How to calculate the payback period

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.

What is the payback period?

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.

How to calculate the payback period

To calculate the payback period, you’ll need to calculate your expenses, estimate your revenue over time, and document your assumptions.

Calculating expenses

Expenses include anything that costs the company money while developing the feature or product. Below are some of the most common expenses:

• Payroll and human resources — How much it cost to pay the team to build the feature, including salary and benefits
• Third-party software licensing — Any software you had to purchase in order to build your feature or product
• Hosting costs — How much it cost to host the new feature or product
• Other miscellaneous costs — Including things like rent, meals provided or consulting expenses

Estimating revenue over time

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.

Documenting your assumptions

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:

• What led to generating revenue? What financial lever was impacted (churn reduction, increased acquisition, etc)?
• What led you to believe you’d generate that amount of revenue in that amount of time?
• What data did you use? How did you source it?

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.

Why is the payback period important for software development?

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.

Key takeaways

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.

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