Risk versus Reward (The Bet)

Posted on: February 12th, 2018 by admin No Comments

Risk versus Reward (The Bet)

Another post borne out of discussions with and observations of John Cuttler’s twitter postings.  I have seen and heard him refer to product development decisions as a bet.  When a company is deciding to undertake any product development project, there is a consideration that I believe amounts to a type of bet, that is a risk versus reward calculation.  I would admit that at times it appears this is a little opaque, but a bet is just that.

To stay relevant and remain in business, a company will invest in developing new products and services.  There may be a myriad of ideas or potential products and services that may be possible.  To find the best possible areas for the company to spend this money on something new, requires some careful consideration of the direction and actions the company will take, or at least this should happen rather than random acceptance of spending and expending of company resources.  This analysis will include estimates of the cost of the project.

Costs breakdown

  1. Development costs
  2. Material costs
  3. Manufacturing costs
  4. Warranty costs (cost of poor quality)
  5. Cost of quality (quality assurance activities an equipment)

We use a set of equations to attempt to quantify what is at stake and determine if the project should be undertaken

Equations

  1. Return on Investment (ROI)
  2. Internal Rate of Return (IRR)
  3. Payback period

There is more to it that than the costs, we need to know the value that the customer will obtain from our product or service. This will set the price for the product in the market place along with the volume of customers we can anticipate.

These have some risks associated, our estimates of costs may be wrong.  A small variation of each of these in the lit could have a dramatic impact on the cost of the project.  The value perceived by the customer may be not as significant as our estimates either, there will be variation in that as well Additionally, the market size may not be grounded or based upon tangible evidence but optimism or wishful thinking or errant information.  The probability of these things not only being true, but also being within the range of what we find acceptable add an element of risk that is akin to a bet.  This may explain why only 64% of projects meet their goals[1]

There is much more to deciding what and how a company will invest.  The opportunity costs for undertaking a project along with the cost for undertaking the project do not guarantee the outcome the business desires.  This risk, makes the project undertaking like a bet.  We bet on our organization and talent, our estimation and calculations, and the market place.  When we are wrong, we lose the bet, and we hope our bet did not include the house and our family.

[1] Project Management Institute: Pulse of the Profession 2015

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