Portfolio Management

Richard Sonnenblick, President of Enrich, John Howell, Founder and President of Portfolio Decisions and Dr. James Mattheson, Chariman and CFO of SmartOrg Inc. talk about maximizing profitability, achieving a balance and the ever-changing landscape of portfolio management.

NGP. The fact that overall industry growth is tied to advancements and setbacks in scientific discovery make it difficult for stakeholders to have a set criteria for decision-making. In an ever-changing landscape, what is the best approach to take whether accelerating or halting any individual project in the pipeline?
RS. In today’s climate most firms can evaluate a drug's basic business case fairly well so they generally know if a project is good – but is it good enough to invest in? This question can only be answered in the context of the company’s overall portfolio. Judging whether a project is ‘good enough’ requires explicit evaluation of two factors: 1) assess the project’s contribution to strategic goals, and 2) compare this project’s contribution to strategic goals with other projects on the bubble.

Strategic goals are about more than just net present value or peak sales: two projects may have a comparable ROI, but one may deliver revenue sooner, or provide a platform for growth in a key therapeutic area. There is no one right answer when deciding between these two projects. Two different firms may prioritize these two projects differently based on their strategic priorities. The key is to make the strategic goals clear and unambiguous so that each project can be measured against them.

With other projects vying for funding, ‘good enough’ also means better than the alternatives. By keeping the set of unfunded, alternative projects up-to-date, you ensure that you are always making the correct comparison.

JH. In a predictable, stable environment, decisions to accelerate or halt a project can be made on a project-by-project basis. In a complex, rapidly changing environment, however, the frame of reference for these decisions needs to be shifted toward a focus on the impact of the project on the company’s strategic goals. A good project is not necessarily a good investment for the company. Good investments interact well with the company’s other investments to improve performance and the probability of meeting the company’s goals. By assessing how a project impacts the probability of meeting those goals (PMG), companies can select good investments from a pool of good projects.

Strategic goals often include costs, product launches, state of the pipeline and critical staff utilization as well as revenue, profit, and/or efficiency measures. A great project might need to be slowed down because it is many years from launch and it reduces the probability of meeting a revenue target in the near future. Similarly, a rather modest project might be accelerated because it substantially improves the PMG for short-term revenue without adversely impairing PMG for staff, launches or the pipeline.

JM. Pharmaceutical R&D has always been a risky undertaking. Those who systematically understand and weigh the potential returns and risks of their undertakings will systematically come out ahead. In the face of uncertainty you cannot ‘call the shots,’ and expect to be right. In any given situation you must distinguish between making good decisions – ones that properly weigh the risks and returns – from getting the outcomes you like. However, over a portfolio of opportunities and over time, consistently good decision-making will lead to the best long-term performance.

It has become popular to devise weighing schemes or scoring rules to judge alternatives. Unfortunately these methods are too simplistic to deal with long-term uncertainty in pharmaceutical decision-making. For example, people will often add a rating of base case financials, usually overly optimistic, to a rating of the probability of reaching that market. A little thought shows that these ratings logically have to be multiplied, not added. Then they toss in their favourite factors, like uniqueness of the approach and size of the un-served market, creating a jumble of untraceable considerations. The result is politically adjusting the numbers to make your favourite alternative come out best. Instead of searching for new schemes or criteria, use time-tested value-based evaluation.

NGP. How can an enterprise achieve a fine balance when considering internal capabilities, strengths and weaknesses versus external opportunities, threats and market potential?
JH. It is not a trivial matter to reach a consensus among decision-makers on the implications of global uncertainties or to build the data needed for analysis. However, by carefully framing a discussion of these uncertainties around specific business questions, the extra effort required can be minimized, and the insights gained can be of tremendous strategic value.

Our portfolio modelling process helps decision-makers to integrate these global, interdependent uncertainties into their decision framework, and to assess the impact of these uncertainties on the probability of meeting goals (PMG). Portfolio balance can be achieved through the ability to quickly search among many thousands of alternatives for the best balance given multiple goals. This capability provides a powerful tool to investigate alternatives to improve your company’s PMG.

For example, decision-makers might learn that their portfolio has a low probability of meeting launch targets for 2012. We drive the portfolio model to maximize the PMG for launches in 2012 given the constraints inherent in accelerating a late stage portfolio. The result has a high PMG for launch in 2012 (90 percent) but a low (30 percent) PMG for costs in 2010. Decision-makers assess these tradeoffs and set a minimum threshold of 60 percent PMG for costs in 2010. This produces a maximum PMG of 75 percent for launch 2012.

