Evaluating Product Investments

How to think like your Finance team, quantify the impact of product work and connect it to what matters for the business (template included!)

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Q: I’m facing challenges that are likely seen more often in larger, maturing companies - how would you generate the business case for a product investment?

First, my pal Leah Tharin just wrote an awesome, four-part series on business case creation. If you’re a B2B PM you should definitely read it. And also subscribe to Leah’s newsletter, listen to her podcast, and send her memes. She loves them.

Second, the genesis for this question that a reader asked me was a bit different than what Leah outlines in her newsletter. There were two specific components to the reader question:

• Creating the case for investment in initiatives that may not be ROI positive in year one (given nascent business segments are competing with resources that could be allocated towards the core business).

• Getting buy-in and resourcing to support a 'crawl, walk, run' strategy across a functional organization (where leaders are incentivized on different KPIs).

To address these questions I’m going to show you how to generate a simple, 3-year product investment ROI (return on investment) in ~5 steps.

Before that, however, it’s important to address the concern about nascent segments competing with resources that could be allocated towards the core business. This is, first and foremost, a question of strategy (see also: WTF is Strategy).

If your company or product org has a strategy that doesn’t advocate for placing any nascent or tangential bets away from the core offering then you’ll be fighting an uphill battle from the beginning. This ROI analysis can help, but you may only have certain points in the year when your leadership is open to hearing suggested strategy adjustments.

The midpoint of the year (which is upon us!) is one of those times though, so act fast!

Unless you’ve been living under a rock recently you’ll notice that the startup world has refocused on profitability, cost-cutting, and is generally trending towards more risk aversion in our current investment climate. The money faucet has slowed to a drip and our zero interest rate phenomenon is taking a breather. 

This is definitely a good thing and while I do think the pendulum will swing in the other direction again no one knows when that will be. That means, for now, there is a lot of pressure on Product Managers, GMs, and other leaders to justify investments in new features, strategies, and teams.

Good news! There are several relatively simple and straightforward analyses that a Product Manager or leader can do to justify their investments. One of my favorites is the three year analysis for return on investment.

This analysis can be broken into 5 steps which I’ll outline here. And I’ll also highlight several of the “gotchas” that you should watch out for because they will fuel your nightmares if you don’t.

Identify Resourcing

The first step should be resource identification. How many people, what types of skills do they possess and how long do you need them to hit your goals. Do you need a Product Manager, Product Designer and three engineers? Great! You’ve got yourself a pod/squad/team/whatever-you-want-to-call it.

Gotcha #1: You don’t need as many people as you think you do.

Entire companies were started and great products created with only a handful of people. We built the first version of Lyft in about 1-2 months with ~3-4 people. With the tooling that exists today you can do even better.

Gotcha #2: It will probably take you longer than you think. 

The Planning Fallacy suggests that this is true and is driven by the Optimism Bias. In other words, people tend to think that they will not experience a negative event. Because of that they underestimate the amount of time that tasks/projects/etc. will take them or their team. If you’ve ever padded an engineering estimate you know what I’m talking about.

Identify Cost of that Resourcing

Your goal with this step is to identify an annualized, per-person cost so that you can calculate the cost of your resources from step 1. I suggest making friends with your counterparts in Finance (this will pay dividends for your entire career by the way, so start now). Your FiF (Friends in Finance) can give you a blended, fully-loaded employee cost depending on the role. No, they’re not going to give you Sally’s salary, but they will give you a generic estimate. You’re in for one of your first surprises here: that cost is more than you think.

You now have enough to figure out the investment cost.

# of people * fully-loaded cost-per-person * % of the year they’ll focus on this = investment cost

Gotcha #3: Focus on quarters or months vs. finer-grain time horizons.

Yes, I know it’s tempting to try to break down into 1/26ths of a year (2 week sprints, 52 weeks/year, 26 sprints). You’re fooling yourself if you think you can estimate at that level of precision. Also, shocker (!!!): people take vacations, get sick, have to take their dog to the vet, etc. so you’ll never be perfectly accurate here.

