Innovation Portfolio Management Process

Best Practice Guidebook Innovation Portfolio Management Process growth team membership 1 guidebook summary Firm: Dow AgroSciences LLC Industry: Chemicals, food ingredients, and biotechnology Headquarters: Indianapolis, Indiana, United States Geographic Footprint: Global Ownership: Public A wholly owned subsidiary of Dow Chemical Revenue (2009): $4.5 billion USD Problem: Due to the size and scale of its innovation portfolio, Dow AgroSciences (DAS) finds it challenging to consistently assess project risks, compare projects, and measure portfolio value. Solution: Dow AgroSciences employs a portfolio management system that uses standardized project data to evaluate, manage, and compare projects individually and across the entire portfolio. Business Results: Dow AgroSciences surpassed its 2001 2010 Compound Annual Growth Rate (CAGR) goals by 8% by the end of 2008 and increased the percentage of realized expected value by 50%. Resources Required: Full-time process leader and one half- or full-time administrator Network infrastructure commensurate with size and scale of the business Portfolio management consultant* and web-based software* system totalling: -- $150 $300,000 USD start-up cost -- $150 $500,000 annual operating costs Applicability of Best Practice to Executive Functions: R&D/Innovation Corporate Strategy Function Applicability * Dow consulted with SmartOrg for its software solution.

2 The portfolio management process prioritizes, monitors, and evaluates the entire innovation portfolio The Portfolio Management Process Use Strategy and Investment Criteria to Screen Projects Establish Baseline Project Values Eliminate Project Risks and Improve Value Assess Project Progress Make Project and Portfolio Investment Decisions Objective Set strategy and investment needs for innovation projects. Objective Develop commercial assumptions for each project and enter them into the portfolio management system. Objective Identify the indicators with the greatest impact on project value and mitigate those uncertainties. Objective Evaluate performance and strategic fit of individual projects and across business units. Objective Perform annual project prioritization and funding allocation. Key Participants Portfolio Management Forum (PMF): The executive team, comprised of the R&D leader and Global Business Line leaders, meets annually to evaluate the portfolio s strategic fit and funding allocation. Key Participants Local Market Teams: Cross-functional, local market teams enter information into the portfolio management system and perform tactical project work. Project Success Leaders: These global project owners direct the activities of local market teams and cross-functional project core teams comprised of biology, regulatory, supply, and finance representatives. Project Success Leaders report to their respective Global Business Line Management Teams (see step 4). Key Participants Global Business Line Management Teams (GBLMT): The management team for each business unit (BU) sets innovation strategy and manages its product portfolio. Key Participants Portfolio Management Forum (PMF) what is an innovation project? Dow AgroSciences (DAS) uses a web-based, integrated portfolio management system to track all innovation projects that qualify for funding. DAS innovation projects are either entirely new or extend an existing product line and can run multiple years. For the purposes of this guidebook we have simplified DAS multi-tiered innovation portfolio to the following three levels: Projects a single innovation based on a specific technology for a specific purpose (e.g., a rice insecticide) Product Line all projects (new innovations and line extensions) in the same product family (e.g., all rice insecticides) Business Unit all product lines that fall under one of Dow s market segments (e.g., pest management)

