Roi Estimation

Anand Paropkari

Estimating ROI For Process Improvements

Agenda

ROI & its significanceElements of ROICalculating ROIChallenges Time – the missing dimensionSummary

What is ROI?

“Return on Investment (ROI) is a measure of investment potential by comparing the expected benefits to the total investment.”

Significance of ROI

Money is the language of business and quality efforts must be communicated to management in their language.

- Juran

Benefits of ROI

• Determine potential of the improvement• Justify value to the management• Prioritize improvements• Track and monitor improvements• Validate improvements

Elements of ROI

Elements of ROI

ROI = (Total benefits – Total Cost) / Total Cost

Benefits : Estimated benefits measured in dollarsCost : Estimated cost measured in dollars

Key Factors Affecting Cost

Infrastructure cost-

•Software tools and technology•Hardware•Support and maintenance of infrastructure

Human Resources-

•Time & Efforts•Training•Hiring people with specialised skills•Rewards and recognition

Vendor-

•Consultancy•Training•Assessment•Certification

Improvement methodology-

•Standard or model (e.g. ISO, 9000, ITIL etc.)•Off the shelf methodolgy / roadmap•Process definition & documentation

Estimating Benefits

Benefits

Tangible benefits Intangible benefits

Intangible benefits may not be traceable to

software engineering processes alone.

•Increased productivity•Reduce waste•Redduced defects•Reduced rework•Reduced cost of operation

•Increased customer satisfaction•Increased employee motivation•Increased market share•Growth in revenue

Calculating ROI

ROI Example

ROI = (235,000-210,000)/210,000 = 11.90%Net benefit = $25,000

Cost BenefitsCategory Amount in $ Category Amount in $

Infrastructure 50,000 Reduced defect and rework

140,000

Vendor 35,000

Training 25,000 Improved cycle time

95,000

Work Effort 100,000

Total 210,000 Total 235,000

Challenges

Challenges of Estimation

Inadequate past data Scope of process improvement Impact to the organization Size and duration of the effort Organization's inertia to change Validity of assumptions Effect of project risks on estimation Good understanding of the organization is required to

overcome these challenges

Benchmarks

Use industry benchmarks with caution Most Benchmarks are organization specific Examples:

Cycle time : Depends on how process is designed and supported by automation

Rework : Depends on way of execution, but percent value may be used as benchmark

Productivity: FP or KLOC value may be used as benchmark

TIME..The Missing

Dimension

Time Value of Money

In 1624 the Native Americans sold Manhattan island for $24

If they had invested $24 at 6% annual interest they would have had $70 billion in year 1999

$1 received 1999 years ago, invested at 6% could now be used to purchase all the wealth in the world

Example taken from the book Foundations of Financial Management by Block and Hirt.

Fundamentals of Finance

Let's understand some basic financial concepts:

• Time Value of Money• Present Value (PV)• Future Value (FV)• Net Present Value (NPV)• Opportunity Cost

Future & Present Value

Year 0 Year1 Year 2 Year 3 Year 4 Year 50

200

400

600

800

1000

1200

1400

1600

1800

Period in Years

Do

llars

At 10% interest per annum,Value of $1000 after 5 years will be $1611, OR$1000 is present value of $1611 earned in 5th year from now.

Future & Present Value

FV = PV(1 + i)n

PV = FV/(1 + i)n

FV : Future value

PV : Present value

i : Rate of interest per annum

n : Number of periodsFunctions to calculate FV and PV are available in MS Excel.

Net Present Value (NPV) The difference between the present value of the

benefits and the present value of the expenditures is Net Present Value

NPV is essentially a profit and loss statement A positive NPV means that the improvement generates

more benefits than it took to fund it and vice versa. ROI alone doesn't give complete picture, flavor of NPV

makes it perfect

ROI ExampleCost Amount in $ Benefit Amount in $

Year 1 Infrastructure 30000 Reduction in defect/ rework 30000Vendor 25000 reduction in cycle time 55000Training 10000Work effort 20000Total 85000 Total 85000



Total Cost 210000 Total benefits 235000

NPV $183,013.26 NPV $203,176.60

Net benefit = $20,163

• Opportunity cost is the potential loss incurred by

not utilizing an opportunity to get benefit.

• It's the cost of 'status quo'

• Example:

If avg. budget overrun of projects is 35%, as compared to

industry avg. of 5-10%, then the opportunity cost is 25-

30% of project budget.

Opportunity Cost

Summary

ROI is a measure management can understand Cost and benefits are basic elements of ROI Accuracy of estimation depends on understanding of

the organization NPV along with ROI gives complete picture of benefits

Anand Paropkari

[email protected]

Questions ?

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Roi Estimation