Portfolio Selection Process

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This article discusses the portfolio selection process and sub-processes, the criteria of project selection, the factors and challenges that impact the decision-making process, relevant frameworks, models and methodologies developed and the managerial implications of those.

In the first part of the article we provide an overview of the portfolio management, identifying relevant processes, selection criteria and distress factors. We attempt to identify the major challenges and factors of the portfolio selection process and we refer to several models and frameworks developed to address the selection process challenges and problems.

In the last part of the article we discuss the findings, highlighting limitations and managerial implications.

1. Overview

Portfolio management was introduced in the 50s in the financial sector for portfolio optimization through diversification. Over the decades Project Portfolio management has evolved and today serves in delivery of organizational benefits through rational investment decisions in effective and efficient manner. Through the Project Portfolio Management organizations are able to select, evaluate and prioritize projects, efficiently allocate resources, monitor the portfolio performance and take corrective actions when required to realign the portfolio components. The portfolio management processes and in particular the selection process (consisting of the evaluation, prioritization and authorization sub-processes), is cyclical and iterative throughout the portfolio life cycle (PMI, 2013).

Successful business value is achieved through comprehensive strategic planning and management. Organizational strategy is a plan developed to capitalize on opportunities, manage organizational resources and stakeholders’ value and respond effectively to changes in the market. Effective strategy gives clear direction for development and growth. Organizational strategies are developed to direct execution of works aiming the organizational objectives achievement; these objectives are measures of goals achievement. The purpose of Project Portfolios is to meet a set of strategic objectives and achieve business value (PMI, 2013).

Decision making about investment and priorities in portfolio is made by a governing body that is also responsible for the implementation of and adherence to the portfolio processes. This governing body is also responsible for the portfolio selection decisions and has the authority to evaluate and make priority and investment decisions as required.

Portfolios may be comprised of past, currently executing and future planned portfolio components. The lifespan of portfolios is longer than its components with new projects and programs being added. The Portfolio formulation processes include identification, evaluation, selection and authorization of the portfolio components. The Portfolio management process is driven by the organizational strategy and the strategic objectives, ensuring at all times that portfolio components are aligned to meet and achieve these objectives. Project Portfolio Selection is a complex periodic process and mainly refers to all those fundamental decisions that will result a set of selected projects that the accomplishment is expected to create value through the achievement of the set organizational strategic benefits. Pre-process stages include a) the definition of strategic focus and the determination of resource limitations and b) the selection of tools and techniques to be used for the portfolio selection (Archer and Ghasemzadeh, 2000).

Literature on Project Portfolio identifies a number of factors that result creating difficulties in the selection process, such as: The type and quantity of objectives that often can be conflicting, uncertainty and risks, project interdependencies and the enormous number of feasible project/portfolios (Archer and Ghasemzadeh, 2000). Complexity of large portfolios with numerous projects is an additional factor that distresses the selection process.

Oh et al. (2012), in their computerized process-focused model, highlight that different types of projects in a portfolio might require different selection criteria to be taken under consideration. Selection criteria for project portfolios traditionally include meeting strategic objectives such as profitability and efficiency, meeting the resource constraints and budget, and within the desired or required timeframe. Coffin and Taylor (1996) have focused on scheduling problems that appear often in portfolios, due to existing interdependencies among projects - that may share resources or have a relationship predecessor-successor. For this reason flexible selection models that use fuzzy logic combining multiple criteria have been developed, attempting to produce optimal selection solutions (Coffin and Taylor, 1996).

2. Decision making genres

There are different genres of decision making and impact significantly the portfolio selection process. Organizations based on the decision making approach they adopt exhibit certain behavior and face a number of challenges when it comes to decision making. In the paper of Kester et al (2009) three types of strategic decision making approaches have been identified:

• The formalist – reactive decision making, adopts a more incremental approach reflecting in processes and responses. This type of decision making creates limitations in innovative attempts of the organization as the decisions are based strictly on available quantitative estimates.

• The organizations adopting the intuitive decision-making approach, are more informed with regards to uncertainties inherent in innovation and rely on the expertise of the decision makers. Intuitive firms lack strategic overview and require further development of their strategy structure in order to achieve efficient decision making.

• The integrative approach in decision making shows competence in identifying opportunities but due to over-ambition might find select more than they are actually able to undertake (Kester et al., 2009).

3. The Selection Process

The selection process commences early in the portfolio life cycle. The Project Portfolio selection begins with the selection and prioritization of promising ideas and concepts that can be converted to successful projects (Kock et al., 2014). There is an important stage referred to as “front-end” or “fuzzy front-end” that involves the early stage of the portfolio innovation process. Literature concludes that an integrated approach is required for effective management of that early stage of the portfolios, while Heising (2012) introduces the Ideation Portfolio Management as a process of holistic approach that integrates the strategic setting of the ideation concept with stakeholders’ management and the ideation culture theories.

