Quantitative approaches for assessing the value of COTS-centric development

Abstract

Software development based on commercial off-the-shelf or COTS, components is currently drawing considerable attention. This paper presents the results of two complementary quantitative valuation methods applied to the assessment of the COTS-centric software development projects. We use a standard corporate finance tool, Net Present Value, as a basis for both methods. The first method, comparative valuation, investigates the economic incentive to choose the COTS centric strategy in a project vis a vis the alternative, the custom development strategy, through an incentive metric based on NPV. The analysis concentrates on the impact of product risk and development time on the defined metric. The second method, real options valuation, primarily deals with uncertainty. It is employed to investigate the value of strategic flexibility inherent in COTS-centric development. We provide examples of several such options and summarize qualitatively the results of their analyses. Using these two approaches, some common anecdotes of COTS-centric development can be substantiated by sound financial arguments. Through scenarios and sensitivity analyses, we show that different circumstances and assumptions give rise to different winning conditions. Some general principles are summarized at the end.