SEN 402

SOFTWARE ENGINEERING ECONOMICS

rdazeez@alhikmah.edu.ng

INTRODUCTION
Software engineering economics is a crucial aspect of software development that involves
making informed decisions about software projects in a business context. The success of a
software product or service depends on effective business management, but often, the
relationship between software development and business goals is unclear. This knowledge area
aims to provide a comprehensive overview of software engineering economics.
What is Economics?
Economics is the study of how value, costs, resources, and relationships interact in a given
context. In software engineering, activities have costs, and the resulting software has economic
attributes that can be studied systematically. Software engineering economics provides a
framework for analyzing these attributes and relating them to economic measures, enabling
informed decision-making.
Main Goal of Software Engineering Economics
The goal of software engineering economics is to align technical decisions with business
objectives, ensuring the sustainability and profitability of the organization. This knowledge
area is relevant to all types of organizations, regardless of their focus, product or service
portfolio, or capital ownership. Even seemingly simple technical decisions can have significant
business implications, making economic analysis and decision-making essential engineering
considerations.
The Concern of a Software Engineer?
Software engineers should be aware of the economic aspects of their decisions, even if they are
not directly involved in business decisions. This knowledge area covers the fundamentals of
software engineering economics, including key terminology, concepts, and practices. It
provides a life cycle perspective, discusses risk and uncertainty management, and demonstrates
how economic analysis methods are applied. Practical considerations are also addressed to
ensure that software engineers have a comprehensive understanding of the subject.
Software Engineering Economics Fundamentals
Finance
Finance is a subset of economics that focuses on the effective management and allocation of
resources, including their acquisition, investment, and utilization. Every organization,
including those in software engineering, relies on finance to operate.
The field of finance revolves around the intricate relationships between time, money, and risk,
as well as how funds are allocated and budgeted. In the context of corporate finance, the
primary objective is to secure funding for an organization's operations, striking a balance
between risk and profitability to maximize its wealth and stock value. While this principle
primarily applies to for-profit organizations, not-for-profit organizations also require financial
management to ensure sustainability, even if they don't aim to generate tangible profits. To do
this, an organization must

Page 1 of 27
 i. identify organizational goals, time horizons, risk factors, tax considerations, and
financial constraints;
ii. identify and implement the appropriate business strategy, such as which portfolio and
investment decisions to take, how to manage cash flow, and where to get the funding;
iii. measure financial performance, such as cash flow and ROI (see section 4.3, Return on
Investment), and take corrective actions in case of deviation from objectives and
strategy.
Accounting
Accounting is a crucial aspect of finance that provides stakeholders with a clear understanding
of how their investments are performing. It helps answer the question of whether the expected
profits were achieved, which is essential for both for-profit and not-for-profit organizations.
In for-profit organizations, accounting is vital for measuring the tangible return on investment
(ROI), while in not-for-profit and governmental organizations, it ensures sustainability and
staying in business. The primary function of accounting is to assess an organization's financial
performance and communicate financial information to stakeholders, such as shareholders,
auditors, and investors.
Accounting communicates financial information through financial statements that show the
economic resources being managed in monetary terms. It's essential to select relevant and
reliable information that meets the needs of users. The timing and content of this information
are influenced by risk management and governance policies. Additionally, accounting systems
provide a valuable source of historical data for estimating and making informed decisions.
Controlling
Controlling is a crucial aspect of finance and accounting that involves monitoring and adjusting
financial performance to ensure alignment with an organization's goals and plans. It plays a
vital role in guaranteeing the success of an organization's objectives. A specific area of
controlling, known as cost controlling, focuses on identifying and addressing deviations
between actual costs and planned costs, enabling corrective actions to be taken.
Cash Flow
The movement of money into or out of a business, project, or financial product over a specific
period is referred to as cash flow. To assess a proposal from a business perspective, cash flow
instances and streams are used to describe the financial implications.
To make informed business decisions about a proposal, it's essential to evaluate it from a
financial standpoint. For instance, developing and launching product X would require paying
for new software licenses, which is an outgoing cash flow instance. On the other hand, the sales
income from product X in the 11th month after launch would be an incoming cash flow
instance. These instances need to be considered to determine the viability of the proposal.
A cash flow stream represents the collection of cash flow instances over time that result from
implementing a proposal. It provides a comprehensive financial overview of the proposal,
including the amount of money going out, when it goes out, and the amount of money coming
in, when it comes in. By comparing the cash flow streams of different proposals, businesses
can make informed investment decisions. A cash flow instance refers to a specific amount of
money flowing into or out of the organization at a specific time as a direct result of an activity.

Page 2 of 27
A cash flow diagram visually represents a cash flow stream, providing a quick overview of the
financial situation of an organization or project. It helps readers rapidly understand the financial
implications of a proposal, making it a valuable tool for decision-making. The figure (chart)
below shows an example of a cash flow diagram for a proposal.

Decision-Making Process
If we assume that candidate solutions solve a given technical problem equally well, why should
the organization care about which one is chosen?
The answer is there is usually a large difference in the costs and incomes from the different
solutions. A commercial, off-the-shelf, object request broker product might cost a few thousand
dollars, but, the effort to develop a homegrown service of the same functionality could easily
cost several hundred times that amount.
If the candidate solutions, adequately solve the problem from a technical perspective, then, the
selection of the most appropriate alternative should be based on commercial factors such as
optimizing the total cost of ownership (TCO) or maximizing the short-term return on
investment (ROI).
Life cycle costs such as defect correction, field service, and support duration are also relevant
considerations. These costs are to be factored in; when selecting an acceptable technical
approach, as they are part of the lifetime ROI (Return on Investment).
A systematic process for making decisions will achieve transparency and allow later
justification. Governance criteria in many organizations demand selection from at least two
alternatives.
A systematic process is shown in the figure below. It starts with a business challenge at hand
and describes the steps to identify alternative solutions, define selection criteria, evaluate the
solutions, implement one selected solution, and monitor the performance of that solution.
The figure below shows the process as mostly stepwise and serial. The real process is more
fluid. Sometimes the steps can be done in a different order and often several of the steps can
Page 3 of 27
be done in parallel. The important thing is to be sure that none of the steps are skipped or
curtailed. It’s also important to understand that this same process applies at all levels of
decision-making: from a decision as big as determining whether a software project should be
done at all, to deciding on an algorithm or data structure to use in a software module.

