Samdo
case study discussion
Chris Chapman and Stephen Ward
Chapman and Ward HMPOR case slide 1
© 2011 John Wiley & Sons Ltd
Discussion starting point
Start with a working assumption about the objective:
maximizing the expected value of M = R – C,
where M = margin (contribution to profit) per year
R = revenue
C = cost (direct and amortisation of capital)
Assume we want to understand the expected
values of M, R and C plus associated opportunity
and risk, and begin by considering R
Chapman and Ward HMPOR case slide 2
© 2011 John Wiley & Sons Ltd
Key components of R (revenue)
• base load power sales to Ontario Hydro
• waste heat (low pressure steam)
• back-up emergency power
We need to size these components,
then identify associated key sources of uncertainty,
and associated key responses (decisions)
Chapman and Ward HMPOR case slide 3
© 2011 John Wiley & Sons Ltd
Key components of C (cost)
• amortised capital cost
• fuel cost
• other costs
We need to size these components,
then identify associated key sources of uncertainty,
and associated key responses (decisions)
Chapman and Ward HMPOR case slide 4
© 2011 John Wiley & Sons Ltd
Creative thinking putting this together
• New untested design CCTG plant?
• Defer emergency power business?
• Back-to-back contract with Ontario Hydro?
• Back-to-back contract with gas supplier?
• Timing issues?
Chapman and Ward HMPOR case slide 5
© 2011 John Wiley & Sons Ltd
Some concluding comments
• The top-down process starting point is useful here
• Many of the key generic process ideas can be
applied to all opportunity, risk and uncertainty
management processes
• Designing processes for contexts is an overarching
key idea
• Seeking simplicity systematically in these processes
is another key idea, part of the overarching
opportunity efficiency concept
Chapman and Ward HMPOR case slide 6
© 2011 John Wiley & Sons Ltd
Transcon 1
case study discussion
1 of 4 2011
Chris Chapman and Stephen Ward
Chapman and Ward HMPOR case slide 7
© 2011 John Wiley & Sons Ltd
Discussion starting point
Start with a working assumption about the objective:
maximizing the expected value of
M = B – C,
where M = margin (contribution to profit)
B = bid (price)
C = cost (direct),
and assume we want to understand the expected
values of M, P and C and associated risk.
Start with C for two components which are useful
examples.
Chapman and Ward HMPOR case slide 8
© 2011 John Wiley & Sons Ltd
Initial operations and training example
1
Cumulative probability
0.8
indicates expected
cost (also median)
0.6
Astro
0.4
Zoro
0.2
0
0.7
0.9
1.1
1.3
1.5
Direct cost (£m)
Chapman and Ward HMPOR case slide 9
© 2011 John Wiley & Sons Ltd
Convert existing programmes example
Sysdoc 1
Cumulative probability
1
Datapol
Sysdoc 2
Sysdoc 3
0.8
0.6
indicates expected
cost (also median)
0.4
0.2
0
0.5
1.0
1.5
2.0
Direct cost (£m)
Chapman and Ward HMPOR case slide 10
© 2011 John Wiley & Sons Ltd
Linking this to common practice
• The value of simple ‘other objective’ assessments
early on
• The value of simple initial cost estimates
• The value of the ‘risk efficiency’ concept and its
assessment via simple linear cumulative
probability distributions
Chapman and Ward HMPOR case slide 11
© 2011 John Wiley & Sons Ltd
Some concluding comments
• The key estimating process ideas have been
used very successfully by a limited number of
organisations
• Many of the key ideas can be applied to all
opportunity, risk and uncertainty management
processes
Chapman and Ward HMPOR case slide 12
© 2011 John Wiley & Sons Ltd
Transcon 2
case study discussion
2 of 4 2011
Chris Chapman and Stephen Ward
Chapman and Ward HMPOR case slide 13
© 2011 John Wiley & Sons Ltd
Discussion starting point
Keep the working assumption that we are
maximizing the expected value of M = B – C,
where M = margin (contribution to profit)
B = bid (price)
C = cost (direct),
and we want to understand the expected value
of C, associated risk and decisions.
Now look at C when discrete events are explicitly
involved.
Chapman and Ward HMPOR case slide 14
© 2011 John Wiley & Sons Ltd
Decision tree for the additional memory issue
pre-install
Astro pay in advance
Cost to Astro
£0.6m
expected cost = £0.6m (1.0 x £0.6m)
probability = 1.0
post-install if necessary
extra memory needed
Astro have to pay
expected cost = £0.1m
(0.2 x 0.5 x £1.0m)
0.2
0.5 ?
Astro do not have to pay
£1.0m
£0m
0.5
no extra memory needed
Key:
0.8
decision node
choices available indicated above ‘choice branches’
expected values indicated below ‘choice branches
chance node
alternative outcomes indicated above ‘chance branches’
probabilities indicated below chance branches’
Chapman and Ward HMPOR case slide 15
© 2011 John Wiley & Sons Ltd
£0m
Cumulative probability distribution portrayal
pre-install
1
post-install
if necessary
Cumulative probability
0.8
0.6
indicates
expected
cost
0.4
0.2
0
0.5
1.0
Direct cost (£m)
Chapman and Ward HMPOR case slide 16
© 2011 John Wiley & Sons Ltd
The ‘post-install if necessary’ option’s extra memory
‘risk’ consistent with probability-impact grid portrayal
1
Probability
0.8
0.6
0.4
0.2
0
0.5
1.0
Direct cost (£m)
Chapman and Ward HMPOR case slide 17
© 2011 John Wiley & Sons Ltd
A revised decision tree to generalise
Astro pay in advance
pre-install
Cost to Astro
£0.4–0.8m
expected cost = £0.6m (1.0 x £0.6m)
post-install if necessary
extra memory needed
expected cost = £0.1m
(0.2 x 0.5 x £1.0m)
0.1 – 0.3
probability = 1.0
Astro have to pay
0.3 – 0.7
Astro do not have to pay
£0.9-1.1m
£0m
0.7- 0.3.
no extra memory needed
£0m
Key:
0.8
decision node
choices available indicated above ‘choice branches’
expected values indicated below ‘choice branches
chance node
alternative outcomes indicated above ‘chance branches’
probabilities indicated below chance branches’
Chapman and Ward HMPOR case slide 18
© 2011 John Wiley & Sons Ltd
Revised cumulative probability distribution
with 0.7- 0.9 probability post-install needed
1
Cumulative probability
post-install
if necessary
0.8
0.6
0.4
pre-install
indicates
expected
cost
0.2
0
0.5
Chapman and Ward HMPOR case slide 19
© 2011 John Wiley & Sons Ltd
1.0
Direct cost (£m)
Some concluding comments
• The value of simple ‘other objective’ assessments
early on
• The value of simple initial cost estimates
• The value of decision trees that do not need exact
probabilities or consequences
• The value of the generality of a minimalist view of
uncertainty as part of a clarity efficient perspective
• Many of the key ideas can be applied to all risk
management processes
Chapman and Ward HMPOR case slide 20
© 2011 John Wiley & Sons Ltd
Transcon 3
case study discussion
3 of 4 2011
Chris Chapman and Stephen Ward
Chapman and Ward HMPOR case slide 21
© 2011 John Wiley & Sons Ltd
Discussion starting point
Still use the working assumption that the
objective is maximizing the expected value of
M = B – C,
where M = margin (contribution to profit)
B = bid (price)
C = cost (direct),
but assume we want to understand the
expected value of C in total, and associated risk.
Chapman and Ward HMPOR case slide 22
© 2011 John Wiley & Sons Ltd
Cost estimate summary sheet example
comp item/option base min max exp choices/assumptions
1 mainframe etc
3.6 3.6 3.6 3.6 no choice
2 Astro
0.3 0.3 0.3 0.3 no choice
Zenith
1.0 1.1 1.3 1.2
total
1.5
3 Zoro
1.0 1.2 1.4 1.3 if no hostile takeover
Astro
0.8 0.7 1.1 0.9 preferred option
4 … omitted
5
to avoid making this slide too complex
___________________________________________________
total direct cost
10.9 14.2 12.5 (£ million)
Could we interpret this as 12.5 +/- 2 £ million?
Chapman and Ward HMPOR case slide 23
© 2011 John Wiley & Sons Ltd
Layered curves can show contributions, including simple
linear curves if discrete outcomes are not portrayed, as
shown here
Cumulative probability
1.0
0.5
1
2
3
…
5
even if precise
non-linear curves
are used, this
portrayal suggests
limited cost risk
0
Cost (£)
Chapman and Ward HMPOR case slide 24
© 2011 John Wiley & Sons Ltd
Linking this to common practice
• The value of simple estimating processes
• The value of more complex estimating processes in
their own right and as the basis of simple estimates
• The key estimating process ideas have been used
very successfully by a limited number of organisations
Chapman and Ward HMPOR case slide 25
© 2011 John Wiley & Sons Ltd
Some concluding comments
• Many of the key process ideas can be applied to all
opportunity, risk and uncertainty management
processes
• Designing processes for contexts is an overarching
key idea
• Seeking simplicity systematically in these processes
is another key idea, introducing complexity where it
pays being a crucial part of this
Chapman and Ward HMPOR case slide 26
© 2011 John Wiley & Sons Ltd
Transcon 4
case study discussion
4 of 4 2011
Chris Chapman and Stephen Ward
Chapman and Ward HMPOR case slide 27
© 2011 John Wiley & Sons Ltd
Discussion starting point
Still use the working assumption that the
objective is maximizing the expected value of
M = B – C,
where M = margin (contribution to profit)
B = bid (price)
C = cost (direct),
but assume now that we want to use an expected
value for C from part 3, assume values for B, and
understand the implications for M.
Chapman and Ward HMPOR case slide 28
© 2011 John Wiley & Sons Ltd
Cost estimate summary sheet example
comp item/option base min max exp choices/assumptions
1 mainframe etc
3.6 3.6 3.6 3.6 no choice
2 Astro
0.3 0.3 0.3 0.3 no choice
Zenith
1.0 1.1 1.3 1.2
total
1.5
3 Zoro
1.0 1.2 1.4 1.3 if no hostile takeover
Astro
0.8 0.7 1.1 0.9 preferred option
4
5
___________________________________________________
total direct cost
10.9 14.2 12.5 (£ million)
Say we round £12.5 million to £13 million
Chapman and Ward HMPOR case slide 29
© 2011 John Wiley & Sons Ltd
Probability of winning curve examples
Key:
1
c1
example discrete values
c2
c3
P(B), probability of winning
0.8
b
discrete values of
particular interest
preliminary probability
of winning curve
0.6
assumed underlying curve
possible extrapolations
0.4
0.2
a
0
10
Chapman and Ward HMPOR case slide 30
15
20
© 2011 John Wiley & Sons Ltd
B, Bid (£m)
25
Bid decision summary sheet example
Assuming expected direct cost estimate C = £13 million
B
15
16
17
18
19
20
P(B) conditional M unconditional M
0.8
15 -13 = 2
2 x 0.8 = 1.6
0.66
3
2.0
0.52
4
2.1
0.38
5
1.9
0.24
6
1.4
0.1
7
0.7
notes
buy work?
optimum for M
nominal price
overstretched?
The key risk is loosing business you want?
Chapman and Ward HMPOR case slide 31
© 2011 John Wiley & Sons Ltd
Linking this to common practice
• The value of simple ‘other objective’ assessments
early on
• The value of simpler and more complex cost estimates
• The value of simpler and more complex bid curve
(probability of winning) estimates
What do more complex bid curve
estimates involve?
Chapman and Ward HMPOR case slide 32
© 2011 John Wiley & Sons Ltd
Probability of winning curves for composite competitor k
and component competitor i, where k = i + j
Probability of winning
1
the space between
these lines indicates the
impact of competitor j
0.8
composite
competitor k
0.6
competitor i
0.4
0.2
0
10
15
20
Adjusted bid (£m)
Chapman and Ward HMPOR case slide 33
© 2011 John Wiley & Sons Ltd
Some concluding comments
• The key bidding process ideas have been used very
successfully by a limited number of organisations
• Many of the key process ideas can be applied to all
opportunity, risk and uncertainty management
processes
• Designing processes for contexts is an overarching
key idea
• Seeking simplicity systematically in these processes is
another key idea, introducing complexity where it pays
being a crucial part of this, part of the overarching
opportunity efficiency concept
Chapman and Ward HMPOR case slide 34
© 2011 John Wiley & Sons Ltd