Stanford University Lecture on Strategic Portfolio Management

it's very exciting to be here I graduated in 1990 which is more years ago than I care to think of and I remain a student of dr. Howard so I'm excited to be here with his current batch of students just just a quick background question how many of you have actual business experience as opposed to just having just done student anyone have business experience so that's great so that's like a third of you what what kinds of roles have you been in if you could just have a couple shoutouts just give me a sense of what what have you done consulting engineering and here software consulting anyone back here no more what was that okay great so that gives me a sense some of you have a kind of business context I always have a time bridging between this is this is in a way a business story as well so let me first give you a little bit about myself yeah blah blah blah right so I've done a lot of things since 1990 been in consult strategy consulting Europe in the u.s. usually at the intersection of Technology and business problems I actually have an inner geek and started my career as a scientist putting transistors on glass and then came to the engineering economic systems program which was a predecessor of MSN II went on worked with strategic decisions group had a great time there and founded Smart org I'm most famous for my book called the smart organization and I have a copy here that I'm going to give away to somebody by the end of the lecture must be present to win so if I get boring that'll be a small incentive to to stay and I should also say I like interaction so I might have a bunch of stuff I need to get through but this is not like core curriculum so I wanted to go somewhere where you guys are going to get something out of it it's going to be interesting and meaningful to that I'm at Stanford as you obviously know here I basically you know you should all be really intimidated by me and my mom's real proud but there's actually something more important that you should know about me does anyone have a favorite food you wouldn't care to share a favorite food tacos okay tacos anyone else pineapple sushi these are great choices except the sushi cuz I'm afraid I don't care for fish but you know be that as it may that's a great choice for you but my favorite food is chocolate and the most important thing about that is that I brought some so we could just send this around I have some here you could you could pass that around feel free to have some chocolate and I'll send this one up this way we'll send up to the back and down the middle err so you have some good chocolate there alright so my but any any chocolate fans here awesome alright off to a good start then I gotta go this way with it okay so my company helps a lot of big companies understand the economic value of opportunities and find the most valuable things to do that's really decision analysis packed into a business context companies like HP have used us an innovation to we've helped them launch thirty-five new businesses as you might imagine uncertainty dealing with uncertainty is really at the heart of innovation companies like Dow AgroSciences use us across their portfolio they make a lot of kinds of new kinds of seeds and herbicides they have a massive global organization this is a company the size of a country and they prioritize their investment portfolio of about 3,000 projects every year one of their growth investments using our software which is called portfolio navigator so that's what we offer as a firm software portfolio navigator and then we offer consulting services around making this real in organizations and as Noah said I think a lot of my journey has been how do you make decision and analytical ideas really used and useful in companies I have been following one question which is why is decision analysis not as prevalent as accounting and making my contribution to that and through embedding decision-making into systems and organizational processes I am also an entrepreneur and we are just launching a new piece of software called wrangle which is about taming spreadsheets a lot of companies use spreadsheets to manage themselves and to do evaluations and one of the interesting things about wrangle is that if you put a spreadsheet in there it puts a decision analysis layer on top of it without you having to do very much so you can kind of embed this way and I'm happy to talk a great length about this but it's not the topic of the talk and I've had my one minute of advertisement so let's move on to the the core content the portfolio decision is a very common problem shows up in a lot of contexts and it has a very repeatable sort of structure which has real analytical and probably more important process kind of implications so here is a cake a dry academic definition of a portfolio so it's a set of related assets that compete for resources and deliver value to an organization and so you're got limited resources and you're delivering the value and the choice is which ones among this set to fund and I think I had some folks shouting out some stuff from businesses earlier have you guys encountered portfolios in your work or will be an example of a portfolio of it that you may have encountered some you've actually had business well you actually use the word portfolio so that was a portfolio of derivatives right which ones to fund its a very stock market oriented line of thinking somebody else had they did project management consulting is that right yeah so what kind of portfolio have you encountered portfolio subscriber a design supply chain what I just missed the last time so okay so portfolio of supply chain design see that alternative designs to pick that are going to feed your supply chain which ones how do you handle the options those sorts of things one other anyone have another example of a portfolio from your experience yes please of staff like Human Resources right so to certain competency skills right which ones you you develop which ones you deliver usually in a corporate setting there's the portfolio question is which ones do we own which ones do we contract outright and that makes a kind of portfolio so these areas all share a lot of a common common characteristics and I'm going to talk about some of these things if you ask people what they want out of their portfolios basically they want two things they want to improve the results and this is actually what MSN II is good at the sort of analysis that tells you what the best answer is so these are various business terms that result in either get more use less drive the future various kinds of things like that but it turns out that a portfolio process as decision making is generally is also a very human process and if you ever think it's just analysis you won't be effective in any kind of organizational setting so if you look at what people are frustrated about its that decisions cycle they don't get made people revisit their decisions there's a lot of politics maybe a polite way of putting politics is the person making the argument is more important than the quality of the argument ah difficulty comparing frustration with risk and uncertainty tends to create fear if if you want to kill somebody's project you tell them there's risk in it and everyone will go ah and then they won't start thinking very well so these are the sorts of things and I want to bring this together in in a kind of exercise here just as a credit I suppose this is the stuff I'm going to show you as part of the decision and risk management program there so I could tell you a lot of interesting things but it's better if you do interesting things so this is the Mark Twain principle of adult education a person who undertakes to carry a cat home by the tail learns ten times as much as a person who simply watches now there was an online simulation available how many of you actually completed that excellent so that's like a little over half maybe three quarters so you're all eligible to win the book now those of you who did not complete it or if you want to do it again it's actually available online and if you don't manage