Business Value Optimization - Made Easy!

Business Value Optimization - Made Easy!

August 20, 2023

Why this article?

We work with a lot of different companies - more and more in agile or hybrid mode. But regardless of the mode, the challenge of portfolio management and decision-making is becoming more and more critical, yet no one is addressing it. Everyone is focused on value streams, product teams, or whatever - but no one is really calculating business value or even optimizing it for the overall organization. We now believe the reason is that "the current way of calculating and optimizing business value is so complex that no one is willing (or able) to do it" - maybe it's so complex that even if you do it, no one will trust it (which I completely understand).

So, this article gives an idea of how to simplify business value optimization based on the Theory of Constraints.

"Best" Practice - What is this thing called Business Value?

For best practices, I often ask ChatGPT-4. Here is a good but complex and lengthy answer. You don't have to read it in detail or remember it - just get an overview of what I'm talking about here:

<chatGPT4>

"Business value" is a broad term that can refer to the tangible and intangible value that a project, process, product, or any business-related initiative brings to an organization. The calculation or estimation of business value can vary widely based on the specific context, goals, and methodologies being employed. There are, however, some common methods and components that businesses consider when determining value:

1. Financial Value: ROI (Return on Investment): It is calculated by dividing the net profit of a project or initiative by its costs. ROI = (Net Profit / Cost of the Investment) x 100 NPV (Net Present Value): This calculates the current value of a series of future cash flows minus the initial investment * Payback Period: This measures the time it takes for the returns of a project to cover the initial investment.

2. Operational Value: Efficiency gains (like reduced processing time or cost savings) * Enhanced capacity or capability.

3. Strategic Value: Alignment with strategic goals or filling a strategic gap Competitive advantage or market positioning * Enhancement of brand reputation or recognition.

4. Customer Value: Enhanced customer satisfaction or loyalty Increased customer base or retention rates * Reduction in customer complaints or service calls.

5. Employee Value: Employee satisfaction or morale Reduction in turnover rates * Skill development or learning opportunities.

6. Innovation and Growth: Potential for future growth or scalability Spawning new product or service opportunities * Intellectual property or technology acquisition.

7. Risk Reduction: Decreased vulnerability to market fluctuations Improved compliance or reduced legal risks * Enhanced data security or business continuity.

8. Intangible Value: Knowledge acquisition or intellectual property Enhanced business relationships or partnerships * Improved organizational culture.

Because business value includes both quantitative and qualitative measures, it's essential to recognize that the calculation might not always be a precise science. Different stakeholders may also have varying perceptions of what constitutes value, so engaging a broad range of perspectives and being transparent about assumptions and methodologies can be vital.

</chatGPT4>

You got it - did you understand, and can you remember all the aspects? I can't. Oh, oh - this is already extremely complex - maybe that is the reason why I have never seen it happen?

"Best" Practice - How to optimize the Business Value of the whole Organization?

And again, I asked ChatGPT-4. Here is also a good but complex and lengthy answer that describes an algorithm for optimizing. You don't have to read it in detail or remember it - just get an overview of what I'm talking about here:

<chatGPT4>

Optimizing business value holistically for an organization is a complex endeavor. Here's a simplified algorithm that can serve as a foundation. The algorithm focuses on capturing data, assessing value drivers, implementing changes, and iterating based on results:

1. Define Objectives and Priorities: List the organization's mission, vision, and strategic objectives Define clear, quantifiable goals related to profitability, growth, market share, customer satisfaction, employee satisfaction, and any other relevant metrics * Prioritize these objectives based on strategic importance.

2. Identify Value Drivers: For each department (like sales, marketing, finance, HR, and production), list potential value drivers (e.g., lead conversion rates for sales and brand recognition for marketing) For each value driver, estimate its potential impact on the defined objectives * Prioritize value drivers based on estimated impact and alignment with organizational objectives.

