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John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 1
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© 2011 John Favaro
Managing Architecture for Value
Managing Architecture for Value
IEEE Software
Associate Editor-in-Chief
Management [email protected]
John Favaro
Intecs S.p.A.
Pisa, [email protected]
SATURN2011
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© 2011 John Favaro
Managing Architecture for Value
Upcoming IEEE Software Highlights
Special Issue on the Software Businesso July/August 2011
o Guest Editor together with Shari L. Pfleeger / Dartmouth
Software Company Business Models
Sharing Source Code with Clients: A Hybrid Business and
Development Model
Developing Cloud Business Models: A Case Study on
Cloud Gaming
Matching Open Source Software Licenses with
Corresponding Business ModelsIEEE
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 2
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Managing Architecture for Value
A Man You Can Trust
An “elephant in the room” is a metaphor for the behaviour of people who deliberately ignore an impending issue. They are fully aware of some major issue that really must be tackled or decided upon, but everyone keeps busy tackling other, often small items, ignoring the big issue, pretending it does not exist, hoping maybe that it will vanish by magic or that someone else will take care of it; that one day the elephant will have left the room.
Elephants in the Agile Room
Philippe Kruchten
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© 2011 John Favaro
Managing Architecture for Value
An Elephant in the Room
…
13. Business value
o… mentioned everywhere, but not
clearly defined, or pushed onto
others to resolve
…
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 3
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Managing Architecture for Value
Getting Business Value from IT
9 June 2005 – London
Panel Discussion and Keynote CEO, Diageo:
Getting Business Value from IT
“Our overriding business objective is to create
shareholder value. It is in this context that I like to
discuss my views on the creative and destructive
powers of technology.”
“As business leaders, we have to stop and ask
ourselves: what value does IT create for our
shareholders?”
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© 2011 John Favaro
Managing Architecture for Value
Creating IT Business Value is Difficult
Let’s start with some basic observations
Spending on IT is about 2.5 trillion dollars today, half of all corporate spending
Investments are huge and failure rates are high*o Gartner Research: on average, 20% of the corporate IT
budget is spent on initiatives that don’t achieve their objectives
Clearly, creating business value with IT is very difficult – but why?
* Source: “Getting IT Right”, Harvard Business Review
John Favaro / [email protected] 18 May 2011
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Managing Architecture for Value
A CEO’s Point of View
Two major reasons why IT too often does
not create business value:
One is related to finance:
Lack of financial discipline in evaluating
technology related investments
The other is related to strategy:
Difficult to sustain technology-based
competitive advantage
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Managing Architecture for Value
Finance: Lack of Discipline
Management often lacks the financial discipline and processes for evaluating technology investmentso “64% of the CIOs interviewed did not have to defend their IT
spending against budget and did not undertake any follow-up to determine whether IT projects failed or succeeded” *
o No idea of whether they are making efficient use of capital and producing Economic Profit rather than merely accounting profit
A CEO’s opinion:o “If business goals are clear, a way to determine the value
technology creates should exist. The inability to determine at the outset the impact an investment has on the business is an early warning sign of failure.”
o “Imagine trying to make your investment decision if you can’t calculate its Net Present Value”
* Source: “How IT spending is changing”, McKinsey Quarterly
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Managing Architecture for Value
Strategy: Replicable IT
Information technology is easily replicatedo It is easily accessible and evolving at a rapid rate
o Any advantage gained quickly erodes as competitors catch up
As much as 85% of technology investments goes into infrastructure (including product line architectures for mobile platforms, …), which is an easily replicable commodity, with only 15% funding front-end innovation
Even front-end innovation is often easily and quickly replicatedo How long did it take to replicate the first Intel chip
technology?
Even front-end innovative software products and services are often easily replicated (much of the iPhone environment, including many apps, has been replicated in other mobile environments)
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Managing Architecture for Value
Another Man You Can Trust
Harry Truman
“What is business value?”
John Favaro / [email protected] 18 May 2011
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Yet Another Man You Can … Trust …
“Let’s start with intrinsic value, an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses.”
“Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”
Warren Buffet
This is business value …
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Business Value in Discounted Cash Flows
The Business
...11
2
21
k
C
k
CBusiness Value =
Where Ci are the yearly cash flows and k is the discount rate
Can you work with this?
John Favaro / [email protected] 18 May 2011
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Evaluating Infrastructure Investment
Infrastructure Investment
Market Entry
Investment and development of enterprise application infrastructure
Emerging, uncertain, high potential market
high growth?
