(this is an excerpt from my upcoming book on Money Stories) As CPOs or product leaders, we often have conversations with CEOs about Return On Investment, which come in two wildly different contexts.
(this is an excerpt from my upcoming book on Money Stories)
As CPOs or product leaders, we often have conversations with CEOs about Return On Investment (ROI). These come in two wildly different contexts, though, with completely different context and rules of engagement. I'll unpack the strategic conversation in this post, and save the less important one for another time.
Here are those two conversations:
1. "Is your product earning its keep?" This is typically an executive-level conversation about the general health and revenue-worthiness of whole products or product lines. The subtext is strategic: should we continue to invest in your product, and do we trust your team to make good decisions? In my experience, this is the fundamental discussion that product/technical leaders must have with CEOs and their C-suite peers.
2. "Can we calculate feature-level or ticket-level ROI and use that to make detailed product decisions?" This usually comes from a finance team that (wrongly) believes we can accurately measure the ROI of each small decision. The subtext is that product/maker teams should apply less judgment – more financial analysis – when prioritizing work. In my experience, trying to accurately match each individual feature or ticket to revenue is a fool's errand.
Let's set the stage.
It's not enough for a product to earn back its direct cost. Most of a company's staff (at scale) is outside the maker organization – including Finance, HR, Sales, Marketing, Operations, Support and Legal – and usually represent 80%+ of total headcount. But everyone's salary eventually has to be covered by product revenue. So products need to earn five or six times (5-6x) its maker-team costs to fund the rest of the company. (I usually pick 6 as my default.)
"Earning Our Keep"
Said another way, a product needs to bring in $6 for every $1 spent on it in order to earn its keep. If we have two teams assigned to Product Z, and those two teams cost a combined $1.6M/year, then Product Z needs to bring in around $10M/year. Or some other product in the portfolio needs to make up the difference… to subsidize Product Z. Otherwise we'll be dealing with unhappy investors, looming staff cuts, and freshly updated CVs.
This applies to products, product lines, and entire portfolios.
Your context, and therefore your numbers, will be different. Pre-revenue startups are hunting for their first paying customers, whatever the cost, and are usually engineering-heavy. PLG companies without a sales force will invest more in products, and need lower multiples. Late-stage companies "harvesting" products with minimum investments will be engineering-light and focused on short-term revenue. Highly technical products may need very expensive expertise. But someone in Finance probably has your company's number.
So product leaders need to anticipate the executive question: "is this product earning its keep?" Or reframed as "are engineering and product and design earning their keep?" The underlying (unstated) question is "can we trust you to make good decisions about this product, or do we need to manage priorities/staffing/assignments more closely?" Teams that are delivering get to make small-to-medium choices; teams that are underwater often get micro-managed (with the best intentions).
The math is straightforward: the "earning our keep" ratio is the total revenue for a product divided by its total cost. For software, that's almost entirely people costs. (And includes all of the care & feeding, support, tech debt, and ongoing work to keep our products healthy... not just shiny roadmap features.)
Following my money story principles, we keep this simple. We’ll use the company’s average cost per employee. Or get the salary total for the entire maker organization and divide by headcount. (Don't waste time chasing down individual salaries or overhead or expenses.)
For example:
(annual revenue for my product) /
(my team size * average cost per person) =
"earning our keep" ratio
€18M annual rev / (14 people * €150k/pp) = 9x
When asked (and even when not asked), we can proudly say that "our product brings in €9 for every €1 we spend, which is well above the company's €6 target. And we have lots of stuff in the pipeline to continue growing our customer base and revenue stream and keeping our current users happy." Perhaps unspoken: "we're making good decisions, setting priorities well, earning our keep. Trust us to continue doing what we do best. When we need help, we will ask for it."
Notice that this is the ultimate money story. Either a product is earning its keep, or is subject to summary execution. As product leaders, we need to strongly make the case that our products are worth nurturing and supporting — or consider end-of-lifing those that aren't.
And this gives us a powerful way to think about major product/technical investments: is some proposal a good spend? Will it help us earn our keep?
For example, a big R&D organization with 20 teams is considering a fundamental re-implementation of its core architecture. Initial guess is that this would occupy 15 of those teams for at least a year. And their average team costs $1M/year. So a cost guesstimate would be $15M, with an implied revenue payback of 6 * $15M = $90M in revenue. Plus not delivering any exciting features next year, since the remaining teams are on care & feeding. Plus the inevitable overruns and delays that every re-implementation runs into.
Will this re-implementation deliver $100M+ more a year in revenue once it ships? Is it a good investment? There should be a solid money story attached to the project, otherwise it is likely to be cancelled part-way through in favor of shorter-term revenue.
Sound Bytes
- Products need to earn their keep, and product leaders need to address this directly. We should celebrate products that are punching above their weight and scrutinize the under-performers.
- It's a myth that we can accurately calculate ROI before we start a major development effort. Bur big decisions about new products or major investments should include thinking through their broad financial impact. Will this make it easier or harder to hit our number?