to crash the servers if you want to go to smarter komm portfolio game and kind of follow along feel free but that might divide your attention I've learned multitasking makes you at least 10 points Jupiter on IQ so I'll leave that up to you whether you have a high enough IQ to do that or not and so we did a simulation involving a portfolio in which I first it's done with dice normally I do it in public contexts and kind of workshops but it's set up based on a kind of metaphor or characterization of a portfolio problem which is this here that is projects undergo kind of two phases the first one you could consider development and the issue is whether they're successful or not and for the purpose of the simulation a project is either successful completely or not successful so it's like a binary thing 0 or 1 so I had some folks with business what are some examples of just success failure in some of the projects that we were that are in the portfolios you've seen maybe nothing yeah yes right so technology development is very common right so it either has to reach a certain level of performance or capability or it's it's a it's approximately worthless until it gets to that point anyone else have an example yeah in the back the ROI was lower than expected or the time was going to take too long for the reason right so he said two things there I tell you might get something and it's sort of successful but it's not really enough to get excited about that's what ROI means it's return on investment that is in particularly the returns are too small you might just stop it or also things take too long right so if they take too long you might in principle be able to finish at some point but you're probably not going to not going to be worth doing so you kind of call so we'll call all that failure now if you get through this development success then you're going to experience some business or commercial result if you think of a startup right as a startup get off the ground and deliver products and get customers that would be successful even if you get that far and you have a successful business you don't know how big the success is going to be and so the commercial success is looking over the whole lifetime of a product or an opportunity or whatever it is what is the total value of that so if you're thinking of like business launches you'd be thinking in terms of like net present value of cash flow something like that could see our financial person is like nodding furiously you've done a lot of that sort of work I think with with HR it might be over the life cycle of a group or something like that or with your example from supply chain probably over some contracting period or something like that might be the value there then I have some more examples written up here for those interested so I'm going to define a portfolio this way for the purpose of an example now I'm afraid I have I have a small confession to make which is I have a wasted youth playing Dungeons & Dragons I understand desi brags it isn't played anymore did any of you happen to play this game okay we have a few we have a few willing to admit it and because the thing is that all the rest of you who didn't play this probably beat beat up people like me right so but anyway they have all these fancy dice and I've learned to use them and make good on on this so that way the simulation works is that we've got these dice and the first one is this polyhedron dice it's a four-sided dice and you would roll it and if it's shows up a one that's a success if it shows up anything else that's a failure and then if you succeed then we're going to roll the colourful dice because of course the commercial results are so much more exciting on a black and white success or failure and in this particular case you get a score between 1 and 6 so that's a basic project simulation you roll each of the dice and you give yourself a score based on a project and the computer simulation just does all this for you it does the die rolling but it's not that interesting to have a single kind of project what makes portfolio management interesting is variation in project types so let's just look at a very simple one here which is I could have won enchants and four of succeeding so that's it that's a hard project this is a black project blacks the opposite of white that one's hard this one's easy and then I could have a big project this one has a potential of only going to six think of it as a small potential project this is a 20-sided die so this can go all the way to 20 so it has a lot of potential and what this creates is a basic grid to look at projects I've applied this in I don't know how many countless situations for helping companies understand their portfolio and balance of portfolio so in the upper left we have easy projects that have limited potential in the lower right we have hard projects that have great potential upper right we have easy projects with a lot of potential and lower left you have hard projects with not very much potential so just this is uh this is a metaphor of course and maybe to help bring this home a little bit can you guys think of some examples of projects of different types that you might encounter in in the real world or in decision situations let's start with bread and butter what kinds of things are bread and butter projects that you may have come across I'm just going to wait them out yes please tick which has a established market manufacturing what for an established market manufacturing a product that has an established market ok so this is a manufacturing improvement in an established market right you can probably pull it off and it's established it's going to be fairly incremental you going to save a few points on your cost or something like that what's another one yes please pass the expansion in like yeah your your mark it's a capacity expansion it could be one of these it's it's it's pretty obvious you can just invest money and make it happen more or less and then was one more there you had your hand up yeah the next version of a putter on a stable market next version right is the is the iPhone C 5 C or whatever that is I mean that's pretty bread-and-butter for for Apple okay that's great now let's jump across to the oyster so these are hard but have a lot of potential if they work there will be some examples of oysters cancer research cancer research it's a great example and there was another one next to you I think entering a new market entering a new market yes startups or pretty much all a stirrers or they try to be another good example here is maybe the launch of the tablet when it was first launched you know people are pretty skeptical about that okay now let's go to the upper right these are pearls these are things that are easy and have a lot of potential they often develop from oysters as you D risk an oyster over time you might find one yes we got one here producing an established technology to a market that hasn't leveraged it yet okay so this is pearl would be a existing technology to new market and often do that anyone else yeah take it arbitrage arbitrage could be this way you're taking a financial anyone else have one you got one no okay yes please new wells in a developed field if it's a big field big and established if it's a if it's a small opportunity then it might might be up there depending on the size that's great and the last one is white elephants now white elephants most companies have and they wish they wouldn't have because they're hard and they're not that big anyone have some examples of white elephants yes please like replacing some antiquated IT system so replacing and antiquated IT system anything else yes please metals wise okay come on why those are white elephant it seems some would be some woody be obviously someone thinks her usually oysters or something but they there's a lot of volatility in metals prices and there's a lot of regulations and I six enormous thing to do it you just kind of rehearing key even if you're doing well your Martin isn't that great yeah block of coal the monitors yeah yeah okay I'll follow that yeah yeah then industry adding a route for airlines