Book Review: Optimizing Corporate Portfolio Management

This is the fourth in a series of reviews of books on the reference list of the Project Management Institute’s Portfolio Management Professional (PfMP) Credential Examination. The complete reference is:

Optimizing Corporate Portfolio Management

A. Sanwal. Optimizing Corporate Portfolio Management: Aligning Investment Proposals With Organizational Strategy. (Hoboken: NJ, John Wiley and Sons, 2007, 190pp.)

This book was written by Anand Sanwal, Vice President of Investment Optimization and Strategic Business Analysis at American Express. It details American Express’s adoption of Corporate Portfolio Management (CPM), which the company refers to as Investment Optimization. Three contributions to the practice of portfolio management described in this book are: (1) Application of portfolio management broadly across the business, rather than limited to one or two functional areas, (2) Insistence that a significant proportion of operating expenses often classified as “business as usual” are in fact discretionary and (3) The practice of creating a pool from 10% of each department’s operating budget to use as part of a competitive portfolio management process. The latter approach offers many advantages: business units must prioritize their spending with the understanding that the bottom 10% will be “up for grabs”, subject matter experts determine the investment allocation of the bulk of each unit’s funds, and a large pool of money is freed up for allocation to the best opportunities presented.

Valuable advice from Sarwal is to develop your portfolio process first, before investing in a portfolio management tool.

The main target audience for this book is organizations wanting to implement a portfolio management discipline. The book is presented in four chapters:

  • Overview of Corporate Portfolio Management
  • Bringing CPM to Your Organization
  • Applying CPM to Functional Areas Within the Organization
  • Case Studies

Overview of Corporate Portfolio Management

Implementation of corporate portfolio management can appear daunting, but recognizing that the corporate portfolio is made up of a series of component portfolios, such as lines of business, information technology, advertising and promotion and R&D, can simplify the task.

Successful CPM implementation requires changes to processes and organizational behavior. Required process changes include standardization of the definition of an investment and of cost/benefit analyses, use of robust driver-based models to perform cost/benefit analyses, appropriate centralization of assumptions such as discount and foreign exchange rates and tracking of actual results vs. forecast. Necessary behavioral changes include aligning incentives to promote selection of the best opportunities regardless of functional area, cross-functional cooperation and shifting to a data-driven, analytical decision-making style.

Sanwal identifies four stages in the evolution of CPM at a company: Unconsciously Incompetent—the organization does not care to understand CPM, Consciously Incompetent—the organization has acknowledged that it has a problem and begun to implement process and behavioral improvements, Consciously Competent—the company has successfully implemented processes and behaviors that enable the effective management of CPM on an organizational level, and Unconsciously Competent—CPM has become a part of the organization’s DNA; this latter stage is more aspirational than real.

Companies struggle to distinguish investments from ‘keep the doors open’ expenses. Much discretionary spending has crept into the ‘keep the doors open’ category. The average among companies surveyed showed that 30 to 40% of operating expenses are discretionary. However, cutting budgets by 30 to 40% a year is recipe for failure. Rather, American Express asks business segment owners to give up the funding associated with the bottom 10% of their investments, creating a pool of funds to be reallocated to the best identified opportunities.

There are seven and a half ‘deadly sins’ associated with mismanaging the corporate portfolio:

  • Defining the portfolio too narrowly
  • Making investment decisions annually and not on an ongoing basis
  • ‘Decibel-Driven’ rather than data-driven decision making
  • Metrics overload
  • Excluding subject matter experts from portfolio decisions
  • Believing that software can optimize your portfolio for you
  • Failure to close the loop by capturing actual returns to compare to forecasts
  • Sin 7.5—Having a portfolio that is a tunnel rather than a funnel

Bringing CPM to Your Organization

Implementing CPM involves four distinct phases: Analyze, Galvanize, Standardize and Optimize.

In the Analyze phase, you seek to understand how your organization is doing today and build a case for why it should undertake CPM. Questions should be asked regarding: Process and Discipline, Organizational Behavior and Attitude and Readiness.

