1. © Copyright Rolls-Royce plc 2011 An Entrepreneurial Approach to Design for Cost presentation to Defence Cost Estimation Conference 2011 Adelaide, Australia Dr Stuart Wicks Head of Business Analysis Rolls-Royce Submarines

2. © Copyright Rolls-Royce plc 2011 Rationale Design for Cost: the opportunities to influence the cost of a new design are mostly at the beginning of the process achieving real influence over cost at this early stage is difficult Influence is confounded by: Uncertainty over the solution, lead time for detailed cost analysis of options conflicting dependencies between analysis of design option costs and the need for design data to feed the analysis. Entrepreneurs work with uncertainty all the time: in a perfect market, opportunities only appear long enough for an entrepreneur to take advantage where the uncertainty prevents others from beating them to it. managing uncertainty and risk is the key differentiator of an entrepreneur. They don’t have time for thorough analysis, but they have to make the right decisions or lose their shirt.

3. © Copyright Rolls-Royce plc 2011 Question? Option 1 commitment spend Option 2 Baseline OptionSunk cost spent on baseline before decision is made Total Cost - including cost sunk on the baseline as time goes on Time Option 1 Option 2 Baseline Option Sunk cost spent on baseline before decision is made Indifference Point on spend So what lessons can we take from entrepreneurs to helps us with the problems of design for cost? How can we make better decisions, faster and with less information? Indifference Analysis - how the cost benefits of options can be eroded by indecision while sunk costs build up for development of a baseline option Indifference Point on commitment

4. © Copyright Rolls-Royce plc 2011 Life Cycle of an Estimate Detailed estimates take time, data and resource. Assessing the cumulative and interdependent consequences of design decisions takes more of each. We need to devolve targets to guide detailed decisions. A firm cost target might be expected to come from a business case, but this may not be ready until relatively late in the process. A Prospect Target is required from the beginning to focus design effort on realistic options.

5. © Copyright Rolls-Royce plc 2011 Decision Opportunities Two approaches to decisions: Alternative focused thinking – decisions as problems, usually solved by selecting from a choice of alternatives Value focused thinking – decisions as opportunities, solved by understanding the values/objectives and identifying more alternatives to find a better solution Strategic Decision Context: Set of all possible alternatives Strategic Objectives: Set of all strategic objectives of the decision-maker Specific Decision Context Fundamental Objectives: Set of all fundamental objectives of the specific decision context Set of means objectives Value JudgementsFactual Information Alternative focused thinking results in limited choices and poor decisions Keeney, R.L. (1992), “Value Focused Thinking: A path to Creative Decisionmaking”, Harvard University Press

6. © Copyright Rolls-Royce plc 2011 Strategic Framing – clarify objectives Understanding what we are aiming for sounds basic but is actually difficult to achieve. Often requirements are vague, partly out of reluctance to constrain the solution, but also because of uncertainty about what is needed. This is often driven by conflicting priorities of the various stakeholders involved. Objectives Hierarchies involve structuring the objectives of all stakeholders into a hierarchy according to logical rules. Advantages of an Objectives Hierarchy include: Identification of hidden objectives or duplication. A framework for prioritisation. Rationalisation of individual stakeholders’ “pet” objectives with buy-in to the “big picture”. Establishing the objectives of a project and its boundaries in measurable terms. Kill Mice Kill Mice in House Minimise hazards to pets Kill Mice Humanely Fundamental Objectives Poison Mouse Strike Mouse Poisoned Bait Poisoned Gas Means Objectives Strategic Objective Minimise hazards to operators Keeney, R.L. (1992), “Value Focused Thinking: A path to Creative Decisionmaking”, Harvard University Press

