# Making the Business Case for Software Performance Engineering

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5 FV = P 0 + ip 0 = P 0 ( 1+ i) If the interest is compounded annually, its future value at the end of n years would be: FV = P 0 ( 1 + i) n Similarly, if we know the interest rate and the future value of an amount invested for n years, we can compute its net present value: NPV = FV ( 1 + i) n This is the amount that we would need to invest today at interest rate i to have FV at the end of n years. Thus, given a present amount and an interest rate, we can calculate its future value or, given a future value and an interest rate, we can calculate its present value. Suppose that you could invest your \$400 at 3.5% annual interest (interest rates aren t what they used to be, are they). Now, if someone offers you \$400 today or \$459 at the end of four years, which would you choose? If you calculate the net present value of \$459 invested at 3.5% for four years using equation 2, it is \$400. So it doesn t matter which you choose. Here, the interest rate of 3.5% is known as the discount rate. It is the rate at which you would be indifferent between two cash amounts received at different times. Discounted cash flows, calculated using equation 2, are useful for comparing amounts paid or received at different times by converting them to a common basis, usually today s dollars. Total Cost of Ownership (TCO) When you buy a capital item, such as a workstation, the purchase price is only a portion of what it costs to own it over its lifetime. There are also installation, maintenance, repair, and other costs. When the item is no longer useful, you may be able to sell it and recover some costs or you may have to pay someone to take it away. Since these costs occur at different times, they must be discounted to a present value. The formula for TCO (also known as Life Cycle Cost LCC) is: TCO = i = 0 where: TCO = Total Cost of Ownership C i = total of all costs occurring in year i N = number of years the item will be owned N C i ( 1 + d) i (1) (2) (3) d = discount rate used to adjust cash flows to a present value For example, suppose you purchase a workstation for \$3,000 and pay \$100 per year for maintenance over 4 years. At the end of the 4 years, you pay a \$25 recycling fee to dispose of the no-longer-needed workstation. If the discount rate is 3%, the Total Cost of Ownership for this workstation is: TCO = \$3, \$ \$ \$ \$25 ( 1.03) 1 ( 1.03) 2 ( 1.03) 3 ( 1.03) 4 TCO = \$3,405 The initial purchase and first year s maintenance occur now (year zero); the second maintenance payment occurs at the end of year one, and so on. Note that, due to discounting, the actual total cost is less than the nominal total of \$3,425. Total Cost of Ownership focuses only on costs associated with owning an asset. It does not consider benefits such as increased revenue that might be produced by the asset. Thus, TCO is most appropriate when comparing alternative purchases for a given purpose. Return on Investment (ROI) Return on investment is calculated as the net benefits of some course of action divided by the amount of the investment: ROI = net benefits investment An investment of \$1,000 that yields benefits totaling \$1,500 has a 50% ROI. Costs and benefits are determined by a cost/benefit analysis as described above. However, it is important to beware of this simple formula if the costs and benefits occur at widely different times. For example, if the costs occur at the beginning of the project while the benefits are not realized until much later, it may be necessary to use discounted cash flows to compute ROI in current dollars. Payback Period The payback period is the length of time (usually years) required to recover the cost of an investment. In general, if you are considering two alternatives, the one with the shorter payback period is the better investment. Payback period = investment periodic savings For example, if the investment is \$500 and the periodic savings is \$100 per year, the payback period is 5 years. (4) (5) 5