In terms of Process and Discipline, questions to be asked are:

  • How are the company’s discretionary investments currently managed?
  • Is there a central group that could deliver unbiased and credible organizational recommendations regarding the portfolio?
  • Does the organization track actual results of investments?
  • How is an investment defined by the organization?
  • Is there a rigorous, formal organizational strategic plan?
  • Is there a framework in place to evaluate investment risk?
  • Is there a widely accepted, small number of core metrics used to evaluate investment success?

In relation to Organizational Behavior, key questions are:

  • How will CPM fit within the ‘personality’ of your organization?
  • What is the ‘political landscape’ of your organization?
  • How much time do you have to develop CPM within your organization?
  • Is cross-functional sharing of information encouraged and actually happening?
  • Are incentives in place to promote total organizational success over individual success?

In terms of Attitude and Readiness, the following questions should be asked:

  • To what extent could CPM help your organization?
  • How much effort will be required to implement CPM in your organization?
  • Is there a senior-level CPM champion at your disposal?
  • Are there potential quick wins for CPM?
  • What resources will need to be deployed to make CPM a reality?
  • As the person who hopes to spearhead CPM, what are your personal ambitions and goals?

The author provides a questionnaire (Exhibit 2.2, page 48) to facilitate the Analyze phase. It consists of 22 items on which you score your organization.

Assuming the Analyze phase shows that CPM will be beneficial for your organization, the next step is to galvanize support. This is done by:

  • Leveraging your champion
  • Building a coalition
  • Avoiding confrontation with detractors
  • Understanding the challenges stakeholders face
  • Doing best practices research on CPM
  • Expanding and demonstrating your personal knowledge of CPM
  • Modeling the ROI of CPM
  • Pursuing organizational change on an ongoing basis – the agendas of an American Express two day CPM summit and HP’s Strategic Financial Analysis Training are presented in the text

Once support has been galvanized for CPM, the focus turns to standardizing the way in which investments are viewed. The challenge is to get the different parts of the organization to speak the same language. This requires:

  • Agreeing on what a discretionary investment is
  • Identifying key metrics
  • Standardizing the modeling of investment projections
  • Deciding how to treat investments that don’t generate returns
  • Determining how and how often data will be collected and analyzed
  • Capturing actuals vs. projections
  • Evaluating qualitative factors such as risk and strategic benefits

Once CPM methods have been standardized across the organization, it is time to optimize the corporate portfolio. The first portfolio review should be modest in its goals, consultative and data driven. Some high-level steps to be followed include:

  • Understand the current portfolio – Identify gaps and opportunities
  • Define your goals – for example, you might want to increase the percentage of the investment portfolio focused on innovation from 3% to 5%
  • Gain CPM champion’s support for your goals – the first investment review can be a contentious event
  • Educate stakeholders in the process – it is fundamental that those who stand to gain or lose from the process have a seat at the table
  • Develop a hypothesis for the investment review team to respond to – for example, fund a, b and c investments and cut investments y and z
  • Make a collective decision – each of the stakeholders should feel empowered by the process
  • Implement decisions and advertise – communicate outcomes of the meeting to all stakeholders
  • Conduct post-mortem – obtain suggestions from stakeholder for process improvements

The Working Council for Chief Information Officers has developed a framework for the selection of portfolio techniques and tools. The basic premise is that as you spend more on an investment and as the complexity of investments goes up, the complexity of the tools you use must also increase. The tools highlighted by the Council, in order of increasing complexity, are:

  • ROI and Payback Period – ROI is most useful where the variability and uncertainty of returns are low. Similarly, projects that are shorter term and less complex may be good candidates for using payback
  • Net Present Value (NPV) and Internal Rate of Return (IRR) – NPV is appropriate for investments in which risk can be approximated and outyear cash flows are not highly uncertain. IRR too is recommended for smaller investments with more certain returns
  • Sensitivity Analysis or Monte Carlo Simulation – Sensitivity Analysis provides a means to understand an investment’s drivers and the sensitivity of results to changes in these drivers. Monte Carlo Simulation is used to show how random error, uncertainty or error impact an investment. The outcomes of Monte Carlo are represented as probability distributions and confidence intervals, telling you with what level of confidence you can anticipate a certain outcome. Due to their complexity, Sensitivity Analysis and Monte Carlo Simulation are best used on larger, more material investments
  • Prediction Markets – Prediction Markets are like a crowdsourcing technique for forecasting. For example, rather than having a small management team predict sales for the next quarter, the entire sales team might be asked for their predictions. Predictions Markets are said to be equal to or better than traditional prediction-making methods
  • Stage Gating – As discussed in more detail in my review of Project Portfolio Management, Stage Gating uses a formal system of stages and gates to determine whether a project will be killed, given additional resources or put on a watch list for closer evaluation
  • Real Options Analysis – Leverages options mathematics to decide which options are worth continuing and which should be dropped. Highly complex, susceptible to flawed inputs

