There are Portfolios and Then There are Portfolios | ValuePoint July 2015

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By Don Creswell, SmartOrg

Just for fun, I Googled the term “portfolio” and not surprisingly was deluged with definitions, ranging from “a flat, portable case for carrying loose papers” or “carrying documents of a government department” to “a grouping of financial assets such as stocks, bonds and cash equivalents” and “any collection of financial assets.”

All of these definitions have one thing in common: they are a collection of things. Except for the loosest definition, most definitions involve comparison among items within a collection of assets. In R&D, new product development and innovation this usually involves projects in one of two portfolio types: a “strategic portfolio” and an “operational/tactical portfolio.” Many companies have yet to recognize the difference between these two types of portfolios, employing the term “portfolio management” while failing to recognize the clear difference between the two.

Strategic vs. Operational Portfolios

The difference between “strategic” and “operational/tactical” is fundamentally about the kinds of decisions that are supported by the portfolio and the people who make these decisions. Despite the marketing claims of many software providers, there are no systems that satisfactorily serve both needs. The information and data to support decision making is quite different. At the strategic level, decision makers are faced with making choices about future investments where there is a great deal of uncertainty around technology, market size, potential competition, pricing and other factors. While data can be informative, there are “no facts about the future”, and short cuts like check lists, score cards and other subjective tools are of limited value, readily subject to politics, gaming and superficial understanding.

Strategic decisions focus on selection of the projects or products in which to invest capital and human resources. Because the future is uncertain and many new ideas will inevitably fail, companies hedge their bets by developing a portfolio of projects; some will fail and some will win but, on balance, the overall value returned will be greater than if the company bet on individual projects in isolation.

At the operational or tactical level, there is an abundance of data to judge and manage performance, and adjustments and corrections can be made as needed. Stage gate processes and tools are among the most-often used aids to operational project management.

As noted above, strategic decisions and operational decisions involve very different casts of characters. Strategic decisions are generally at the most senior level of the organization by people who are judged by the financial performance of the company or business units. Operational decisions are mostly made by departmental, functional executives or other managers charged with producing results on budget and on time.

The two types of portfolios discussed above are generally seen in companies that develop, manufacture and market tangible products. There are however, although not as common, portfolios that support decisions around a collection of M&A candidates, capital investments, markets, geography, technology and business units.

Cutting Costs without Cutting the Future

One particularly interesting application of portfolio analysis has been deployed when companies face the need to cut costs while retaining their ability to grow. We have called this “buy up and buy down” as a catch phrase. The portfolio may contain items as large as individual business units where the analysis identifies BUs with low future potential vs. ones with higher future potential — or as small as allocation of sales territories or location of distribution centers. A portfolio view will provide a graphic view of the trade-offs and potential value gained by reducing investment in low-potential assets while adding the money saved to support those with higher-potential.

Cost Cutting Example
A major Fortune 500 company was faced with budget cuts. The company employed SmartOrg strategic portfolio evaluation software to evaluate the expected economic value of competing opportunities, compare them in a portfolio and re-allocate funding to accelerate development and commercialization of high-potential projects while reducing funding of projects with lower growth potential.

The “buy-up/buy-down” approach can be applied to any mix of assets. A classic application involved work by my colleagues at SDG (Strategic Decisions Group) where a major pharmaceutical company was under pressure to reduce R&D budget. Application of the methodology to their development portfolio identified projects where funds could be released from less-promising projects to support projects with higher expected value. As reported in the Harvard Bussiness Review, they believed the new portfolio to be 30% more valuable than the old one, without any additional investment. The marginal return on additional investment had tripled from 5.1 to 15.1. To exploit this opportunity, the company ultimately decided to increase development spending by more than 50%. Without this kind of evaluation, the company would most likely have reduced its R&D budget and missed the chance to create billions of dollars in value. (Reference HBR Reprint 98210.)

As noted at the beginning of this article, there are different kinds of portfolios and that portfolios are basically a comparison of opportunities and assets. The challenge is to develop the appropriate and consistent analysis at the opportunity level to enable apples-to-apples comparison at the portfolio level. And, where there is future risk and uncertainty involved to use decision analysis methodology to deal with these issues.

SmartOrg professional services, consulting and enterprise software have helped Fortune 500 companies evaluate, create and manage strategic portfolios for more than 15 years.