Product Portfolio Risk Management

Assessing and Managing Risks of
Product Portfolios

Ruedi Klein, NPDP, PMP

Product Manager

Alcatel-Lucent

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

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


1
‘Efficient Frontier’ of New Product
Portfolios


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


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

Two Asset Investment Decision

R2 A2
ρ = -1

ρ=0 ρ= 1

R1
A1
Return

Risk X1 X2


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

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

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)


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


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

2
Portfolio Risk Assessments


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


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)


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


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.

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?


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


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)

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’

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

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

3
Integration of Portfolio and Project Risk
Management


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


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

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
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Typical Distribution of Technical Risks

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All Rights Reserved © Alcatel-Lucent 2007
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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

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


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

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


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