What is Software Worth ?
Gio Wiederhold
Stanford University and MITRE Corp.
October 2004, revised Dec.2004
www-db.stanford.edu/people/gio.html
Oct 2004
Gio: Worth
1
Current State
• Software producers traditionally care about
– Cost of writing high-quality code
– Time to complete products
– Function & capabilities
• When the value is a concern
– Business people
– Economists
– Lawyers
– Promoters
Oct 2004
life
assess its value:
inconsistently
subjectively
naively
badly
Gio: Worth
2
Why a Concern
• Making decisions about creative tradeoffs
– Elegance versus functionality
– Rapid generation versus maintainability
– Careful specification versus flexibility
• Dealing with customers
Dijkstra model: for self-satisfaction
Engineering model: formal process driven
Startup model: see if it sticks to the wall
• Gain respect: know what you are doing
Oct 2004
Gio: Worth
3
Why me
•
•
•
Much software is being exported as part of
offshoring (offshore outsourcing)
It is typically property – i.e., protected
If it is not valued correctly – i.e., too low
1.
2.
3.
4.
Oct 2004
Loss of income to the creators in the USA
And loss of taxes
to the US treasury
Excessive profits kept external to the USA
Increased motivation for external investment
Gio: Worth
4
Intangibles
•
•
Product of knowledge
Cost of original >> cost of copies
1.
2.
3.
4.
5.
6.
Oct 2004
Books
Software
Inventions
Trademarks
Knowhow
Customer Loyalty
Gio: Worth
by
authors
programmers
engineers
advertisers
managers
long-term quality
5
Valuation of intangibles
•
Principle
The sum of all future income
discounted to today (NPV)
•
Example
Value of a well-known company (SAP)
– Largely intangible – like many modern enterprises
1. Bookvalue – sum of all tangible assets [10K] €6.3B
2. Market value = share price × no. of shares €31.5B
3. Difference: value of SAP’s Intangibles
€25.2B
–
How much of it is software ?
•
Oct 2004
20%
100%
80%
No numbers given, although it’s the majority of its property.
We have just the stockholders’ guess.
Gio: Worth
6
Software is slithery !
Continuously updated
1. Corrective maintenance
bugfixing reduces for good SW
2. Adaptive maintenance
Life time
100%
80%
60%
externally mandated
3. Perfective maintenance
satisfy customers' growing
expectations
40%
20%
Ratios differ in various settings
Oct 2004
Gio: Worth
7
IP sources for
• Corrective maintenance
– Feedback through error reporting mechanisms
• Inadequate protection
• Taking care of missed cases
• Complete inadequate tables and dimensions
• Adaptive maintenance
– Staff to monitor externally imposed changes
• Compliance with new standards
• Technological advances
• Perfective maintenance
– Feedback through sales & marketing staff
• Minor features that cannot be charged for
Oct 2004
Gio: Worth
8
Effect: SW Growth
Rules: Sn+1 = 2 to 1.5 × Sn per year [HennessyP:90]
Vn+1 ≤ 1.30% × Vn [Bernstein:03]
Vn+1 = Vn + V1 [Roux:97]
Deletion of prior code = 5% per year [W:04]
at 1.5 year / version
R
and W
Oct 2004
Gio: Worth
R
9
Observations
•
Software cannot grow exponentially
no Moore's Law here
Because
1. Cost of maintaining software grows exponentially
with size [Brooks:95]
2. Can't afford to hire staff at (exponential rate) 2
3. Cannot have large fraction of changes in a version
4. Cannot impose version changes on users < 1 / year
5. Deleting code is risky and of little benefit
except in game / embedded code
Oct 2004
Gio: Worth
10
Price remember IP =f(income)
•
Price stays ≈ fixed over time
like hardware Moore's Law
Because
1.
2.
3.
4.
