David Matheson - SmartOrg, Inc.

In the Eye of the Hurricane of Change - Part 3 - David Matheson

When my grandfather was young man, he went to New York harbor to see his sister off. She had married a Sicilian, and was headed by ship to start her new life. My grandfather fully expected to never see her again. At that time, world travel was a huge ordeal and very expensive. A trip to Sicily to visit his sister would have been a multi-month extravagance, well beyond the means of an upper-middle-class high-school principal.

Yet during his life, airplanes moved out of the research phase, became instruments of war, luxuries for the super rich and eventually a routine form of transportation. Later in life, he flew in a jet to visit her. It took about a day, the amount of time we expect it will take to get pretty much anywhere on Earth.

But the Moon takes longer. The phrase “when they put a man on the moon” meant to my grandfather more or less what “when hell freezes over” means to me. His phrase now connotes humankind’s astonishing ability to do the seemingly impossible.  Late in his life, of course, he saw the moon landing on TV.  The computer, which used to be a profession – the guy with the slide rule, became a machine that, among other things, made the moon landings possible.  My grandfather saw the development and rise of the computer, and died in 1974, around the time of the ATM machine, which he never seemed to get the hang of.  His long life was made possible by many medical innovations. The Spanish flu, killed more people in the US around WWI than that or any other way. It was caused by a virus, a biological entity unknown at the time. Now we routinely use viruses to transfer manipulated DNA into cells. These medical advances save had tremendous impact of ordinary people. My brother caught the bubonic plague a few years ago – the disease that destroyed much of Europe in the middle ages, and rather than having a death sentence, he was quickly diagnosed and given an antibiotic that cured him in a day or two.

In the Eye of the Hurricane of Change - Part 2 - David Matheson

My grandfather’s education probably included some instruction on how to write a good letter, as letters were the main communication mechanism. Now these have been displaced by the telegraph, telephone, and mobile wireless that carries voice and data.  Entire new media, such as television have developed and transformed society in my grandfather’s lifetime.  The TV has become a necessity -- on a trip to rural Mexico, I was astonished to notice that many poor households would buy a TV before a refrigerator!

The history of refrigeration seems like a failure of imagination. Before mechanical refrigeration, things were kept cold by cutting ice out of ponds in the winter, and packing it underground in straw for storage and use during the hot summer. When mechanical refrigeration was first invented, it was used to store and transport ice that was chipped out of ponds.  Then came the central ice plant, where ice was made more-or-less locally and distributed to the icebox in every home.  Finally, the home refrigerator came along, which replaced an entire industry and transformed what we eat.

My children think nothing, indeed do not even notice, that some of their food has come from the Southern Hemisphere, traveling thousands of miles refrigerated to arrive almost fresh. This nearly unimaginable distance to my grandfather has now become routine. 

David Matheson - In the Eye of the Hurricane of Change – Part 1

My son was entertained; my dog was not. My son was focused intently on a book, unaware that it was also a computer.  When he touched a page it would read it to him; when he touched word it would pronounce and define it. He did not realize it was teaching him to read.  The dog looked blankly at the book, in that guard state half between sleep and ready to spring into action should a squirrel run through our living room.

As I approached, the dog looked hopefully at me, raising its ears and starting to wag its tail slightly. “A walk?” it seemed to say. I reached for the leash, and realized that this interaction has been shared by dogs and humans through the generations. My grandfather, born in 1889 would find this familiar.  He might even recognize the book, although only because of the extraordinary technological change experienced by his generation.

He went to school in a one-room school house, six days a week. Younger kids were taught to read by the teacher and the older students as well.  They had Sundays off, of course, but his strict teacher kept the children at their lessons. My grandfather had one field trip in his elementary school career – to the local village to see the horseless carriage.

The school was lit by candlelight, and my grandfather did his studies also by candlelight.  Eventually, electric lights moved from a luxury to a utility.  After generations of light by fire, can you imagine the psychological impact of light separate from heat? Electricity worked its way into every corner of our life, for example reducing the size of motors from gigantic steam-powered machines to power tools to quartz watches. These shifts transformed industry, the household, and lifestyle.

I call the dog, who instantly jumps up and comes running. My son turns off his book and closes it. “I want to hold the leash,” my son says, clipping on a leash made from some leash made of a synthetic material colored a gaudy pink never seen in nature. We think nothing of it as we head off to the park.

Inspiration at Inspire - Don Creswell

Probably no industry deals with uncertainties as challenging as those faced by the pharmaceutical industry. Very long development cycles. Huge amounts of money on the table for long periods of time.  FDA approvals. And more. Decision making in this environment, is to say the least, immensely challenging.

This is why "value-based management" i(VBM) is rapidly gaining support in pharma and biotechnology. VBM provides management with the information and tools needed to confidently select the most promising projects to support. By focusing on "True North": the economic value that projects can return and the critical uncertainties that must be managed to management and their teams gain insights that lead to faster, better decision-making. And, to higher portfolio returns.

