Project Economics Demystified - WordPress.com · Project Economics Demystified ec·o·nom·ics ( Mk' %-n pm' _ks) n. “Body of knowledge that discusses how a society tries to solve

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Project Economics Demystified

Project Economics Demystifiedhow to make your customers smile

and laugh all the way to the bank

Gustaf BrandbergTietoEnator Digital Innovations

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make profitnot software.

”There is no such thing as TECHNICAL success!”

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ec·o·nom·ics ( k' -n m' ks) n.

“Body of knowledge that discusses howa society tries to solve the human problems of

unlimited wants and scarce resources.”-- Encyclopedia of Business

“Wants, Needs, and ScarcityAs a society, and in economic terms, people have unlimited wants;

however, resources are scarce. Don't confuse wants and needs. Individuals oftenwant what they don't need. In the automobile example used above, someone mightwant to drive a large luxury car, but a small pickup truck may be more suited to thepurchaser's needs if he or she must have a vehicle for hauling furniture. Economicdecisions must be made.

A resource is scarce when there is not enough of it to satisfy humanwants. And human wants are endless. Because of unlimited wants and limitedresources to satisfy those wants, economic decisions must be made. This problem ofscarcity (limited resources) must be addressed, which leads to economics andeconomic problems.”

-- Encyclopedia of Business,cited from http://www.answers.com/topic/economics

“[An economist must] possess a rare combination of gifts. He must bemathematician, historian, statesman, philosopher-in some degree. He mustunderstand symbols and speak in words. He must contemplate the particular interms off the general, and touch abstract and concrete in the same flight of thought.He must study the present in light of the past for purposes of the future. No part ofman's nature or his institutions must lie entirely outside his regard. He must bepurposeful and disinterested in a simultaneous mood; as aloof and incorruptible asan artist, yet sometimes as near the earth as a politician.”

-- Nobel Prize Laureate John Maynard Keynes in Essays inBiography, 1933

http://www.answers.com/topic/economics

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Profit/Loss

Accumulated

Pay back time

Launch date

Positive Cash Flow

Burn rate

Investment

Profit

Observations:

#1 The total profit depends on when we measure it –at 24 months it is €7.5 M, butat 20 months it is 0.

#2 The depht of the curve –the size of the investment –represents risk because it isthe maximum amount of money the customer has to put into the project and thus isrisking to loose. A more shallow curve means less (economic) risk.

#3 Just because we have a positive cahs flow, it doesn’t mean we have made aprofit yet.

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models.

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What isa model?

1. Parameters

3. Purpose

2. Relations

“The Mercator projection is a cylindrical map projection presented by the Flemishgeographer and cartographer Gerardus Mercator, in 1569. It became the standardmap projection for nautical purposes, for it is a conformal projection (scale is thesame in every direction, around any position) and rhumb lines, which are the linesmaking constant angles with the meridians, are represented by straight segments.[… ]

The abuse of the Mercator projection in world representations, as wellas the controversy caused by the political promotion of the so-called Gall-Petersprojection, led several American geographic societies to approve, in 1989-90, arecommendation rejecting the use of rectangular world maps for general purposes orartistic displays.

Like all map projections, attempting to fit a curved surface onto a flatsheet, the shape of the map is a distortion of the true layout of the Earth's surface.The Mercator projection exaggerates the size and distorts the shape of areas farfrom the equator. For example, Greenland is presented as being roughly as large asAfrica, when in fact Africa's area is approximately 13 times that of Greenland asshown by Tissot's Indicatrix.

Although the Mercator projection is still in common use for navigation,critics argue that it is not suited to representing the entire world in publications andwall maps due to its distortion of land area. Mercator himself used the equal-areasinusoidal projection to show relative areas. As a result of these criticisms, modernatlases no longer use the Mercator projection for world maps or for areas distantfrom the equator, preferring other cylindrical projections, or forms of equal-areaprojection. The Mercator projection is still commonly used for areas near the equator,however.”http://en.wikipedia.org/wiki/Mercator_projection

http://en.wikipedia.org/wiki/Mercator_projection

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Characteristics of models.

easilymanipulated.

necessarilyincomplete.

à Describe reality better

à Deceive people

“CHARACTERISTICS OF MODELS, Introductory Statistics: Concepts, Models, and Applications, David W.Stockburger

1. Models are necessarily incomplete: Because it is a representation, no model includes everyaspect of the real world. If it did, it would no longer be a model. In order to create a model, a scientist must firstmake some assumptions about the essential structure and relationships of objects and/or events in the realworld. These assumptions are about what is necessary or important to explain the phenomena. For example, abehavioral scientist might wish to model the time it takes a rat to run a maze. In creating the model the scientistmight include such factors as how hungry the rat was, how often the rat had previously run the maze, and theactivity level of the rat during the previous day. The model-builder would also have to decide how these factorsinteracted when constructing the model. The scientist does not assume that only factors included in the modelaffect the behavior. Other factors might be the time-of-day, the experimenter who ran the rat, and the intelligenceof the rat. The scientist might assume that these are not part of the "essential structure" of the time it takes a ratto run a maze. All the factors that are not included in the model will contribute to error in the predictions of themodel.