The portfolio selection process comprises of four distinct steps:

• Identification and categorization of projects/programs – during this phase the inventory of the portfolio components is being produced including both potential and ongoing projects. The listed portfolio components then are being classified by type (size, importance, urgency etc).

• Evaluation and prioritization of portfolio components – this stage is very important as the accurate and correct evaluation and prioritization will result maximization of benefits. Portfolio components are being prioritized based on strategic considerations, risks, funding, etc.

• Authorization of projects/programs – following prioritization in this stage the portfolio components are being “activated” by allocating resources,

• Reporting and revising the portfolio – in this stage changes and decisions are being communicated and portfolio documents (performance reports, portfolio roadmap) are being updated.

For the assessment of the portfolio components during the selection process except the strategic criteria and factors, metrics and Key Performance Indicators should be considered in order to have measurements of outcomes and performances for re-assessment.

In another paper, the project portfolio selection process consists of idea gathering (Ideation Portfolio Management), project portfolio screening, project portfolio evaluation, and project portfolio prioritization (Koivuniemi, Piippo, Kärkkäinen, & Tuominen, 1999).

Selecting the right projects at the right time is critical for the success of the portfolio. The process of selection consists of two sub-processes: Evaluation of projects and prioritization of projects.

In the evaluation process projects will be recorded and a business case will be developed consisting of information such as costs, timeframes, financial and non-financial benefits, opportunities and threats, risks, legal and/or compliance requirements etc (PMI, 2013).

During the portfolio prioritization the rank or priority is assigned based on the defined criteria. Due to the wide range of criteria, the process is multi-dimensional and should be repeated periodically. There are several suggested tools for project portfolio prioritization such as the Analytic Network Process (ANP), the Relative Alignment Index (RAI) and the Relative Weight Index (RWI). For the correct application of these tools the in-depth knowledge of the environment is required (Garcia-Melon et al, 2015).

4. Selection Criteria

Selection of project components is made based on selected criteria that are required to be met. PMI in the Standard for Portfolio Management identifies several elements that shall be considered and detailed analyzed when defining our selection criteria: Organizational strategy and organizational strategic objectives, financial and non-financial benefits, market conditions and opportunities, associated costs, internal and external risks, potential legal or compliance requirements, technology, human resources and urgency (PMI, 2013).

The selection criteria should reflect certain quality attributes such as consistency, completeness and lack of redundancy. Selection criteria might differ from portfolio to portfolio and from organization to organization. There are though certain selection criteria that are universally adopted by organizations when it comes to portfolio selection. The three most important portfolio selection criteria are: Portfolio value maximization, risk minimization and strategic alignment. Based on the selection criteria, portfolio managers will classify portfolio components and will construct portfolio alternatives. The definition of criteria is of great importance as the criteria will serve as measuring tools for the performance and achievement of their objectives, and can be qualitative or quantitative (PMI, 2013).

5. Performance management

Performance management is the process that manages the sourcing of assets and resources of the portfolio to ensure the best possible returns on investments. Performance metrics and their results will be used as input during the portfolio selection process. Through this discipline portfolio components’ progress is analyzed and measured against strategic objectives and goals and it enables corrective actions when necessary (change in risk acceptance levels, reallocation of resources, etc.) (PMI, 2013)

6. Distressing Factors

There are several factors that hinder the success of portfolio management and in particular the evaluation, the selection and the prioritization of project portfolio components sub-processes. Archer and Ghasemzadeh (2000) identify uncertainty, risks, size of portfolios and their interdependencies. Below distress factors are addressed individually.

7. Uncertainty

Uncertainty is a significant factor that can impact the portfolio selection process outcome and the overall portfolio success in positive (opportunities) or negative (threats) ways. Traditional selection processes through mathematical scorings fail to incorporate and take under consideration all uncertainty factors that might impact the portfolio success.

Liesiö and Salo (2012) introduce a scenario-based approach to addressing exogenous (external) uncertainties that might impact the projects and the portfolio. Probabilities were assigned with set inclusion of capturing relevant incomplete information, segregated the non-dominated portfolios, offering interactive decision support tool.

The same framework was developed further in following study. Fliedner and Liesiö (2016) have developed a Robust Modelling System where conservatism is controlled by the decision makers allowing interactive decision support and adjustable levels of robustness. The model takes under account uncertain information, uncertain decision making preferences and uncertain project interdependencies. The authors suggest further research to assess which project scores have the greatest impact on non-dominant portfolios.

Ghapanchi, Tavana, Khakbaz and Low (2012) suggest a methodology that takes under consideration component project uncertainties and interdependencies among projects. The research highlights the lack of a decision making methodology that accounts project uncertainties and introduces a methodology that encourages the “big picture” approach providing the basis of a rational decision making model. The proposed model though is subject to further research, as it fails to take into account multiple interactions and only pair-wise interactions were able to be evaluated.

