Software Economics introduction to Business Case Analysis ......4/39 Course Objective •Principles...

Software Economics

introduction to Business Case Analysis and Online Product

Management (9 Sessions)

Session 1

Georg Singer

georg.singer ät ut . ee

2/39

Who am I?

• Austrian

• MSc ( theoretical physics), MBA (Business administration)

• General management and business development experience

• own Web projects

3/39

Who are you ? – Introduce yourself-1 min per person

• Who of you is currently working?

• Who is not working?

• Who of you has budged responsibility?

• Who of you does not have budget responsibility?

• Who needed to write a proposal to get an investment?

• Who is doing product management?

• Who thinks sales capabilities are important in getting a project accepted?

4/39

Course Objective

• Principles and methods of Business Case Creation

• Role of measures like NPV, ROI, TCO and the like for investment decisions

• Online product management

• Any wishes what to cover?

5/39

Structure of the course

• 2 sessions covering:

– Principles of business case analysis

• 1 solving a case in class

• 1 pitching session

– You sell me your business case

• 1 Cloud computing economics and SaaS

• 3 sessions on online product management

• 1 OPM assignment presentations

6/39

Grading

• Based on your two assignments: – Assignment 2: Business Case Analysis (15

pts)

– Assignment 3: Business Models & Product Management (15 pts)

• Grading criteria will be announced

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Readings and Resources

• Readings & resources listed in the course pages:

– http://courses.cs.ut.ee/2012/se/

– D.J. Reifer, “Making the Software Business Case”

– T. Pisello, “IT Value Chain Management- Maximizing the ROI from IT investments”

http://courses.cs.ut.ee/2012/se/

8/39

What you have learned so far in the software economics course

• productivity and quality in development projects

• size and costs of software projects

• earned value analysis

• Measure Estimate Control

• Next 5 Sessions Relating (potential) benefits with costs (put them together in business cases)

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Outline of today’s session

• Economic Terms

• Setting and Motivation

• Definition of “Business Case”

• BBBBBRRREEAAAK

• Business Case Principles

• Business Case Tools

– Future Worth (FW)

– Present Value (PV)

– Net Present Value (NPV)

10/39

After this course you will have learned

• Necessity of business cases

• Vehicle to sell change in organizations

• Metrics and measures for success and failure

• Base your decisions on facts and data

11/39

Economic/Business Terms

• Turnover/Revenue

• Profit/Earnings

• Profit Margin

• Tax

• Interest

• Compound interest

• If there are other UNCLEAR terms, please ask!

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The Setting: Business Environment today – Innovate or Die

• (Hyper)competition

• Innovation is key (products, processes)

• Improvement is everybody’s business, also YOURS

• Improvements often accompanied by software changes (processes and products)

• Primary function of software is to accommodate change (otherwise features would be put into hardware)

• Change and innovation is “done” by numbers

• Business cases are the medium to sell change

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The Reality – IT Executive

I.T. Staffs Lack Financial Chops For Project Analysis , 03/24/2003 ,

By Eric Chabrow, InformationWeek

14/39

What is a Business Case?

• A business case:

– materials prepared for

– decision makers to show that the

– idea considered is

– a good one and that the

– numbers that surround

– it make financial sense

15/39

Business vs. Technical Cases

• Engineers and accountants speak “different languages”

• You as engineers have to understand, how to communicate the benefits of

– what are you trying to accomplish

– in nontechnical language

– so that that accountants, CIOs….understand it

• Sell change WITHIN and INTO organizations

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Some stereotypes about accountants

• So you better speak their language!

17/39

Exercise – Create Business Cases • 20 minutes, 5-6 groups

• SCENARIO: You are boss of a software development company

• Due to the ongoing recession your company’s profits are shrinking

• Create 5 business cases to boost the profits, please also briefly describe your business

• Each group briefly presents the 2 best cases, explain why best

• Please summarize the cases in the following table:

What you will do

What you will gain (EUR)

What it will cost (EUR)

Time frame (years)

Risk of significant deviation (0-100%)

1

2

3

18/39

BREAK 10 minutes

19/39

Business Case Principles

• Decisions are made relative to alternatives (opportunity costs) – Linux vs. Windows?

• Money common denominator

• Investment decisions and time value of money (based on simple model)

• Quantitative (tangible) and qualitative (intangible) factors

• The risks need to be quantified

• NOW WE DEVELOP THE TOOLSET TO MAKE BCs

20/39

Session progress




• Business Case Tools I – Time value of money




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Future Worth (FW)

• How much a given sum of money is "worth" at a specified point of time in the future

• PV=present Value

• n=number of years

• i=interest rate (rate of return, reflects risks and uncertainty)

ni)(1PVFW

Where does it come from?

22/39

Formula for Compound interest - Too simple to show

Year 0: V0

Year 1:

V1 = V0 + x%= V0+V0*x/100= V0*(1+x/100)

Year 2:

V2= V1*(1+x/100)= V0*(1+x/100)*( 1+x/100)=

=V0*( 1+x/100)2

Year n

Vn= V0*(1+x/100)n

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Example – Future Worth

• Your uncle in America passes away.

