I've been telling myself that I needed to attempt to apply formal investment portfolio management techniques to how we value, prioritize and manage our portfolio of product development efforts, so here goes (definitely still a work in progress)
Back in 1950's Dr. Harry Markowitz created an investment model called the 'Efficient Portfolio'. Markowitz stipulated with his theory that an "Efficient Portfolio is one where no added diversification can lower the portfolio's risk for a given return expectation (alternately, no additional expected return can be gained without increasing the risk of the portfolio)".
The Markowitz Efficient Frontier is the set of all portfolios that will give the highest expected return for each given level of risk.
This model set the framework for how current money managers build a portfolio of securities that provide range of investment returns to meet each investors risk profile. Providing investors with a broad range of risk/return choices allows individual investors to build an investment portfolio that meets their specific risk threshold with respect to a given rate of return.
An efficient portfolio looks like this:
When you are younger and have time to take chances your risk/return profile might be higher on the frontier, whereas at retirement you will slide down that scale as you are more interested in protecting your total investment. One thing to note is that if your risk/return data falls above the efficient frontier, then you are accepting a level of risk that is not in line with the rate of return you might receive. Pushing past the efficient frontier can open you up to unexpectedly high returns but conversely you can also expect very high negative returns due to the risk you are taking on.
Product Development organizations can utilize the Frontier as well, for example, a young startup will have a much higher appetite for risk as they understand that to take market share from competitors they need to take risks with speed to market. However there are specific elements of risk that need to be considered as you speed your product to market. Ensuring that Usability has been considered, Prototypes have been developed, code quality is considered and test automation all need to play part when you are building your risk/return Efficient Frontier for your Product Portfolio.
If we were to apply the Efficient Frontier to how we manage our Software Development investments we could build a risk/return profile that is easy to understand and align with the organizations risk/return profile. There are many software projects that at inception are known to be risky, however a lack of empirical data often means that the projects will get the green light and then fail miserably. The organizations inability to accurately asses risk/return at any time with their software development investments is a huge blind spot and keeps us from consistently delivering the value that the organization needs to stay competitive.
Agile addresses the value (return) part of what the Efficient Frontier speaks to however it talks nothing of Risk overtly. Risk is more implied with the notion that we manage it by delivering in short increments and focus on shipping value consistently. However Risk is more quantifiable as I mentioned earlier.
Building an Efficient Frontier in the investment world is a data intensive effort, which our current product/software development processes doesn't easily support. However I believe that we can use the formula that Markowitz created to generate an Efficient Frontier for Product and Software Development organizations.
For this effort we will make some assumptions with respect to the Frontier model and changes to Markowitz's formula so that it works with our limited data set:
- Portfolio = Product Development
- An organization can have several Products in their Portfolio -
- Consumer Facing
- Internal Facing
- Infrastructure
- Research and Development
- An organization can have several Products in their Portfolio -
- A security is equivalent to a Scrum Team.
- These would equate to the individual securities that Markowitz speaks to in his model. Where an investment portfolio consists of many securities, each with their own risk/return profiles so to does an organizations product development portfolio consist of the same. Each team is a security that can on its own provide return that comes with an associated risk.
- Though we don't think of investment securities as having dependencies (as software development teams have) in fact a diversified investment portfolio consists of a range of investments that will perform a certain way based upon the dependency that business has to the market that they operate in, so in this case the notion of a portfolio still holds as a viable means to build a Product Development Efficient Frontier.
- Potential Risk Parameters:
- Development Lifecycle - Waterfall, Agile, RUP, XP, Blended (use at macro level). You could equate this potentially to Bonds, Stocks or other investment instruments.
- Experience of Team
- Number of Scrum Teams
- % Test Automation
- Code Complexity
- Speed to Market
- Roadmap volatility
In my next post I'll provide some supporting ways we can 'build' an efficient frontier for Agile Product Portfolio analysis that both Product and Program Managers can utilize to assess priorities for the entire organizational backlog.