Ward Peterson, Vice President, Discovery of Inspire Pharmaceuticals will report on the successful deployment of VBM processes and supporting software at his company, at two upcoming events sponsored by SmartOrg: a Webinar on 25 April "Enhancing Portfolio Value" and the Global Project and Portfolio Managment for Pharma conference in Philadelphia 21-22 May. Details about each of these events are on the SmartOrg web site: www.smartorg.com

At the events, Ward will describe how a VBM system helps Inspire select projects that can be expected to contribute the highest portfolio value. The system, according to Peterson, "Provides a consistent, repeatable selection process that effectively factors in the impact of risk and uncertainty on portfolio value."

Big Mistakes in Evaluation - David Matheson

Robin Karol, CEO of the PDMA once told me “By far the biggest mistake in decision making is treating an evaluation as an analysis rather than a conversation.” This view is a bit astonishing, as many analysts spend a lot of time learning about the mathematical modeling in evaluation. It is a trap I have fallen into.

My conversation with Robin brought a flashback to early in my career.  I saw myself in a boardroom finishing the presentation of what I thought was a brilliant analysis to the executives. The bottom line: closing the power plant early would save the company tons of money.  There were a few questions, easily answered from my analysis. Then one executive piped up, “I don’t know, my gut says otherwise.”

Shocked, I marshaled my wits and prepared to use the analysis to convince the skeptic. But I did not have the chance. The president politely dismissed my colleagues and I, “Thank you for your hard work. We will take it under advisement.”

As we left the boardroom, my colleague offered me these consoling words, “Don’t worry David, you did a good job. Lots of decisions get made on gut.”

These were empty words, consolation for wasted analysis.  I had made Robin’s number one mistake.

This mistake shows up in other ways as well. People treat evaluations as boxes to be checked on some process form so they can get on with the real work. People use evaluations to persuade investors by making outrageous assumptions and saying “the analysis says go!” with a straight face. People use evaluations to make points in arguments, or to negotiate a budget. In all of these cases, the evaluation is merely an analysis—a tool or a deliverable in a mathematical format.

So what?

From an analyst’s point of view, this is frustrating because it invalidates lots of hard work.  From a business point of view, this is inefficient because the hard work is essentially wasted effort for all the participants. But fundamentally, the damage is more than frustration or waste: it represents a failure to learn. In complex or unfamiliar situations, it is impossible to make good judgments uniformed by good evaluations. This failure to learn leads to poor decisions and poor performance in many organizations.

In this case, according to my analysis, failure to close the power plant could lead to catastrophic loss for the company.  Their major city the utility served was discussing dropping the company because costs were too high. Yet it seemed that the executives were not getting the message.

While these dysfunctions may seem like part of what it means to be in an organization, a root cause analysis shows it does not have to be this way.

To treat an evaluation as a conversation, you need to start with questions people actually have and craft a model to answer them, in a spirit of inquiry.  You need to provide variables that reflect people’s concerns and allow them to express themselves.  You need to use analytical results and models as a forum for learning about what matters and the best course of action.

In ongoing conversations, Robin and I shaped a list of the biggest mistakes in evaluation.  They all flow this basic insight that you must treat an evaluation as a conversation, not an analysis.  Here they are in brief:

1. PEOPLE – treating a project evaluation as an analysis rather than as a conversation. Not having the right people (or process) to have the conversation. Failure to connect the analysis to the decision making process.

2. TOOLS – Use of convenient tools that lack the power to provide real insight or drive a lasting business decision. 

3. VALUE – Failing to bring an evaluation to the bottom line prevents real discussions of business issues and tradeoffs.  Narrow view of value as NPV. Undocumented assumptions lead people to believe that a particular value metric is more comprehensive than warranted.

4. UNCERTAINTY – Critical issues covered up using assumptions rather than explicitly quantified as uncertainty.  Failure to evaluate, vet and learn about uncertainty. No understanding of the business’ ability to manage risk and uncertainty.

Fortunately for my earlier self, the power plant decision was not made in that boardroom on that day. Somehow we were able to correct for the mistakes that Robin and I later identified.

We followed up with the skeptical executive and tried to understand his gut.  After some inquiry, we realized that he had an implicit assumption:  that decommissioning costs would be lower in the future.  Other executives where concerned these costs would be high.  They were all making assumptions, and failing to see this issue as an uncertainty.

We repurposed the analysis to show that both were in some sense right in their gut: if decommissioning costs were low, then it really was better to keep the plant open; if they were high it was better to close it now.  What was at issue was the probability of high or low decommissioning costs. Both sides confessed to having little expertise in this area. By connecting the uncertainty to value, we were able to bring both sides together.

