Bush tag seminar 06 mar12

MEASURING STRATEGY
QUANTIFYING RISK AND UNCERTAINTY

“When you can measure what you are speaking about, and
express it in numbers, you know something about it;

but when you cannot express it in numbers, your knowledge
is of a meager and unsatisfactory kind;

it may be the beginning of knowledge, but you have scarcely
in your thoughts advanced to the state of science.”

-  Lord Kelvin .

© 2012 COPYRIGHT ROBERT D. BROWN III AND GERALD A. BUSH - ALL RIGHTS RESERVED 2

TECHNOLOGY STRATEGY FROM MY PAST
Initial Plan
•  Our company had the chance to lead the medical
diagnostics industry in using new biosensor
technology for diabetic glucose monitoring.

Business Case
Forecast economics showed $240 MM NPV.
Key issues and risks were listed, but not quantified.
Decision makers were concerned about reliability.


WHY MEASURE A STRATEGY?
Strategy Value ($MM)
100 200 300
Medical Device Strategic Issues
§ New product cost of goods
§ Launch timing
§ Design / Mkt Share capture
§ Recall risk / QC costs
§ Product support costs
§ Channel costs

Downsides range from $28 – 140 MM
Upsides range from $5 – 48 MM


WHAT CONCLUSIONS WERE DRAWN?

Success would require a Quality transformation of the
entire operation to mitigate the risks.
Simulation of top six benefits quantified the return:
§ Expected value = $165 MM for expected risk mitigation
§ Estimated cost of TQM/Six Sigma initiative = $12 MM

How have TQM/Six Sigma initiatives done?
•  Georgia Tech’s financial analysis of industry
•  34% better stock price performance than benchmark firms
•  43% better operating performance measured by profit growth
•  Sustainable advantage has been retained over a long term


BENEFITS OF MEASURING STRATEGIES

Clarity
§ Resolves ambiguous and/or conflicting values
§ Communicates the purpose and aims of the decision

Transparency
§ Based on collaborative expertise and rationale
§ Alignment of personal & organizational agendas
§ Confers understanding of uncertainty, tradeoffs, complexity, risk

Transferability
§ Does not rely on one individual's special insight
§ Promotes systemic thinking and comprehension
§ Builds an environment for effective collaboration


WHY IS THIS IMPORTANT TODAY?

To meet the fiduciary responsibility of officers/directors
§ “Duty of Care” means not taking information at face value, but being fully
informed when making decisions.
§ To identify risks and uncertainties that could have a material impact on
the business and taking appropriate mitigation steps

Quantifying the risks for their impact on value
§ Avoiding the “illustion of understanding” of qualitative methods
§ “What gets measured gets done.” - Drucker
§ “You get what you inspect, not what you expect.” - Deming


WHAT HAS BEEN DIFFICULT OR
FRUSTRATING FOR YOU IN YOUR
STRATEGIC DECISION PROCESS?


THE PATH TO VALUE HAS LOTS OF TRAPS

Inappropriate reliance on
intuition and speculation

Adversarial advocacy positions

Lack of open inquiry
Competing impressions
Unforeseen risks or
Unrecognized disasters dismissed
opportunities
Lingering doubts
and uncertainties
Analysis paralysis

Lack of buy-in Misalignment
and alignment among tactics and
policies


MONEYBALL (AND BRAD PITT) HAVE
DONE A LOT TO POPULARIZE ANALYTICS


AVAILABLE DATA OR VALUABLE INFORMATION ?


COMPETING ON ANALYTICS Tom Davenport
and Jeanne Harris
– THE SCIENCE OF WINNING

According to Tom Davenport,
“Companies that invest heavily in
advanced analytical capabilities
outperform the S&P 500 on
average by 64%”.

An IBM-CFO study shows that analytics-driven organizations had 33% more
revenue growth, 12 times the earnings (before interest, tax, depreciation,
amortization) and 32 percent more return on capital invested.


HISTORY HAS PROVEN THESE LESSONS WELL

Babylonian Triples ~2000 B.C. Quipu Peruvian knot record ~1000 B.C.

Earliest recorded math table on clay Believed to be numerical record
tablets, perhaps used to calculate keeping system used by the Incas for
triangle dimensions for construction. keeping track of commerce.


DATA ADDS VALUE BY DRIVING DECISIONS

Chinese counting boards and Village Lawyer by Pieter the Younger,
abacus were essential for the dated 1621 with stacks of paper
Emperor’s men to assess the records for billing clients.
right amount of tax to collect.


COMPUTING SYSTEMS (1820 – 1950) ENABLED
MORE BUSINESSES THE COMPETITIVE ADVANTAGE

Charles Xavier Thomas
invented a mechanical
calculator for his insurance First used in 1928 for vital statistics
business to assure accurate tabulation by the NYC Board of Health.
pricing based on actuarial data It was IBM’s most profitable product
for the next 50 years with mainframe
computing for businesses.


