WHITE PAPER: How to Measure a Return On Investment from Software Development

Transcription

1 WHITE PAPER: How to Measure a Return On Investment from Software Development

2 Synopsis How to Measure a Return On Investment from Software Development: Evaluating the success of a software development project does not need to involve approximations and ambiguity. When IT and Finance are aligned on the key criteria,return on investment (ROI) can be documented, monitored and fully realised. In this white paper we present the four steps every organisation should take to measure ROI on software development. Introduction According to research published in Computer Magazine, the majority (56%) of IT projects are actually initiated by the Board or business functions. This is particularly the case when it comes to enterprise applications that have a direct impact on business process, for example CRM or ERP systems, financial suites, business intelligence solutions and the like. 1 Therefore, in an increasingly competitive and global business environment, the release of funds for a major software development must be built on a robust business case. Demonstrating return on investment (ROI) to the Board or other business functions means setting measurable criteria from which to attribute value. The alignment of goals between the IT and Finance functions is critical to this process. Setting these criteria enables the real success of software development projects to be fairly judged, helps justify future development projects, and enables Finance to ensure the organisation gets value for money. Calculating ROI on software development may depend on some variables that are specific to each individual organisation. However, we believe there are four key steps that both IT and Finance Directors can follow to guarantee an accurate assessment of the value of a software project; aiding the decision-making process, regarding whether or not to invest. 2

3 4 steps to calculating ROI in software development 1. Interrogate the project 2. Agree on a timeframe 3. Decide how to measure costs 4. Choose the right supplier Step 1 Interrogate the project Understanding ROI means understanding the nature of the project. It might seem simple but very often organisations do not ask the single most important question before analysing the ROI on software development: What type of project is it? Typically, projects fall into one of two categories: Cost saving investments These are often the technical projects that are designed to replace suboptimal systems, consolidate infrastructure or applications and improve performance from existing processes. With such investments it is easier to forecast value and calculating ROI is more straightforward. Revenue growth investments Characterised by a common aim to deliver added value to the organisation, these are the types of projects listed above in the example from Computer Magazine. They often act as a business enabler, achieving higher throughput and designed to offer competitive advantage at some point in the future. With these projects it is harder to predict ROI and in many cases any such analysis is done retrospectively. For analysing ROI, both categories of project require a similar approach to information gathering but will differ in terms of the assessment period. Step 2 Agree on a timeframe The ROI on cost saving investments is easier to measure because they often have a set timeframe. Whether initiated by IT or the wider business, these projects are designed to meet a specific target by a set date. With revenue growth investments, returns are often projected over the longer term. 3

4 The longer the timeframe, the more likely that the organisation will be content to use a projected ROI figure. Real ROI, however, can only ever be truly understood if it is measured at key points over time until the project is seen to have run its course. This requires a shift in mind-set. Both IT and Finance have to agree to a longer timeframe with regular milestones so that real ROI can be calculated and fed back into business plans. That is not to say that projected ROI is without its merits. But that it should be seen for what it is: a forecast and not the actual calculation for a return on investment, which can only be made when the actual figures are available. Step 3 Decide how to measure costs The biggest area of consideration for ROI on software development is cost. The method of measuring costs has a significant bearing on the perceived success of a project. Therefore, it is worth considering the different measurements that are used for assessing cost saving investments and revenue growth investments. Total cost of ownership Any cost-saving or revenue growth project needs to calculate costs as Total Cost of Ownership (TCO) for the software. TCO can vary significantly between off-the-shelf software and bespoke software - ROI on software development needs to take this into account. For instance, the operating costs of running off-the-shelf software that only meets 80% of the organisation s requirements will mean manual workarounds for the remaining 20%. This will involve allocating roughly the same percentage of staff time to development, maintenance, management and end user support. In contrast, the total cost of ownership of a software development project would include the 20% of previous requirements not serviced by the original product. This represents not only a saving in terms of staff costs but also gives the IT department 20% more time to focus on other projects, such as new applications that might improve revenues. Cost saving investments For any software development project there are four key cost measurements. To be clear, these are not costs for developing the software but the cost measurements used to evaluate how the project has saved money. 4

5 At this stage, IT and Finance need to agree how these costs will be calculated and apportioned. This will depend on individual organisational circumstances but it is worth taking the time to break down each category so that the figures derived are as accurate as possible. That way there will be no confusion or disagreement about ROI further down the line when the project is underway or completed. Key costs: People The IT function will know how much of its budget is being used up by manual workarounds for existing systems and the subsequent IT support required to help users. Finance will have the necessary information to calculate individual day rates. Combining this information will provide a comprehensive view of the staff costs saved when a project is completed. Equipment and hardware costs Existing IT architecture might have been purchased from a particular vendor that provides its own maintenance or management services and these need to be paid for, specially when the system is underperforming. Both Finance and IT should have a clear view of these costs as well as the amount of money the organisation spends on software licenses or end point devices. Running costs All IT systems require a significant amount of power to run all of the servers, storage, network infrastructure and end points or devices. If the new project is designed to improve efficiency in the organisation then any consolidation of equipment is also likely to result in a reduction in energy use. Again, both IT and Finance should already have this information to hand as well as the cooling costs for datacentres and any back-up systems in operation. Efficiency By running underperforming existing systems there is a cost to operational efficiency. Ongoing loss of productivity, a lack of scalability within systems to deal with fluctuations in demand (paying for what is not required) and the prevention of business growth are all major factors to consider. To place a value on this opportunity cost, both IT and Finance will need to agree what is considered a regular business cost and what is avoidable. 5