3. Data Collection: For each prioritized value driver, define metrics that will be used to measure its current performance Implement tools, systems, or surveys to collect relevant data on these metrics regularly * Analyze the data to determine areas for improvement.

4. Brainstorm Solutions: For each area for improvement identified in step 3, brainstorm potential solutions or changes that can optimize the related value driver Estimate costs, benefits, and risks associated with each solution * Rank solutions based on expected ROI (return on investment) and alignment with organizational priorities.

5. Implementation: For each solution from step 4, develop a detailed action plan, including the resources required, timelines, and responsible teams or individuals Execute the action plans in prioritized order * Continuously monitor the implementation to ensure adherence to the plan and make adjustments as necessary.

This algorithm is designed to be iterative. Optimizing business value is a continuous process that adapts and evolves as the organization grows and as the external environment changes.

</chatGPT4>

Oh, oh, oh, oh - this is already the simplified version - this is extremely complex - maybe that is the reason why I have never seen it happen? And if you do it, would you trust it? Imagine you have to do this for 100 incoming ideas - I wouldn't.

And by the way, it's just a rough description. If you want to do it, you need more precise and clear algorithms and formulas that are clear and consistent for everyone.

So there must be a more comprehensible way!

Everything changes (gets easier) if you know your constraint

To make a long story (see above) short, "the current accounting is so complex because it tries to optimize everything!" The main assumption of accounting is that "every team or department has to be efficient - meaning loaded at 100%" and that "if you load every team to 100%, then the overall output is also optimized!"

But that is impossible because every system has exactly one constraint (see Theory of Constraints). Without a constraint, it would grow at infinite speed, explode, or exhaust all resources. And it would die immediately. If it has two or more constraints, it will oscillate and show chaotic behavior. So more than one constraint is possible - but it leads to lower performance, and typically, systems with one constraint will win and take over. So systems with just one constraint have an evolutionary advantage. Another fact - systems that show multiple constraints (chaotic behavior) and are still alive are typically wasting a lot of their capacity on stuff that is never delivered or paid for. If you take this out of the organization, you'll see just one constraint again.

Look here for details about TOC and how to find or define your constraint.

So now, if you believe that there is always just one constraint, everything gets much easier. If you know (or have defined) your constraint, then you typically move as many resources as possible to it, and you'll protect the constraint. I assume that this has already been done.

So now it's all about new ideas popping up, and you have to decide in what order to implement them. The result of all decisions is a ranked list of initiatives according to their business value/importance. And based on the constraint, the algorithm is simple.

What kind of idea is it?

There are two cases: (A) a new feature that brings more sales (or prevents penalties) or (B) a process optimization - which means it has no direct sales impact. You have to find out whether it is (A) or (B) - simple!

And first, we deal with (A) new features - step by step ...

A.1 If this new feature is a real must - meaning that if you don't implement it, you have to close the company due to compliance requirements or legislation ↣ then you have to do it - but as late as possible. So its position on the list is the latest position at which you will still be able to deliver on time, depending on the constraint.

A.2 If this new feature is not a must but has a positive throughput (Sales - Totally Variable Costs) and does not need any constraint resources or lead to a situation in which another constraint pops up ↣ then you have to do it as soon as possible. So it goes into the first position on the list. This does no harm to the other projects because the constraint is not touched.

A.3 If this new feature touches the constraint, then you can calculate the octane number = (Sales - Totally Variable Costs) / constraint units consumed ↣ so you can put it on the list before an initiative with a lower octane number than the new idea.

Just a side note - typical octane numbers are around $10k to $300k per constraint day.

A.4 If this new feature has such a low octane number that it will be delivered so late that it won't generate any sales, or the probability that it will be pushed to such a late delivery is very high ↣ then dismiss it.

That's it - simple!

And initially, you just start with one initiative and process all the others with this algorithm. The result will be the optimal ranking for optimal overall business value.

Ok, now we still have these other initiatives: (B) the process improvements.

