Funding For Outcomes: How to budget in Product Mode Organisations
The primary goal of governance is to determine how an organisation will allocate its limited resources to the work that will have the greatest chance of delivering its business goals and aspirations. This allocation is defined by a combination of the organization’s investment strategy (whether that be focusing on objectives that explore the development of new product or service ideas or objectives that exploit and enhance existing ones) and the relative benefit of each proposed initiative. The priority and sequence of initiatives are determined by business benefit, dependency, and the investment strategy. As I wrote in The themes of an adaptable operating model there is a need for agility in how we work and therefore by definition the investment model must also be equally flexible. The funding model must be able to support a quick response to changes that result from internal feedback and events in the external business environment.
The investment process is made up of four stages, as illustrated in Figure 1:
- Setting Investment Targets: The executive team sets investment targets for objectives and goals based on the strategic direction of the company. Investment can be targeted by business unit portfolios, product portfolios, or strategies. Investment targets act as guardrails on how the organization intends to allo- cate its investment budget. An organization could choose to target short-term payback investments, known as run and grow, that exploit the current business model versus long-term transformable investments that are more speculative but are vital to ensuring the business avoids being disrupted. Other methods to define investment targets could involve geographies, specific products, or cus- tomer segments.
- Allocating Funding to Initiatives: Most of the investment at this level is the funding in team capacity, how many people and teams within each given product group, plus any budget for software. For cross teamwork, an initiative can also be funded as a project and a one-off investment. The executive team funds product groups based on the criticality of their product area (business capability, value stream, or customer journey) in relation to achieving the outcomes detailed in the initiatives. In addition, the exec team will also fund based on the capacity needed to maintain existing capabilities to continue to run the business.
- Allocate Funding to Team Capacity to Deliver the Initiatives: This splits investment into two phases. First, the organization determines how much it wants to invest in each area of the business in terms of team capacity to action change — the capacity investment level. Second, there is an investment in business outcomes we want the different areas to focus on based on the business strategy.
- Allocating Capacity to Projects and Programs: After each product group has been funded, the product group and product owners will allocate product teams’ time based on the features they believe are needed to deliver the initiatives in the strategic plan.
Setting Investment Targets
Before teams can be allocated funds, there is a need for the exec team to allocate investment targets. As illustrated in Figure 2 the exec team determines what percentage of the investment budget should be spent on each strategic objective over the coming year. The exec team’s investment strategy is based on how best to achieve the business vision and not a pure return on investment calculation. For example, the exec team may choose to invest 10 percent in discovering new products and be prepared to have little to no return on investment in this financial year. They may decide to invest in geographical expansion, which could have a lower ROI than if they invested in the core market. However, their thinking could be based on how more appealing a business looks if it can operate in a larger market. Alternatively, they could choose to focus investments on the unit economics of their core market and exploit existing products to consolidate cash if there are unfavorable market conditions for exploration. This is why it is key to understand the business context. You need to understand the policies behind decisions and especially the future intentions of the board.
Allocating Funding to Initiatives
At the tactical level, we fund initiatives as shown in Figure 3. The outcomes are those that we believe will contribute to the strategic objectives. The conventional IT budgeting process is based around the concepts of transient teams, fixed plans, fixed costs, and fixed scope. For anything other than simple problems with obvious solutions, this simply does not work. The way we fund work should complement how we work, the context of the work, and how we are organized. Traditional methods are based around funding a project model and prioritizing on the strength of a business case with a forecasted ROI. It is predicated on the assumption that work is deterministic and therefore scope, budget, and time can be fixed. This makes sense for very simple projects in well-understood obvious problem domains or for exploiting well-known business areas. However, awarding investment based on the strength of a business case and the details of the plans is not applicable in all problem contexts. We simply do not have that level of precision upfront for every initiative.
For problems in complex contexts, there are simply too many unknown unknowns to predict the exact activities, costs, and scope that are required to solve them. Prioritisation planning methods that are held annually are slow to react to changes in the business environment. They demand detailed ROI projections and detailed data on opportunities, which is not effective for complex problem contexts and business envi- ronments of high volatility. Work in complex contexts by its very nature is emergent; therefore, we will not get to a level of precision until we start the work. While traditional methods of investment and priority are suitable for problems in obvious contexts, they are barriers to ways of working and how we are structured to tackle problems in complex contexts.