6 Revenue growth investments While these projects typically have a broader timeframe in which ROI can be calculated, any such evaluation does not have to be indefinable or imprecise. There are several cost measurements that can be applied to revenue growth investments so long as they are measured consistently at key points over the lifetime of the software. Opportunities for growth Individual organisational circumstances and sector status play an important role here but the defining characteristics of these costs are scalability, new product development and faster time to market: What is the value of flexibility in the organisation (for example, increasing or decreasing the number of users at no cost either for new licenses or to break existing license agreements)? How much time has been saved that can be reapportioned to other, more strategic activities, such as improving services or creating new products? At what rate can the organisation launch these products or services and start to generate new revenues or save other organisational costs? These are all criteria to which IT and Finance can assign a specific value based on an analysis of existing organisational data. Measuring new revenue A popular method of calculating how much extra income the organisation receives is monthly gross margin. This is the contribution to revenues that is judged to have been a direct result of the new software development project. Again, this requires alignment between Finance and IT not just in calculating the margin but the dates between which the software can be analysed as having had an impact. Revenue growth investments As well as the internal savings there are some direct commercial benefits from developing software applications. Whether the organisation operates in the private, public or third sectors, it can apply for R&D Tax Credits. Under the scheme, the Government is effectively rewarding organisations for innovation. As long as a software project seeks to achieve an advance in overall knowledge or capability in a field of science or technology through the resolution of scientific or technological uncertainty then it is worth applying for the credits

7 If the software project is successful, there is no reason why the organisation cannot license it to others in the sector. Just because those other organisations are in direct competition or funded differently does not mean that an industryleading software solution will not be of benefit to both parties. If the software does not offer a specific competitive advantage then there is no loss of earnings attributable to the sale of licenses and any income can be used to support a positive return on investment. Revenue growth investments Case study A One of the world s leading insurers turned to MSM as the sector specialist to build a bespoke risk management platform. The project also involved the creation of a back office Windows application and client-facing website to assist with the risk management of premises insured by its clients. The project budget was approximately 490,000 and delivered what has been widely regarded as the best platform in the sector. The risk engineering function that the software supports has been credited with achieving an improvement in the company s loss ratio and avoided claims of between 800,000 and 3.9 million per annum. Over its eleven year lifespan, it has avoided estimated claims of 25 million for just 500K of investment. Case study B This British institution receives thousands of applications for research funding every year. It s old, manual system was becoming unworkable and it needed an automated solution to process applications quickly and easily. MSM developed a bespoke version of a software platform it had designed for the institution s sister organisation that would allow applicants to submit their applications electronically. End-to-end automation has enabled the institution s research awards team to process nearly 50% more applications per staff member per year. The time saved also allows these staff members to focus on other, strategically important work. What is more, the institution had originally expected to replace the software platform after five years. However, the MSM solution has easily outlasted that projection and will continue to generate ROI over the course of its anticipated 10-year lifespan. 7

8 Step 3 Decide how to measure costs Despite all efforts between IT and Finance to put in place measurement criteria for ROI on software development, projects can still go wrong. With ZDNet quoting that 68% of IT projects fail3 and the British Computer Society4 suggesting that the figure is more like 88%, organisations simply cannot afford to select the wrong supplier. Once the measurement criteria for ROI on software development are set there is just one final decision to make: whether to undertake the project in-house or engage a software development company. At this stage, it is worth noting that doing the work internally means the project does not qualify for the Corporation Tax savings available through the R&D Tax Credits scheme. If the organisation does decide to put out a tender for the project then it will need to engage the services of a software development company that understands the organisation s ROI measurement criteria and can deliver against them. Only when Finance and IT are fully aligned on the goals will this process be easier to complete and more likely to result in a successful long-term software development project. 8

9 Need Support? Talk to MSM about enterprise application development As a specialist software developer, we can create bespoke applications that will help your teams work smarter and give you a competitive edge. No matter how complex your requirements, our specialist software development team will help you achieve your objectives. Contact us today on or visit softwaresolved.com to find out more about our services, including: Bespoke software development Software support and application management Consultancy Business process outsourcing 9

10 The human face of software development Software SOLVED Mobile SOLVED Cloud SOLVED Data SOLVED Management Systems Modelling Ltd. t/a MSM Software Solved. London office 3rd Floor News Building 3 London Bridge Street SE1 9SG Tel: london@softwaresolved.com Bristol office 1 Friary, Temple Quay, Bristol BS1 6EA Tel: bristol@softwaresolved.com Exeter office 8 Cranmere Court, Matford Business Park, Exeter EX2 8PW Tel: exeter@softwaresolved.com 10