R&D Portfolio Management & Budgeting

1. R&D Portfolio Management & Budgeting Instructor: Gregory H. Watson Introduction to Strategy, Technology and Integration ETM 5111 Session 2 – Part 3

2. Managing risk only protects against loss! How to sustain performance? Growth comes from taking advantage of opportunities!

3. Managing opportunities – the other side of risk! • How to recognize opportunities? • Strategic dialog and environmental scanning • How to decide where to invest? • Portfolio planning and risk-based decisions • How to deploy an opportunity? • Policy deployment and objectives cascade

4. Drivers of product design requirements: • Industry product standards • Standard product requirements • Trade customer specifications • End-user emphasis on weight/size • Features and designs of competitive products • Industrial design of the user interface (display, etc.) • Product reliability requirements • Built-in testing requirements • Packaging requirements for robotic assembly • Power requirements and battery size • Marketing-specified differentiating features • Teardown and recycling considerations • Environmental factors in material and process choices

5. Customer value entitlement chain Customer Expectation Customer Entitlement What the Customer Wants What the Customer is Promised What the Customer Gets Defect Defect Defect TYPE I TYPE III TYPE II Opportunity to add value. Opportunity to add value. Quality Gap Failed to deliver a specified design. Design Gap Missed the right design opportunity. + = Quality is a ‘value entitlement’ of customers. Quality = Value entitlement!

6. Delivers Promise to Customer Yes No Product delivered is competitive. Type I Defect: Fails to Deliver Design Know What Customer Really Needs True MANAGED RISK PRODUCER’S RISK Type II Defect: Design Fails Need Type III Defect:Product Delivered is not competitive. False CONSUMER’S RISK SHAREHOLDER RISK Alpha (a) Quality Risk = Probability of Type I Defect Beta (b) Quality Risk = Probability of Type II Defect Gamma () Quality Risk = Probability of Type III Defect Reliable organizations work to reduce risk: Success: Manage risk & deliver opportunity!

7. Competitiveness Product Technology Product Innovation Process Technology Number of Improvements Process Innovation Time Innovation profile comparison:

8. Notional relationship for managerial influence: High Product Planning Concept Investigation Basic Design Prototype Build Pilot Production Production Management’s Ability to Influence Outcome Index of Management Attention and Influence Actual Activity Profile of Senior Managers Low

9. The Cost of Poor Quality to correct problems Cost At source Final inspection Customer site Time before defect is Identified Diagnostic time Repair time Delay in delivery Minor delay Easily fixed Sorting cost Warranty cost Impact of time-to-detect-errors on cost: The rule of "ten's" applies:

10. Risk and business process control: Inherent Risk Inherent risk is the total business exposure associated with a business process before applying any controls are applied to processes. Every activity has some level of inherent risk.When the inherent risk in a business unit is fully understood, controls can be designed for the key business processes to manage risk. Controlled Risk Controlled risk is that part of the inherent risk that is being managed through business process controls. Residual Risk Residual risk is that part of the inherent risk that remains exposed to loss, theft or error, after applying business controls. The level of residual risk that is acceptable is a management judgment.

11. Routine management actions to reduce risk: Decentralization -  Decentralized management and accountability means breaking the business down into manageable units. Decreased span of control allows managers to exercise proper decision authority and be accountable for performance. Segregation - Duties and responsibilities are to be segregated; e.g., the person receiving material can't be the same person who orders material. This protects the company and the employee. No employee can have exclusive knowledge, authority or recording responsibility for any significant transactions. Documentation - Documentation reduces the chance for error or misrepresentation because it usually involves at least two people. Documentation also provides a record that can be used to authenticate an event, recreate it or support the facts in a dispute. Documentation should always be produced as part of a work process. Supervision and Review - Supervision and review ensures that employees are not the sole evaluators of their own decisions. This supports better decision-making and control over work processes and allows those with decision rights to evaluate inputs. Timeliness - Controls must work as close to an event’s occurrence as possible and commensurate with risk exposure in order to both improve accuracy and allow for timely corrective action when deviations occur, i.e., reducing an exposure’s duration. Risk Relevance - Risk relevance means that the business control cost is related to the benefits derived by the business control. [NOTE: Regulatory compliance is not subject to a cost-and-benefit analysis. Regulatory compliance is mandatory.]  Minimum Interdependence - Business controls should minimize interdependence. The failure of one business control should not compromise or reduce effectiveness of other controls. Furthermore, business controls should provide checks and balances and not work against one another.