What we need is a way of adapting funding that is sympathetic to work in complex domains in addition to traditional methods of funding that are suitable for obvious problem contexts. We need to use the appropriate method of funding based on context. We need to fund teams to work on delivering value without being tied to a prescriptive plan or upfront scope so that they are not restricted in their ability to change tactics to meet goals as their understanding of a problem area increases. We also need a fast method of priority that employs good enough data, human judgement, and relative prioritization based on value. However, by sacrificing precision for speed, we also need to fund and prioritize on a more frequent cadence, allowing us to review, change, or amend priority decisions in reaction to internal feedback as well as the external con- text, thus reducing the impact of making the wrong choices.
Using the Right Investment Method for Initiatives
As illustrated in Figure 4, the way we fund initiatives depends on the problem context and how we will approach solving it. Teams working on novel and unique capabilities versus teams working on improving waste and immaturity in commodity capabilities need to be funded in dif- ferent manners. For commodity or simpler contexts where requirements are fixed and don’t require an agile way of working, we can employ a project- or plan-focused method of investment For teams that are working in a new, novel area with complexity with high uncertainty, it makes sense to opt for more of a venture capital approach from the start, where funds are released over time in small drops in line with value generated. This investment method is commonly known as product funding. The difference between the traditional method of funding and this new approach can be seen in Table 1.
Product Funding: Using a Venture Capital Approach to Investment in Complex Problem Domains
We can think of product investment in complex contexts in the same manner as a venture capitalist would approach a new product investment. We start by giving teams a business outcome to focus on and provide some seed money. Further funds are released to the team as value is delivered, value being a measurable progression toward the business outcome. As shown in Figure 5, teams look at multiple bets to have the best chance at achieving an outcome. Once they have proved that a hypothesis produces value, they can continue to invest in it until they reach the point of diminishing returns. At this point, they can pivot to a new bet. This funding model prevents sunk costs in that we only fund for the bets that work as opposed to the project model, where we fund for full scope and deliver it in its entirety whether it provides value or not. We can avoid investing too much in the wrong idea by having regular feedback via short delivery cycles and basing progress on leading outcome-based metrics that have a direct link to the desired outcome.
This venture capital–style approach is in stark contrast to the traditional project-led model of execution, which only measures value at the end of a project, if at all. This is all made possible due to the short development cycles, which in turn allow for releasing funds in shorter budget cycles. So, while we allocate budgets annually at a capacity level, we can manage them monthly, quarterly, or in whatever cadence we choose at a team outcome level. This funding process contributes to the mind shift of a focus on delivering incremental value rather than delivering output and features. Because of the regular cadence of plan-fund-do-feedback, teams are ruthlessly focused on ensuring that investment brings value in the shortest time frame. The result is a more flexible method of allocating investment, one that can adapt to changes in the context and can reinvest in bets that result in capability improvements that contribute to business outcomes and stop funding ideas that are not contributing to strategic goals.
It is far easier to fund at a coarser level where there is predictability (i.e., capacity for change) as opposed to funding discrete projects at a granular level where there is uncertainty in how effective they will be. We do not lose any governance in this funding model because we are able to review regularly and report on progress toward each business outcome, making any correcting actions such as increased investments, removal of impediments, and direction setting as necessary. We remove the need to spend time and effort checking that we are adhering to a budget or a plan. Instead, we align funding capacity, teams, and leadership around the organization’s most important business problems and make governance decisions and accountability around the KPIs that measure the outcomes we truly care about, value delivered, rather than any other vanity project metrics such as features shipped.
Project Funding: Using a Project-Led Approach in Simple Contexts
While most of the funding will be for the capacity of long-lived product groups and teams focused on delivering outcomes, some will be assigned for discrete projects that don’t require a consistent and permanent team to invest in their evolution. For commodity capabilities and where we are looking to leverage COTS (Commerical off the shelf) software products usually in conjunction with a systems integrator, we can use a more traditional plan- driven project approach. This enables us to have more certainty about total costs, and we can perform more due diligence to ensure that if we are signing up to a three-year deal with a software supplier with integration and ongoing costs, we are backing the right horse. As mentioned, these capabilities may need to be project led for the initial implementation of a COTS but then revert to a venture capital approach when the platform is integrated.
Investing in Team Capacity
As illustrated in Figure 6, an approach to investment that can reduce the risk of trying to predict unknown unknowns, offers greater flexibility to move investment quickly when the context changes, and ensures that investment is allocated to the most important areas is to fund the capacity to change at a product level. Rather than trying to spread the budget across a disparate set of projects, we can explicitly invest in the products that are critical to delivering tactical initiatives, aka business outcomes. This represents a move to a top-down investment strategy by prioritizing investment, in the form of teams, in the most impactful areas and then setting outcome targets for teams to determine how best to achieve them. By making this change we can control investment allocation more easily and move the funding decisions to the critical capabilities and to people closest to the work rather than to a central committee judging business cases.
