Focusing on Customer Value

When an organization works on too many ideas at once, the overhead and context switching slow teams down. The more things you start, the fewer things you finish. Even when you limit the work in progress (WIP) to the capacity of the development teams, you often overload related organizations—manufacturing, sales and marketing, training, or customer support. In her book, Manage Your Project Portfolio, Johanna Rothman¹ states that it is the responsibility of portfolio managers to reduce WIP.

When organizations ignore customer value, the portfolio of work can get filled with low-value items. Capacity limits force companies to ignore better opportunities. To maximize business outcomes, you need an objective way of selecting the programs that will deliver the highest customer value. In Chapter 11, the Record stage was referenced in the enterprise idea pipeline. In Record, a value is used to rank order ideas to help the enterprise focus on the highest-value work. Prioritization methods help you come up with an optimal rank order. The best ones will provide an objective value or score.

Highlighting Prioritization Methods

When working with teams and projects, you may have used some of the simpler, qualitative methods for prioritizing the product backlog. Some teams just follow the product owner’s (hopefully well-informed) opinion. Some other methods include MoSCoW (Must Have, Should Have, Could Have, Won’t Have), “Buy a Feature,” or HiPPO (Highest Paid Person’s Opinion).

At the sprint level, it is the right and responsibility of the product owner (PO) to have unilateral responsibility of priorities in the product backlog. Good POs regularly meet with their stakeholders (customers, chief product owners, sales managers, architects, technical managers, and so on) to get input for prioritization. Some POs add structure to the process using one or more of the following prioritization methods:

• MoSCoW: This method helps frame the PO’s thinking to define the smallest possible solution that could possibly work. This approach places a level of importance on each requirement including a wish-list container that helps bucket features or stories that should be recognized as having been considered and explicitly deferred or rejected. This approach succinctly explains the decisions that have been made and allows the team to focus on the “must haves.”

• Buy a Feature: This is an online “game” developed by Innovation Games (now Conteneo) to help POs choose the features to include in an upcoming release that would be most valuable to their customers or stakeholders. Each feature being considered is listed along with a “price.” The price might be related to the estimated development cost or anticipated customer value. The players (customers) are each given a fixed amount of play money to spend on features. Expensive features may require customers to negotiate and pool their money. This is encouraged. Playing this game multiple times with different sets of customers can give the PO useful data on what is more likely to satisfy customers.

• HiPPO: Senior leaders typically have many years of experience in the industry. Even when they want their teams to own decisions, they feel that it’s their duty to share their knowledge and offer opinions, particularly on priorities. If they are expressing an opinion, treat it as one of many inputs from the stakeholders. If they believe their opinion is the correct one, you might have to accept their opinion as the decision. This is known as HiPPO. If you sense a trace of epistemic arrogance, as discussed in Chapter 2, attempt to discourage this certainty thinking as this removes the opportunity of options and allows the enterprise to apply a discovery mindset toward customer value.

These are all qualitative prioritization methods. They are based on opinions and individual preferences. While qualitative methods are sufficient for product backlog and sprint-level planning, enterprise-level prioritization deserves economic justification. At this level, the stakes are too high to leave prioritization to subjective methods. When you have many good ideas, you need an economic rationale to help sort the high-value ideas from the lower-value ones that clutter your portfolio and distract people and investments.

Many organizations make portfolio-level decisions based on HiPPO. There are rare instances where companies have completely disrupted industries and dominated their markets by implementing the vision of a single leader. There are vey few visionaries like Steve Jobs who can provide that kind of vision. Even Steve Jobs could be wrong. Remember the Newton?

Some of the common economically based prioritization methods include Return on Investment (ROI) and Weighted Shortest Job First (WSJF). ROI is (Value/Effort)*Confidence, where value is typically measured in incremental revenue. WSJF is a ranking based on a subjective, linear, and relative business value. It factors in a relative-time criticality and risk reduction. Since all three of these factors are estimated on a linear scale of 1–10, any one of these factors can be over weighted and distort this subjective view of cost of delay. While these have been used in traditional organizations, they overlook some important elements that Agile enterprises need to consider.

Exploring Cost of Delay (CoD)

Since the goal of most companies is to make profits, it is important to understand the economic consequences of prioritization trade-offs. The best way to measure the value generated by an idea is the life-cycle profit impact, which is the incremental gross margin generated by that product over its useful life cycle. CoD measures the life-cycle profit impact over time and, therefore, is an excellent way to clarify both the value and urgency for new ideas in the pipeline. It is an economic-based method that allows companies to prioritize those ideas that will create the highest value by putting a price tag on time. As Don Reinertsen has said, “If you only quantify one thing, quantify the cost of delay.”

CoD is the net change in forecasted gross margin per week. CoD is typically stated per week to support the granularity of the impact of priority trade-offs. If you have an annual forecast, divide by 52.

