The document discusses new frameworks for IT portfolio selection that consider both financial and strategic metrics. It summarizes that traditional portfolio selection focused solely on financial metrics, but recent research shows this led to underinvestment in strategic areas. The new framework evaluates investments from four perspectives: demand, supply, governance, and alternatives. This allows executives to consider financial returns, strategic alignment, risk exposure, architectural fit, options, costs, deadlines, and skills. Successful companies now use multiple financial and strategic metrics to optimize resource allocation and maximize investment value and benefits.

1. Measure What Matters: New Perspectives on
IT Portfolio Selection
A UMT White Paper
By Yorai Linenberg and Gil Makleff

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Stock market investors articulate their goals explicitly or implicitly by following the philosophy and methodology of a
market expert that fits their investment objectives and appetite for risk. For example, for value and income stocks they
may rely on the research conducted by Wharton finance professor Jeremy Siegel¹ or read up on market pros like War-
ren Buffet.
Regardless of the strategy that you follow (e.g, growth and income, deep val-
ue, foreign value, mutual funds) you will consider some metrics and guiding
principles to help you during portfolio selection. Some of the metrics that
you may consider are: stock price, 52 week low-high, market cap, P/E ratio,
forecast earnings growth, free cash flow, dividend and return on assets. You
may use multiple objectives as guiding principles to select your portfolio (i.e.
better than average earning growth, a generous dividend payout or debt rel-
ative to equity). Much like the stock market investor, companies investing in
change face similar challenges when considering where to allocate budget
and resources to meet financial and strategic objectives.
After struggling with the question of project portfolio selection and metrics
for more than a decade, practitioners have begun to search for new portfolio
selection frameworks that are better suited for the present economic and
organizational environments. New research from UMT, shows that successful
companies are transforming the way decisions about IT investments are
made. Investments are no longer justified solely on the basis of financial
business case. Companies need to focus first on the strategic needs of the
organization and then on the resources required - mainly capital and skills –
to implement projects that meet those strategic goals.
The author recommends a new investment approach based on a framework
we developed after studying the investment practices at more than 50 com-
panies over the last seven years. The new portfolio selection paradigm can
be implemented using portfolio management software to capture portfolio
information, create business cases, derive key metrics, optimize resource
allocation, display warnings and provide guidance on potential actions (e.g.,
go, kill, delay, analyze).
Dozens of Global 1000 companies have already successfully implemented the new project portfolio selection frame-
work and their early experiences have confirmed that it can be implemented successfully and deliver positive results
(Fig. 1). First, the framework brings together multiple decision metrics for consideration. Second, it optimizes resource
allocation. Third, it provides real-time guidance on potential actions.
Traditional Views of Portfolio Valuation
Traditionally financial goals are imposed by shareholders, analysts, and the board. Because financial goals are so visible,
tangible and easy to understand, they often become the focal point for project and application portfolio selection. Fi-
nancial metrics were developed in the beginning of the 20th century to help in the management of a multi business
company. They provide summary financial measures to evaluate operational and investment efficiency. Firms use a
variety of financial metrics including:
 Payback Period. The payback period is the ratio of the initial investment divided by the estimated annual cash
inflows. The payback period may be a good indicator for risk - the faster the investment is recovered the less risk
to which the company is exposed.
Lessons From the Field
“[Portfolio management] led our Senior Execu-
tive Team to increase the 2004 IT Budget to allow
additional projects to be funded based on their
proven Strategic Value.”
Frank La Rocca, CIO
Keyspan Energy
"
…we saved $5 to $10mm [out of a $50mm budg-
et] in the first year alone on projects that would
have automatically gone through before.” (4)
Paul Bateman, Director of Enterprise Govern-
ance
AXA Financial
“Wachovia is using specialized [portfolio man-
agement] tools to allow a much higher degree of
interactivity and participation. It’s been extremely
well received by our business partners. Some
business units are even using the tools on non-
technology projects. It isn’t fundamentally about
cost savings. It’s about resource allocation.” (5)
Allan Shub, Vice President Retail
Wachovia