The difference is how financially significant the decision is and, therefore, how much effort
should be invested in making that decision. The project-level decision is financially significant
and probably warrants a relatively high level of effort to make the decision. Selecting an
algorithm is often much less financially significant and warrants a much lower level of effort
to make the decision, even though the same basic decision-making process is being used.
More often than not, an organization could carry out more than one proposal if it wanted to,
and usually, there are important relationships among proposals. Maybe Proposal Y can only be
carried out if Proposal X is also carried out. Or maybe Proposal P cannot be carried out if
Proposal Q is carried out, nor could Q be carried out if P were. Choices are much easier to
make when there are mutually exclusive paths—for example, either A or B or C or whatever
is chosen. In preparing decisions, it is recommended to turn any given set of proposals, along
with their various interrelationships, into a set of mutually exclusive alternatives. The choice
can then be made among these alternatives.
Valuation
In an abstract sense, the decision-making process— be it financial decision-making or other—
is about maximizing value. The alternative that maximizes total value should always be chosen.
A financial basis for value-based comparison is comparing two or more cash flows. Several
bases of comparison are available, including;
i. present worth
ii. future worth
iii. annual equivalent
iv. internal rate of return
v. (discounted) payback period.
Based on the time value of money, two or more cash flows are equivalent only when they equal
the same amount of money at a common point in time. Comparing cash flows only makes sense
when they are expressed in the same time frame.

Page 4 of 27
Note that value can’t always be expressed in terms of money. For example, whether an item is
a brand name or not can significantly affect its perceived value. Relevant values that can’t be
expressed in terms of money still need to be expressed in similar terms so that they can be
evaluated objectively.
Inflation
Inflation refers to the gradual increase in prices over an extended period. This means that goods
and services cost more now than they did in the past. When making business decisions with a
planning horizon spanning several years or in environments with high inflation rates (above
2% annually), it's crucial to consider the impact of inflation on a proposal's value. To accurately
assess the present value, adjustments must be made for both inflation rates and exchange rate
fluctuations.
Depreciation
Depreciation is the process of allocating the cost of a physical asset over several time periods,
enabling the calculation of how investments in assets are deducted from income over multiple
years. This is crucial for determining after-tax cash flow, which is vital for accurately assessing
profit and taxes. When developing a software product for future sale, costs should be
capitalized and depreciated over subsequent periods. The depreciation expense for each period
is calculated by dividing the capitalized development cost by the number of periods the
software will be sold. To make informed comparisons, it's essential to determine how other
proposals, including software and non-software options, would be depreciated and how profits
would be estimated, allowing for a comprehensive evaluation of investment options.
Taxation
Governments impose taxes to fund essential public expenses that no individual entity would
undertake. Corporations are required to pay income taxes, which can significantly reduce their
gross profit. Failing to consider taxation in decision analysis can result in misguided choices.
A proposal with impressive pre-tax profits may appear far less profitable after taxes are
factored in. Moreover, neglecting taxation can create unrealistic expectations about the
potential profitability of a proposed product, leading to disappointing outcomes.
Time-Value of Money
The concept of time-value, which states that money's value fluctuates over time, is a
cornerstone of finance and business decision-making. The same amount of money has different
values at different times, a principle recognized since ancient times. To fairly evaluate
proposals or portfolio components, they must be standardized to their net present value,
considering cost, value, and risk. Additionally, currency exchange rate fluctuations over time,
based on historical data, must be factored in, especially in international collaborations and
cross-border projects.
Efficiency
Economic efficiency measures how well a process, activity, or task uses resources, comparing
actual consumption to expected or desired consumption. Efficiency is about achieving results
with minimal effort, or "doing things right." It's distinct from effectiveness, which focuses on
achieving goals. In software engineering, various factors can impact efficiency, including
product complexity, quality standards, time constraints, process maturity, team distribution,
interruptions, changing requirements, tools, and programming languages. These factors can
influence how efficiently resources are utilized and impact overall productivity.
Page 5 of 27
Effectiveness
Effectiveness is about having an impact. It is the relationship between achieved objectives to
defined objectives. Effectiveness means “doing the right things.” Effectiveness looks only at
whether defined objectives are reached—not at how they are reached.
Productivity
Productivity is the ratio of output over input from an economic perspective. Output is the value
delivered. Input covers all resources (e.g., effort) spent to generate the output. Productivity
combines efficiency and effectiveness from a value-oriented perspective: maximizing
productivity is about generating the highest value with the lowest resource consumption.
LIFE CYCLE ECONOMICS
Product
A product is an economic tangible or intangible (goods) outcome generated through a process
that converts inputs (resources) into a valuable output that is created in a process that transforms
product factors (or inputs) into an output. When sold, a product is a deliverable that creates
value and experience for users. A product can be a combination of systems, solutions,
materials, and services delivered internally (e.g., in-house IT solution) or externally (e.g.,
software application), either as-is or as a component for another product (e.g., embedded
software).
Project
A project is a limited-time initiative aimed at creating a one-of-a-kind product, service, or
outcome. In software engineering, various project categories exist, such as developing a
product, providing outsourced services, maintaining software, or creating a service.
Throughout its lifespan, a software product may require multiple projects to be executed. For
instance, during the conceptual phase, a project might focus on identifying customer needs and
market requirements, while during maintenance, a project might aim to develop the next
product version, highlighting the iterative and evolving nature of software development.
Program
A program is a collection of interconnected projects, subprograms, and activities managed
together to achieve benefits that wouldn't be possible through individual management.
Programs often oversee multiple deliveries to a single customer or market over an extended
period, typically spanning several years. By managing these related components in a
coordinated way, programs can optimize resources, reduce redundancy, and enhance overall
efficiency and effectiveness.
Portfolio
A portfolio is a collection of projects, programs, sub-portfolios, and operational activities
managed together to achieve strategic goals. It encompasses all assets within a business line or
organization, allowing for simultaneous management and oversight. By considering the entire
portfolio, decision-makers can assess the broader implications of their choices, such as
allocating resources to one project, which may limit their availability for other projects. This
holistic approach ensures a coordinated and strategic allocation of resources to maximize
overall success.

