4.6 Breakeven Point

4.4 Return on Investment

ROI is the amount of money that is gained after spending an amount of money. ROI is the amount of money that is returned from an investment. That is, ROI refers to the amount of money that you earn above the principal you apply to the investment. For example, an ROI of 10% means that for every dollar you invest, 10 cents is returned. That is an impressive, unprecedented, and uncommon ROI. An ROI of 100% means that for every dollar invested, one dollar is earned. An ROI of 1,000% means that for every dollar invested, 10 dollars in profit is earned. ROI is a numerical measure of money or profit. ROI is often used out of context. Some people loosely refer to soft-side benefits as ROI. However, ROI is firmly grounded in terms of dollars and cents . Figure 10 illustrates the formula for ROI.

Figure 10: Formula for Return on Investment

Before you decide to stop reading, throw this book in the garbage, and demand your money back, let's quickly put this into context. If a Wall Street investor calls you and offers an ROI of 1,000%, hang up the phone immediately! You would be doing very well if your retirement savings had only a slightly negative ROI, but product development is not like the stock market. It is not uncommon to expect an ROI of 100% or 1,000% in the field of high-technology design.

For example, if you manufacture semiconductors and your line puts out 9,999 defective memory chips for every 10,000 produced, you may want to spend a million dollars to improve it. If you can increase the yield to 100% and sell one million memory chips this year at a cost of two dollars per unit, it is worthwhile. What this means is that for a measly one million dollars, you have revenue of two million dollars, or an ROI of 100%. If instead of memory chips you make microprocessors that sell for 100 dollars, then your revenue is 100 million dollars. And it only cost you one million dollars. In other words, you just experienced a typical ROI of 9,900%.

The lesson here is not to confuse Wall Street and process improvement. A few SPI methods have similar economics and routinely yield an ROI of 10%, 100%, or even 1,000%. The Software Inspection Process, Personal Software Process ^SM , and Team Software Process ^SM are just such SPI methods. They reduce defect populations by orders of magnitude at a nominal fee. These SPI methods increase product yields and can exhibit impressive ROI results. A few simple HTML instructions can yield a profitable Web site and one billion instant customers for a few minutes of investment. The ROI potential of using HTML is off the charts compared to C or C++.

ROI is very similar to B/CR and is a minor variation of it. B/CR gives you a ratio of benefits to costs. ROI gives you a similar ratio expressed as a percentage. With ROI, the costs are first subtracted from the benefits before dividing them by the costs. Subtracting the costs from the benefits isolates and quantifies the true benefits. Let's look at an example. If you spend one dollar on a SPI method that yields two dollars, your B/CR is 2:1. But is that a true measure of ROI? No! Is B/CR useful? Yes! However, ROI is even more useful than B/CR. Let's analyze the results of the same SPI method. You spend one dollar and receive two dollars back. The B/CR is 2:1, but the ROI is 100%. How does that work? First, you subtract the costs (two dollars back minus one dollar spent) and get a result of one dollar. Then you divide the adjusted benefits (which are one dollar) by the costs. That is, divide one dollar in modified benefits by one dollar in costs, which results in a value of one. Then multiply one by 100%. So, two dollars in benefits from one dollar in costs is a B/CR of 2:1 and an ROI of 100%. Both are useful measures of business value. B/CR is a rapid measure of business value, an easy concept to grasp, and conveys the value of the new SPI method. ROI is a more accurate measure of business value that gives us a better picture of what is happening with our SPI methods.