What's the Appropriate Level of Product Investment?
It’s a nearly universal complaint from product managers: There isn't enough ongoing investment in their products. Whether it's not enough engineers, not enough marketing and promotion or lack of support for improving infrastructure, most product managers feel like their products are getting the short end of the stick.
Some of them are right, but most are not—and it's difficult to discern which is which. Executives are constantly being pulled in different directions with requests for investment. And our finance colleagues often question whether ongoing investment is needed at all. Can we get away with spending less and still earn the same amount? Can we cut funding without impacting revenue? Simply put, product managers nearly always want to spend more, while other execs nearly always want to spend less.
The decision is not just about whether to invest in Product A vs. Product B. Your request for additional funding doesn’t just compete against other products; it competes against all of the other ways the organization can use that money. This could include different investment levels in different product portfolios or markets; investing in infrastructure or optimizing operations; spending money in sales, marketing or public relations; buying back shares or paying dividends or literally investing money in the market. Product managers may want to believe that there’s some magic formula to calculate how much to invest or a basic metric that can be tracked. But this oversimplifies the investment decisions, and can lead to disastrous consequences for new and existing products.
The goal of this article is to review some possible and popular metrics to use in evaluating investment decisions. It covers pros and cons of using them as guides for product investment levels, and hopefully will help you identify appropriate metrics to use within your organization.
Percentage of Revenue
Provide each product with ongoing reinvestment based on a percentage of revenue. If that percentage is 5%, for example, then a product bringing in $10 million this year would get an investment of $500,000 for next year.
Pros: One challenge for technology products—especially web-based or subscription-based products—is that ongoing investment is needed to keep pace with market changes and competitors. A minimal set of “table-stakes” investments is usually required to protect existing revenue and continue growth. And in fast-moving markets, additional features and enhancement requirements may not be known when investment allocations are being made.
Providing a set percentage of revenue back to the product in the form of ongoing investment provides some level of guarantee of product investment. It also is equitable in that it rewards more successful products. The larger a product is in terms of revenue, the more important it is to the company to keep that revenue growing (or at least not shrinking), so allocating more funding to products with more revenue makes sense in this regard.
Cons: The problem with this approach is that the amount of revenue a product brings in may have nothing to do with how much funding it needs. Imagine a hypothetical product that generates a lot of revenue and has high levels of customer satisfaction, while also operating at a high profit margin in an uncompetitive market that is seeing very little change. This may not be your top priority for product investment, given the leading position, existing high margins and lack of competitive threat.
Another issue is that current-year revenue may not reflect future revenue. Many companies with multiple product lines have some which are growing faster than others, and potentially some whose revenue is shrinking. It does not make sense to allocate the same funding to a $10-million product growing at 20% as to a $10-million product declining at 15%.
Percentage of Profit
Provide each product with ongoing reinvestment based on a percentage of profit. If that percentage is 25%, for example, then a product with $10 million in revenue and $6 million in costs (and thus $4 million in profit) would get $1 million back for investment next year.
Pros: Similar to basing investment on revenue, using a product’s profit as a measurement rewards products with key contributions to the company. Products with high profit margins are often high priorities for the organization, and it is vital to keep and grow those margins to grow absolute profit. It also rewards successful products, by providing reinvestment based on how well they have performed financially. Unlike investing based on revenue, investing based on profit ensures you will not be allocating resources toward high-revenue but low-profitability (or money-losing) products.
Cons: There are a number of challenges with allocating based on profit, the most basic being that companies often have poor understanding of product-level P&L. This is a fundamental problem that is separate from dealing with investment decisions, but it makes using this metric especially difficult. In larger organizations especially, most of the true costs of the product are spread across multiple departments and may not be properly allocated back to the appropriate product line. If your product requires a lot of customer support, and the customer support group needs to hire additional resources, does your product “pay” for those? If salespeople sell more than one product, are their costs (salary, commission, benefits, travel, etc.) allocated back to each product–and is it proportional?
Logistical issues aside, even if you can have a reasonable approximation of product profitability, using it as a base of future investment decisions presents the same issue as using revenue as a guide: A product’s profitability may have nothing to do with how much funding it needs. Usually, early-stage products need the most investment, and are often unprofitable initially. Or a large investment in one year may adversely impact the amount of investment in subsequent years. And going back to the above example of a popular high-revenue product that operates at a high profit margin and faces little competitive threat, the company probably wants to develop other products that can be as successful as this one vs. pouring significant investment into this already-lucrative area.
Last Year’s Budget, Plus a Consistent Increase
Provide each product with a consistent and nominal increase in investment each year. For example, if two products received $300,000 and $400,000 in investment last year, with a 5% increase they would receive $315,000 and $420,000 respectively for next year.