Page 6 of 27
Product Life Cycle
The software product life cycle (SPLC) encompasses all aspects of a software product or
service, from definition and development to operation, maintenance, and eventual retirement.
While the initial development phase (software development life cycle - SDLC) is significant,
the subsequent phases; implementation (operation), maintenance, and deployment (retire)
stages typically span a much longer period and require more resources and effort. The majority
of costs are incurred during the maintenance phase. The true value of a software product or
service can be objectively measured during the operation and maintenance stages. As such,
software engineering economics should consider all SPLC activities, including those beyond
the initial release, to ensure a comprehensive understanding of the product's economic impact
and value delivery.
Project Life Cycle
The project life cycle consists of five process groups: Initiating, Planning, Executing,
Monitoring and Controlling, and Closing. However, software project life cycle activities often
overlap, intersect, and repeat in various ways. For example, agile product development
involves multiple iterations that yield incremental deliverable software. A software product life
cycle (SPLC) should incorporate risk management, coordination with suppliers (if applicable),
and transparent decision-making processes that provide auditable records (e.g., for product
liability or governance compliance). The software project life cycle and software product life
cycle are interconnected, with an SPLC potentially encompassing multiple software
development life cycles (SDLCs).
Proposals
Business decision-making starts with a proposal. It is a suggested course of action which is
aimed at achieving a specific business objective, whether at the project, product, or portfolio
level. A proposal represents a single, distinct option under consideration, such as undertaking
a software development project or deciding not to.
Alternative proposals might include enhancing an existing software component or
redeveloping a new one from scratch. Each proposal represents a discrete choice, offering a
clear option to be implemented or rejected. The ultimate goal of business decision-making is
to carefully evaluate the current circumstances and determine which proposals to pursue and
which to decline.
Investment Decisions
Investors allocate funds and resources to pursue a specific goal, driven by economic objectives
like maximizing returns, enhancing organizational capabilities, or boosting company value.
Investors can be internal stakeholders, such as finance teams or board members, or external
parties like banks. Additionally, investors should consider intangible factors like brand
reputation, corporate culture, and core competencies, which play a crucial role in achieving the
target objective.
Planning Horizon
When an organization invests in a proposal, it commits resources that become 'frozen assets,'
initially having a significant economic impact that decreases over time. In contrast, operating
and maintenance costs associated with the proposal start low but increase over time. The total
cost of ownership, including both frozen assets and operating costs, follows a curve where

Page 7 of 27
initial costs dominate early on, but operating costs become more significant later. The point at
which the total cost is minimized is called the minimum cost lifetime.
To fairly compare proposals with different lifespans, such as four versus six years, it's essential
to consider the economic implications of either shortening the longer proposal or reinvesting
profits from the shorter proposal. This requires establishing a consistent planning horizon, also
known as the study period, which takes into account factors like software lifespan. Once set,
various techniques can be applied to standardize proposals with different lifespans within the
planning horizon, enabling a more accurate comparison.
Price and Pricing
The price of a good or service is the amount paid in exchange for it, playing a crucial role in
financial modeling and marketing strategies. As one of the four Ps of the marketing mix, price
stands out as the sole revenue-generating element, while product, promotion, and place
represent costs.
Pricing is a critical aspect of both finance and marketing, involving the determination of what
a company will receive in exchange for its products. Various factors influence pricing
decisions, including production costs, market positioning, competition, market conditions, and
product quality. Pricing involves applying prices to products and services based on factors like
fixed amounts, quantity discounts, promotions, and specific vendor quotes. Effective pricing is
essential in marketing, as it converts consumer needs into demand by considering their
willingness and ability to purchase. Initially set during the project initiation phase, pricing is a
vital part of the "go" decision-making process.
Cost and Costing
Cost refers to the value of resources used up in producing something, making them no longer
available for use. In economic terms, a cost represents an alternative that is sacrificed as a result
of a decision.
A sunk cost is an expense incurred prior to a certain point in time, often used to distinguish
past expenses from current decisions, which can be emotionally challenging. From a traditional
economic perspective, sunk costs should not influence decision-making. Opportunity cost, on
the other hand, represents the value of an alternative that must be forgone to pursue another
option.
Costing is a crucial aspect of finance and product management, involving the determination of
costs based on expenses such as production, software engineering, distribution, and rework, as
well as target costs to remain competitive and successful in the market. Cost management,
including planning and controlling costs, is essential and should be integrated into costing. The
target cost may be lower than the estimated cost.
The total cost of ownership (TCO) is a vital concept in costing, particularly for software, as it
encompasses various hidden costs associated with software product life cycle activities beyond
initial development. TCO represents the total cost of acquiring, implementing, and maintaining
a software product, comprising direct and indirect costs. This accounting method is essential
for making informed economic decisions.
Performance Measurement
Performance measurement is a systematic process that helps organizations define and track key
indicators to assess the success of their programs, investments, and acquisitions. It serves three

Page 8 of 27
main purposes: to verify whether performance goals are being met, to manage resources,
budgets, and progress, and to identify areas for improvement, enabling data-driven decision-
making and enhanced performance.
Earned Value Management
Earned Value Management (EVM) is a project management approach that assesses progress
by evaluating the value created so far. It involves comparing the current project results with
the planned budget and schedule at a specific point in time. This comparison helps to identify
potential performance issues early on by examining the resources consumed and achievements
made against the planned values. A fundamental principle of EVM is monitoring cost and
schedule deviations by comparing planned versus actual schedules and budgets versus actual
costs. This tracking method provides earlier detection of discrepancies, enabling prompt
corrections, unlike traditional cost and schedule tracking methods that only focus on completed
documents and products.
Termination Decisions
Termination refers to the process of ending a project or product, which can be either planned
[in advance], such as when a product reaches the end of its lifespan, or suddenly, like when a
project fails to meet its performance targets during development. In either case, the decision to
terminate should be made after careful consideration of the alternatives, including continuing
or ending the project. A thorough cost estimation of different options is crucial, taking into
account factors like replacement costs, information gathering, supplier impacts, alternative
solutions, asset utilization, and the potential to redirect resources to other opportunities. It's
important to note that sunk costs, which have already been spent and cannot be recovered,
should not influence this decision-making process.
Replacement and Retirement Decisions
An organization faces a replacement decision when it must choose between keeping an existing
asset or replacing it with a new one, such as deciding whether to continue supporting an
outdated software product or redeveloping it entirely. This decision follows the same business
decision-making process, but it's complicated by two additional factors: the sunk cost of the
existing asset and its potential salvage value.
On the other hand, a retirement decision involves discontinuing an activity or product
altogether, like a software company stopping sales of a particular product or a hardware
manufacturer halting production of a specific computer model. However, retirement decisions
can be influenced by lock-in factors such as technological dependencies and high exit costs,
making it difficult to discontinue the activity or product.
RISK AND UNCERTAINTY
Goals, Estimates, and Plans
In software engineering economics, goals are primarily business-oriented, aligning business
needs (such as boosting profitability) with resource investment decisions (like initiating a
project or launching a product with a specific budget, scope, and timeline). These goals apply
to both operational planning (e.g., achieving a milestone by a certain date or extending testing
to reach a desired quality level) and strategic planning (e.g., attaining a target profitability or
market share within a specified timeframe).