Annual Investment in Product Team Capacity Based on Strategic Need
Capacity investment is drastically different from the traditional annual operating planning budget process. However, there’s still a need to allocate funds and size product teams and their budgets, and this still makes sense on an annual basis, in line with overall financial budgeting activities. During annual investment cycles, funding is allocated by the leadership team. We can determine at a high level the capabilities required to support the strategic goals based on the detail covered in the IT strategy (see my post on IT Strategy). By funding annually and basing funding around fixed strategic goals and business capabilities, we have the best chance at keeping teams stable.
Funding is based on the relative importance of the business capabilities that each product group supports — in other words, how much contribution we think the teams will make to the strategic goals. Leaders will determine relative investment levels based on the strength of road maps of outcomes that will contribute to business goals. Rather than a bureaucratic and wasteful governance process requiring detailed plans to receive investment, teams define a road map of high-level themes and problems that they intend to focus on to achieve the desired strategic outcomes. Simply put, the more investment in an area, the more capacity we have for change. When it comes to team capacity, more funds equate to larger teams or multiple subteams.
This greatly simplifies portfolio investment where you allocate budget to areas of strategic importance without the need for detailed information on plans, ROI, and timelines as you might in a project portfolio process. Funding by product capacity results in a predictable and easy method to track cost, as cost is made up largely of the wages of each product team. The budgeting process is more straightforward than traditional approaches as it is largely a case of what areas we want to focus on over others. This is a different way to manage investments compared to a traditional portfolio management approach; instead of a portfolio of projects to fund, we have a portfolio of products to invest in.
It is worth noting that what I am describing here occurs within an organization’s single product or service offering. This process will need to be replicated in each of the products in the organization’s portfolio. As shown in Figure 7, a small to medium enterprise will typically have only a single product or service, while a large enterprise will have several products and/or services, and this process is repeated within each product.
Invest in the Capacity to Manage BAU as Well
When determining the funding allocation to product groups, the exec team needs to consider not only the portfolio of initiatives (strategic, operational essentials, architectural) that sit within a product group’s area but also to include funding for the capability to manage BAU portfolios, where decision rights and prioritization are democratized to the teams themselves. Remember in the Product mode organisational structure there is no dedicated small change, support, or BAU team. In this new method of investment, there is no separation between build and run activities. Product teams own all the applications and technology that relate to their business area. They design solutions to problems; they build it and they run it with no handoffs. This means that one team deals with strategic business outcomes as well as BAU items, where BAU covers small enhancements, technical debit, and bugs.
The knock-on effect for investment is that we need to fund capacity not only for strategic outcomes but for lights on operational needs as well. All capabilities need to be covered and owned by a team even if that team is kept to a minimum. Capability areas that are covered by COTS solutions should not be exempt either. While this may seem that we are funding and investing in areas of no strategic importance, we only need to invest the minimal capacity. It means we can retain team knowledge and architectural integrity to be responsive to changing needs. If we compare this to the alternative project mode of operating, we have transient teams that have no intrinsic motivation to invest in the code base that they are working on before they hand it over to another project or maintenance team. The project model results in a loss of deep domain knowledge and a code base that is ever more difficult to change every time a project ends and a team is broken up.
Reviewing Funding Allocation
Funding is typically set at the start of the financial year, but capacity allocation can be reviewed on a regular basis and be adjusted over time if things change. At this level the investment is based on the executive team’s judgement, on the strategic position and the expected value to the organization of improving capabilities. The funding allocations are still based on hypotheses on where the investment will be needed the most. If the external context changes, there may be a need to move capacity to differ- ent capability areas as goals may change.
Allocating Team Capacity to Deliver Outcomes, Projects, and Programs
At the operational level of investment, each product team collaborates with a business outcome owner to determine how best to improve their business area to contribute toward achieving the desired outcome. As shown in Figure 8, teams spend their budget against business outcomes rather than plans, which are aligned to the strategic priorities. Funds will be released based on feedback through a regular cadence, whether that is monthly or quarterly. Where the investment level rises above assigned capacity to product areas, the outcome investment level releases funds against that budget for teams to run experiments, build features, and test hypotheses to achieve the desired outcomes. It is the role of the outcome owner to allocate approved funds for work that will validate hypotheses and bets on the best way to achieve an outcome.