2. The model may be changed or manipulated with relative ease: To be useful it must beeasier to manipulate the model than the real world. The scientist or technician changes the model and observesthe result, rather than doing a similar operation in the real world. He or she does this because it is simpler, moreconvenient, and/or the results might be catastrophic. A race car designer, for example, might build a small modelof a new design and test the model in a wind tunnel. Depending upon the results, the designer can then modifythe model and retest the design. This process is much easier than building a complete car for every new design.The usefulness of this technique, however, depends on whether the essential structure of the wind resistance ofthe design was captured by the wind tunnel model. Changing symbolic models is generally much easier thanchanging physical models. All that is required is rewriting the model using different symbols. Determining theeffects of such models is not always so easily accomplished. In fact, much of the discipline of mathematics isconcerned with the effects of symbolic manipulation. If the race car designer was able to capture the essentialstructure of the wind resistance of the design with a mathematical model or computer program, he or she wouldnot have to build a physical model every time a new design was to be tested. All that would be required would bethe substitution of different numbers or symbols into the mathematical model or computer program. As before, tobe useful the model must capture the essential structure of the wind resistance.

The values, which may be changed in a model to create different models, are calledparameters. In physical models, parameters are physical things. In the race car example, the designer might varythe length, degree of curvature, or weight distribution of the model. In symbolic models parameters arerepresented by symbols. For example, in mathematical models parameters are most often represented byvariables. Changes in the numbers assigned to the variables change the model.”http://www.psychstat.missouristate.edu/introbook/sbk04m.htm

But: As a consequence of the model being easy to manipulate easily to fit the purpose of the model, itmight just as well be manipulated to fit the purpose of the modeller. Watch out!

http://www.psychstat.missouristate.edu/introbook/sbk04m.htm

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DISCLAIMERNever confuse the model with reality.

Ceci n’est pas une methode

The Treachery Of ImagesFrom Wikipedia, the free encyclopedia

"This is not a pipe." The Treachery Of Images (La trahison des images) (1928–1929)

The Treachery Of Images (La trahison des images) is a painting from BelgianSurrealist painter René Magritte, famous for its inscription Ceci n'est pas une pipe or“this is not a pipe”. It is currently housed at the Los Angeles County Museum of Art(LACMA) in Los Angeles, California.

The picture shows a pipe that looks as though it might come from a tobacco storeadvertisement. Magritte painted below the pipe "Ceci n'est pas une pipe" (This is nota pipe), which seems a contradiction, but is actually true: the painting is not a pipe; itis an image of a pipe. As Magritte himself commented: "Just try to stuff it withtobacco! If I were to have had written on my picture 'This is a pipe' I would have beenlying.“

http://en.wikipedia.org/wiki/The_Treachery_Of_Images

http://en.wikipedia.org/wiki/The_Treachery_Of_Images

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an economic model.

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purpose.

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How should we prioritizeour development resourcesin order to maximize profit?

The purpose of this model is to assess the value of specific features, for example to compare its relative importance to otherfunctionality in order to prioritize a Scrum back log.

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Parameters andrelations.

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Profit/Loss

Accumulated

Parameters.

Development costs

Benefits –Maintenance cost

f(software property)

Profit =Monthly profit/loss

Now with amazing

Feature!

So, how do we connect a piece of functionality to different parameters in the model?

“Identify Minimum Marketable Features (MMFs)— the fundamental units of value in softwaredevelopment. A minimum marketable feature is the smallest possible set of functionality that, by itself,has value in the marketplace. You could release your software with just one of these features and youwould see some benefit.”Software by Numbers: Low-Risk, High-Return Development by Mark Denne, Jane Cleland-Huang

Development costs are surely related to the Marketable Features that need to bedeveloped –no doubt about that! The more complicated the requirements are, the more time it willtake to develop the feature, and the costs will increase.

Let us also assume that the second parameter, benefits, is also a direct function ofthe Marketable Features, such as functionality, usability and non-functional properties (e.g.performace and stability). This is clearly a simplification if we are generating revenue by selling theproduct, since the sales also will depend on your company’s brand value, the marketing effort, pricingand a lot other circumstances. But, as already stated, any model is by neccesity incomplete and sincewe have no influence of these factors, they are constants as far as we are concerned.

Let us finally assume that maintenance costs are related to the Marketable Features.For example, with high usability few customers will contact your company to get help using theproduct and your support costs will decrease. High code quality has the same effect on your technicalsupport since you will not have to spend money on correcting defects and distributing patches. Highperformance code reduces the need for a lot of servers.

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1. Development costs.

Now with amazing

Feature!

# Story Points

The development costs are based on the estimates of how long a specific productproperty would take to develop, plus any purchases of third part products or toolsthat are needed.