Page 9 of 27
An estimate is a thorough assessment of the resources and time required to achieve defined
goals. It determines whether project objectives can be met within the constraints of schedule,
budget, features, and quality attributes. Estimates are typically generated internally and may
not be publicly disclosed. They should be based on realistic evaluations, rather than solely
driven by project goals, to avoid overly optimistic projections. Estimation is an ongoing
process, with regular revisions throughout the project.
A plan outlines the necessary activities and milestones to achieve project goals, aligning with
the estimated resources and timeline. However, this alignment may not always be
straightforward, such as when a project's requirements conflict with the client's target date. In
such cases, plans require a review of initial goals, estimates, and underlying uncertainties.
Creative solutions are applied to resolve conflicts and achieve a mutually beneficial outcome.
Effective planning considers project constraints and stakeholder commitments, making it a
valuable exercise.
The figure below shows how goals are initially defined. Estimates are done based on the initial
goals. The plan tries to match the goals and the estimates. This is an iterative process; because
an initial estimate typically does not meet the initial goals.

Goals, Estimates, and Plans

Estimation Techniques
Estimations are used to analyze and forecast the resources or time necessary to implement
requirements (see Effort, Schedule, and Cost Estimation in the Software Engineering
Management KA and Maintenance Cost Estimation in the Software Maintenance KA). Five
families of estimation techniques exist:
1. Expert judgment: Relies on the experience and knowledge of experts to estimate project
costs, duration, or resources. Experts provide subjective estimates based on their
understanding of the project scope and requirements.
2. Analogy: Involves comparing the project to similar projects or activities to estimate
costs, duration, or resources. This method assumes that the current project will have
similar characteristics and requirements as the analogous project.

Page 10 of 27
 3. Estimation by parts: Breaks down the project into smaller components or tasks and
estimates each part separately. The individual estimates are then combined to arrive at
a total project estimate.
4. Parametric methods: Uses mathematical models and algorithms to estimate project
costs, duration, or resources. These methods rely on historical data and statistical
relationships to generate estimates.
5. Statistical methods: Employs statistical techniques, such as regression analysis and
Monte Carlo simulations, to estimate project costs, duration, or resources. These
methods analyze historical data and project variables to generate estimates.
No single estimation technique is perfect, so using multiple estimation techniques is useful,
because, each family of estimation techniques has its strengths and weaknesses, and the choice
of technique depends on the project's complexity, available data, and the estimator's expertise.
Convergence among the estimates produced by different techniques indicates that the estimates
are probably accurate. Spread among the estimates indicates that certain factors might have
been overlooked. Finding the factors that caused the spread and then reestimating again to
produce results that converge could lead to a better estimate.
Addressing Uncertainty
Because of the many unknown factors during project initiation and planning, estimates are
inherently uncertain; that uncertainty should be addressed in business decisions. Techniques
for addressing uncertainty include:
i. consider ranges of estimates
ii. analyze sensitivity to changes of assumptions
iii. delay final decisions.
Prioritization
Prioritization involves ranking alternatives based on common criteria to deliver the best
possible value. In software engineering projects, software requirements are often prioritized to
deliver the most value to the client within constraints of schedule, budget, resources, and
technology, or to provide for building product increments, where the first increments provide
the highest value to the customer (see Requirements Classification and Requirements
Negotiation in the Software Requirements KA and Software Life Cycle Models in the Software
Engineering Process KA).
Decisions under Risk
Decisions under risk techniques are used when the decision maker can assign probabilities to
the different possible outcomes (see Risk Management in the Software Engineering
Management KA). The specific techniques include
i. Expected Value Decision Making (EVDM): This technique calculates the expected
value of each possible decision outcome by multiplying the probability of each outcome
by its corresponding value. The decision with the highest expected value is chosen. It
helps evaluate decisions under uncertainty by considering the probability and value of
each possible outcome.
ii. Expectation-Variance and Decision Making (EVarDM): This technique considers both
the expected value and variance (risk) of each decision outcome. It helps evaluate
Page 11 of 27
 decisions under uncertainty by considering the trade-off between expected value and
risk. Decisions with higher expected values but also higher variances may be riskier,
while those with lower expected values but lower variances may be more conservative.
iii. Monte Carlo Analysis (MCA): This technique uses random sampling and simulation to
estimate the expected value and variance of decision outcomes. It helps evaluate
decisions under uncertainty by generating multiple scenarios and analyzing the results.
Monte Carlo analysis can handle complex uncertainties and provide a range of possible
outcomes.
iv. Expected Value of Perfect Information (EVPI): This technique calculates the maximum
value of obtaining perfect information about uncertain outcomes before making a
decision. EVPI helps evaluate the value of reducing uncertainty and can guide decisions
about whether to gather more information or make a decision with existing uncertainty.
Decisions under Uncertainty
Decisions under uncertainty techniques are used when the decision maker cannot assign
probabilities to the different possible outcomes because needed information is not available
(see Risk Management in the Software Engineering Management KA). Specific techniques
include

i. Laplace Rule: This technique assumes equal probabilities for all possible outcomes
and chooses the decision with the highest expected value. It's a simple and neutral
approach, but may not accurately represent the decision-maker's risk attitude.

ii. Maximin Rule: This technique chooses the decision with the maximum minimum
value, ensuring the best worst-case outcome. It's a conservative approach, suitable for
risk-averse decision-makers.

iii. Maximax Rule: This technique chooses the decision with the maximum maximum
value, aiming for the best possible outcome. It's an optimistic approach, suitable for
risk-tolerant decision-makers.

iv. Hurwicz Rule: This technique combines the Maximin and Maximax rules, using a
coefficient (alpha) to balance between the two extremes. It allows decision-makers to
express their risk attitude, with alpha = 0 being maximin and alpha = 1 being
maximax.

v. Minimax Regret Rule: This technique chooses the decision that minimizes the
maximum regret, which is the difference between the actual outcome and the best
possible outcome. It's a more nuanced approach, considering the potential regret of each
decision.

