Since Markowitz came up with the Modern Portfolio Theory in the 50's it has been used as the tool for financial asset management. In innovation portfolio management, however, portfolio theory has been largely focused on balanced portfolio that very seldom operates at the efficient frontier. The only efficient frontier approach in innovation portfolio that I have ever come across is related to resource use. Where the objective is to maximize return for a given resource use, and risk is then often balanced to have a nice spread between high risk and low risk projects. From MPT perspective this is not an efficient frontier solution for these innovation portfolios. Efficient frontier maximizes returns for a given risk. Resources are just an input that sets limits to the realization of the return. Additionally in innovation portfolio there is always a nice correlation between resources and returns that is always of diminishing returns. With modern tools all these variables can be pulled into one nice package, which allows looking at portfolios in a more flexible way, where risk, resources and return choices can be looked at once. This brings flexibility into decision making and enables a way to manage risk at portfolio level in innovation. To demonstrate this I combined monte carlo simulation with the efficient frontier optimization (using crystal ball) and ran the simulations for different budget constraints for a simulated innovation project portfolio. Each dot in the graph represent a mix of projects that is the efficient frontier solution for the portfolio for a given risk and budget. The result is shown in the image above. This approach allows making choices between risk, investment and returns for various optimal solutions for any given project portfolio. I find it very useful in understanding the potential of my pipeline. However, I have not seen this being used int he innovation industry and would be interested in knowing if anybody else has used this for their portfolios?
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