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 Discounted Cash Flow. This method determines the net present value of all future cash flows and discounts
them by the required rate of return, commonly referred to as the ‘hurdle rate.’
 Internal Rate of Return. Internal rate of return is the discount rate that equates the cash inflows and outflows.
Challenges to Financial Valuation Theories
For many years, financial metrics were a valuable and necessary feature to evaluate projects. Recently, it became ap-
parent that excessive dependence on evaluating investments “by the numbers” – that is excessive reliance on financial
metrics, without knowledge of the strategic direction – have become a real concern. Some of the apparent effects of
this overemphasis on financial metrics are described below.
Economic research by Gartner revealed that a company’s value is not fully explained by financial valuation. In 1982 the
average capitalization of a company in the S&P 500 was 1.3 times book value (Fig. 2). Book value is calculated using
standard accounting measures. In 1998, market capitalization was 5 to 6 times book value, leaving over 80% of market
value unexplained by standard accounting measures. How was this additional value generated?
By November 2001, market capitalization fell back under 3 times book value still leaving 60% unexplained by standard
accounting measures.²
Also not to be overlooked was a series of studies by Joseph Bower, showing that companies regularly are unable to ac-
curately estimate the value of their investments in change. Joseph Bower reported the following results regarding the
accuracy of current discount cash flow methods.³ For the companies that he evaluated, the ratio between actual and
expected forecasts were: Cost reduction 1.1, Sales expansion 0.6, New products 0.1.
While results were quite accurate for estimating the benefits from cost reduction projects, within the new products
category the ratio was only 0.1 (a score of 1 means the forecast was perfectly in line with actual). Another challenge
against reliance solely on financial measures is the fact that they depend heavily on the accuracy of the discount rates,
or hurdle rates, and it is very difficult for a company to estimate what is a valid discount rate. We have seen this lead to
the inflows being overstated and the investment being understated.
Furthermore, the inability to properly forecast revenue growth and the bias towards short term investments are seri-
ous limitations. This leads to under investment in intangible assets such as product innovation, customer satisfaction or
Financial Valuation Gap
Figure 2

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employee motivation, all areas critical to a company’s success. Existing financial measures alone are unlikely to provide
a useful indication of the true full value of investment opportunities. For those who seek to use better metrics for valu-
ation there is a strategic alignment framework based on aligning a project’s impact with the strategic drivers of the
firm.
The Transition to New Paradigms in Portfolio Selection
How does this strategic alignment framework work? A firm starts by setting a number of corporate goals. These goals
are translated into business drivers such as maximize wallet share, attract and hold superior management, maintain a
conservative risk policy or increase customer loyalty.
How do they expect to accomplish so much? Aren’t they aware that they need to compromise? Obviously, they know.
There is simply never enough budget and resources to do everything. Decision makers understand that they will need
to trade off one business driver against another and reach consensus on the priorities of their business drivers. They
will research and understand how each proposed investment will influence the business drivers. Using key process indi-
cators as a proxy for the business drivers, one can show that an investment that will advance the strategy of the firm
must make a significant impact on the key business drivers. In a world of scarce resources and finite horizons, valuing
the investments is not enough. Project valuation does not ensure optimum allocation of resources. The company must
optimize against budget and resource constraints to maximize investment value and benefits realization.
The strategic alignment framework metrics reflect revenue growth, support multiple objectives, capture the cause and-
effect relationships between project features and improvement in business objectives and are forward looking meas-
urements. However, metrics focused on strategic alignment often ignore the flow of funds and reinvestment.
Recent polls (Fig. 3) show that the ma-
jority of organizations (69%) are starting
to move from financial metrics to a
more complete view that includes fi-
nancial and strategic metrics. The re-
sults are encouraging. While many fac-
tors may have contributed to the
changes in selection methods, the most
noteworthy factors include dissatisfac-
tion with current methods, increased
portfolio management maturity, the
need to address multiple objectives,
steep shifts in shareholder’s orientation
toward revenue growth and changes in
decision making settings from central-
ized-monarchic to democratic-federal.
On this last point specifically, we have
seen a major shift from single decision
making, based on limited input, to group decision making, with multiple input and various understandings and per-
spectives.
Heated debate has raged over which metrics should be used to evaluate investments. Imagine investing in stocks using
only one single metric. Clearly, you could not select your portfolio based only on price without considering market cap
or P/E ratios. So, why would we believe that executives need only a single metric to make investment decisions? Execu-
tives are exposed to a larger level of scrutiny from the board and shareholders. They need information on value, cost,
architectural fit, risk, regulatory mandates, competencies and time to market. These metrics allow managers to look at
*Source: UMT Webinar;72 Global 1000 Respondents
Figure 3

