Wait, what? When is it bad to eliminate risks? Many companies we speak with are keen to score their portfolio of initiatives across a number of dimensions, like:
- Strategic fit
- Market value
- Development cost
- Technical risk
- Commercial risk
So far, so good. The process goes awry when teams, seduced by the idea of simplicity, distill all the dimensions into a single score for each project.
High strategic fit and market value are “good” and increase the score, while high cost and risk are “bad” and reduce the score. And therein lies the problem.
This single-score approach will always reward low-cost, low-risk projects. The likely outcomes of prioritizing by this single score include:
- A low-risk or no-risk portfolio that includes only product line extensions and incremental product improvements
- A portfolio that funds late-stage partnerships that require minimal cash outlays and hold minimal risk but require high-royalty payouts, and thus do little to increase company operating margins.
- A portfolio that deprioritizes early-stage and research initiatives that have higher risks and require longer-term investment, but could yield significant returns over the long run.
- A company opts to buy back its public shares rather than increase investment in higher-risk initiatives (US corporate stock buybacks since the beginning of the year have totaled more than a trillion dollars).
When companies value stability over innovation, some risks increase: they risk slowly losing market share and fading into the background of their industry. So what do we do? The solution lies in the understanding that effective R&D governance cannot, and should not, distill projects into a single number.
5 Ways to Assess and Communicate Risk
The right number of high-risk projects in your portfolio is probably not zero. The exact number will depend on your corporate goals, risk tolerance, and financial reserves. Here are a few ways to assess and communicate risk in your portfolio.
Risk vs. reward
Rather than burying risk in an overall project score, construct a time-tested risk vs. reward chart to highlight the trade-offs (or lack thereof) between project risk and project value. Management may be surprised to see how many — or how few — risky projects populate the portfolio.
If your firm tends to be risk-averse, you might also consider recasting risk in the language of innovation. Rather than a risk score, assess technology readiness or initiative innovation levels.
Project pipeline
You can also look at the balance of high- and low-risk initiatives in the portfolio. Are your high-risk projects all concentrated in one division or market segment? Given the attrition you expect in your development lifecycle, is the balance of early- to late-stage initiatives appropriate? Are these allocations by design, or happenstance?
Portfolio revenue with uncertainty
Bubble charts are eye-catching, but they don’t address key questions of sufficiency: Do you have a sufficiently ambitious portfolio to meet your medium- and long-term goals? For that, you need to forecast project returns across the portfolio to understand how many high-risk, high-return initiatives must be funded to increase the chances of meeting portfolio goals.
With the right financial mechanics, you can forecast portfolio revenue while accounting for development attrition and commercial uncertainties. You may conclude that even if everything goes your way, reaching revenue goals is unlikely (an uncomfortable, yet important, realization).
Balancing value and competing objectives
You can use charts like a prioritization dashboard to illustrate portfolio value and balance.
Operational risks
Finally, you can use charts like a flag chart to identify the mix of high- and low-risk projects in terms of upcoming milestones or reviews. Many charts can be improved by overlaying some aspect of project risk.
Eyes Wide Open: Risks Ahead
By now, it’s clear I’m not suggesting we should ignore risks: It’s critically important to assess project risk across the portfolio. Risk assessment allows teams to identify the highest risks affecting the portfolio and focus their experience and talent on risk mitigation.
However, we need to differentiate between risks that should be mitigated (often with mitigation efforts that have a very high ROI) and risks that can only be resolved through the normal course of development.
The methods I’ve discussed above vary in sophistication, from Monte Carlo methods simulating thousands of financial outcomes for each project to simple project inventories, but they skew towards the simple rather than the complex.
Adding methodological sophistication isn’t always the solution: Brick and bar views are transparent, simple to explain, and are more likely to spur essential conversations about portfolio value and balance among your decision makers. Ultimately, those conversations will be more important than the sophistication of the analytic methods you employ.
How do you measure and account for risk in your product portfolio? Does your organization recognize and fund more innovative, less-certain initiatives to ensure a long-term future?