See also: J. Favaro and K. Favaro, “Strategic Analysis of Application Framework Investments,” in: Building Application Frameworks
Discounted Cash Flows + Real Options Techniques used for evaluating attractiveness of application framework investment
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A Stream of Economic Profits Over Time
See also: J. Favaro, “Value Based Management and Agile Methods,” XP2003
Business Value = =
This year … Next year … …
EP1 + EP2 + EP3 +
where EPi = Economic Profit = Profit minus a charge for the capital used
Can you work with this?
John Favaro / [email protected] 18 May 2011
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Managing Architecture for Value
Three Perspectives onto Economic Profits
Profitability x Revenue Growth
Business unit EPs+Cross-BU EPs
Each perspective provides a complete equation for Economic Profit
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Three Tensions
Profitability versus
Growth
WholeversusParts
Each perspective also provides a lens on three tensions in management
John Favaro / [email protected] 18 May 2011
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Something You Can Work With
Growth Profitability
Short Term
Whole Parts
Long Term
Successful management of these three tensions leads to value creation
See “The Three Tensions”
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Managing Architecture for Value
The Problem
Take another look at the equation for Economic Profits
Economic value is created by the combination of
o Growth and profitability
o Short term and long term
o Whole and parts
Yet they seem always to function as opposites
o Improve one, and the other goes down
o That will not lead to value creation
o Opposites cancel out
The key and the challenge: find the common bonds that
unite them and resolve the tension between them,
making both possible
John Favaro / [email protected] 18 May 2011
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Managing Architecture for Value
Patterns Are a Common Technical Bond
Patterns are an example of a common bond that
resolves tensions in design and architecture
o Time versus space
o Flexibility versus efficiency
o Extensibility versus simplicity
o ….
Patterns often make it unnecessary to choose between
one architectural quality and other
o They make it possible to have both
They add technical value to an architecture
Similarly, common management bonds add economic
value by resolving management tensions
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Opposites?
There are many ways to enhance growth
o Expanding your product lines (“product line technology”?)
o Adding new services to existing products (SaaS / SOA?)
o Increase market share by discounting strategies (“value for money”)
There are many ways to enhance profitabilityo Increase efficiency, e.g. through lean or agile processes
o Raise prices
o Outsourcing (big IT topic, think also “global software engineering”)
But they are usually considered to be opposites. Can both be achieved at the same time?o What is the common bond that resolves the tension between growth
and profitability?
John Favaro / [email protected] 18 May 2011
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The Common Bond: Customer Benefit
The common bond that unites profitability and growth is customer benefito The customer benefit of a product or service is not what the
product or service can do
o Rather, it is the reward that customers receive through their experience of choosing and using that product or service
Customer benefit is not that hard to measure (indirectly)o The measure of customer benefit is willingness to pay
o Thus an increase in customer benefit manifests itself in a higher price without losing market share, or a higher market share without having to lower prices .. or both
o If that doesn’t happen, then there is probably no customer benefit
Sounds obvious and easy, doesn’t it?
See D. Dodd & K. Favaro, The Three Tensions
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Customer Focus = Customer Benefit?
Management innovation in the last five decades was all about sales and marketing – customer focuso All the innovations concerning e.g. customer relation
management (CRM), brand positioning, etc.
o In software development, agile processes focus on delivering business value to the customer
o A current buzz-phrase is “customer-centric development”
Incredible though it may seem, customer focus can also result in unprofitable growtho Companies confuse “customer focus” for “a focus on customer
benefit”
o Agile processes alone cannot distinguish customer benefit from customer focus
John Favaro / [email protected] 18 May 2011
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The Customer Focus Trap
Trap: confusing features with benefits
The obvious strategy for increasing customer focus is to improve what you offer customers to distinguish it from otherso But it is surprisingly easy to add features without
adding benefits
o Study: 80% of companies thought they were delivering a superior customer experience – only 8% of their customers agreed
o Technology can create benefit, but it is not always functionality that brings the most benefit from a new technology – Apple has delivered customer benefit through fashion in recent products
Expanding product lines with variants can be a way to reflect differences across customerso But unless it materially adds to customer benefit, it
will likely lead to a proliferation of low-volume lines
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The Piranha Pond
An efficient market is like a pond full of piranha
Intelligent, competitive investors are hungry for information
As soon as new information arrives, they pounce upon it and “strip it to the bones”
o Disseminate it
o Analyze it
o Act upon it
Result: the market always reflects the effects of all available information
o plus whatever is implied for the future by available information
Information-hungry investors in an efficient market
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Efficient Markets Separate Past from Future
In an efficient market, everything that might be relevant in predicting a stock’s future price has already been consideredo E.g. if you think a stock’s price will rise in 2 weeks, you buy it now
Only truly new information can influence market movementso But truly new information is by definition unpredictable
The market follows a random walk in response to random arrivals of new information
?
