Agile Economics John Favaro Consulenza Informatica Pisa, Italy [email protected] NAME Workshop 17...

Agile EconomicsAgile Economics

John FavaroConsulenza Informatica

Pisa, Italy

[email protected]

NAME Workshop17 October 2002

Bolzano-Bozen, Italy

Agile EconomicsJohn FavaroSlide 2

NAME Workshop, 17/10/2002

SummarySummary

My consulting work in Agile Methodologies has been primarily directed at management. I have found that without a sound strategic and economic case, management is generally resistant to their introduction. My approach has been a framework derived from value-based management (VBM) that introduces the concept of “strategic options” and makes use of both traditional and advanced financial valuation techniques. I disseminate these strategic and economic arguments in professional development seminars and workshops, and in book and journal publications.



The Elements of Value-Based ManagementThe Elements of Value-Based Management

Strategic Financial

Value Based Management is a systematic approach to

managing companies to maximize wealth creation

over time

Value-Based Management is built on two pillars



The Integration of Strategy and FinanceThe Integration of Strategy and Finance

Strategy Finance

Finance is inherently myopic — it needs strategy for vision

Strategy needs finance to be grounded



Framework for Work in Agile EconomicsFramework for Work in Agile Economics

Value Based IT Management

MECP Framework, ...

Strategic Options

Contingent Claims Analysis, ...

Operational Economics

Discounted cash flow, ...



Strategic Elements: The MECP FrameworkStrategic Elements: The MECP Framework

Cost and Asset Position Differentiation

Usually Unprofitable

Always Unprofitable

Usually Profitable

Always Profitable

AdvantagedDisadvantaged

Unattractive

AttractiveTwo direct forces

Four limiting forces

Market Economics

Competitive Position



Financial Elements: DCF and CCAFinancial Elements: DCF and CCA

Agile Methodologies such as XP generate both operational and strategic economic benefits

Some operational benefits: Lower costs – great emphasis on

keeping costs down Lower defect rates – great emphasis on

quality and testing

Some strategic benefits: Flexibility to respond to changing user

requirements Ability to take advantage of new

information, whether technical or business-related, whether good or bad

Advanced Valuation:

contingent claims analysis (CCA)

Traditional Valuation:

discounted cash flow (DCF)



XP is an Options-Driven ProcessXP is an Options-Driven Process

“We need to make our software development economically more valuable by spending money more slowly, earning revenue more quickly, and increasing the probable productive lifespan of our project.

But most of all, we need to increase the options for business decisions.”

- Introduction to Chapter 3, Economics of Software

Development, XPEX, p. 11

XP has been explicitly described as an agile, flexible process for the creation of strategic business options

We are interested in the strategic and financial consequences of this



Strategic Options Strategic Options in Agile IT in Agile IT ProcessesProcesses

Waiting to see whether the customer really needs the feature before implementing it

Technologies and practices that keep

the cost to a minimum if the

project is modified or cancelled

Talented, trained personnel able to switch course rapidly with new or modified stories

Checkpoints after every iteration where

the customer can take mid-course decisions

FeatureOption



Financial Analysis Financial Analysis of Strategic of Strategic Options in XPOptions in XP

Waiting to see whether the customer really needs the feature before implementing it

Technologies and practices that keep

the cost to a minimum if the

project is modified or cancelled

Talented, trained personnel able to switch course rapidly with new or modified stories

Checkpoints after every iteration where

the customer can take mid-course decisions

FeatureOption



Typical Financial Analysis (Option to Abandon)Typical Financial Analysis (Option to Abandon)

Customer Development Right #1

“You have the right to be informed of schedule changes, in time to reduce scope to restore the original date. You may cancel at any time and be left with a useful working system reflecting investment to date.”

- Ron Jeffries



Optional Scope XP ContractsOptional Scope XP Contracts

Optional scope contracts are a central management feature of XP

As the team “exercises” the options in the contract, completing the features, the customer has to decide which new options to exercise

These may be options that were in the original scope options that were under consideration

originally but not in the original scope newly discovered options

Optional scope contracts are introduced to management as an alternative way of managing flexible IT process development

Contract life

FeatureOption

FeatureOption

FeatureOption



Dissemination in Books and JournalsDissemination in Books and Journals

Extreme Programming Perspectives, Chapter 43 Erdogmus, H. and J. Favaro,

“Keep Your Options Open: Extreme Programming and Economics of Flexibility,” in: XP Perspectives, ed. M. Marchesi & G. Succi, Addison-Wesley Professional Series, Fall 2002.



SeminarsSeminars

Aimed at project and enterprise-level managers

Integration of strategic and financial treatment

Value of flexibility in IT processes

Examples of options taken from XP

Treatment of optional scope contracts

Implications for process and risk management

1-2 days



Typical Seminar ContentsTypical Seminar Contents

Introduction: Strategic Options in IT processes Flexible IT processes in an

increasingly uncertain world – the example of Agile Methodologies

Evaluating the “intangible” benefits of IT processes

The relationship between finance and strategy

Basic Economic Valuation Present Value concepts, DCF, NPV,

DTA

Motivation for active management

Advanced Economic Valuation Option Pricing Theory

Black-Scholes, Binomial Method, Risk-Neutral Valuation

Real Options and Flexible IT Processes Small initial investment: option

to grow

The technical premise of XP: option to abandon

You Aren’t Going to Need It: option to defer investment

Incremental releases: learning option

The value of flexibility: option to switch

Implications for Management Continuous option formulation

(spikes), total risk management

Optional scope contracts Negotiable requirements and

customer rights



Relationship to other DisciplinesRelationship to other Disciplines

The economics of AMs is closely related to the economics of several other software engineering disciplines Reuse Product lines Component-oriented

development

Reason: they are mostly about cost savings, flexibility and support for strategy

Results in one area will help in the others

AMs

Reuse

Components

ProductLines



The Way AheadThe Way Ahead

AMs are sufficiently different from traditional methodologies that a convincing management argument is needed for acceptance This is a very active area (e.g. SIP from Beck, ideas from “Lean

Management”) but no clear emerging direction yet

One approach: success stories As more become available, this approach will become more valuable

Another approach: show how AMs support management best practices This is the approach I am taking in my consulting work Many IT managers do not have backgrounds in management – they

came up through the IT ranks There must be a process of education first in management (strategic

and financial) best practices, then the link to AMs It must be viewed as a discipline worthy of study and training, not an ad

hoc add-on to technical project management

Agile Economics John Favaro Consulenza Informatica Pisa, Italy [email protected] NAME Workshop 17...

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