In a previous post, I promised to continue the discussion of measuring the value of software. I have had several discussions over the last weeks. Many practitioners measure the value of software using intangibles such as strategic alignment. This permits staff to set priorities by agreeing that some software has more alignment than others and so should be prioritized first. That approach has its strengths and weaknesses. A strength is that is it is ‘math free’, and so daily consumable. The weakness is that it is ‘math-free’, and so does not provide objective, comparable measures for comparing investment decisions.
The challenge for software and systems is that the future costs and benefits are uncertain. So there are a couple of ways to proceed. One way is to treat the investment as a option and apply option pricing models. Option pricing models has some real advantages, but take some advanced math. There are especially difficult when there are multiple sources of uncertainty (aka volatility). I think we are years away of generally using such methods (although I know one example of an investment bank using such methods).
A simpler measure of an investment that has a flow of future costs and benefits is a risk-aware version of the net present value (NPV) equation. It is how the conversation with the funding stakeholder’s begin. One accounts for the uncertainties by treating the future values in the NPV probabillistically and using Monte Carlo simulation. This uses some math, but not beyond the skill level of our field. I describe this approach here. (There is also this article.)