Executive Summary
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Valuing R&D projects is a critical component of project portfolio management.
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Traditional methods for valuing financial assets cannot be easily used for valuing R&D projects, as they are very different in nature.
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Decision analysis is widely used for valuing projects in R&D-intensive industries such as pharmaceuticals and energy.
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Using decision trees, one can determine a project’s expected net present value (eNPV) and downside risk, two essential ingredients for determining whether or not to proceed with the project.
Introduction
Project portfolio management, the equivalent of financial portfolio management but focused on R&D projects rather than financial assets, often relies on decision analysis methods to value projects rather than traditional financial valuation methods such as net present value (NPV). In finance, the idea of managing portfolios of assets goes back a long time, with the first formal methods being developed in the 1950s. Simply put, assembling a portfolio of stocks, bonds, and other financial instruments balances the risk a manager is taking with any one of the investments. Over time, this same idea has also taken hold for managing a portfolio of R&D projects, where it is referred to as project portfolio management.
Project portfolio management considers the company’s set of projects in a holistic way, providing an overview of the potential value, as well as the inherent risks of both the projects a company is currently engaged in and those it plans to initiate in the future. By means of project portfolio management, risks can be reduced through diversification of the product portfolio and value enhanced by identifying synergies between projects. Companies in the pharmaceutical and energy industries, for instance, have long recognized the value of project portfolio management, and they are using sophisticated methods and software tools to support this process.
Project portfolio management comprises the following functions:1
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determine a viable project mix;
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balance the portfolio;
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monitor the projects in the portfolio;
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analyze and enhance project performance;
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evaluate new opportunities against the current portfolio, taking into account capacity and funding capabilities;
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provide information and recommendations to decision-makers.
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