12. Business controls for risk management: • Performance Standards assure that work is done consistently and that the output meets customer performance expectations. • Business Auditsassure that performance standards are used appropriately. • Change Management Process assures that continuous process improvements are consistently made across processes and that recognized improvement opportunities are implemented in all applicable areas. • Standard Owners are responsible for managing standards to the state of the known art. • Process Owners are responsible for the effective management of the work processes. • Decision Rights and Delegation of Authority are two tools that are used to assure that the right person makes the right decision and that accountability is maintained for all decisions and work process outcomes.

13. Risk assessment – key to managing risk! • Conduct risk assessment as part of normal business analysis • Assess risk dimension in all business decisions • Identify risk factors inherent in work processes and decisions • Screen risk factors for severity of magnitude • Screen process for performance sensitivity to risk factors • Reduce risk factors in the process at the source of the risk • Manage your business system for lowest risk commensurate with your targeted performance goals! Risk Know the risks and manage the opportunities!

14. Change Initiative Budgeting Flow Charting Project Selection Investment Allocation Baseline Analysis Process Map Benchmarking System Evaluation Competitive Benchmarks Criteria Business Measures Entitlement Determination Capability Analysis Goals & Objectives Technology Assessment Business Measurement System Business Scan Strategic Direction Evaluating alternative business opportunities: For business improvement opportunities:

15. Product Decisions Portfolio decisions are driven by complex issues: Capital Investment Allocation Intellectual Property Competitor Analysis Technology Portfolio Product Portfolio Product Line Roadmap But, how should we create this portfolio of product projects? Technology Roadmap Market Research Business Factors

16. 100 90 80 70 60 50 40 3020 10 0 Catches per Ball 0 1 2 3 5 6 7 8 9 10 11 12 Number of Balls How much can you juggle? The ancient art of juggling provides a good measure of the number of things that we can manage consistently when such action requires both physical and mental effort. A ‘juggle’ involves throwing an object into the air and catching it more than one time. A ‘flash’ requires that the object only be caught once. This chart shows ‘world class’ performance in juggling – seven items have been juggled successfully almost 100 times, but the last world record was only 2 cycles for 10 items. What is your span-of-control? What is your process capability?

17. CLOSING – making the choice of an option OPENING – discovering the options for analysis SORTING – finding logical relationships and purging duplicates Initial Issue: What should we do in the future? NUMBER OF OPTIONS Open Sort Close TIME Three Phases of a Strategic Dialog Engaging the organization in a strategic dialog:

18. t n = 1 CFn (1+ r)n Internal Rate of Return (IRR): • This is a metric that assesses the value of alternate investment proposals to determine their relative worth to the organization. • When this is set as a minimum acceptable return for a project, then this becomes the “hurdle rate” which must be exceeded if the investment is going to proceed. • The cost of capital (COC) is the after-tax return rate a business must achieve in order to exceed the capital investment that a company could make in the market at large. • If CFn refers to the cash flow of a Project in the nth year of that project (t = total length), then solving the following equation for r (rate) will provide the IRR: Project Cost = S

19. Calculating IRR using Excel: Tool: Excel > Insert > fx Function > Financial > IRR Example: Calculate the internal rate of return after five years for the following investment project. The initial investment requirement is $700,000 and the expected return (net expenses) for the next five years is: $120,000, $150,000, $180,000, $210,000 and $260,000. Answer: 8.66%

