Return on Software. Maximizing the Return on Your Software Investment. Steve Tockey.
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1 Return on Software Maximizing the Return on Your Software Investment Steve Tockey Steve Tockey All Rights Reserved. Construx Delivering Software Project Success construx software consulting training software projects construx.com 2
2 Harsh Realities 23% of software projects fail to deliver any working software at all Of projects that do deliver, they average 63% late 45% over budget 67% of the features and functions delivered 40% of commercial applications of computers are uneconomical Reference: [Standish01], [Kidder81] construx software consulting training software projects construx.com 3 Harsh Realities (cont) Annual software budget in the US is about $275 billion $63 billion/year in cancelled projects alone As much as $149 billion/year in net money- losing projects Reference: [Standish01] construx software consulting training software projects construx.com 4
3 The Cost of Bad Decisions Poor project performance can almost always be traced back to bad decisions (whether accidental or intentional), either by the customer, the development staff, or both Which projects to do Not getting good requirements Not giving good requirements Using inappropriate technology Choosing the wrong design or architecture Not giving the project team adequate resources Not planning and/or managing the project Not paying attention to quality construx software consulting training software projects construx.com 5 Business on Purpose Why are companies in business? Because it s s fun? Educational? A way to have a positive impact on society? No: companies are in business to make a profit for the owners Where does the money come from? construx software consulting training software projects construx.com 6
4 Where Does the Money Go? Gross Revenue Cost of Goods Sold Material Labor Operating Expenses Selling expenses General and administrative expenses Taxes (other than income) Investment-related Expenses Interest on loans Depreciation Income Taxes Federal State Local Return On Equity Cash dividends on stock Operating Income Net Income Before Taxes Net Income After Taxes Retained Earnings construx software consulting training software projects construx.com 7 PeopleSoft, 2003 $2,267M (100.0%) Gross Revenue Cost of Goods Sold Material Labor Operating Expenses Selling expenses General $1,282M and administrative (56.6%) expenses Taxes (other than income) $868M (38.3%) Investment-related Expenses Interest on loans -$22M Depreciation (-0.9%) Income Taxes Federal $53M (2.3%) State Local Return On Equity Cash dividends on stock $0M (0.0%) Operating Income Net Income Before Taxes Net Income After Taxes Retained Earnings $117M (5.2%) $139M (6.1%) $85M (3.8%) $85M (3.8%) construx software consulting training software projects construx.com 8
5 Economics, the Science of Choice software economics has often been misconceived as the means of estimating the cost of programming projects. But economics is primarily a science of choice, and software economics should provide methods and models for analyzing the choices that software projects must make Reference: [Levy87] construx software consulting training software projects construx.com 9 The Business Decision Making Process Understand the real problem Define the Identify all reasonable technically-feasible solutions Evaluate each proposal against the Select the preferred proposal Monitor the performance of the selected proposal construx software consulting training software projects construx.com 10
6 Understand the Real Problem In software, this is usually the requirements Issues in contemporary requirements Ambiguity Example Incompleteness Mistaking a solution for the problem Find the best way to invest MegaCorp s development resources over the next 6 months construx software consulting training software projects construx.com 11 The Business Decision Making Process Understand the real problem Define the Identify all reasonable technically-feasible solutions Evaluate each proposal against the Select the preferred proposal Monitor the performance of the selected proposal construx software consulting training software projects construx.com 12
7 Define the Selection Criteria Selection criteria need to be Unique Sufficient Meaningful Discriminating At MegaCorp Profitability Risk Staff morale construx software consulting training software projects construx.com 13 Typical Selection Criteria Financial Initial investment Present worth (Net present value) Internal rate of return Discounted payback period Technical Performance Reliability Maintainability Non-technical Reputable provider Creature comfort construx software consulting training software projects construx.com 14
8 Cash Flow Diagrams $8150 $5900 $3650 $2900 $650 $ $850 Time Income Expense Initial investment -$10,000 construx software consulting training software projects construx.com 15 Interest: Time is Money Ik Pk Ik+1 Pk+1 Ik+2 Pk+2 Tk Tk+1 Tk+2 construx software consulting training software projects construx.com 16
9 Some Interest Formulas Single-payment Present-worth (P/F) unknown n-1 n known P F 1 = n ( 1+ i) Present Worth, PW(i) t= 0 ( ) t 1 i PW(i) = F + n t construx software consulting training software projects construx.com 17 Minimum Attractive Rate of Return (MARR) A statement that the organization is confident it can achieve at least that rate of return through its typical operations aka Opportunity cost construx software consulting training software projects construx.com 18
