Cost Cutting for Grown Ups

To calculate the cost of an investment, we multiply two amounts:

  1. The total day rate
  2. The duration of the investment

For example, for a day rate of £20,000, and an investment duration of 20 days, the cost is £400,000.

screen-shot-2017-01-29-at-12-32-50

We then receive a “memo” from the finance department that the CFO has failed to do his job properly and secure funding for the investment and you need to cut costs. How do we do this? There are two options, we can cut the day rate, or we can cut the duration of the project.

In the day rate example, we decide to slash and burn the team. We cut the team size in half to £10,000 per day, but what happens to the duration of the project? Well the same amount of work needs to be done, so the duration doubles to 40 days. Have we reduced the costs? No, not at all.

screen-shot-2017-01-29-at-12-33-05

In the duration example, we increase the size of the team (ignoring mythical man month for now) to 40 people, and the duration halves to ten days. Have we reduced the costs? No, not at all.

screen-shot-2017-01-29-at-12-33-29

Now lets consider the overhead costs.

Not all of the day rate goes to the value stream delivery capability. Not all of it is spent on product owners, developers and testers… A lot of the daily rate is due to overhead, people on the project that:

  • Assist the value stream. e.g. Scrum Masters who facilitate the developers.
  • Support improvement in the value stream. e.g. Agile Coach.
  • Governance. e.g. Architects, Finance or Assurance individuals
  • Management. e.g. Project managers and Line managers
  • Administrative support. e.g. PMO or personal assitants

Normally, some of the “overhead” is considered specialist in nature or it is not acceptable for a single individual to wear two hats (for fear of conflicts of interest).

In addition, we assume that the overhead is already as small as it can be, and that the overhead does not have to scale if the value stream delivery capability increases (which is a fair assumption).

As such the overhead part of the day rate is more fixed. It is the value stream capability that is often adjusted.

Now lets consider our example from earlier and consider the impact of the overhead costs. The costs now look like the following:

screen-shot-2017-01-29-at-12-33-50

Reducing the daily rate results in doubling the overhead costs.

screen-shot-2017-01-29-at-12-34-02

Reducing the duration results in halving the overhead costs.

screen-shot-2017-01-29-at-12-34-15

The following graph shows the impact on the overall cost of adding or removing ten percent capacity to the value generating capacity for different percentages of cost overhead.

costaddremovecapacity

This leads to the conclusion that there are two effective strategies for reducing the cost of an investment:

  1. Reduce overhead (or Muda as it is known in Lean)
  2. Reduce the duration of the investment (or lead time as it is known in Lean)

Why do people reduce the day rate?

The reason people reduce the day rate is because they can immediately demonstrate to their superiors that they are reducing costs. In other words, they do it because it is easy.

A more effective demonstration of competence would be to show that less investment dollars were stuck in the development machine by reducing the weighted lead time of the department. By reducing the weighted lead time, we create more options for the business investors.

I would like to thank Dale Steanson for having the patience to let me ramble through this explanation and get it straight in my mind.

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About theitriskmanager

A IT programme manager specialising in delivering trading and risk management systems in Investment Banks. I achieve this by focusing on risk rather than cost. A focus on costs can lead to increased costs. View all posts by theitriskmanager

2 responses to “Cost Cutting for Grown Ups

  • Steve Freeman

    you forget the other “reduce the day rate” trick, which is to cap it for individuals. This looks good in accounting but also has the effect of forcing out your most qualified people, and the results won’t show for a while. We know of at least one CIO who applies this technique everywhere he goes. As long as he moves every 2 years, before the downside kicks in, he does very well.

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