Product Portfolio Risk Management

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A view of how to assess risks in product portfolio based on risk and return models used with financial investment vehicles

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Product Portfolio Risk Management

  1. 1. Assessing and Managing Risks of Product Portfolios Ruedi Klein, NPDP, PMP Product Manager Alcatel-Lucent
  2. 2. Agenda 1. ‘Efficient Frontier’ of New Product Portfolios 2. Portfolio Risk Assessments 3. Integration of Portfolio and Project Risk Management 2 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  3. 3. State of the Mobility Market Double digit growth is a thing of the past Market Growth • Growth areas for voice are China and India • In NAR, declining voice ARPU will be countered with blended offers driving data usage Data adoption remains a major opportunity • Beginning to see data demand in enterprises Market Trends • Driven by lifestyle applications for mass market • IMS enables operators to capture these segments with blended services 3G alternatives continue to generate interest Technologies • EV-DO has first to market advantage • Wi-Fi and WiMAX distract the DO market Cost control and revenue growth still top priority Operator Challenges • Capex and Opex efficiency still key in maturing markets • Squeezing value from embedded base while moving to Packet Market consolidation Landscape Challenges • Non-traditional competitors entering to own “telecom wallet” • Legislative impacts 3 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  4. 4. 1 ‘Efficient Frontier’ of New Product Portfolios 4 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  5. 5. What is Product Portfolio Management? Portfolio Management A method to compare the attractiveness of alternative investments. Unknown Product Portfolio Management Portfolio management is a dynamic decision process, whereby a business’s list of active new product (and R&D) projects is constantly updated and revised. In this process, new projects are evaluated, selected, and prioritized; existing projects may be accelerated, killed, or deprioritized; and resources are allocated and reallocated to the active projects. Bob Cooper 5 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  6. 6. Objectives of Portfolio Management (*) 1. Maximization of Value Allocate Resources to maximize the Value of the Portfolio in terms of some Company Objective 2. Balance Achieve a balance of Projects in terms of a Number of Parameters 3. Strategic Direction Portfolio is strategically aligned and truly reflects the Business’s Strategy ‘Strategic’ Projects A project is ‘strategic’, when the money will come outside the planning horizon. In business case lingo the project has a ‘Terminal Value’. (*) Cooper, Robert G.; Edgett, Scott J.; Kleinschmidt, Elko J.” Portfolio Management for New Products”, 1998, Addison-Wesley 6 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  7. 7. Two Asset Investment Decision R2 A2 ρ = -1 ρ=0 ρ= 1 R1 A1 Return Risk X1 X2 7 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  8. 8. Varying Investment Levels, result in varying Rate of Returns New Product Return E(rG) Asset Return Return WACC Investment Level New Products are better evaluated as Projects, not as ongoing Businesses 8 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  9. 9. Comparing Product to Asset Investments R2 P2 ρ = -1 Threats to Independence ρ=0 ρ= 1 1.Markets 2.Product Lines R1 3.Technology or P1 Platforms Return 4.Resources 5.Project Types Risk X1 X2 “Put all your eggs in one basket and watch that basket!” & “Diversification is a hedge against stupidity!” – Warren Buffet 9 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  10. 10. Efficient Frontier for New Products (*) Two Portfolios E(rG) O2 O1 Individual Projects Return rf = WACC ‘Efficient’ Frontier Risk σG (*) Efficient Portfolios were first mentioned in H.M. Markowitz, “Portfolio Selection”, Journal of Finance, 7:77-91 (March 1952) 10 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  11. 