Published here February 2004. 

PART IV | Reason 5 | Definition of the Efficient Frontier
Finding the Frontier | PART VI

Finding the Frontier

It is relatively easy for a computer, with an efficient optimization engine, to try various combinations and locate the efficient frontier, provided the right algorithms are in place. These algorithms must be set for determining how the costs and benefits of individual projects combine to determine the costs and benefits of the project portfolio as a whole. In simple situations where projects are independent and risks are either independent or do not matter, the costs and value of the project portfolio are basically just sums of the costs and values of the individual projects. However, if there are interdependencies or a need to adjust for risks, more sophisticated models are required.

Evidence that finding the efficient frontier adds considerable value

If we locate the efficient frontier, then for any specified total portfolio cost we can pick the specific project portfolio that produces the greatest possible value. Figure 12, derived from an actual application, shows that an alternative portfolio was found that increased value by over 30% without increasing costs. Similarly, an alternative portfolio was found that reduced costs by 40% without decreasing value. This result is typical. Application of the efficient frontier approach shows that current project portfolios are often well below their potential.

Figure 12: Project portfolio enhanced by applying the efficient frontier
Figure 12: Project portfolio enhanced by applying the efficient frontier

The Efficient Frontier Moves Over Time

It should be noted that the efficient frontier is not static. Organizations face the challenge of finding project alternatives that advance the frontier. As project managers better understand the link between their project designs and the value derived by the organization, they create better project proposals. Also, better technology creates new opportunities that create more value for less cost. This causes the efficient frontier to move up over time. The fundamental goal, though, remains the same -- Create as much value as possible using as little capital as possible. To do this, you must find the efficient frontier.

Next Month

The final part of this paper will provide a summary and recommendations for what organizations should to do if they are to better manage their project portfolios. It will also describe the two pitfalls that must be overcome if effective tools for portfolio management are to be successfully introduced into the organization.

Definition of the Efficient Frontier  Definition of the Efficient Frontier

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