Evaluating Projects and Creating Portfolios: Balancing Costs, Benefits and Risks

Dr Lawrence PhillipsVisiting Professor of Operational ResearchLondon School of Economics & Political Science

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Development portfolio decisions in your company are made...

A: …by proposing the

best way forward for

each individual

project, then

adjusting funding on

some projects to

ensure the total

budget is not

exceeded.

B: …by considering

options for each

project, judging trade-

offs between projects,

then selecting those

options that are

collectively best within

the total budget.

OR

3

Two approaches to project decisions

A: Silo decisions B: Portfolio decisions

PotentialBlockbuster

Orphan

PromisingMarketLeader Me-

too

?

4

Does it matter? A real case:

Silo decisions:P: Current

development spend is expected to yield benefits of 415 (relative units).

Portfolio decisions:B: Same spend will

yield benefits of 515. P to B: 24% more

value Can exceed $2 Bn NPV!

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Portfolio decisions: 7 principles

1. Think strategically: what & why before how & when

2. Identify areas of strategic importance3. Pursue multiple goals; express as criteria4. Evaluate investment options, not projects5. Judge trade-offs between areas and criteria6. Create portfolios: the best ‘bang-for-the-

buck’ option from each area7. Explore the best portfolios under different

judgements and assumptions

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1. Think strategically Ask WHAT should

be done and WHY before engaging in operational questions of HOW and BY WHEN.

Maintain ‘Helicopter View’ but ensure realism.

Example:• Develop this broad

spectrum anti-cancer agent for lung cancer because it shows good anti-tumour activity in animals and the unmet medical need is great.

• NOT, complete Phase II studies and begin Phase III (this is the next step in how the above will be done).

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2. Identify strategy areas Areas are budget categories for allocating

resource• therapeutic areas (discovery research)• projects (development)• disease states (marketing)• etc.

Areas should be relatively independent: more or less resource could be allocated to one without commitment to another

Worry about interactions later

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3. Pursue multiple objectives

“Contrary to business school doctrine, ‘maximizing shareholder wealth’ or ‘profit maximization’ has not been the dominant driving force or primary objective through the history of the visionary companies. Visionary companies pursue a cluster of objectives, of which making money is only one--and not necessarily the primary one.”

Collins and Porras, Built to Last, 1996

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Express objectives as criteria

Financial• net present value• profit• market share• revenue

Risk• probability of

success• doability• confidence

Non-financial• unmet medical

need• time to market• leadership• strategic alignment• innovativeness• future potential

(extension of life)• franchise

enhancement

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4a. Identify investment options

Disaggregate the current plan into separate strategies.• P1: lung cancer• P2: breast cancer

Propose new investment strategies. • +1: colon cancer• +2: sustained-release formulation

Include a ‘shut down’ or ‘no-go’ option Work in multi-functional teams; think

creatively

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4a. Identify investment options

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14

13

12

Strategic 11

Invest- 10

ment 9

Options 8

7

6

5

4

3

2

1 exit exit exit exit exit exit exit exit exit exit exit exit exit exit exit

Project A B C D E F G H I J K L M N O

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4b. Evaluate options on the criteria Assess options for

their total cost from the

decision point through to completion,

non-financial value financial value, and risk (probability).

Area: CancerMed Cost NPV Need Prob

None 0 0 0 1.0P:Lung 10 260 30 0.6P:Breast 11 300 15 0.3+Colon 15 50 10 0.2+SusRel 9 40 5 0.1

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4c. Re-scale evaluations Convert positive

benefits into scores that sum to 100.

Convert proba-bilities to negative penalty scores (score=100 log p), then re-scale so sum equals -100.

Area: CancerMed Risk Cost NPV Need Score

None 0 0 0 0P:Lung 10 40 50 -9P:Breast 11 46 25 -21+Colon 15 8 17 -29+SusRel 9 6 8 -41

Sum 100 100 -100

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5a. Judge trade-offs between areas

Assess the extent to which successful completion of all the options for one area will contribute value as compared to all the options in another area.

Area A Area B

£300MNPV Preference

… this swing in preference.