11. Limitations of Efficient Frontier Model 1. New Product Project Investment Levels and Returns are linked Return Rate drops as Project Investment Level differs from Optimum Optimum Portfolio is unlikely to result in Portfolio Investment Level at the Company’s R&D Budget Level 2. New Product Investments are rarely independent 3. Any Model purely based on IRR/NPV ignores the Existence and Value of Options 11 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  12. 12. Efficient Frontier Conclusion Helps to devise a New Product ‘Strategy’ Enhances traditional Risk / Return Maps Visualizes the Return of New Product Projects Explains, why we need to subtract the WACC from Returns, when using Return / Risk Ratios for Prioritization Theoretical Model, applicable to New Product Portfolios 12 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  13. 13. 2 Portfolio Risk Assessments 13 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  14. 14. Inputs to the Portfolio Decision Markets and Customer Lists “The information you have is not the Resource Information and Total R&D information you want. Spending Level The information you want is not the Products and R&D Project Lists information you need. Business Cases The information you need is not the information you can obtain. Risk Assessments The information you can obtain costs more than you want to pay.” – Anonymous 14 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  15. 15. Risk in Product Portfolio Management Quantities Unit Cost R&D Unit Price & Expense “Risk is the central element that influences financial behavior.” – Robert C. Merton (1999) 15 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  16. 16. Most Success Factors in New Product Development are Not Technical (*) 1. Unique, differentiated, superior Products 2. Strong Market Orientation 3. Sharp, early, fact-based Product Definition 4. Solid up-front Homework (competitive, market, technical, and financial Studies) 5. True cross-functional Teams 6. Leverage (building on Core Strengths) 7. Market Attractiveness 8. Quality Launch Processes (well-executed Marketing Actions) 9. Technical Competence/Technology Actions well-executed “Anything that won’t sell, I don’t want to invent. Its sale is proof of utility, and utility is success.” – Thomas Edison (*) Source: Robert Cooper 16 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  17. 17. Uncertainty Reduction for Risk Areas (*) High Market Product Launch Acceptance Level of Uncertainty Product Product Unit Cost Medium Performance Technical Low Feasibility 0 1 2 3 4 Years (*) Source: F.M. Scherer , "New Perspectives on Economic Growth and Technological Innovation" prepared for publication by the British-North American Committee, and derived from Merton J. Peck and Frederic M. Scherer, "Uncertainty and Time in Program Decisions" in The Weapons Acquisition Process: An Economic Analysis (Boston: Harvard Business School Press, 1962) pp. 299-323. 17 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  18. 18. Risk Assessments Delay Volume / Quantities Price • What competitive Scenario does your • What alternatives are buyers aware of • What specific markets does this Project Project face? (Consequence of Delay) when making a purchase? support? • Does your Project have any 3rd Party • Does the product have any unique • Who are the Key Customers for your Dependencies? attributes that differentiate it from Project and how many • When will the market/customer require competing products? • Have customer commitments already been this Project? • What amount of change, technological or made? • How long can we sell the product? The business will the customer be required to • What percentage of the project volume shorter the riskier. make? comes from current products? • Does your Project have any cross- • How significant are buyers expenditures • There is a 10% chance that the volume of company Dependencies? for the product in absolute dollar terms? this project will be reduced by ___. • What is the probability that this project • Product Expenditures (Cost) relative to will be delayed by one or more releases? End-Benefits? • There is a 10% chance that the discounted price of this project will be reduced by ___. Profitability Unit Cost / NPV R&D Expense • Have Target Costs been established? • What is the estimated size