may be certainly incremental ones and there was a guy behind you yeah moving medicines Amana diseases medicines for rare diseases okay so these are great examples you might think about why companies would have these in their portfolios which gets you sort of to the human side of portfolio management because nobody really wants to pursue a stupid idea but we'll just let that hang for a bit and move on a little bit so the way the portfolio simulation works is you get to pick ten projects I mean you're presented with the opportunity to pick alright you're presented with a selection of 10 projects and you get to pick five and fund them is anyone playing along by the way live here okay excellent and you're going to simulate the results of the project which the the computer will do for you and then you you get ten I only make people play for money because it makes it much more interesting so I charge them five dollars to play and then you get ten dollars back if you get a minimum score so you're going to score based on hitting a certain threshold of points which is fairly achievable but it's also a competitive simulation and that you get the most whoever gets the most score from their projects in their portfolio gets an additional bonus call the market share bonus if you think about the structure of business for a moment they seem to fall into two sort of categories so one kind of company is a company where what matters the most is whether or not you're the big gorilla Microsoft is probably a great example of this sort of company they have a lot of momentum they get a lot of margin they have a lot of market muscle primarily because they're the big gorilla and I think you could argue that their products are maybe not quite first-class it's an arguable point I think but they what matters is that they're big or Google actually is like this way also so that that in that kind of environment the market share bonus in the simulation is very large another kind of business is much more an accumulation of individual opportunities and a good example of this one would be like the specialty chemicals business the specialty chemicals business consists of very precisely tuned molecules so I might have the absolute best chemical for I'm just going to make something up for putting a certain color onto a car in a way that's going to last in a car lifetime way and and I own that little market and somebody else might have something for putting it on two ships in a different kind of environment they own that little market and so you're power in a way or you're your profit is essentially the accumulation of how many these little pieces you have and in this sort of industry the market sure bonus doesn't matter nearly as much okay you're with me so this game is set up to sort of balance those two points and that creates that set up and that that sort of scoring system creates a wonderful diversity of strategic considerations and arguments and interesting things that go on so I had you guys pick strategies and this is what people did we had and this is averaged over not just this class but actually previous classes as well so there are in the simulation you have let me back up a second in the simulation you've got one Pearl for oysters for red and butter and one white elephant and you need to pick five so actually maybe I'll use two suggestion just turn to your neighbor if you have this portfolio what would you want to pick you got 30 seconds to figure it out go alright times up I learned to do that as a kid you know I've always wanted the thing with your two fingers in the mouth on the whistle I've never been able to figure that out so if anyone could teach me please see me afterward but I can do this one with the all right so let's just have a couple shout outs who wants to tell me what they did and why all right yes and what was your thinking and I think he wants you the pearl of this and then I guess the question was how many oysters grandmother Amalia I felt that friend voters what happened to Johnny bread and butter and then one oyster feed to expose that but I see sort of a hopeful strategy right you want you you were tempted by the oysters and yeah any study was worth maybe you don't to others if you were okay what did somebody else do thank you so he's brave to go first yes please one pearl in toy stores two breads uh-huh hey what was your thinking they're making sure that I will wait somehow just kind of a hedging idea right or a balance idea yeah yeah balance is a really interesting phenomena in real portfolios because it's probably a good thing in a portfolio but I'm afraid to report that often what people do is they they actually compromise so a portfolio could be a big fight I want to fund so you guys want to fund one set of projects you guys want to fund another set of projects you can't agree and so you sort of split the difference and call that balance because it sounds so much better that's not really portfolio balance it's compromise that's a political element yes please I want to throw in three moistures because said I was risk neutral in this box okay you know your expected value moister is slightly more than the bread-and-butter like a five versus four point five okay so you did a little calculation the expected value of the oyster is higher than the bread and butter or so you thought and so you put more into the oyster yeah good okay one more you can be last similar thing but kind of different result I think that I thought that the oysters and the bread and butter and the same expected value but the bread butter had lower variance yes and so I think you're risk averse I would just take one girl and all the oysters all the bread mutters so you went for the bread and butter once you think it's better to be in the cell you put a principle out there right so your principles take the highest expected value and his principle is if this collective are the same pick the one with the lower variance or risk yeah that it turns out that creates a lot of very interesting dynamics so here is the the spread of what folks did the one pearl for bread and butter zero oyster I call the safe strategy sometimes and that that actually makes a lot of sense in many companies because companies have a sort of relentless need to deliver every year every quarter and typically bread and others or shorter term projects that's something that the simulation is sort of abstracted away but there is certainly something to that and then the hopeful one is where you you you want to take some of those risky projects so you try one I don't know about the wisdom of trying one risky project but we'll see how that works out the balanced strategy is what has been the most common here and then you get the that well let me go to the for oysters that's the go for it strategy we're going to just try to win the prize and then the people who don't are a little frayed I call them chicken they do one bread and butter just because so keep your strategies in mind and I want to show you a little bit of statistics here this is the management science part of this discussion where you can see how these work out the first question is what is this project worth anyone have any suggestions on how to evaluate this project to figure out a value of this project would you propose yeah okay sales okay so sales is a common way to evaluate real projects that's it that's a great example in in the context of the dice the metaphorical land what would how would you approach this particular this particular situation yes please point five into the sum of one to six right so he's calculating an expected value or an e value I think all of you know how to do that and uh yes I mean given the course I hope so yeah okay and that is technically the right answer and I want to report that almost nobody does that almost nobody does that have you any of you ever heard of something called a business case okay can someone want to shout out a definition of a business case in your experience let's take a look yes please I got any definition but I think up anywhere I used to work they would have like asked the top managers with top executives and they would have