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# Project Economics

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### Project Economics

1. 1. Copyright Mountain Goat Software, LLCProject Economics:Selecting and PrioritizingHigh Value ProjectsMike CohnMountain Goat Softwaremike@mountaingoatsoftware.com1
2. 2. Copyright Mountain Goat Software, LLCFounding member anddirector of Agile Alliance,Scrum Alliance, and AgileProject LeadershipNetworkFounder of MountainGoat SoftwareConsultant, author,and speakerMike Cohn - background2
3. 3. Copyright Mountain Goat Software, LLCWhat we want to do1234133
4. 4. Copyright Mountain Goat Software, LLCNet Present Value (NPV)Internal Rate of Return (IRR) and ROIPayback PeriodModeling ReturnPrioritizingNon-financial approachesToday’s agenda4
5. 5. Copyright Mountain Goat Software, LLCWhich project would you prefer?\$1,000Project AInvestment Return Investment ReturnYear0 \$1,000Project B1 \$200 \$3,0002 \$300 \$5003 \$500 \$3004 \$3,000 \$2005
6. 6. Copyright Mountain Goat Software, LLCThe time-value of moneyA dollar today is worth more than a dollar ayear from nowI’ll gladly pay youon Tuesday for a hamburgertoday.6
7. 7. Copyright Mountain Goat Software, LLCCalculating the value of future dollarsTo buy a \$5hamburger nextTuesday...To buy a \$5hamburger in a year,how much do I put inthe bank today?I would put around \$4.99in the bank today\$5.001+0.10\$5.001.10\$4.54==Assumes 10%interest rateThe present value of\$5.00 a year from now7
8. 8. Copyright Mountain Goat Software, LLCPresent value of one future amountFuture Value1+interest ratePresentValue=\$5.001+0.10= \$4.54An example:GeneralizingFV(1+i)tPV =SimplifyingPV = FV(1+i)-t8
9. 9. Copyright Mountain Goat Software, LLCNet present value (NPV)Measures the return on a theme or project asan amount of moneyFt(1+i)-tNPV(i) = ∑t=0n9
10. 10. Copyright Mountain Goat Software, LLCNPV exampleAssuming 12% annual discount rate (3% / quarter)QuarterCashflow(1+i)-t DiscountedCash FlowRunningTotal0 -200 1.000 -200 -2001 -600 0.971 -583 -7832 100 0.943 94 -6893 300 0.915 275 -4144 500 0.888 444 3010
11. 11. Copyright Mountain Goat Software, LLCDiscount rate sensitivityNPV is highly sensitive to the chosen discount rateQuarter Cash flowDiscounted CashFlow (3%)Discounted CashFlow (6%)0 -200 -200 -2001 -600 -583 -7832 100 94 -6893 300 275 -4144 500 444 30Total 100 30 -29Do the project underthese conditionsBut not under these11
12. 12. Copyright Mountain Goat Software, LLCComparing NPVsHighest NPV brings the most present-valuedollars to the companyTheme NPVScalabilityGift registryAd hoc reportingPay by invoice\$2,100\$1,253\$784\$385Comparing NPVs can bemisleading. What if:“Pay by invoice” requires a\$5 investment“Scalability” requires\$50,000?12
13. 13. Copyright Mountain Goat Software, LLCNet Present Value (NPV)Internal Rate of Return (IRR) and ROIPayback PeriodModeling ReturnPrioritizingNon-financial approachesToday’s agenda13
14. 14. Copyright Mountain Goat Software, LLCReturn as a percentageRather than expressing returns in dollars, we’dlike to express return as a percentageAllows for direct comparisonsNPV = how much money a project will returnROI = how quickly an investment will grow14
15. 15. Copyright Mountain Goat Software, LLCInternal rate of return (IRR) and ROIIRR = Internal Rate of ReturnOften called Return On Investment (ROI)The interest rate at which NPV is 00 = PV(i*) = Ft 1+ i( )−tt= 0n∑15