PROGRAMMED COMPUTERS 1950 – 1980
BEGAN DEMOCRATIZING IT TO SMALL FIRMS

Lyons Electronic Office (LEO) was Dan Bricklin received an award from
the first programmed device to Osborne Computer for creating VisiCalc,
evaluate costs, prices and margins a program that made it worthwhile to
of that week's baked output at buy a personal computer.
Lyons London tea shop.


ENTERPRISE SYSTEMS 1990-2000 DECADE

ERP software promises to
integrate internal and external
management information
across an entire organization.

CRM software gives business
the ability to create, assign
and manage requests made
by customers.


WEB / CLOUD IS EVOLVING – 2010 DECADE


NEXT GEN BIG DATA IS NOW IN HYPERDRIVE


CAN WE REALLY DEAL WITH EXABYTES?

Stage 1: Analytically Impaired – Lack of
analytical skill or executive interest.
Stage 2: Localized Analytics –
Uncoordinated activities or silos.
Stage 3: Analytical Aspirations – Good
intentions with slow progress.
Stage 4: Analytical Companies – Widely
use analytics internally.
Stage 5: Analytical Competitors – Use
analytics as a competitive advantage.

Competing on Analytics – The Science of Winning
by Tom Davenport and Jeanne Harris


DARK SIDE OF THE STORY -
MAJORITY OF INVESTMENTS FAIL TO DELIVER

Set Direction Exploration Evaluation Implementation
100%
% Successful After 2 Years

Ones that Work:
Improvement

Dialog (internal experts) or Pilot
Creative Synthesis of Options
in understanding,

Collaborative Participation
participant buy-in,
50%
use of creative ideas
Framing

and focus on real
Business business results.
Idea Case Edict or
Justification Single
Persuasion
Option

0%

Four Key Phases of Projects
127 cases studied in North America
(by Paul Nutt, Ph.D., Ohio State University)


A QUICK EXAMPLE – AIRLINE FUEL DATA
Jet fuel costs - $2.1 billion per year
Fuel Management system proposed to integrate all fuel
data, improve data integrity and functionality.
•  Project cost - $4.5 million
Tangible savings (could put in the budget)
•  back office cost reduction and simplification of IT systems
Intangible benefits – (could not guarantee exact value)
•  reporting accuracy for fuel taxes,
•  inventory and fleet fuel burn per day,
•  fewer errors, optimized inventories, etc.
Business case – not approved due to negative ROI


QUANTIFYING THE INTANGIBLES
What decisions could real-time data significantly improve?
•  Selection of fueler with lowest spot cost.
•  Tankering of fuel – where to fuel at low cost & tax airports

Quantifying uncertainties:
•  How big a price differential is there typically? – 0.5 to 1.5¢/gal
•  How many fueling events are there per day? – 3200 to 3500
•  How many gallons per event – thousands
•  How often has the lowest price been missed? – 30% to 60%

Probability
Benefit range $5-25 million per year

$5 M $25 M


HOW TO MEASURE INTANGIBLES
Do we understand what we trying to measure?
•  Value of making decisions with better information

What does measurement really mean?
•  Not a precise forecast, but quantifying what we know

How can we find ways to make the measurement?
•  Ask questions, find analogies or scenarios, etc.

Summarized from Douglas W. Hubbard -
“How to Measure Anything: Finding the Value of Intangibles in Business”


Case Study – ERP System

Major oil company approved a capital spending project
of $100 million for a new global ERP system.

After starting with a positive NPV, the business case
was tweaked to a point where it became a whopping…


MUCH HAND WRINGING ENSUED…

How can we justify the $$$?
What should we do?
-------

Maybe we should cut out all
of that training cost and
reduce development costs.

Would this push the project
NPV back into the black?


WHAT WENT WRONG?

•  Poor problem framing
•  Irrelevant sensitivity analysis
•  Inappropriate accounting of value


UNDERLYING BEHAVIORS AND TRADITIONS
CAN OBSTRUCT THE CREATION OF VALUE
•  Ratherthan quantifying the “intangible” value and risk,
teams allow technical arguments and cost substitution
issues to become the basis for investment decisions
•  Decisions
are made by negotiation or power-plays rather than
focusing on expected value or fit with the strategy
•  Bad
ventures frequently persist for too long, wasting time
and resources that could be used on better projects.
•  The key to understanding and making informed decisions…
is quantifying the value of the intangibles!