Applying CPM to Functional Areas within the Organization

This chapter briefly discusses the application of portfolio management to the following functional areas: Information Technology (IT), Innovation/Research & Development (R&D), Marketing/Advertising and Promotion, Capital Budgeting and Capital Expenditure and Sales Force. More detailed discussions of portfolio management for IT can be found in Project Portfolio Management and for R&D in Portfolio Management for New Products.

Information Technology (IT) has probably done the most to bring recognition of CPM as a discipline. An industry, commonly known as Project Portfolio Management, has evolved largely due to a focus on IT. Gartner has found that two-thirds of IT investments do not achieve their intended benefits, showing the difficulty in realizing IT value. A global CIO survey by Accenture found that although 75% of companies recognized the need for metrics tied to business objectives, only one-third currently uses them.

With a CPM process in place within the IT organization, you should be able to answer the following questions:

  • Is an individual IT investment proposal worth pursuing?
  • Are our current practices for managing the IT investment portfolio adding value?
  • Where are we investing our IT resources today, and what value are they bringing to the business?
  • How should I communicate this value to senior management and other stakeholders?
  • Are IT, finance and the business appropriately aligned when thinking about IT investments in a way that is accountable and transparent?

A 2005 Bain study of the Global Innovation 1000 (the 1,000 publicly traded companies from around the world that spent the most on R&D in 2004) showed no relationship between level of R&D expenditure and measures of corporate success, such as growth, profitability and shareholder return. Rather, superior results seem to be a function of the quality of an organization’s innovation process.

CPM applied to R&D will show you how much you are truly investing in innovation, and how much in incremental projects. CPM gives added visibility to innovation initiatives, allowing you to push them through more quickly. It is important to recognize that CPM does not replace the need to come up with innovative ideas. Generally, developing driver-based models for innovative products will not be possible, decisions will need to be made taking qualitative factors into consideration (e.g., competencies, competitive landscape).

A great deal is spent on marketing. In the first half of 2006, US media spending totaled $73 billion. This is for just 6 months. Marketing can be categorized into three classes depending on the exactness with which marketing campaigns can be valued: (1) Precise – consumer packaged goods and direct marketing firms have access to a wealth of information about their marketing investments, allowing them to develop cost/benefit analyses and make tradeoffs between investments to select the ones that generate the best returns, (2) Vague – these are loyalty investments centered on retention and changing customer behavior; test and control cells can be used to develop cost/benefit analyses, (3)Uncertain – brand equity and consumer awareness investments, almost impossible to develop cost/benefit analyses. CPM allows you to understand how much of your marketing investment is going against the three marketing classes. Ultimately, the objective is to bring measurable data to areas that historically were rarely measured.

A CFO Executive Board survey revealed that the capital budgeting process is characterized by politicization, resulting in 40% of incremental expansions and 90% of discontinuous innovations failing to achieve their objectives. CPM allows all investments to be considered side by side, removing some of the political, decibel driven decision making that plagues capital investments.

In talking to organizations with sales forces, they often question the need for CPM, pointing out that they have customer relationship management (CRM) software to manage their sales force’s efforts. It should be pointed out that the two are not mutually exclusive, in fact the data contained in CRM can be used to help with a CPM capability. CPM is about measuring potential value and tracking sales-force-driven value. In addition, CPM can help you decide whether building up your sales organization with new salespeople would be beneficial.

Case Studies

Five case studies are presented: American Express, TransUnion, Hewlett-Packard, Cisco Systems and the State of Oregon Department of Human Services.

The American Express case study tells the story of the company’s implementation of CPM (called Investment Optimization) during the period 2001 to 2006. Perhaps the first thing that jumps out from this case study is that it took 4 to 5 years to reach the point where cross-segment reallocation of funds became a reality. This is in an organization with a market cap of $71 billion and annual revenues of $21 billion.