•
Customers expect to pay same for same functionality
Keep new competitors out
Enterprise contracts are set at 15% of base price
Shrink-wrapped versions can be skipped
Effect
The income per unit of code reduces by 1 /
size
Oct 2004
Gio: Worth
11
Growth diminishes IP
at 1.5 year / version
Oct 2004
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12
Total income
Total income = price × volume (year of life)
• Hence must estimate volume, lifetime
Best predictors are Previous comparables
 Erlang curve fitting (m=6 to 20, 12 is typical)
and apply common sense limit = Penetration
 estimate total possible sales F × #customers
 above F= 50% monopolistic aberration
P
Oct 2004
Gio: Worth
13
Sales curves
18,000
^ 50,000 w hen
| Erlang m ~ infinite
16,000
Erlang m = 6
14,000
For 50 000 units over 9 years
12,000
10,000
8,000
6,000
4,000
Erlang m = 12
Oct 2004
Gio: Worth
15
14
13
12
11
10
8
7
6
5
4
3
2
1
0
0
9
|
| end of time horizon
| 9 years
|
2,000
14
Software users
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
(Pareto rule)
4. combinations
Oct 2004
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15
*
Fraction of income for SW
Income in a software company is used for
• Cost of capital
typical
– Dividends and interest
≈ 10%
• Routine operations -- not requiring IP
– Distribution, administration, management ≈ 40%
• IP Generating Expenses (IGEs)
– Research and development, i.e., SW
– Advertising and marketing
≈ 25%
≈ 25%
These numbers are available in annual reports or SEC 10-Ks
Oct 2004
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16
Discounting to NPV
Standard business procedure
• Net present Value (NPV) of
revenue 1 year later = R×(1 – discount %)
Standard values are available for many businesses
based on risk (β) of business, typical 15%
Discounting strongly reduces effect of the far future
NPV of $1.- in 9 years at 15% is only $0.28
Also means that bad long-term assumptions have less effect
Oct 2004
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17
Combining it all
factor
Version
today
y1
1.0
y2
y3
2.0
y4
3.0
500
y5
4.0
unit price
$500
500
500
500
Rel.size
1.00
1.67
2.33
3.00
3.67
New grth
0.00
0.67
1.33
2.00
replaced
0.00
0.05
0.10
old left
1.00
0.95
Fraction
100%
57%
y6
y7
5.0
500
y8
y9
6.0
7.0
500
500
500
500
4.33
5.00
5.67
6.33
7.00
2.67
3.33
4.00
4.67
5.33
6.00
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.90
0.85
0.80
0.75
0.70
0.65
0.60
0.55
39%
28%
22%
17%
14%
11%
9%
8%
Annual #
0
1911
7569
11306
11395
8644
2646
1370
1241
503
Income K
$0K
956
3785
5652
5698
4322
2646
1370
621
252
SW IP 25%
0
239
946
1413
1424
1081
661
343
155
63
Due old
0
136
365
400
311
187
93
39
14
5
Disct 15%
1.00
Contribute
0
Total $
989
Oct 2004
0.87
118
0.76
0.66
276
0.57
263
177
0.50
93
0.43
40
0.38
15
0.33
5
0.28
1
K ≈ $ 1 million
Gio: Worth
18
Result of Example
• Selling 50 000 SW units at $500 ≈ $ 1M
not $ 25M
Once it’s 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, spend less than ≈ $500 000
to develop the software product.
Oct 2004
Gio: Worth
19
Alternate business model
Consider maintenance and its income
long-term "Service model"
• More assumptions – now include cost
1. Original cost $494 000 (used to estimate 2.)
2. Maintenance cost 20%/year of original cost
3. Maintenance fee 15%/year of original price
4. Lag = Δ (t cost , t income) = 1.5 years
5. Stop maintenance when cost > total income
Oct 2004
Gio: Worth
20
Effect of service model
SW cost $494K today
Version
y1
1.0
Maint.cost
y2
2.0
y3
y4
3.0
y5
4.0
y6
y7
5.0
y8
6.0
y9
7.0
0
99
165
231
297
363
429
495
560
626
disc. for lag
0
122
203
285
366
447
529
610
691
772
Income - cost
0
834
3581
5369
5332
3875
2117
761
-70
-520
Aggreg.sold
0
860
4558
9755
14477 17352 18262 17806 16645 15233
Maint. Inc.
0
0
129
684
1463
2172
2603
2739
Sum
0
834
3710
6052
6795
6047
4720
3500 2601
1977
0
725
2806
3980
3885
3006
2040
1316 850
562
15% disc/year
19170 K ≈ $ 2 million
Total $
 20% if designed
for maintenance
2671
2497
after paying $1 780K (disc.) for maintenance
Good time to quit if no
maintenance income
Generates income
10 more years
Cost of actual maintenance = 3260/(494+3260) = 87% of total
Oct 2004
Gio: Worth
typical
21
Long Term
Oct 2004
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22
Service model
«
Analysis shows profitability in service model
• To achieve such a beneficial model
1. Management must value maintenance
2. Marketing and sales must provide feedback
3. Education and training must recognize the
value of maintenance and maintainability
– Often ignored today
1. Academics don't teach it (3/850 pages [Pressman:01])
2. Companies give maintenance tasks to novices
 Experienced programmers should maintain their work
Oct 2004
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23
Knowing what software is worth
• Allows rational design decisions, as
• Limiting development efforts
• Programming investment for maintenance
• Allows rational business decisions, as
• Choice of business model
• Where and when to invest
• How to assign programming talent
• Improve focus of education in software
• Consider quality, not just quantity in assignments
• Effectiveness of curriculum
Oct 2004
Gio: Worth
24