”Deriving an estimateThe three most common techniques for estimating are•Expert opinion•Analogy•Disaggregation”Agile Estimating and Planning, by Mike Cohn

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2. Maintenance cost.

What are the monthly costs associated with this product/software feature, forexample•Extra support costs•Extra IT-costs•Distribution costs•…

Remember: We might be able to reduce initial hight maintenace costs after productlaunch, but then we have to take the cost of reducing the maintenance costs intoconsideration as well.

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3. Benefits.

€

Newcustomers1 More revenue

from existingcustomers2

Retainedcustomer3

Efficiencygains

4Non-

quantitativebenefits

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1. New customers2. Additional revenue from existing customers

1. More licenses2. Add-on modules3. Encourages consulting services

3. Retained customers that would otherwise go to a competitor4. Increased efficiency

1. Make sure that the cost cuts are real.

Sales are always hard to predict.What affects the customer’s buying desicion? It’s a combination of rational

arguments and design.Customer’s profit/loss statement (application model) might be a good tool.

Regarding non-quantitativ benefits:- Try to quantify them somehow, if it can be done without too much discussions.- Tip: The one that wants them as benefits in the Business Case, should also beprepared to pay for them- If not possible to quantify, just mention them but don’t count on them!- The PENG-model deals with this issue.

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launch date.

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Incremental development.

Big Bang!

The time factor is the most efficient argument for adopting Scrum and otherincremental development methods, as opposed to a Big-Bang-approach. Bylaunching software more often, the return-on-investment increases dramatically.

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Profit/Loss

Accumulated

Profit : €7M

Baseline.

Example of the effects of a one-month delay.

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Profit/Loss

A ccumulated

One month delay.

Break even

Profit : €4,5M

Development costs €-1 MLost revenue €-1.5 MTotal: €-2.5 M

The delay cost in this example is €-2.5 M (or €1.5 M depending on how you choseto count the development cost). Note that the lost revenue is and should becalculated as one month in lost benefits at the the sales/efficiency peak.

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Putting it all together.

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• It takes 10 minutes to manually register an order.• The process can be automated by 2 programmers in 1 month.

Automating an order flow.

How valuable?

Payback time, Profit, Cost of Delay

Use a 2 year time horizon.Development costsDevelopment costs: 2 X 1 X 100 000 SEK = 200 000 SEKMaintenace costs: No differenceCost savings:1000 orders/month x 10 minutes = 167 hours/month = 1 Full Time EmployeeCost per FTE/month: 25 000 SEK*Cost savings: 25 000 SEK per month

*) Note: We cannot automatically assume that saved time equals saved costs. Dowe actaully get rid of salary or consultant costs, or are these people spending theirtime on something else instead?

Payback-time = 200000/25000 + development time = 9 monthsProfit = 375 000 SEKCost-of-delay per month = lost cost reductions = 25 000 SEK/monthThe development costs for one month is 200 000 SEK which totals 225 000SEK/month if you have to pay the programmers during the delay.ROI = (Profit/Investment) –1 = (375 000/200 000) –1 = 88 %Figures in bold are missing from the original problem statement.

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Communication tool.

empowerthe team.

'impressyour boss.

A good economic model serves two important communication purposes:

1. It shows you boss that she can rely on you

2. It tells the team what is important to focus on

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remember.

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Keep it simple!

Hans Werthén, President of Electrolux, one of Sweden’s biggest companies during a period whenElectrolux acquired a lot of companies. Before each desicion to buy a company, he would go throughthe prospect with the subordinate responsible for making the Business Case, writing down the keyfigures on two small paper notes. One of the notes, he would give to his subordinate; the other hewould tuck under his desk cover.

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Focus on the facts!

+

-

model outputinput

Keep the model simple and concentrate to get the underlying facts right, because:•The facts will affect the output more than making a more sofisticated model•A more sofisticated model will be more difficult to understand. Remember: We wantto use it as a tool for communication.

A related tip is to make a stability analysis of the variables; often just two or threeparameters make all the for the result –focus on getting these few facts right.

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And, things sometimes don’t work out as planned.

© The Perry Bible Fellowship, http://pbfcomics.com

It’s important to learn from your successes and your mistakes. After each deal, HansWerthén booked a meeting with the subordinate that had been responsible for thedeal, picked out the piece of paper he had put under his desk cover, and comparedthe calculations with the actual results. An effective way of getting feedback.

The illustration is from the excellent web site:

http://pbfcomics.com

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More information

http://gustafbrandberg.wordpress.org

Recommended reading:Mike Cohn: Agile Estimating and PlanningPreston G. Smith, Donald G. Reinertsen: Developing Products in Half the TimeDonald G. Reinertsen: Managing The Design Factory

http://gustafbrandberg.wordpress.org

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Project Economics Demystified - WordPress.com · Project Economics Demystified ec·o·nom·ics ( Mk' %-n pm' _ks) n. “Body of knowledge that discusses how a society tries to solve