By focusing on life-cycle profits, CoD makes it clear that prioritization decisions can be based on more than incremental revenue. Revenue is important, but it is only one of the four major ways in which an idea can impact profits. The contributors to life-cycle profitability are as follows:

1. Increase revenue - Grow sales to new or existing customers with ideas that delight customers and increase market share. Disruptors increase market size and make the pie bigger.

2. Protect revenue - When competitors or market conditions threaten the revenue stream. Ideas or innovations that improve current products can sustain current market share and revenue.

3. Reduce costs - Look for ways to increase efficiency that will reduce costs that are currently being incurred. This will improve the gross margin or profit contribution.

4. Avoid costs - Make improvements to keep the current costs constant. This eliminates costs that are not currently being incurred, but may be in the future. An example is conforming to new regulations to avoid fines.

Calculating Cost of Delay

A simple way to calculate the CoD is to determine the profit via all four contributors to profitability in a given year. It can also be done for a three-year period, and then divided by three. This CoD example will use a weekly figure to drive home the impact of priority trade-offs, so you divide the annual gain by 52. Here is the working calculation with examples:

CoD = (Contributors to Profitability including Increase Revenue + Protect Revenue + Decrease Costs + Avoid Costs)/52

• Example #1: Increasing conversion rate. You have an idea in the pipeline that would improve the customer experience on your website, projected to increase the conversion rate from 5.5% to 6.0% (or a 0.5% increase). If you have approximately ten million visits to your site per year, your average sales order is $32, and your average gross margin is 30%. The increased contribution to profitability from the additional revenue in one year is (10,000,000*$32*0.005*.30) or $480,000. The weekly CoD is $480,000/52 or $9,230. This is an example of CoD to increase revenue.

• Example #2: New regulations. The Consumer Protection Agency has issued a new regulation requiring increases in information security to counter the latest threats from hackers. The company ignored this regulation when it was issued. Now the security measures must be in place or the company will face fines of $100,000 per calendar day. Since we know the cost per day, the weekly CoD is $700,000. This is an example of CoD to avoid costs.

• Example #3: New mobile application. Customers have been asking for a mobile app to access financial products. Having this application available could retain about 240,000 current customers and add another 360,000 new customers in the next year. It is estimated that the company can make $36,000,000 in a year. The weekly CoD is $36,000,000/52 or $692,308. This is an example of CoD to protect revenue and increase revenue.

As a word of caution, do not use the CoD as a forecast. It is only a prioritization tool. When the CoD is used as a forecast, it becomes the target on the back of the product owner. This can drive fear into the organization and impact the value of the CoD.

As we will see later, assumptions can greatly impact the CoD. By challenging assumptions and applying a uniform set of standards about assumptions, the CoD of different opportunities can be compared. Therefore, protect the value of assumptions driving these important conversations and prioritization.

Enterprise Value Curve

By using the CoD, you can understand where you can have a significant impact on profitability. Consider the value curve distribution of the value of ideas that companies typically work on. As shown in Figure 12-1, all too often, companies fund or initiate few of the really high-value ideas (whose CoD can be enormous) because they are so consumed by the low-value work.

Figure 12-1. Typical company value curve distribution of ideas by CoD

Why do companies fund so many ideas with little or no value and do not fund ideas that are high value? It would seem logical that they would want to invest in primarily the ideas with the highest CoD. The problem is that companies tend to use subjective prioritization methods and trust their gut. They do not use economically based methods like CoD to make investment decisions.

When you use the CoD to select ideas from your pipeline, your value curve is more likely to resemble the one in Figure 12-2 than the typical value curve shown in Figure 12-1. You will be investing in the high-value ideas instead of the long tail of low-value ideas. Cutting the tail will increase profitability by allowing your company to focus on the highest-value work.

Figure 12-2. Ideal value curve distribution of ideas by CoD

Not all CoD profiles are equal. Some products have a very long lifetime and, once you hit the peak profitability, the ongoing profits are stable, as illustrated in Figure 12-3. In this case, the CoD is linear and constant. This analysis looks at the urgency profile associated with the product in its market. Other urgency profiles include short life cycle, peak affected by delay; long life cycle, peak affected by delay; and short life cycle, seasonal or date-driven.

Figure 12-3. For ideas with a very long life with peak unaffected by delay

The “late entry” line highlights the cost of delaying customer value, which means delaying the opportunity to increase profitability. The longer the late entry line, the more you miss. If you wait too long, a competitor can be first to market. This changes your urgency profile to “peak affected by delay, long life cycle” and can leave you with a smaller piece of the overall pie.

Calculating CD3 for a Value Score

In order to make optimal investment decisions, you have to include one more factor—duration. Some organizations would rather fund three medium-value projects that can be delivered quickly rather than one high-value project that could take years. To complete the analysis, you get an estimate of the duration for the project.

