Know your project teams: alpha / beta performance analysis

Moderately sophisticated security investors are familiar with the alpha and beta risk ratios. The beta coeficient is supposed to gauge the volatility of a specific security when compared (over the long run) to a benchmark (most often a market indicator such as the S&P 500). If the market as a whole has a beta coeficient of 1, fractional betas indicate securities that are less risky (but also return less over the long run) whereas a beta coefficient over 1 indicates a higher risk / reward ratio. The fundamental thing to understand is that beta is measuring the so called 'market' risk. A certain set of characteristics determines this volatility. Two identical competitors in the same market will have the same beta coefficient because their business volatility should be the same (they are subjected to events in the same way). Alpha on the other hand measures deviations that can be attributed to managers skills (or other aspects).

How does this help knowing your team? While the comparison isn't perfect, and measurements might be hard to accomplish, it might be useful to think about analyzing teams by trying to divide performance variability in its alpha and beta components. Why are some teams overperforming whereas others and underperforming? If one could establish a reasonable benchmark for performance, either across a large organization or across an industry, then the team's beta would be the ratio between cost to performance. Projects under a high flying startup (or a skunkworks type of inner organization) able to attract the brightest talent should perform better than the ones in an established organization. From that perspective, the high performing teams would have a higher than 1 beta, whereas the established ones would have a lower than 1 beta. If one is able to adequately determine the beta coefficient for one's environment, then the deviation from that is each individual's team alpha. A positive alpha over the long run will be correlated with well performing managers / well run projects. A negative alpha - with poor managers.

So how does this help? In assessing teams, instead of looking for absolutes - e.g. project was under / over budget, one can look at the teams' beta and alpha. The latter are much more actionable. Consistently negative project results might point to an organizational problem rather than to team performance. Teams might actually be overperforming and still come short of unrealistic expectations. Shrewd executives would sometimes use setting unrealistic goals as a motivation technique. Thus, when looking at team performance retroactively, it would be more accurate to look at their alpha / beta coefficients instead of how they measure against often arbitrarily set project metrics.