Can You Accurately Justify a Software Purchase?
Years of experience on the front lines of sales have provided multiple opportunities for my teams to create some type of financial justification tool or calculator to assist customers in understanding the value of the software they are purchasing. Some of these tools were designed to take customer input, while others are built with static data from prior customer experiences. The latter provides more of an impact analysis and tends to be more accurate.
Return on Investment
In most cases, the tool of choice for sales folks is a return on investment (ROI) calculator or tool. The primary reason for this is that it can financially display the business gains versus costs in a ratio format so the customer can justify the purchase. The ROI calculates the high-level costs of the product, including license, subscription, maintenance, and support over a period—say a year, for example—and compares that to the business metrics the customer was interested in improving when making the product purchase. An acceptable software ROI is somewhere around 20 percent or less over cost of capital per year. An ROI calculator is designed to use with software purchases that can have an effect on business metrics customers are trying to attain. Table 1 shows the kinds of metrics customers may be attempting to achieve.
|Increases in:||Reductions in:||Improvements to:||Creation of:|
|Profit||Cost||Ease of use||Alignment|
|Efficiency||Defects, complaints||Capabilities||New processes|
|Product value||Administration||Information||New business|
|Stakeholder retention||Stakeholder attrition||Reputation||New products|
|Number of systems (KISS)||Reliability|
Sadly, this approach requires a lot of preparation and attainment of truthful customer input to provide an accurate ROI assessment. Additionally, some of the product costs based on customer input can be intangible due to inconsistent execution of required actions—for example, ill-timed product configuration, unreliable product training, lack of required implementation services, or lagging end-user adoption—which may, in the end, skew the ROI in the wrong direction. In some ROI assessments, these intangible badly executed actions and customer assumptions may introduce a lower level of confidence in the overall results, especially in year two or three of the purchase when the inconsistent execution of actions on the customer side continue to fail.
Total Cost of Ownership
Another tool that can assist the customer in understanding the value of a software purchase is a total cost of ownership (TCO) analysis. Because a TCO analysis is focused on the cost side of the equation only and does not consider advantages the software may bring, such as increased revenue, it typically is employed for software that will not have an impact on the business metrics referred to in Table 1. Examples of this kind of software might include an email or CRM system. For a TCO analysis, it’s more important to know the cost of the software from acquisition to end of life (EOL) and then compare that to a competitor’s presented TCO to understand the differences. That said, because it is targeting costs only, a TCO analysis should be considered the starting point for any financial justification.
Economic Impact Analysis
A third measurement type is the economic impact analysis (EIA). This is different from an ROI or TCO, both of which are forward-looking methods that rely on assumptions about potential costs and returns. An EIA looks back at historical data regarding the software purchase and business gains to establish the ratio between the two.
All of these tools have their place in helping customers understand the justification for the purchase of a software package at different points in the sales lifecycle, but due to the historical nature of the data used in an EIA, it tends to be a more accurate depiction of the economic value of the purchased software package over time.
Why to Use All Three—and When
My suggested approach from a customer perspective would be to use all three—TCO, ROI, and EIA—during the lifecycle of a large software purchase.
First, use a standard TCO approach to understand all of the costs connected to the purchase, including the associated intangible actions or assumptions. Keep this action isolated, with the sole purpose of being laser-focused on gaining accurate numbers on costs without being tainted by potential business gains.
Once you have the costs nailed down, look at the potential business gains. Keep in mind that these gains characteristically are assumptions and cannot be verified until after they have happened. My experience tells me to be very conservative on these numbers to make the resulting ROI more accurate.
Finally, execute an EIA on a consistent, suitably timed cadence over the life of the product so that you are using the accurate historical data gathered during implementation to understand what has been successful and what is failing in your initial cost/benefit analysis. Then, adjust accordingly, so you are attaining the results you were expecting.
Cost and benefit analysis of software purchases is becoming a hot topic. Understanding how software purchases are affecting your business and learning which aspects are most effective at solving business challenges is valuable and makes it easier to get buy-in for future technology.
Download “The Total Economic Impact of NETSCOUT Omnis AED” to see how Forrester and NETSCOUT measured the ROI for one key software solution.