Basware in 2013: Transition to Software as a Service 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 Basware in 2013: Transition to Software as a Service case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Basware in 2013: Transition to Software as a Service case study is a Harvard Business School (HBR) case study written by Robert A. Burgelman, Debra Schifrin. The Basware in 2013: Transition to Software as a Service (referred as “Basware Saas” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Competitive strategy, IT.

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 Basware in 2013: Transition to Software as a Service Case Study

In 2013 Basware, the Finland-based e-invoice operator and Enterprise Resource Planning (ERP) software vendor, was going through a large and critical transition: moving from selling and installing licensed software to selling Software as a Service (SaaS). Basware, which sold automated Purchase-to-Pay solutions for Business-to-Business to 2,000 Nordic and global clients, was responding to a sharp decline in those sales in the previous few years; more and more customers were switching to competitors that offered SaaS.(With SaaS, vendors stored a client's data in an external server or in the cloud, and maintained the software and relevant hardware.) Transitioning to SaaS required the a??114 million company simultaneously to transform its strategy, business model, technology and culture; and the change process was bumpy. SaaS customers paid as they used services, rather than upfront as they did with the licensed software and installation business; that difference had an immediate negative impact on Basware's revenue stream. The company's new SaaS technology would be best in breed when it was complete, but it was taking longer than expected to be ready. Basware also needed to reorganize as a global organization, its sales people needed to be retrained or transitioned out, and its culture needed to adjust to match these rapid changes. At the same time, Basware's e-invoice operator business was booming. In 2013, there were an estimated 63 million transactions across the Basware Commerce Network, and the company expected to hit 150 million transactions by the end of 2015. Speed was the name of the game for Basware, as each transaction brought in money and because the network's size was Basware's competitive advantage. Although the software and e-invoicing businesses were two separate businesses, they were synergistic. The more customers moved from paper to e-invoicing, the more they would be able to use the full functionality of Basware's automated software solutions.

Case Authors : Robert A. Burgelman, Debra Schifrin

Topic : Leadership & Managing People

Related Areas : Competitive strategy, IT

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Calculating Net Present Value (NPV) at 6% for Basware in 2013: Transition to Software as a Service Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10015624)	-10015624	-	-
Year 1	3451171	-6564453	3451171	0.9434	3255822
Year 2	3977575	-2586878	7428746	0.89	3540028
Year 3	3945888	1359010	11374634	0.8396	3313044
Year 4	3240415	4599425	14615049	0.7921	2566712
TOTAL			14615049		12675605

The Net Present Value at 6% discount rate is 2659981

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

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Formula and Steps to Calculate Net Present Value (NPV) of Basware in 2013: Transition to Software as a Service

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 Leadership & Managing People 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 Basware Saas 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 Basware Saas 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	(10015624)	-10015624	-	-
Year 1	3451171	-6564453	3451171	0.8696	3001018
Year 2	3977575	-2586878	7428746	0.7561	3007618
Year 3	3945888	1359010	11374634	0.6575	2594485
Year 4	3240415	4599425	14615049	0.5718	1852718
TOTAL					10455840

The Net NPV after 4 years is 440216

(10455840 - 10015624 )

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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	(10015624)	-10015624	-	-
Year 1	3451171	-6564453	3451171	0.8333	2875976
Year 2	3977575	-2586878	7428746	0.6944	2762205
Year 3	3945888	1359010	11374634	0.5787	2283500
Year 4	3240415	4599425	14615049	0.4823	1562700
TOTAL					9484381

The Net NPV after 4 years is -531243

At 20% discount rate the NPV is negative (9484381 - 10015624 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Basware Saas 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 Basware Saas has a NPV value higher than Zero then finance managers at Basware Saas 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 Basware Saas, then the stock price of the Basware Saas 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 Basware Saas 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 –

Understanding of risks involved in the project.

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

What can impact the cash flow of the project.

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.

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 Basware in 2013: Transition to Software as a Service

References & Further Readings

Robert A. Burgelman, Debra Schifrin (2018), "Basware in 2013: Transition to Software as a Service Harvard Business Review Case Study. Published by HBR Publications.