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
Year 2 Infrastructure 10000 Reduction in defect/ rework 60000Vendor 10000 reduction in cycle time 25000Training 10000Work effort 50000Total 80000 Total 85000
Year 3 Infrastructure 10000 Reduction in defect/ rework 50000Vendor 0 reduction in cycle time 15000Training 5000Work effort 30000Total 45000 Total 65000
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
Top Related