A robust credibilistic optimization method was developed by Liu and Liu (2016) addressing uncertainties in portfolio selection process, where uncertainties were modelled based on optimistic value criterion. The method has limitations and suggests further development to incorporate multi-objective model. Similarly, Zhang et al. (2011), propose a financial model - Credibilistic Return Index (RI) and Credibilistic Risk Index (LSVI) - with improved algorithms enabling portfolio selection through flexible and dynamic management.

8. Risks

Risk is an uncertain event that may have one or more root causes, positive or negative impact. Risks are addressed and managed through the portfolio management process. Risk management is a critical function especially when significant interdependencies exist and the cost of failure is high.

One of the portfolio risk management objectives is to ensure that the acceptable risks will be undertaken with the anticipation of rewarding outcomes throughout the life cycle of the portfolio, increasing the probability of positive events. Main concerns of portfolio risk management are i) maximizing the financial value, ii) aligning with the organizational strategy and objectives, iii) balancing portfolio components based on available capacities and capabilities.

Portfolio risks are highly dependent on the environment of the portfolio and can be either external risks (competition, economical, legal, technological changes etc.) or internal (poor decisions, corruption, bankruptcy, changes in priorities etc.). Risks can be identified at any point in the portfolio life cycle and at any organizational level. During the selection process the type of risks that is relevant is the structural risks. The structural risks are concerned with the ability of an organization within hierarchical structures to organize the project portfolio’s mission. Structural risks also address governance, best practices, quality of portfolio management and inconsistencies in strategy (PMI, 2013).

The selection process is impacted by the portfolio risk management plan, as the determined risk strategy and risk tolerance of the organization will determine which portfolio components are allowed to be selected and which will be rejected.

Risks in project portfolios should be identified early and monitored throughout the portfolio life cycle. The risk appetite of a firm has been found positively related with the ability of the firm to implement new ideas and exploit market opportunities. In addition, the front end success of portfolios has greater effect in large portfolios with many interdependencies between projects (Kock et al., 2016).

9. Size of Portfolios and Interdependencies

Portfolios usually will face the challenge of more projects available for selection than the organization can actually undertake based on the available resources. Therefore firms should use the right selection tools and techniques considering available resources and limitations in order to achieve optimal portfolio component selection and further project portfolio efficiency.

During the portfolio selection process, interdependencies among projects are of great consideration as it can impact timeframes and resource allocation. Interdependencies among projects can be defined as contingent relationships.

When examining interdependencies between projects we should always keep under consideration the project portfolio main goals: maximizing project portfolio value, balancing the portfolio components and maintaining strategic alignment (PMI, 2013).

The functions of the selection techniques are to estimate, evaluate and finally select the portfolio components through the phases of strategic considerations, followed by evaluation of individual projects and finally portfolio selection (Archer and Ghasemzadeh, 1999), always considering urgency and resource availability. However Kock, Heising and Gemunden (2016) in their research , have identified that in large project portfolios with great number of interdependencies among projects, the success of the project portfolio was dependent on the successful management of the early stage of the project portfolio life cycle.

10. Discussion – Conclusions

This article reveals gaps in the methodologies used in the portfolio selection process. There is no framework to facilitate optimal and comprehensive project portfolio selection. The majority of the frameworks and decision support tools introduced for optimal project portfolio selection process, though they have been tested and validated to certain extend, require in general further research. More specific:

In Ideation Portfolio Management, Heising (2012) admits that although both internal and external dynamics are being explored as moderating factors in his study to construct the proposed conceptual framework, further research is required due to limitations to confirm the significance of effects. Ideation Portfolio Management though it addresses ideas and concepts evaluation and selection, it’s output will become input to the selection process and in practice Ideation Process overlaps with the Project Portfolio Selection process.

It is also noted that the main challenges identified in project portfolio selection process relate to existing risks and uncertainties. Although several methods and frameworks have been developed, only uncertainties have been addressed through algorithms and fuzzy values. Risks, though of great importance and significance during the project portfolio selection process, have not been considered and adequately addressed in literature.

Another area that has not been explored adequately is the preferences of decision makers with regards to selection and modelling techniques (Archer, 1999); Kester, Hultink and Lauche (2009) attempted to classify the decision making genres from firm’s type perspective, but there is no classification of decision makers’ behaviors and what drives those behaviors.

Overall, all project portfolio selection frameworks mentioned in this article have considered only sets of strategic criteria and limit to solving problems caused by one or two distress factors, modelling with fuzzy vague variables offering a questionable result through computerized models. To date there is no comprehensive framework taking under consideration all the selection criteria, addressing and solving in optimal manner the selection process problems.

References

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Coffin, M.A. and Taylor, B.W.(1996) "Multiple Criteria R&D Project Selection and Scheduling Using Fuzzy Logic". Computers Operations Research, 23(3), pp. 207-220

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Zhang, W.G., Mei, Q., Lu Q. and Xiao, W.L. (2011) "Evaluating Methods of Investment Project and Optimizing Models of Portfolio Selection in Fuzzy Uncertainty". Computers & Industrial Engineering, 61, pp. 721-728