QUANTIFYING THE UNCERTAINTIES
REVEALED THE CRITICAL COST DRIVERS
simple business informed business case
case value = $0 value = $80
NPV $million
User adoption
Critical cost drivers System reliability
Data integrity

Development Cost
Important but not
critical cost drivers Training


BY INVESTING MORE - THE TEAM MITIGATED THE
USER ADOPTION RISK AND ASSURED THE UPSIDE
VALUE OF DATA INTEGRITY AND RELIABILITY
1
0.9
Cumulative Probability

0.8
0.7
Original strategy Hybrid strategy
0.6
NPV range NPV range
0.5
0.4
0.3
0.2
0.1
0
$80 $380

NPV $ (millions)


EACH STAGE RESOLVES KEY QUESTIONS
BEFORE MAKING A FINANCIAL COMMITMENT

Discovery Framing Evaluation Agreement
ü What is the real ü What are the decision ü What are the effects ü Which path best
situation? boundaries and open of uncertainties on meets our objectives?
decisions? solution goals?
ü What is the ü How much should we
opportunity? ü What are the sources ü What is the difference spend to control
of uncertainty? in value among the uncertainties?
ü What are our goals alternatives?
and objectives? ü Can we develop an ü What are the keys to
80% confidence ü How much risk do we implementation?
range for the face with each
uncertainties? alternative? ü What resources will
we need for
ü Is the information ü What insights can we implementation?
worth the time and create for contingency
cost of analysis? plans or options? ü What contingent
actions should we
take?


FOCUSING ON THE OBJECTIVES IS MORE
PRODUCTIVE THAN ARGUING ABOUT TACTICS
Discovery Phase

Maximize
Fundamental Stakeholder
Value

Capital Operational Service
Contributing Costs Costs Execution
Excellence

System System System Data Service Appropriate
Means Arch.
HW SW
Overhead Complexity Integrity Reliability Tools


DECISION HIERARCHY FORCES EXPLICIT
AGREEMENT ON SCOPE AND FOCUS
Framing Phase

•  Generate a wide array of creative,
Policy (givens, boundaries) doable alternatives that are
Decisions already made, foregone consistent with objectives
•  Create alternatives as a coherent
set of actions, usually one option
Strategic (focus, open options) from each decision category
Team Focus
for Analysis Decisions categories with sub-
•  Alternatives should represent
options to be considered now
strategically different themes
versus the full combination of all
Tactical (execution dependent) options
Decisions to be made later, deferred •  Sets the stage to consider
opportunity costs thoroughly


CLARIFYING UNCERTAINTIES AND LOGIC
HELPS FRAME THE EVALUATION MODEL
Framing Phase

•  Captures the essence of the problem
and facilitates the dialog between the
team members

•  Becomes a well defined model of the
situation, containing all the
necessary and relevant information
needed to assess the situation

•  Used as a means to communicate
the shared knowledge of the team to
the organization


QUANTIFYING 80% CONFIDENCE INTERVALS
HELPS AVOID ASSUMPTION “BLIND SPOTS”
Evaluation Phase

We recognize assumptions We observe results
are really uncertainties as distributions

Uncertainty

Uncertainty

Probability
Simulation
Uncertainty Objective
Engine!

Uncertainty

$0 $ NPV
Uncertainty


HOW EASY DO YOU THINK IT IS TO ASSESS A
10/50/90 RANGE OF POTENTIAL OUTCOMES?
80% confidence interval

.10! .50! .90!

p10 - 90% confident the outcome will be higher than this

p90 - 90% confident the outcome will be lower than this

p50 - equal likelihood the outcome could be higher or lower than this


EXERCISE - WHAT IS YOUR 80% CONFIDENCE
INTERVAL FOR THESE UNCERTAINTIES?
p10 p50 p90

1.  The number of revenue passengers
enplaned on U.S. airlines in 2007?
2.  The year that the the world’s first pure
food and drink law got passed?

3.  The year Attila the Hun died?

4.  Annual U.S. egg production in 2008?

5.  Elevation of the highest point in Texas?


CULTURAL PRESSURE FOR CERTAINTY
We are trained to provide “the answer”.
Uncertainty makes us restless, whereas we are comfortable
and content with the appearance of certainty
Planning is much easier if we suppress uncertainty

Suppressing uncertainty is dangerous in business!
§ we are surprised and unprepared to deal with the situation
Explicit treatment of uncertainty in planning:
§ improves communication of difficult issues, reducing surprises
§ encourages contingency planning
§ creates insight into potential upside potential


THE RIGHT EXPERT CAN EXPLORE CAUSES OF
UNCERTAINTY AND AVOID SURPRISES

Traditional Analysis (Forecaster)
§  Make assumptions to get to a forecast
§  Focus on what has to go right for success,
often blinding us to what could go wrong

Uncertainty Analysis (Desired Expert)
§  Explore the factors that create extreme
outcomes or contribute to uncertainty
§  Understand what could go wrong and what
the upside and downside may be
§  Develop a range of possible outcomes


P50 ± 10% ANCHORS ON THE ESTIMATE
CREATING AN ILLUSION OF THE UNCERTAINTY

p50 value
What will be the $2/Gal
average price of
gasoline over the
next 5 years?

