Figure 4: Table listing % of Good proposals in each strategic bucket
Figure 5: The quality of prioritization and project selection for each strategic bucket
Cutoff Values, Hurdle Rates and Bucket Sizes
The preceding metrics, and forthcoming Figures 8 and Figure 9, arise from your proposal evaluations and a twofold classification of completed projects: Good vs. Bad. With a more thorough evaluation of completed projects the model can provide additional metrics. Specifically, if you can estimate the value created or lost by each project, the new model can relate project selection to portfolio ROI and NPV. Figures 6 and 7 illustrate these metrics. (For ease of presentation, these Figures assume that projects are evaluated on a ten-point scale and that Bad projects have a NPV < 0.)
Figure 6: How NPV varies with cutoff values
For each strategic bucket, Figure 6 shows how NPV varies with the cutoff value that you select. If you select a high cutoff value, will be high, so NPV > 0. However, you will select few proposals, so NPV will be small. If you lower the cutoff value and select more projects, will decrease. Initially, the value from the additional Good projects will exceed the losses from the additional Bad projects, so NPV will increase. However, if you continue to lower the cutoff value, will decrease too much. At some point, the losses from the additional Bad projects will exceed the value created by the additional good ones. When this situation occurs, NPV will decrease. If you continue to reduce the cutoff value, NPV will become negative.
The maximum of each curve shows the optimal cutoff value for its strategic bucket. The points where NVP = 0 show the lowest cutoff values you can set before each bucket's NPV turns negative. Figure 6 could display NPV vs. hurdle rate or bucket size (budget), so the new model can help you set cutoff values, hurdle rates and bucket sizes.
Figure 6 is analogous to the productivity curves found in PPM dashboards and the "efficient frontier" produced by optimization. However, Figure 6 differs from those metrics in two ways. First, Figure 6 considers the impact of prioritization errors, but the other curves do not. For this reason, productivity curves and "efficient frontiers" display an optimistic bias. Second, productivity curves and "efficient frontiers" present expectations that arise from the assessments of your current proposals. Figure 6 presents expectations that arise from your past portfolios. It reveals your company's proven performance. Both types of metrics are useful and should be considered.
Balancing Strategic and Financial Goals
Figure 7 reveals the relationship between each strategic bucket's cutoff value and ROI. A high cutoff value (cautious selection) raises ROI. A low cutoff value (aggressive selection) lowers ROI. This relationship occurs for two reasons. First, in a prioritized list the "bang-for-the-buck" tends to decrease as one moves down the ranking. Second, because prioritization is imperfect, decreases as one selects down a ranking. This relationship implies a trade-off between strategic and financial goals. In the short-run, aggressive pursuit of strategic goals will hurt financial performance.
Figure 7: How ROI varies with cutoff values
Figure 7 helps you manage this trade-off. To see how, suppose you wish to obtain 30% of revenue from new products while producing an ROI = 15%. You can estimate the number of proposals you must select to produce the revenues. This estimate identifies the cutoff value that will achieve your strategic goal. With Figure 7 you then estimate the ROI for this cutoff value. If the estimated ROI < 15%, your strategic and financial goals are incompatible and destined to fail. If this situation occurs, Figure 7 will help you select the best trade-off for your company. You can then relax the trade-off by using methods I present later in this paper.