8. Rule Four: Manage Your Portfolio

How should executives decide which value chains to cut?

The answer is found in business strategic planning.

We generally think of business strategy as a means to growth. But just as we use strategy to drive decisions on where we invest in good times, the same is true in hard times.

Rule four is: Use business strategy to decide what the shorter list of deliverables will be.

The thinking is identical. Both are a matter of portfolio management. With a finite supply of revenues, cash, and capitalization (available spending power), executives must decide which of the many investment options a company chooses.

In good times, there is more spending power. With it, the company can support less profitable products/services and fund growth strategies.

In hard times, less spending power means the company cannot afford all the strategies it funded in prior years, and may have to eliminate less profitable products/services.

But in either case, executives must understand their options and the expected costs and returns on each. Then, they must prioritize the portfolio of investments, and draw the line at the level of affordability.

Whatever the level of affordability and wherever that line is drawn, portfolio management is a key step in business strategic planning.

Portfolio management decisions are based on costs and expected benefits, i.e., on returns on investments.

It's sometimes difficult to pinpoint the benefits that will be forgone if a value chain is cut.

It's fairly obvious that cutting a big project saves a lot of money, but also passes up a lot of payoff.

More subtly, cutting an internal support service may save money in one organization while it increases costs throughout the company as others struggle to get by without a critical support function or turn to higher-cost sources such as decentralization and outsourcing.

To put some structure around portfolio-management decision-making, value chains can be placed in four categories:

• Strategies: Business strategies that create new products/services or improve deliverables of the above types.

  This includes investments in unprofitable product lines in order to reap significant profitability later, as well as investments in new products/services.

  The focus for cutting here is on strategies with marginal rates of return, unusually high risk, or particularly long payback time frames.

• Support: Support that makes other organizations within the company more productive (indirect expenses).

  The key is to cut internal support services in a way that doesn't just drive costs outward (and higher) when internal customers inevitably turn to decentralization or outsourcing.

  The focus should be on services the company can do without, regardless of who provides them. Do not cut indirect value chains which are necessary to stay in business or to keep others productive.

• Product Added Value: Support that adds value to existing products and services, a value that improves competitive position and/or customer satisfaction. Examples include customer service and marketing.

  The focus for cutting should be on added values which are beyond the point of diminishing returns, i.e., those which contribute only marginally to customers' perceived utility.

• Products: Existing products or services (external value chains, with all the direct throughout the company).

  The focus for cutting should be on mature (stable or shrinking) products/services which aren't sufficiently profitable or are cash-flow negative. This doesn't necessarily mean cutting entire product lines or organizations.

This framework is not intended to encourage cutting one category more than another. Rather, the framework suggests the right questions to ask within each category to understand the benefits of a value chain, its strategic relevance, and the unintended consequences of eliminating it.

All these various types of investments can then compete fairly for funding in the portfolio management process.