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Agile Economics

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

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Agile Economics

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

  2. 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

  3. 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

  4. 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

  5. Framework for Work in Agile Economics Value Based IT Management Strategic Options Operational Economics Discounted cash flow, ... Contingent Claims Analysis, ... MECP Framework, ... Agile Economics

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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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