Published

28

Jan

2019

Position Paper

Mapping #5: Restoring the Proper Balance of Power

Our society is centred around building value. We frown upon internal corporate politics and power games, we have made physical aggression illegal, and we promote healthy competition in the market. Recent studies1 go one step further. They claim that evolution rejected the most aggressive members of our population, because cooperation was more beneficial to the tribe than in-fighting; and that mass collaboration was one of the defining features shaping the transformation of hunter-gatherers into organized communities2.

Mapping #5: Restoring the Proper Balance of Power

While this interesting concept has yet to be verified and accepted widely, we cannot deny that our societies are indeed centred around cooperatively building and providing value instead of fighting for it. Across centuries, that cooperation has become structured and codified. Individuals, corporations, governments, non-profit organizations and other undertakings seem to have very different goals, but

upon closer investigation, they all aim to deliver value to some beneficiary group. Moreover, there is an entire branch of science that covers how value flows through different systems and how it changes in time: Economics.

Note that we use the term ‘value’ instead of ‘money’. Money is just a form of value measurement and comparison – and certainly not the only one; organizations providing non-monetary value can use different measurements (such as QALY – quality-adjusted life year3 – in the health services space).

But no matter how sophisticated a measurement is, it flattens and conceals the true nature of value, removing a lot of important information.

For example, imagine that you donate the equivalent of a latte to a charity supporting a particular orphanage in a third-world country. Measuring this donation financially, as $5/€4/£3, completely distorts its nature – in terms of value, you have donated a term of care for a child in the orphanage, which can create potential for the future or even directly create the future for that child. Meanwhile a latte can improve your mood – but if drank in excess, might bring you insomnia and actually destroy value instead of creating it.

This simple example is not here to make you feel guilty about your coffee, but to highlight the complex nature of value, which extends far beyond the meaning of numbers. Of course, numbers are important, and so is keeping cashflows positive and balances in check, but that is something any accountant can do for you. Understanding and thinking in terms of value is something completely different. It requires a different mindset – the mindset of a CFO.

Let’s get back for a second to the cooperative aspects of modern societies and use of directed power. We, as a society, have indoctrinated ourselves so well that we frown upon intra- organization fights for power and corporate politics, we penalize physical aggression, and we pretend we are not interested even in civilized displays of status and power. More, we bind power to responsibility to ensure that the former is not abused.

In corporations, governance frameworks serve exactly that purpose. They prevent an individual from gaining too much power and building a personal empire or establishing an authoritarian regime to their own advantage. But what those frameworks fail to do is to spot excluded participants who have responsibility for a given domain but insufficient power to shape it; they are likely to become scapegoats.

In particular, CFOs who do not understand the value delivered by the company (e.g. because they are not up-to-date with the most recent market and technology changes or they have insufficient situational awareness) are not able to execute their power and knowledge effectively to the benefit of the company. Despite being master experts in finance, they become just ciphers with a grand title.

The emperor has no clothes

The CFO, without question, is always deemed to be one of the most important persons in the organization, sometimes even more powerful than the CEO.

CFOs are high-profile and powerful because they control their organizations’ money. They act as financial stewards, ensuring that company resources are used in the best possible way. They decide which departments thrive and which are starved of cash, which projects are within the company’s budget and which are too expensive – and whether you are allowed to fly business class.

However, the power of the CFO is limited: the CFO cannot make projects happen, but can only help evaluate their impact on the company and ensure that inefficient projects do not waste company resources. Success in this relies heavily on the assumption that the CFO fully understands the nature of proposed projects and looks at them from a much broader perspective than a purely financial one.

Figure 1 – The power does not come from the title: Emperor Tamarin

A CFO can easily exert real influence on the company.

The CFO has the power to block projects, but if the project is in line with stakeholder expectations, should only do so with very good reasons. Without an understanding of the true nature of projects, the CFO should never exercise this power. So despite possessing expert financial skills, by focusing on just the numbers, the CFO creates a serious power imbalance that could damage the relationship with the rest of the company. Without deep understanding of the business domain, CFOs cannot prioritize projects accurately, and have to rely on others making the right judgements and providing them with the right data.