6 NPV \$ \$ Investment 1 \$80.00 Investment 2 \$60.00 \$40.00 \$20.00 \$0.00 -\$ \$ \$ \$80.00 Interest Rate While payback period is simple to calculate and its interpretation is intuitive, it does have limitations. Payback analysis typically does not consider the time value of money (discounted cash flows). Thus, if the investment is made early in the project but the expected benefits do not occur until several years later, the analysis may overestimate the value of the benefits. In addition, payback analysis does not consider benefits that occur after the payback period. Internal Rate of Return (IRR) Internal Rate of Return is less intuitive than Payback Period but it overcomes the limitations of payback analysis by taking an investment view of the proposed project or action and explicitly considering the time value of money. It is most useful for comparing investment alternatives where the costs and benefits differ and/or occur at different times. The IRR for an investment is the effective interest rate (discount rate) that makes the net present value (NPV) of all cash flows related to the investment both costs and benefits equal to zero. N NPV = = 0 ( 1 + d) i i = 0 where: NPV = Net Present Value C i = total of all cash flows occurring in year i N = number of years under consideration d = discount rate C i Figure 2: Internal Rate of Return (6) 6 Solving this equation for d yields the discount rate that makes NPV zero or the Internal Rate of Return. In general, this equation must be solved iteratively. However, we can get a feel for IRR by looking at a graphical example. Table 1: Alternative Investments Consider the two investments shown in Table 1. We have two alternatives both of which require an initial investment of \$ (the numbers in the first row are negative since they are cash outlays or costs). The investments both return a total of \$ but the timing of the returns is different. Figure 2 shows the NPV of these returns as a function of interest rate. Investment 1 has a zero NPV at an interest rate of approximately 30% while Investment 2 has a zero NPV at approximately 45%. Thus, the IRR for Investment 1 is approximately 30% while the IRR for Investment 2 is approximately 45% and Investment 2 is the better choice. CASE STUDY Timing Investment 1 Investment 2 Now -\$ \$ Year 1 \$40.00 \$80.00 Year 2 \$40.00 \$60.00 Year 3 \$40.00 \$40.00 Year 4 \$40.00 \$10.00 Year 5 \$40.00 \$10.00 Total \$ \$ Background WayOut Widgets, Inc. has made several incremental upgrades to its Web site. Following each upgrade, they

8 not used can be calculated using a simple expected value formula (weighted average): Cost/Benefit Worksheet One-Time Costs \$ Cost Avoidance \$ Tools Refactoring \$ 812,500 Performance Modeling Tool \$ 8,000 Hardware Upgrade \$ 600,000 Load Driver \$ 70,000 Lost Revenue \$ 975,000 Workstation \$ 4,000 Telephone Agents \$ 325,000 Training In-House Training (15 Developers) \$ 66,846 Performance Engineer \$ 5,923 Consulting/Mentoring \$ 250,000 Total One-Time Costs \$ 404,769 Total Cost Avoidance \$ 2,712,500 Recurring Costs (Annual) \$ Intangible Benefits Software Maintenance (Tools) \$ 12,100 Improved Corporate Image Salaries (Including Benefits) Enhanced Customer Relations Performance Analyst (1.0 FTE) \$ 100,000 Improved Employee Morale Continuing Education \$ 2,200 Total Recurring Costs \$ 114,300 Figure 3: WayOut Widgets, Inc. Cost/Benefit Worksheet EV = ( 6) + 12 = period. The average sale is \$50. Thus, the amount of lost sales revenue that would be avoided is \$975,000. Thus, the amount of refactoring expected to be saved is 6.5 months. The burdened cost of 15 developers for 6.5 months is \$812,500. Hardware Upgrade For previous projects, post deployment tuning efforts were insufficient to achieve the required performance. In each case, server upgrades were also necessary. The average cost of server upgrades over the previous projects was \$600,000. Note: As with the workstation, it is possible to perform a Total Cost of Ownership analysis for the server upgrades. If this analysis were performed, the overall cost of this line item would be higher. The historical data is sufficient, however and, to keep the case study simple, we have used it. Lost Revenue Marketing estimated lost revenue by comparing sales figures for times when the web site was performing poorly with those during normal operation. Since some orders that would normally have been placed via the web site were obviously being placed via telephone (see below), these were subtracted from the lost revenue figure. The marketing estimate is that 100 sales per day were lost due to customers abandoning the web site due to poor performance. These losses would occur every day during the expected 6.5 month refactoring/tuning Telephone Agents After deploying each previous release, the company needed to hire 10 temporary agents to handle the increased telephone order volume due to customers abandoning the web site. The burdened cost of a temporary agent is \$60,000 per year. These agents would be needed for the expected refactoring time of 6.5 months for a total of \$325,000. Intangible Benefits Intangible benefits of deploying web-site upgrades that meet performance objectives include: Improved corporate image The web site is important to presenting a professional corporate image. Enhanced customer relations customers, especially repeat customers who use the web site frequently were becoming angry due to long waits. Improved staff morale Developers take pride in their work and were becoming discouraged over fielding products with performance problems. Return on Investment Table 2 shows the total costs and benefits for an 18- month project. Table 2: Cost/Benefit Summary Number of Years 1.5 Costs Benefits 8

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