Of all the concerns, politics, debates and confusion surrounding the plant decision, the best course of action boiled down to one key thing: decommissioning costs. This alone was a huge advance in the conversation because the executive team stopped debating issues that did not matter. The tools we were using had the power to focus the discussion productively.

A quick study was commissioned and the evidence for rising decommission costs was strong. The skeptical executive himself assigned a small chance that costs would remain low, and was persuaded to close the plant.  He, and the whole executive team, had learned and now had a more informed “gut”.  The conversation had been guided effectively by the evaluation.

A couple of months later, they sent me a newspaper clipping. It featured a picture of the skeptical executive in front of the power plant. He was announcing its closure. I should really show it to Robin one day.

Project and Portfolio Strategy: Don’t let the tail wag the dog

The goal of Value-Based Management is to create maximum economic value (see my post dated Jan. 12, 2007, below). So whenever someone says there are other considerations, such as alignment with strategy or resource constraints (e.g. money or staff) I must ask how much are those issues worth?

Alignment with strategy is an easy one. Shouldn’t the strategy maximize value? If there are some “strategic considerations” that are broader than the project or portfolio being evaluated, the cost or value of these strategic considerations should be built into the value model – then they are automatically taken into account! Alternately, one could adjust the project for these considerations and see how much the project value decreases. Then ask are the “strategic considerations” worth this loss of project value? But watch out, “strategic considerations” are often the excuse for taking the politically correct option rather than maximizing value – the tail wags the dog. It is a best practice to model those considerations in economic terms and do what maximizes total value.

 

Adding resource constraints to a portfolio is a similar matter. The figure above shows a plot that builds up a portfolio project by project, in order of their value (NPV) to cost ratio. This creates an efficient frontier, and like a stock efficient frontier, any portfolio not on the curve will be beneath it, and therefore will have less value or more cost than portfolios on the curve. Sometimes called the CFO chart, all other considerations aside, one should pick projects in this order up to the budget level, and then ask if the budget level is set correctly, by looking at the return ratios of the marginal projects, the projects on either side of the budget line. Ideally, the budget should be a result of this analysis, not an input to it.

But what do we do with considerations not on this chart? There certainly could be other key issues such as interactions among projects, which can either be included in a more sophisticated version of the CFO chart or added manually when certain combinations of projects are undertaken.

But another criticism is that this chart does not take year-by-year resource constraints into account. Here we have the tail wagging the dog problem.

Shouldn’t the annual resources be adjusted to maximize value, rather than being regarded as constraints? Again there are a couple of ways to deal with this issue. One is to modify the portfolio selection to take these “constraints” into account, see how much the value changes, and then decide whether it is worth adjusting the constraint. The other method is to price departures from the constraints, and include these costs in the CFO chart in the first place.

Once the optimal choices are made – choices that maximize total value to the shareholders – then the operational planners and managers need to wrangle getting the needed resources in place. Their job is to help create maximum value, not to live the more predictable life achieved by artificially constraining resources.

Don’t let the tail wag the dog!

Limitations of Scorecards

The letter to the editor of CFO magazine, reproduced below, makes some good points about the misuse of scorecards.

Scoring Scorecards 

Have you ever noticed that the biggest advocates of the balanced business scorecard are IT companies ("Links Still Missing," Topline, January)? Data companies and accountants love all that data collection, storage, and parsing, and ignore two key facts:

1. Too many measurements often lead to conflicts, and there is no mechanism other than managerial judgment to resolve the conflicts in scorecards.
2. There are no successful scorecards that tie into value programs, because the time horizons for scorecards tend to be daily, weekly, or monthly, and value is the present value of future cash flows, hence a structural conflict in the application.

Besides these primary flaws, scorecards are almost always static, and markets and circumstances change faster than scorecards do. In fact, all of that useless data is itself an impediment to value-creating behavior, because it tends to make people try to game the system.

This is not to say measurement isn't important; it's vital, but scorecards are only a small part of the answer in operations and worse than useless in decisions about strategy.

Richard Bassett
Via E-mail

http://www.cfo.com/article.cfm/8760553?f=search.

Don’t Call the Shots: Lessons from GM - Jim Matheson

When the new R&D Chief arrived, he saw his duty to make the hard calls.  After all he was brilliant, trained and approved by the best schools, spent long years working his way up through management, and now was anointed as Captain of the team.  It was tough work making risky decisions — now it was his turn to call the shots.  His first task was to decide where the market and technology were going, and the second pick only the winning projects that fit this future.  Why waste money on projects that would fail anyway?

This kind of top-down direction killed the advanced gasoline hybrid automobile development at GM.  They called the shots — deciding that hydrogen fuel cells would be the winner.  Well guess what?  In this generation, the hybrid is the hot new car and GM doesn’t have any.  Is this just bad luck for poor GM?  Or is there something wrong with this picture?