20. Identifying risk for elimination or mitigation : Types of risk addressed in product design: • Performance • Design • Manufacturability • Cost • Reliability • Service • Safety • Producibility • Supplier performance • Defects • Cycle time • Tooling • Measurement • Training • Operability • Marketing • Packaging • Transportation • Inventory

21. Management Risk Scorecard Eliminate issues, increase number of “proceed with caution” issues Number Of Issues Legend: Significant Risk Fix Before Launch Proceed With Caution Time Decrease number of show stoppers, significant risk, fix before launch Verify Define Measure Analyze Design Analyze business risk throughout the project: Goal: No show stoppers, significant risk or fix before launch issues in Verify step!!

22. B.E.T. = Breakeven Time Effect of Market Forecast Error and Variability in Potential Sales Breakeven Time Product Initiation Date Net Profit (Positive Revenue) Time Discounted Cash Flow Payback Date Product Launch Date Time-to-Market BET measures accumulated ROCE! Determine when new products will payback:

23. Analytical Hierarchy Process: AHP is a multi-attribute decision analysis methodology used to prioritize among choices for several decision criteria based on their relative importance to a customer for judging between alternative choices. Analytical hierarchy process (AHP): What is the best way to make a complex choice? Evaluate alternatives relative to criteria for choice.

24. Analytical hierarchy process (AHP) • AHP provides a logical approach for making a complex decision by presenting the problem in a hierarchical structure and using relevant decision criteria and pair-wise comparisons to determine trade-offs among the objectives and make the most appropriate choice. • AHP is based on three concepts: • Decomposition of the decision problem into a hierarchy • Comparative judgment of the alternative by criteria • Synthesis of the priorities into an overall judgment

25. Choice Criteria 3 Criteria 4 Criteria 1 Criteria 2 Option A Option B Option C Hierarchical decision structure: AHP evaluates alternative options according to the same criteria as weighted for importance to the decision-maker. The final choice is made for the option having the highest overall score. STEP 1: Structure the decision problem in a hierarchy:

26. Verbal scale Numerical value Equally important, likely or preferred 1 Moderately more important, likely or preferred 3 Strongly more important, likely or preferred 5 Very strongly more important, likely or preferred 7 Extremely more important, likely or preferred 9 NOTE: Intermediate values are used to reflect compromises by the decision-maker 2, 4, 6, 8 Make comparative judgments: Step 2: Compare the alternatives and the criteria. These comparisons are made in pairs for each element – both criteria and decision options. To establish relative comparisons, the following scale may be used to translate verbal descriptors into numerical values:

27. Option 1 Option 2 Option 3 Local Priority Option 1 Option 2 Option 3 Synthesize decision priorities: Step 3: Synthesize the comparisons to derive the priorities for all of the alternatives with respect to each of decision criterion and the relative weighting of each criterion with respect to the desired choice. The local priorities are then multiplied by the weights of the respective criterion. The results are summed up to get the overall priority of each alternative and determine the final rank order of all options. Pairwise comparisons of the options:

28. Pair-wise comparisons of the criterion with respect to the choice: Criteria 1 Criteria 2 Criteria 3 Criteria 4 Weights Criteria 1 Criteria 2 Criteria 3 Criteria 4 Priorities, weights, and final ranking of the options: Criteria 1 Criteria 2 Criteria 3 Criteria 4 Global Rank (Weight) (Weight) (Weight) (Weight) Priority Order Option A Option B Option C AHP decision process – continued: Sensitivity study of final rank evaluates impact of criteria.

29. Project plotted (risk, benefit) HIGH RISK BENEFIT Relative Benefit MEDIUM RISK BENEFIT LOW RISK BENEFIT Relative Risk Plot results: Capital Asset Pricing Model (CAPM) • Determine project risk (AHP) • Determine the potential project benefit (forecast BET) • Plot project coordinates on CAPM Grid • Determine sequential relationships in project completion • Rank projects in order of risk-benefit by inherent sequence for completion (e.g., technology readiness) • Make project decisions based on hurdle rates for risk & budget to achieve targeted benefits Develop business contols to reduce risk.

