There might not be a magic formula to calculate product investment, but there are some metrics that can help.
It’s a nearly universal complaint from product managers: There isn't enough ongoing investment in their products. Whether it's not enough engineers, not enough marketing and promotion or lack of support for improving infrastructure, most product managers feel like their products are getting the short end of the stick.
Some of them are right, but most are not—and it's difficult to discern which is which. Executives are constantly being pulled in different directions with requests for investment. And our finance colleagues often question whether ongoing investment is needed at all. Can we get away with spending less and still earn the same amount? Can we cut funding without impacting revenue? Simply put, product managers nearly always want to spend more, while other execs nearly always want to spend less.
The decision is not just about whether to invest in Product A vs. Product B. Your request for additional funding doesn’t just compete against other products; it competes against all of the other ways the organization can use that money. This could include different investment levels in different product portfolios or markets; investing in infrastructure or optimizing operations; spending money in sales, marketing or public relations; buying back shares or paying dividends or literally investing money in the market. Product managers may want to believe that there’s some magic formula to calculate how much to invest or a basic metric that can be tracked. But this oversimplifies the investment decisions, and can lead to disastrous consequences for new and existing products.
The goal of this article is to review some possible and popular metrics to use in evaluating investment decisions. It covers pros and cons of using them as guides for product investment levels, and hopefully will help you identify appropriate metrics to use within your organization.
Provide each product with ongoing reinvestment based on a percentage of revenue. If that percentage is 5%, for example, then a product bringing in $10 million this year would get an investment of $500,000 for next year.
Pros: One challenge for technology products—especially web-based or subscription-based products—is that ongoing investment is needed to keep pace with market changes and competitors. A minimal set of “table-stakes” investments is usually required to protect existing revenue and continue growth. And in fast-moving markets, additional features and enhancement requirements may not be known when investment allocations are being made.
Providing a set percentage of revenue back to the product in the form of ongoing investment provides some level of guarantee of product investment. It also is equitable in that it rewards more successful products. The larger a product is in terms of revenue, the more important it is to the company to keep that revenue growing (or at least not shrinking), so allocating more funding to products with more revenue makes sense in this regard.
Cons: The problem with this approach is that the amount of revenue a product brings in may have nothing to do with how much funding it needs. Imagine a hypothetical product that generates a lot of revenue and has high levels of customer satisfaction, while also operating at a high profit margin in an uncompetitive market that is seeing very little change. This may not be your top priority for product investment, given the leading position, existing high margins and lack of competitive threat.
Another issue is that current-year revenue may not reflect future revenue. Many companies with multiple product lines have some which are growing faster than others, and potentially some whose revenue is shrinking. It does not make sense to allocate the same funding to a $10-million product growing at 20% as to a $10-million product declining at 15%.
Provide each product with ongoing reinvestment based on a percentage of profit. If that percentage is 25%, for example, then a product with $10 million in revenue and $6 million in costs (and thus $4 million in profit) would get $1 million back for investment next year.
Pros: Similar to basing investment on revenue, using a product’s profit as a measurement rewards products with key contributions to the company. Products with high profit margins are often high priorities for the organization, and it is vital to keep and grow those margins to grow absolute profit. It also rewards successful products, by providing reinvestment based on how well they have performed financially. Unlike investing based on revenue, investing based on profit ensures you will not be allocating resources toward high-revenue but low-profitability (or money-losing) products.
Cons: There are a number of challenges with allocating based on profit, the most basic being that companies often have poor understanding of product-level P&L. This is a fundamental problem that is separate from dealing with investment decisions, but it makes using this metric especially difficult. In larger organizations especially, most of the true costs of the product are spread across multiple departments and may not be properly allocated back to the appropriate product line. If your product requires a lot of customer support, and the customer support group needs to hire additional resources, does your product “pay” for those? If salespeople sell more than one product, are their costs (salary, commission, benefits, travel, etc.) allocated back to each product–and is it proportional?
Logistical issues aside, even if you can have a reasonable approximation of product profitability, using it as a base of future investment decisions presents the same issue as using revenue as a guide: A product’s profitability may have nothing to do with how much funding it needs. Usually, early-stage products need the most investment, and are often unprofitable initially. Or a large investment in one year may adversely impact the amount of investment in subsequent years. And going back to the above example of a popular high-revenue product that operates at a high profit margin and faces little competitive threat, the company probably wants to develop other products that can be as successful as this one vs. pouring significant investment into this already-lucrative area.
Jeff Lash has more than 10 years of experience in technology product management and user experience design for companies including MasterCard International, Sendouts and XPLANE. Currently, Jeff is Vice President, Product Portfolio Management for the Clinical Decision Support division of Elsevier, an information provider and publisher of scientific, medical and technical resources. He also blogs about product management at "How To Be A Good Product Manager," runs the product management Q-and-A site, "Ask A Good Product Manager," and dispenses product management wisdom 140 characters at a time on Twitter (twitter.com/jefflash).