The estimate of duration should be consistently applied to ideas. You may use “dream” or “standard” duration. Dream duration is the shortest possible duration if you have all of the people and resources able to work on the idea, while standard duration is the typical duration when including all dependencies and wait states. I recommend dream duration, but either is fine when getting started.

You can calculate a value score called CD3 (CoD divided by duration). CD3 asks for the CoD amount and then you divide by your duration method (dream or standard) = (for example, Cost of Delay/Duration).

• In Example #1 above, the CoD per week is $9,230. If the dream duration is three weeks, the CD3 value score is ($9,230/3) or 3,077 or 3K.

• In Example #2, the CoD per week is $700,000. If the dream duration is 24 weeks, the CD3 value score is ($700,000/24) or 29,167 or 29K.

• In Example #3, the CoD per week is $692,308. If the dream duration is six weeks, the CD3 value score is ($692,308/6) or 115,384 or 115K.

In these examples, you will notice that Example #3 is an order of magnitude larger than Example #2, and Example #2 has a CD3 score that is an order of magnitude larger then the CD3 in Example #1.

The intent of CD3 is to provide a rough rank order. With CD3 scores of 3K, 29K, and 115K, respectively, it is clear that Example #3 should be considered as the idea with the highest value. However, if you have a CD3 score of 3K and 4K, then further investigation of the assumptions and alignment to strategy should be factored into the decision on which one to work on next.

By calculating a CD3 score for every idea in your pipeline, you can rank order them during the Reveal stage to maximize your return, as illustrated in Figure 12-4. This can help you predict which idea will yield the biggest positive impact on profitability for the time invested. Since there is much to learn about CoD and CD3, consider reading The Principles of Product Development Flow by Donald Reinertsen² and the Black Swan Farming’s website.³

Figure 12-4. Rough rank order of Ideas by CD3 value score

Challenging Assumptions about CoD

CoD is calculated early in the idea life-cycle. As a result, in order to calculate the CoD, many assumptions have to be made. As part of transforming toward an Agile culture, it is important to apply a discovery mindset that includes positively challenging assumptions so that you can better understand the idea and you can better ensure that the idea is of the value it states or adapts accordingly for the betterment of the enterprise.

For Example #1, which is focused on increasing conversion rate, by challenging the assumptions, you learn some readily available facts such as the number of small businesses in North America. As you challenge the 0.5% increase from 5.5% to 6.0%, you learn that this conversion rate is based on a history of similar products. Some data has a high degree of confidence based on the data warehouse and some are a guess. It is important to know which is which.

The PO might argue that the conversion rate would actually increase to 7% while the experience designers might defend the original 6% estimate. You could design a quick prototype to validate with customers to see which increase is more realistic. While different assumptions can result in widely varying initial calculations for the CoD and CD3, this process allows you to make those assumptions more visible.

When you do challenge assumptions, make sure you use open-ended questions. For example, use questions such as the following: What led you to that conclusion? What do you think the level of uncertainty is? What is your riskiest assumption? What information do you need to validate this?

When people have widely different calculations, you can challenge the assumptions behind those calculations beginning in the Reveal stage. By having reasoned conversations about those assumptions and ironing out those differences, you can get a consensus on the likely CoD and value score by applying CD3. When the value scores or rankings are based on subjective, gut feelings, those discussions can turn negative.

Are You Cutting the Tail?

Prioritization can take many forms, from gut feelings to qualitative research to quantitative research. Since selecting the right enterprise ideas to invest in will have a major impact on the company’s profitability, it makes sense to evaluate these ideas using an economic approach. CoD and CD3 are good economic methods for prioritizing ideas in the enterprise idea pipeline.

By working on the highest value ideas, it exposes the tail of low-value work that is left. The question is, will you cut the tail? It may be more challenging than you think because people will come up with many reasons why that work is important. If you apply a value-based model for identifying low-value work, you can begin making better investment decisions.

If you are not already doing so, try using CoD and CD3 for prioritizing your current list of on-deck ideas. Plot them in a value curve showing the highest CoD as your first idea and the lowest as your last. This plot is likely to look similar to Figure 12-1. Are you ignoring high-value ideas? Are you investing too much in the long tail of low-value ideas? How can you cut the tail?

For additional material, I suggest the following:

• Manage Your Project Portfolio: Increase your Capacity and Finish More Projects by Johanna Rothman, Pragmatic Bookshelf, 2016

• The Principles of Product Development Flow: Second Generation Lean Product Development by Donald Reinertsen, Celeritas Publishing, 2009

• http://blackswanfarming.com/cost-of-delay/ , Black Swan Farming, Limited

• VFQ Prioritization by Emergn Limited, Emergn Limited Publishing, 2014