and complexity • Has Lucent built something similar before? • Risk Scores capture of this project? • Are the hardware requirements clear and Variability • How much capital/other expense is stable? required? • Is the Product Definition clear and stable? • Correlation Coefficients • How stable are the requirements? • What phase is the project currently in? capture Weights • Availability and readiness of development • What is the Cost Estimate based on? staff? • How volume-sensitive is the Unit Cost? • Delay has Impact on • Availability and readiness of test staff? • There is a 10% chance that the unit cost of either Price or Volume • What are the schedule risks for this this project will be increased by ___. • Validate Questions project? • Availability and readiness of lab space / time? 18 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  19. 19. Sample Assessment Question Example: Pricing Risk / Sensitivity Q19 How significant are buyers expenditures for the product in absolute dollar terms? Product Expenditures relative to CAPEX? Very Small / <1% of Total CAPEX ............................................................................................................. Small / <5% of Total CAPEX .................................................................................................................... Medium / <10% of Total CAPEX ................................................................................................................ High / <25% of Total CAPEX .................................................................................................................... Very High / >25% of Total CAPEX ............................................................................................................. Five Categories – Multiple-Choice Anchored Scales – As unambiguous as possible Easily answerable, if a Customer Value Proposition exists Run a Dry-Run with someone, who sees the Survey for the first Time Derive Risk Scores / Variability (*) CAPEX – Capital Expenditures 19 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  20. 20. Four Delay Scenarios Competition Restricted Competition Perfect Competition (Interoperability Issues (Standard Interfaces / Product /Network Effects) standalone Products) Growth No-Growth Customers don’t switch to Customers switch to Competing Competition Products Products Volume overall stays same – Price Volume is reduced throughout somewhat reduced Lifecycle High-Growth Customers don’t switch to Customers switch to Competing Competition Products Products Volume overall stays same – Price Volume is reduced throughout somewhat reduced Lifecycle, but more severely in Margins depressed more severely later Stages, due to lower Growth in later Stages Sales Just Two Parameters: 1) Delay Time and 2) Percent Revenue Reduction (Price or Volume) 20 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  21. 21. Four Delay Scenarios – Revenue Outcomes (*) Case 1 – No-Growth / Restricted Competition 120% Case 2 – No-Growth / Perfect Competition 120% 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% Y1-Q1 Y1-Q3 Y2-Q1 Y2-Q3 Y3-Q1 Y3-Q3 Y4-Q1 Y4-Q3 Y5-Q1 Y5-Q3 Y6-Q1 Y6-Q3 Y1-Q1 Y1-Q3 Y2-Q1 Y2-Q3 Y3-Q1 Y3-Q3 Y4-Q1 Y4-Q3 Y5-Q1 Y5-Q3 Y6-Q1 Y6-Q3 Initial Sales - Baseline Total Sales - Case 1 Initial Sales - Baseline Total Sales - Case 2 Case 3 – Hi-Growth / Restricted Competition Case 4 – Hi-Growth / Perfect Competition 250% 250% 200% 200% 150% 150% 100% 100% 50% 50% 0% 0% Y1-Q1 Y1-Q3 Y2-Q1 Y2-Q3 Y3-Q1 Y3-Q3 Y4-Q1 Y4-Q3 Y5-Q1 Y5-Q3 Y6-Q1 Y6-Q3 Y1-Q1 Y1-Q3 Y2-Q1 Y2-Q3 Y3-Q1 Y3-Q3 Y4-Q1 Y4-Q3 Y5-Q1 Y5-Q3 Y6-Q1 Y6-Q3 Initial Sales - Baseline Total Sales - Baseline Initial Sales - Baseline Total Sales - Baseline Initial Sales - Case 3 Total Sales - Case 3 Initial Sales - Case 4 Total Sales - Case 4 (*) Partial Source: Preston Smith, Don Reinertsen, ‘Developing Products in Half the Time’ 21 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  22. 