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John Favaro Consulenza Informatica Pisa, Italy john@favaro.net. NAME Workshop 17 October 2002 Bolzano-Bozen, Italy. Agile Economics. Summary.

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john favaro consulenza informatica pisa italy john@favaro net
John Favaro

Consulenza Informatica

Pisa, Italy

john@favaro.net

NAME Workshop

17 October 2002

Bolzano-Bozen, Italy

Agile Economics

summary
Summary

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.

Agile Economics

the elements of value based management
The Elements of Value-Based Management

Value Based Management is a systematic approach to managing companies to maximize wealth creation over time

Strategic

Financial

Value-Based Management is built on two pillars

Agile Economics

the integration of strategy and finance
The Integration of Strategy and Finance

Strategy needs finance to be grounded

Finance is inherently myopic — it needs strategy for vision

Strategy

Finance

Agile Economics

framework for work in agile economics
Framework for Work in Agile Economics

Value Based IT Management

Strategic Options

Operational Economics

Discounted cash flow, ...

Contingent Claims Analysis, ...

MECP Framework, ...

Agile Economics

strategic elements the mecp framework
Strategic Elements: The MECP Framework

Attractive

Two direct forces

Usually Unprofitable

Always Profitable

Market Economics

Always Unprofitable

Usually Profitable

Four limiting forces

Unattractive

Disadvantaged

Advantaged

Competitive Position

Cost and Asset Position

Differentiation

Agile Economics

financial elements dcf and cca
Financial 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

Traditional Valuation:

discounted cash flow (DCF)

Advanced Valuation:

contingent claims analysis (CCA)

Agile Economics

xp is an options driven process
XP 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

Agile Economics

strategic options in agile it processes

FeatureOption

Strategic Options in Agile IT Processes

Checkpoints after every iteration where the customer can take mid-course decisions

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

Technologies and practices that keep the cost to a minimum if the project is modified or cancelled

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

Agile Economics

financial analysis of strategic options in xp

FeatureOption

Financial Analysis of Strategic Options in XP

Checkpoints after every iteration where the customer can take mid-course decisions

LEARNING

OPTION

SWITCHING

OPTION

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

Technologies and practices that keep the cost to a minimum if the project is modified or cancelled

OPTION TO

ABANDON

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

OPTION

TO DELAY

Agile Economics

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

Agile Economics

optional scope xp contracts

FeatureOption

FeatureOption

FeatureOption

Optional 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

Agile Economics

dissemination in books and journals
Dissemination 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.

Agile Economics

seminars
Seminars
  • 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

Agile Economics

typical seminar contents
Typical 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

Agile Economics

relationship to other disciplines
Relationship 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

Reuse

AMs

ProductLines

Components

Agile Economics

the way ahead
The 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

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