Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes case study is a Harvard Business School (HBR) case study written by T.S. Raghu, Collin Sellman. The Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes (referred as “Education Agile” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, IT, Marketing, Operations management, Product development.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes Case Study

Pearson Plc is an education company that operates worldwide and is headquartered in London, the United Kingdom. Its six primary business units are North American Education, International Education, Professional, the Financial Times, Interactive Data, and Penguin Publishing. The vice-president of product management within the Digital Learning division of the North American Education unit based in Chandler, Arizona begins to transform the product development processes to better meet the needs of his customers in the education market, specifically in transitioning from using an off-shored waterfall software development model to an on-shore Agile model. When the vice-president first joined Pearson a year earlier, the Digital Learning unit had spent significant resources developing a major upgrade to one of its educational software products. The first version of this new product was challenged by the disconnect between what the software development group was delivering and what the vice-president's customers desired. He is faced with a decision to continue focusing on the specific methodology they had implemented (Scrum) or move to a new one (Kanban). Additionally, he has to consider expanding his focus to help drive Agile methodologies both with other groups in his business unit and outside his business unit. These decisions must be made at a potentially critical time for his products as his organization deals with the growing pains associated with the shift to Agile.

Case Authors : T.S. Raghu, Collin Sellman

Topic : Technology & Operations

Related Areas : IT, Marketing, Operations management, Product development

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Calculating Net Present Value (NPV) at 6% for Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026745)	-10026745	-	-
Year 1	3466977	-6559768	3466977	0.9434	3270733
Year 2	3963950	-2595818	7430927	0.89	3527901
Year 3	3965799	1369981	11396726	0.8396	3329761
Year 4	3247747	4617728	14644473	0.7921	2572520
TOTAL			14644473		12700916

The Net Present Value at 6% discount rate is 2674171

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Profitability Index
3. Internal Rate of Return
4. Net Present Value

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Education Agile shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Education Agile have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Technology & Operations Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Education Agile often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Education Agile needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10026745)	-10026745	-	-
Year 1	3466977	-6559768	3466977	0.8696	3014763
Year 2	3963950	-2595818	7430927	0.7561	2997316
Year 3	3965799	1369981	11396726	0.6575	2607577
Year 4	3247747	4617728	14644473	0.5718	1856910
TOTAL					10476565

The Net NPV after 4 years is 449820

(10476565 - 10026745 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10026745)	-10026745	-	-
Year 1	3466977	-6559768	3466977	0.8333	2889148
Year 2	3963950	-2595818	7430927	0.6944	2752743
Year 3	3965799	1369981	11396726	0.5787	2295023
Year 4	3247747	4617728	14644473	0.4823	1566236
TOTAL					9503149

The Net NPV after 4 years is -523596

At 20% discount rate the NPV is negative (9503149 - 10026745 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Education Agile to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Education Agile has a NPV value higher than Zero then finance managers at Education Agile can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Education Agile, then the stock price of the Education Agile should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Education Agile should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What will be a multi year spillover effect of various taxation regulations.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes

References & Further Readings

T.S. Raghu, Collin Sellman (2018), "Pearson's Successmaker: Putting the Customer First in Transforming Product Development Processes Harvard Business Review Case Study. Published by HBR Publications.