Page 12 of 27
ECONOMIC ANALYSIS METHODS
For-Profit Decision Analysis

The for-profit decision-making process

The figure above; describes a process for identifying the best alternative from a set of mutually
exclusive alternatives. Decision criteria depend on the business objectives and typically include
ROI (see section 4.3, Return on Investment) or Return on Capital Employed (ROCE) (see
section 4.4, Return on Capital Employed).
For-profit decision techniques don’t apply to government and non-profit organizations. These
two organizations have different goals—which means that a different set of decision techniques
are needed, such as cost-benefit or cost-effectiveness analysis.
Minimum Acceptable Rate of Return (MARR)
The minimum acceptable rate of return (MARR) is the lowest rate of return an organization
considers a worthwhile investment. It's unwise to invest in a project with a 10% return when
another project offers a 20% return. The MARR represents the organization's confidence in
achieving a certain return on investment.
The MARR represents the opportunity cost of investing in one project over another. When an
organization chooses to invest in a project, it's explicitly deciding not to invest in another
project. If the organization is confident it can achieve a certain rate of return, it should only
consider alternative projects with a rate of return at least that high. Using the MARR as the
interest rate in business decisions helps account for this opportunity cost. Evaluating an
alternative's present worth at the MARR shows its value in present-day cash terms compared
to investing at the MARR.

Page 13 of 27
Return on Investment
Return on Investment (ROI) is a metric that assesses the financial performance of a company
or business unit, calculating the return or profit generated by an investment in relation to its
cost. The ROI serves various purposes, including justifying future investments and informing
acquisition decisions, by providing a clear indicator of an investment's profitability and
potential for growth.
Return on Capital Employed
The Return on Capital Employed (ROCE) is a metric that evaluates a company's or business
unit's profitability by calculating the return on the capital invested. It's defined as the ratio of
earnings before interest and taxes (EBIT) to the total assets minus current liabilities, providing
insight into the return generated by the employed capital, and helping assess the efficiency of
capital utilization.
Cost-Benefit Analysis
Cost-benefit analysis is a popular method for assessing individual proposals. If a proposal has
a benefit-cost ratio of less than 1.0, it can typically be dismissed immediately, as the costs
outweigh the benefits. Proposals with a higher ratio require further evaluation, considering
factors like investment risk and comparing the benefits to alternative investments with a
guaranteed return, such as the Minimum Acceptable Rate of Return (MARR).
Cost-Effectiveness Analysis
Cost-effectiveness analysis is similar to cost-benefit analysis. There are two versions of cost-
effectiveness analysis: the fixed-cost version maximizes the benefit given some upper bound
on cost; the fixed-effectiveness version minimizes the cost needed to achieve a fixed goal.
Fixed-Cost Version:
Also, known as Cost-Benefit Analysis which refers to a capital budgeting ratio wherein the
estimated costs and benefits of a project are compared to determine its economic feasibility.
If the cumulative benefits of a potential project are anticipated to outweigh the incurred costs,
a company is more likely to decide in favor of proceeding with undertaking the project.
However, if the projected costs outweigh the benefits, the likelihood of the company approving
the project (or investment) is far lower, since it would be irrational to pursue an opportunity
where the monetary benefits are offset by the losses.
Formula:

Example: A cost-benefit analysis of a preschool program would compare the benefits (e.g.,
future labor market earnings, improved health, reduction in crime) to the costs (e.g., program
costs, potential increased public-sector spending on higher education)
How Does Cost-Benefit Analysis Work?
The cost-benefit analysis (CBA), or “benefit-cost ratio” (B/C), is a decision-making tool relied
upon by corporations to quantify the economic viability of a potential project or investment.
Page 14 of 27
The cost-benefit analysis ratio measures the economic viability of a potential project by
comparing the present value (PV) of the associated benefits to the present value (PV) of the
associated costs.
Conceptually, the cost-benefit analysis ratio should exceed 1.0 for the project to be approved,
since that implies the expected benefits outweigh the costs.
If the projected benefits outweigh the costs, the project could be worth pursuing, considering
its potential to create positive economic value for the company, and vice versa.
Otherwise, the approval of a project where the aforementioned condition is not met (“net loss”)
contradicts the risk-return trade-off theory, a fundamental principle in capital budgeting.
For the most part, the decision by a corporation to approve (or reject) a potential project abides
by the following guidelines:
• Benefits > Costs → Approve Project
• Costs > Benefits → Reject Project
The practical utility of conducting a cost-benefit analysis is namely to ensure the project (or
investment) opportunity is profitable, with the potential to contribute positive economic value
on behalf of the corporation.
How to Calculate Cost-Benefit Analysis Ratio
Corporations should only undertake a project if the net proceeds received exceed the costs per
economic theory, since that implies the project is economically feasible (and thus worthwhile
to pursue).
Given the perceived net gain (or net loss) from pursuing the project, the anticipated monetary
rewards can be compared to other opportunities to which to allocate capital, With that
comparison, the goal would be to allocate more capital toward the one where the risk-reward
profile is more favorable.
The implicit assumption that underpins the cost-benefit analysis is termed the “opportunity
cost”, a fundamental economic concept that states each decision must consider the foregone
value of alternative options with a comparable risk profile.
In other words, the time and resources of a company are scarce, so the decision for which
projects to pursue must be the one deemed to be the most profitable relative to the alternative
options available on the date of the given analysis.
The step-by-step process to calculate the cost-benefit analysis ratio is as follows:
• Step 1 → Quantify the Projected Monetary Benefits (Revenue)
• Step 2 → Quantify the Projected Monetary Costs (Expenses)
• Step 3 → Discount the Benefits and Costs to their Present Value (PV)
• Step 4 → Divide the Cumulative Present Value (PV) of Benefit by the Coinciding Cost

