The “Business” Portfolio
In the November 2011 issue of ValuePoint, I defined what I call the “business” portfolio to describe portfolio management that focuses on creating economic value from investments in R&D, NPD and Innovation. In this issue, I will take the concept into deeper waters. (I will use the term “portfolio” throughout this article to refer to business portfolios.)
My colleague, David Matheson, who frequently lectures at Stanford University on portfolio management and decision analysis, defines the “business” portfolio (my term) as “a related set of assets that compete for resources and deliver value for an organization.” Not bad.
In relation to R&D (includes NPD and Innovation), David stresses the importance of focusing on two kinds of uncertainty that impact the portfolio:
- Achieving Project Success (Overcoming all Hurdles) – in R&D or development projects, this means creating a commercially viable result and passing all the legal, regulatory and sometimes public acceptance barriers that support successful commercialization.
- The Value of Commercial Success (Extracting the Value) is most often characterized as an uncertain net present value, which depends on uncertainties such as market demand, competitive response, product costs, etc.
Since resources are most often limited, a major challenge in portfolio management is “saying No to a good idea in order to fund a better one” and making decisions about project selection and prioritization and allocation of resources based on a well-balanced portfolio. In their book, The Smart Organization, the Mathesons introduce the R&D Grid: Project Portfolio Matrix, displaying the mix of projects in four quadrants.
- The upper left quadrant consists of “bread and butter” projects that fulfill the need to produce regular results for existing business units and to support shorter-term profit objectives. The projects have a high probability of success with good commercial value.
- The upper right quadrant contains projects with the greatest potential for both commercial and technical success, returning high value. Unfortunately, as in nature, pearls are rare things and only found by “opening a lot of oysters.”
- The lower right quadrant of the grid represents early-stage projects designed to produce new strategic advantage; they may have blockbuster potential. As the Mathesons point out, “The majority of projects in this quadrant are expected to fail, but those that do succeed should win big.” A management challenge: work on diminishing as many of the uncertainties as possible to improve the harvest of pearls from the oyster bed.
- Finally, the lower left quadrant contains white elephants. Like the proverbial white elephant, these projects consume resources and are unlikely to enjoy development success or produce commercial value. Unfortunately, almost all companies have a herd of white elephants: the challenge is to have a disciplined process to evaluate all projects and find out where the white elephants are hiding and kill or repurpose them.
Since no one can consistently pick winners, managing an R&D portfolio to optimize value is like a dice game. A disciplined decision process around project evaluation and portfolio management will not guarantee winners, but it will considerably improve the roll of the dice.
R&D Portfolio Strategy is covered in detail in Chapter 10 of The Smart Organization: Creating Value through Strategic R&D book (Matheson and Matheson, Harvard Business School Press). (How to order)