-10% +10%

1.40 1.60 1.80 2.00 2.20 2.40 2.60

Product price, $/gal


AN 80% CONFIDENCE RANGE EXPLORES A
MUCH MORE ROBUST VIEW OF REALITY

Range p10 p50 p90 Initial Ranged
p50 value p50 value
Anchored 1.80 2.00 2.20
$2/gal $2.40/gal
Calibrated 1.00 2.40 3.15

Range -58% +31%

-10% +10%

0.50 1.00 1.50 2.00 2.50 3.00 3.50

Product price, $/gal


MONTE CARLO SIMULATION REVEALS THE
VARIATION IN VALUE CAUSED BY UNCERTAINTY
1
A B C •  Demonstrates the aggregate
0.9
effect of all the uncertainties
0.8

0.7
by both their impact &
0.6 prevalence
0.5
0.4 •  Shows the probability of
0.3 important intervals and the
0.2 opportunity for optimization
0.1
0 •  Shows if one decision
Low High dominates another
Value Metric


SENSITIVITY ANALYSIS - WHAT REALLY
MATTERS AND WHAT TO STOP ANALYZING
Value Measure of Primary Objective
0

Effect of Uncertaintyi on Value Measure

Critical
Value
Drivers

Minor
Value
Drivers


ASKING “WHAT IF” QUESTIONS CAN CREATE
TREMENDOUS VALUE IN A DECISION

Value of Information
What if we had better information?
What would it tell us? How much should
we pay for it?

Value of Control
What if we more had leverage over
critical uncertainties? What might we
do? How much should we pay for it?


“WHAT IF” WE COULD REDUCE THE RISK
WHILE CAPTURING THE UPSIDE?

A B
1
0.9
0.8

0.7 Hybrid Strategy
0.6
Hybrid
0.5 ™  Limits downside to A
0.4
0.3 ™  Captures potential of B
0.2
0.1
0
Low High
Value Metric


DECISION ANALYSIS PROCESS FLOW

Discovery and Framing Policy

Strategic

NPV Tactical

Cost Revenue

Do we understand the situation What outcomes are
and our strategic question? we targeting?
What decisions & creative
strategies to consider?
Quantifying Insights Low
High Strategy, NPV, M$
Base Value: $360
$100 $150 $200 $250 $300 $350 $400 $450 $500 $550 $600

Uncertainty One

Uncertainty Two

Uncertainty Three

Uncertainty Four

Uncertainty Five

Uncertainty Six

Uncertainty Seven

Uncertainty Eight

Uncertainty Nine

Uncertainty Ten

$ How to realize the
What are the ranges of How to gain insights from the value through effective
uncertainty and risk? uncertainty to maximize value? implementation?


AUDITS HAVE SHOWN MAJOR BENEFITS
OF DA OVER TRADITIONAL METHODS
Value realization from alignment
and effective execution

Value of framing & ROI increases from measurement
and continuous improvement
quantifying alternatives

Value of
Economic Value

focusing on the
right problem

Value promised Audited results:
in the business case 80% do not achieve their
business case number

Opportunity Alternatives Transformation Implementation Measurement &
Identification Evaluation Roadmap and Change Optimization

USED BY PERMISSION OF CHEVRON CORPORATION 47

IT FEELS LIKE MORE TIME UPFRONT, BUT A
BETTER DECISION IS IMPLEMENTED SOONER

Quantitative
Save time & energy,

Decision
Decision Analysis

Making
Create
Definition
Options create confidence.

Traditional
Definition

Solution Decision Re-visit
Decision Development Making Decision
Making

Recycle
time


QUESTIONS?

Gerald A. Bush, Ph.D.
Tel: (678) 641-6254
Email: gabush@mac.com

Robert D. Brown III
Tel: (678) 947-5997
Email: rdbrown@incitedecisiontech.com


SELECTED READINGS
“Value Focused Thinking: A Path to Creative Decision-making”
by Ralph L. Keeney

“How to Measure Anything: Finding the Value of Intangibles in Business”
by Doug Hubbard

“Smart Choices: A Practical Guide to Making Better Decisions”
by John Hammond, Ralph Keeney and Howard Raiffa

“Why Can't You Just Give Me The Number?
by Patrick E. Leach

“Decision Traps”
by Edward Russo and Paul Shoemaker

“Against the Gods: The Remarkable Story of Risk”
by Peter L. Bernstein

Bush tag seminar 06 mar12

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