Page 15 of 27
Cost-Benefit Analysis Formula
The cost-benefit analysis involves comparing the monetary benefits of a project to the costs.
The formula to calculate the cost-benefit analysis ratio divides the projected present value (PV)
of benefit by the present value (PV) of cost attributable to a project.
Cost Benefit Analysis Ratio = Present Value (PV) of Benefit ÷ Present Value (PV) of Cost
The projected benefits and costs must consider the opportunity cost of capital (or discount
rate), which requires discounting each cash flow to its present value (PV).
While there are a multitude of metrics that can be derived from performing a cost-benefit
analysis – such as the net present value (NPV), payback period, and return on investment
(ROI) – the CBA ratio is one of the more straightforward “back of the envelope” metrics used
to analyze a potential project.
If the benefit-cost ratio exceeds 1.0, that is perceived positively by corporations, since the
project is implied to be cost-effective and create positive economic value (i.e. monetary benefit
> monetary cost).
However, the minimum requirement for the benefit-cost ratio to be greater than 1.0 is
insufficient as a standalone metric – albeit, the metric provides a basis for comparing against
other projects or investments.
Cost-Benefit Analysis Calculator
We’ll now move to a modelling exercise, which you can access by filling out the form below.
Cost-Benefit Analysis Calculation Example
Suppose we’re tasked with calculating the cost-benefit analysis ratio of a project on behalf of
a corporation.
In the initial period (Year 0), the total cost incurred to proceed with the investment is $20
million.
From Year 1 to Year 2, the project cost is anticipated to be $6 million and $4 million, with the
cost fixed at $2 million for the remainder of the forecast period.
• Project Cost (Year 0) = ($20 million)
• Project Cost (Year 1) = ($6 million)
• Project Cost (Year 2) = ($4 million)
• Project Cost (Year 3) = ($2 million)
• Project Cost (Year 4) = ($2 million)
• Project Cost (Year 5) = ($2 million)
On the other hand, the project benefit – which refers to revenue here – is as follows.
• Project Benefit (Year 1) = $4 million
• Project Benefit (Year 2) = $8 million
• Project Benefit (Year 3) = $10 million

Page 16 of 27
 • Project Benefit (Year 4) = $12 million
• Project Benefit (Year 5) = $16 million
The discount rate – the minimum return for the corporation to accept the project (or “hurdle
rate”) – is 5.0%, with the project expected to last five years in total.
• Project Discount Rate (%) = 5.0%
Since the cost and benefit are forecasted measures of the project’s cash flow, each metric must
be discounted to the present date using the 5.0% discount rate.
The present value (PV) of each metric is determined by dividing each cash flow metric by one
plus the discount rate, raised to the period number.
Present Value (PV) = Cash Flow Metric ÷ (1 + Discount Rate) ^ Period Number
Once each metric is discounted, we’ll calculate the cumulative present value (PV) of the two
cash flow streams to arrive at $34 million and $42 million for the cost and benefit, respectively.
• Present Value (PV) of Cost = ($34 million)
• Present Value (PV) of Benefit = $42 million

Note: If the monetary costs are input as negatives, a negative sign must be placed before the
formula for the output to return a positive integer.
In closing, the cost-benefit analysis ratio comes out to 1.2, which we arrived at by dividing the
present value (PV) of the anticipated benefits by the present value (PV) of the anticipated costs.
• Cost-Benefit Analysis Ratio = $42 million ÷ $34 million = 1.2
Therefore, the project is more likely to be approved by the corporation since the ratio exceeds
1.0 – but to reiterate from earlier, the insights obtained from the other capital budgeting metrics
must also support the decision.

Page 17 of 27
What is Present Value?
The Present Value (PV) is a measure of how much a future cash flow, or stream of cash flows,
is worth as of the current date.
Conceptually, any future cash flow expected to be received on a later date must be discounted
to the present using an appropriate rate that reflects the expected rate of return (and risk profile).
Why? The time value of money (TVM) principle, which states that a dollar received today is
worth more than a dollar received on a future date.
Formula:

Present Value (PV) = Future Value ÷ (1 + Discount Rate) ^ Number of Periods

Where:
• Future Value (FV) → The future value (FV) is the projected cash flow expected to be
received in the future, i.e. the cash flow amount we are discounting to the present date.
• Discount Rate (r) → The “r” is the discount rate – the expected rate of return (interest)
– which is a function of the riskiness of the cash flow (i.e. greater risk → higher discount
rate).
• Number of Periods (n) → The final input is the number of periods (“n”), which is the
duration between the date the cash flow occurs and the present date – and is equal to
the number of years multiplied by the compounding frequency.
How to Calculate Present Value (PV)
The present value (PV) concept is fundamental to corporate finance and valuation.
The core premise of the present value theory is based on the time value of money (TVM),
which states that a dollar today is worth more than a dollar received in the future.
Therefore, receiving cash today is more valuable (and thus, preferable) than receiving the
same amount at some point in the future.
In short, two primary reasons that support this theory:

Page 18 of 27
 1. Opportunity Cost of Capital → If the cash is currently in your possession, those funds
could be invested into other projects to earn a higher return over time.
2. Inflation → Another risk to consider is the effects of inflation, which can erode the
actual return on investment (and thereby future cash flows lose value due to
uncertainty).
How Does the Discount Rate Affect Present Value?
Since money received on the present date carries more value than the equivalent amount in
the future, future cash flows must be discounted to the current date when thought about in
“present terms.”
Moreover, the size of the discount applied is contingent on the opportunity cost of capital (i.e.
comparison to other investments with similar risk/return profiles).
All future receipts of cash (and payments) are adjusted by a discount rate, with the post-
reduction amount representing the present value (PV).
Given a higher discount rate, the implied present value will be lower (and vice versa).
Lower Discount Rate → Higher Valuation
Higher Discount Rate → Lower Valuation
When estimating the intrinsic value of an asset, namely via the discounted cash flow (DCF)
method, how much a company is worth is equal to the sum of the present value of all the
future free cash flows (FCFs) the company is expected to generate in the future.
More interesting is, that the intrinsic value of a company is a function of its ability to generate
future cash flows and the risk profile of the cash flows, i.e. the company’s value is equal to the
sum of the discounted values of its future free cash flows (FCFs).
Present Value (PV) Calculation Example
Let’s say you loaned a friend $10,000 and are attempting to determine how much to charge in
interest.
If your friend has promised to repay the entire borrowed amount in five years, how much is the
$10,000 worth on the date of the initial borrowing?
Assuming that the discount rate is 5.0% – the expected rate of return on comparable
investments – the $10,000 in five years would be worth $7,835 today.
• Present Value (PV) = $10,000 ÷ (1 + 5%)^5 = $7,835
Present Value vs. Future Value: What is the Difference?
The present value (PV) calculates how much a future cash flow is worth today, whereas the
future value is how much a current cash flow will be worth on a future date based on a growth
rate assumption.
While the present value is used to determine how much interest (i.e. the rate of return) is needed
to earn a sufficient return in the future, the future value is usually used to project the value of
an investment in the future.
• Present Value (PV) → How much is the future cash flow worth today?
• Future Value (PV) → How will this current cash flow be worth in the future?
Page 19 of 27
Excel PV Calculation Exercise Assumptions
Suppose we are calculating the present value (PV) of a future cash flow (FV) of $10,000.
We’ll assume a discount rate of 12.0%, a time frame of 2 years, and a compounding frequency
of one.
• Future Cash Flow (FV) = $10,000
• Discount Rate (r) = 12.0%
• Number of Period (t) = 2 Years
• Compounding Frequency (n) = 1x
PV Formula in Excel
Using those assumptions, we arrive at a PV of $7,972 for the $10,000 future cash flow in two
years.
• Present Value (PV) = $10,000 ÷ (1 + 12%)^(2 × 1) = $7,972
Thus, the $10,000 cash flow in two years is worth $7,972 on the present date, with the
downward adjustment attributable to the time value of money (TVM) concept.

