Economic Frameworks

i290 lean/agile product management unit 2: economic frameworks

@jezhumble https://lapm.continuousdelivery.com/

humble@berkeley.edu

This work © 2015-16 Jez Humble Licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

grasp the principles of cost of delay

understand the principles of decision theory

calculate the value of information

make product decisions in an economic framework

know how to apply optionality

learning outcomes

“you may ignore economics, but economics won’t ignore you”

— Don Reinertsen

“The measure of execution in product development is our ability to constantly align our plans to whatever is, at the moment, the best economic choice.”

— Don Reinertsen

decision theory

The analysis of complex decisions with significant uncertainty can be confusing because 1) the consequence that will result from selecting any specified decision alternative cannot be predicted with certainty, 2) there are often a large number of different factors that must be taken into account when making the decision, 3) it may be useful to consider the possibility of reducing the uncertainty in the decision by collecting additional information, and 4) a decision maker's attitude toward risk taking can impact the relative desirability of different alternatives.

Craig W Kirkwood, Decision Tree Primer, p1

risk matrix

probability (0-1)

impa

ct ($

)

low probabilitylow impact

high probabilitylow impact

low probabilityhigh impact

high probabilityhigh impact

decision tree

temperature sensor:

• development cost: $100k, revenue $1m

• probability of success: 0.5

pressure sensor:

• development cost: $10k, revenue $400k

• probability of success: 0.8

decision trees

Craig W Kirkwood, Decision Tree Primer, p4

EV=$400,000

EV=$310,000

EV=$0

EV=$400,000

exercise

value of information

• information reduces uncertainty about decisions that have economic consequences

• information affects the behavior of others, which has economic consequences

• information sometimes has its own market value

Douglas Hubbard, How to Measure Anything (3rd edn), p145

measurement

A quantitively expressed reduction of uncertainty based on one or more observations

Douglas Hubbard, How to Measure Anything (3rd ed.), p31

perfect information

Value of information = EV after - EV before = $100k

value of information

Expected Opportunity Loss (EOL) = chance of being wrong x cost of being wrong

Expected Value of Info (EVI) = Reduction in EOL; EVI = EOLbefore info — EOLafter info

Expected Value of Perfect Info (EVPI) = EOLbefore info (since EOLafter info is zero if info is perfect)

Douglas Hubbard, How to Measure Anything (3rd ed.), ch. 7

build-measure-learn

not normally binary decisions — a continuum

humans are risk averse when the stakes are high

use utility functions; reduce stakes

don’t capture time dependence

use calculus monte carlo analysis

problems with decision trees

opportunity cost

In microeconomic theory, the opportunity cost of a choice is the value of the best alternative foregone, where a choice needs to be made between several mutually exclusive alternatives given limited resources. Assuming the best choice is made, it is the "cost" incurred by not enjoying the benefit that would be had by taking the second best choice available.

Wikipedia

time is money

t = m

Δt = Δm

Δt ( ) = Δm

cost of delay

cost of delay

Task A: upgrade package to support credit card encryption

CoD: fine of $50,000 per day we’re not in compliance.

Duration: 2 weeks

Task B: Complete a feature for a key customer

CoD: we’ll close $100,000 per week with this feature

Duration: 1 week

cost of delayTask A: 2 weeks, CoD $250k / weekTask B: 1 week, CoD $100k / week

urgency profiles

exercise

Should I wait for the feature?

We have completed sufficient features for 85% of our target customers.

We can:

• Take 2 more months to finish last 15%

• Launch what we have, add last 15% in next release, 6 months from now

Cost of delay for project: $200,000 / month

exercise

Delay 85% of functionality by 2 months:

$200,000 x 0.85 x 2 = $340,000

Delay 15% of functionality by 6 months:

$200,000 x 0.15 x 6 = $180,000

technology adoption lifecycle

Geoffrey Moore, Crossing the Chasm

three horizons

Baghai, M., Coley, S. and White, D., The Alchemy of Growth

Intuit horizons and metrics

optionality

Nassim Taleb, Antifragile