They are often even more interesting than the features - but they are not really visible in classic accounting because they do not generate sales - the ROI is minimal. But they interfere with the features - so here, the next part of the algorithm deals with them more appropriately. And here, the constraint also helps a lot.

B.1 The first question is: "Does this process improvement have an impact on the constraint?" There are three cases: (I) it reduces the average constraint consumption of all following features, (II) it increases the average capacity of the constraint, or (III) it prevents flow disruption in the upstream processes before the constraint so that buffer holes are eliminated ↣ if none of these is the case, then dismiss it.

B.2 If it positively impacts the constraint, then you have to do some calculations.

First, you need a rough estimate of the throughput increase [deltaT].

• In case (I), deltaT = 1 / (1 - average constraint reduction) - 1. E.g., 30% less constraint consumption leads to a deltaT ~= +43%.
• In case (II), it's clear - if you get +10% more capacity by making the improvement, deltaT = +10%.
• In case (III), if you can reduce the buffer holes by 1%, then deltaT is also 1%. So the initiatives in class I have the biggest impact.

If you can't sell all of deltaT, then you have to reduce it to the amount you think you can sell.

With this deltaT, the calculation of the bottom-line effect is simple. The base is the current throughput = current Sales - current Totally Variable Costs. Then the revenue increase = current Throughput * deltaT. Those are often astonishing numbers already.

The octane number = current Throughput * deltaT / constraint units consumed. It's often extremely high, and you have to look at it as a "virtual" number, useful only for setting the right priorities.

As a real example, we once had a company as a customer with $2 billion in sales and 50% TVC. DeltaT was estimated (and proved by a pilot) at +60%. Sales said 10% could be sold, and the constraint usage was around two days. You can calculate it yourself! The octane number was $5 million per constraint day! No discussion about priorities - it's first, before all others!

The challenge is that the octane numbers are so huge that you have to put all these process improvements at the top of your list of initiatives. But there are limits.

B.3 So you should prioritize based on the octane number until (a) you can't sell the additional throughput anymore (that was the case in the example above - just one process improvement was enough), (b) must-have features are affected, or (c) you have to postpone too many features or new business opportunities, jeopardizing your growth story.

But pay attention: after making a process improvement, your capacity at the constraint gets better, or constraint consumption goes down - so typically, all the features come faster and earn more money sooner! So typically, it's the other way around - you don't have to postpone features - but you have to find more and better ones!

Even if this algorithm, based on the Theory of Constraints (TOC) and Throughput Accounting (TA), does not look so simple at first - it's much easier because every step is deterministic and easy for everyone to understand. It's a step-by-step approach, so you don't have to calculate everything at once - only when a new idea comes up.

Some more positive Effects

And I'll just use ChatGPT-4 again - it's much better at blah-blah-blah than I am - but nevertheless, every word is absolutely right ...

<chatGPT4>

• Simplify Decision Making: TA reduces the number of financial metrics an organization needs to focus on. Instead of many traditional costing metrics, organizations look primarily at throughput, operating expense, and investment.
• Promote Holistic Thinking: By concentrating on system constraints, TA encourages managers to think about the organization as a whole rather than getting lost in the minutiae of departmental budgets or localized efficiencies.
• Speed Up Response Time: Because TA provides a clearer picture of the organization's true profitability, it allows for quicker decision-making. When a constraint is identified, efforts can be quickly focused on that area without the delays that can come from traditional budgetary reviews or cost allocations.
• Align Operational Decisions with Strategy: By emphasizing constraints, TA ensures that operational decisions are always aligned with the organization's goal (which is often to maximize profitability).
• Focus on Constraints: This narrow focus speeds up the optimization process because the organization is not trying to optimize everything at once; it's focusing on the most impactful areas.

The overarching theme is that by simplifying and focusing on what truly matters (constraints and throughput), the organization can more rapidly optimize its operations and financial performance.

</chatGPT4>

So have fun with TA and TOC - Yours, Wolfram, the BlueDolphin