The Efficient Frontier simplifies a complex portfolio management problem to highlight and clarify some basic questions: scarcity, efficiency, trade-offs, opportunity cost, and the value of breaking the constraints. It offers a simple way of thinking about investment decisions, discovering ways to increase the efficiency of portfolio investments, and avoiding investment in regions of diminishing returns.
Both the business and IT sides of an organization should get comfortable with Efficient Frontier thinking and analysis. The most important purpose of this chapter is to look at the economic ways of thinking that are applied to portfolio management. I have covered a balanced approach to applying the model based on both theoretical foundations and practical applications. Because of the mathematical foundation of the Efficient Frontier model, experience shows that this approach, together with a set of tools, is required to help you maximize the value of your investment immediately.
Of course, the Efficient Frontier is just one critical part of a successful portfolio management program. Keep in mind that the key prerequisites for success in using it are the ability to translate business
Experience shows that organizations that have used Efficient Frontier principles together with accurate portfolio valuation are able to reduce waste or increase value creation opportunity by 20 percent to 40 percent.
strategy into business drivers, rank and weight the drivers, identify the quantifiable impact that the projects will have on the business drivers, and derive the potential value created by the projects. At that point, you can use the Efficient Frontier framework to further understand and remove constraints and to optimize labor supply and demand.
This rational approach helps to break the traditional wall between the IT and business sides and improves the way people interact with one another and make decisions.
Mike Gruia is a cofounder and president of United Management Technologies. He spearheaded the creation of the modern portfolio prioritization and optimization framework and governance approach, which is being used by leading Fortune 1000 firms worldwide. He holds B.S. and M.S. degrees in industrial and systems engineering and a P.E. in operations research from Columbia University.
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