said the most likely scenario is four and three okay you're like this is a safe scenario and then there's one high-value scenario then well one more risky scenario yeah I will just average them and that's the future so they would have picked three or something or four maybe right and call that the business case anyone have something that's substantially different than that the the basic character of a business case is that you make a bunch of assumptions and then you run it through an economic model and then you act as if that's the value of the project and so he had a criteria in there which is a very common one you pick a likely scenario and you work to that and you consider anything better the upside and everything better worse the downside so that's sort of the language people use and so here you know you pick something in the there perhaps that's a common method there are other methods as well and let me give you a couple of them now these are the three that are the most common so you you you make a high case if you want to show what's possible if you've ever been a startup doing a business case it's a giant law you tell to get money right and you you show a very high one another possibility is a low case so that you can exceed expectations because people are generally rewarded or punished based on whether they deliver what's in their business case and the last one which is the one he brought up was the most likely case so these are typically what's done in an organization and they often very much cloud the issue on the in terms of portfolio trade-offs so here is the business case based on a high number you would pick the six and you tell a big story about why the six was a was the right number and why your assumptions were quote justified and then you would act as if this has a value of six it's the big law you tell to get funding this one is based on a business case of a low number if you want to exceed expectations and I would advise you that if you're ever in an organization this method works best if your project is already approved right so sometimes people do their business cases independent of the decision making so there's really no kind of value which is in in the analysis process itself an assumption I think well I and probably most people in this in this room would think is a bit crazy and opponents might actually use this to kill a project so you claim six but it could be one I've just cast a lot of doubt on your project and maybe the management pick mine instead of yours and the the most likely case it usually means the three or the four which is the example he gave but notice that this project is actually a very uncertain project in terms of its success the most likely case is actually zero which seems like a very weird thing to plan for so that kind of doesn't work either and the I think the right way to approach this is as you all pointed out the expected value and this particular one I've done the math 0.875 now this is very confusing to business folks because it's a value that can't occur I'm sure for us or Howard has said that to you but this is quite a head bender and the best analogy I find in business terms is to talk about this in analogy to the evaluation of a start-up right so a company has a valuation which is the price you would trade it this is very much like the buying price kind of thinking and a start-up has a low valuation which improves over time as it goes up and it delivers on its uncertainty and so the expected value works that way it's a great metric and it's not where most people's heads are so you need to help people understand that if there's any kind of risk trade-off in the portfolio which there very much is on this one this word expected value by the way goes by a lot of names probability weighted average risk adjusted value it's also called options value I'm not really clear why but people call it that sometimes or sometimes they'll just say Monte Carlo to mean calculate this but the one thing you'll never hear is eval you that's only happens in this room yes risk adjusted well so you have to think of this from the point of view of someone who thinks the value is a business case at six so they know in their heart that six isn't right so they say well let's risk adjust it and then they mean something like an expected value in fact there's a step in between where they'll take the six and they'll just multiply it by the probability and they won't actually look at the commercial distribution but that's much more where people are coming from is I have a case and what I'm interested in is can I make it or not make it the answer your question yeah and if you look at the expected value for all the projects you'll see that the white elephant is 0.875 the pearl is seven point eight seven five and then the bread-and-butter and the oyster are basically the same now how many of you in your little discussion decided to fund the pearl this is like an arguable weight kind of question anyone here wanted to fund the white elephant you funded the white elephant you want to explain what your thinking was thought it'd be fun okay would be fun no skin in the game that's I got to get you playing for money then might change up actually had a person who funded the white elephant and insisted on it after some explanation of clarity and she eventually said we're running a simulation and I want to simulate what my company would actually do okay so this presents a basic dilemma and I think there are actually two dilemmas in this presentation if you look at this the first one I think you already pointed out is that there's some kind of risk return trade-off between the oysters and the bread and butters so we're going to get to that there's another issue lurking in this which i think is even more problematic and it's kind of hinted at home economist slide is are there any bad projects here and the answer is they're all good projects right now the white elephant which I've you know put down is in fact a good project it's just not the best price the worst project it's not but it's still objectively a good project it's got a positive expected value and so this is really gets right to the heart of what's hard about portfolio management it is relatively easy and by the time a consultant wanders into a business they've gotten rid of the idiot ideas more or less the challenge is this one how do you say no to a good idea when the ants when the reason is I'm funding a better one now let me just bring this home for you a little bit what's your name okay so Matt here is a project leader for us and I know that's let's do product development so you've got a new product that's being developed it's it's going into the market and the technology isn't quite working out the way you hoped sorry Matt but you're going to keep we're going to double down we're going to keep going on the competitor beats us to market ok Matt I'm sorry we have to kill the project it's just not working out so we all feel sorry for Matt everybody ah but we're going to help Matt get on to the next project right because this projects just not working out that is in fact a relatively easy it's not that it is easy but relatively speaking it's easy let me show you a more difficult case so um what's your name Jordan okay so Jordan he's our project leading star and he's driving his project forward and his technology works maybe even works a little better than we'd hoped and he starts to beat the the competitors to market it's looking great he's hitting all his milestones and Jordan I have some news for you we're cancelling your project that's a great question why well and what's your name it's because Adrienne's here is better what goes through his mind when the answer is because Adrienne's is better it's very different than what went through poor Matt's mind right so there is a fundamentally portfolio management is fundamentally a conflict resolution process so you can think of decision in the abstract but you also think of into human terms of a conflict resolution see these guys have stake in their projects he's afraid he's going to get hired or at least lose status by having a project that's