10 Present Worth (Net Present Value) Inventory Control Project CRM Project End of Net cash Discounted End of Net cash Discounted year flow (P/F,14%,n) cash flow year flow (P/F,14%,n) cash flow 0 -$450, $450, $450, $450, , , , , , , , , , , , , , , , ,919 Total $510,000 $266,418 Total $600,000 $264,462 construx software consulting training software projects construx.com 19 The Business Decision Making Process Understand the real problem Define the Identify all reasonable technically-feasible solutions Evaluate each proposal against the Select the preferred proposal Monitor the performance of the selected proposal construx software consulting training software projects construx.com 20
11 Identify Reasonable Technically- feasible Solutions We re usually pretty good at this Creative/lateral thinking helps (see [DeBono92] or [vonoech98]) construx software consulting training software projects construx.com 21 Identify Reasonable Technically- feasible Solutions (cont) Option 1 Extend product with new functionality Option 2 Fix outstanding defects Option 3 Make it a client-server application construx software consulting training software projects construx.com 22
12 The Business Decision Making Process Understand the real problem Define the Identify all reasonable technically-feasible solutions Evaluate each proposal against the Select the preferred proposal Monitor the performance of the selected proposal construx software consulting training software projects construx.com 23 Evaluate Each Proposal Against the Selection Criteria Proposals Financial Risk Morale Extend $66, Fix defects $58, Client-server $76, construx software consulting training software projects construx.com 24
13 The Business Decision Making Process Understand the real problem Define the Identify all reasonable technically-feasible solutions Evaluate each proposal against the Select the preferred proposal Monitor the performance of the selected proposal construx software consulting training software projects construx.com 25 Select the Preferred Proposal Non-compensatory techniques Dominance Satisficing Lexicography Compensatory techniques Nondimensional scaling Additive weighting Analytic hierarchy process construx software consulting training software projects construx.com 26
14 Additive Weighting 1. Define the criteria weights 1. Assign points to each criterion by importance 2. Divide by total points across all criteria 2. Scale the values on the proposals 1. Worst value within a criterion assigned Best assigned some arbitrary value, say Intermediate values are scaled proportionally 3. Calculate total scores for each proposal 1. Add up (scaled value * criterion weight) 4. Identify best score construx software consulting training software projects construx.com 27 Select the Preferred Proposal (cont) Proposals Financial Risk Morale Total (0.60) (0.25) (0.15) Extend $66, (42.9) (33.3) (100.0) Fix defects $58, (0.0) (100.0) (0.0) Client-server $76, (100.0) (0.0) (60.0) construx software consulting training software projects construx.com 28
15 The Business Decision Making Process Understand the real problem Define the Identify all reasonable technically-feasible solutions Evaluate each proposal against the Select the preferred proposal Monitor the performance of the selected proposal construx software consulting training software projects construx.com 29 Monitor the Performance of the Selected Proposal Look at where you ve been Meeting expectations? Look at where you are Earned value Look at where you re going Improve future estimates construx software consulting training software projects construx.com 30
16 Other Important Methods and Tools Proposals Alternatives Planning horizons and economic life Replacement and retirement decisions Inflation and deflation Depreciation General accounting and cost accounting Income taxes and their consequences Not-for for-profit decisions Break-even even analysis Optimization analysis Estimation, risk, and uncertainty construx software consulting training software projects construx.com 31 Other Important Decisions Which software project(s) ) should we do? Should Technology X be used on this project? Which software development lifecycle should we use? How much software testing is enough? construx software consulting training software projects construx.com 32
17 Engineering, Defined Finding the balance between what is technically feasible and what is economically acceptable Doing well with one dollar that which any bungler can do with two Reference: [DeGarmo93], [Wellington1887] construx software consulting training software projects construx.com 33 References [DeBono92] Edward DeBono, Serious Creativity: Using the Power of Lateral Thinking to Create New Ideas,, Harper Collins, 1992 [DeGarmo93] E. DeGarmo,, W. Sullivan, J. Bontadelli, Engineering Economy,, 9th Edition, Prentice Hall, 1993 [Kidder81] Tracy Kidder, The Soul of a New Machine,, Little, Brown & Company, 1981 [Levy87] Leon Levy, Taming the Tiger Software Engineering and Software Economics,, Springer-Verlag Verlag,, 1987 [Standish01], Extreme Chaos,, The Standish Group, West Yarmouth, MA, 2001 [vonoech98] Roger von Oech, A Whack on the Side of the Head, Revised Edition, Warner Business, 1998 [Wellington1887] A. Wellington, The Economic Theory of the Location of Railways,, 2nd Edition, John Wiley & Sons, 1887 construx software consulting training software projects construx.com 34
18 Contact Information Consulting (425) Construx Delivering Software Project Success Software Projects Project Consulting Seminars On-site Training construx software consulting training software projects construx.com 35
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