- Applications and ROIs
- Why ROIs Matter
- The Business Case
- Cash Flow ProjectionsThe Business CaseWhy ROIs Matter
- Payback Time
- Breakeven Time
- Net Present Value
- Breakeven Time
- Internal Rate of ReturnBreakeven Time
- Summary of the Terms
- An Example
- Incorporating MMFs into the Financial Case
- Comparing the MMF-based ROI with the Classic ROI
- Taking the Risks into Account
- The Impact of MMF Ordering
Incorporating MMFs into the Financial Case
Now let's take a look at that funding model again. As it stands currently, it's a classic ROI scenario in which we invest the majority of the capital up front and achieve a return only at the very end of the lifecycle. Intuitively, this is unsurprising. The application clearly has to be designed, written, integrated, tested, and packaged before sales of the software result in a revenue flow to offset the development costs.
But suppose it were possible to generate revenue earlier? How would this impact the ROI model?
At first, these may seem like theoretical questions. After all, how can revenue be released before the development work has been completed?
However, imagine we were able to separate the application into groups of features that, although they represented just a subset of the overall application feature set, were still inherently marketable. These MMFs would by definition be capable of creating revenue when released independently and incrementally.
We explore the concept of an MMF and discuss how use cases or user stories can be composed into an MMF in Chapter 3.
For now, let's assume that the total functionality of this application can be partitioned into four distinct MMFs. We'll imagine that we can develop the MMFs sequentially, aiming to bring one to market each year in years 2, 3, 4, and 5 of the project. For the purposes of this example we'll assume each MMF is equally valuable.
In year 2 we get a small revenue flow from MMF 1. In year 3 we get revenue from MMFs 1 and 2, and so on.
There are clearly additional costs associated with packaging and releasing these early MMFs, so this needs to be taken into account in the financial model. There are also additional headcount costs, because of the additional testing at the MMF level.
Taking these into account, and again using broad-brush estimates only, the returns of our modified project are shown in Figure 2.4.
Figure 2.4. ROI Analysis Using MMFs ($US in Thousands)
The PV analysis, using the same conventions as previously, reveals the modified NPV of the project as shown in Figure 2.5.
Figure 2.5. NPV Analysis Using MMFs ($US in Thousands)
The incremental delivery approach produces a development project that now looks like this:
The project generates $7.8 million (vs. $5.6 million) over five years, at a total cost of $4.712 million.
The business invests a total of $1.64 million to fund it (vs. $2.76 million).
The project returns that investment and pays back an additional $3.088 million at the end of five years.
The resulting ROI over that period is 188% (vs. 47%).
The project reaches self-funding status in year 3 (vs. year 4).
Breakeven status is achieved during year 5.
The NPV of the project, assuming an annual discount rate of 5%, is $2.236 million (vs. $650,000).
The NPV of the project, assuming an annual discount rate of 10%, is $1.594 million (vs. $194,000).
The IRR of the project is 36.3%.