Assessing and Managing Risks of Product Portfolios

8/6/2019 Assessing and Managing Risks of Product Portfolios

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Agenda

1. Efficient Frontier of New Product Portfolios

2. Portfolio Risk Assessments

3. Integration of Portfolio and Project Risk Management

All Rights Reserved Alcatel-Lucent 20072 | Assessing and Managing Risks of Product Portfolios | May 2008


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State of the Mobility Market

Double digit growth is a thing of the past

Growth areas for voice are China and India In NAR, declining voice ARPU will be countered with blended

offers driving data usage

Data adoption remains a major opportunity

Beginning to see data demand in enterprises Driven by lifestyle applications for mass market IMS enables operators to capture these segments

with blended services

Market Growth

Market Trends


3G alternatives continue to generate interest EV-DO has first to market advantage Wi-Fi and WiMAX distract the DO market

Cost control and revenue growth still top priority

Capex and Opex efficiency still key in maturing markets

Squeezing value from embedded base while moving to Packet

Market consolidation

Non-traditional competitors entering to own telecom wallet Legislative impacts

Technologies

Operator Challenges

Landscape Challenges


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Efficient Frontier of New Product



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What is Product Portfolio Management?

Portfolio Management

A method to compare the attractiveness of alternative investments.

Unknown


Product Portfolio Management

Portfolio management is a dynamic decision process, whereby a businesss list of

active new product (and R&D) projects is constantly updated and revised. In this

process, new projects are evaluated, selected, and prioritized; existing projects

may be accelerated, killed, or deprioritized; and resources are allocated andreallocated to the active projects.

Bob Cooper


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Two Asset Investment Decision

= 0= 0 = 1= 1

== --11

R2R2 A2A2


R

eturn

R

eturn

R1R1

X1X1 X2X2RiskRisk

A1A1


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Varying Investment Levels, result in varying Rate of Returns

E(rE(rGG)) AssetAssetReturnReturn

New ProductNew Product

ReturnReturn


WACCWACC

R

eturn

R

eturn

Investment LevelInvestment LevelNew Products are better evaluated as Projects, not as ongoing

Businesses


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= 0= 0 = 1= 1

== --11

R2R2 P2P2

Comparing Product to Asset Investments

Threats toIndependence1.Markets


R

eturn

R

eturn

R1R1

X1X1 X2X2RiskRisk

P1P1

RiskRisk

.

3.Technology orPlatforms4.Resources5.Project Types

Put all your eggs in one basket and watch that basket! &Diversification is a hedge against stupidity! Warren Buffet


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Efficient Frontier for New Products (*)

E(rE(rGG))

O1O1

O2O2

Two PortfoliosTwo Portfolios


rrff

G

ProjectsProjects

R

eturn

R

eturn

RiskRisk

= WACC= WACC EfficientEfficientFrontierFrontier

(*) Efficient Portfolios were first mentioned in H.M. Markowitz, Portfolio Selection, Journal of Finance,7:77-91 (March 1952)


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Limitations of Efficient Frontier Model

1. New Product Project Investment

Levels and Returns are linked

Return Rate drops as Project Investment

Level differs from Optimum

Optimum Portfolio is unlikely to result in

Portfolio Investment Level at the

Companys R&D Budget Level


2. New Product Investments are rarelyindependent

3. Any Model purely based on IRR/NPV

ignores the Existence and Value of

Options


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Efficient Frontier Conclusion


Helps to devise a New Product Strategy

Enhances traditional Risk / Return Maps

Visualizes the Return of New Product Projects

Explains, why we need to subtract the WACC from Returns, when using Return / RiskRatios for Prioritization

Theoretical Model, applicable to New Product Portfolios


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Portfolio Risk Assessments



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Inputs to the Portfolio Decision

Markets and Customer Lists

Resource Information and Total R&DSpending Level

Products and R&D Project Lists

Business Cases

Risk Assessments

The information you have is not theinformation you want.

The information you want is not theinformation you need.

The information you need is not theinformation you can obtain.

The information you can obtain costsmore than you want to pay.

Anonymous



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Risk in Product Portfolio Management

Quantities

Unit Cost


Risk is the central element that influences financial behavior. Robert C. Merton (1999)

Unit PriceR&D

Expense


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Most Success Factors in New Product Development are Not Technical (*)

1. Unique, differentiated, superior Products

2. Strong Market Orientation

3. Sharp, early, fact-based Product Definition

4. Solid up-front Homework (competitive, market, technical, and financial Studies)5. True cross-functional Teams

6. Leverage (building on Core Strengths)

7. Market Attractiveness


8. Quality Launch Processes (well-executed Marketing Actions)

9. Technical Competence/Technology Actions well-executed

(*) Source: Robert Cooper

Anything that wont sell, I dont want to invent. Its sale is proof ofutility, and utility is success. Thomas Edison


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Uncertainty Reduction for Risk Areas (*)

HighHigh

MediumMedium

ncertain

ty

ncertain

ty

Product LaunchProduct Launch

ProductProductPerformancePerformance

ProductProductUnit CostUnit Cost

MarketMarketAcceptanceAcceptance


00 11 22 33 44 YearsYearsLowLow

LevelofU

LevelofU

(*) Source: F.M. Scherer , "New Perspectives on Economic Growth and Technological Innovation"prepared for publication by the British-North American Committee, and derived from Merton J. Peck andFrederic M. Scherer, "Uncertainty and Time in Program Decisions" in The Weapons Acquisition Process:

An Economic Analysis(Boston: Harvard Business School Press, 1962) pp. 299-323.