canceled because his invent is is better right and so he's going to ask all sorts of questions like what lie did he tell how can I get the same consultant that recommended this project to recommend my project to add some horsepower who can I go talk to on the side you know all these kinds of things are going to come up and and the issue is how do you make no stick and there are fundamentally two ways power which works like this if you don't like it you're fired any questions okay and then persuasion which i think is the better method because it teaches people what it takes to make projects great because at the end of the day I want people like him to be coming up with better projects and this is actually kind of a teaching moment for the organization to figure out what makes project bear so that's the root of persuasion and this leads me to the golden rule of portfolio management which is sometimes but not very often achieved which is the political loser comes to the same conclusion himself this puts a very high standard on your pran your process and how you make decisions in an organization so it's bad for me but I have to agree it's the right priority there's my stressed-out political loser there this is the gold standard I've actually had this happen before where organizations are jammed up when they come to realize that they don't really need to work on a project that's just going to add a few pennies to maybe a production cost or so they realize their project they don't want to work on it either people don't come to work to work on mediocre things they want to change the world so if you can help somebody really understand that they will go join the other teams on their own and abandon their own projects this is hard to achieve so you might well end up here which is also pretty good silver standard which is that the political loser accepts that the process was fair and accurate so these two have presented their information to some kind of committee they make their case they got a loser we got a winner the loser says I think that's wrong I should be the funded project but I have to admit this is a tough call you know they heard the right information and they made a tough call so I can I can move on with that so that would be the silver standard and if you put this in your mind it'll change a lot about how you think about decision-making in organizations so that's the that's the first dilemma in this situation and it shows up on this period of time okay keep going it shows up on this this chart this is an efficient frontier fear an efficient frontier chart I've used a I can use this language let's go a greedy algorithm to figure out what the efficient frontier is so if you invest nothing you get nothing in return if you invest in one project the best one is the pearl which is worth almost eight and then your next project is either an oyster and bread-and-butter depending on this risk return kind of question we talked about until you hit the budget limit and so basically you would fund up to some budget limit and then the other projects out there you don't fund and then there's the white elephant which is the last one any comments or questions about this so far yes please Simpson is like leave money on the table just raise finance and do the additional bread butter projects or or is it the organizational reasons things are too complex or is it that is a great great question many people think of portfolio management is constrained by a budget or some other thing and in some ways it is but mostly it isn't because every constraint in an organization is usually not always it's usually a decision made by somebody else which means it's subject to influence and I've been in in to situation 3 situations where people saw how valuable it was and they up their budget including some things that went to the street and redefined a company's expectations but this is a huge point most of the reason that companies don't think this way is because they don't believe the analysis and the inputs so they're using a budget to control people so if this is other consequence by the way if you can get to the golden rule the standard becomes much higher and people will change their minds by the way so this is one of them also one of the reasons I find linear programming not very helpful in portfolio management is because it assumes the constraints are hard and usually they're incredibly fuzzy and very subject to negotiation so as a practical matter in most situations I encounter a simple thing like this will get you 95% of the way in terms of changing people's minds about what they want to do and then they will go reengineer the constraints to make the right things happen so that's my that's just my experience with with those sort of proaches yes what about shared resources strangers share breezes yeah like people or something right so again those those are also constraints in fact usually those are more real than the financial ones because they can they change may another way they change slower right so you can you can't hire somebody today but you could hire someone next year so often people will do things like that if they see this they'll start to adjust their mixes the other thing is that we are blessed in being in a great market economy and most resources you can actually buy so if you if you really see the economic value when people start to believe it they will again start changing their options the option space that they're working in this is I think probably if I make another generalization about decision analysis for me the most in here thinking the most important thing about decision analysis was making a good decision I've completely changed my view so now that that's wrong but I think a decision analysis as one of the best ways to drive learning and inspire creativity because when you buy the time you do a decision analysis you've you've created an artificial world and it's people's of knowledge of what matters to them causes them to do smarter things I'd say in virtually every situation I've been in there a couple that maybe haven't been this way the ultimate answer is not any of the alternatives analyzed because of the insight that comes through doing the process and I think this portfolio constraint thing is a sort of variation on the same theme people are just confused a lot and they don't know what's actually in their best interest anything else all right let's get to risk and return so main challenge is to balance bread and butter and oyster projects and so at first this looks like a basic risk return trade-off greed versus fear and for any of those in degreed I believe there's some more chocolate here any takers okay there we go and what a standard financial theory tell you about a risk return trade-off basically says uncertainty or risk is something to be avoided right and you have to be rewarded to take more risk this can be a very misleading idea because most organizations are trying to create something so that that idea has I think baked in and a lot of assumptions about a market where you can trade a lot and it's not really about making something happen which is what most businesses are doing and that shows up in this game at a very interesting way which is which you can see here at the sort of strategic level of these things so if you want to know which strategy is better so I've analyzed two strategy here and I apologize that's something after the color scheme the the left one is the bread and butter which should be red and the right one is the oyster which would be yellow they both have an expected value of 818 so that means you take a pearl and for bread and butters or pearl and for oysters and there are other strategies sort of in between but those are two kind of examples so they have the same expected value so all things being equal you should take the take take the lower risk one so what is the lower one there are many ways of doing it you could look at variance I'm sure you guys would handle that for a business audience easier to explain downside risk as the chance of getting less than ten points now ten points you may recall was what you had to do to get to