While fighting for power for the sake of power is frowned upon, it’s essential to make active efforts to restore the proper balance of power between different organizational departments, or performance will suffer.

This paper outlines a mechanism that can help CFOs regain their correct position in the balance of power.

Getting the basics right

Classic project evaluation rules favour calculation of a Net Present Value (NPV) of any given project, to estimate how that project will contribute to the value of a company, expressed in today’s money4. From a mathematical perspective, it is a fairly simple task that most people can easily do, and popular spreadsheets have built-in formulas supporting these calculations. The difficulty is not the arithmetic, but the ability to predict and evaluate the impact of a project, and express it as a financial measurement.

Imagine a situation where you are about to start competing with banks by delivering a particular"service 30 percent cheaper. You can figure out exactly how many users of that service there are, how many would be willing to change provider, etc.; and then calculate how much profit will be brought by those customers and when. But most analyses fail to acknowledge that the banks can – and will – fight back, and that the lifespan of your service is limited. What will happen to the assets created and acquired for the purpose of providing the service? Some of them will be repurposed, but others will be written off, and it may turn out that the project will not add any value because revenue created by the project must be balanced against the write-offs.

It is the CFO’s responsibility to ensure that a project starts only after adequate analysis of delivered value. Sometimes, the marketing team has already gathered enough customer data to help with that task (e.g. the price an average customer is willing to pay for a phone every two years), but the situation is far more challenging for internal projects or projects whose outcomes are difficult to measure (e.g. code refactoring in IT). Inevitably, some of the key variables will not be known in advance, and therefore it is necessary to assume their value. It is vital to make those assumptions explicit for the sake of further project verification (to answer such questions as is it still on track? and has the environment changed?). The knowledge resulting from this analysis should be widely distributed among the project team, so each team member is equipped to raise a hand if something unexpected happens.

A short meeting is enough to clarify what is known, what needs to be researched and what is unknown. It may turn out that the market has yet to be created (i.e. uncertainty is high), in which case there is no way of estimating the NPV, and the company has to accept this project as an experiment and be ready to lose all the investment5.

Defining characteristics

No product and no user need can be totally new or fully predictable. When a completely new solution appears in the general market, it has no customers, nobody knows how to use it, and it is highly likely to change. On the other hand, when a solution is well established in the market and consumers already know how to use it, there is little room for significant change, efficiency is what matters most, and failures are not tolerated. Every product or solution falls somewhere on the spectrum between those two extremes, and the general rule of thumb is that the next"product/solution has to be more efficient than the last or it will not gain any customers6.

At LEF, we have defined four major categories of products, reflecting four stages along the spectrum:

  • Stage I – Genesis. These are newly created, unstable products with no market, so failures are expected. In other words, these are experiments that will pay off always in knowledge, and sometimes, by a stroke of luck, will identify user needs that can be further explored. Typically, these projects will be executed in the R&D department. To keep them under control, you need to manage economic risk by keeping costs down (for example, by restricting project length or resources) and maximize reward if the project is successful by targeting the hypothetical user needs that have the greatest potential. In the long term, a steady stream of these projects can increase the company value if the company is able to monetize newly found knowledge.
  • Stage IV – Commodity/Utility. At the opposite end of the spectrum, there is a well-defined market and every customer who could use a given solution is already using it. Competition is almost exclusively on efficiency expressed as price. This kind of market can be observed, for example, in electricity supply: customers know how to use the solution and how much they need; no upfront investment is necessary; and it does not matter to the customers who provides the solution as long as it is inexpensive and available where they need it. Generally, these are markets of established players, as winning a new customer in a well-defined market is simply too expensive without a breakthrough in efficiency.
  • Stage II – Custom-built. This situation arises after a successful experiment has been conducted, and the search is on for how additional value can be created using the new knowledge it has revealed. The market is not quite there, though users know they have a problem and are looking at the experiment’s results in the hope it will lead to a future solution. Failures are still expected and tolerated up to a point. For example, take the large battery packs used to offset energy demand peaks faster than the grid is able to respond by enabling more power blocks: there are only a few of these battery packs around the world, and they were custom-built for their respective customers. The CFO must look at these projects from two different perspectives:"
    • Knowledge – intense exploration of use cases results not only in better market definition but also in knowledge that will be required to create more efficient versions if the market develops.
    • Individual project profitability – this might be difficult to achieve if the project is executed only once or twice. High uncertainty makes it still a gamble, and the project may fail. The reward must be high enough to make it worthwhile, which limits this phase to really high-profile uses.
  • Stage III – Product/Rental. Knowledge gathered in phases I and II helps develop an efficient product. Customers with a problem are looking for a predictable and risk-free solution, so these are the characteristics you should deliver. Adoption is growing, potential competition is focused on developing new features or improving parameters (e.g. phone manufacturers today) and margins are good. Once improvements become marginal and the market saturates, the product enters stage IV.

A table covering all the characteristics of these stages is given in the Appendix.

Building shared understanding

The previous section outlined a simple method of defining market expectations, market size and project characteristics. With that knowledge, it is possible to prioritize projects and cancel them early if they do not meet market expectations.
It helps to represent the final product (and, later, key components) on the Evolution axis, as shown in Figure 2 below:

Figure 2 – The white dot ‘Use electricity’ shows the stage of evolution of the market for electricity consumption. According to the table in the Appendix, being at the Commodity/Utility stage, it is a very mature user need, ubiquitous, and customers expect that it will be delivered without failures and interruptions. The brand is not important to customers, but efficiency (value for money) is

Such a visualization is simple to draw and read, but it requires multiple people to agree on what the project is going to achieve and how it should look. The value of this process is hard to underestimate, as all involved parties (e.g. financial, legal, technical and marketing divisions) have to build a shared understanding and uncover assumptions.

However, that discussion will reveal only what the market expects, and what needs to be done to deliver it. A different diagram of dependencies, highlighting the most important activities and components necessary to build a proposedsolution, is shown in the example below (Figure 3).

Figure 3 – An example of a value chain that starts with the user need at the top and shows what is required to satisfy that user need

The key challenge in the domain of power production is to figure out how much power should be focused.This requires a mix of skills, practices and assets (not shown here – this is all included in the ‘Produce power’ component). Since launching new generators is expensive and takes time, we could use batteries to store some power and give us a little bit more time to act in response to increased demand. Adapting to demand is easier with large-scale batteries than without them.

Both diagrams can be combined into a Wardley map7 that binds together the evolution axis and the value chain, as shown in Figure 4:

Figure 4 – An example Wardley Map. The X-axis is labelled ‘Evolution’ and it binds together different attributes, including market and maturity because those things are correlated (as detailed in the Appendix). The Y-axis shows how different components are used to deliver value. It is labelled ‘Visibility’ because the end users are closer to the components at the top and are sometimes exposed to them (use them directly in the case of electric power) while components at the bottom are invisible to the users (they do not care how the power is produced nor do they interact with power plants)

To draw this map, first determine the stage of evolution of each of the important components, which defines their characteristics. Representing explicit dependencies on the map will make the major risks in project execution clear8.

Note that it is not the diagram that is important but the process that leads to it, which breaks large projects into small, manageable parts and identifies the uncertainty associated with them. This process gives you complete situational awareness – what will be done, what is the cost structure and what are the key risks. That situational awareness helps different teams to take decisions, plan or test marketing campaigns, research relevant legal cases or even cancel the project if it does not build enough value.

