Concepts
As product owners aspiring to become Certified Scrum Product Owners (CSPO), it is crucial to understand the various terms associated with product economics. This comprehension allows you to have an in-depth understanding of product value, economic prioritization, and financial decision-making in product development. In this regard, we will discuss three primary terms related to product economics, namely, Opportunity Cost, Economic Value Added (EVA), and Return on Investment (ROI).
1. Opportunity Cost
Firstly, Opportunity Cost refers to the potential benefits a company misses when it decides to choose one option over another. In terms of product development processes; if a team decides to work on one feature at the expense of another, the foregone utility of the other feature represents the opportunity cost.
Consider an example: A company, XYZ, has enough resources to develop either a new mobile application or upgrade an existing web platform. If the company opts to build a new mobile app, the benefits that improving the old web platform could have brought would be the opportunity cost here.
2. Economic Value Added (EVA)
Secondly, in product economics terms, Economic Value Added (EVA) measures a product’s financial performance based on its residual wealth. EVA is calculated by deducting the cost of capital from Net Operating Profit After Taxes (NOPAT). This gives an insight into the real profitability of a product, considering both the operating income and the amount of capital invested.
Take an instance where product A generates a net operating profit of $10,000 with a total capital cost of $4000. The EVA here would be $10,000 – $4,000, equalling $6,000. This indicates the product is creating wealth, thus a good economic value.
3. Return on Investment (ROI)
Thirdly, Return on Investment or ROI is a popular and often-used measure in product economics, which evaluates the efficiency of an investment or compares the efficiencies of several different investments. ROI aims to directly measure the amount of return on a particular investment, relative to the investment’s cost. It is typically expressed as a percentage and is used for personal financial decisions, to compare a company’s profitability or to compare the efficiency of different investments.
For an example, if you spend $200 on developing a product and earn a profit of $800, the ROI calculation would be: (Profit – Cost)/Cost * 100. So, ($800-$200)/$200 * 100 = 300%. This indicates every dollar invested yields a three-dollar profit.
Conclusion
In conclusion, gaining a clear understanding and practical knowledge of these product economics terms is vital in maximizing product value through informed decision-making. It empowers product owners to make sound economic decisions around feature prioritization during the product development process. Practising these economic concepts will play an instrumental role in helping you progress towards becoming a successful Certified Scrum Product Owner.
Answer the Questions in Comment Section
True or False: Marginal cost is the change in total cost that arises when the quantity produced changes by one unit.
- True
- False
Answer: True
Explanation: Marginal cost indeed is the cost change that results from a one-unit change in the output.
In economics, which term refers to the relationship between the inputs (factors of production) required to make a good or service and the output of that good or service?
- A. Opportunity cost
- B. Production function
- C. Economic equilibrium
- D. Diminishing returns
Answer: B. Production function
Explanation: The production function is a mathematical representation of the relationship between inputs, such as labor and capital, and the output of a product or service.
Diminishing returns is a phenomenon observed in which sector of economics?
- A. Investment economics
- B. Labor economics
- C. Microeconomics
- D. Behavioral economics
Answer: C. Microeconomics
Explanation: Diminishing returns, or decreasing marginal returns, is a concept in microeconomics that states that a production function can exhibit decreasing marginal returns i.e., a unit increase in a single input, when all other inputs are held constant, will eventually yield smaller and smaller increases in output.
True or False: Opportunity cost is a term that implies the most preferred possible alternative.
- True
- False
Answer: True
Explanation: Opportunity cost deals with economic decisions and trade-offs. It is the loss or gain of making a decision based on the options or alternatives available.
In terms of production economics, what does elasticity measures?
- A. How quantity demanded changes with price
- B. How quantity supplied changes with price
- C. How quantity demanded or supplied reacts to changes in price or income
- D. All of the above
Answer: D. All of the above
Explanation: Elasticity in economics measures how a demand or supply quantity reacts to changes in price or income.
What does the term ‘economies of scale’ refer to in product economics?
- A. The increase in efficiency of production as the number of goods being produced increases.
- B. The degree to which demand for a product increases with a decrease in price.
- C. The extent to which the cost of a product decreases as its production volume increases.
- D. Both A and C
Answer: D. Both A and C
Explanation: Economies of scale refer to the cost advantages resulting from an increased level of output. It explains the relationship between the size of the firm and its production cost per unit.
Ture or False: Fixed costs are costs that do not change with an increase or decrease in the amount of goods or services produced.
- True
- False
Answer: True
Explanation: Fixed costs are expenses that have to be paid by a company, independent of any business activity. It includes expenses like rent, salaries, and loan payments.
Which concept relates to the reduced growth rate of the marginal product of labor?
- A. Law of diminishing returns
- B. Economies of scale
- C. Marginal cost
- D. Supply and demand
Answer: A. Law of diminishing returns
Explanation: The law of diminishing returns applies to scenarios where the productivity of a factor of production, such as labor or capital, starts to decline if all other factors are held constant.
Multiple select: Which of these are considered principle aspects of product economics?
- A. Elasticity of demand
- B. Marginal cost
- C. Economies of scale
- D. All of the above
Answer: D. All of the above
Explanation: Elasticity of demand, marginal cost, and economies of scale are all crucial aspects of product economics, each playing a role in understanding and predicting the behavior of production costs, demand, and supply.
True or False: The break-even point in product economics is when total revenue equals total cost.
- True
- False
Answer: True
Explanation: The break-even point is indeed when total revenue equals the total cost, that means the company is not making any profit, but it’s also not incurring any losses.
What term refers to the cost associated with taking one course of action instead of the next best alternative in product economics?
- A. Sunk cost
- B. Opportunity cost
- C. Marginal cost
- D. Total cost
Answer: B. Opportunity cost
Explanation: The opportunity cost of any decision is the value of the most valuable decision forgone due to the decision taken.
True or False: Economies of Scale and Diminishing Returns are the same thing.
- True
- False
Answer: False
Explanation: While both terms relate to production and cost efficiency, they are different concepts. Economies of Scale is the cost advantages that enterprises obtain due to size, with cost per unit going down as quantity goes up. Diminishing Returns is the decrease in the marginal output as more inputs are added.
Can someone explain what Economic Value Added (EVA) means in the context of product economics?
What is the significance of Net Present Value (NPV) in product economics?
Great blog post! Very helpful explanations.
Has anyone here applied Internal Rate of Return (IRR) in their product evaluations?
Thanks for the detailed info!
I found EVA a bit confusing. Any simpler way to understand it?
This blog post was a good read, very informative.
I feel NPV can sometimes be misleading. Any thoughts?