Three Ways to Calculate Software ROI

In last month’s newsletter, we provided a step-by-step process to create the raw data for an ROI analysis. That methodology used a pilot software project to compare the performance of a “control” group (that isn’t using your software) against the performance of a similar “subject” group that is. The raw data that results can provide you with inputs for three different ways to calculate and express ROI. Here they are:

Method #1. ROI in terms of Gross Revenue. If the software is something that primarily increases revenue, you compare the revenue generated by each group. For example, if you’re selling CRM, suppose the control group sells $1.1 million in the quarter following installation, while the subject group books $1.2 million. In that case, the net benefit for the quarter for the pilot is $100,000. If the subject sales group consists of 10 employees, then the net average revenue benefit per sales rep is $10,000. Therefore, if the entire sales force consists of 100 employees, then the additional yearly revenue for a full installation is $4 million. So, if the software license cost for the entire company is, say, $1 million a year and the customer intends to keep the software up and running for five years, you achieve ROI in five fiscal quarters.

Method #2. ROI in terms of Cost Savings. If the software is something that primarily decreases costs, you compare the expense in the control group versus the expense in the subject group. For example, if you’re selling Product Lifecycle Management (PLM) software, and the control group manufactures a million widgets at $1 a widget while the subject group manufactures a million widgets at $.90 a widget, the cost savings for the pilot is $.10 per widget. If the entire company normally manufactures 10 million widgets a quarter, then the cost savings is $1 million per quarter or $4 million per year. As above, if the software license cost for the entire company is $1 million a year and the customer expects to keep the software for five years, then ROI for your software is five fiscal quarters.

Method #3. ROI in terms of Net Profit. If the software both saves money and increases revenue, it must by definition have a positive impact on net profit. In this case, you combine the two figures above. For example, if an ERP system (which includes CRM and PLM) increases revenues by 10 percent and simultaneously decreases costs by 10 percent, then the software has made the company approximately 11 percent more profitable. (The cost savings generates 10 percent of that figure and the increased sales generate an additional 1 percent of the total profit.) Note: when looking at profit, it’s almost always more attractive (from an ROI viewpoint) to generate cost savings than to generate revenue increases. This reflects the fact that selling more of something that’s marginally profitable doesn’t always make good business sense.

Which method should you use when presenting to the customer’s decision makers? That depends a great deal on how the customer likes to measure itself. The best way to find this out is to ask the customer’s CFO. Better yet, get the CFO’s sign-off that the project is a success if it achieves an ROI that you’re certain is achievable!