win your basic prize you're going to simulation you pay me five dollars if you get ten points I'll give you ten back it's a great deal for you but you can see the bread-and-butter strategy has a 15% chance of losing and the oyster strategy has a 30% chance of losing so on the basis of that analysis or you can do a variance analysis you come to the same kind of answer you should go bread and butter there's no reason not to and I think actually you articulated this really quite well at the beginning the issue is that most of us are here to make a difference or to change something and so you've got to look at the upside and the upside is not merely mathematical variation particularly in the simulation I think that's also probably not true in the real world so chance of getting 25 or more points which is a fairly difficult number the bread and butter has a 5% chance the oyster has a 20% chance okay so that's just some math but but why does that matter well it matters because of this question of winning what does it take to win what is the structure of the market that you're in or if you think of a personal portfolio what do you have to do with your life what does success actually look like for you and so there are certainly are situations like you know kids soccer here where everybody gets a trophy that's great in that case probably this risk analysis is completely correct there are also cases where we have two absolutely amazing athletes one of whom will be forgotten forever over 1/10 of a second difference and the thing is the high variance strategies are more likely to win and if you win once you might have made the difference you want to make so you get into a very different view if you have this other suite I mean I can frame it mathematically as winning the prize but I think you also want to think about in terms of a human dimension of what does it take to accomplish what you set out to do and in the math of this game it works this way this is a competitive analysis of the oyster strategy here sorry this is what others are playing and in this scenario this is a six-person analysis six everybody else five other teams are playing the the bread-and-butter strategy and nobody else plays the oyster strategy so if you look at that red line up there if you play the bread-and-butter strategy and everybody else plays the better strategy and there are six teams your chance of winning is one and six I mean these are dice after all right so the math is kind of easy but if you switch to the oyster strategy and everybody stays the same your chance of winning goes up a lot you can jump are the other side do the same kind of analysis if I play Easter the other five teams play Easter my chance of winning is one and six if I switch to bread and butter going from the yellow to the red then my chance of winning drops dramatically so the high variant strategies also are most likely to win which creates quite a interesting tension in in this in this simulation so here again you can see the distribution of strategies let me try another we can go a fifteenth turn to your partner have you changed your mind about what you want to invest in it works pretty well all right how many change their mind half anyone not changed their mind okay quarter something like that so somebody who changed your mind why what did you change and why what did you chafe you changed your mind what did you change and why yes please why often not to go for the whale and this time gotta love this guy this is this same probability of getting zero last return yeah great anyone else yes I decided to shift the weight Lord for the oysters I'll hop in why and that's mainly because I guess I didn't realize how big the trade-off was for the bonus yeah I think it's also contextual in terms of you know how much I really want or need the bonus versus my desire and need to perform satisfactory right right satisfactory verses great right what do you want - where do you want to be it's great anyone who didn't change your mind yes - the chicken straighten a chicken strategy okay I was thinking more about like a stable market in which I stood it's highly likely that I get the 10 which allows me to play this game again twice yes yeah I'm just waiting and in real businesses that consideration of having ability to go over you is much more important than business simulation and that said what I find is companies need to up their risk a lot because they don't realize this anyone else ok so let me move on to this is the results from the unfunded portfolio here so the overall average was eleven point three and the number of unfunded successes was two point one I think I didn't do this with enough drama because in this simulation you can do something you never get an opportunity to do in real life which is see how the projects you cancelled would have done and this is a picture of the projects you cancelled what do you see about the projects you said no too yes please well you could say Y average is higher than the ten wines that you would've needed to end the game the average is higher than the ten points in this in this case which is also typically true so that unfunded portfolio is pretty good anyone see anything else see any have a low score they have a looks or at least relative to my scale that goes out the sixty yeah yeah good there's also a lot of success this is the number of projects that roll a success on the black and white pie and you got to think of that every time somebody rolls a success somebody gets excited because they've accomplished their milestones so there's this difference between success and wealth creation if you will so what did anybody have a successful project score very high sorry an unfunded project score high you had an unfunded project score high which project and how high did it score um well if you my strategy was I picked before red yes girl and so all we always did find to see very well and okay so she funded the bread and butter but when the unfunded simulation went she discovered that her oyster projects did very well so you mean to tell me that you cancelled the project and the project leader went off to work on the basement side yeah and then you said no again and then the guy went home worked at home and got some friends to come over and help it out and eventually it became the backbone of our entire business yeah what kind of idiot is she so this is something I call the myth of R&D and it's like it's a profound misunderstanding of how portfolios work the idea that you need to pick the winner is impossible in a situation where there's any uncertainty and so people are worried what would have happened to this great project in fact this particular myth is so strong that it's often used as an argument not to cancel a project right that is you can say I want to cancel your project you say no but I might succeed oh I can't I can't be embarrassed by that so it's what you get is is this sort of situation I'd sure like to kill the project but what if I were to succeed so what do you think happens in real organizations when people are afraid of this kind of embarrassment factor they don't cancel very much and what happens as a consequence they get a lot of white elephants everything becomes difficult to get done right so you get these portfolios that are complete traffic jams you'll hear a lot of people in organizations talk about the need for more resource management in their portfolios basically because they have more projects than they could possibly do 90% of the problem is they haven't cancelled the projects I think that this is the cleaning closet analogy I would like to clean my closet I'm embarrassed say I have a somewhat messy closet but you know rather than cleaning it it's so much more fun to go down to the store and buy an organizer and I can spend a lot of time working on my organizer and it's a great way of avoiding cleaning the closet if I just clean my closet I could still get an organizer but it would be a very different sort of organizing you'll see a lot of organizations are trapped in this sort of resource management mentality that's fundamentally coming from they haven't cancelled the