Thursday, 18 June 2015

Estimates, Risk & ROI

Today I got involved in a friendly debate about Cost Estimates in product development or project management.

In particular I responded to this statement from @PeterKretzman:

"Implicitly or explicitly, you can't make a purposeful decision without 'estimating' cost."

 He in turn was responding to a tweet from @duarte_vasco, who is of course an advocate of the #NoEstimates movement.

Firstly let me say that I am not a vocal advocate of the #NoEstimates movement. I've read the literature and applied it to my experience and other things I've read, but I don't feel strongly enough about it to be trying to raise awareness of it, or get more people to consider it.

In reading the quote above today though, I challenged myself to think about whether the statement was true or not, and asked the OP whether he had considered fixing the cost, and instead estimating the value that could be achieved for this cost, to achieve the same goal as [I imagine] estimating the cost. Namely; Is the ROI sufficient that I will take the risk.

Risk is what I want to talk about next, because all of this, for me, comes down to professional management of risk. ROI is a calculation of Return (reward) received based on the hope that Investment (cost) will provide. If we assume that Return and Investment are variable:

e.g. [We believe that ] our company needs a new way to bill our customers.

 ==> The hypothesis is perhaps that some customers prefer certain billing types, and that providing more options for billing will generate an increased chance of converting a sales lead into a paying customer.

 ==> We _estimate_ that in order to build the functionality, we will incur total costs of £XXXX.XX and XXX weeks

 ==> We _estimate_ that the increase in conversion will generate an addition of £XXXX.XX in sales/annum and/or profit, and as such can calculate the point at which the work will have paid for itself, and project ROI into the future.

Because we've estimated, that implies uncertainty. The cost is uncertain and so is the conversion uplift. Uncertainty is risk in this context. If the cost estimate is negatively off, but the conversion uplift is accurate then the ROI is screwed. If the cost estimate is accurate but the conversion uplift doesn't materialise, then the ROI is screwed. If both are negatively inaccurate, then we're really screwed.

Consider an alternative:

[We believe that] our company needs a new way to bill our customers.

 ==> The hypothesis is perhaps that some customers prefer certain billing types, and that providing more options for billing will generate an increased chance of converting a sales lead into a paying customer.

 ==> We _estimate_ that the increase in conversion will generate an addition of £XXXX.XX in sales/annum and/or profit.

 ==> Based on the estimate of value, we _fix_ the investment we are willing to make to find out whether we are correct. No estimate of cost [implicit or explicit] is required. Because we've estimated, that implies uncertainty. The conversion uplift is uncertain. Uncertainty is risk in this context. If the conversion uplift estimate is off, the ROI is screwed.

The cost wasn't estimated though, it was fixed. We've removed some element of uncertainty and in real terms ensured that we've limited our risk.

And this fixing of cost Doesn't need to be as constraining as it may sound. Imagine if its just a hard decision point, where we can choose whether to invest further or not? If you've heard of the sunk-cost fallacy, hopefully you'll recognise the value that creating this decision point [which gives you options] provides?

So what am I not saying?
 - I'm not saying that fixed cost is the way to go for everything
 - I'm not saying that you can focus only on the return (value) and not on the investment (risk).
 - I'm not saying that estimating is bad in any way.

What am I saying?

 - In risk lies opportunity, but risk should be actively managed, and using past performance etc to predict or estimate ROI can be a useful way to manage risk.
 - I am saying that logically, if the cost can be infinite, you can fix the return you want but typically it is more pragmatic to fix the cost and gamble instead only on the return.

Feel free to let me know what you think.

4 comments:

  1. Hi!

    Nice post! And thanks for twitter convo!

    I have to read more carefully before I comment. But overall I like your thoughts and approach to things. Instinctively this post made me think about a presentation by Tim Lister, don't know if you've seen it? I think you'll love it. I do :) http://www.infoq.com/presentations/risk-project-management

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  2. I guess your definition of NoEstimates is NoCostEstimatesInSpecificCases? That's completely fine. But allow me to not like the general sweeping name of "no estimates". And that we don't really need a general "concept" or "movement" or whatever for such contextual situations.

    As in your example:
    "Based on the estimate of value, we _fix_ the investment we are willing to make to find out whether we are correct. No estimate of cost [implicit or explicit] is required."

    First of all there's an estimate of value here. Secondly, it seems to me an estimate of size would be valuable here. I mean, some idea that the fixed investment will be sufficient for building something that will get that monetary estimated value. Or perhaps we'd be willing to actually loose (risk) all the investment. That might be fine, but I wouldn't say it's a general good advice or approach. In some certain cases perhaps.

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  3. I am not actually trying to define #NoEstimates. This post and discussion were to disprove this statement:

    "Implicitly or explicitly, you can't make a purposeful decision without 'estimating' cost."

    If you take the word cost out of it, I would perhaps only debate the semantics of 'purposeful' with you. :)

    This makes the estimate of value totally fine in my example, since I'm not advocating estimating nothing.

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  4. I'd actually go further and say "Implicitly or explicitly, you can't make a decision at all without 'estimating'"

    But then again, I'd tell myself "No, there are ways". Flipping coins, rolling dice, tarot cards etc Maybe that's what we're talking about ;)

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