7. © Copyright Rolls-Royce plc 2011 Test Assumptions – FAST Diagrams Eliminate Mice Kill Mouse Strike Mouse Release Striker Trip Trigger Attract Mouse Bait Trap Set Trigger Arm Trap Position Striker Compress Spring Store Energy Release Energy Prepare Trap Locate Trap How Why Whe n Level of abstraction FAST Diagram: High level model of functional steps required to generate a desired outcome. Considering a mouse trap: is the requirement to kill the mouse? This requirement might generate options such as: the traditional spring trap poison a cat If we ask, “Why do we want to kill the mouse?” we might get the answer, “Because we want to eradicate mice from a locality.” This is called “raising the level of abstraction” - this often opens up a range of other options, e.g. capture techniques for subsequent release elsewhere? ultra-sonic devices to deter mice? Kaufman J.J. & Woodhead R. (2006), “Stimulating Innovation in Products & Services: with function analysis and mapping”, Wiley Interscience

8. © Copyright Rolls-Royce plc 2011 Establish a Target Cost – Reverse Financials Imagine a company seeking to launch a new mouse trap design. Assumptions: Target rate of return10% Global market size1 million units pa = £10 million pa Believe they can capture 50% market shareIf product to market in <1 year Implications: they are targeting a turnover of £5m pa with profit of at least £0.5m pa So cost of sales must not exceed £4.5m pa market price of £10 each the unit sales cost cannot exceed £9 each. detailed targets can be broken out based on a few high level assumptions. These assumptions need to be tested and quickly confirmed before significant investment is made. E.g., how realistic is the 1 year target for time to market? If this takes 18 months, what impact could this have on the potential market share? So design options that take too long to develop, or are likely to cost more than £8 each to produce will not achieve the objective and should be rejected. If the distribution and marketing costs are estimated at £0.5m pa, the production cost must not exceed £4 million pa for 500,000 units, and so the unit cost must be less than £8 each.

9. © Copyright Rolls-Royce plc 2011 Keep Testing Assumptions – Delivery Specification Eradica te Mice Set up Trap Purcha se Trap Trap works Dispo se of body Design Trap License Trap Manufacture Trap Distribute Trap Promote Trap Write Instructions Print Instructions Print Warning LabelsPackage Trap Public Liability Insurance Customer’s Experience/Expectations Assumption that customer takes care of this! Re- use Assumption that reliability meets customer expectations! How many mice are we dealing with? Defining the scope is fundamental for costing, but how to define the scope in advance of a detailed programme? “Deliverable Specification” is a high level but systematic breakdown of the desired customer experience and how this will be achieved - “The Voice of the Customer” - mapping customer expectations as “Moments of Truth.” For each Moment of Truth, we can then make assumptions about how that expectation will be met. Each item in this example could be broken down further. The Deliverable Specification: helps identify costs that might have been overlooked enables the reverse financials to be developed in more detail exposes further assumptions

10. © Copyright Rolls-Royce plc 2011 Risk & Portfolio Management Ultimately, the assumptions that cannot be fully tested transpire as risk in the project. Investors typically use portfolio analysis to asses the potential risks and rewards of different opportunities and choose those to invest in. If we plot design options against axes for risk and reward we can differentiate the options that offer the more optimum balance of risk and reward. In some cases projects can hedge their risk by maintaining options that depend on opposite outcomes of a single assumption. Low Risk portfolio High Risk portfolio Reward (Cost Saving?) Risk Baseline Option Option 1 Option 5Option 2 Option 3 Option 4 Option 6 Option 7 Optimum risk-reward balance Just Daft! Bank Savings Rate – the best return available with no risk

11. © Copyright Rolls-Royce plc 2011 portfolios Categorise options for Programme/Organizational Uncertainty and Technical/Implementation Uncertainty and weight for the benefit each option returns towards the objectives Risk & Portfolio Management – contd. Programme/Organizational Uncertainty Technical/ Implementation Uncertainty Radical options carry the greater risk but also offer the greater benefit Depending on the ambition of the project, the optimum is usually a balance of one or two radical options (not too many that they can’t be effectively managed) and the remainder relatively conservative options.