projects often because of this issue and you guys think this is a big issue or a small issue for our company big depends on the depends on the company yeah who are whose including how many people's in play what are their needs yeah certainly it does if we think a big companies from it a big established ones it's a it's big problem and I had the opportunity to work in Hollywood it's only pictures so I have a good example of this now just to give you a sense of this they screened 12,000 picture up proposals every year and they they develop them so that means getting writers and doing things like that and over the course of time they produce 12 movies so every year 12,000 new things in 12 movies out that's a huge cancellation rate and the thing they all live in fear of is this embarrassment moment where a gorgeous actress gets up at the Academy Awards viewed by about a billion people and she holds up her award and says I want to thank all my friends at Tristar for believing in me after those bastards at Columbia turned me down and the camera zooms in on you like oh god okay so you live in abject fear of this and I asked a guy Mel Harris who ran the the shows of the television studio how much money goes into preventing this embarrassment this is a billion dollar a year budget anyone care to estimate what his answer was how much is going into supporting projects to prevent embarrassment I change out the mic okay any thoughts please zero was much higher than that but thank you for getting us started anyone else a billion dollars being spent how much of that is going into projects that are designed to prevent embarrassment fifteen percent five zero well he the second person got that was his answer fifty percent and he actually figured it out by cutting the budget by 50% and he found his productivity went up because we were spending so much time on stuff that did that didn't didn't work out so this is a huge huge deal this clean the closet principle is a massive issue so with that let's move to the any questions comments on the unfunded yes please can you make the case in some like Hollywood though where everyone's success is based at least in part on the reputation that it's actually there is some kind of positive return on funding things that I'm trying to keep people from being embarrassed so that you sure I'll have access to and heat your projects or something sharp be like no you embarrass me so no yeah yeah there's a lot of relationship stuff going on there's no doubt and and I don't want to diminish the importance of that I also want to say so firmly that there's a lot of stuff that's just sort of defensively done that doesn't really need to get done in that case but in many portfolios people are moving on thinking they're doing smart things but they've never actually really looked at them or they're afraid of this possibility and something and and the lesson from portfolio management is if you're in this position some of the rejected projects would have succeeded period some of the rejected projects would have succeeded just you got to get used to it because what matters is not what you cancel but what you keep and think of this for your own career how many of you wanted to be a fireman when you were younger or an astronaut right these are all careers you haven't taken that maybe I need to veterinarian to to get a few more people in the room see and if you spend your life worrying about what would have happened had you not been whatever your childhood favorite career was you know it doesn't matter what matters is what you keep what you actually do that you're here today enjoying this brilliant lecture and eating the chocolate okay so let's look at the funded portfolio here there's the score average 18 point six funded projects 2.8 what do you guys notice there what was that good news it worked better right so the portfolio that you kept this essentially the added value of portfolio management is the difference between these two so the portfolio that you guys kept on average was better there are certainly some people who do better and worse now there is a small anomaly in this particular data set if you look at the funded projects you'll see that they're higher in the successes I'm sorry and the funded projects are higher most of the time it's the reverse yeah and it's because people often take risky moves now I think because there's less setup here you guys have a sort of random distribution over what strategies you picked the strategies that you know after some discussion we're probably riskier strategies we usually do that and in that environment success is not correlated with wealth so it's often the case in a portfolio that a portfolio of risky projects in fact is the least risky portfolio people think that portfolio risk and project list are the same and they're not one way to envision us is that if you're going to walk across you're walking along and you have to jump over a chasm you have to jump if you take step by step you're going to fall in the chasm so the idea that success should be what your word in the sense of development success isn't completely accurate and people in organizations use that as a proxy a lot for value just did I meet my milestones did I accomplish what I said I would do and it's just really not directly related obviously you want success success is good so it's correlated in some sense but it's what you want to do is create wealth create new opportunity here is measured by the score and so this another sort of head vendor idea for people and once they see it they realize that by rewarding success they actually undermine their ability to accomplish their objectives which strategies win here are the statistics here and this is again averaged over multiple courses but the high scoring strategies there are all the oyster strategies and those are the ones that win so to the extent that to the extent that you're it what matters is being first as opposed to just accumulating then it's really important to actually play risky strategies now have you ever hear any heard of a common business as a common business strategy and it's called being number 1 or 2 in your market or exiting I think it was coined by Jack Welch right this is common business wisdom to do a strategy like that requires risky positions and often these same companies have procedures that that fund that fund the the less risky projects that anybody in the simulation have their perl fail and perl failed okay so what happens to the project leader who's perl fails you're the guy running the perl and it fails it's probably a career limiting move right and I worked at AT&T which actually went bankrupt in the late 90s the new 18t is not the old one that the brand got bought out and they were such a dysfunctional company they had a word for this which was I'm running a project it's about to fail hey I've got this great you know leadership opportunity for you you want to take my project this was called the lateral arabesque so like I lateral you the project and do my arabesque and then off I go and then you know all blame went there right so this was a clever maneuver but what happens in organizations if people are punished or rewarded based on the success or failure of their projects just strictly the development success or failure what would actually happen less risky projects you take less risky projects I think this is endemic I call it the flight to mediocrity right so it comes from a best practice actually in project management which is if people make commitments they have to keep them sounds great it's called holding people accountable so you take a project on I hold you accountable and if it under delivers then I punish you and so what happens is over time people do systematically less and less risky things it is one of the reasons the Silicon Valley and startups create so much more wealth than then traditional businesses is because the reward structures are really fundamentally different in a way if you punish people for Wardens success on their projects you're transferring corporate risk onto individuals and it really distorts behavior and you know we talk about risk tolerance