Software Economics introduction to Business Case Analysis and Online Product Management (9 Sessions) Session 1 Georg Singer georg.singer ät ut . ee
Who am I? • Austrian • MSc ( theoretical physics), MBA (Business administration) • General management and business development experience • own Web projects 2/39
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? 3/39
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? 4/39
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 5/39
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 6/39
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” 7/39
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) 8/39
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) 9/39
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 10/39
Economic/Business Terms • Turnover/Revenue • Profit/Earnings • Profit Margin • Tax • Interest • Compound interest • If there are other UNCLEAR terms, please ask! 11/39
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 12/39
The Reality – IT Executive I.T. Staffs Lack Financial Chops For Project Analysis , 03/24/2003 , 13/39 By Eric Chabrow, InformationWeek
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 14/39
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 15/39
Some stereotypes about accountants • So you better speak their language! 16/39
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 What it will Time frame Risk of significant gain (EUR) cost (EUR) (years) deviation (0-100%) 1 2 17/39 3
BREAK 10 minutes 18/39
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 19/39
Session progress • Setting and Motivation • Definition of “Business Case” • Business Case Principles • Business Case Tools I – Time value of money – Future Worth (FW) – Present Value (PV) – Net Present Value (NPV) 20/39
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) n FW PV (1 i) Where does it come from? 21/39
Formula for Compound interest - Too simple to show Year 0: V0 Year 1: V 1 = V 0 + x%= V 0 +V 0 *x/100= V 0 *(1+x/100) Year 2: V 2 = V 1 *(1+x/100)= V 0 *(1+x/100)*( 1+x/100)= =V 0 *( 1+x/100) 2 Year n V n = V 0 *(1+x/100) n 22/39
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%? 23/39
Solution • FW= $ 10.000 * (1+0,05)6= • = $ 10.000*(1,34)= • = $ 13.400 24/39
Session Progress • Setting and Motivation • Definition of “Business Case” • Business Case Principles • Business Case Tools – Future Worth (FW) – Present Value (PV) – Net Present Value (NPV) 25/39
And now the other way round.... 26/39
Time Value of Money Excel Discount Factor 27/39 Source: Investopedia.com
Present Value (PV) • Value of a future net cash flow (Cash in minus Cash out) TODAY FW (Cash flow) PV n (1 i) • i= discount rate (risk free interest rate + risk premium) • n=number of years • What are those risks? 28/39
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 29/39
Net Present Value (NPV) • TOTAL Present Value of a series of net cash flows N Net Cash Flow NPV n n (1 i) n 0 • 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 30/39
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 31/39
Example Solution Year Cashflow Present Value -100.000/(1+0,10) 0 T=0 - € 100,000 (30.000-5.000)/(1+0,10) 1 T=1 € 22,727 (30.000-5.000)/(1+0,10) 2 T=2 € 20,661 (30.000-5.000)/(1+0,10) 3 T=3 € 18,783 (30.000-5.000)/(1+0,10) 4 T=4 € 17,075 (30.000-5.000)/(1+0,10) 5 T=5 € 15,523 (30.000-5.000)/(1+0,10) 6 T=6 € 14,112 NPV € 8,881.52 Excel Simulation 32/39
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!!!! 33/39
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 ? 34/39
Exercise (Slide 2/2) - Interpretation of NPV After you have finished the first part, discuss and fill in the following table It means...(add, Then...(accepted, rejected, If... substract, not impact) yes/no) NPV > 0 the investment would the project should ………. ………value to the firm NPV < 0 the investment would ………value from the firm the project should ………… NPV = 0 the investment would …………value for the firm This project should ……….. 35/39
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