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January 13, 2006

A Brief Survey of Gain

Why is it so often the case that when you get what you asked for it isn't what you wanted?

The easy answer is probably the correct one: you didn't ask for the right thing. Setting aside all matters of blame, the more important two points to consider are:
(1.) Why did you ask the way that you did? and...
(2.) What other way might you have asked?

An especially strong focus on this situation comes through using a portfolio manager. The amazing advantage of a managed portfolio is that it (normally) contains within it the logic that explains two things:
- how it is that what you ask for turns out to be what you want, as well as...
- why it makes sense to want what you need.

I.

Anyone raising children should be able to immediately appreciate the profound difference in the house that would occur if their kids had those two habits! And joking aside, this is really to the very point of portfolios: they implement maturity in the perspective on investment and gain.

A major ingredient of this maturity is the ability to distinguish different levels of commitment and expectations, and to logically match up commitments and expectations, consistently.

We can readily see this in the language that is typically used to describe events and conditions related to expectations and commitments -- but the irony is that in the heat of action we often lose our bearings and mismatch them:

One immediate "finding" from looking at the vocabulary is that it's a good idea to not confuse expense and cost -- and likewise to not confuse value and worth. By looking at what each of those items "will give" (third column) we can see that there's a difference and that one must ask for the right thing.

Our vocabulary chart seems to have a lot of redundancy in it, but one of its main points is to show that in a given situation we might easily think about gain in one way yet do something about it in a different way. What's the difference between why (before the fact) we pursue something and how (after the fact) we evaluate it?

II.

Another problem lies in potential confusion of what kind of commitment is being leveraged to serve the current purpose. Let's look at expense versus cost. What if, under the purpose of offering products or services, we're asked to "hold down cost"? That's not the same thing as being asked to "hold down expense".... Is something that is expensive necessarily costly? We can start to see in the vocabulary that the answer is "No" -- because the acquisition allowed by an expense might be something that greatly increases benefits, through ownership, and the benefits may be redeemable to lower overall cost.

Example: a person finds that a better car that is more expensive has reliability that, by allowing safe and flexible commuting over longer distances, increases opportunities to work for more money, which in turn can be used to lower outstanding debt or otherwise come to a better net balance. The reverse: a very inexpensive car has bad reliability, spends too much time not working well, and poses frequent risk and other limitations to reaching and keeping better work. Worst case, losing the job might also mean losing the car. In this latter scenario, "inexpensive" turns out to be pretty costly.

Such relationships start us thinking up the chain from expense to worth. How do we drive "good" value with cost? How do we drive "good" worth with value?

III.

On that point, what is the difference between worth and value? Simply defined, value is "a significant difference". But what is significant to one party or situation may not be to another. Worth puts the value in a context. Something may increase in value, but is the additional value producing high-priority benefits?

Example: a product or process might improve, but if it is not being used any more frequently by any more people then its additional value is not worth much. Different example: a party is trying to prove that a new approach is viable in a task; here, if the task outcomes show the slightest bit of improvement over the usual, that validates the approach, so that tiny increase in value has tremendous worth.

These are ideas that are not so much unusual or even news to us. Instead, the problem is that we often allow our familiarity with them to be sidestepped by decisions and actions that for some reason prescribe to notions and expectations that are not nearly as logical.

IV.

Observing a more rigorous vocabulary helps to clarify thinking. For example: if we think we need something to be valuable, we should know that what we are after is some kind of impact. This impact may or may not have anything to do with expense. But the point is that pursuing greater value does not automatically necessitate lowering (or raising) expense -- so we shouldn't expect expense to adequately talk about value. In some instances it might work out logically that expense will be a key factor of the opportunity to increase value, but that would be determined as a characteristic of the particular occasion for value-pursuit, not taken as a default principle of generating value. (Question: what does budget-compliance tell us about whether operations were effective? Answer: if anything, not much.)

Other scenarios as well should be more carefully understood. For example, can something that is very costly also be very worthy? Sure -- this is characteristic of the response to many emergencies, and in those cases it probably is true because whatever is very costly is also sufficiently valuable. On the other hand, we don't want everything to be an emergency, and it makes no sense to impose an evaluation system for emergencies onto non-emergency situations. Yet meanwhile, one situation that is not an emergency but is simply relatively "extreme" is common in the marketplace: it involves super-costly products (like the highest-end street-legal cars or virtuoso solo pianists), which virtually create business that otherwise would not exist.

Naturally, this thinking must also address ROI (return on investment).

Looking at the vocabulary chart, we see the left-most column naming commitments that "pay back" in accordance with objectives listed two columns to the right. When commitments are made , "returns" should be represented by the benefit provided towards the objective.

There is no special reason why the objective should ever be displaced as the reference for assessing the effects of making the commitment. However, this involves more than the benefits.

Following through with a commitment introduces other issues that, if tracked and weighed, might have characteristics that discourage or encourage a decision to make that same commitment again in the future. Knowledge of similar previous experience -- even that of other parties -- could have the same influence. It might therefore be that the "burden" experienced in certain commitments would compete with the basic objective in the process of justifying a decision to commit. The burden might set tolerances or precedents that must be forecasted and addressed "satisfactorily" before the follow-through is allowed to commence. Over time, attention to these "qualifiers" can dominate the perception of certain types of commitments -- especially for those that are recurring ones. A symptom of this is when the attention to the commitment is more about whether, compared to "the last time" or "usually", it is expected to be less problematic or moreso.

The execution of the follow-through to the commitment is a serious subject, but it still should not substitute its performance issues for the real objective of the commitment. If it does, it distorts the calculation of ROI.

V.

Instead, the objective is supposed to represent that a certain need has a sufficient priority to mandate supporting execution. The delivery of benefits to the objective should be assessed in terms of how much it helps the objective.

There may be competing objectives, however, and a limit to the overall capacity to address them all. So the correct way to approach things is to first decide whether the particular need is, at this time, really one that should be addressed -- and secondly, how aggressively it should be addresed.

In a portfolio, the corresponding move is to include or exclude investment categories in the portfolio. A category (which represents a need) has an objective, and investments are made within the category to help achieve the objective. Within the category, some investments made are better than others, from one time to another -- having to do with how effectively the selected sources of contributions to the category are executing as contributors.

By careful selection of contributors to carefully selected categories, we set up production of benefits that achieve objectives. But as cautioned in the vocabulary above, we need to be clear about what it is that we are really after, in order to ask for the right thing to make it happen.

Posted by Malcolm Ryder at January 13, 2006 9:47 AM

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