When Payback Can Take Decades

For capital-intensive businesses, the variables in portfolio decisions can seem overwhelming. Streamlining can help.

October 2015 | by Robert Harris

For companies in capital-intensive industries, investments are more often than not of the supersized variety. The utility that builds new plants that employ a variety of power-generating technologies, for example, handles an investment volume of a daunting size and complexity. Then there is the uncertainty: once a company embarks on an investment, decades can pass before it actually creates value. In the basic-materials and energy industries, for instance, the average new project costs about $500 million and takes 20 to 30 years to create value on a net present value (NPV) basis.

Taken together, the uncertainty and the complexity make it particularly difficult for companies to sort through myriad combinations of prospective investments and select the most promising ones. If a power company, for example, considered only limited variations of the most obvious factors—the size, location, technology, and timing of possible investments, as well as a variety of future market scenarios—it would still end up with more possible portfolio combinations than it could evaluate easily.

As a result, executives typically opt for an overly simplistic approach: They evaluate investment opportunities intuitively, considering the two or three most obvious risks and uncertainties rather than conducting a systematic analysis. They also usually assess options on a stand-alone basis, overlooking how a group of assets might affect a single portfolio. And they rank investment prospects by the ratio of NPV to investment volume, in effect shaping their corporate portfolio for the next several decades simply by ticking down the list of possible investments until their funds are exhausted. At that point, few executives give much consideration to financial constraints that might emerge as the target portfolio is implemented, which can be decades.

Our work with clients in capital-intensive industries in Europe suggests a better approach to structuring portfolios. For it to be effective, companies must overcome three common obstacles. First, they must understand the relevant risks and uncertainties and how they are linked. Second, companies need to systematically sort through an infinite number of possible portfolio configurations. Last, they must apply that perspective to identify the most appropriate candidates for future portfolios. Once under way, this approach can help companies avoid locking themselves into today’s vision of a single portfolio that must last 20 years. Instead, they can retain the flexibility to adapt to changing market conditions.


Executive Editor

Ms Anna Sullivan

Ms Anna Sullivan