Early in the process the company created an investment decision making guide called “Six Steps to Better Investing”. Those steps were:

  • Begin with a compelling business case. This is the foundation for any investment proposal
  • Employ realistic assumptions. Assumptions should be supported by rigorous analysis and include key business drivers, level and growth of business drivers and startup and continuing costs as well as fixed expenses
  • Create a robust driver-based model and projections
  • Apply consistent decision making criteria
  • Obtain appropriate approval
  • Conduct detailed post implementation review

American Express defined an investment as anything that is discretionary. A dialog was undertaken with the business units to generate support for the initiative. Two key points made as part of this dialog were that (1) the requirement to submit business cases to corporate should not create extra work for the units, since these were required by the units themselves and (2) the process created the possibility that a business unit could receive more funding than it would have in the absence of CPM.

Among the benefits accrued by American Express with the implementation of CPM are:

  • CPM contributed to double digit growth in cards over several years
  • For acquisition investments, returns improved from ’04 to ‘06
  • CPM aided in the decision to exit certain businesses, including the decision to spin off American Express Financial Advisors (AEFA). The rationale for the spin off was that AEFA was competing for investment dollars with businesses that usually generate higher returns and that their investment funding would likely be limited due to the company’s CPM framework

TransUnion is a leading global information solutions company that offers a broad range of financial services that allow customers to manage risk and capitalize on market opportunities. The company had three objectives for implementing CPM: (1) Align decision making and improve communication across the business, (2) Make smarter investment choices for initiatives that meet customer needs and drive profitability and growth, (3) Establish a clear sense of ownership and accountability.

CPM at TransUnion began in a single department and then was broadened to the company’s largest business unit. Focus was initially on product investments and expanded into IT. Information is collected on the full portfolio and investments over $100,000 are taken through the review, approval and prioritization process. The company has a standardized cost/benefit analysis process for all investments. TransUnion hopes to soon be practicing CPM enterprise-wide.

Hewlett-Packard (HP) began using portfolio management on investment projects in the late 1990s and gradually transitioned to using it on its businesses and their full range of investments. The decision to implement portfolio management was driven by an R&D benchmarking study which showed that HP’s R&D processes were quite good, but processes to decide what R&D projects to undertake were not robust. Additionally, there was a need to sync up the supply and printer R&D processes.

An Imaging and Printing Group (one of three major HP business segments) initiative to achieve its goal of being #1 in certain markets used a two-step portfolio management approach. First, conceptual opportunities were evaluated using a GE/McKinsey framework which plots business strength and competitiveness against industry attractiveness. This framework identified a rich set of opportunities available to HP. Next, participants were required to justify their proposals to a core cross-functional team. The five main metrics used to evaluate investments were:

  • Increasing shareholder value, calculated as expected NPV
  • Return on investment, calculated as expected NPV divided by total discretionary incremental operating expenses and capital over several years
  • Short-term profit (measured over several years)
  • Time to profitability
  • Risk

As at TransUnion, advocates of portfolio management at HP hope to make it an enterprise-side practice.

Cisco Systems has implemented a CPM discipline that is higher level in its scope than many other organizations. It focuses on the portfolio from a strategic perspective. This is consistent with the culture of autonomy and empowerment that the CEO has brought to the company.

Monthly operating committee and quarterly ‘dashboard’ meetings that Cisco holds ensure that issues and opportunities are addressed in a timely and appropriate manner by permitting constant revisiting of resource allocation and strategic imperatives. The company explicitly ties resource allocation to strategy and utilizes a cross-functional and collaborative leadership style.

The Oregon Department of Human Services (ODHS) has 9,400 employees and an annual budget of $9.9 billion. Its mission is to help people become independent, healthy and safe. Oregon state law requires the implementation of IT portfolio management by state agencies. In response, ODHS put in place a requirement for the development of a formal business case for any business investment opportunity that has an IT component. Business cases are reviewed by the IT Governance Council (ITGC). Since implementing the business case process, the ITGC has evaluated 33 business cases involving projects totaling $94 million. ODHS has seen several benefits from its implementation of IT portfolio management including: A cultural shift towards recognizing the value of developing business cases, driving agency leadership to do the right thing and increased alignment with ODHS core values.

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