JM. It is critical to put all considerations into a single value-based analysis. Too often early-stage decision-makers put most of their effort into technical (can we make it) and project risk (when and at what cost will we make it) and give short shrift to commercial risk and return. An excellent positive case was Searle’s decision to go to market with Celebrex in a joint venture with Pfizer. In the early R&D stages, Searle’s mind-set was that Celebrex would be a great opportunity to build their own sales capability. However, value-based analysis keep showed them in a neck-to-neck race with Merck, who could easily tromp on Seale in the market, even if Merck took second place entering it.

Facing this challenge over a series of value-based evaluations, Seale management took the step of venturing with Pfizer, even though it left them with less control. This decision created so much value that two companies were acquired, Searle (Monsanto) by Pharmacia, and Pharmacia by Pfizer, to capture this value. Commercial considerations can be as important as technical decisions, even in the early stages of pharmaceutical R&D.

RS. There is a balance to be struck, but there is nothing fine about it. Management must provide clear, explicit leadership on the companies’ core capabilities; those that are intended to build lasting shareholder value. If you lack a crucial component of these capabilities, you acquire or develop it. For everything else, you partner or outsource. It’s that simple.

We’ve seen an interesting pattern among initially successful small- to mid-sized drug development firms in the last decade. Their first successful launch includes, of financial necessity, a partnership with big pharma. With that success comes an irresistible temptation to take a drug to market solo. In doing so, they typically underestimate the risks, depth of pipeline, and amount of funding required to go it alone. These firms lose sight of the fact that their initial success stemmed from a drug discovery capability or novel technology platform – capabilities that do not readily transfer to a competency in late-stage development.

Larger companies are not immune to similar tendencies. When planning a move into a new therapeutic area or disease, they may overlook a critical resource or capability. The key is to take a cross-functional look throughout the organization and ensure all bases are covered.

NGP. When entering international markets with a well-established product, what are the key commercial and regulatory gaps that must be identified and dealt with to maximize the project's profitability and minimize risk failure?
JM. In a value-based evaluation, all major uncertainties are vetted, often in contrast to trying to hide or deny them, and their impact on value is determined. When entering international markets new uncertainties arise; such as regulatory hurdles, different competitors, etc. All uncertainties are treated by analyzing thousands of cases to see which factors are key (this analysis has been made routine by modern computing, as exemplified by SmartOrg’s Portfolio Navigator). The reward of this work is that the impact of every uncertainty is compared on a bottom-line economic bases and risks are exposed and economically ranked. In each specific case the key risks will be different, and actions can be taken to deal with those risks (as Searle did), whether they be technical, regulatory, commercial or international. Project managers are often motivated too highly to focus on the narrow risks of project cost overruns and small delays, which are usually swamped by technical and commercial uncertainties. A sound analysis gets your eyes focused on the right balls no matter what stage of decision-making you are considering!

RS. There is a marked divergence in some aspects of drug approval criteria across regions: drug efficacy vs. established therapies, ease of dosing and administration, contraindications and side-effects. These must all be reviewed in light of each region's regulatory environment.

Reimbursement in many regions is increasingly tied into the regulatory process and can be a make-or-break factor in profitability. A thorough review of reimbursement practices in the relevant TA and a sober assessment of your drug’s competitive position will help you forecast the likelihood of full or partial reimbursement for your therapy.

Patent enforcement in less-industrialized nations may also have profound implications in long-term sales and overall profitability. This is not to say the some regions should not be entered or served, but rather that forecasts of a product’s effective life may need to be risk-adjusted in order to be realistic.

JH. Commercial and regulatory gaps vary widely based on the specific product and market. Given an established product with a good record for safety and efficacy, some regulatory markets are relatively straightforward, others require a bridging strategy. Commercial gaps need to be considered separately. Even if a drug passes regulatory hurdles easily, a company may not be allowed to price it so that an acceptable profit could be obtained. Obviously, companies must communicate proactively with regulatory bodies in order to assess the cost and benefits of each market.

By putting a system in place that takes market uncertainties explicitly and quantitatively into consideration, these uncertainties can be examined with regard to their effect on the entire portfolio and not just to one particular project. Modelling can highlight performance gaps and what it might take to fill those gaps. Project-by-project analysis can thus give way to a more holistic approach that can establish if your company’s goals can be met. More specifically, it may help answer the question of what combination of products and partnerships, given the constraints of commercial and regulatory issues, will maximize the probability that your company can reach its strategic goals.

