Trade-off Triangle

Introduction

I’ll discuss the idea of a “trade-off triangle,” involving three elements of a decision; a revenue source, what it is that you are trying to get done, and some form of value delivered to the customer.

When one point of the triangle is changed, such as a reduction in revenue, there should be a corresponding change in what you can accomplish and in turn, how much value your customer’s realize from the resulting deliverables. Unfortunately, this knock-on effect does not always happen. Let me explain.

Variants

This model works to describe both public and business environments.

Defining strategy involves goals to be achieved, revenue to fund the work of achieving the goals, and value--which in this case, is value delivered to the investors, or shareholders, or customers.

Or it can be applied to new product development product portfolios (i.e. R&D programs) where the variables are the type and quantity of development programs to achieve the highest value, given the available capital invested in R&D.

In the next series of slides I’ll focus on this concept in the context of public sector decisions, since this is really the critical issue now for any government or institution that relies on taxpayer funding. I’ll call this the “public policy” trade-off problem. My variables here are the various Initiatives I want to implement in order to meet my policy objectives. What I can do is a function of what I can afford (i.e. revenue sources), and how much value I provide to the public for whom the policies are designed to help.

Revenue sources are decreasing for many public entities. There are a series of "things" you are doing that add value to your constituents or customers, and the question is... which "things" add the most value and which "things" add the least--those at the bottom of the list need to be either delayed or cut in order to make the most efficient use of the available resources. It is the classic cost-benefit problem. The question is what to cut?

Ideal

Ideally, you want a system where when revenue decreases, there is a corresponding decrease in the number of initiatives or programs than can be funded. The challenge is to find the right mix of initiatives that generate the greatest value. This is the problem, since value is viewed from each stakeholder’s unique perspective. High value to one, could be low to another. What is needed is a clear and transparent decision criteria that is used to make this decision. These weighted objectives are used to influence the ranking of the alternatives based on the most value they generate.

Typical

Now lets look at the case that is most typical. When revenues decrease, initiatives continue to grow, since the value is expected to remain constant. But what really happens when the hard decisions are not make to cut, is that value actually is diminished. There is an attempt to do everything, but with less funding. Things are delayed, less gets done or the work product is compromised, people get burned out, and performance suffers.

Constrain Initiatives & Value

If you constrain two points of the triangle, the third point has to remain flexible. For example, if you want to do all your initiatives and add 100% value to your customers, then cost has to remain flexible. If cost is fixed (yet not enough) and you need to do all your initiatives (in some form) then the value will go down (meaning you could do a little of everything, yet not enough to satisfy anyone at the end of the day).

So lets play the game of reducing revenue and fixing initiatives and value. This means I force all initiatives to be done and don’t cut any. I do them, but not well since I don’t have the resources to do them right or on time. This impacts value. In the end, this forced attrition produces fewer results and a lower return on the invested capital (i.e. lower value).

Constrain Revenue & Value

In this case revenue is decreased and then constrained at the lower amount. I still want to maximize value, so my initiatives have to remain flexible. This means doing less, but selecting the right ones that maximize value. Leaders need tools and methods of doing this in an open and transparent way that involve the stakeholders in the process of selection, based on careful and reasoned trade-off analysis.

Cost Benefit

When plotted on a cost-benefit curve the initiatives that should be worked on are the ones that add the greatest value towards achieving the stated objectives. The ones that can be delayed or removed are those that add the least value.

There are some things you do that contribute high value and there are some that contribute low value. When you look at these on a chart you can visually see that a few things usually generate the most benefit and the rest just waste valuable resources. Those low value things are in the part of the curve called "diminishing returns."

In most instances where we model this, we find that 20% of the alternatives generate 80% of the benefit. Knowing which of those alternatives falls into the 20% bucket is the key to solving the “reducing revenue and increasing value” problem most public entities face today.