12. © Copyright Rolls-Royce plc 2011 Problems with conventional Risk Analysis Conventional Risk Analysis involves cataloguing all the risks we can think of, perhaps prompted by a check list of things to consider. Projects then typically try to estimate the potential probability and impact of each risk. The quantification of risk for the project is then taken to be the sum of the products of all the probabilities and impacts. i.e. Overall Project Cost Risk =  P i. C i where: P i = probability of risk i occurring C i = expected cost impact if risk i occurs However, this simplistic approach has some fundamental problems: not all the risks will be independent not all the risks will be additive the probability of a risk occurring is rarely independent of the scale of the impact, so: What level of impact is assumed when estimating the probability? a distinction must be drawn between uncertainty in the estimates, which might be modelled by three- point-estimates, and discrete risks, so: How do we ensure there is no duplication of risk between the uncertainty in the estimates and the specific risks modelled? Attempts to manage these issues result in ever more complicated and onerous tools and processes for managing risks – good business for consultants - but an entrepreneurial approach suggests an alternative…

13. © Copyright Rolls-Royce plc 2011 An entrepreneurial approach to Risk Analysis …Rather than try to estimate a value for the total risk, an entrepreneur seeks to bound and then limit the risk. Instead of cataloguing individual risks, bottom-up, return to the strategic framework and consider the adverse outcomes you are concerned to avoid. Generically, the top level risks are often very similar: We cause ill-health, injury or death We don’t make enough money/ We lose money We break the law We fail to deliver The customer is dissatisfied Our brand is damaged Starting from these top level risks, we can begin to break them down into the ways these outcomes might occur. In our mouse trap example, the high level risks might be: Trap closes on users fingers Trap does not work – mice escape Trap does not kill mice – mice die a slow, agonising death Trap does not meet customer expectations for re-use Not enough traps are sold Costs exceed target Traps are not delivered to market in time Public are offended by dead mice A Risk Hierarchy gives us a useful way to analyse this…

14. © Copyright Rolls-Royce plc 2011 A Risk Hierarchy Mouse Trap top level risks safetyProfit/(Loss)LawDeliveryCustomer Satisfaction Brand cost price We don’t need to catalogue all the detailed risks in order to bound the total. What limits might there be to the level costs could rise to, and how could we manage that? How would we detect cost rises early? What assumptions have we made and how robust are they? Successful entrepreneurs don’t rely on guessing what will happen: they bound their risks and find ways to test their assumptions, reduce the uncertainty and limit the risks. Design programme costs more Programme overruns More people needed Manufacture costs more More process steps More material More expensive material Factory overheads/utilisation Distribution costs more After sales liabilities – fines/legal fees People trap fingers Mice suffer unacceptably Trap doesn’t work What might cause a programme overrun? How bad could it be – is there a maximum? What can we do to minimise programme overruns? If the programme over ran, what would we do to minimise the damage?

15. © Copyright Rolls-Royce plc 2011 Cost Management to Targets The above steps will have generated a comprehensive list of assumptions that should also form the agenda for gated reviews at the key stages of the project. Standard agendas can lead to a “tick box” mentality. Using the specific assumptions identified previously to structure relevant questions and tests at gated reviews can make the review more relevant to the project and focus the team on addressing the real issues. Targets define success or failure for a project and designers should maintain charts like this one to be used at project reviews. This makes the expectation clear to the designers of what they are being asked to achieve and gives management an immediate report of the status of the project. benchmarkshistory of the estimateplanned cost/risk reduction measuresFCACTarget

16. © Copyright Rolls-Royce plc 2011 Conclusion Entrepreneurs, like designers, cannot afford to bet their shirt on every opportunity that arises but if they jump too soon they can lose everything. The principles of the entrepreneurial approach to design for cost are: be very clear about the objectives and what is to be achieved establish targets and understand the assumptions behind each option devise low-cost, low-risk experiments to test these assumptions quickly assess each option as part of a portfolio that is continually refined manage to targets, monitor assumptions retain the flexibility and decisiveness to reject options that fail these tests and commit to those that pass In the parlance of the television programme “Dragons’ Den”, they must decide if they are “in” or “out”.