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.
 learning outcomes
understand the principles of decision theory

calculate the value of information

grasp the principles of cost of delay

know how to apply optionality

make product decisions in an economic framework

“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

impact ($) risk matrix

low probability high probability

high impact high impact

low probability high probability

low impact low impact

probability (0-1)
 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

EV=$400,000

EV=$400,000

EV=$310,000

EV=$0

Craig W Kirkwood, Decision Tree Primer, p4

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
 problems with decision trees
humans are risk averse when the stakes are high

use utility functions; reduce stakes

not normally binary decisions — a continuum

use calculus monte carlo analysis

don’t capture time dependence

 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 cost of delay

Δt ( ) = Δm
 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 delay
Task A: 2 weeks, CoD $250k / week
Task 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