How do you calculate ROI for software development?

Return on Investment, or ROI, is a figure you need to understand and determine at the very beginning of a project to ensure you get a positive return on your investment – so how do you calculate ROI for software development?

In the past (decades ago), software was considered a necessary overhead expense, it was a cost to a company.  Now a business considers software as a critical part of their infrastructure and competitive advantage.  So this means a software development project needs to be run like a profit centre, and this means performing the requisite sums to get the funding to run the project.

Why ROI for software development?

ROI is a very valuable financial measurement to determine how a company’s resources will be used to deliver maximum profit.

The goal of software development is to generate more revenue than it cost to develop the product, or at the very least recoup the investment made into the custom piece of software.

Here are a few reasons why you should bother with software development ROI:

  • it enables the real success of the project to be fairly judged
  • helps justify future development projects
  • enables finance to ensure the organization gets value for money.

It also assists you to:

  • determine and quantify benefits over time
  • determine total ownership costs against schedule
  • determine if a project is worthwhile.

The main resources of a company are money and employees’ time, and everyone wants to save both.  Performing an ROI analysis will help in doing this, and to fund the software development project.

ROI depends on the software that is being developed

Creating software is generally not a straightforward job, and trying to calculate the projected return isn’t either.  At the start of a project, all you really have to work with is the idea of the software you want to build, which doesn’t help your ROI predictions.

ROI will depend on the type of application or software that is being created.  The return for a business process software product will be different for a commercial software product.  Thus, the ROI is calculated differently for these two types.

  1. Business Process Software

This type of software will typically be created to handle the workflows and processes of a business.  The measurement of this software will be in the improved efficiency of a process and will be measured in hours.

Some considerations when projecting your ROI for this type of software development project:

  • How much time will the new software save your company
  • Will sales increase, is upselling and lead conversion going to improve
  • Will any unnecessary business communication be reduced
  • Is maintenance going to be improved, up time increased, can you consolidate inventory and resources
  • How much extra data on your supply chain will you gain that can inform you of potential bottlenecks and slowdowns
  1. Commercial Software

The focus of this software is to make sales.  The measurement of this investment will be increased sales and revenue.

To project the ROI for this custom software project, you should ask the following:

  • Is there a market for your software? Always start with the market research.
  • How much will it cost you to get a new user or lead?
  • What will your customer retention rate be?
  • How will you provide support to your users? How will they contact you with questions or issues?
  • Are you going to incorporate an annual license fee with your software product, or will it be a once off retail cost?

Calculating the ROI of software can seem daunting. But if you do the research ahead of time, calculate costs accurately and honestly, you can be in a better position for success.

Calculating the ROI of software development

The concept of ROI and the measurement of ROI can vary because there are different criteria by which to measure ROI, and there are many ways to quantify it.

The basic ROI calculation is the ratio of present value of expected benefits over the present value of expected costs, or:

ROI = (PV OF EXPECTED BENEFITS / PV OF EXPECTED COST) * 100

Other calculations that are typically produced at the same time as calculating ROI are:

  • NPV (net present value) – the return a project will make at a specified discount rate.
  • IRR (internal rate of return) – the yearly return % of the investment.
  • Payback – the number of years it takes to recover the investment.

Projects with an ROI of more than 100% are more likely to get the funding you need.  Projects with an ROI that is less than 100% will need a very strong business case as well as strong executive sponsorship.

Something else important to consider is the expected payback from the project. When the expected benefit exceeds expected costs, and that benefit is expected to be realized within the first year of the project implementation, the more likely the project is to proceed.

Getting the funds for a software development project must be built on a strong business case, and getting help from a financial person will ensure that you quantify the ROI for a new project even if you think that you couldn’t.

Measuring the ROI of software development

Once the software has reached the market, you will hopefully have made many sales.  This is the measurement of a successful ROI.

You developed software to improve your internal business processes.  These business processes are now more streamlined and more efficient.  This is the measurement of a successful ROI.

The measurement of the ROI of your custom software development project is the evidence that is provided by the newly developed software.  This is the proof that the investment was well spent.  You can see the returns as your software is sold or implemented successfully.

Your custom software development investment will continue to provide returns.  These benefits that will provide the returns include:

A competitive advantage – technical innovation keeps a company competitive.  Keeping your technology and business processes updated keeps your business thriving.

Efficiency and productivity – a custom software product ensures your specific business needs are addressed, increasing productivity and efficiency.

Ongoing flexibility – a custom software product can evolve with time, as the requirements of a change, allowing for continuous business growth.

No shelf-life – custom software development means no ongoing updates and license fees which means no additional and ongoing costs to your business.

Software development and ROI

Xpedia are a world-class software development company based in Centurion, South Africa who can create custom software.

The Xpedia development team boast skills across multiple technologies including PHP, MySQL, Microsoft SharePoint, Microsoft SQL Server, ASP.NET, C#, Oracle database, SQL Server Analysis Services and Reporting Services, and more. They have experience integrating with a wide variety of systems using everything from file-based integration to SOAP or REST web services.

Through a combination of prioritizing development effort in order of expected ROI and fixing project cost and duration up front to keep costs under control, Xpedia have developed its processes and methodologies to provide clients with optimal ROI from software development.

Sources

  • idealware.org
  • techrepublic.com
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