?
?Past Future
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An Agile Metaphor: Efficient Projects
There is an interesting analogy between efficient markets and efficient projects
YAGNI is all about implementing exactly and only what is implied by the available information
Projects developed with agile methodologies disseminate new information quickly and completelyo Collective ownership
o Pair programming
o Constant refactoring
o Frequent stand-up meetings
o Absence of fixed roles (“Chief Architect”) that tend to compartmentalize information
As in efficient markets, common knowledge is created in efficient projects
Efficient markets
Efficient projects
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A “Law of One Architecture”?
Extreme Programming projects are characterized by emergent architectureo Developed incrementally as information
is absorbed
Two forces at work o simplest possible implementation and
relentless refactoring place downward pressure on complexity
o failing tests place upward pressure on complexity
Result: complexity of architecture is generally appropriate to the information availableo The best unbiased estimate
o A kind of “architectural arbitrage”
simplicity,refactoring
See also: J. Favaro, “Efficient Markets, Efficient Projects, and Predicting the Future,” XP2004
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The Broader Context?
How does the concept of Efficient Projects manifest itself
in architecture today?
A project with technical debt is an inefficient project
o It does not implement everything that is implied by the available
information
What about the broader management context?
o This is related to the broader problem of managing the tension
between the short term and the long term
o Does the market prefer the short or the long term?
John Favaro / [email protected] 18 May 2011
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The Market Values Both Short & Long Term
Growing earnings today and on a path to making money tomorrow
Average TSR = 21%
Not growing earnings today, but on a path to making money tomorrow
Average TSR = 12%
Growing earnings today, but on a path to losing money tomorrow
Average TSR = 6%
Not growing earnings today, and on a path to losing money tomorrow
Average TSR = 1%
Source: The Three Tensions
Biased toward positive
Biased toward negative
Biased toward negative Biased toward positive
Tomorrow’s PerformanceCumulative Economic Profits over
subsequent five years
Today’s PerformanceEarnings Growth This Year
Total Shareholder Returns (TSR) over a 15-year period for 1000 companies
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The Common Bond: Sustainable Earnings
Past Present Future
Sustainable Earnings
Sustainable earnings are those earnings that are not influenced by borrowing between timeframes
Earnings can be borrowed from the future by deferring investment that will have to be made
Earnings can be borrowed from the past by continuing to exploit obsolete technologies and capabilities
Sustainable earnings are the common bond between the short and long term
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Borrowing from the Future
There are many ways to increase your current, single-year earnings
without actually increase performance
o Postpone projects requiring upfront investment
o Cut R&D, marketing, and any other discretionary spending whose
benefits are felt after the current year
o Sell assets – facilities, equipment, whatever you can put down as a
capital gain this year
o In general, postpone costs into the next year or pull earnings into the
current year
But this isn’t sustainable
o This isn’t renewing the assets necessary to keep earning
o It’s moving earnings between timeframes without any economic reason
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Managing Architecture for Value
Borrowing from the Past
Earnings increases from squeezing more performance out of a
business model whose time has passed are also unsustainable
The Boiled Frog Syndrome
o This happens when technologies or capabilities
that have produced earnings in the past must be
replaced rather than renewed
o Telecom networks, moving to the web, electronic
publishing
o Assets have become unable to compete with
newer assets that deliver more value
More evolution than revolution – sometimes the transition is extremely
gradual and it’s not clear when the move must be made
“Should we move to the Cloud?”
“Should we go mobile?”