30. Product Planning & Strategy Integration Instructor: Gregory H. Watson Introduction to Strategy, Technology and Integration ETM 5111 – Summer 2003 Session 2 – Part 3

31. Politics Regulations Economics Technology Environment Market Research Technology Assessment Competitive Analysis Strategic Benchmarking Customer Analysis Business Performance World of Facts Scenario Options World of Possibilities Critical Assumption Evaluation Discontinuity Analysis Business Case Enterprise Values Vision Strength-Weakness-Opportunity-Threat Analysis Quality Improvement Plan Capital Investment Plan Information Systems Strategy Human Resource Plan Business Imperatives Performance Indicators Strategic Plan Business Presidential Review Operating Review Self-Assessment Annual Plan Diagnostic Analysis Performance Feedback Corrective Action Preventive Action Operations Review Project Management Process Management Problem Solving Operating Budget Implementation Plan Business Management Performance management system:

32. Policy Setting Policy Review Policy Deployment Policy Implementation Daily Management Controlling the policy management cycle: The entire context of the organization is set by its policy for values and the ethical conduct of work. “the business control function” Policy Management: The process of setting policy, implementing policy in the business processes and working procedures and reviewing work activities to recognize innovative business improvement opportunities.

33. Product Decisions Portfolio decisions are driven by complex issues: Capital Investment Allocation Intellectual Property Competitor Analysis Technology Portfolio Product Portfolio Product Line Roadmap But, how should we create this portfolio of product projects? Technology Roadmap Market Research Business Factors

34. Market Requirements for Features Market Strategy Customer Analysis Product Development Plans Competitive Analysis Product Road Map Technology Plan Alignment Technology Development Plans Technology Strategy • Acquire or Develop • Buy, Trade or Partner • Technology transfer timing • Identify leveraged technology • Obtain new technology • Develop new technology Current Technology Inventory Technology Portfolio Planning Activities Planning Documents • Current product features • Intellectual property portfolio • Technology License agreements Integrated product & technology planning process

35. It is essential to understand which technical parameters makes market differences and to understand migration pathways that transfer new technology into the market. Measurement Time Remember the “S-curve”? • A characteristic plot for progress of a key technology attribute • A family of curves, derived from historical data from a large number of previous technologies • The basic assumption is that progress in all new technologies behave in a similar manner and follow a similar curve.

36. Natural Limit Measurement Time Natural or physical limits to growth: • Caused by a physical property which constrains a key parameter to a limit beyond which it can not exceed. • Growth in progress will slow down as it asymptotically approaches this limit.

37. Example: Superparamagnetic Limit

38. Choosing S-curve measurement parameter(s): • Every market has 1 or more key market parameters driving product value. • Key technology parameters are determined by key market parameters that are dependent on the underlying technology. • Every technology has one or more key technology parameters that drive its market value. • Identification Process: • Identify independent technical parameters related to key market factors. • Rank and select the most significant technical parameter(s) that have the greatest influence on the key market parameter(s). • Use the top 1 or 2 parameters to plot the S-curve for that technology. • Caution! • Choice of the wrong key technical parameter will lead to incorrect technology forecast, false conclusions, and bad business decisions.

39. Choosing the best S-curve parameter – 1: • S-Curves must have a definitive and correct Y-Axis parameter. • Ask yourself: 1) What is the main market factor customers use to choose between competing brands of products? 2) What technical parameter in the product or process must constantly improve to remain competitive in meeting that market factor? 3) What is the unit of measurement (Y-axis) of that improvement requirement? • Key market parameters are the most significant measurement factors that customers use to select or choose between products. • Cargo Truck Example: Lowest cost of cargo hauling capacity / pound / mile. • Key technology parameters are “technology” factors which have the most effect on the Market Parameter measurement. • Cargo Truck Example: Fuel Efficiency / pound cargo at average speed.

