If you’re a digital product owner or in the C-suite at your organization, you're likely evaluating how technology investments will impact your bottom line. Building custom technology or licensing expensive software solutions are complex, yet oftentimes necessary, investments to see major gains in your business. Measuring the ROI of those investments can be an even more complex equation, making it that much more difficult to explain their financial impact.
This article seeks to give you a clearer understanding of how to evaluate your technology decisions and measure their impact on your organization.
✋ Before reading further - even though we build custom software, we only recommend it to organizations who are willing to support the cultural, leadership, and talent changes that come with digital transformation investments.
First you should evaluate if building custom software is right for your business. If it's not, could you license existing software in a SaaS model? Or actually do nothing until you find an alternative solution? If you’re trying to figure out what to do, start there and come back to this article once you decide.
Why is it valuable to measure the ROI of your software investments?
ROI is an incredibly valuable financial measurement to determine how your company will deliver maximum output and profit. The goal of software development is to generate more revenue than it costs to create the software product or, at the very least, recoup the investment made into the software while improving your processes, competitive advantage, or decision making abilities.
Learning how to calculate the ROI of your software projects will help you:
- Justify further development of your products
- Determine total ownership costs to your returns over time
- Enable you to speak clearly to your stakeholders about the ROI being generated from these investments tangibly or through efficiencies
What kind of software will you develop?
The type of software that you're building will inevitably impact how you calculate the ROI as different types of software have different goals, costs, and benefits. In this article, we cover Business Process Software vs. Commercial Software / SAAS.
1. Business Process Software
These software projects are created to improve internal business processes and optimize workflow for your team. Start by listing all areas where you think you can capture revenue, lower expenses, or improve customer service with this software. Every business has unique workflows, so the following software ROI calculator points are used to get you thinking about what you stand to gain:
- Calculate the cost of the processes that the software will replace. Can you do it more efficiently with help from software? By how much? Don’t know? Ask your staff!
- Calculate your opportunity for increased revenue by winning more clients with the same amount of staff OR improving your likelihood of winning more clients.
- Calculate your sales efficiency. Can your sales staff become more efficient and self-reliant?
- Calculate your risks associated with anticipate or avoid problems sooner. What value does decreased risk or process standardization provide your company?
- Calculate how your improved customer experience will generate customer retention and renewals.
- Calculate what improved data integrity could mean for your company.
Software ROI will be measured by a combination of these factors:
- Hours saved for the teams/roles across your company
- Increased opportunity to win more business (becoming more efficient at sales)
- Improved customer service so increased likelihood of retaining, growing, or gaining net new clients
- Anticipate or avoid problems sooner, which leads to less opportunity for risk
There is always a cost to keep things the way they are. Do you know what it's costing you?
Any company, regardless of industry, can benefit from process improvements via tech if the financials work out. Unlike tangible capital expenses like buildings & equipment, software expenses are recorded as capitalized expenditures (expenses that become assets). Software assets are then amortized over their useful lifespan.
- Example: An engineering firm is looking to scale the amount of projects they can take on in a year, so they build software to improve the workflow of their team and increase efficiency while improving the client experience.
- Example: A large insurance company uses a bespoke design process for their proposals that is expensive and inefficient. Software investments seek to improve the proposal process making it easier for all involved and decreasing overall cost. Improving sales independence allows sales reps to be more efficient.
Measure impact with this matrix
There are countless ways for companies to adopt and build technology to replace mundane, antiquated ways of working – like running your company off of Excel (sound familiar?). The way to measure the impact to your organization could be to make a matrix, as seen below.
Calculate your net loss every year with your current process if you do nothing. Next, attempt to calculate your net gain with the software expense calculated into it as well. This example provides conservative guesses at what type of ROI a software could deliver in the form of net new business, client growth, and productivity.
Example for a new internal proposal software for a large engineering firm
Once you understand the level of investment to build this software and the opportunity to gain tangibly from the investment, your decision should be clear whether or not to proceed. Remember, the ROI is multi-faceted, and rarely clear. You may have to hedge some bets and set some minimum requirements, but given that you’ve read this far, you are likely thinking about this already. Now you won’t be shocked about the level of investment it will take, because you know the return will be high.
The relevance of investing into business process software has never greater than in our current state of affairs. McKinsey Insights Reports states that B2B software is now 50% more important in a post COVID-19 environment, and my experience says it’s even greater than that. It is more relevant than ever to allow people to be able to work in modern & efficient tools and to eliminate inefficient structures in how we run our organizations.
In addition, the way in which we engage with our business clients is changing. Clients expect to be able to interact with your business in an easy & modern way. Investing in technology will pay dividends both in efficiency and productivity for years to come. There has never been a better time to get started than right now. During times of uncertainty, innovation can help your company thrive.
2. Commercial Software or Saas
SaaS refers to ‘software as a service' - SaaS companies build software to service a particular customer and the software is your main source of revenue for the company. The ROI will be measured in sales generated as revenue in MRR or ARR subscription terms (monthly/annual recurring revenue). Interestingly, your clients likely measure the ROI of your software by the above list of criteria. Knowing both will be necessary to help close more contracts and sell deeper into your clients’ needs.
- Example: A fin-tech company is building a new underwriting platform for small businesses lending.
- Example: A tech company building property tech to improve property ownership experience.
- Example: A tech company building project management software of agencies and product teams to run their projects.
The first step of calculating ROI would be to calculate your break even point. Of your investment, how many customers do you need to have to break even each month between your revenue and expenses? Unless you’re selling a very expensive software solution, you will likely need hundreds, if not thousands, to break even on your total SaaS investment. However, you may be able to break even on your monthly spend with just a few customers, which is a great place to start.
Most early stage SaaS companies struggle to get to break even because their product doesn’t have many customers yet and they’re still searching for the right product-market fit. As your SaaS company grows, so will your expenses: software development expenses, customer service & sales expenses, marketing expenses, office rent and overhead expenses, and so on. SaaS isn’t as wildly profitable as it may seem from the unicorn companies that we always hear about – at least at the beginning.
There are extensive expenses that mostly incur to get a SaaS company off the ground to start finding customers. If starting a business were easy and wildly profitable, everyone would do it, but that’s just not reality. These companies are hard to build because you have to invest & borrow lots of resources to get a SaaS business off the ground.
There are no shortage of other metrics of success for SaaS companies like monthly customer churn rate, cost per acquisition, client LTV, and so on. All of these are great metrics, but cashflow is king to early survival of your SaaS startup.
As the graph above dictates, you will be operating off of savings or a seed round to get things going for your first 12-18 months, and total upfront investment depends on your skillset and the simplicity of the initial release of your product.
A good rule of thumb is to ask, “what is the minimum amount of features my product needs to make a sale?” More often than not, venture capitalists find that startups usually overcomplicate their product by focusing on far too many features and not going deep enough into one or two of them.
Can you start smaller? Can you validate sooner? Do you know who your first prospective customers are?
Wrapping up
Measuring the ROI of your software spend may be difficult to calculate, but you should try your best to do it. Even if you predict a modest return on your investment, you should end up covering the cost of development and benefiting from the business process created because of it. As a product leader, it’s also your responsibility to make sure your product will appease investors and internal stakeholders.
Using the formula above within your pitch decks, you should have a much more informed conversation and an easier time convincing those on the fence that the investment will be worth it in the long run.
