ROIs can help project and product manager to quantify the value of their investment for the company. For internal products, calculating a ROI can be challenging as there are no obvious revenue streams or paying customers.
The ROI is the ratio between the net profit and the investment for a project or a product.
If the ROI of a project is 20%, this means that for every 1 $ that has been invested, the company sees 20 cents in profit.
ROI for Internal Products
In order to calculate the ROI, we can consider the organizational cost savings as the return or benefit.
Without your product, it may take your current customers more time to perform a certain task. There may be an alternative product they can use or no product at all. In order to determine the organizational savings, we have to look at the total organizational cost of the alternative solution compared to the scenario where your product is in place.
In the example above, you can see that your product is more expensive for the organization than the currently available alternative product. Customers however safe money when using your product in comparison to the alternative solution due to e.g. less hours to get a task done.
Return is the amount gained — amount spent. The amount gained is the total organizational cost of the alternative solution, the amount spent is the the total organizational cost with your product.
Return = (200,000 $ + 600,000 $) - (300,000 $ + 100,000 $) = 400,000 $
Investment is the total cost of your product:
Investment = 300,000 $
ROI = (Return / Investment) * 100 = (400,000 $ / 300,000 $) * 100 = 133 %
Which means for every 1 $ that has been spent on your product, the company sees 1.33 $ in profit.
Types of Cost
For each of the four categories of cost above (1) alternative product, 2) your product, 3) alternative user cost, 4) product user cost) you can distinguish three different types of cost:
Dev & Ops & PO Cost
This is cost caused by people. We measure this cost in FTE / year. Note that the FTE cost is standardized, there is a defined value for the cost of one FTE in your company.
This is cost caused by infrastructure or cloud resources. You can use your cloud provider cost management tool to determine infrastructure cost.
License / Support Cost
This is cost caused by licenses or support teams have to pay for.
Our time frame for the ROI calculation is one year. The actual values for the various types of cost mentioned above may be changing with time. You may have 10 customers using your product in the beginning of the year and 50 customers at the end of the year. Similarly, your infrastructure cost or support cost may change during the course of the year.
In order to determine an accurate ROI, you have to use the average value for the year. If your infrastructure cost is increasing linearly from 10,000 $ to 20,000 $ within one year, a good number for your yearly ROI calculation would be 15,000 $. If there is no straight forward way to determine the average cost for one year in your case, you can use an estimation.
What if you are following the ROI guideline and it turns out your product has a negative ROI? There are different reasons for negative ROIs:
Temporary negative ROI
When developing or launching a new product, the investment may be high in the beginning and the return not significant yet, as customers are still to move over to the new product. In such a case, the negative ROI may be temporary.
In order to account for the negative ROI in year n, you can substract the loss when calculating your ROI for year n + 1.
Return for year 2021: -50,000 $
Investment for year 2021: 100,000 $
ROI for year 2021: — 50 %
Return for year 2022: 100,000 $ — 50,000 $ (from year 2021)
Investment for year 2022: 100,000 $
ROI for year 2022: 50 %
Note: For long-term strategic investments, the ROI may be negative for multiple years.
Permanently negative ROI
It is important to understand that a negative ROI has nothing to do with your performance as a Product Manager or the performance of the development team. Part of product management and the product development process is to validate assumptions about customers, the product-market fit and the ROI / business model of a product. Many data points that are required to validate these hypotheses are not known until a product is actually launched and used by customers. Determining that a product has a negative ROI is therefore an achievement as it unveils previously unknown information.
Generally, there are two possible ways to deal with a negative product ROI:
Based on your product metrics and customer feedback, you may be able to make changes to your product or your working and business model to better meet customer problems or get to a positive product ROI.
If your core hypotheses about your customers, their problems or the business model for the product are proven wrong, discarding the product can be the right choice