This is where top-down strategic direction meets bottom-up operational execution and is part of the strategic deployment that I have posted about before. By cascading desired outcomes over projects, we provide the autonomy, purpose, and mastery to fuel the intrinsic motivation required to solve complex problems. By giving strategic direction in the form of desired outcomes but not prescribing how to tackle them, we achieve accountability and alignment to balance team autonomy. From a funding position, outcome owners and product teams are completely accountable for how they use their time and how they prioritize work in the pursuit of outcomes.
Quicker to Adapt
As we are funding outcomes rather than projects with fixed scope, teams can pivot at will, evolving their road map of work (hypothesis if you will) constantly as they gather more data on the business outcome problem or indeed if the context changes and they need to target a new outcome. As product teams discover more about their problem domain, they will come up with new ideas. If they find a promising solution that is delivering results, they may continue to invest in that over experimenting with other ideas. Because we fund product groups and not projects, product group leaders have the autonomy to allocate time and investment where they feel it will have the biggest chance of delivering the desired business outcomes. If we give teams the accountability for outcomes, then we must give them the autonomy to use their budgets as they see fit without having to keep going back to get these things approved at a higher level. This enables those people closest to the problem to make quick decisions and drive real business value.
Funding in this manner is simpler because, instead of asking, “What project should we prioritize based on assumptions and predictions of the future?” we can ask ourselves, “How much money do we want to invest in solving this problem or achieving this outcome?” “What can we achieve by this date?” “How much should we invest in this hypothesis to achieve the outcomes before we look at alternative ways?” This makes far more sense when dealing with complex problems because we can control the controllables (i.e., how much we want to spend on a problem) and task a team with prioritizing the next best action to reach the outcome and regularly review to determine if we want to continue to invest or move funding somewhere else.
Trusting Teams to Manage Funds
The autonomy given to product groups on how to allocate team time and spend funds is made possible chiefly because of clear and specific business outcome measures. The exec and board sign off and invest based on the road map of outcomes within the stra- tegic plan, and product groups work on what to build to achieve them. The exec team can be confident that the money they signed off is being spent wisely as governance is handled by regularly reporting progress against the business outcome measure rather than project output; in other words, governance is about driving value rather than predictability. In this sense, it is in the outcome owner’s and product group leaders’ interest to act like investors when allocating the time and effort of their teams. Instead of focusing full capacity on a single solution, bets can be spread for highly uncertain work and only full capacity committed when an idea shows promise through early feedback or experimentation; in other words, we organize for responsiveness and opportunity rather than cost-efficiency. This autonomy allows the frequent reallocation of capacity and funds without the need to seek approval from a portfolio committee, enabling the teams to react and make decisions faster.
The product a team is based around is owned by the team. The team manages bugs, technical debt, and small enhancements as well as strategic work. The team is responsible for achieving the business outcomes rather than simply producing output. Therefore, they need the autonomy to use the funds at their discretion. This means we must empower the team to do what is right in terms of how they spend their time, where time equates to money. What is right may involve prioritizing unplanned BAU features over strategic work, such as trade-sensitive small enhancements, critical bugs, or paying back on technical debt. The teams are accountable for making prioritization decisions between BAU and strategic work. This is preferable, as they are the people closest to the work, they are best placed to make this call, and they are aware of the trade-off between operational and strategic needs. This is why we need to balance team autonomy with the alignment to strategy, alongside regular review, and steer sessions to avoid a total focus on local optimization. Work and progress is transparent and the cadence of feedback regular, which avoids the need for micromanagement or detailed reporting.
Trusting teams, giving them both autonomy and accountability, to use their time and funds in the most effective way is part of the mental model change required to instill an intrinsic motivated workforce. We don’t prescribe projects for teams; instead, we delegate outcomes and support teams to solve it their way while also balancing the BAU needs of their business area. We don’t lose any control over funding in this model. How success is measured is still defined by leadership from defining the strategic outcomes. With autonomy comes accountability. To build trust and continue receiving funds, teams are accountable for value. They regularly show progress toward outcomes using business-focused metrics over activity metrics to continue to secure funding.
In Summary
The conventional IT budgeting process is based around the concepts of transient teams, fixed plans, fixed costs, and fixed scope. For anything other than simple problems with obvious solutions this simply does not work. If we are to organise persistent teams around products and focus on outcomes, then the funding process must complement this structure rather than fight against it. Instead of funding for projects in complex contexts, we can fund the capacity of product teams based on strategic need and the strength of a high-level road map. These teams can then have the freedom to determine the best use of the funds to achieve desired outcomes.
What to read more?
This article was a summary of prodict team funding from my new book The Accidental CIO: A lean and agile playbook for IT leaders. If you want to read more please follow these links or look for it at your favourite book seller.
