One of the primary responsibilities of management is to make decisions during the execution of projects so that gains are maximized and losses are minimized. Decision analysis is critical for projects with built-in flexibility, or options. when these choices operate in the presence of uncertainty. [1]
The notion that we can spend other peoples money in the absence of the immutable principles of Managerial Finance and Microeconomics of decision making pervades the #Noestimates community. Here's a few of those principles to counter that fallacy.
- We can't determine the value of a software feature or product unless we know the cost to acquire that feature or product. If we determine the value of a feature in our new ERP system is worth $150,000 in savings to us every year. What if to acquire that feature, it costs $50,000 one time and $10,000 a year in maintenance, a typical 20% maintenance charge. That sounds pretty good. But what if to acquire that feature it costs $1,200,000 for a one time charge and $150,000 a year in maintenance? It'll take 80 years to break even not counting the maintenance. This is the principle of cost benefit analysis. And since both the cost and benefit are random variables in the future we'll need to estimate both and construct time phased money to determine the cash flow, sunk cost recovery and benefit flow..
We can't know the benefit until we know the cost to achieve that benefit
- When we need to make a decision in the presence of uncertainty, and there are multiple choices we need to choose between all of them and pick one. If we know something about the cost of each choice,we can assess the beneficial outcome of that choice. The cost of the choice - that is to acquire a feature - also has a cost of NOT choosing the other choices. This is the opportunity cost between all the choices. This opportunity cost makes visible not only the beneficial outcome of our choice, but the cost of NOT making the other choices.
Microeconomics of decision making in the presence of uncertainty is based on Opportunity costs
- In any complex software system development domain the usefulness of a precise numerical and analytical approach to make choices breaks down. Resorting to heuristics - empirical assessment of the past, modeling of the future - is not always the best approach, since it's sometimes hard to evaluate the validity of the heuristic because of the informal structure. One approach in this situation is an economics approach that recognizes software efforts expend valuable resources in the presence of an uncertain payoff. This is decision making under uncertainty. Like the Microeconomics of opportunity cost - Real Options is a tool applicable to this problem. We're not trading stock here, but a real options view of capital investments is based on the observation that investment opportunities are similar to a call option that confers upon its holder the right but not the obligation to purchase an asset as a set cost for a period of time. This value seeking approach is called Real Options.
Uncertainty is a central fact of life on most large IT capital investments. Along with uncertainty comes managerial flexibility. A real option refers to the right to obtain the benefits of owning a real world asset without the obligation to exercise that right.
So in the end, when making a decision - that is selecting from more than one choice - there are several methods listed here.
Each of these methods of making choices in the presence of uncertainty requires making an estimate of the impact of that choice, an estimate of the cost to acquire the value for the choice, and an estimate of that value.
[1] Real Options: The Value Added through Optimal Decision Making, Graziadio Business Review,
