We’ve all been there — you’re sitting in a meeting and someone asks you how long it’s going to take to make back your investment in a new product feature. You rack your brain trying to think of a good answer, but know you’re going to need some time to run some calculations.
Instead of freezing up, you can use a payback period calculation. In this article, you will learn how to calculate the payback period, why it’s important, and how you can use it to optimize your feature development.
The payback period is the length of time it takes for a new feature or product to generate the amount of money it costs to develop the new product or feature.
For example, let’s say you spent $50,000 to develop a new feature for your product. By launching the new feature, you expect to make $50,000 in the next six months. The payback period, in this case, would be six months.
To calculate the payback period, you’ll need to calculate your expenses, estimate your revenue over time, and document your assumptions.
Expenses include anything that costs the company money while developing the feature or product. Below are some of the most common expenses:
Once you have your expenses, you need to calculate the amount of revenue the feature or product is expected to generate.
To do this, you typically forecast how much revenue will be generated on a month-to-month basis over time.
This might look something like:
| January | February | March | April | May | June |
| $5,000 | $8,000 | $12,000 | $10,000 | $15,000 | $10,000 |
In this case, your average monthly revenue for the first six months is $10,000 per month.
It’s crucial to document the assumptions that go into your calculation. You’ll want to write down how you arrived at the conclusion so that in the event someone questions your math, you can quickly and easily explain what you were thinking.
You’ll want want to document:
Once you’ve done these three steps, you’re ready to calculate the payback period. The simplest way to calculate payback is with this formula:
Payback period = Total cost of project / monthly revenue generated from project
For example, let’s say your new feature cost $50,000. You expect to generate $5,000 per month from the new project:
$50,000 / $5,000 = ten months
Your payback period in this case would be ten months.
As a product manager, payback period calculations can help you make a compelling case for what feature or product to invest in next. If you have a list of ten features you want to build, the payback period can help you narrow down which feature or project might help extend your runway.
If you pair the length of time it takes to develop something with the payback period, you begin to have a powerful tool for analyzing which new feature to build next:
If you can add the estimated timeframe a feature will take to complete, you can start to prioritize features that may generate more revenue more quickly, allowing for faster growth.
Using this method to discuss prioritization with your stakeholders can help make a case for a feature that may take a little longer, but the payoff might be quicker. Or, if you’ve had trouble getting traction for a feature that customers desperately want, you might be able to build a case with this framework.
The payback period can be a valuable tool to help with decision making and prioritization. The faster a payback period is, the quicker you can increase revenue. By considering the payback period alongside feature delivery, you can quickly build a prioritization model that outlines how you came to your revenue projections.
Featured image source: IconScout
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