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How to fund digital products: Part 1 - Traditional budget planning

In part one of this two-part series, we'll look at some of the ways you can make a compelling case for investment using the data organisations typically have access to.

Josh Smith
Josh Smith

15 September 2024

4 minute read

Securing funding for innovative digital product ideas can be a challenge. This two-part blog series explores effective strategies for building a compelling business case and obtaining the necessary investment. Part 1 focuses on leveraging traditional budget planning methods and utilising the data readily available within your organisation.

Question 1. How do I know if this idea will be profitable?

Cost-benefit analysis (CBA)

Most organisations follow a traditional business case model that requires certain metrics like revenue uplift and cost savings to complete a cost-benefit analysis. In fact, often it is a requirement to follow an established process to ensure consistency when deciding on internal innovation funding. If such a template does not exist for your organisation, projectmanager.com has a free downloadable resource to get you started. 

One simple and effective form of CBA is the CBA Ratio. If the benefit-cost ratio exceeds 1.0 then your efforts are cost-effective.

Breakout box 1

However, if you need to look a little deeper, there are many other traditional tools at your disposal, some of which we will discuss. And in Part 2 we’ll look into some less traditional methods too.

Payback period + break-even point

The payback period is the amount of time between the date of the initial investment and the date when the break-even point (the price or value that an investment or project must rise to) has been reached. 

BO Box 2 - NPV

One of the downsides of the payback period is that it disregards the time value of money. In other words, money is worth more now than in the future, due to factors such as delayed rewards, inflation (devaluation) and interest earnings (growth). However this can be mitigated by a short payback period. Should the payback period be longer than say one year, then net present value might be a better choice.

Net present value (NPV)

NPV is a method of determining the net value of an investment. The result of which will tell you whether the investment is more valuable today than in the future. One factor that also has to be considered is the discount rate. Put simply, any losses from other potential uses of that same money.

BO Box 3 - NPV

For example:

  1. First calculate the expected inflow (annual earnings)
  2. Then adjust for the discount rate (e.g. 5%), which represents the depreciation of the value of money over time.
  3. Total the inflow:

Year 1: $20,000 / 1.05) = $19,047

Year 2: $25,000 / 1.05)  = $23,809 

Year 3: $30,000 / 1.05) = $28,571

Total: $71,427

  1. Finally, subtract the outflow (the amount being spent)
    1. $71,427 - $50,000 = NPV of $21,427 

In general, projects with a net-positive value are worth undertaking. To work out your own, Microsoft Excel and Google Sheets provide NPV functions out of the box. 

Question 2. Can I use an existing product, service or manual business process to justify funding a new product or new features?

Forecasting

In short, yes but with caveats. If accurate forecasts as to the income from a future product can be made, then investing in it can be justified. But, how can you guarantee that all your well-formed assumptions, including buyer intent, will become a reality? Well, you can’t. Even a letter of intent is just that, an intent – it’s most often non-binding. 

However, early signals like intent and, even better, direct customer engagement in your product or service might give you confidence in how much your audience thinks your product is worth, especially when testing the market with familiar and small monthly costs for SaaS products on a subscription model.

As an example of this thought exercise, If X is willing to spend Y per month on a given feature set and we have Z customers with 20 percent projected growth year-on-year, then we can make some informed assumptions about future revenue. As mentioned above, even better if these assumptions are backed up by evidence and known usage behaviour.

This is forecasting in its most basic form. However, it relies heavily on some unfounded growth assumptions, which are very hard to predict and can never be taken as a certainty. Therefore, we might want to find ways to de-risk this assumption with evidence. We’ll discuss this in part 2.

Summary

While this blog post is by no means a full account of every type of budget planning available, it is a good place to start. However, sometimes there are situations where traditional methods just dont work. Continue reading our next post on ‘Innovation budget planning’ to see how budgeting can be achieved when an idea is entirely new or has no historical data to leverage.

Josh Smith
Josh Smith

15 September 2024

4 minute read

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