Figure 4 can be interpreted as:

  • For the customer, electricity must be produced in the right quantities. Thus the supplier needs to perform the two activities of producing power and adjusting its availability.
  • The market for producing electricity is pretty mature and failures are not tolerated.
  • The ‘adjusting availability’ activity is also very mature, but probably due to the increasing peak demands, it could be made better. It might not be efficient enough, but there is a potential solution, which is …
  • … deployment of a large battery. This is custom-built and somewhat experimental. It can quickly switch between charging and discharging, and thanks to high price differences when energy production does not balance consumption, the battery can be charged up for very little and its
    energy sold at high prices – as well as stabilizing the power availability for end users.

Such shared understanding enables all the stakeholders to meet their responsibilities as defined in the governance framework, and restores the proper power balance. They can again not only be responsible, but also act with confidence in their area of responsibility.

Making it repeatable

The process of identifying key project stakeholders, making them identify components and their characteristics and exposing their assumptions, can and should be embedded into corporate culture. The CFO has the tools to do so – the spend control mechanism9. This will ensure that all projects of a given size or importance will be analyzed for delivered value.

The CFO should exercise this power – it is in the company’s best interest to spend resources where it matters most. As time progresses, the review threshold can be lowered to include even more projects.

Figure 5 – Making such an analysis a standard step for projects of certain size is absolutely necessary

Further play

No single CFO can analyze all the changes that are happening within the company. That’s why it is necessary to establish a threshold and ensure that the most important projects receive appropriate attention. It is up to the CFO to decide when to step away from smaller projects. They may not be worthy of direct supervision, and if the spend control framework is sufficiently widespread, only the most important projects will require the CFO’s intervention, and the majority will not.

When the CFO decides to step back, there is only one way forward – a body has to be established that will:

  • Verify that the proper effort was put into project analysis
  • Connect people facing similar challenges (such as deciding whether it would be better to buy or build a certain component)
  • Remove cross-projects’ contradictory assumptions (e.g. market shape, tried solutions, etc.)

Thanks to its unique position and access to almost any information within the company, over time, this body will transform itself into a strategic advisory group.

Conclusions

Power stems from control over rare assets, regardless of what those assets are – finances, authority, knowledge. Not knowing or not understanding what is happening in your immediate environment is a big risk. It is not enough to be a financial expert, or any expert whatsoever, unless that expertise is put to work for the benefit of your organization. Indeed, the willingness to learn and to extract knowledge outside of our primary domain and outside of our comfort zone is one of the key aspects
that makes us powerful enough to live up to our responsibilities.

“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.” - Sun Tzu, The Art Of War

Appendix

A cheatsheet table that allows for assessing product maturity and expected features.

A cheatsheet table that allows for assessing product maturity and expected features.

Mapping #5: Restoring the proper balance of power

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1. https://bigthink.com/philip-perry/humans-were-the-first-domesticated-species-hypothesis-states

2. https://www.ynharari.com/book/homo-deus/

3. https://en.wikipedia.org/wiki/Quality-adjusted_life_year

4. https://www.investopedia.com/terms/n/npv.asp

5. This is actually the first step towards managed uncertainty removal, where the company makes conscious efforts to experiment where it can bring significant benefits. Check out Mapping #4: From ad-hoc to strategic learning for more.

6. Sufficient investment in the marketing can change that, but then sales will be based on deception and might affect company reputation.

7. Wardley mapping in this context uses only a fraction of its potential. It is a way of thinking that:

- keeps stakeholder needs above everything

- forces you to accept uncertainty

- forces you to be explicit about your assumptions

- encourages you to design for constant evolution

- inspires you to iterate and learn from the past

The assumption is that everything else (e.g. money, market share) will follow. Learn more about Wardley maps here.

8. Maps can be used to quickly remove those risks and uncertainties, before too much investment is made.

See https://leadingedgeforum.com/publication/mapping-3-uncertainty-driven-project-execution/

9. https://www.gov.uk/service-manual/agile-delivery/spend-controls-check-if-you-need-approval-to-spend-money-on-a-service


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