Optimum Tradeoffs Between Return on Investment (ROI) and Combat Effectiveness:
An Analytical Methodology for the US Navy
Louis E. Alfeld, ScD.
Decision Dynamics, Inc 2000
FleetSight is an innovative simulation modeling tool developed by Decision Dynamics, Inc. (DDI). The tool allows planners to easily calculate life-of-system combat effectiveness and return on investment (ROI). Model variables include planned or postulated changes in operating conditions, maintenance, personnel skills, and/or system upgrades.
An illustrative example compares the future worth in Year 2017 of two hypothetical ship upgrade options for $40M and $90M, respectively. The table shows that calculations for ROI and the combat effectiveness index (CEI) will vary, depending upon the start year for the investment. For later start years, ROI falls because the time between the investment year and 2017 shortens, thereby reducing the cumulative cost avoidance benefit from the upgrade. CEI, on the other hand, rises because the shorter time period between the investment year and 2017 means less erosion of capability resulting in higher remaining combat effectiveness in 2017. FleetSight quantifies this tradeoff between ROI and combat effectiveness.
The graph plots a “payoff index”, obtained by multiplying ROI times CEI from the table. If the investment is made in 2001, both investments show a similar payoff, although it is clear from the graph that in whatever year the investment is made, the $40M option is a better choice. Waiting until 2003 actually raises the payoff for the $40M upgrade, making 2003 the optimal time to start the investment. Although the $40M upgrade buys less capability, it has a higher ROI; the $90M upgrade buys more but gives a smaller return in future cost avoidance over the same period.
Past 2003, both curves show a decline. As the table shows, although CEI rises due to the shorter aging period, the ROI payback falls faster because of the shorter payback period. If the graph were extended to 2017, both curves would reach zero because all ROI would disappear. If one applies a discount rate to ROI and/or to combat effectiveness, the relative ranking of investment options remains unchanged. If one also includes an availability index that accounts for changes over time in the fraction available (Ao), the two options can change their relative ranking.
In summary, the larger the investment, the lower the ROI but the greater the combat effectiveness. By itself, ROI analysis supports lower investments; by itself, effectiveness analysis supports higher investments. ROI and combat effectiveness analysis tend to work against one another. Joining the two in a single payoff index offers one solution for identifying optimum investments over time. Multiple payoff graphs for different future worth years (2014 to 2020, for example) creates an “investment envelope” within which investment options can be valued.