Pros: On the surface, this is a fair and equitable approach that may seem to appease product managers. All products get additional investment, and that additional investment is consistent and proportional so that one product is not favored over another. This is also reasonably straightforward from a financial and budgeting standpoint.
Cons: The simplicity and fairness of this approach is also its downfall. It does not take into account product performance, market conditions or extenuating circumstances. It favors products that have historically received heavy investment (or those, which by their very nature, are just more costly to upkeep) and shortchanges newer products and those with inconsistent investment needs from year to year. It encourages ballooning spending, by continually increasing investment and implicitly encouraging product managers to use the money whether they need it or not.
Lastly, from a portfolio perspective, budgets rarely increase at a consistent and predictable rate, so any attempt to implement this would likely run into the realities of the annual budgeting process most companies follow.
Product Life Cycle Stage
Provide each product with an ongoing investment level, based on its life cycle stage: Introduction, Growth, Maturity or Decline.
Pros: Product life cycle stage is a measure of a number of different factors, including revenue, profitability and elements like market growth and market size. By not relying on a single measure, this provides a more holistic view of the product and portfolio to use for calculating an investment decision.
Cons: Though the product life cycle concept is taught in most Marketing 101 classes, actually assigning all products in a portfolio to a life cycle stage is often difficult. Many companies do not perform these calculations, and thus assigning investment based on the stages is difficult if not impossible. The product life cycle also does not naturally take into account factors like competitive position. Two products may both be in the growth stage, but if one is an industry leader in a huge market and one is an also-ran in a less attractive market, investment allocations probably should not be equal.
This also highlights another challenge with relying on product life cycle stage alone: It doesn’t provide a specific formula to use, like percentage of profits. If you have two products–one in growth, one in maturity—how do you know how to divide the investment funds? There should probably be more put toward the product in growth, but how much more? It also doesn’t account for the respective revenue of the products and investment levels needed. Two products both in maturity may need vastly different amounts of investment to maintain high profit levels.
Location in the Growth-Share Matrix (aka BCG Matrix)
The growth-share matrix was created by the Boston Consulting Group as a way of representing an organization’s product portfolio or lines of business. Products are grouped into four quadrants—Question Marks, Dogs, Stars, and Cash Cows—based on the market growth rate and their relative market share. Ongoing investment could be provided based on a product’s position in the matrix.
Pros: This blends some of the strengths of the product life cycle approach—adjusting more investment toward markets that are high-growth–and also addresses some of its weaknesses, by taking into account the market share of products. Presumably, more investment would be given to products with high market share in a fast-growing market, while little (or no) investment would be given to those with low market share in a slow-growing market.
Cons: Using market share and market growth provides only a piece of the overall picture of a product, since it misses whether the product is profitable. This measurement also doesn’t account for new products, which by their very nature will have low market share—thus potentially shortchanging their investment.
Some of the same problems with product life cycle also apply here: There is no specific formula or weighting, and it doesn’t account for the relative revenue and cost to maintain and enhance products. How much more investment should a Star receive vs. a Question Mark? Should two Cash Cows receive the same exact investment allocation?
No Simple Answer
These examples assume we have a fixed amount of money and we’re trying to allocate it to a number of different products for investment. This whole exercise gets trickier when the tradeoffs aren’t as clear. Let’s assume we have $1 million to invest, and we’re trying to figure out what product to invest it in:
Should we put $1 million into a $50-million product to keep its revenue at $50 million, rather than having it otherwise drop to $45 million?
Or should we put the $1 million in a new $1-million product to get it to grow to $6 million, instead of staying at $1 million?
Or should we put $1 million in a $25 million product to minimize its revenue decline, resulting in a future revenue of $20 million with investment instead of $15 million without?
In terms of overall revenue, the totals are the same, regardless of where that $1 million investment goes, though the choice of which product to fund has very different implications on the longer-term strategy and the overall product portfolio.
So, back to the original question: How do we determine how to allocate investment appropriately across a number of different products? As with many things in product management, the answer to how much to invest in an existing product is: “It depends.”
Coming up with a consistent and agreed-upon investment approach may not be quick or easy, but the process itself will likely be as worthwhile as the end result. In debating the virtues of revenue vs. profit, of new products vs. existing products and of growth rates and market share, you will understand the different priorities and perspectives of different stakeholders and the organization as a whole.
The idea of a “magic formula” that can output an investment budget if a handful of numbers are provided is a dream, not a panacea. Removing all subjectivity from the process doesn’t improve the process, it hinders it. Products are complex. Product portfolios are even more complex. Deciding where to allocate a company’s investments is one of the most crucial parts of strategic planning, and shouldn’t be left to a formula. So, take the time to have these discussions with colleagues and senior management. Talk about vision, goals and priorities. Understand what’s important and come up with a way of measuring your products–and investments—based on those criteria. Then, use those as an input and guide to your investment decisions—not to serve as judge and jury.
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