16. 16. Copyright Mountain Goat Software, LLCRemember this table?IRR gives us the discount rate at which we don’t carewhether or not we do the projectWe don’t make \$30; we don’t lose \$29; we break evenQuarter Cash flowDiscounted CashFlow (3%)Discounted CashFlow (6%)0 -200 -200 -2001 -600 -583 -7832 100 94 -6893 300 275 -4144 500 444 30Total 100 30 -2916
17. 17. Copyright Mountain Goat Software, LLCHow to calculate ROI or IRRUse Excel’s irr function+irr({−200, −600, 100, 300, 500})An investmentday of the project remainder ofproject(4 quarters)17
18. 18. Copyright Mountain Goat Software, LLCAdvantages and disadvantagesAdvantagesYou don’t need to guess at a discount rate like with NPVCan be used to directly compare projectsDisadvantagesCalculation is hard to do by hand (but easy in Excel); maylead to numbers being distrustedCannot use in all circumstances18
19. 19. Copyright Mountain Goat Software, LLCNet Present Value (NPV)Internal Rate of Return (IRR) and ROIPayback PeriodModeling ReturnPrioritizingNon-financial approachesToday’s agenda19
20. 20. Copyright Mountain Goat Software, LLCQuarter Cash Flow Running Total01234-200 -200-200 -400100 -300300 0500 500Payback periodThe amount of time before an initialinvestment is paid backI loan you \$5.You pay me back \$1/week.Thepayback period is 5 weeks.Payback periodis 3 quarters.20
22. 22. Copyright Mountain Goat Software, LLCDiscounted payback periodwhen the investment is paid backDiscounted payback period = 4 quartersQuarterCashFlow(1+i)-ti=3%DiscountedCash FlowRunningTotal0 -200 1.000 -200 -2001 -200 0.971 -194 -3942 100 0.943 94 -3003 300 0.915 275 -254 500 0.888 444 41922
23. 23. Copyright Mountain Goat Software, LLCFinancial analysis recapNet PresentValue (NPV)Expresses return as an amount of moneyReturn on Investment (ROI) / Internal Rate of ReturnThe interest rate at which NPV = 0That is, at which you’d be indifferent to the investmentExpresses return as a percentageDiscounted payback periodAmount of time before discounted returns equal theinvestmentExpresses return as an amount of time23
24. 24. Copyright Mountain Goat Software, LLCNet Present Value (NPV)Internal Rate of Return (IRR) and ROIPayback PeriodModeling ReturnPrioritizingNon-financial approachesToday’s agenda24
25. 25. Copyright Mountain Goat Software, LLCYou need a business modelThese formulas assume you have a model ofthe returns a project or theme will generateBusiness modelCurrentcustomersFuturecustomersCompetitionMarketacceptancePeriod 1 Period 2 Period 325
26. 26. Copyright Mountain Goat Software, LLCA relatively simple way to modelConsider your revenue sources and groupthemThese four often work well:1. New revenue2. Incremental revenue3. Retained revenue4.26
27. 27. Copyright Mountain Goat Software, LLCNew revenueMoney we’ll make selling products or servicesto new customersthink of the return on a projectIn addition to selling books,Amazondecides to sell music CDs.27
28. 28. Copyright Mountain Goat Software, LLCIncremental revenueSometimes worth distinguishing from newrevenueTypically comes because new product or service:Encourages existing customers to buy or licensemoreIncludes optional, add-on modules that are soldseparatelyIncludes features that justify a higher priceEncourages use of consulting servicesAn eCommerce site decides to offer giftwrapping for \$5 per box.28
