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Analytics Magazine

ROI for RFID: Evaluating Investment Projects

January/February 2011

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Different definitions, assumptions make determining return on investment for Radio Frequency Identification tricky business. Here are two performance measures to focus on.

Jerry Banks Analytics Magazine Federico Trigos
Analytics Magazine

By Jerry Banks (left) and Federico Trigos (right)

While return on investment (ROI) is a long used measure, Radio Frequency Identification (RFID) is a technology that has re-emerged since Wal-Mart started pushing it on its suppliers in 2003. More recently, Wal-Mart announced that it is going to use RFID intensively in the sale of merchandise (Wailgum, 2010). Taken together, many realists and doubters have wondered whether RFID has a ROI.

The appearance of ROI and RFID in the same sentence led us to search what is the definition of ROI when used in the context of RFID. The RFID Journal (2009) says that ROI is: “The ratio of money gained or lost on an investment relative to the amount invested. The amount gained or lost may be referred to as interest, profit/loss, gain/loss or net income/loss, while the money invested may be referred to as the asset, capital, principal or cost basis of the investment. ROI is sometimes also known as ‘rate of profit’ or ‘rate of return.’ ”

If this definition were unique, that would be the end of it. However, at least 14 financial performance measures satisfy this definition. Each has its own assumptions, definitions and interpretations. Therefore, we say that the above definition is not “discriminatory.”

In this article, we will examine definitions of ROI as well as other articles that discuss RFID and ROI. Then, we will give our recommendation of how to proceed.

Table 1 shows 14 financial performance measures. Each of them has a mathematical formulation that can be found in the reference indicated. The first five are absolute measures. Absolute measures are solely monetary. Numbers 6 through 11 are relative measures. These measures compare cash inflows to cash outflows. The last three are corporate measures. Corporate measures assess the performance of a business unit for a specified time period.

Table 1: Fourteen financial performance measures.

Table 2 shows the financial performance method, all called ROI in the source material.

Table 2: ROI measure used in RFID-related articles.

Table 2: ROI measure used in RFID-related articles.

The 32 articles used to construct Table 2 range from informative to scholarly. The first column of Table 2 shows the different performance measures that were mentioned. Their frequency of use is shown in the second column. There are articles that indicate more than one measure of ROI. That is why the column labeled “Frequency” sums to 40 measures. We don’t call these 32 RFID articles a sample; they are the result of a search. Table 2 shows further that there are at least six different measures of ROI used in the RFID literature. In addition, some 15 out of 32 articles mention ROI, but do not give enough information to determine the exact performance measure used.

We learned that there was little in the way of standardization of the computation of ROI. We use the term ROI to represent the many measures – 14 mentioned in this article – that indicate the return from a capital investment.
We checked the consistency of these 14 measures. That is, from a mathematical standpoint, if one of the measures indicates that a project should be undertaken, then all of them do the same, under some reasonable assumptions that hold for many projects. If one measure indicates that a project should be rejected, all of them do the same, again, under some reasonable assumptions that hold for many projects. Yes, the measures are consistent.

Still, there are problems with the use of ROI. Consider the article that was mentioned in the first paragraph (Wailgum, 2010). The article appeared in the July 28 issue of Bloomberg Businessweek and discussed Wal-Mart’s push to introduce RFID tags at the retail level. The article says, “…presumably, ROI can be attained.” But, as in many (15) cases indicated in Table 2, no definition of ROI is given.

In an RFID software advertisement (not considered an article for Table 2) appearing online (http://blog.deploysoft.com/index.php/rfid/ accessed Aug. 17), whoever wrote the copy made some excellent points:

“If you have been following the RFID market for a while, chances are that you have heard the term ROI (Return of Investment) quite often. Although ROI calculation may be relatively straightforward for many projects, this is not the case with RFID projects. … The ROI calculation for RFID projects requires that we have a very good understanding of two key variables: return and investment. … Return is usually considered to be the net profit resulting from RFID projects in a certain amount of time. This is not always easy to determine since you may have returns that are not necessarily a matter of financial profit. Some RFID projects may not yield significant cost reduction nor increase in revenue – at least not right away. However, they may provide significant benefits like increase in customer satisfaction or risk reduction.”

Recommendation

Financial performance measures, collectively called ROI, used to evaluate RFID investment projects, have different meanings and assumptions. It is important to consider each of them in order to make the appropriate interpretation. We also mentioned that these performance measures are consistent, under some reasonable assumptions that hold for many projects, in that they concur in the decision to approve or reject a project. In general, not all of them give the same information and interpretation. The corporate measures are not created to evaluate projects but to measure the performance of firms in a particular period of time. Therefore, we do not recommend corporate measures to evaluate investment projects.

In summary, we recommend the use of net present value as an absolute measure of ROI, and return on invested capital as a relative measure of ROI in RFID investment projects evaluation. These two measures are the most meaningful in determining the worth of an RFID project.


Jerry Banks (jerry_banks@itesm.mx) holds the title Academic Leader at Tecnológico de Monterrey in Monterrey, Nuevo León, México. Previously, he retired from the faculty of the School of Industrial and Systems Engineering at Georgia Tech in Atlanta and then he was Senior Simulation Technology Advisor at Brooks Automation (now part of Applied Materials, Inc.). Federico Trigos (ftrigos@itesm.mx) is a professor at the EGADE Business School at Tecnológico de Monterrey in Monterrey, Nuevo León, México. He is the chair of the Leaders for Manufacturing Program on that faculty.

REFERENCES

  1. Avery, H.G., 1959, “Economic values vs. original cost – A discussion of bases for calculating earnings,” N.A.A. Bulletin, (February), pp. 5-14.
  2. Bierman, H. J., 1957, “Some problems in computation and use of return on investment N.A.A. Bulletin, (December), pp. 75-82.
  3. Eckstein, O., 1958, “Water Resource Development: The Economics of Project Evaluation,” Harvard University Press, Cambridge, Mass.
  4. Nyland, H.V. and G.R. Towle, 1956, “How we evaluate return on investment – Experience of an oil company,” N.A.C.A. Bulletin, (May), pp. 1,092-1,099.
  5. Park, C.S. and G.O. Sharp-Bette, 1990, “Advanced Engineering Economics,” John Wiley, New York, N.Y.
  6. RFID Explorer, 2010, http://blog.deploysoft.com/index.php/rfid [accessed Aug. 17] URL dated July 17.
  7. Thuesen, G.J. and W.J. Fabrycky, 2001, “Engineering Economy” (9th ed.), Prentice Hall, Upper Saddle River, N.J.

The list of the 32 articles used for analysis in this article is available upon request to the first author.

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