We don’t decide the future.  We can only assess the odds that various futures will happen.  Realizing that the future is uncertain leads us to bet on a diversified portfolio rather than picking winners.  A personal analogy will make this clear.  Would you bet your life savings on a single stock pick? That is in effect what GM did in betting on a particular future — it bet the life savings of its workers and shareholders that it could pick winners, and it came up short!  Where do executives come up with the idea that they are oracles?  Getting personal again, you must bet your life saving on something.  So what do the professional advisors tell you?  They say to bet on a diversified portfolio, stick with it for a while, and then rebalance it as you see how the future develops.  Why don’t companies do this with their R&D portfolios?

GM could have clearly afforded to keep their options open.  Missing the winner was a likely outcome, given their management style.  By keeping their options open, GM could have at least been a fast second as the public interest in buying hybrids became clear.  The extra money spent on R&D would have been a pittance compared to the additional profits they did not make.  Efficiency is fine for manufacturing, but diversification is necessary to play the R&D game well.  GM is big enough to have sufficient resources to play a diversified development (and marketing) portfolio, but the notion of picking winners and shedding losers, prematurely, gets in their way.

I am somewhat unfairly focusing on GM because their plight is in the public light, but there are many others like them.  How did those certified excellent companies fare, like Polaroid, Westinghouse, Motorola, … (Peters and Waterman, In Search of Excellence, New York, Harper & Row, 1981).  All of these companies were excellent at designing and manufacturing high quality products.  But because of poor strategic management, they were constitutionally unable to develop the products that customers wanted to buy. 

In another edition, I will limn the principles and practices of value-based portfolio management.

Decision Advisor v7.1 - Terry Chinn

In our years supplying software to the value management community, we often find users in, roughly, two different camps.  In one camp, there are those who want to create a business case to evaluate a business opportunity for upper management.  In the other camp are the artisans, the analysts, the purists who want to know more about the intricacies of the key drivers to maximize the value of an opportunity.

Our recent release of Decision Advisor v7.1 has some key new features that each type of user may find interesting.  For this first 'nuts and bolts' level of analysis, you use components of the value map to describe the characteristics unique to the business opportunity.  From there, the software creates an Excel spreadsheet that displays the cash flows, revenue, cost, etc. and ultimately the NPV of the opportunity. The software will then perform a sensitivity analysis producing a tornado chart to show you the variables that most affect value. Finally, you can create "S-curves" showing the risk and potential return of your opportunity.

To some, this is the right amount of analysis. Some refinement of numbers and they are good to go.

For the other camp, we have added some features with a simple graphical user interface to answer questions like "What's it worth to spend more money on marketing?" or "If we could improve X, would we do anything different?" To answer these questions we have enhanced the software to gain insight into these questions. From the value map, you create an Influence diagram that is a fully specified probabilistic model.  From there you can use Value of Perfect Information and Control, Sensitivity to a Probability, and the Decision Tree to determine how you can maximize the value of your opportunity.  These analyses will give you insight into how value changes as a variable changes within its range of uncertainty.

At SmartOrg, one of our challenges is to provide valuable, easy to use software tools to enable business professional to evaluate complex business prospects and provide transparency into the "black box" nature of many business models. Decision Advisor v7.1 is the big step in this direction.

A Rose by Any Other Name - Don Creswell

With apologies to Bill Shakespeare (a rose by another other name) and to Gertrude Stein (a rose is a rose is a rose), I address the dual and  confusing terms Product Management and Portfolio Management (PPM). There must be a better way to differentiate management of day-to-day activities involved in PPM as opposed to higher level management activities devoted to forecasting and managing economic value produced by new and revised products, R&D projects and other business opportunities. It is obvious that successful companies must accomplish both but it is most difficult to reorient the thinking of people who are rewarded for producing results measured in terms of days, weeks and months, units of output, etc., towards thinking about the economic value that can (should) be derived from investments in research, development and other activities. I submit that we might change terminology to more clearly reflect this dual management roles. Let PPM stand for getting products/projects "out the door" on time, within budget;, meeting quality standards, and so on. What some term "operational" activities. Then, add one little letter - a "V" - to PPM, producing PPVM or Product Portfolio Value Management; making decisions based on optimizing economic return.

PPVM answers questions like, "what things SHOULD we be working on to give us the highest possible economic return for our investment of human and capital resources." Then, manage operations based on traditional metrics (accounting measures, cost, etc.) and in parallel manage economic value based on NPV that reflects the impact of risk and uncertainty. Track both measures in parallel as time unfolds, making sure that the "value meter" continues to rise. PPVM should be on the radar of all managers, not just those "upstairs."  All important stakeholders - managers and doers - should understand where the value comes from in each of their projects (products), the key value drivers, and where to place their efforts to make value creation as deep a mind set as meeting daily/weekly/monthly milestones.