However, the sub-portfolios did not contribute equally. Overall, the ratio of portfolio value to cost was 3 to 1, meaning an investment of $1 million was expected to produce a return of $3 million. The projects with the least expected productivities were targeted for review to determine whether they could be improved and, if not, were candidates for elimination. Most projects fell in the middle with productivities normal for these types of businesses, however only a few were low-probability, high-value projects, suggesting that the lab might want to pursue more "reach" projects ( pearls). A few very high productivities mostly corresponded to projects that were almost finished or very inexpensive. Prioritized ranking of project productivitiesĪ plot of the expected project productivities (right) produced results typical for prioritizations. The projects generally corresponded one-to-one with new products or processes, so the assumption that they were independent was considered reasonable. The analysis evaluated roughly 50 projects selected from four sub-portfolios: (1) electronic test equipment, (2) computer-integrated manufacturing, (3) new technology for existing markets, and (4) existing technology for new markets. In other words, projects were to be prioritized based on expected project productivity. Project value was defined to be the probability of technical success multiplied by the NPV of the estimated product cash flows, and the metric for ranking projects was chosen to be project value divided by the remaining costs to complete the project. Cash flow estimates given success were obtained consistent with the judgments of the firm's most knowledgeable product commercialization experts. Accordingly, probabilities of success were obtained as judgments from a neutral group of the company's most knowledgeable scientists. The probability of R&D success was assumed to be the product of the probabilities of the specific breakthroughs required for the success of each project.Įxecutives accepted that the probability of success and cash flows given success should be based on best available professional judgment. Launching a successful new product might require multiple discoveries, innovations, or inventions. Likewise, whether a given R&D project will ultimately produce a marketable product is highly uncertain. The probability of technical success equals the product of the probabilities of success for each necessary breakthrough. Such factors are difficult to predict in the short term, let alone years in the future. What those cash flows might be depends on factors such as the product's characteristics, production capability, competition, market size, market share, and the product's duration of technical advantage. The value generated if a project were to successfully produce a new product was assumed to be the net present value (NPV) of the cash flows obtained from selling the product. Executives, however, had a clear view of the portfolio objective-the portfolio should generate the greatest possible financial return for the R&D capital provided. Decisions must be made in the face of technical complexity, uncertainty, and long time horizons. R&D is a particularly difficult area to manage. Project value was assumed to be the probability of success multiplied by Given the importance of R&D success to the company's future, a portfolio analysis was undertaken to provide hoped-for answers. There was a concern, however, about whether the right projects were being conducted under the right R&D budget. The firm had been spending roughly $100 million annually on its R&D laboratory but, because of heightened business competition, executives were considering substantially augmenting the R&D budget. The following summary of an acclaimed portfolio analysis reported by fellow decision analysts Jim Matheson, Mike Menke, and Steve Derby illustrates the approach for this special case.Ī large electronics firm that mostly produced test equipment was grappling the digital revolution. The special class is private sector company project portfolios for which increased profit is the objective, for example, projects to develop new products or services. Before further exploring the questions of how project value should be defined and what metrics may be used to measure it, I should note that for one important class of project portfolios, the answers have, apparently, already been established.
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