There are much better ways to guide project portfolio management than using business cases.
“It’s not so easy,” replied the development manager of Philips Microcomputer Development Systems back in the early eighties. I’d seen him struggle with next year’s projection, trying to fit as many ideas as possible in a limited budget. I was an angry young boy, often wrong but never in doubt, and I suggested only including projects with the largest return on investment. “It’s not so easy,” he replied. And he was right.
During the remainder of my career, I kept wondering whether using business cases for project portfolio management was the right approach. In the many projects I was involved in, I saw a lot of uncertainty on the cost side and even more uncertainty on the benefit side. People spent a lot of time closely monitoring the costs but hardly any time monitoring the benefits, especially when the costs were already included in the profit/loss account of previous years anyway. I also often saw many dependencies between different business cases, which made it difficult to judge them separately.
The most important insight I got was when we analyzed the effectiveness of R&D at a slightly higher level. R&D can be seen as an investment to create future profit and we found that in many different industries, best-in-class companies showed at least a factor 2 return on their R&D investment. Recent annual reports show this performance for companies like Apple, ABB, Boeing, Daimler, Renault, Intel and Siemens, and also ASML reports a factor over 1.8 in 2020.
Here, typical business case calculations fall short. You may be happy with a 10 percent return on your R&D investment, but the above shows you shouldn’t be happy with less than 200 percent. This is why bespoke engineering and customization is often such a bad investment; you can realize much better returns when you create standard products or at least have a high level of re-use.
Ƒor me, portfolio management is about strategic decisions, and strategy is about making choices – what to do to achieve strategic objectives but especially what not to do. A company I worked for had an excellent initial performance because of a very focused strategy and an excellent execution. It still pains me to see that this company is used as an example of bad portfolio management after this initial phase. They supposedly didn’t make any strategic choices about where to invest, spreading their investments too thinly.
Again, it’s not so easy. How much do I invest in growth areas and how much do I invest in the more mature product lines to protect my flanks? Should we invest the minimum to sustain mature product lines and invest everything else in growth opportunities? You often don’t know and there’s a risk you end up in analysis-paralysis mode, with endless discussion. My advice is to just make a decision, go for it and adapt on the fly, all within the limits of the profit-over-R&D benchmark.
The above benchmark figures help when you’re managing a portfolio of businesses, each with its own profit/loss account. But often product lines don’t have that, as allocation of central costs may be arbitrary. Moreover, shareholder value isn’t only determined by profit; growth potential is also a key element in the value of a company or a product portfolio. Products typically go through various phases during their lifecycle, like emerging-growth–mature–decline. Both the growth potential and profit contribution change during the lifecycle. A balanced portfolio spreads investments over products in different phases.
Rather than using profit per product line, I often use margin. You can also see R&D as an investment to create gross margin, as margin reflects the customer value added. Looking at various products ranges, I found that gross margin over R&D ratios range from over 8 for declining markets (milk them), to over 5 in mature markets, and to less than 1 for emerging, fast-growing markets or product lines. The annual reports of most companies mentioned above have a ratio over 5 as an average over all their product families, and a growing company like ASML shows a ratio over 3.
We can still judge the total performance of a portfolio on profit, and we can judge a portfolio of product lines looking at both growth and margin over R&D. In this way, I can balance a portfolio of product lines and allocate annual resources, where the total was limited by the profit benchmark. I prefer to use actual results rather than optimistic plans for my figures, but you can’t avoid having to trust your gut to gauge growth potential.
After the allocation of the annual resources, I left it to the teams to prioritize and find ways to realize the growth or the margin in a continuous flow of deliveries within the fixed budget. There’s no need to micromanage the portfolio at a high level; you have better things to do. I, however, see companies using portfolio management to track the progress of various projects and, even worse, track the cost side of the business case.
As discussed many times in this column, predictability is important when processes can only be synchronized by committed delivery dates. But it comes at the cost of lower productivity caused by the use of buffers. I’ve also often mentioned that many managers require a higher level of predictability than necessary. It provides them with the illusion of control. In many cases, I’ve seen portfolio management being used to track if all activities run according to (an often arbitrary) plan. Tracking against a predefined plan is indeed much easier than real portfolio management. But that’s because real portfolio management is not so easy.