Cs207 4
0 likes246 views
This document contains notes from a CS207 class on software valuation taught by Gio Wiederhold. It includes: 1. Announcements about new sign-up sheets and the option to write a report to make up a missed class. 2. An example spreadsheet model that calculates the discounted income from selling software over multiple versions, showing that income is approximately $1 million, not the initially expected $25 million. 3. A discussion of alternative business models for software, including charging for ongoing maintenance rather than just the initial sale.
![Reports
Write an initial statement on the issue you are addressing.
Having it written down will help you focus.
Then make a list of one or more candidate documents.
You could Google for likely documents and use the attached to the CS207 wiki page.
Read the ones that seem significant.
Write a one or two paragraph summary,
with citations [Author: title; publication, [vol.no.], date, page numbers].
Make notes of their assumptions and results, be critical.
This is your contribution !
Folk that advocate a specific point-of-view often forget or ignore important factors.
Add a brief conclusion.
Relate to your initial the intro.
The conclusion will tell me -- and the world on the web -- what you have learned.
The value of your work is the clarity of your point.
Don’t worry about the length; it is harder to be brief than voluble.
10/22/2011 Gio: CS207 3](https://image.slidesharecdn.com/cs207-4-111026225842-phpapp02/85/Cs207-4-3-320.jpg)
Cs207 4
- 1. CS207 #4, 21 Oct. 2011 Gio Wiederhold Gates B12 10/22/2011 Gio: CS207 1
- 2. Admin notes: • New Sign-up sheets – prior entries have been transferred • miss a class? write & mail me a brief report by 19 Nov. • Subjects for a missing class report? Questions? 22-Oct-11 CS207 2
- 3. Reports Write an initial statement on the issue you are addressing. Having it written down will help you focus. Then make a list of one or more candidate documents. You could Google for likely documents and use the attached to the CS207 wiki page. Read the ones that seem significant. Write a one or two paragraph summary, with citations [Author: title; publication, [vol.no.], date, page numbers]. Make notes of their assumptions and results, be critical. This is your contribution ! Folk that advocate a specific point-of-view often forget or ignore important factors. Add a brief conclusion. Relate to your initial the intro. The conclusion will tell me -- and the world on the web -- what you have learned. The value of your work is the clarity of your point. Don’t worry about the length; it is harder to be brief than voluble. 10/22/2011 Gio: CS207 3
- 4. Syllabus: 1. Why should software be valued? 2. Open source software. Scope. Theory and reality 3. Principles of valuation. Cost versus value. 4. Market value of software companies. 5. Alternate business models. 6. Intellectual capital and property (IP). 7. Life and lag of software innovation. 8. Sales expectations and discounting. 9. The role of patents, copyrights, and trade secrets. 10. Licensing. 11. Separation of use rights from the property itself. 12. Risks when outsourcing and offshoring development. 13. Effects of using taxhavens to house IP. 10/22/2011 Gio: CS207 4
- 5. Example revisited Software product 7 versions Sells for $500/copy Market size 200 000 Market penetration 25% Expected sales 50 000 50 785 V1-V7 Expected income $25M Discounted gross income $14.7M Available for SW maintenance $3.7M Ok but see when it is needed 10/22/2011 Gio: CS207 5