Discounted Cash Flow Analysis Assumptions (DCF)

In the next part, we’ll discount five years of free cash flows (FCFs).
Starting off, the cash flow in Year 1 is $1,000, and the growth rate assumptions are shown
below, along with the forecasted amounts.
• Year 1 = $1,000
• Year 2 = 10% YoY Growth → $1,100
• Year 3 = 8% YoY Growth → $1,188
• Year 4 = 5% YoY Growth → $1,247
• Year 5 = 3% YoY Growth → $1,285
DCF Present Value (PV) Calculation Example
If we assume a discount rate of 6.5%, the discounted FCFs can be calculated using the “PV”
Excel function.
=PV(rate, nper, pmt, [fv], [type])
Page 20 of 27
 • “rate” → Rate of Return (or Interest Rate)
• “nper” → Number of Compounding Periods
• “pmt” → Periodic Payment Value
• “fv” → Future Value
• “type” → Timing of Cash Flow (0 = End of Period; 1 = Beginning of Period)
• Year 1 = $939
• Year 2 = $970
• Year 3 = $983
• Year 4 = $970
• Year 5 = $938
The sum of all the discounted FCFs amounts to $4,800, which is how much this five-year
stream of cash flows is worth today.

What is Future Value?

The Future Value (FV) refers to the implied value of an asset as of a specific date in the future
based upon a growth rate assumption.

How to Calculate Future Value (FV)

The future value (FV) is a fundamental concept to corporate finance, whether it be for
determining the valuation of a potential investment or projecting cash flows to support capital
budgeting decisions.
Page 21 of 27
For investors and corporations alike, the future value is calculated to estimate the value of an
investment at a later date to guide decision-making.
The calculated future value is a function of the interest rate assumption – i.e. the rate of return
earned on the original amount of capital invested, or the present value (PV).
The present value (PV) is defined as the initial investment amount, whereas the future value
represents the ending amount, with the original amount as well as any accumulated interest.
The “time value of money” states that a dollar today is worth more than a dollar tomorrow, so
future cash flows must be discounted back to the present date to be comparable to present
values.
There are two types of interest: 1) simple interest and 2) compound interest.
1. Simple Interest: The amount of interest earned is calculated off the original principal
(or deposit) amount, which remains constant throughout the investment horizon.
2. Compound Interest: The incremental amount of interest earned is calculated off the
original principal amount (or deposit) and the accrued interest to date, i.e. “interest on
interest”.
Remember, the formula used to calculate the future value is shown below.
Future Value (FV) = PV × (1 + r) ^ n
Where:
• PV = Present Value
• r = % Interest Rate
• n = Number of Compounding Periods
How Does Compound Interest Impact Future Value?
The number of compounding periods is equal to the term length in years multiplied by the
compounding frequency.
The more compounding periods there are, the greater the future value (FV) – all else being
equal.
• Annual Compounding = 1x
• Semi-Annual Compounding = 2x
• Quarterly Compounding = 4x
• Monthly Compounding = 12x
• Daily Compounding = 365x
For example, if you decided to invest $100.00 at an interest rate of 10% – assuming a
compounding frequency of 1 – the investment should be worth $110 by the end of one year.
• Future Value (FV) = $100 × (1 + 10%) ^ 1 = $110.00
However, if the interest compounds semi-annually, the investment is worth $110.25 instead.
• Future Value (FV) = $100 × (1 + 10 ÷ 2%) ^ 2 = $110.25

Page 22 of 27
Future Value Calculator (FV)
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Corporate Bond Assumptions
Suppose a corporate bond has a present value (PV) of $1,000 with a stated annual interest rate
of 5.0%, which compounds on a semi-annual basis.
If we assume that the term length is 8 years – the following are the inputs to calculate the future
value of the bond investment.
• Present Value (PV) = $1,000
• Annual Interest Rate (r) = 5.0%
• Term Length (t) = 8 Years
• Compounding Frequency = Semi-Annual (2x)
Since the number of compounding periods is equal to the term length (8 years) multiplied by
the compounding frequency (2x), the number of compounding periods is 16.
• Number of Compounding Periods (nper) = 8 Years × 2 = 16
Future Value Calculation Example (FV)
The “FV” function in Excel can be used to determine the value of the $1,000 bond after an
eight-year time frame.
= FV(rate, nper, pmt, pv)
Note, a negative sign must be placed in front of the present value input for the Excel function
to work as intended.

FV Calculation Example in Excel

If we enter our assumptions into the Excel formula, we arrive at a future value (FV) of $1,485.
=FV(5.0% ÷ 2, 16, 0, –$1,000)
So the bond has increased from $1,000 to $1,485 after eight years, given the annual interest
rate of 5.0% compounded on a semi-annual basis.

Page 23 of 27
The more frequently that the deposit is compounded, the greater the amount of interest earned,
which we can confirm by adjusting the compounding frequency.
• Annual Compounding = $1,477
• Semi-Annual Compounding = $1,485
• Quarterly Compounding = $1,488
• Monthly Compounding = $1,491
In conclusion, the implied future value (FV) of the bond increases with a higher frequency of
compounding.

