TVP – Metric 3 Projected Value of the R&D Pipeline

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1. Metric Definition

The calculated sum of future value expected to be realized from current R&D projects, in terms of future sales revenue, income, net present value, or future options values.  This metric may be expressed in absolute terms or as a percentage of future sales.

a. Projected Sales

Projected Sales is the calculated sum of future sales from current R&D projects. This metric may be expressed in absolute terms or as a percentage (%) of future sales.  Typically this metric will be used in combination with a trailing metric such as sales of new products for the past five years.
Proper application of this metric requires a clear definition of the relevant time horizon.  For example, if new products are defined as those introduced within five years, then projected sales will be calculated for five years after commercialization. portfolio in the same terms.  In this way, it is possible to track progress towards this objective and also compare to previous results for the relevant time horizon. 
This estimate may be modified by applying a probability of attaining the projected amount, including technical and/or commercial considerations.

b. Projected Income

The cumulative income stream associated with the Projected (new) Sales above.  As with projected sales, solid definitions and a consistent method of predicting this amount should be established.  This metric may be expressed as an absolute number or as a fraction of net income.

c. Net Present Value (NPV)

Net Present Value (NPV) is today’s discounted value of the total future income stream resulting from R&D projects after subtraction of initial investments, in this case, the necessary R&D and capital investments.  This metric requires definition of an appropriate cash discount rate and the estimated time to commercialization. 

Connected concepts are the discounted cash flow (DCF) and internal rate of return (IRR), values for which are available from the same data used to calculate NPV.  The DCF is the projected total cash flow adjusted to reflect its time value.  The IRR is the discount rate for which the total present value of future cash flows equals the cost of the investment.  In other words, it is the interest rate that produces a zero NPV.

d. Real Option Value

The Real Option Value metric incorporates additional flexibility through a phased estimate of portfolio value that explicitly accounts for uncertainties and risks in technical and commercial development, deferability of investment decisions and prevailing interest rates.

2. Advantages and Limitations

This metric provides a forward-looking, ongoing anticipation of the expected results from current R&D programs. Because it is prospective, it provides an evaluation of the future benefits that are being created by today’s R&D investments.  The ability to measure the metric at any point in time allows it to be tracked over periods of significance (such as year to year) and against key targets.  By effectively linking this metric to a trailing measure, it is also possible to evaluate the predictive power of the metric and to improve its performance over time.

The limitations are due to the intrinsic uncertainties underlying forward projections and difficulties in obtaining estimates about the likely commercial benefits if the technology is successful. Additionally, estimates may not be consistent when made by different teams or individuals.

3. How to Use the Metric

The Projected Value of the R&D Pipeline is perhaps the single most important but also least used metric. It provides ongoing guidance regarding expected future business gains attributable to R&D.  This should be used as a check that both the strategy and the resource allocations are appropriate. Are the sales impacts large enough?  Are there sufficient numbers of new products? Is the timing of various elements in the pipeline appropriately aligned? Are the overall R&D returns adequate? Is the metrics on a year-to-year basis showing constancy, increase or decline?
If the value of this metric remains constant or increases, particularly with respect to the deployment of R&D resources, then R&D effectiveness is being maintained or is increasing.

Alternatively, if the value of this metric decreases, further diagnostics are needed to understand the reasons for the decline and to identify corrective actions.

4. Options and Variations

Variants are few because this is an underused metric.  One option is to consider absolute sales or net income over a five-year horizon on the presumption that projects progress at different rates, i.e., some will finish and be productive within a relatively shorter time horizon of two to three years while others will deliver impact at a later point, in the fourth and fifth years. Another option is to estimate the commercial impact without adjustment by probabilities of success.

5. Champions and Contacts

6. References

Boer, F. P. 2003. Risk-Adjusted Valuation of R&D Projects. Research-Technology Management, 46(5), pp. 50-58.
MacMillan, I.C., van Putten, A. B., McGrath, R. G., and Thompson, J. D. 2006. Using Real Options Discipline for Highly Uncertain Technology Investments, Research-Technology Management, 49(1), pp. 29-37.
Mathews, Scott. 2009. Valuing Risky Projects with Real Options. Research-Technology Management, 52(5), pp. 32-41.