29. 29. Copyright Mountain Goat Software, LLCRetained revenueRevenue you’ll lose if the project is notperformedRevenue you’ll lose is different from revenue you won’tgetCustomers who will stay with you whootherwise would leaveWe’re losing customers because oureCommerce site doesn’t offer gift wrapping.Our competitors have added features wedon’t have29
30. 30. Copyright Mountain Goat Software, LLCMost applicable for internally used softwareBut also a factor on commercial productsAnything that takes a long timeOr will take a long time as the company growsAnything that improves accuracy or reduces reworkAn eCommerce site with third-party sellers. It takes 2hours of manual time to add each seller.Our commercial software has usability issues, we get alot of tech support calls.We spend 16 hours training new employees how touse our internal software30
31. 31. Copyright Mountain Goat Software, LLCAn example:WebPayrollOffers web-based payroll system to smallcompaniesCalculates payroll taxes, prints checks, etc.We tell customers they need to enter payrolldata 3 days before they want checksOur goal: Next-day serviceEnter data by 5pm, we print checks and overnightthem to the company31
32. 32. Copyright Mountain Goat Software, LLCFacts about WebPayrollAverage customer – pays \$400/year in feesOvernight delivery will appeal to smallercustomers, paying an average of \$200/yearWe think we’ll make another \$100/year percustomer that uses the over night serviceAverage new customer is then worth \$300/year (\$200+\$100), or \$75/quarterNew feature will take four months to deliver32
33. 33. Copyright Mountain Goat Software, LLCWebPayroll: new revenueSales says 50 new customers/quarter thisyear; 100 next yearQuarterNewCustomersRevenue perCustomerNew Revenue123456780 \$0 \$050 \$50 \$2,50050 \$75 \$3,75050 \$75 \$3,750100 \$75 \$7,500100 \$75 \$7,500100 \$75 \$7,500100 \$75 \$7,50033
34. 34. Copyright Mountain Goat Software, LLCWebPayroll:incremental revenueWe estimate we’ll sign up 100 existingmembers per quarter until we have 400Quarter CustomersRevenue perCustomerIncrementalRevenue123456780 \$0 \$0100 \$16 \$1,600200 \$25 \$5,000300 \$25 \$7,500400 \$25 \$7,500400 \$25 \$10,000400 \$25 \$10,000400 \$25 \$10,00034
35. 35. Copyright Mountain Goat Software, LLCWebPayroll: retained revenueSales say we’ll retain 10 customers per quarterQuarterRetainedCustomersTotalRetainedRevenue perCustomerRetainedRevenue1234567810 10 \$100 \$1,00010 20 \$100 \$2,00010 30 \$100 \$3,00010 40 \$100 \$4,00010 50 \$100 \$5,00010 60 \$100 \$6,00010 70 \$100 \$7,00010 80 \$100 \$8,00035
36. 36. Copyright Mountain Goat Software, LLCWe can avoid hiring a new payroll clerk a year fromnow at a fully burdened labor cost of \$30,000/year.QuarterPayroll ClerksNot NeededFully BurdenedLabor CostOperational123456780 \$0 \$00 \$0 \$00 \$0 \$00 \$0 \$01 \$7,500 \$7,5001 \$7,500 \$7,5001 \$7,500 \$7,5001 \$7,500 \$7,50036
37. 37. Copyright Mountain Goat Software, LLCAll the numbers forWebPayrollQ Dev CostNewRevenueIncr.RevenueRetainedRevenueOper. Net CashFlow12345678−\$90,000 \$0 \$0 \$1,000 \$0 −\$89,000−\$30,000 \$2,500 \$1,600 \$2,000 \$0 −\$23,900\$3,750 \$5,000 \$3,000 \$0 \$11,750\$3,750 \$7,500 \$4,000 \$0 \$15,250\$7,500 \$7,500 \$5,000 \$7,500 \$27,500\$7,500 \$10,000 \$6,000 \$7,500 \$31,000\$7,500 \$10,000 \$7,000 \$7,500 \$32,000\$7,500 \$10,000 \$8,000 \$7,500 \$33,00037
38. 38. Copyright Mountain Goat Software, LLCWebPayroll - NPVQuarter Net Cash Flow (1+i)-t PresentValue12345678−\$89,000 0.971 −\$86,419−\$23,900 0.943 −\$22,538\$11,750 0.915 \$10,751\$15,250 0.888 \$13,542\$27,500 0.863 \$23,733\$31,000 0.837 \$25,947\$32,000 0.813 \$26,016\$33,000 0.789 \$26,037NPV (12%) = \$43,10638