The frog who doesn’t realize he is slowly being boiled – until it’s too late
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Borrowing from the Present
We have seen how we penalize the long-term by
borrowing from the past or future
o Now let us see how we penalize the short-term by borrowing
from the present
We borrow from the present through excess investment
o Excess investment is investment (money, time, people, effort)
beyond what is necessary to achieve the future profits for
which it is designed
Excess investment hurts the short-term
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Managing Architecture for Value
Penalizing the Short-Term
All things being equal, the less money you need to build tomorrow’s business, the less often you will have to choose between today and tomorrowo Cutting back excess investment is in
itself a way to increase sustainable earnings, because it doesn’t harm the future
In IT, excess investment is everywhereo Over-specification of systems
o Bad cost control
o Bad process management
Gold-plated keyboard
John Favaro / [email protected] 18 May 2011
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How to Avoid Borrowing From the Past
What you can do:o Take every technological development in your area of
business dead seriously
o Allocate management time for re-evaluation of business models and future sustainability
o Establish an “observatory” of technological evolution relevant to your business Look broad and deep – “substitution” is a key factor in IT
obsolescence
Look for the symptoms
o Simply raising prices on ongoing projects and personnel in order to squeeze more revenue
o The “cash cow” syndrome: becoming complacent about a successful business model – a classic trap for IT service companies who just place personnel and then sit back
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How to Avoid Borrowing From the Future
Look for the symptoms
o Start-stop investing
o Technical debt – deferred
implementation, maintenance,
even professional
development
What you can doo “Dollar cost average”
investment – don’t fall in the trap of investing only in the good times
o Make a realistic analysis of the potential for growth in your sector – you’ll still be the best
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 19
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How to Avoid Borrowing from the Present
Look for the symptoms
o Bad project management skills –
wasting time, money
o “Gaming” the funding process
o Buying new equipment when
current equipment would do the job
What you can do
o Lean processes can help
o Strive for correct funding levels
o Master time management
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Managing Architecture for Value
Managing for the Short and Long Term
You manage for the short and long
term by managing for sustainable
earnings
Manage the long term by managing
how the short term is produced
Don’t just hold post-project technical
retrospectives – hold post-earnings
retrospectives
o Where did those earnings come from?
o Did they steal from the past or future?
o Did they contribute to building sustainable earnings?
Retrospectives are not just for agile developers, but also for managers
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 20
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Managing Architecture for Value
Where Does Speed Really Count?
Where is it really important to be “fast” today?
Where can speed and efficiency really make a
difference?
Technological development?
o To some extent – but we have seen that technological
advantages can erode quickly
What about the speed and efficiency of the decision-
making process?
o A real effect on sustainable earnings
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Managing Architecture for Value
Which Resources are Scarce?
Capital is not scarce
o Capital is available but expensive
o Warren Buffet is always ready to help
Talent is not scarce
o Talent is available but expensive
“[In November 2010], Google gave every employee a raise of 10 percent or more. The motivation was, in part, the ‘war for talent,’ [CEO Eric] Schmidt said. People who have other job offers have been persuaded to stay with seven-figure bonuses.”
- New York Times, 29 November 2010
In April 2011 Microsoft announced raises for its employees – as part of the war for talent.
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 21
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Managing Architecture for Value
The Scarcest Management Resource
Some conclusions from the study:o Management teams often spend little time
together: average of only two days per month
o Only 5% had any kind of disciplined process for setting agendas
Ironically, they all had a rigorous and disciplined process for allocating capital and for assigning and developing talent
Yet no process for managing the only scarce resource: time
The only real scarce management resource is timeo A one-year survey of 187 companies
to understand how top management time is invested (or squandered)
o Focus on the corporate decision-making process
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Managing Architecture for Value
80% of the Time Spent on 20% of the Value
Total Top Management Time 250 hours / year
Subtract from that:
Operating performance reviews 62
Crises of the moment 27
Administrative issues and policy 22
Workforce issues 22
Corporate governance 18
Financial policy 14
Investor communications and guidance 12
Team building 11
Succession planning 10
Litigation 6
Community service / social responsibility 6
Other 3
Time left for strategy development 37 hours / year(Marakon Commentary Winter 2005)
Managers tend to let the urgent crowd out the important
John Favaro / [email protected] 18 May 2011
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Managing Architecture for Value
Efficient Decision-making Process
How managers allocate and spend their time is a hidden determinant of their ability to grow sustainable earningso Allocate management time based on value at stake
o L. Northrop, SEI: A seemingly successful product line team was spending all its time in useless meetings
Measure the real, sustainable value of every item on the agenda
Is it really possible to do that?o Consider this: “we have five things we need to discuss, and one
of them is worth 20 times the other four combined.” Where would you start?
Estimating the sustainable value of every agenda item in a strategy meeting is one of the most powerful tools to help set prioritieso Do the exercise before the meeting in order to set focus
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Managing Architecture for Value
Opposites?
“Whole” versus “Parts” is in
large measure about
centralization versus autonomy
Should operations be
centralized in a corporate
center?
Should operations be
decentralized in
business units?
How much autonomy
should a business unit
have?
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 23
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Managing Architecture for Value
Leaders and Followers
The “whole” versus “parts” issue comes up often in
architecture
o In roles and competencies: the “lead architect”
o In assets: central development / pool of reusable assets in
product line development
Source: IBM
How is the problem of
centralized asset
development reconciled
with autonomous product
development?
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Managing Architecture for Value
Coordinated Agile Architecture?
