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A Project Management Primer - Scope - Scope, Visions and Goals - Return on Investment

March 6, 2008 | Author: admin | Filed under: Scope Management, Cost Management, Project Scope Management, Cost Estimating, Economic Evaluation

A Project Management Primer - Scope - Scope, Visions and Goals - Return on Investment (#10 in the Hut A Project Management Primer)
By Nick Jenkins

One important component of many formal business cases is a ‘Return on Investment’ or ROI calculation. Simply put an ROI calculation compares the cost of a project with the benefits you expect to achieve. Different projects can then be evaluated on a like-for-like basis and the best use for the money selected.

Obviously to compare costs to benefits they need to be stated in the same ‘units’ and not surprisingly these are usually “dollars”. This is where the problems start. The cost of a project is usually fairly easy to determine but the benefits can be much harder to quantify. Benefits are usually determined by asking the customer to estimate what benefits, in dollar terms, they hope to achieve through using the product.

This could range from freeing up someone from a manual process (saving money) to attracting more customers. These are fairly easy to put a dollar figure to but are based on future predictions which can be unreliable. For example how many hours of someone’s day will you free up ? How many more customers will this product attract?

Sponsors tend to inflate predicted returns in order to get ‘their’ project up and running. They will confidently stick a finger in the air and predict a 50% increase in customer numbers if the project is delivered correctly. While it is not primarily your problem, you might be lumbered with unrealistic expectations for your project. You might also be lumbered with the blame for ‘not implementing the project properly’ when it fails to deliver the expected returns. Fortunately most companies are terrible at actually comparing expected results with actual results.

Notwithstanding this, if you can confidently estimate one of these values you can then compare your costs to your benefits. Your return on investment is the ratio between the costs and the benefits with a positive ratio indicating profit, or a return on your investment. This is normally done over an extended period of time to determine when the product will reach its ‘payback’ point.

For example if I decide to make a terrific new product which would help me breed marmosets, I could work out the ROI like this :

1. I estimate that it will take me roughly six weeks to design, develop and debug my product. I will also need a new PC costing about $2000 and some important marmoset measuring equipment costing about $500. I also pay myself about $500 a day, so the cost would therefore be : 30 working days x $500 + $2500 hardware = $17 500

2. By surveying my prospective market I determine that there are about 1000 marmoset breeders in my local area. I estimate that I will reach about 10% of them the first year, then as my fame catches on I will sell to another 30% of them and then as competing products come on the market sales will decline back to a steady 10% per year.

Since marmoset breeders aren’t rich I decide to charge about $50 a copy for my software giving me the following benefit calculation :
10% of 1000 is 100 x $50 = $5000 in the first year
30% of 1000 is 300 x $50 = $15000 in the second year
10% of 1000 is 100 x $50 = $5000 in the third and successive years

3. My ROI calculation thus looks like this:

	Year 1	Year 2	Year 3	Year n
Cost	$17500	$0	$0	$0
Benefit	$5000	$15000	$5000	$5000
ROI	28%	114%	143%	…

Based on this calculation my product will reach payback in 1 year and 10 months. Not bad for something that only took six weeks to write!

Next in the Hut A Project Management Primer:

A Project Management Primer - Scope - Requirements

Previously in the Hut A Project Management Primer:

A Project Management Primer - Scope - Scope, Visions and Goals - A Decent Proposal

Nick Jenkins is an IT manager with 10 years experience in software development, project management and software testing. He’s worked in various fields of IT development in Australia, Britain and the USA and occasionally he learned something along the way. Now he lives on the banks of the Swan River in Perth, Western Australia, and he publishes the odd guide to help aspiring IT professionals. Nick’s website can be found at www.nickjenkins.net.

Related Articles

• A Project Management Primer - Scope - Scope, Visions and Goals
• A Project Management Primer - Scope - Scope, Visions and Goals - A Decent Proposal
• A Project Management Primer - Scope - Scope, Visions and Goals - The Vision as Inspiration
• A Project Management Primer - Scope - Scope, Visions and Goals - Goals as a Filter for Requirements
• A Project Management Primer - Scope - Requirements

This entry was posted on Thursday, March 6th, 2008 and is filed under Scope Management, Cost Management, Project Scope Management, Cost Estimating, Economic Evaluation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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