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Are you a decision-maker at your organization?
Then you must be busy figuring out ways to make your company’s investments worthwhile.
While custom software solutions provide the best ways to extract maximum business potential, measuring ROI in software development can be quite complex. In today’s competitive business landscape, you can lose millions due to inefficient software architecture, which makes cost-effectiveness necessary.
Calculating the ROI for software projects is crucial to making informed business decisions. The metric provides greater clarity to business owners and stakeholders on the profitability of custom software solutions they invest in. The typical ROI for a software project is 20% or less, which is a little over the cost of capital.
Why ROI Matters in Software Development
ROI calculation provides detailed insights into the capital invested by your company in a given project, team, or campaign.
When it comes to custom software development, the intention is to generate higher revenue and improve operational efficiency to get a competitive advantage. In this case, the ROI metric helps you understand whether the custom software project is indeed profitable or harmful for your company.
Regardless of the type of software you want for your company’s ecosystem, you need to determine whether it will be beneficial in the long run. Ideally, the software must work efficiently even when your business grows to new industry verticals. Apart from identifying how much profit your company can make by using a particular custom software solution, ROI also points out any potential drawbacks.
Why ROI Calculation is Essential in Software Development?
The calculation of ROI is the foundation of any custom software development project. It helps determine the actual value of your investment and whether your business can benefit from it. That being said, ROI calculation also helps your business beyond the numbers.
Make smarter decisions with ROI insights
Startups and small businesses simply do not know whether they will make more money than they are investing in custom software development. Instead of relying on guesswork or assumptions, you can have real numbers in front of you by calculating ROI. When you have a clear understanding of the pros and cons of a custom software project, you can make confident and informed business decisions.
Align software goals with business objectives
Apart from setting your project budgets and other financial planning, ROI also helps create clear business objectives. When you have a definitive roadmap for business growth, you can align your software goals and set clear requirements for custom software development. This means you can get the right functionality for your business and also allocate your resources more efficiently.
Explore Software Types for ROI Calculation
Different types of businesses require different kinds of software to achieve maximum benefits. This means that the ways to calculate ROI for different types of businesses can vary depending on the goals, benefits, and costs involved.
Business Process Software
Custom software built to improve internal business operations and streamline workflow are quite common these days. The calculation of ROI for business process software involves the cost of implementation, software maintenance, and employee training on how to use the software.
Since every business has its unique operations and workflows, there are several aspects to be considered while calculating the ROI. For instance, you need to factor in the time saved by incorporating a more efficient system, the improvement in sales, and the following:
- The cost of operations is replaced by custom software
- The efficiency of the custom software and how much it improves the operations
- The percentage of increase in revenue and clients with the use of custom software
- The improvement in sales efficiency
- The ability to perform risk analysis and avoid problems with and without the software
- The improvements in customer satisfaction and retention rate
You can get a cost estimate for the custom software you want to build, but what’s important is to consider what you will gain from your investment. You need to have all the numbers in front of you before deciding whether you should make the investment. Here’s how you can perform the calculations:
| Problem | Losses | Cost/Gains | Loss/Profit |
|---|---|---|---|
| Unused Productive Hours Example: 3800 hrs/year At a rate of $40/hour |
-$152,000 due to lost productive hours |
Business Process Software -$200,000 |
-$352,000 |
| Acquire 2 new clients $200k per new client |
+$400,000 | ||
| Business growth of 20% Average client revenue is 500k/year Total clients are 50 |
+$5000 | ||
| Gain of productive hours | +$152,000 | ||
| Total Loss: | -$152,000 | Total Gain: | +$909,000 |
Calculating ROI for software projects is never a straightforward process because it involves multiple aspects related to each business process. In some areas, you might need to cut down your budget and set a minimum threshold. Considering the increase in profits shown in the example above, you can easily jump to the conclusion that the ROI of your custom software development project will be high.
Commercial Software or SaaS
For SaaS, or ‘software a service’ companies, the software itself is the revenue stream. It’s not hard to guess that calculating the ROI for SaaS projects will be much different compared to business process software. Here, ROI is measured using sales data in the numbers of MRR and ARR subscriptions. But there’s more to SaaS - as your clients who are using the SaaS product will be calculating their own ROI as end-users.
That being said, in order to determine the ROI for SaaS projects, you need to consider various factors apart from the ones seen previously. One of these factors is the trading time of the SaaS company because they often need a significant amount of capital, especially in their intial days. An example of ROI in such companies is seen in tech companies offering project management solutions. These SaaS companies calculate ROI by putting subscription profits against the cost of the software project and its implementation.
