An alternate approach to model ROI of a new Product
Introduction
If you are a startup founder or a Product Manager at an early stage startup, one of the most important things you might have to look at is the ROI of a new product you are planning to develop.
Expected ROI= (reach of users * new or incremental usage * value to business) — development cost
In this formula there are two broad elements at play- Internal and External elements.
Internal- Development Cost
External- (Number of users * value to business)
For a new product, the development cost would include salaries of everyone involved in product development, operating costs and so on. As a PM, it is extremely difficult and time consuming to get these numbers. Also, you haven’t started development so you won’t know how much you are actually going to spend. So how do we calculate the development cost?
Another aspect of the product that is driven by development cost is your pricing.
Price of your Product = Development Cost + Margin
Instead of looking at Pricing being driven by development cost, let’s look at development cost a function of pricing. Advantages of doing this is
- This approach is more customer focused
- Pricing is determined by the market and customer willingness. You can’t actually increase your prices just because your development budget shot up.
We can assume our product is going to be priced the same as our competitors.
For this exercise, let’s take an example of developing a new smart fridge- SmartCool. How would you determine the ROI for your new smart fridge.
We will try to calculate SmartCool’s ROI 5 years from now (2024) and estimate how much we can invest in developing SmartCool YOY.
Global market for smart fridges is USD 450 million (From the Internet)
Our competitors smart fridge costs an average of USD 2000.
Number of fridges sold+potentially to be sold in 2019= 450 million/2000 = 225000
Currently Samsung and LG are market leaders in Smart fridge space
We will try to get the number of Smart fridges sold by Samsung and LG using app downloads from Playstore.
Samsung
Number of downloads of Samsung’s smart fridge app= 100,000 (from playstore)
Assuming 2.5 downloads per purchase (including dummy downloads). Number of smart fridges sold by Samsung so far= 40,000. Assuming they will sell 40,000 more fridges in 6 months by EOY, total number of fridges sold by Samsung in 2019= 80,000.
LG
Number of downloads of LG’s smart IOT app (for controlling all LG smart appliances= 1 million
Assuming 10% of the downloads (1,00,000) will be for smart fridges, we can estimate LG also would have sold 80,000 smart fridges in 2019.
Smart Fridge Market Share 2019
Now since we are a new product, we can conservatively estimate that our target will be the rest of the market i.e 28.9%. Let’s assume we capture 20% of the 28.9% i.e 6% of the total market.
Assume SmartCool launches it fridge in 2020.
Given that CAGR is 17.6% for smart fridge market.
CAGR%= (End value/Start value)^1/N — 1
CAGR%= (Value in 2020/Value in 2019)-1
Market Value in 2020= USD 540 million
SmartCool’s market share is 6%= USD 32.4 million
SmartCool’s fridge is priced USD 2,000, similar to its competitors. Number of fridges sold= 16,000
ROI = SmartCool’s expected market share — Development+Maintenance cost
We can assume ROI = 0 for year 1 (2020).
Development+Maintenance cost per fridge = USD 2,000
Assuming we bring down the development cost down by 5% every year and the price of a fridge remains same i.e USD 2,000.
Let’s assume we maintain the market share at 6% until 2024 (This is actually conservative)
ROI if we maintain Development+Maintenance cost per fridge= USD 2,000
ROI if Development+Maintenance cost per fridge is 10% higher= USD 2,200
This approach will help you make a conservative estimate of how your market looks like, how you can price your product and how your ROI will look like.
Let me know your thoughts in the comments below. Appreciate your feedback.