Fixed-Effectiveness Version:
i. Compares the costs required to achieve a certain outcome
ii. Formula: Costs ($) / Outcome
iii. Example: A cost-effectiveness analysis of a preschool program focused on increasing
high school graduation rates would estimate the cost of the program per additional
graduate. This cost could then be compared to other interventions aimed at improving
graduation rates.
Break-Even Analysis
Break-even analysis identifies the point where the costs of developing a product and the
revenue to be generated are equal. Such an analysis can be used to choose between different
proposals at different estimated costs and revenue. Given estimated costs and revenue of two
or more proposals, break-even analysis helps in choosing among them.
Business Case
The business case is the consolidated information summarizing and explaining a business
proposal from different perspectives for a decision maker (cost, benefit, risk, and so on). It is
often used to assess the potential value of a product, which can be used as a basis in the
investment decisionmaking process. As opposed to a mere profitloss calculation, the business

Page 24 of 27
case is a “case” of plans and analyses that is owned by the product manager and used in support
of achieving the business objectives.
Multiple Attribute Evaluation
The topics discussed so far are used to make decisions based on a single decision criterion:
money. The alternative with the best present worth, the best ROI, and so forth is the one
selected. Aside from technical feasibility, money is almost always the most important decision
criterion, but it’s not always the only one. Quite often there are other criteria, other “attributes,”
that need to be considered, and those attributes can’t be cast in terms of money. Multiple
attribute decision techniques allow other, nonfinancial criteria to be factored into the decision.
There are two families of multiple attribute decision techniques that differ in how they use the
attributes in the decision. One family is the “compensatory,” or single-dimensioned,
techniques. This family collapses all of the attributes onto a single figure of merit. The family
is called compensatory because, for any given alternative, a lower score in one attribute can be
compensated by—or traded off against—a higher score in other attributes. The compensatory
techniques include
• nondimensional scaling
• additive weighting
• analytic hierarchy process.
In contrast, the other family is the “non-compensatory,” or fully dimensioned, techniques. This
family does not allow tradeoffs among the attributes. Each attribute is treated as a separate
entity in the decision process. The non-compensatory techniques include
• dominance
• satisficing
• lexicography.
Optimization Analysis
The typical use of optimization analysis is to study a cost function over a range of values to
find the point where overall performance is best. Software’s classic space-time tradeoff is an
example of optimization; an algorithm that runs faster will often use more memory.
Optimization balances the value of the faster runtime against the cost of the additional
memory.
Real options analysis can be used to quantify the value of project choices, including the value
of delaying a decision. Such options are difficult to compute with precision. However,
awareness that choices have a monetary value provides insight in the timing of decisions such
as increasing project staff or lengthening time to market to improve quality.
PRACTICAL CONSIDERATIONS
The “Good Enough” Principle
Often software engineering projects and products are not precise about the targets that should
be achieved. Software requirements are stated, but the marginal value of adding a bit more
functionality cannot be measured. The result could be late delivery or too-high cost. The “good
enough” principle relates marginal value to marginal cost and provides guidance to determine
criteria when a deliverable is “good enough” to be delivered. These criteria depend on business
Page 25 of 27
objectives and on prioritization of different alternatives, such as ranking software requirements,
measurable quality attributes, or relating schedule to product content and cost.
The RACE principle (reduce accidents and control essence) is a popular rule towards good
enough software. Accidents imply unnecessary overheads such as gold-plating and rework due
to late defect removal or too many requirements changes. Essence is what customers pay for.
Software engineering economics provides the mechanisms to define criteria that determine
when a deliverable is “good enough” to be delivered. It also highlights that both words are
relevant: “good” and “enough.” Insufficient quality or insufficient quantity is not good enough.
Agile methods are examples of “good enough” that try to optimize value by reducing the
overhead of delayed rework and the gold plating that results from adding features that have
low marginal value for the users (see Agile Methods in the Software Engineering Models and
Methods KA and Software Life Cycle Models in the Software Engineering Process KA). In
agile methods, detailed planning and lengthy development phases are replaced by incremental
planning and frequent delivery of small increments of a deliverable product that is tested and
evaluated by user representatives.
Friction-Free Economy
Economic friction is everything that keeps markets from having perfect competition. It involves
distance, cost of delivery, restrictive regulations, and/or imperfect information. In high-friction
markets, customers don’t have many suppliers from which to choose. Having been in a business
for a while or owning a store in a good location determines the economic position. It’s hard for
new competitors to start business and compete. The marketplace moves slowly and predictably.
Friction-free markets are just the reverse. New competitors emerge and customers are quick to
respond. The marketplace is anything but predictable. Theoretically, software and IT are
frictionfree. New companies can easily create products and often do so at a much lower cost
than established companies, since they need not consider any legacies. Marketing and sales can
be done via the Internet and social networks, and basically free distribution mechanisms can
enable a ramp up to a global business. Software engineering economics aims to provide
foundations to judge how a software business performs and how friction-free a market actually
is. For instance, competition among software app developers is inhibited when apps must be
sold through an app store and comply with that store’s rules.
Ecosystems
An ecosystem is an environment consisting of all the mutually dependent stakeholders,
business units, and companies working in a particular area. In a typical ecosystem, there are
producers and consumers, where the consumers add value to the consumed resources. Note
that a consumer is not the end user but an organization that uses the product to enhance it. A
software ecosystem is, for instance, a supplier of an application working with companies doing
the installation and support in different regions. Neither one could exist without the other.
Ecosystems can be permanent or temporary. Software engineering economics provides the
mechanisms to evaluate alternatives in establishing or extending an ecosystem—for instance,
assessing whether to work with a specific distributor or have the distribution done by a
company doing service in an area.
Offshoring and Outsourcing
Offshoring means executing a business activity beyond sales and marketing outside the home
country of an enterprise. Enterprises typically either have their offshoring branches in lowcost
countries or they ask specialized companies abroad to execute the respective activity.
Page 26 of 27
Offshoring should therefore not be confused with outsourcing. Offshoring within a company
is called captive offshoring. Outsourcing is the result-oriented relationship with a supplier who
executes business activities for an enterprise when, traditionally, those activities were executed
inside the enterprise. Outsourcing is site-independent. The supplier can reside in the
neighborhood of the enterprise or offshore (outsourced offshoring). Software engineering
economics provides the basic criteria and business tools to evaluate different sourcing
mechanisms and control their performance. For instance, using an outsourcing supplier for
software development and maintenance might reduce the cost per hour of software
development, but increase the number of hours and capital expenses due to an increased need
for monitoring and communication. (For more information on offshoring and outsourcing, see
“Outsourcing” in Management Issues in the Software Maintenance KA.).

Page 27 of 27