A quarter or month breakdown makes the calculation above easier.

Gotcha #4: Assuming all the people are in the building already.

Ideally, you’re following a staffing model that involves leveraging existing people, like the one I recommend in Reforge’s Growth Leadership program. But if you need new people you should be prepared to extend that time horizon and adjust cost upward.

https://www.reforge.com/programs/growth-leadership

Estimate Year 1 Revenue

Once you’ve got your cost estimate you can park that on the spreadsheet and move to the revenue line item. Also, take a minute to pause here and see whether that cost is palatable for your business given its current state. If it’s not, you’ll have a steeper hill to climb; need larger revenue output; or creativity to lower staffing costs.

So how do you estimate revenue? First, look at which lever in your Growth Model this investment is designed to move. No Growth Model? That’s okay – I’ll cover that in a future post. Let’s do a quick back-of-envelope version:

• Is your investment designed to improve acquisition (more new customers), retention (longer lifespan for existing customers), or monetization (more paying customers or more money from customers)?

• What can your FiF tell you about how these improvements would impact revenue? For example: if your investment increases the number of monthly new customers by 10%, each customer retains for ~1 year, and spends $100/month then you have enough of a basic financial model to project revenue impact from this investment.

Gotcha #5: Year 1 revenue will be significantly less than you think.

Remember that only about ~30% of product investments actually work— and even fewer on the first try—so you’ll want to be conservative on time to impact. Also, remember our friend the planning fallacy? It’s going to take longer to get the work done than you think. 

Because the meter is already running on team cost it’s a good idea to be reasonably confident in revenue generated by your investments at this stage. If you’re not that confident you can tone down the estimates or assume very little in Year 1. In general I recommend discounting by 70-90% if you’ve never worked in this area before, 30-50% if you’ve got some experience but limited quantitative data, and 10-30% if you’ve got high confidence and first-party data. 

Estimate Year 2 and 3 Revenue + Costs

I’ve got good news and bad news for you about Y2 and Y3 estimates. 

Good: You’ll have a full year of impact. Hooray!

Bad: Your costs don’t go to zero.

Product investments will always have maintenance costs. Building and maintaining isn’t free in this world—even in software development. Make sure you are realistic with the number of people needed to provide your new investment with the ongoing care and feeding (bug fixing, improvements, etc.) necessary to keep it going. A good starting heuristic is 50% in Year 2 and 25% in Year 3.

As for revenue you won’t have the planning fallacy to contend with since you’ve already built the initial product in Y1 (or at least, I sure hope so). But don’t model out any compounding improvements in revenue unless that’s normal for your business or you plan on investing more in improvements.

Evaluate what you see

You now have three years of revenue plus three years of human capital costs. It's still not the entire "cost" picture but it can show you whether your human investment is worth the return. What you’ll probably observe here (if you’re lucky) is slightly negative in Year 1, positive in Year 2 and very positive in Year 3.

Gotcha #6: Don’t adjust under pressure; balance optimism with realism.

One common issue that people find themselves in when they get to this step is that they want to tweak assumptions until the investment case looks stronger. I get it. You want to invest in the project or team that you’re excited about. But slow your roll here. Over-promising and under-delivering is a career-limiting move. 

Why does this all matter?

One of the main reasons that all of this matters is because the role of a product organization is to solve customer problems and generate business return. Being really good at solving problems that don’t generate returns will bankrupt you. Forcing yourself to go through this exercise helps you start to speak the language of your leaders which you’ll need to do if you want to become one yourself.

Marketing teams have been focused on return on ad spend, LTV/CAC ratio and payback period for a long time. Why should they have all the fun?

Creating a three-year investment model will show you how high the bar is for product investment; how important cash flow is; and the cost of your ongoing investments. It’s a great tool for deciding not to do certain work as well.

So the next time you want to hire another person, staff a team, etc. and want to understand why leaders can be so tough on this (excluding the zero interest rate phenomenon of the last several years) this is why.

Now, hopefully, you’re better prepared as a product leader.

Reference this simplified template for your three year investment ROI: