Episode 32 - 20 Apr 2016
Have you ever heard of Discounted Cash Flow Analysis?
It's not nearly as dull as it sounds.
And when you get it, you'll see that Agile has a massive head-start over Waterfall when it comes to profitability.
That's what today's episode is all about.
(Don't worry, there are no complex equations or boring spreadsheets to wade through.)
Warning.
In the next few minutes you'll see graphic images of finance and accounting concepts.
Please don't be alarmed.
There will be no equations. And no spreadsheets.
Some viewers may shocked to find that the concepts presented are... rather awesome.
If that is the case for you, support resources will be presented at the end of this video.
Money now is worth more than money later.
Everything we'll look at today stems from this single principle.
If in was to give you £12,000...
I'm sure you'd prefer to have it now.
The "Money now is worth more than money later" thing is, for most people, intuitive.
We even have a saying for it:
What if I offer you £10,000 now OR £12,000 later. Which would you prefer?
I'm sure you'd say that that depends on what I mean by "later".
If "later" if tomorrow... You'd wait for the £12k
If "later" is 50 years from now... You'd take the £10k now.
But what if "later" is 6 months? Or 18 months?
That's far from clear-cut.
The difficulty is this:
We need to be able to compare a present value - the £10,000.
With a future value - the £12,000.
These are two different things.
And as any schoolboy will tell you, you can't compare apples and oranges.
We need to be comparing apples and apples.
A present value with a present value.
Luckily, there's a way to do exactly this.
Finance types talk about discounting future cash flows down to their present value.
It's something that can be calculated.
Here's how the value of the £12k payment various over time:
The further we travel into the future, the less it's worth.
Each of these bars moves us a year into the the future.
By the time we get 20 years into the future, £12,000 is worth... hardly anything at all.
If we do the same thing, but taking small steps...
... then at a certain point the
the PRESENT value of £12k drops below £10k.
We can apply the same approach to multiple payments.
Here we have four quarterly payments of £3k.
We already know that adding up the £3k's would be a case of mixing...
What wee need to do is DISCOUNT each of the payments down to their PRESENT values.
once that's done, we have values that can be compared - and totalled.
This total is known as the Net Present Value. NVP for short.
I know what you're thinking.
These pretty graphs are all very well...
But what about the whole Agile / Waterfall thing?
Let's see.
Agile and Waterfall are projects...
and projects involve expenses... and *income.
Let's start with a super-contrived example of a project:
It has expenses of:
At that point, the product is launched and the money starts pouring in:
£60k out. £60k in. Break even?
Not so fast: we need to do a spot of discounting.
There's now more RED than green.
This project has a negative Net Present Value.
That's not a good thing.
If we could magically switch this around...
so that the income came before the expenses...
This time, discounting works in our favour.
There's more green than red.
The net present value this time is positive.
Interesting isn't it?
The only thing that changed was the TIMING of the cash flows.
That - and that ALONE - made the difference between loss and profit.
There's something else that I'd like you to take from this. To MAXIMISE profit:
Ready for some Waterfall and Agile?
It's a while since I've worked on a Waterfall project,
but as I recall it went something like this:
We'd start with a small small project team and get to work.
We might spend a couple of months On research
Two or three months on design.
Then the build.
As the launch date loomed, we'd panic and add people.
Finally. we'd be ready for the GRAND LAUNCH.
And the money would start rolling in.
(Never quite at the level we would have hoped... but that's another story.)
Ideally, we look at the entire lifetime of the project, but 24 months is enough for our purposes.
On to Agile.
The team stays more or less constant throughout - and there's no "Big Bang" launch.
So the costs - the outgoings - are much more stable. I'll draw them in now for the whole period.
In good Agile fashion, a first version of - whatever-it-is - comes out early.
It doesn't bring out a huge amount of money...
... But that's not the point.
The point of the first release It's to learn. To get feedback.
To take that feedback and improve and develop the product.
The next version does better.
The team keeps working. The sales keep increasing.
Two different projects.
Two very different sets of income and expenses
However...
You'll be SHOCKED to learn that I've fixed the numbers:
For each project, if you add up the greens, add up the reds, take one from the other.... you'll get the same number.
The net value of both projects is EXACTLY the same.
The difference between the projects is the size of and TIMING of the cash flows.
its time for some discounting.
Ready... Three two one... GO
The winner is... the Agile project.
The Waterfall project got off to a great start by keeping its expenses low at the beginning - and the delaying some of the big costs.
While Agile started (an continued) with high costs, is was able to get some green on the board early on.
Although the income was modest, the DISCOUNTING APPLIED to those early flows was also modest.
After the Big Bang launch, Waterfall was quick to ramp up its income.
But these income flows didn't turn up until 12 months after the project started
the income flows were subject to fairly heavy discounting.
Conculsive Proof?
I'd love to claim that this is proof positive that Agile is more profitable than Waterfall.
Of course, we haven't come anywhere near to proving it.
It is, for my money, one of the strongest arguments for the Agile approach.
Starting small. Test the market. Make improvements.
Rinse and repeat.
It gets green on the board early and that - as we've seen today - makes all the difference.
What we've been looking at today falls under the general banner headline of "Discounted Cashflow Analysis" (DCF).
I'm not a finance type - far from it - but I think DCF is extremely cool.
It's high up on my this-should-be-taught-in-schools list.
If you'd like to dig a little deeper, I have not one, not two, not three but four videos for you to check out:
Thanks you very much for watching. I hope you enjoyed watching it as much as I enjoyed putting it together.
And don't forget to click subscribe for a new video every week.
Talk to you next time.
Watch "Agile vs. Waterfall. Which is more PROFITABLE?" on YouTube.