- 6. Combining it all and adjusted for end-of-life factor today y1 y2 y3 y4 y5 y6 y7 y8 y9 Version 1.0 2.0 3.0 4.0 5.0 6.0 7.0+ unit price $500 500 500 500 500 500 500 500 500 500 Rel.size 1.00 1.67 2.33 3.00 3.67 4.33 5.00 5.67 6.33 7.00 I New grth 0.00 0.67 1.33 2.00 2.67 3.33 4.00 4.67 5.33 6.00 P replaced 0.00 0.05 0.08 0.12 0.15 0.18 0.22 0.25 0.28 0.32 old left 1.00 0.95 0.92 0.88 0.85 0.82 0.78 0.75 0.72 0.68 Fraction 100% 57% 39% 28% 22% 17% 14% 11% 9% 8% Units sold 0 1911 7569 11306 11395 8644 2646 1370 1241 596 Income Rev, $K 0 956 3785 5652 5698 4322 2646 1370 620 299 SW IP 25% 0 239 946 1413 1424 1081 661 343 155 75 Due old 0 136 371 416 320 204 104 45 18 6 Disct 15% 1.00 0.87 0.76 0.66 0.57 0.50 0.43 0.38 0.33 0.28, 0.25 Contribute 0 118 276 263 178 94 40 15 6 2 Total SW 990 ≈ $ 1 million out of $14 771 discounted sales 10/22/2011 Gio: CS207 6
- 7. Result of Example • Selling 50 000 SW units at $500 ≈ $ 1M not $ 25M Once its in a spreadsheet, the effect of the many assumptions made can be checked. When assumptions later prove unwarranted then management can make corrections. To be wise, don't spend more than ≈ $500 000 to develop the software product. 10/22/2011 Gio: CS207 7
- 8. Transients due to versions Customer behavior w.r.t. new versions, superimposed on basic sales curve 2-year version life Vn+1 Vn+2 Overall steady state sales New version New version New version announced release announced Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 10/22/2011 Gio: CS207 8
- 9. Income Factors 1. Business overhead takes 50% of net revenue An average, when sales are low, fraction is higher Be lean, especially when sales fall Focus on on-line sales 2. Marketing uses 25% of net revenue Assess customer base, but don’t skimp here 3. Available for maintenance is still 25% of net Enough once sales become substantial Requires initially additional capital 10/22/2011 Gio: CS207 9
- 10. Guidance obtained • We applied an overall Erlang sales curve new versions keep market going but customers do not replace earlier versions • The assumption are sufficiently simple that alternatives can be intelligently discussed 1. keep development costs low 2. design so that SW maintenance is low 3. charge a higher price 4. minimize sales cost, without reducing market size 5. broaden the market 6. or → 10/22/2011 Gio: CS207 10
- 11. Business models 0. New versions do not replace earlier versions Alternative business models 1. New versions encourage replacement 2. Provide related services 3. Charge for maintenance Lower initial cost, slower income stream 4. Make product Open source to broaden market Charge only for services 10/22/2011 Gio: CS207 11
- 12. Alternate business model Consider maintenance and its income "Service model" • More assumptions – now include cost @50% of value 1. Original cost $500 000 (used to estimate 2.) a. Maintenance cost 15%/year of aggregate original cost b. Maintenance fee 15%/year of original price, 1 year delay. c. 85% annual retention of customers. 2. Maintenance Lag = Δ (t cost , t income) = 1 year 3. Stop maintenance when cost > income 10/22/2011 Gio: CS207 12
- 13. Additional Effect of service model factor today y1 y2 y3 y4 y5 y6 y7 y8 y9 Version 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Org.cost $K 500 Assume designed for maintenance Maint.cost 0 75 86 99 114 131 151 174 200 230 Spending 75 86 99 114 131 151 174 200 230 Σ1523 SW@Cust. 0 812 4475 9456 13735 15997 16243 15176 13520 11744 Maint.Fees 0 0 122 671 1419 2060 2060 2400 2437 2277 Total income 0 956 3906 6324 7116 6382 5045 3806 2897 2380 Contribute @25 0 239 977 1581 1779 1569 1261 952 724 570 Unspent SW -75 153 877 1467 1648 1445 1088 752 495 306 Unspent Disc. -75 133 663 965 942 718 470 162 87 40 Total 4 348 ≈ $ 4.3 million >> sales only but $1 523M for maintenance Cost of maintenance = 1523/(500+1523) = 75% of total typical 10/22/2011 Gio: CS207 13
- 14. Lag delays benefits of R&D investments Estimate effective lag . growth limit ~37% → Effort → @27.4% → ~14% → Testing growth limit Development Research 35%→ start 75% 50% 25% done 10/22/2011 Gestation period → Gio: CS207 14