• You inherit $ 10.000.

• Due to bureaucratic hurdles getting access to the money will take 6 years

• What is the future worth of the money in 6 years given a rate of return of 5%?

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Solution

• FW= $ 10.000 * (1+0,05)6=

• = $ 10.000*(1,34)=

• = $ 13.400

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Session Progress








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And now the other way round....

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Time Value of Money

Excel Discount Factor

Source: Investopedia.com

Discount.xlsxDiscount.xlsx

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Present Value (PV)

• Value of a future net cash flow (Cash in minus Cash out) TODAY

• i= discount rate (risk free interest rate + risk premium)

• n=number of years

• What are those risks?

ni)(1

flow)(Cash FW PV

29/39

PV Formula – Deduction (again too simple to show

• Inverted compound interest formula

• Start with future value formula

• FW= PV * (1+i) n

• Bring the discount factor to the right side

•PV= FW/(1+i)n

One more step to NPV

30/39

Net Present Value (NPV)

• TOTAL Present Value of a series of net cash flows

• Net cash flow= Cash in – cash out

• i= discount rate

• N=total number of years

• NPV should be positive in order for a project to

• make economic sense

N

0ni)(1

FlowCash Net n

nNPV

31/39

Example

• Introduction of new ERP Software

• Upfront costs (License, Training): € 100.000

• Other yearly costs: € 5.000 per year

• Benefits: € 30.000 per year (Cost savings)

• No Gains after 6 years

• Rate of Return: 10% (5% risk free interest + 5% risk adjustment because. Software very new)

• Calculate the NPV

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Example Solution

Year Cashflow Present Value

T=0 -100.000/(1+0,10)0 -€ 100,000

T=1 (30.000-5.000)/(1+0,10)1 € 22,727

T=2 (30.000-5.000)/(1+0,10)2 € 20,661

T=3 (30.000-5.000)/(1+0,10)3 € 18,783

T=4 (30.000-5.000)/(1+0,10)4 € 17,075

T=5 (30.000-5.000)/(1+0,10)5 € 15,523

T=6 (30.000-5.000)/(1+0,10)6 € 14,112

NPV € 8,881.52

Excel Simulation

Examples.xlsx

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QUESTION

• Who thinks, Windows Vista was an excellent operating system?

• yes:

• No:

• Who thinks an upgrade from XP made financial sense for a company?

• Yes:

• No:

Lets see!!!!

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Group Exercise (Slide 1/2) – 30 minutes Project: Upgrade from XP to Vista

• Please build 4-5 Groups • One time Investment Costs(licenses, manpower, etc.):

– 2000 PCs,

– License costs: € 150 per PC

– Manpower (for installation): € 25 per PC (all in year 0)

• Yearly Maintenance Costs : € 50.000 (starting in year 1)

• Yearly Benefits € 150.000 (starting in year 1)

• Rate of Return: CIO wants 8% (4% risk free+ 4% risk adjustment)

• Years to the next upgrade: 4 (the next upgrade will be at the beginning of year 5)

• What is the NPV?

• Is it a GOOD investment for the company ?

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Exercise (Slide 2/2) - Interpretation of NPV

If... It means...(add, substract, not impact)

Then...(accepted, rejected, yes/no)

NPV > 0 the investment would ………value to the firm

the project should ……….

NPV < 0 the investment would ………value from the firm

the project should …………

NPV = 0 the investment would …………value for the firm

This project should ………..

After you have finished the first part, discuss and fill in the

following table

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Solution

Year Cashflow Present Value

T=0 -350.000/(1+0,08)0 -€ 350.000

T=1 (150.000-50.000)/(1+0,08)1 € 92.592

T=2 (150.000-50.000)/(1+0,08)2 € 85.733

T=3 (150.000-50.000)/(1+0,08)3 € 79.383

T=4 (150.000-50.000)/(1+0,08)4 € 73.502

Total € -18.787

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Solution - Interpretation of NPV

If... It means... Then...

NPV > 0 the investment would add value to the firm

the project may be accepted

NPV < 0 the investment would subtract value from the firm

the project should be rejected

NPV = 0 the investment would neither gain nor lose value for the firm

This project adds no monetary value. Decision should be based on other criteria, e.g. strategic positioning or other factors not explicitly included in the calculation.

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Is it a realistic example?

• What is missing?

– Hard ware upgrades necessary to run Windows 7 properly

– What does it cost to stick to Vista and skip 7? • No hardware support

• Higher license fees for Windows X if Windows 7 was skipped

– Etc.

– Etc.

39/39

What we have done today








40/39

Outline of next session

• More Business case tools

– Return on Investment (ROI)

– Internal Rate of Return (IRR)

– Payback Period/Break Even Analysis

– Total Cost of Ownership (TCO)

– ….. Thank you and see you next week!

Software Economics introduction to Business Case Analysis ......4/39 Course Objective •Principles...

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