In software development, ROI considers the financial returns a business expects to gain from investing in a custom software project.
Measuring the ROI helps in several ways.
First and foremost, it helps with decision-making, providing clarity on whether you will make or save more money than it costs to build the software.
It also helps with budgeting and financial planning, ensuring you allocate resources wisely.
Calculating ROI gives you a concrete number to show stakeholders the project’s potential value, making it easier to gain buy-in.
And it acts as a benchmark against which the actual returns can be compared, highlighting areas of improvement.
In this article, we look at how to effectively measure the ROI of custom software development and the key factors that influence it.
Steps to Measure the ROI of Custom Software Development
In a nutshell, the process of measuring the ROI of custom application development looks like this:
- Define the Costs: Consider all direct and indirect expenses, from development to maintenance.
- Calculate Tangible Benefits: Quantify the direct financial benefits like increased sales or cost savings.
- Estimate Intangible Benefits: Recognize non-monetary advantages, such as improved user experience.
- Perform the Calculation: Utilize the information gathered to calculate the ROI and interpret the results to determine the project’s financial feasibility.
Let’s take an in-depth look at each step.
1. Define the Costs
Assessing the full spectrum of costs involved in custom software development is pivotal to calculating your ROI accurately. Be sure to factor in not only initial development costs but also the expense of maintenance, support, training, and upgrades.
Initial development costs are the biggest piece of the budget pie. They include:
- Design and Planning: Before any coding begins, there’s a phase of requirement gathering, architectural design, and planning. Costs include salaries for project managers, business analysts, architects, designers, and any tools or software used during this phase.
- Development and Testing: This is often the most labor-intensive phase. Costs include developer salaries, licenses for development tools, testing tools, quality assurance, and more.
- Deployment: Once developed, the software needs to be rolled out. Deployment can involve server costs, cloud service costs, or even physical hardware if the software is deployed in a specific environment.
Ongoing maintenance costs cover the work to create regular updates, bug fixes, and patches that ensure the software runs efficiently and securely. Maintenance costs can vary but often include salaries for a dedicated maintenance team and any associated infrastructure costs.
New software often requires training for end-users or IT teams who will support it. Training costs include creating training materials, holding dedicated training sessions, or hiring external consultants.
As business needs evolve, so too will the software. These upgrades can be minor tweaks or major overhauls. Upgrade costs are often similar to initial development costs but on a smaller scale.
2. Calculate the Tangible Benefits
You probably know some of the tangible benefits of building a custom solution. Are there others you haven’t thought about?
When calculating the tangible benefits, consider the following factors.
Increased sales or revenue: This is relevant for applications designed to enhance sales processes—for example, e-commerce platforms or CRM systems. It’s the difference in sales figures pre- and post-deployment.
Cost reductions: Custom software can automate repetitive tasks to reduce workforce demands, leading to less human error. Fewer errors often mean reduced costs for correcting them.
Increased productivity: Time saved due to process optimization can lead to more productivity without increasing the size of your staff.
Scalability and growth potential: Custom software can pave the way for business expansion, allowing for more clients, products, or services without proportionally increasing costs.
3. Estimate the Intangible Benefits
Because it’s tailor-made for your business, a custom application can meet niche needs commercial software doesn’t address. While not directly monetary, these benefits can have significant long-term impacts.
For example, if you’re a facilities maintenance provider, you may need a custom ERP solution that can estimate how much de-icer to use on a client’s property based on the severity of a snowstorm. A commercial solution won’t have that, but it will save you time and money.
Intangible benefits are harder to estimate but can include some advantages.
Improved user experience: Enhanced user satisfaction can increase customer loyalty and referrals. Reducing customer churn alone can prevent significant lost revenue.
Enhanced decision-making capabilities: Custom tools or analytics can lead to more informed business decisions.
Better data analytics and insights: Advanced data tools can provide deeper insights into customer behavior, preferences, and market trends.
