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

1. Evaluating Projects and Creating Portfolios: Balancing Costs, Benefits and Risks Dr Lawrence Phillips Visiting Professor of Operational Research London School of Economics & Political Science

2. 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. Development portfolio decisions in your company are made... OR

3. A: Silo decisions B: Portfolio decisions Promising Market Leader Potential Blockbuster Me- too Orphan ? Two approaches to project decisions

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!

5. Portfolio decisions: 7 principles 1. Think strategically: what & why before how & when 2. Identify areas of strategic importance 3. Pursue multiple goals; express as criteria 4. Evaluate investment options, not projects 5. Judge trade-offs between areas and criteria 6. Create portfolios: the best ‘bang-for-the-buck’ option from each area 7. Explore the best portfolios under different judgements and assumptions

6. 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). 1. Think strategically

7. 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

8. 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

9. 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 Express objectives as criteria

10. 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

11. 4a. Identify investment options

12. Assess options for their total cost from the decision point through to completion, non-financial value financial value, and risk (probability). Area: Cancer Med CostNPVNeedProb None 0 0 0 1.0 P:Lung 10 260 30 0.6 P:Breast 11 300 15 0.3 +Colon 15 50 10 0.2 +SusRel 9 40 5 0.1 4b. Evaluate options on the criteria

13. 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: Cancer Med Risk CostNPVNeedScore None 0 0 0 0 P:Lung 10 40 50 -9 P:Breast 11 46 25 -21 +Colon 15 8 17 -29 +SusRel 9 6 8-41 Sum 100 100 -100

14. Preference NPV NPV Preference £1,500M 100 £300M 100 This swing in preference is five times… … this swing in preference. 0 0 0 0 Area A Area B 100 Pref scale weight= 20 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.

15. 5b. Assess trade-offs among criteria • Assign weights to express the relative importance of the criteria Medical NPVNeedProb 100 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’

16. ‘BANG for the BUCK’ RISK- ADJUSTED BENEFIT COST 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.

17. Why not prioritise just on benefit?  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.

18. 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.

19. Portfolio depends on the criteria

20. 7. Explore results and reflect • Examine Frontier Portfolio at Plan Portfolio cost Indicates Plan strategy falling outside Frontier

21. 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

22. 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.

23. 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

24. A sample design of social processes • Brief • Senior Execs Kick-off Meeting T e a m M e e t I n g s Merge Meeting Evaluate & Digest, Recommend assess trade-offs explore portfolios

25. 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

26. Promising Market Leader Potential Blockbuster Me- too Orphan ? 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 optimal Silo decisions always create sub-optimal use of the available resources!

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.

28. 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