- 15. Service model factors • Same proportion was used for SW contribution: 25% Maintenance income has lower sales cost, perhaps more should be made available for software improvements • Discount total only after maintenance cost Income comes at time of spending • Maintenance fees still generate substantial income Organize business sector to collect those in out years Use excess SW income for replacement or new products • Continue longer, but stop in time! When maintenance costs more than income 10/22/2011 Gio: CS207 15
- 16. More years of service model ? factor Cont. y10 y11 y12 y13 y14 y15 y17 y17 y18 Version 7.0 8.0 9.0 10.0 11.0 12.0 13.0 Curr.cost $K 1530 Maint.cost 229 264 303 349 401 461 530 610 702 540 Spending 264 303 349 401 461 530 610 702 540 SW@Cust.$M 11.7 10.1 8.6 7.3 6.2 5.3 4.5 3.8 3.2 1.9 Maint.Fees 2038 1761 1511 1289 1098 933 794 674 573 487 Total income 2280 1855 1543 1300 1101 934 794 674 573 487 Contribute @25 570 464 386 325 275 234 198 169 143 122 Unspent SW 306 160 40 -76 -186 -297 -411 -533 -397 -145 Unspent Total 2015 1551 1194 898 639 404 184 -27 32.6 221 Unspent Disc. -75 133 663 965 942 718 470 162 87 40 Total SW 4 158 Less, out year losses because $5 687M spent on maintenance Good time to quit Quit: reduce expense & But still have income to v12 income 1/3 each16year 10/22/2011 Gio: CS207
- 17. Total income vs technical cost 10/22/2011 Gio: CS207 17
- 18. Net income, after sales cost End of profit on sales End of profit on all income 10/22/2011 Gio: CS207 18
- 19. All Graphs 10/22/2011 Gio: CS207 19
- 20. Life of Software We learned now why software has a finite life Although SW can be indefinitely maintained Eventually the maintenance costs exceed income • A very well-selling product can have a long life 1. Unique 2. High quality Conflict? 3. Well maintained • An easy to maintain product can have a long life 1. Well designed 2. Insulated from change by established standards 10/22/2011 Gio: CS207 20
- 21. Software users & IP Companies that 1. develop & sell software → * • Basis of IP: income from sales 2. purchase & license software for internal use • Do not generate IP with software 3. develop software internally for their own use • Basis of IP: relative SW expense × all income 4. combinations 10/22/2011 Gio: CS207 21
- 22. Allocaction • When there are multiple products • When there are other contributors to income Substantial hardware Financial consultants in financial firms Experts in call centers Brand name Not all of the income can be allocated to the software • Pareto Optimum 10/22/2011 Gio: CS207 22
- 23. Pareto Optimality (not Pareto Efficiency : 80/20 rule) The point were any change lowers the total benefit/cost • Spending more on software will have less benefit than spending on other stuff People 1870 startup: Rome Railway Co. Hardware Advertising For large 10 IT companies the average value allocated to their brand name is 22% (BW survey). Conclusion: • If a company is managed optimally, we can allocate IP contribution by multi-year spending patterns 10/22/2011 Gio: CS207 23
- 24. Setting License fees Say you want to delegate sales in Europe to some company EUsales that can do it easier over there • How do you set the fees or royalties? 1. You have computed a value of your SW of $1M But without discounting, it is actually $1.6M = Σ(due old, slide 5) You will also maintain the SW 1.36M = Σ(maintenance cost, slide 12) The total due is $3M 2. You expect the European sales will be 40% of total, 20 000 The reason for not discounting is that funds arrive at the same times. • To earn the same you should charge 1./2.= $150/unit It does not matter how EUsales sells it and what it charges Complexities are required language, interface improvements 10/22/2011 Gio: CS207 24
- 25. Discussion • Many choices now a. Technical b. Business Interact with each other. 10/22/2011 Gio: CS207 25