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Using Portfolio Management to Boost Innovation

Dr. Robert G. Cooper

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The Challenge
Most businesses’ development portfolios have far too many projects, and often the wrong ones, according to a major APQC study (Figure 1). The fact is that, over the last 15 years, portfolios have drifted from moderately balanced to a huge imbalance, with far too many small projects and few major or breakthrough initiatives.

A major part of the problem lies with portfolio management – how executives make their R&D investment decisions, relying largely on financial approaches, including NPV, ROI, and payback period. These methods are fine for evaluating traditional and “known” projects. However, an overreliance on these popular financial approaches favors incremental projects (whose financial forecasts are reasonably reliable), but tends to kill all but the sure bets. The result is an anemic portfolio of development projects!

A related portfolio cause is the failure to set aside strategic resources to undertake these major initiatives and breakthrough projects. After the portfolio allocation exercise, resources are already over-committed, and thus there are few or no resources available to do the breakthroughs … and so they get postponed or put on hold.

Portfolio Solutions
First is the recognition that there is indeed a problem: A solid portfolio review is a good place to begin – a current state assessment of the breakdown of projects. Develop pie charts showing breakdowns of resource allocating across projects types, and also pie charts revealing sales revenues or profits, again broken down by project type. The results are often provocative, showing a real shortage of higher impact, major new products.

Fencing-Off Resources: Resources are often not available to do larger projects simply because they are totally consumed by too many small projects. One solution is an organizational one, namely to fence off people who working 100% on major developments or breakthroughs. A second solution is a portfolio approach, namely strategic buckets. Here, management makes a strategic decision to set aside resources for different types of projects including breakthroughs. This strategic approach is based on the premise that “strategy becomes real when you start spending money”…. so make the spending (allocation) decisions! (Strategic buckets is explained more in my book Product Innovation and Technology Strategy, and the seminar Deciding Your New Product Portfolio: Making Strategic Choices and Picking Winners).

Scoring Models For Early Go/Kill Decisions: Another solution is to use a scoring model for evaluations at early-stage portfolio reviews or gates. The goal is to protect more venturesome projects in the early days – to get them through the “valley of death” – until the project team has something tangible to show management and customers. A second goal is to reduce the over-reliance on financial models in the case of breakthrough initiatives, where so little is known with certainty, especially in the early stages.

Scorecards place more emphasis on non-financial factors, the theory being that certain projects have a winning profile, and that profiling via a scorecard is a much better predictor of success than financial projections. (Tried-and-proven and research-based scorecards are demonstrated in the seminar Deciding Your New Product Portfolio: Making Strategic Choices and Picking Winners).

An Options Approach: What some managers miss is that, at the early stages of a venturesome project, they are not making an all-or-nothing Go/Kill decision, but rather a relatively small investment to undertake a preliminary investigation – to “test the waters”. Thus the initial investment decisions do not need the rigor of later-stage decisions. Think of the idea-to-launch process as “buying a series of options” on the project, rather than “buying the whole project outright”; buying options is one way to mitigate risk. Thus a gating or buying options approach helps to manage the risk of breakthrough development projects.

If you view development investment decisions as a series of “options purchases” from beginning to end of project, then it becomes immediately apparent that traditional NPV and related financial techniques are wrong for this type of investment decision. NPV is a standard capital budgeting technique which assumes an all-or-nothing decision: Should we build the new factory or not? By not building in the risk mitigating strategy of buying options, NPV and related financial techniques tend to undervalue (penalize heavily) venturesome projects…. and so these projects get killed!

A more realistic financial model is the Expected Commercial Value (ECV) which looks at risks and probabilities, but most important, takes the investment a step-at-a-time via a decision tree approach. By considering the options-buying nature of new-product projects, which mitigates risk, the ECV method will value venturesome projects much more fairly (usually much higher) than do NPV methods  (For more about this powerful financial method, attend the seminar Deciding Your New Product Portfolio: Making Strategic Choices and Picking Winners)

Not Enough Breakthroughs? -- Some Good Solutions Are Available
Portfolio management offers some of the solutions:

  • Employing strategic buckets to preferentially set aside resources for big, risky projects.
  • Using scoring models for early gate decisions (instead of over-reliance on financial models).
  • Adopting a step-wise approach to investment decisions to mitigate risk.
  • Using the right financial models (options models) such as Expected Commercial Value.

References:
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Cooper, R. G. (2012). Creating bold innovation in mature markets. IESE Insight, Third Quarter, Issue 14: 20-27.
Cooper, R. G. (2013). Where are all the breakthrough new products? Using portfolio management to boost innovation. Research-Technology Management, Sept-Oct: 25-32.

About Stage-Gate International

Stage-Gate International’s highly knowledgeable and experienced team of advisors have guided hundreds of organizations to successfully implement a best-practice Stage-Gate Idea-to-Launch process in as little as 4-8 weeks. We accelerate time-to-benefit with an extremely attractive return on investment by:

  • Crafting a balanced Idea-to-Launch Process Solution of expertise, advice, facilitation and best practices that fits your company’s situation, sense of urgency, and budget.
  • Collaborating with you so that your Idea-to-Launch process is implemented rapidly and your organization is equipped to ‘own’ and manage the process as quickly as possible.
  • Leveraging our market-leading accelerators, Benchmarker™ and SG Navigator™, to not only deliver all of the foundational elements straightaway, and ‘clear the path’ for rapid achievement of a  best-practice Idea-to-Launch process.

Dr. Robert G. Cooper

Robert G. Cooper is one of the most influential innovation thought-leaders in the business world today. He pioneered many groundbreaking discoveries in product innovation, including the Stage-Gate® Idea-to-Launch Process, now implemented by almost 80% of North American companies. Having spent 40 years studying the practices and pitfalls of 3000+ new product projects in thousands of companies, he has assembled the world's most comprehensive research in the field of product innovation management. His presentations and practical consulting advice have been widely applauded by corporate and business event audiences throughout the world, making him one of the most sought-after speakers.

A prolific author, Dr. Cooper has published 100+ academic articles and thirteen books, including the best-selling 'Winning at New Products', now in its 4th edition. He is the recipient of numerous prestigious awards including the Crawford Fellow from the Product Development and Management Association (PDMA) and the Maurice Holland Award from the Industrial Research Institute (IRI). He is also Professor Emeritus of Marketing and Technology Management at the DeGroote School of Business at McMaster University, and Distinguished Fellow at the Institute for the Study of Business Markets (ISBM) at Penn State University.