Optimizing Software Product R&D costs

Picture2 CASE 3

The Problem

A listed Telecom software IT major providing software services & products to global customers needed to strike a balance in R&D spends for new product development spanning multiple years,  while maintaining a targeted quarterly profit margin – necessitating careful selection of R&D Projects and continuously monitoring the profitability of products in it’s portfolio – with a greater focus on “predictive” focus than “historical”  since R&D costs once committed in advance are rarely “rolled-back” unless the product road-maps are altered or scrapped altogether.

Key Challenges

  • Software Services and Products businesses had unique characteristics, but certain common expenses e.g. common bench, common freshers pool of campus hires, a common sales force yet different sales cycles making allocation of common costs very contentious
  • Need to distinguish between efforts spent on Product Development, customizations and Post-sales Support.
  • Likewise – Product revenue streams from Licensing, customizations and AMCs needed separate tracking– so that profitability of each segment could be tracked over time
  • Siloed automation, absence of integration between different applications meant manually aggregating and cleansing of data relating to revenues, efforts and costs

Project Costing, extended to Product Development

A Project costing system – with Direct salaries, travel, consumables and Other Direct costs traced to Projects based on Project codes, PLUS allocation of common infrastructure & support functions costs was first put in place.

Sales teams were asked to provide periodic estimates of time spent towards each SBU using the timesheet – preferring a direct input from Salespeople over other indirect methods

Two levels of Bench – one at SBU Level and another at Corporate level was proposed to “trace” the cost of this “spare capacity” to individual  SBUs – avoiding arbitrary allocations upto SBU Level.

Extending to Products

For Products – the Project level costs arrived at as above were accumulated each year, arriving at Gross R&D costs. Using the lower of estimated remaining life or future revenues – the development costs were amortized to arrive at Net R&D costs for each Product

Allocated non-cash expense was added back to compute cash invested in R&D and cash generated from sales – to compute IRR & NPV for each Product AND the overall portfolio 

Using the system for BudPicture1-CASE 3geting & Forecasting

Planned R&D effort was costed using the same system – to see if proposed spending levels at individual Product level – enabled the Product individually, and aggregated at the overall Portfolio level – met profitability thresholds after amortizing R&D costs.  Products whose Forecast P&Ls did not reach target levels were dropped from the portfolio

Key Benefits

A listed company that was expected to meet investors’ expected topline growth and profitability numbers needs to keep – among other costs – it’s net product R&D costs tightly in control.

At the same time – Product Development being a multi-year process – discounted cash flow methods are best suited to evaluate performance of each individual product, unlike services projects.

The Project costing system – extended and adapted to Products – enabled quarter-wise and year-wise P&Ls to meet short term profitability goals at the overall Portfolio Level.

IRRs and NPVs computed across multiple years provided the Product SBU Heads the flexibility to “allow” some products in the portfolio to make short term losses (covered by other profitable products in the portfolio in the same quarter / year)

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