Whether investing in equities or in software, there are three distinct approaches to how we make an investment decision: based on our intuition or experience, based on our analysis of an opportunity, or based on our ability to rapidly discover and respond to market feedback. Let's look at each in turn.
When we invest based on experience, our decisions are rooted in the expertise we've gained from things we've done before. When based on intuition, our decisions are based on strongly held convictions. An equity investor familiar with retail might recognize demographic changes in specific geographic areas (e.g., migration of families with young children to Florida and Texas) and intuitively invest in firms exposed to those changes (such as commercial construction businesses operating in those areas). In the same way, somebody who has first hand experience can invest in developing a technology solution: the inspiration for Square, Inc. came from a small firm that couldn't close a sale because it couldn't accept credit cards. Although expert investing will likely involve a little bit of analysis, for the most part the investor relies on gut. Because we invest primarily on the courage of our convictions, capital controls on intuitive investments tend not to be very strict. In absolute terms, the capital commitment is generally small, although in relative terms the committed capital may be quite large especially if it is a private placement. As a result, the capital tends to be impatient: trust in an expert lasts only so long; investors will get cold feet quickly if there aren't quick results.
We can invest based on research and analysis. Value investors in equities study company fundamentals looking for firms with share prices that undervalue the assets or the durability of cash flows. In the same way, we can look for value gaps in business operations or market opportunities and identify ways that technology can deliver value to fill those voids. The foundation of the analysis are things such as value-stream mapping, or competitive analyses of solutions developed by sector and non-sector peers. From this, we can produce a financial model and, ultimately, a business case. We need expertise to develop a solution, but by and large we make our investment decision based on the strength of our analysis. In absolute terms, the amount of committed capital can be quite large. But, having rationalized our way to making an investment, the capital controls tend to be strict, and the capital tends to be patient.
Finally, we can invest based on our ability to discover and adjust based on market or user feedback. Traders move in and out of positions, adjusting with changes in the market and hedging based on how the market might change. Over a long period of time, the trader hopes to end up with large total returns even if any given position is held for only a short period of time. We can do something similar with software, using approaches like Continuous Delivery and Lean Startup. In this approach, we aren't just continuously releasing, but rapidly and aggressively acquiring and interpreting feedback on what we've released. We can also use things like A/B testing to hedge investments in specific features. When we invest this way, we do so based not so much on our expertise or analysis, but based on our willingness and ability to explore for opportunities. Capital controls are strict because we have to explain what features we're spending money on and how we're protecting against downside risk of making a mistake. The capital backing a voyage of discovery will be impatient, wanting frequent assurances of positive feedback and results. But at any given time, the amount of committed capital is small, because investors continually evaluate whether to make further investment in the pursuit.
Each of these approaches makes it easy to answer "why" we are making a particular investment. Why should we part with cash for this particular feature? Go ask the expert, or see how it fits in the business case, or go get user feedback on it. "Why" should drive every decision and action made in pursuit of an investment. Without the "why" there is no context for the "what". In its absence, the "what" will suffer.
No approach is universally superior to another. The approach we take has to play to our strengths and capabilities. Either we have people with expertise or we don't. Either we have people with analytic minds and access to data or we don't. Either we have the ability to rapidly deliver and interpret feedback or we don't. The approach we take must also be suitable to the nature of the investment we're making. A voyage of discovery is well suited for developing a product for a new market, but not for an upgrade to a core transactional system. The business case for investing in a customer self-service solution is going to be much more compelling than a business case for developing a product for an emerging market segment.
Just because we take one of these approaches is no guarantee of success. Not all investments are going to pay off: our experts may turn out to have esoteric tastes that aren't appealing to a mass audience. Our thoroughly researched market analysis might very well miss the market entirely. We might deliver lots of features but not find anybody compelled to use them.
Worse still, each of these approaches can be little more than a veneer of competency to unprofessional investing. A hired-in expert may be a charlatan. Many a manager has commissioned a model that inflates benefits to flatter an investment - only for those benefits to never be realized. Just because we can get continuous feedback from users does not mean that we can correctly interpret what that feedback really means.
Most of the time, of course, we take a hybrid approach to how we invest. We supplement expertise with a business case, or we charter an investment with a business case but use Continuous Delivery to get feedback. However we go about it, we need to get the essential elements of the approach right if we're to have any chance of success. Otherwise, we're just unprofessional investors: investing without experience, thoughtful analysis or an ability to respond quickly is reckless use of capital.
Entirely too much software investing fits this bill.