By Don Creswell, SmartOrg
It is always gratifying to hear from ValuePoint readers, particularly where our viewpoints are challenged, opening a dialog that expands knowledge and learning. In this month’s issue, I’ll pick up on some of the questions and comments related to last month’s article “Innovation Portfolio Management: People + Process + Software.”
What is Portfolio Risk?
Like many things, it all depends. There is uncertainty and associated risk at the individual project level. And there can be global factors that may expose the entire portfolio to risk. At the project level, given that projects are independent (changes in one project do not affect another project), an evaluation that produces an expected net present value (NPV adjusted to reflect uncertainty) for each enables projects to be assembled into a portfolio that provides a graphic picture of risk vs. return. Things can become more complex should there be dependencies among projects or cannibalization among projects.
Two tools (1) provide insight into the relative risks and rewards of projects and portfolios: the tornado chart, which reveals the effect of uncertainty around each variable and its impact on NPV and the innovation screen that arrays each project based on risk vs. return.
The basic value of each of these tools is to initiate conversations among stakeholders—the numbers, though important, are a starting point for discussion and not an end in themselves. In regard to portfolio risk, the innovation screen in the example provides a clear picture of risk (vertical axis) vs. eNPV (horizontal axis). A “balanced” portfolio considers the relationship between the upper left quadrant and the lower right quadrant, fundamentally a tradeoff between sure things relative to high-risk but potentially very valuable projects.
While there have been approaches that attempt to put a single numeric value on portfolio risk, this is of little use in developing understanding of the tradeoffs that lead to good decisions.
In some industries, there may be risks to the entire portfolio—a change, for instance, in oil prices or in energy prices may have an effect on every project in the portfolio. If one or more of these forces is important, it would be prudent to construct alternate scenarios that reflect the impact of these uncertainties and develop contingency plans accordingly.
How can tornado diagrams be used at the portfolio level?
A set of tornados can be compared side by side.
Why don’t you use optimization and simulation tools?
Our work mostly involves new product development, R&D and innovation. We find that at strategic planning levels, business models with around 20 variables are sufficient to make quality decisions, that sophisticated analyses do not necessarily drive better decisions and can confuse more than enlighten decision makers.
What is meant by “agile decision making?”
We borrowed the approach from software engineering. Because there are many unknowns when introducing new products into new markets, it is good to move through a series of development phases, with decision points at key intervals that enable development of options for moving forward. The difference with agile approaches is that decision making is a fundamental expectation of the product owner and project team. The team is expected to be self-managing which includes empowering them to know when a decision will require outside blessing or input (2).
1. Tornado Diagram: Resolving Conflict and Confusion with Objectivity and Evidence, Somik Raha, SmartOrg
2. Author Archives: Kiron Bondale