2019

EXPERT ANSWERS

Influence vs. control

Q: What is the difference between sphere of influence and sphere of control?

A: To answer this question, it’s best to refer to the illustration in Figure 1.

Figure 1

Although shown in two dimensions, imagine for a moment the circles as concentric spheres. You are centered in the spheres. The red sphere represents your sphere of control. In an organizational environment, the sphere of control represents those you manage directly or otherwise have direct control over.

This may make more sense in a team-based environment in which you, as the team leader, have individuals who are superior, equal or subordinate to you, all of whom report to you. In a family environment, you’re directly responsible for the care of siblings, older parents and children. In these examples, the lines of controls are direct and apparent.

In contrast, the blue sphere in Figure 1 represents the sphere of influence. The sphere of influence extends well beyond the sphere of control and represents those who you influence or indirectly control as a result of your organizational position. As such, your sphere of influence may affect individuals you may not know or haven’t even met.

Finally, the space beyond both spheres encompasses that which you can neither control nor influence. That’s an important area to identify, particularly from a management or leadership perspective.

Though much of the literature written on this topic is dedicated to a geopolitical perspective, some literature discusses the management or leadership perspective and how individuals in that position can focus on expanding their personal spheres. I encourage you to take the opportunity to research these concepts. You’ll find them most interesting.

T.M. Kubiak
President
Performance Improvement Solutions
Weddington, NC

For more information

  • Jing, Gary G., "Flip the Switch," Quality Progress, October 2008, pp. 50–55.
     

What’s your return?

Q: Despite having read 30 to 40 articles on return on investment (ROI) for process improvements, I am still unable to find a simple step-by-step method of calculating ROI.

Even if we do some rough calculations based on published data in our business case scenario for process improvements, it’s not breaking much ground with senior management. Somewhere, I read that 67% of CEOs do not believe ROI figures in business cases (not only for process improvements). Is there anything we can do to combat this?

Santosh Mishra
Calgary, Alberta

A: There are many reasons why CEOs are skeptical of ROI estimates:

  • Experience has taught them the actual returns will often be significantly less than the expected returns.
  • Large capital investments with a multiyear payback schedule are risky because market conditions may change, and the returns for later years may never be realized.
  • Some projects rely too heavily on "soft" savings, such as labor reduction. Workforce reductions frequently have hidden costs and other undesirable effects, such as reduced morale and productivity, as well as increased employee turnover.
  • Other projects may have flawed assumptions or overly optimistic savings estimates.

Many companies have an internal hurdle rate (a required rate of return) the project must exceed to be considered. The hurdle is usually set fairly high to account for the uncertainty associated with obtaining accurate estimates of future cash flow.

There are many methods for estimating the ROI of a project. One common method is to estimate the payback period. To do this, simply calculate the number of years it will take to recover the initial investment. Projects with quick payback periods are desirable. The weakness of the payback method is it does not take into account the savings that will accrue after the initial investment is recovered. If you have scarce resources, you will want to consider multiple opportunities and pick the ones with the highest return.

Unfortunately, the payback-period approach makes it difficult to compare projects. Some projects with short payback periods may have limited total savings over the life of the investment, whereas others may have a longer payback period but a higher total return because they generate savings for a longer period of time.

To facilitate a fair comparison of project opportunities, I prefer to estimate the net present value (NPV) of a project. NPV considers the time value of money. Future cash flows are discounted at the cost of capital (this should be equal to or higher than the cost of obtaining a loan from a bank).

Excel software has a function to simplify the calculations, which I’ll illustrate using the following example:

A quality engineer wants to replace an old machine that is generating too much scrap. The new machine will cost $125,000 and should eliminate the scrap. The machine is expected to last five years. Current scrap costs are approximately $80,000 per year. The engineer prepares a table showing the savings over the next five years (see Table 1). As the machine begins to wear out, the savings diminish.

Table 1

The Excel equation you can use in this situation is: =NPV(0.1, B2:B7).

The first argument in the Excel equation is the interest rate (10%). This should be entered as a decimal, as shown. The second argument is a range that includes all of the cash flow, including the initial investment, which should be negative.

The new machine is expected to eliminate $332,000 in scrap costs (sum of the positive cash flows), but you must subtract the initial investment of $125,000. The net savings are $207,000, which Excel discounts to account for the interest rate.

You can enter this example into a spreadsheet and verify the NPV of the investment is $121,652. Because the NPV is positive, the project is viable and should be considered. You could create two estimates to reflect optimistic and pessimistic expectations for the cash flows.

The Certified Engineer Handbook has a more complex example that includes a decision tree, which compares three options for fixing a problem and incorporates probabilities to account for the uncertainty of the outcomes.1

I advocate full disclosure. If you show your CEO your assumptions and method of calculation, he or she may be more likely to accept the project because the risks and assumptions are clearly stated.

Andy Barnett
Consultant, Master Black Belt
Houston

Reference

  1. The Certified Quality Engineer Handbook, third edition, ASQ Quality Press, 2008, pp. 22–27.

For more information

  • Sherman, Peter J. and James G. Vono, "All Ears," Quality Progress, July 2009, pp. 16–23.

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