39. 39. Copyright Mountain Goat Software, LLCWebPayroll - ROI+irr(A1:A9, .10)A1234567890−\$89,000−\$23,900\$11,750\$15,250\$27,500\$31,000\$32,000\$33,0006%39
40. 40. Copyright Mountain Goat Software, LLCWebPayroll - Payback PeriodQuarter Net Cash Flow Running Total12345678−\$89,000 −\$89,000−\$23,900 −\$112,900\$11,750 −\$101,150\$15,250 −\$85,900\$27,500 −\$58,400\$31,000 −\$27,400\$32,000 \$4,600\$33,000 \$37,600Payback period = 7 quarters40
41. 41. Copyright Mountain Goat Software, LLCWebPayroll - Discounted Payback PeriodQuarterNet CashFlow(1+i)-t3%PresentValueRunningTotal12345678−\$89,000 0.971 −\$86,419 −\$86,419−\$23,900 0.943 −\$22,538 −\$108,957\$11,750 0.915 \$10,751 −\$98,206\$15,250 0.888 \$13,542 −\$84,664\$27,500 0.863 \$23,733 −\$60,931\$31,000 0.837 \$25,947 −\$34,984\$32,000 0.813 \$26,016 −\$8,968\$33,000 0.789 \$26,037 \$17,069Discounted payback period = 8 quarters41
42. 42. Copyright Mountain Goat Software, LLCNet Present Value (NPV)Internal Rate of Return (IRR) and ROIPayback PeriodModeling ReturnPrioritizingNon-financial approachesToday’s agenda42
43. 43. Copyright Mountain Goat Software, LLCYou need to know the costTo prioritize you must know the costIf you had no idea of the costs, which car wouldyou be inclined to buy?Estimate the development time of each projectPerson-weeks, story points, ideal daysCalculate your cost per that unit\$4,500 per person-week\$3,100 per story point43
44. 44. Copyright Mountain Goat Software, LLCCalculating cost per person-weekDevelopment budget last year \$2,100,000Person weeks worked 6x52+1x39=351Cost per week \$2.1M / 351 = \$5,982So, if a project isestimated at 25 person-weeks:- 25 x \$6000 = \$150,00044
45. 45. Copyright Mountain Goat Software, LLCUsing story pointsDevelopment budget last year \$2,100,000343Cost per story point \$2.1M / 343 = \$6,122So, if a project isestimated at 25 storypoints:- 25 x \$6000 = \$152,50045
46. 46. Copyright Mountain Goat Software, LLCTheme (project) comparison matrixPersonWeeksCost3-YearReturnNPV IRRD. Payback(Quarters)Theme ATheme BTheme CTheme DTheme ETheme FTheme GTheme HTheme ITheme JTheme KTheme LTheme MTheme NTheme OTheme P25 \$150 \$1,085 \$448 133% 232 192 \$2,109 \$940 172% 490 \$540 \$2,537 \$883 89% 248 \$288 \$1,360 \$443 76% 455 \$330 \$900 \$191 48% 279 \$474 \$1,365 \$331 56% 490 \$540 \$5,964 \$2,519 139% 550 \$300 \$2,415 \$1,023 146% 215 90 \$1,600 \$747 221% 130 \$180 \$640 \$182 65% 275 \$450 \$516 (\$104) 5% NA40 \$240 \$171 (\$110) (12%) NA80 \$480 \$1,025 \$142 36% 318 \$108 \$185 \$7 24% 26 36 \$155 \$53 90% 112 \$72 \$1,505 \$748 355% 146
47. 47. Copyright Mountain Goat Software, LLCWhat do you select?It’s March 18 and youare meeting to plan theApril-June quarter.Your team now has 7people. That’s 7*13=91person-weeks in a quarter.What do you select?47
48. 48. Copyright Mountain Goat Software, LLCTheme (project) comparison matrixPersonWeeksCost3-YearReturnNPV IRRD. Payback(Quarters)Theme ATheme BTheme CTheme DTheme ETheme FTheme GTheme HTheme ITheme JTheme KTheme LTheme MTheme NTheme OTheme P25 \$150 \$1,085 \$448 133% 232 192 \$2,109 \$940 172% 490 \$540 \$2,537 \$883 89% 248 \$288 \$1,360 \$443 76% 455 \$330 \$900 \$191 48% 279 \$474 \$1,365 \$331 56% 490 \$540 \$5,964 \$2,519 139% 550 \$300 \$2,415 \$1,023 146% 215 90 \$1,600 \$747 221% 130 \$180 \$640 \$182 65% 275 \$450 \$516 (\$104) 5% NA40 \$240 \$171 (\$110) (12%) NA80 \$480 \$1,025 \$142 36% 318 \$108 \$185 \$7 24% 26 36 \$155 \$53 90% 112 \$72 \$1,505 \$748 355% 148
