Abstract-Background: There are too many design options for software effort estimators. How can we best explore them all? Aim: We seek aspects on general principles of effort estimation that can guide the design of effort estimators. Method: We identified the essential assumption of analogy-based effort estimation: i.e. the immediate neighbors of a project offer stable conclusions about that project. We test that assumption by generating a binary tree of clusters of effort data and comparing the variance of super-trees vs smaller sub-trees. Results: For ten data sets (from Coc81, Nasa93, Desharnais, Albrecht, ISBSG, and data from Turkish companies), we found: (a) the estimation variance of cluster sub-trees is usually larger than that of cluster super-trees; (b) if analogy is restricted to the cluster trees with lower variance then effort estimates have a significantly lower error (measured using MRE and a Wilcoxon test, 95% confidence, compared to nearest-neighbor methods that use neighborhoods of a fixed size). Conclusion: Estimation by analogy can be significantly improved by a dynamic selection of nearest neighbors, using only the project data from regions with small variance.