22. NPV Probability Distribution and Risk Weights / Impacts Net Present Value Probability Tornado Diagram Distribution 1.6 Unit Price 0.826 M ean = 387217.5 1.4 1.2 Volume 0.485 1 0.8 0.6 Unit Cost -0.34 0.4 0.2 R&D Expense -0.028 0 -$0.4 $0.0 $0.4 $0.8 $1.2 -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 Values in Millions Std b Coefficients Positive Business with a low Probability to fall below NPV=$0 Wide Range of possible Outcomes Typical Profile of Influence Factor Impact on NPV R&D Expense, while an important Constraint, is almost never the Factor with the most Impact on Profitability 22 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  23. 23. Portfolio Risk Map (*) 100% 50% Probability NPV < 0 Expected Losses 10% $1,000 $10,000 $100,000 $1,000,000 Maximum Loss [000s] (*) Adapted from Preston G. Smith and Guy M. Merritt, “Proactive Risk Management – Controlling Uncertainty in Product Development”, 2002, Productivity Press 23 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  24. 24. 3 Integration of Portfolio and Project Risk Management 24 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  25. 25. CMMi Risk Management Process Area (*) Prepare for Risk Management Identify and Determine Establish Analyze Risks Risk Sources Define Risk A Risk And Parameters Management Categories Strategy Identify Risks Risk Repository Evaluate, Categorize, Mitigate And Prioritize Implement Risks Develop Risks Risk Risk Mitigation Mitigation Plans Plans (*) © 2002 by Carnegie Mellon University 25 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  26. 26. Project Level Risk Analysis (*) Probability of Probability of Risk Event Impact Ex. 30% Ex. 80% Total Risk Event Impact Loss Ex. Gate 1 Postponed Ex. Delay Release by 2 Weeks Ex. Missed major Customer Budget Cycle Risk Event Impact Driver(s) $50M NPV Driver(s) Ex. Dev. Not ready to Ex. Takes 2 Weeks to re- commit schedule Gates “Volatility per se, be it related to weather, portfolio returns, or the timing of one’s morning newspaper delivery, is simply a benign statistical probability factor that tells us nothing about risk until coupled with a consequence” – Robert H. Jeffrey, 1984 (*) Source: Preston G. Smith and Guy M. Merritt, “Proactive Risk Management – Controlling Uncertainty in Product Development”, 2002, Productivity Press 26 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  27. 27. Sc h e 0 5 10 15 20 25 30 35 40 45 R dule es ou rc Fe So e a t f tw ur ar e C e h 27 | Assessing and Managing Risks of Product Portfolios | May 2008 H urn T e ar d ch w a no re lo gi c Pr al Typical Distribution of Technical Risks oc Pr es od s uc t R Co oa st dm Ve Re Ex ap nd qu ter n a All Rights Reserved © Alcatel-Lucent 2007 or ir O Pe em l rg r fo e n t an rm s iz C a at io o n nc na tra e l /M c an tua ag l er ia l
  28. 28. Risk Resolution Process (*) Review Risks Defer Action for Take no Action Develop Action more Info (Accept Risk) Plans Avoid Risk Transfer Risk to a Provide Mitigate Risk 3rd Party Redundancy Prevention of the Contingency if Reserves of Risk Event Risk Event Occurs Budget/Schedule (*) Source: Preston G. Smith and Guy M. Merritt, “Proactive Risk Management – Controlling Uncertainty in Product Development”, 2002, Productivity Press 28 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  29. 29. Risk Management Benefits and Uses Crucial Part of Investment Evaluation Integration with Project Management is 2-Way Risk Assessment –Continuity is Key Lower Costs and less Chaos 29 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  30. 30. Next Steps – Implementation 1. Start with a Review / Identify Areas of Weakness 2. Put in Place a simple regular Risk Assessment within your Portfolio Review Process 3. Using Prompt Lists 4. Covering the whole Portfolio 5. Involving all Stakeholders 6. Follow-Through 7. Making sure identified Risks are addressed 8. Risks are known throughout Company 9. Don’t let Risk get a bad Name “In preparing for Battle I have always found that Plans are useless, but Planning is indispensable.” – Dwight Eisenhower 30 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007
  31. 31. www.alcatel-lucent.com Ruedi Klein, NPDP, PMP Product Manager Alcatel-Lucent Tel. (973) 386-6695 ruediklein@alcatel-lucent.com http://www.alcatel-lucent.com 31 | Assessing and Managing Risks of Product Portfolios | May 2008 All Rights Reserved © Alcatel-Lucent 2007

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