NPV Preference

0

£1,500M 100

0 0 0

100

This swing in preference is five times…

Pref scale weight= 100 20

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5b. Assess trade-offs among criteria

Assign weights to express the relative importance of the criteria

MedicalNPV Need Prob100 60 40

normalised 0.5 0.3 0.2 Weights are best assessed by the

decision makers and senior executives who see ‘the big picture’

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6a. Determine priorities Calculate overall risk-

adjusted preference (benefit)--weighted sum.How? See Goodman and Wright, Decision Analysis for Management Judgment, Wiley, 1997, Chs. 2 & 12.

Calculate the priority of each strategy option: risk-adjusted benefit divided by cost.

COST

RISK-ADJUSTEDBENEFIT

‘BANG for theBUCK’

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Why not prioritise just on benefit?

Prioritisation of Projects

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

100.00

0 1000 2000 3000 4000 5000 6000 7000 8000

Cumulative Cost

Benefit/Cost

Benefit Only

59 projects prioritised in two ways.

If budget= 8000, all projects can be pursued.

If budget < 8000, more benefit is realised by funding projects on the basis of benefit/cost.

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6b. Construct best portfolios

Stack triangles from each project in order of declining slopes.

Any point on the curve is a portfolio which includes all strategies up to that point, from all areas.

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Portfolio depends on the criteria

1514 Balanced portfolio

13 $ NPV & technical risk

12 Medical Need & tech risk

Strategic 11

Invest- 10

ment 9Options 8 $

7 $ $ $

6 $ $ $

5 $ $ $

4 $ $ $

3

2 $ $

1 exit exit exit exit exit exit exit exit exit exit exit exit exit exit exit

Project A B C D E F G H I J K L M N O

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7. Explore results and reflect

Examine Frontier Portfolio at Plan Portfolio cost

Indicates Plan strategy falling outside Frontier

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7. Explore results and reflect (con’t.)

Bring selected options into Frontier, see trade-offs

Strategy brought into Frontier

Strategies traded out to keepsame cost for Frontier Portfolio

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Those 7 steps constitute MCDA--multi-criteria decision analysis

An approach to evaluating strategic options characterised by multiple objectives.

Options are evaluated against individual criteria (criterias) using data and judgements.

Criteria are weighted to reflect their relative importance; a key role for judgement.

Overall evaluations are calculated as weighted averages.

The ‘big picture’ can then be explored.

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Purposes of the MCDA process

To create shared understanding of the opportunities in the portfolio

To develop a sense of common purpose across different areas or ‘silos’

To gain commitment to subsequent decisions by senior decision makers.

The MCDA model is used as a tool for thinking.

The MCDA process requires careful design to engage the right people in the right way at

the right time

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A sample design of social processes

Kick-offMeeting

T e a m M e e t I n g s

MergeMeeting

assess trade-offsexplore portfolios

BriefSenior Execs

Evaluate& Digest,

Recommend

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After the Merge Meeting Evaluate and digest results

• to deal with unexpected results• to consider new perspectives that were

revealed Create a temporary decision system (or use

the existing system if it can do the job) that• relies on multi-functional forum• draws on appropriate authority relationships• is steered by a core project team• elicits & sustains overall portfolio view• creates space for negotiation among key

stakeholders

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Why does MCDA process work?

Allocating resources on a project-by-project basis imposes the ‘Commons Dilemma’:when total resources are limited, even if each area is using its share optimally, the result will not be collectively optimalSilo decisions always create sub-optimal use of the available resources!

PotentialBlockbuster

Orphan

PromisingMarketLeader Me-

too

?

27

Why does MCDA process work?

MCDA manages the complexity of viewing the portfolio as a whole.

MCDA shows where to allocate resources as they become available.

MCDA indicates how the whole can be greater than the sum of its parts.

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The value of the MCDA approach

Better communication across ‘silos’ Shared understanding of strategic goals Development of an ‘idea-generating’ culture Improved team-working Better appreciation of trade-offs in the portfolio Commitment to the way forward Smarter, defensible decisions Creation of more value, financial and non-

financial