At this point you might be wondering about the metrics for measuring ROI in SaaS projects. Here are the factors you need to consider, with the first one being the most important if you are a SaaS startup:
- Cashflow
- Monthly customer churn rate
- Cost per client acquisition
- Client LTV
Calculating ROI for SaaS companies involves identifying your break-even point. You need to determine how many customers you should have each month in order to balance your expenses and revenue. For companies selling regular software, the break-even point is acheived by onboarding upwards of 500, and ideally above 1000 customers.
A Step-by-Step Guide to Calculate ROI for Software Development Projects
Gather Investment Data
The first and most important part of calculating the ROI of custom software projects is defining the costs. You need to break down the cost of each step of the project, including design, development, deployment, and maintenance. Then, you need to sum up the cost associated with each step, which will be the cost of investment for your software project. Apart from the development costs, the investment also includes hardware, employee training, and annual operational costs.
Identify Returns
Once the investments part is settled, the next step is to determine the amount in savings and profits that your software project will provide. In the beginning of your ROI calculation, you will find it difficult to estimate the returns. For this reason, most companies are forced to use estimates in place of true values. You can create estimates using similar projects involving software that are currently in use, and identify whether they improve efficiency and reduce errors. Most importantly, the software must help improve sales and profitability.
Quantify Returns
Here’s the tricky part. You need to ensure that all your software development project capital is decided while staying within the defined budget. For this purpose, the resources must be allocated efficiently for maximum returns. For tangible benefits, you need to quantify the financial gains, such as increases in sales or savings. For intangible benefits, you need to identify other advantages that are not directly linked to your finances. These include enhanced user experience and user ratings, feedback, and Google rankings.
Calculate ROI
The ROI (return on investment) of your custom software development project shows you how much revenue you have generated for your investment. Calculating the ROI is your actual objective, and having a positive result here means that the project will most likely be a success. Here’s how to calculate ROI for software development project:
ROI % = Net Profit / Cost of Investment * 100%
To calculate the ROI using this formula, you need to have concrete values of investments and returns of your custom software project.
For example:
If your Net Profit is 450,000
And your investment is 300,000
450,000 / 300,000 x 100% = 150% ROI
Your ROI is 150%
Interpretation and Analysis
Now that you have calculated your ROI, how will you know whether it is good enough for your business? To know this, you need to compare the value with industry benchmarks and the goals set by your company in its early stages. Your ROI shows you how the software project will impact your business as it factors in every small detail of the project. Assessing the ROI in the right way is crucial to understanding how you can maximize your profits and take your business to the next level.
Strategies to Maximize ROI in Software Projects
Efficient Project Planning
As we have seen, ROI in software development is dependent on various factors that often go unnoticed. However, leaving out any of these factors can have an unexpected impact on your business. So it’s important to plan your project effectively. You need to incorporate processes that make the project more efficient and feasible so that the ultimate goal of your company can be achieved.
Agile Development Practices
One of the ways to improve the efficiency of your software project is by choosing an agile methodology. This process of software development lowers your costs and increases the productivity of your teams. Not to forget, it also improves the ROI of your custom software project.
Agile methodology is used by software developers to make the process smooth and bug-free. The resulting software is more adaptable as it is less costly to change features and release new updates with Agile.
Here is why Agile is the way to go in software development:
- You get more feedback during the development and have better chances of tailoring the software to your needs
- The development takes less time and resources, which helps cut down your valuable investment
- The flexibility of the Agile framework decreases individual workload and helps adopt a problem-solving approach
- Higher customer satisfaction
Effective Resource Allocation
No matter what the nature of your project, resource allocation is always a key aspect for maximizing ROI. In this step, you need to assign roles based on the experience and skillset of each individual involved in the project. Allocating the wrong resources to the wrong parts of the project often results in delays or even alters the direction of the project. You need to clearly define the goals, the scope, and the dependencies of the project. It’s also important to set priorities for each phase of the project based on the skills and availability of resources.
Continuous Improvement
Any project that comes at a standstill after its completion is bound to go useless after a given period of time. For this reason, your software project should undergo continuous improvement practices.. These include regular evaluation of the performance and making improvements where necessary. Examples of companies that have implemented these best practices to enhance ROI include Amazon, Netflix, and Microsoft.
Key Takeaways
Calculating the ROI for custom software projects may sound difficult for starters, but it is becoming increasingly important for businesses to thrive. Even if you do not have concrete values, you should still calculate ROI for your projects using estimates and have a clear understanding of the impact it will have on your business. That being said, it is important not to overestimate the benefits and underestimate the costs of the project.
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.