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the investments from four different perspectives: demand, supply, governance and alternatives. The difficulties facing
executives in making portfolio selection decisions has forced them to look at the investments from four different per-
spectives (Fig. 4) and ask nine questions:
1. What are the expected financial returns?
2. How do the initiatives align with our strategic goals?
3. What is the risk exposure in these investments?
4. How do these projects conform to our architecture strategy and standards?
5. What technical and business options do we have?
6. What projects must we do to meet external imposed mandates (e.g., SOX)?
7. What is the cost? What are our budget limitations?
8. When can we complete these projects? What are the critical deadlines?
9. What are the required skills and competencies to complete them?
In summary, these four different perspectives are important, because they force management to understand and con-
sider all important aspects of demand, supply, governance and architecture that they need to review and approve in-
vestments.
Demand Perspective: What are the Expected Returns?
Value metrics, including financial and strategic metrics, estimate how the investment contributes to the execution of
company strategy and to improvement in the bottom line. The two metrics, financial and strategic, underline the con-
trast between short and long term goals. In the near term, financial metrics are impacted by past decisions, and long
term commitments (legal, lending). Strategic value metrics relate to the company’s performance in the marketplace,
where it competes for capital, human resources and market opportunities.
Demand
Governance
Supply
Alternative
Investment
What is the risk exposure in these
investments?
How do these projects conform to
our architectural strategy and
standards?
What is the cost? What
are our budget
imitations?
When can we complete
these projects? What are
the critical deadlines?
What are the required
skills and competencies to
complete them
What technical and business
options do we have?
What are the expected
Financial returns?
How do the initiatives
align with our strategic
goals?
What projects must we
do to meet external
imposed
The Four Structures that Impact Portfolio Selection
Figure 4

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A business performance framework consisting of both financial and strategic metrics represents a complete view of an
enterprise operation and will close the gap in determining the real business value of investments.
When capital is abundant, there is less due diligence and more projects pass the value/cost test. The real challenge is
evaluating projects located at the borders of the accept/reject region. Small changes in scope or in the accuracy of the
cost and value estimates could move a project from ‘go’ to ‘kill’ status. Therefore, smart organizations tend to re-
evaluate these “borderline” projects to decrease the acceptance and rejection errors.
Alternatives: What Options do We Have?
Innovation is usually risky, and is often costly. The risks and project costs pose ”asymmetric information” problems -
the project owners know much more about the project’s value, costs and risks than executives. Many and probably
most of the projects could be carried at reduced scope and cost and still achieve most if not all of the expected value.
What strategies can organizations pursue to mitigate this risk of over spending? One standard strategy is to develop
multiple parallel proposals. Some of those proposals are killed immediately; others are carried to the point where the
organization is confident about their choices.
Governance: What is the Risk Exposure?
IT Governance for portfolio management ensures that an organization has the optimum structures, processes and rules
(corporate law) to manage investment cost economics and reduce risk and exposure.
If investors are risk averse, as most modern capital risk research tends to believe, innovation and change may be dis-
couraged by what is often considered substantial risk. Investments have two major success probabilities: the probabil-
ity that a project’s technical objectives are achieved and the probability that the business objectives are achieved.
Governance affects many domains including setting business priorities, budgeting, project selection, resource alloca-
tion, application portfolio strategy, and performance measurement. Here we focus briefly on the domain of risk and
architectural fit.
The architectural fit perspective measures the fit against a future state and perhaps the effect on the total cost of own-
ership (TCO). Companies using architecture fit measurements realize that while many decisions will help in the short
term, they may not be good for the long haul. What strategies can organizations pursue to mitigate the effect of risk
and the effect of architectural misalignments?
One standard strategy is rejecting projects above a certain risk or level of architectural misalignment. Second, some
risks, and especially technical risks, can be reduced by changing the scope, changing suppliers or the architecture.
Supply: What are the Required Skills?
On the supply side, organizations face tightening resources and an increased concern with resource efficiencies. They
are concerned with optimizing their budgets, aligning their skills and capacity to business demand and monitoring
portfolio performance. The basic supply variables include: cost, time, skills and sourcing. Typically, these variables are
constrained by organizational budgets, skill capacity and availability, external imposed deadlines and freedom of sourc-
ing.
The complexity of the metrics requires viewing the data from multiple perspectives in order to segment the portfolios
and to trade-off one metric against another (e.g., value vs. risk). The final objective of this information gathering and
analysis is to make investment decisions (e.g., select, kill, and delay a project). The most important metrics are those
that measure the value and the leverage of the investment. Similar to P/E ratios, the investment leverage measures the