Improved brand reputation and customer trust: Reliable and innovative software can bolster a brand’s image and foster trust among clients or customers.
4. Perform the Calculation
With the costs and estimated benefits defined, you’re ready to calculate the ROI. You can calculate ROI in a few different ways, but the most common formula is net income divided by the total cost of the investment, or ROI = Net income / Cost of investment x 100.
This will give you a percentage. Anything over 100% is profit; anything under 100% is loss.
For example, if you spend $100,000 developing a mobile app and estimate the tangible and intangible benefits to be worth $300,000, you end up with a net income of $200,000. When you plug these numbers into the formula above, you get the following:
200,000 / 100,000 x 100 = 200
So your ROI is 200%. Whether that is a good or bad ROI depends on your business goals.
Potential Pitfalls in Measuring ROI
A lot is riding on calculating ROI correctly. Let’s examine some common errors that can skew your ROI estimate.
Overestimating the Benefits
Optimism is natural when embarking on a new project, but overconfidence can lead to inaccurate ROI projections. Take off the rose-colored glasses to avoid overestimating the benefits you’ll gain from the product. These can include the following:
- Unrealistic Projections: Sometimes, businesses might project a more rapid or significant uptick in sales or other benefits than is realistically achievable.
- Overreliance on Best-Case Scenarios: Planning based solely on best-case scenarios without considering average or worst-case outcomes can lead to skewed expectations.
- Ignoring External Factors: External market shifts, regulatory changes, or competitive actions can impact the anticipated benefits of the software, and failing to consider these can result in overestimations.
Underestimating the Costs
Just as overestimating benefits can be problematic, underestimating the costs can be equally detrimental to accurate ROI calculations. Look for hidden costs and pad your estimate to factor in the expense of any delays or scope creep.
- Hidden Costs: Development projects often have costs that aren’t immediately apparent at the outset, like additional licensing fees, consultancy costs, or unforeseen challenges requiring additional resources.
- Failing to Account for Delays: Delays can increase costs in terms of extended labor hours, potential penalties, or lost opportunities.
- Scope Creep: Expanding the project’s scope without adjusting budget projections can result in costs outpacing expectations.
Not Accounting for the Changing Market Dynamics
The market doesn’t stand still, and neither should ROI projections. Be sure to factor in the following:
- Evolving Customer Preferences: What customers want or expect can change over the course of a software development project, potentially affecting the benefits the software was meant to provide.
- Technological Advancements: New technologies or platforms can emerge that render certain aspects of the custom software outdated or less competitive.
- Competitive Actions: Competitors might launch similar or superior solutions, potentially reducing the market share the new software was projected to capture.
Ignoring the Intangible Benefits
ROI isn’t just about direct costs and revenues; intangible benefits can also significantly impact the overall value of software investment. We touched on intangible benefits earlier, but some often overlooked intangibles are listed below.
- Enhanced Brand Image: Quality software can elevate a company’s reputation, increasing customer loyalty and attracting potential clients or partners.
- Employee Satisfaction: Efficient software tools can improve employee morale and productivity, reducing turnover and associated costs.
- Improved Decision Making: Advanced analytics or data tools embedded within the software can lead to better business decisions, even if these aren’t immediately quantifiable in monetary terms.
- Stakeholder Relationships: Improved interfaces or tools can enhance collaborations with partners, suppliers, or other stakeholders, leading to long-term strategic advantages.
Dive Deep into ROI
An ROI estimate can measure a software solution’s impact on your business—encompassing tangible profits, operational efficiencies, intangible benefits, and strategic advancements. It is a compass that points to areas of success and highlights improvement zones.
For businesses at the crossroads of technological decisions, the message is clear: Dive deep into ROI analysis, celebrate the successes, learn from the misses, and continuously refine the approach.
In doing so, they maximize the value derived from their projects and foster a culture of informed decision-making, strategic alignment, and continual growth.