Developing the organizational capacity to evaluate and optimize the business portfolio can be very costly in terms of time and resistance to new methodologies within the organization. What is the level of sophistication that our business needs? What is the best way to achieve a portfolio management culture?

Portfolio methodologies make it possible to optimize in a more efficient way the allocation of resources to products, assets, projects, channels, and other variables in order to maximize the value they contribute to the business as a whole. I previously published an article, “How to stretch the blanket? Use of optimization tools”, where I presented basic concepts of a portfolio optimization method. The questions now are, “How to apply this tool? How do I know where my company is, in terms of portfolio management?” and “How to improve?”

First of all, it should be remembered that we should not rush into implementing complex methodologies for the mere fact of updating ourselves, without taking into account what we really need, and of course, this recommendation also includes portfolio optimization methodologies.

There are different alternatives to incorporate only the tools we need at each stage of the maturity of our business. First, we need to identify where we are. There are at least five levels of maturity in which a company can find itself regarding its ability to evaluate and optimize its portfolio.

1) Evaluation of individual projects: projects are evaluated independently based on their contribution to the results. In this type of situation, there are usually no unified criteria to evaluate all projects in the same way and sometimes there are significant asymmetries between different areas of the organization. Decisions are made “project by project”, as opportunities appear, and the expected returns of each project are compared against a desired minimum profitability threshold. At this level of maturity, there is usually a high competition for resources between the different areas of the organization.

2) Database of projects: in this second level, information about the projects begins to be compiled in a global project database. These are the first attempts to establish a comparison that allows all initiatives to be evaluated and to be able to compete transparently. However, the criteria for evaluating each of the projects are not defined in advance and often vary from one area to another. In general, a ranking is put together through the comparison of expected returns or contributions and then exceptions are made to this ranking to contemplate those projects with strategic value difficult to quantify.

3) Portfolio analysis: the portfolio principles are known by key people in the organization, and it is agreed that the global optimum does not usually result from the sum of the local optimums. A priori metrics are defined, similar evaluation models are built, and tools are used to quantify the value added to the global portfolio for each project. Despite this progress, the strategic value of each project or asset is usually considered only in a qualitative way and the risk of the portfolio is not usually rigorously evaluated. The balance between risk and return is done intuitively. There are no probabilities or quantified risks and basic notions of risk levels are established only at a qualitative level (critical, medium and moderate) penalizing or favoring the results of the projects.

4) Stochastic portfolio optimization: quantitative risk analysis methodologies are used for portfolio optimization. Risks are estimated through a reliable process and probabilistic optimization models are built that support project prioritization decisions and allocation of funds and resources. External variables are incorporated, and efficient frontiers are sought that reach new value thresholds for the business.

5) Decision Management for portfolios: a portfolio management culture is shared by the different areas of the organization. There is active collaboration between the areas to carry out a global evaluation of the portfolios and competition for independent resources is minimized. Global optima are prioritized over local optima. Strategic planning decisions are made for products, assets, projects, channels, and any key aspect to prioritize through stochastic portfolio optimization tools to maximize the added value of resources towards the achievement of the organization’s long-term objectives.

Towards a portfolio management culture

Regardless of the degree of progress of each company in the implementation of portfolio optimization methodologies, the most important change begins by installing the habit of evaluating all projects, assets or products with a global vision. This implies creating spaces and mechanisms to stop weighing projects individually and start evaluating the potential impact of each one on the total portfolio.

By implementing this global vision, you will not only optimize value, but will also reinforce the financial discipline of the team, share resources with potential savings opportunities, allow units to take risks they would not take independently, and facilitate the capturing of opportunities for business synergies. In short, many projects may seem highly profitable when analyzed separately, but from a global perspective, they can generate suboptimal results for the organization.

Precisely, portfolio management methods help us avoid this trap. The companies that best apply them often reject investment alternatives that their competitors would love to have. But ultimately, these companies seek to maximize the total result of the business and not that of particular areas. Thus, they manage to do more with less, stretching the “short blanket” through an optimal allocation of their resources.

Gastón Francese
Partner at Tandem.
gf@tandemsd.com