NGP. How can portfolio managers ensure that the information they need to make strategic decisions is thorough, timely, accurate and manageable in a fully integrated system that really allows them to see the overall risk and potential financial return?
RS. Executives who approach us with this question almost always envision a technological solution. Technology is a critical component – as we understood six years ago when we introduced the Enrich Portfolio System – however, technology is only part of the answer. We see three prerequisites to agile, rational, fully-aware decision making.

First, put a process in place to ensure that project valuations are performed on a consistent, apples-to-apples basis, and the results are vetted and blessed by middle management. This keeps portfolio reviews from digressing into discussions of individual project valuations.

Second, executives must publicly assert their support of the valuation process, their use of the process outcomes to make portfolio decisions, and the requirement that all projects seeking funding go through the valuation process. This ensures that project leads take the valuation process seriously and are accountable for their assessments of project value.

Third, put the right technology in place to manage the deluge of data and analysis involved in portfolio decision-making. Using a database, not a spreadsheet, to manage project and portfolio data, will help shift the focus from data to strategy. Real-time point-and-click analysis and visualization capabilities will also enable you to make portfolio review meetings come alive.

JH. Understanding what questions you are trying to answer is crucial in ensuring that your information will be timely, accurate, and manageable. The context for any analysis – the key strategic options and the most critical uncertainties – must be made explicit. Otherwise it won’t be clear what data is needed at what level of detail, and the best approach to quantifying risk will be difficult to determine.

Risking must be calibrated across teams and must be appropriate for the level of uncertainty inherent in a given project. Smaller, more predictable projects probably do not need multiple development options, each described with probabilistic outcomes. On the other hand, large high-risk projects are often described with too little consideration for the full range of available options and possible outcomes.

A few rules of thumb for designing data collection systems: First, data must be validated and owned by the business units. The data refresh should be pushed up by project teams as projects evolve instead of being pulled up as the planning department needs it. Secondly, avoid the trap of overly precise and/or overly detailed data – either is as much a problem as data that is too high level. Finally, provide ease of use via version control and a familiar look and feel for the user.

JM. Managing a portfolio requires comparing disparate alternatives on a level playing field. Sound comparison means minimizing the political considerations and maximizing the objectivity and comparability of each project analysis. Making tradeoffs among projects also means using a common measure of value. Most companies would like to maximize long-term shareholder value. The only straight-forward measure that has stood the test of time is net present value (NPV), properly weighed for risk and return. From the analysis of thousands of scenarios, a probability distribution of NPV each project (and consequently each portfolio) can be calculated. This shows bottom-line risk and return to the long-term investor, and it is the fundamental measure for good decision-making.

Fortunately, a single project does not usually make or break the company. In this case only the average (or expected) value of these probability distributions matters. A sound portfolio has lots of uncertainty about which projects will be the winners, but little uncertainty that there will be several winners producing long-term value to the company. Do not confuse uncertainty about which projects will win with uncertainty about the overall value of the portfolio!

Richard Sonnenblick, the President of Enrich Consulting, has been with Enrich since its inception in 1998. The vision he brought to Enrich has been realized in the Enrich Portfolio System, which he architected in 2000. Prior to founding Enrich, he built a decision analysis consulting practice at Lumina Decision Systems, where he worked on integrated assessments of environmental legislation and R&D valuation models for high technology firms. Dr. Sonnenblick holds a Ph.D. and MS from Carnegie Mellon University in Engineering and Public Policy, and a BA in Physics from the University of California, Santa Cruz.

Dr. James Matheson, Chairman and CFO of SmartOrg, Inc., is a world-recognized leader in the development and application of decision analysis. Dr. Matheson received the Ramsey Medal, the highest honor in the field of decision analysis. He recently was elected Fellow of INFORMS. Dr. Matheson serves on the Board of the Decision Education Foundation, which is training teenagers better decision making

Dr. Matheson’s recent focus at SmartOrg has been to create value-based management systems, comprising clear processes and modern software that offer organizations new capabilities for making value-creating choices. His goal is to make the best decision making processes readily available to all key decisions.

John Howell, Founder and President of Portfolio Decisions Inc. started the company in 1998 to meet the increasing demand of companies for assistance with planning, strategy and portfolio management issues. He works with executive and senior management teams on cultural and technical aspects of portfolio management. Howell combines a decision-maker’s perspective with leading-edge thinking in portfolio management.
Howell’s experience in portfolio management and quantitative decision-making began in the early 1980’s.

Howell has spoken around the world on portfolio management at meetings, conferences and workshops and has published more than 40 articles and presentations on portfolio management topics, including strategy development, investment decisions, analytical case studies and the implementation of portfolio processes.