49. 49. Copyright Mountain Goat Software, LLCNet Present Value (NPV)Internal Rate of Return (IRR) and ROIPayback PeriodModeling ReturnPrioritizingNon-financial approachesToday’s agenda49
50. 50. Copyright Mountain Goat Software, LLCKano analysisLinear The more of it, the betterThree types of featuresExciters /DelightersFeatures a user doesn’t knowshe wants, until she sees itMandatory /BaselineMust be present in order for50
51. 51. Copyright Mountain Goat Software, LLCSurveying usersTo assess whether a feature is baseline, linear,or exciting we can:Sometimes guessOr survey a small set of users (20-30)We ask two questionsA functional questionHow do you feel if a feature is present?And a dysfunctional questionHow do you feel if that feature is absent?51
52. 52. Copyright Mountain Goat Software, LLCFunctional and dysfunctional formsFunctionalform ofquestionIf your hotel roomincludes a free bottleof water, how do youfeel?I expect it to be that way.I like it that way.I am neutral.I can live with it that way.I dislike it that way.XDysfunctionalform ofIf your hotel roomdoes not include afree bottle of water,how do you feel?I expect it to be that way.I like it that way.I am neutral.I can live with it that way.I dislike it that way.X52
53. 53. Copyright Mountain Goat Software, LLCCategorizing an answer pairQ E E E LR I I I MR I I I MR I I I MR R R R QLikeExpectNeutralLivewithDislikeLikeExpectNeutralLive withDislikeDysfunctional QuestionFunctionalQuestionM MandatoryL LinearE ExciterQ QuestionableR ReverseI Indifferent53
54. 54. Copyright Mountain Goat Software, LLCAggregating results3 11 31 1 3 24 22 20 4 1 021 9 14 5 1 1Apply formatting themesAutomate report executionExport reports to PowerPointQuestionableReverseIndifferentMandatoryLinearExciterTheme54
55. 55. Copyright Mountain Goat Software, LLCWhat to includeAll of the baseline featuresSome amount of linear featuresBut leaving room for at least a few exciters55
56. 56. Copyright Mountain Goat Software, LLCRelative weightingAssess the impact of having a story/theme from 1-9Assess impact of NOT having it from 1-9Calculate the value of each story or theme relative to theentire product backlogThis gives you the relative value of that story or themeEstimate the cost of each story themeCalculate the cost of each story or theme relative to theentire product backlogThis gives the relative cost of that story or themePriority is given by (RelativeValue ÷ Relative Cost)56
57. 57. Copyright Mountain Goat Software, LLCRelative weighting:an exampleValue Percent = TotalValue / ∑ (TotalValue)Cost Percent = Estimate / ∑ (Estimate)8 6 14 40 64 44More investment choicesPortfolio rebalancingComply with new lawCostPercentEstimateValuePercentTotalValueRelativePenalty91PriorityTotal9 2 11 31 40 27 1151 9 10 29 42 29 10035 100 146 100Themes57
58. 58. Copyright Mountain Goat Software, LLCAn example with weights8 6 22 41 64 44More investment choicesPortfolio rebalancingComply with new lawCostPercentEstimateValuePercentTotalValueRelativePenaltyThemes93PriorityTotal9 2 20 38 40 27 1411 9 11 21 42 29 7253 10 14 102 1Weight→58
59. 59. Copyright Mountain Goat Software, LLCmike@mountaingoatsoftware.comwww.mountaingoatsoftware.com(720) 890-6110 (office)(303) 810-2190 (mobile)Mike Cohn contact info59