There is much interest in agile approaches to architectureo But we have just seen that much
architecture work implies some form of coordination
Distributed agile development has brought out the problem of reconciling the classic autonomy of agile teams with the overall coordination necessary for distributed development
How does the issue manifest itself in corporate management?
What lessons can be learned from o Mergers & Acquisitions?
o Central and independent business units?
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 24
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Managing Architecture for Value
Vertical versus Horizontal Value
Vertical value depends only on the relationship between
the corporate center and the business unit
Horizontal value is performance added through
coordination with other units
Business Unit
Corporate Center
Business UnitBusiness Unit
Ver
tica
l va
lue
Ver
tica
l va
lue
Ver
tica
l va
lue
Horizontal value
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Managing Architecture for Value
Which is Easier?
There are traps endangering both vertical and horizontal value
The Centralization Trapo Textron CEO: “One thing you have to watch out for is the
tendency of people running central functions to focus more on their efficiency than their value to customers”
The Autonomy Trapo The more you free up business units to act independently, the
more they will cite “accountability” as a defense from any kind of central interference
o Equating accountability (responsibility for outputs) with authority (decision rights over inputs)
o Narrow, myopic boundaries of vision. Alcan CEO: “What crime is there in knowing something about your business?”
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 25
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Managing Architecture for Value
Another Elephant in the Room
…
12. Abdicating responsibility for
product success
…
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Managing Architecture for Value
M&As Generally Don’t Work
It is well accepted that Mergers and Acquisitions are a
seller’s market
o (Look at what happens to the respective stocks)
They rarely add up to the sum of the two businesses
There are many, many examples of this in the tech industry
“The H-P Compaq Merger Two Years Out: Still Waiting for the Upside” – Oct. 2004
Where does the fundamental problem lie?
John Favaro / [email protected] 18 May 2011
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Yet Another Elephant in the Room
…
15. Culture
o… better understanding of the
concept of culture, at the
organization level and …
…
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Managing Architecture for Value
Culture Clashes
In corporate mergers, it is nearly
universally the clash of corporate
cultures that makes them fail
Even within corporate business
structures, it is the culture clash
that leads to failures
o A Culture of Autonomy creates
barriers to sharing and cooperating
o A Culture of Centralization can
damage the motivation of individual
business units to perform better
Once again, the goal must be to add both horizontal and
vertical value at the same time
o Where is the common bond?
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 27
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Managing Architecture for Value
The Common Bond: Diagonal Assets
Vertical Assets• Specific market position• Local knowledge• …
Horizontal Assets• Shared service units• Corporate branding• …
Diagonal Assets• A sense of connectedness• Common aspirations• Shared sense of “how we do
things around here”• Cultural values
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Diagonal assets make it possible to add vertical and
horizontal value at the same time
Don’t centralize or decentralize: do both at the same
time
o Strengthen the center even as you strengthen the parts
“Centralize policy, decentralize operations”
o This can also be in the form of standards
Companies are enterprises, not confederations
o The company must keep firm control of
Strategic planning
Cultural values
Controls
Performance measurement
Both Whole and Parts
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 28
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“Balance” and the Corporate Cycle
If there is one lesson here, it is that “balancing” can be a sign that something is wrong
“Balancing” perpetuates the corporate cycleo And it perpetuates the
cycle of IT fads and trends
Concentrate on strengthening the common bondso They resolve the tensions
and make it possible to have both
o This is managing for value
See “The Three Tensions”
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One Last Elephant
…
13. Managers and management are
bad
o… as an instance of pushing any failure
to others?
John Favaro / [email protected] 18 May 2011
Managing Architecture for Value 29
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Managing Architecture for Value
The “Both” of Business Value
“… it is good management – not technology – that
creates value in business.”
While technology is too easy to replicate, innovative
business changes are generally too difficult for the
competition to replicate
The key is not to master only technology, or only
management, but both of them together
It was demonstrated in a study by McKinsey and the
London School of Economics that the combination of
technological and managerial excellence creates
significant, sustainable competitive advantage
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Management Impact versus IT Impact
+8% +20%
+2%0
Man
agem
en
t-p
ract
ices
sco
re
75th percentile and above
25th percentile and below
Comparative influence of Management and IT on Total Factor Productivity
Source: London School of Economics – McKinsey
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Managing Architecture for Value
On the cusp
Architecture is unique among software engineering
disciplines
It lives on the cusp of the technical and management
divide
Architecture sees farther than the other disciplines, including agile
Architecture really can be managed for value
But it is not automatic
The challenge of great management must be accepted
slide 60SATURN 2011
© 2011 John Favaro
Managing Architecture for Value
THANK YOU!
Managing Architecture for Value