A  PRACTICAL  APPROACH  TO  PORTFOLIO  MANAGEMENT

Kenneth Crow
DRM Associates

© 2004 DRM Associates   All rights reserved. May be printed for reading, reference & distribution with attribution. Other use prohibited.

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Portfolio Management is used to select a portfolio of new product development projects to achieve th following goals:

  • Maximize the profitability or value of the portfolio
  • Provide balance
  • Support the strategy of the enterprise

Portfolio Management is the responsibility of the senior management team of an organization or business unit. This team, which might be called the Product Committee, meets regularly to manage the product pipeline and make decisions about the product portfolio. Often, this is the same group that conducts the stage-gate reviews in the organization.

A logical starting point is to create a product strategy - markets, customers, products, strategy approach, competitive emphasis, etc. The second step is to understand the budget or resources available to balance the portfolio against. Third, each project must be assessed for profitability (rewards), investment requirements (resources), risks, and other appropriate factors.

The weighting of the goals in making decisions about products varies from company. But organizations must balance these goals: risk vs. profitability, new products vs. improvements, strategy fit vs. reward, market vs. product line, long-term vs. short-term. Several types of techniques have been used to support the portfolio management process:

  • Heuristic models
  • Scoring techniques
  • Visual or mapping techniques

The earliest Portfolio Management techniques optimized projects' profitability or financial returns using heuristic or mathematical models. However, this approach paid little attention to balance or aligning the portfolio to the organization's strategy. Scoring techniques weight and score criteria to take into account investment requirements, profitability, risk and strategic alignment. The shortcoming with this approach can be an over emphasis on financial measures and an inability to optimize the mix of projects. Mapping techniques use graphical presentation to visualize a portfolio's balance. These are typically presented in the form of a two-dimensional graph that shows the trade-off's or balance between two factors such as risks vs. profitability, marketplace fit vs. product line coverage, financial return vs. probability of success, etc.

Risk vs. Reward Map Example

The chart shown above provides a graphical view of the project portfolio risk-reward balance. It is used to assure balance in the portfolio of projects - neither too risky or conservative and appropriate levels of reward for the risk involved. The horizontal axis is Net Present Value, the vertical axis is Probability of Success. The size of the bubble is proportional to the total revenue generated over the lifetime sales of the product.

While this visual presentation is useful, it can't prioritize projects. Therefore, some mix of these techniques is appropriate to support the Portfolio Management Process. This mix is often dependent upon the priority of the goals.

Our recommended approach is to start with the overall business plan that should define the planned level of R&:D investment, resources (e.g., headcount, etc.), and related sales expected from new products. With multiple business units, product lines or types of development, we recommend a strategic allocation process based on the business plan. This strategic allocation should apportion the planned R&D investment into business units, product lines, markets, geographic areas, etc. It may also breakdown the R&D investment into types of development, e.g., technology development, platform development, new products, and upgrades/enhancements/line extensions, etc.

Once this is done, then a portfolio listing can be developed including the relevant portfolio data. We favor use of the development productivity index (DPI) or scores from the scoring method. The development productivity index is calculated as follows: (Net Present Value x Probability of Success) / Development Cost Remaining. It factors the NPV by the probability of both technical and commercial success. By dividing this result by the development cost remaining, it places more weight on projects nearer completion and with lower uncommitted costs. The scoring method uses a set of criertia (potentially different for each stage of the project) as a basis for scoring or evaluating each project. An example of this scoring method is shown with the worksheet below.

Weighting factors can be set for each criteria. The evaluators on a Product Committee score projects (1 to 10, where 10 is best). The worksheet computes the average scores and applies the weighting factors to compute the overall score. The maximum weighted score for a project is 100.

This portfolio list can then be ranked by either the development priority index or the score. An example of the portfolio list is shown below and the second illustration shows the category summary for the scoring method.

Once the organization has its prioritized list of projects, it then needs to determine where the cutoff is based on the business plan and the planned level of investment of the resources avaialable. This subset of the high priority projects then needs to be further analyzed and checked. The first step is to check that the prioritized list reflects the planned breakdown of projects based on the strategic allocation of the business plan. Pie charts such as the one below can be used for this purpose.

Other factors can also be checked using bubble charts. For example, the risk-reward balance is commonly checked using the bubble chart shown earlier. A final check is to analyze product and technology roadmaps for project relationships. For example, if a lower priority platform project was omitted from the protfolio priority list, the subsequent higher priority projects that depend on that platform or platform technology would be impossible to execute unless that platform project were included in the portfolio priority list. An example of a roadmap is shown below.

This overall portfolio management process is shown in the following diagram.

Finally, this balanced portfolio that has been developed is checked against the business plan as shown below to see if the plan goals have been achieved - projects within the planned R&D investment and resource levels and sales that have met the goals.

With the significant investments required to develop new products and the risks involved, Portfolio Management is becoming an increasingly important tool to make strategic decisions about product development and the investment of company resources. In many companies, current year revenues are increasingly based on new products developed in the last one to three years. Therefore, these portfolio decisions are the basis of a company's profitability and even its continued existence over the next several years.

ABOUT THE AUTHOR

Kenneth A. Crow is President of DRM Associates, a management consulting and education firm focusing on integrated product development practices. He is a distinguished speaker and recognized expert in the field of integrated product development. He has over twenty years of experience consulting with major companies internationally in aerospace, capital equipment, defense, high technology, medical equipment, and transportation industries. He has provided guidance to executive management in formulating a integrated product development program and reengineering the development process as well as assisted product development teams applying IPD to specific development projects.

He has written papers, contributed to books, and given many presentations and seminars for professional associations, conferences, and manufacturing clients on integrated product development, design for manufacturability, design to cost, product development teams, QFD, and team building. Among many professional affiliations, he is past President and currently on the Board of the Society of Concurrent Engineering and is a member of the Product Development Management Association and the Engineering Management Society. For further information, contact the author at DRM Associates, 2613 Via Olivera, Palos Verdes, CA 90274, telephone (310) 377-5569, fax (310) 377-1315, or email at kcrow@aol.com.

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