As I continue talking with companies, and trying their real data, the value of the software is proving itself.
One company allocates $25M/quarter to invest in opportunistic projects. They provided ~400 such projects, ranging in investment size from $100k to $35M total, with the investment spread over 1-16 quarters, and the return coming back over time (up to 8 years).
“How would you select them?” I asked.
They would typically rank them by decreasing NPV, and select projects until their available capital was allocated. This is a typical “rank and cut” approach that many companies use, and seems perfectly reasonable. It’s straightforward and relatively simple to understand and implement.
I manually replicated this process, investing in projects (starting with the greatest NPV project first, and continuing down the list) each quarter until the available capital was exhausted. This approach invested $500M over 20+ quarters in the 80 most valuable (by NPV) projects. As these are forecast to be very valuable projects the NPV of the resulting cash flows was forecast to be ~$3.6B.
Wanting to see if the software could improve on that, I limited the quarterly investment spend to $25M and a total $500M over the total time-frame.
Honestly, I didn’t expect to get a result much different from their approach, given that they were already picking the 80 most valuable projects.
In 10 minutes, I was able to add $300M to their portfolio’s value!
It again invested the same $500M over 20+ quarters, but instead picked 226 different projects, and again never spending any more than $25M per quarter.
The optimization approach identified the optimal set of projects and their timing to maximize the NPV of cash flows, given the various constraints. (you’re actually able to maximize or minimize any of the key metrics you provide or calculate).
Also, in this case, picking a larger number of projects reduced the risk because the portfolio was no longer dependent upon relatively few of them to succeed.
As I look forward to using these tools to help clients, and eventually getting the tools in their hands, I expect there to be many more such successful mornings.