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value created per dollar invested. To hold in check some of the risks, organizations need warning metrics which will
point to excessive risk or severe architectural problems.
Additionally, management needs information about project alternatives and mandated investments. Finally, because
companies are concerned with taking unnecessary risk or committing decision errors such as approving a project that
should not be selected or rejecting a project that should have been selected, they task their planners and project man-
agers to further analyze and redesign certain projects.
One significant step taken in developing a new Portfolio Decision Dashboard (Fig. 5) was to recognize that normative
information, (i.e. go, hold, kill, etc) has to be augmented by factual information (i.e. cost, risk, alternatives, etc) and by
warning metrics (e.g., investment risks beyond accepted thresholds). Rich evidence exists that companies embracing
this new portfolio selection paradigm are able to increase the yield from their investment portfolios.
Portfolio Decision Dashboard
Figure 5
Strategic Investment Alignment Map
Figure 6

8. How Does the System Work?
A company’s executive committee sets the priority of the business goals. Managers identify potential projects that
may advance the firm’s strategy and address long and short term objectives. Portfolio analysts cater to the needs of
decision makers and prepare metrics and information as detailed above. Governance committees are fed with infor-
mation and metrics and make informed investment decisions. The Portfolio Decision Dashboard provides metrics and
information, enables clear comparison among portfolio alternatives, allows executives to make soft booking, simu-
late results, analyze consequences and finally make decisions and commit resources.
The continuous alignment of investments to organizational priorities poses serious challenges. This alignment ques-
tion requires that the firm examines the gap between business priorities and the dollars invested. The Strategic In-
vestment Alignment Map (Fig. 6) is a very useful way to graphically display investment in company strategy and to
see how well the investments are aligned to the business priorities. Having constructed a Strategic Alignment Invest-
ment map of a company, a number of analytical steps can be illuminating. We can immediately see areas of potential
under and over investments and point to misalignments and investments that require further analysis and realloca-
tion.
Conclusion
My hope is that organizations will recognize the complexity inherent in any portfolio management decision system.
While investment decisions are usually associated with the future, its link to the past, through previous investments
(i.e. current systems) is no less important. This paper has emphasized the paradigm shift from one single metric to
multiple metrics and perspectives. As businesses master this new process, they must pay attention to organizational
settings (i.e. consensus, style and culture) and to governance factors. They must also consider tools to enable data
management, decision support, and information reporting. More could be done, and the pace of portfolio effective-
ness would be accelerated if organizations continuously re-align the IT competencies to portfolio demand and relent-
lessly increase the available skills and portfolio management awareness.
As portfolio managers have tried to implement the new concept, they have found that they need the participation
and support of senior management, who have the complete understanding of the company’s business drivers, priori-
ties, resource limitations, and risk propensity. Few of the processes suggested here will be without resistance from
various management levels. For individual steering committee members, participation in these decisions means
more work, more time and more uncertainty and concerns. Since there is much at stake, the variety of experience,
perspectives, technical and business knowledge can extend each person’s constrained view of the world and stimu-
late innovative decisions in a fast changing business environment.
As companies implement this portfolio selection framework, they realize that the framework represents a paradigm
shift from the traditional methods. This new portfolio selection paradigm focuses on strategy and investment effec-
tiveness and not on project management and implementation efficiency.
Early results have been positive, showing savings or improvements in investment value of 15% to 35%. In one nota-
ble example, Paul Bateman of AXA Financial indicated a savings of $5-10 million on a budget of $50 million in the first
year of AXA’s portfolio management Implementation.⁴
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