ROI. Return on Investment. We’ve all probably heard the term at some point in our lives, especially if we’re coming from a business background, and it’s the single most important thing that comes into play when making business decisions.
Every time a business wants to make a sound decision or put a value on the effectiveness of a marketing campaign, they refer to the ROI.
Not just businesses go through this process. Individuals do it too. “Should I buy the extended warranty for $2000 more or just take my chances with American manufacturing?” Economists have a term for it: marginal cost/benefits analysis. Am I, the average consumer, making a decision that’s going to make me better off or am I just needlessly throwing money away?
The basic idea is just a matter of input and output. What you get out should be more than you put in. It gets a bit more complicated when you’re dealing with things like discounted cashflow, opportunity costs, sunk costs and weighted cost capital but the basic concept still holds.
So let’s go through a thought exercise on the ROI of a GMAT course. They all require a considerable up-front cash investment. If you’re using a reputable GMAT prep company with high standards and a track record of success, most courses are over $1000 and possibly more if you’re dealing with private tutoring. So is all that cash really worth it?
Let’s consider the following:
According to the US News Ranking: America’s Best Graduate Schools 2008, the student body of the top 20 MBA programs achieved an average GMAT score of 697. When you look at the 20 MBA programs ranked from 41st-60th, the average GMAT score falls to 642. That’s a difference of 55 points. But now, let’s look at how much those 55 points are worth. The average starting salary of 2007 MBA graduates from the top 20 programs was $113,061. Graduates from the programs ranked between 41 and 60, that average starting salary drops down to $78,088. That’s a difference of $34,973 dollars each year, every year! Not to mention the fact that the 5 year figures become even more divergent. That translates into roughly $6,359 for every 10 point improvement on the GMAT.
Now let’s take a look at the GMAT Prep class side. The Veritas Prep Full Course costs $1500 historically, students have improved their score from a previous GMAT between 90 and 110 points. For the sake of this exercise, we’ll just be less optimistic and assume that we missed a couple of classes and didn’t get as dramatic of a score increase and only improved 55 points. We still improve our score enough to get into a top 20 program though, based on the ranking data.
We’ll go ahead and do a discount cashflow calculation over a 5 year period with the beginning of year 1 being the first $1500 outlay of cash for the course. Then, towards the end of year 1, we get our acceptance letter to a top 20 program and at start the MBA program the beginning of year 2. We graduate and start working in years 4 and 5 and realize marginal cashflows of $34,973 at the end of year 4 and year 5 (sorry, no annual raise or bonuses). So our cashflows look something like:
Now we have to adjust for the time value of money, since money now is worth more than money 4 years from now. Small firms typically have a weighted cost of capital of around 12% while it’s lower for larger firms. We’ll use a discount rate of 15% since MBA students are usually in the beginning stages of their careers, like a small, growing company. So once we discount those two marginal salary cashflows back to year 0, they are only worth $19,996 and $17,391, respectively. So for an investment of $1500, we’ve gotten back a return of $37,387. What’s that, a 2392% return? That beats the stock market any day.
This type of ROI analysis is basic stuff, but is frequently used in every business decision and is definitely something you’ll be going over in one of your MBA classes. You can take this same model and repeat it to value other decisions. A good one is to calculate the ROI on an actual MBA Program. Is it worth it to give up your current job and salary to get an MBA? You’ll have to consider: 1. How much am I making now and could make over the next 3 years staying at my job (what am I giving up). 2. How much is this MBA going to cost me in tuitions, fees, books and room & board? 3. What’s my expected post-graduation salary? 4. Will I have to borrow money and pay interest to fund my tuition?
One thing I think we can all agree on is that in terms of the MBA application process, additional GMAT points are worth a lot of money in the long run and paying for those points is a solid investment.