation solution will return on the investment over time.
There are a lot of factors that come into play when calculating the Payback Period of a sorter. If you include a lot of factors, you improve your forecast. But sometimes it’s sufficient to provide an estimate, depending on your selection stage. If you don’t feel confident executing these calculations, you can always ask your consultant, finance department, or integration partner to support you. Happy calculating!