TechnicalTechnical

FeasibilityFeasibility


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Risk Assessments

Delay What competitive Scenario does your

Project face? (Consequence of Delay) Does your Project have any 3rd Party

Dependencies? When will the market/customer require

this Project? How long can we sell the product? The

shorter the riskier. Does your Project have any cross-

company Dependencies? What is the probability that this project

will be delayed by one or more releases?

Volume / Quantities What specific markets does this Project

support? Who are the Key Customers for your

Project and how many

Have customer commitments already beenmade?

What percentage of the project volumecomes from current products?

There is a 10% chance that the volume ofthis project will be reduced by ___.

Price What alternatives are buyers aware of

when making a purchase? Does the product have any unique

attributes that differentiate it from

competing products? What amount of change, technological or

business will the customer be required tomake?

How significant are buyers expendituresfor the product in absolute dollar terms?

Product Expenditures (Cost) relative to


Profitability/ NPV

Risk Scores captureVariability

Correlation Coefficientscapture Weights

Delay has Impact oneither Price or Volume

Validate Questions

- There is a 10% chance that the discounted

price of this project will be reduced by ___.

Unit Cost Have Target Costs been established? Has Lucent built something similar before? Are the hardware requirements clear and

stable? Is the Product Definition clear and stable? What phase is the project currently in? What is the Cost Estimate based on? How volume-sensitive is the Unit Cost? There is a 10% chance that the unit cost of

this project will be increased by ___.

R&D Expense What is the estimated size and complexity

of this project? How much capital/other expense is

required? How stable are the requirements? Availability and readiness of development

staff? Availability and readiness of test staff? What are the schedule risks for this

project? Availability and readiness of lab space /

time?


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Sample Assessment Question

Example: Pricing Risk / Sensitivity

Q19 How significant are buyers expenditures for the product in absolute dollar terms? Product Expendituresrelative to CAPEX?

Very Small /


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Four Delay Scenarios

Competition

Product

Growth

Restricted Competition

(Interoperability Issues

/Network Effects)

Perfect Competition

(Standard Interfaces /

standalone Products)

No-Growth

Products

Customers dont switch toCompetitionVolume overall stays same Pricesomewhat reduced

Customers switch to CompetingProductsVolume is reduced throughout

Lifecycle


High-Growth

Products

Customers dont switch toCompetitionVolume overall stays same Pricesomewhat reduced

Margins depressed more severelyin later Stages

Customers switch to CompetingProductsVolume is reduced throughout

Lifecycle, but more severely in

later Stages, due to lower GrowthSales

Just Two Parameters: 1) Delay Time and 2) Percent Revenue Reduction(Price or Volume)


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Four Delay Scenarios Revenue Outcomes (*)

Case 2 No-Growth / Perfect CompetitionCase 1 No-Growth / Restricted Competition

0%

20%

40%

60%

80%

100%

120%

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3

0%

20%

40%

60%

80%

100%

120%

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3

-Q1

-Q3


Case 4 Hi-Growth / Perfect Competition

(*) Partial Source: Preston Smith, Don Reinertsen, Developing Products in Half the Time

Case 3 Hi-Growth / Restricted Competition

0%

50%

100%

150%

200%

250%

Y1-Q

1

Y1-Q

3

Y2-Q

1

Y2-Q

3

Y3-Q

1

Y3-Q

3

Y4-Q

1

Y4-Q

3

Y5-Q

1

Y5-Q

3

Y6-Q

1

Y6-Q

3

Initial Sales - Baseline Total Sales - Baseline

Initial Sales - Case 3 Total Sales - Case 3

0%

50%

100%

150%

200%

250%

Y1-Q

1

Y1-Q

3

Y2-Q

1

Y2-Q

3

Y3-Q

1

Y3-Q

3

Y4-Q

1

Y4-Q

3

Y5-Q

1

Y5-Q

3

Y6-Q

1

Y6-Q

3

Initial Sales - Baseline Total Sales - Baseline

Initial Sales - Case 4 Total Sales - Case 4

Y1

Y1

Y2

Y2

Y3

Y3

Y4

Y4

Y5

Y5

Y6

Y6

Initial Sales - Baseline Total Sales - Case 1

Y1

Y1

Y Y Y Y Y Y Y Y Y Y

Initial Sales - Baseline Total Sales - Case 2


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NPV Probability Distribution and Risk Weights / Impacts

Net Present Value Probability

Distribution

M ean = 387217.5

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Tornado Diagram

0.826

0.485

-0.34

-0.028

Unit Price

Volume

Unit Cost

R&D Ex ense


Positive Business with a low Probability to fall below NPV=$0

Wide Range of possible Outcomes

Typical Profile of Influence Factor Impact on NPV

0

-$0.4 $0.0 $0.4 $0.8 $1.2

Values in Millions-1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1

Std b Coefficients

R&D Expense, while an important Constraint, is almost never theFactor with the most Impact on Profitability


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Portfolio Risk Map (*)

bability

bability

V

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Assessing and Managing Risks of Product Portfolios