41. Choosing the best S-curve parameter – 2: • Key technology parameters do not include other “non-technical” parameters which also might significantly affect the key market parameter, but which are not a part of the cargo truck “design”. • Cargo Truck Example: NOT - Fuel cost per mile or truck driver labor cost/pound of cargo per mile, or total operating cost per mile. • Each key technology parameter has several supporting technologies that contribute to the measurement of its improvement progress. • Cargo Truck Example: Weight of the truck per hauling capacity pound, or the transmission gear efficiency, or the truck’s aerodynamic drag, etc. • Progressive improvements or new additions to these supporting technologies provide the means to advance and improve the key technology parameter. • Improvements in these provide a means for a logical step improvement of the technology S-curve. • Supporting technologies do not represent “alternative technologies” because they support progress of the original technology, and do not replacement for it.

43. Success: timely observation and good choice! Business Objective: • To understand what the progress rate for the key technical parameter is for the industry as a whole • To plan to exceed or at least match the industry progress in parameters that are critical to commercial success • NOTE:Progress does not follow a predetermined or inevitable path! • The exact shape of a technology “S” curve is determined by many factors: • Amount of investment & resources applied • Industry interest and supporting infrastructure • Progress of required & supporting technologies • Number of competitors • Etc., etc.

44. Success: A step-by-step journey! Progress on the S-curve happens in both small incremental steps (from the migration of technology) and breakthrough leaps (from new technology). To stay on the Industry S-curve you must:  Know which steps are most important  Know when these steps must be taken  Know what it takes to make them happen  Plan to make them happen  Make them happen Excellence comes from execution – planning anticipates needs!

45. S-Curve steps MICRO ACTUATOR 30% SLIDER (AREAL DENSITY) Measurement PRML CHANNEL MR HEADS LASER TEXTURED DISK TIME Example: Incremental technology pathway

46. Breakthroughs from alternative technology: • Cell-Phones - Analog to Digital • Disk Drives - Magnetic to Optical • PC Monitors - CRT to Flat Panel • Film - Photo Chemical to Digital • Video Recorders - Magnetic Tape to DVD-CD What technology would completely change your business?

47. Product plans: Design a path to the future Requires careful consideration, accommodation and integration of many related factors: • Customer, market and competitive dimensions • Technology maturity • Assembly and production capability • Design rules that are set by manufacturing capability • Etc., etc. • Objective: • Respond to corporate strategy with plans for profitable and timely products, leading in their markets and meeting customer needs. • How: • Develop integrated, consistent market and technology strategies that are aligned with the corporate strategy and customer needs.

48. Road map assumptions: • Future market needs are projected based on industry history, customer inputs and competitive moves • Performance attributes are driven by key technology parameters and plotted as an S-curve forecast • Timing driven by customer and competition based on market history and technology forecast • Price/cost/margins requirements projected from the current status as well as past market history

49. ? PRODUCT E PRODUCT D PRODUCT C PRODUCT B PRODUCT A Example: Product line road map:

50. Example: Product-specific road map 2.5”, 12.7mm, 4 disc drives 1/00 7/98 4/99 10/00 Start b-Test 3/00 9/98 6/99 12/00 8/99 Produce 11/98 2/01 5/00 Market Requirements 30 GB 21 GB 15 GB RD0143 9 GB RD0042 RD9941 13,000 Mb/in2 RD9840 S-Curve 9700 Mb/in2 20% slider Microactuator 1394 Interface 3.3V Intro 6200 Mb/in2 GMR Quick Stop New Self Test Easy Plug 4000 Mb/in2 SAL PWR. SAVE RAMP 1000 Gs Non-Op Shock Fluid Bearing Spindle Market requirements