and things like that in these classes that's like a third order effect the fundamental issue is how people are treated in conditions of failure when they're taking risk on behalf of the company in virtually every situation I've been and again that's like 95 percent situations expected value is more than enough to illuminate what's going on and help people find the right direction it's kind of an example of that I'm trying to decide how much I can do here I think I'm just going to run to the end there's more to this about value of information which I'm going to run right through here and let me give an opportunity for questions and reward the book so these were the people who had submitted something by last night at the time I read this so if you if you submitted since then not qualified so a Sailor Moon in this group got 43 a Sailor Moon here right there congratulations so I'll be happy to give you a book come on up and I'll sign it for you are there any questions or comments we've got about five minutes for whatever you want to talk about yes please from somebody you have a good project got canceled yeah but got the gold standard of Management yes so you didn't say how you make she believed that he should have abandoned the project yeah have you achieved this process for him and the second question is by on the last slide interesting fact but I jumped over a lot so oh yeah sorry business about the same thing I'll do chief yeah me how do you do the new rewarding process is you don't want to provide somebody on the outcome of this project happy I'll be rewarding those are great questions and I'm not gonna really shed much light on them in four minutes I'm afraid but I will take a crack at it most project most portfolio management systems I use the following process like in the room here alright so they use this process so what you do is you justify your projects so what you basically say is make the argument why I should fund this we know this is an economic environment so one of the requirements is you make a business case put in some kind of economic terms there are variations of what that means but basically put it into an economic format and then what happens is that you parade this in front of a committee of the great and the good and these guys basically you know you make your pitch okay like that one you make your pitch up sorry make your pitch Nassar you make your I like yours you're sorry and I think that's what they do right they have a big argument over it now those people are basically put in an impossible position because there are two things going on for those that committee of the great and good one is that the information coming to them is highly distorted think about biases or anything like that if you guys had any courses and risks and biases and things like that I'd highly recommend them the psychology side of this is great and at because people want their projects not in fact you've you've created a system in which you've asked people to exaggerate because you've asked them to justify their projects so the first job this committee has is untangling that so I might know that you're optimist so I gotta say hmm he gives me a pitch he's always optimist I got to dial that one back a little bit but I know you're a pessimist so I know the project doesn't look good on paper but maybe I'm going to up that a little bit and this person has an interest in this area because her PhD thesis was on that so I'm not so sure it's a good idea maybe she is a little biased and you know okay so it's just what is being said and correcting for that and the second thing that goes on is then once I figured all that out and if I'm a committee I might you know each one of you might be a project and me and my 10 friends or five friends have to figure out which you to fund so then I have to say what are the implications boy if I if I cancel all the projects here that takes me out of a business area and I'm not sure I want to do that or if I fund all these projects over here that's a pretty risky portfolio right so there's two problems what does it mean and what do I do and so people resort to is essentially subjective factors and so they'll use proxies and sometimes these get very elaborate in terms of scoring role systems I'm going to write all these projects on a scale of one to five against strategic fit and market size and difficulty and compute scores of figures of Merit and I'll have all my projects between 0 and 100 abstract points nobody believes it and then we just have a political fight over these numbers or sometimes we just the weights and things like that as all kinds of games people play but the bottom line is that this process is not designed to produce wealth for the company it's from a quality point of view as a terrible terrible process it's got built-in bias it has a lot of ambiguity and so on so a much better process is this so evaluate projects and the the key here is that this has to be useful to the project teams themselves to actually understand whether or not this project is good or how to make it better see here it's assumed that the project is going to have to make the case this is not at any of the the project leader here doesn't get a lot of value out of doing this evaluation game so here you get you get more value you get more use for there and typically have to include uncertainty the second step is calibration and this is typically it's done with a peer review or something like that this is making sure that the evaluations are actually credible and comparable so in a little scenario I ran between these two guys if both of them were already familiar with the other person's evaluation and the assumptions and the inputs and they actually believe there was a reasonable comparison it would go a lot easier when it came to decision time so you change the process that way and then the last thing is portfolio decisions and now you're in a much better position to make the decisions so in a way by doing the economic part the sort of management science part the portfolio decisions become easier because the simple relatively simple sort of economics of it are kind of taken off the table and you can actually focus on the questions you want to add and serve at it and then typically because these things change over time you need to track and adjust as you go so that's a long answer and a partial answer to your two questions but maybe that points the right direction anything else yes please sequencing but what about sequencing projects what if what if by doing them in a different order we produce better results yeah so sometimes projects have these inner dependencies and you can change the order and and so on that's a complication right you need a more sophisticated model I think the same principles would apply here and you could look at those as options I will say empirically though what I find is when when people think that their projects have high levels of interdependence it's usually a framing problem they're thinking of projects as scopes of work and not as results being created in a market so if you're coming from a very tactical project management point of view these questions of sequencing become primary but that's not really a wealth creation or decision-making kind of discussion you have that to chunk up a level to see what's going on anyone else have something I will hang out for a few minutes if you have any questions I want to talk further thank you so much for letting me talk to you for a while it's a great privilege to be here you

Channel: SmartOrgInc

Views: 196,968

Rating: 4.8354611 out of 5

Keywords: Stanford University (College/University), center for professional development, portfolio management, strategic portfolio management, portfolio simulation, SmartOrg, Portfolio Navigator, management consultant, innovation portfolio management, strategy consulting, PPM, Project portfolio management, product portfolio management, strategic portfolio management training, uncertainty analysis, project evaluation, decision making, decisionmaking, tornado diagram, stanford

Id: rKSNExXEo9A

Length: 75min 48sec (4548 seconds)

Published: Thu Dec 12 2013