Biomedical Engineering Reference
In-Depth Information
In Sect.
3.3
, we discuss three topics in portfolio optimization. In Sect.
3.3.1
, we
describe the effect of competition on overall R&D investment. In Sect.
3.3.2
, we
discuss portfolio composition in terms of the tradeoff between incremental and radi-
cal innovation. In Sect.
3.3.3
, we discuss methods for optimal project selection and
prioritization.
In addition to portfolio evaluation and optimization, we discuss four execution
issues in Sects.
3.4
. We separate execution from portfolio optimization based on a
large literature that suggests that strategy should precede execution (Day
1990
;
Lehmann and Winer
2006
). However, we recognize that portfolio optimization and
execution can be intertwined in reality and in some cases even beneficially so, as
organizations “improvise” (Moorman and Miner
1998
). Thus, we suggest to the
reader that clarity in portfolio optimization (which typically results from an explicit
strategic planning phase) can help guide purposeful execution. Specifically, we dis-
cuss how organizational design impacts portfolio performance (Sect.
3.4.1
), how to
manage the frequency of change in the portfolio and organization (Sect.
3.4.2
),
acquisition and licensing as alternative vehicles to source new projects (Sect.
3.4.3
),
and incentive design to motivate decision makers to act in the firm's best interest
(Sect.
3.4.4
).
We conclude in Sect.
3.5
by positing open questions for future research.
3.2
Portfolio Evaluation
Managing a portfolio requires a clear definition of the metrics used for evaluation.
Since the financial stakes are high in making large-scale R&D investment decisions,
it is imperative to select the most diagnostic measures for evaluation. Typical met-
rics of interest include market value and risk of individual projects as well as entire
portfolios (Davis
2002
). The operationalization of value and risk are not trivial as
there exist multiple ways to value innovation programs with high levels of uncer-
tainty. Note that to produce an estimate of portfolio value, risk is often taken into
account and vice versa, generating an interplay between the two metrics. In this
section, we focus on methods of valuing individual projects, methods of valuing an
entire portfolio, methods for measuring risk, and managerial heuristics used in
interpreting data such as portfolio measures.
3.2.1
Valuation of Individual Projects
A classical approach to project valuation invokes DCF analysis. As outlined in any
introductory finance textbook (e.g., Ross et al.
2003
), given a set of cash flows based
upon project parameter values such as cost of development over several years, pro-
jected drug sales and manufacturing costs, and the cost of capital, the NPV and IRR
values can be computed and used to make decisions with a threshold rule. The
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