3 key takeaway: Establish strategy requirements and investment hurdles for innovations entering the portfolio DAS Portfolio Management Forum (PMF) uses three screening criteria to determine whether a project should enter the portfolio management system and receive funding Qualifying for the Portfolio Management System Market Attractiveness Market Attractiveness Factors Growth rate Size Political/social factors Technology factors Is the project in one of DAS strategic markets? The Market Attractiveness Matrix helps determine DAS ability to achieve a profitable long-term market position. The PMF updates the Matrix every two years to analyze its portfolio, identify attractive markets, and determine where to increase or decrease investments. Market Attractiveness Matrix (Illustrative) H L Weak Rice Strong L H DAS Competitive Strength Competitive Strength Factors Market share Brand equity Distribution reach Profitability To ensure an optimal blend of new and mature products, the PMF gauges the life cycle stage of any new product under consideration. Entirely new innovations are automatically classified as invest projects, while all other innovations are classified based on the their life cycle stage and market s attractiveness (per the Matrix). Product Line Life Cycle Stages INVEST GROW DEFEND Manage for Cash Early What is the project s life cycle stage? Late Project X Illustrative Example Renew Sales Profit Does the project meet the minimum investment hurdles for its life cycle classification? PMF follows predetermined investment hurdles to determine innovation eligibility in the current budget cycle. The classification system removes the least strategic projects and gives insight to the expected value DAS should realize from its investments. Classification and Hurdles INVEST GROW DEFEND Manage for Cash Productivity Rate (NPV/ >5 >10 >15 >20 Cost) IRR% (Internal Rate of Return) >25% >40% >60% >75% Payback Years <10 years <8 years <6 years <4 years Due to these projects high growth and profit potential, their investment hurdles are relatively low. Because these projects have a low potential for future growth and their profits are more at risk, their investment hurdles are relatively high. Idea: Project X is a rice insecticide line extension replacing an existing product in three years. Rice is a large but weak market for DAS, given its many competitors, low prices, and low margins. A rice line extension project falls into the defend product life cycle stage. However, given DAS weak competitive position in the rice market, the PMF downgrades it to Manage for Cash. As a Manage for Cash investment, Project X meets the required investment hurdles Productivity (22:1 per $ spent), IRR (76%), and Years to Payback (2 years) and therefore enters the portfolio management process.

4 DAS identifies ten key indicators of a project s value key takeaway: Create commercial market assumptions based off predetermined indicators of projects value Project teams then establish assumptions around each indicator and input the information into the portfolio management system Generate Commercial Assumptions Input Commercial Assumptions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. ten indicators of project value Price at maturity Volume at maturity Cost at maturity Impact of cannibalization (by market and by new product) Development costs for project Capital investment required Impact on maturity sales of technical failure Shape of product life cycle Incremental selling manpower Promotion costs predicting innovation success DAS evaluated 15 years of financial data to reduce 100+ data points used in innovation assessments to the 10 indicators listed above. These indicators ensure project teams focus on factors most likely to determine project success. Additionally, these ten indicators enable apples-to-apples comparisons across all projects. Assumptions are estimates for each indicator based on market research and industry/market experience. Project X Local Market Team Project Success Leader Project X Homework Meeting 1 2 hour discussion led by the Project Success Leader Cross-functional representatives from key areas of accountability: Commercial, Biology, Regulatory, Finance Discussion of factors influencing each indicator s low- and high-value assumptions -- Document rationale for the range and revisit annually Define Review Guidelines Background Information Assess Inputs Manage Data sets Technical Success Review Evaluation Uncertainty Diagram Comparison and Tracking Title Project X Background Information Project X is a line extension of Project XYZ for managed rice crops Objective Project X will replace existing product in the Southern U.S. managed rice crop insect protection product line when it sundowns in 3 years Probability of Technical Success 0.6 Probability that all technical requirements will be achieved Commercial Assumptions 10 Indicators Units Low Base High Price at maturity Volume at maturity Cost at maturity Portfolio Management System Impact of cannibalization Development costs Capital investment Impact of technical failure Product life cycle shape Incremental Selling Manpower Promotion Costs Local currency per unit 1,000s of units Local currency per unit Compendium of measures Last Change 7.5 9 10.5 6/3/2008 100 150 200 6/3/2008 2 3 4 7/15/2008-7.5-13.5-21.0 $1,000s USD 0 1 2 $1,000s USD 2 3 3 Compendium none average high 7/15/2008 Compendium short medium long $1,000s of local currency $1,000s of local currency 3 10 15 12 20 30 Ranges save time spent on perfecting the numbers.

5 key takeaway: Evaluate assumptions to identify the indicators with the greatest impact on a project s commercial value The tornado diagram depicts the impact of uncertainty on the assumptions governing each of the ten key indicators; it calculates the NPV for each of its high, base, and low values; the longer the bar, the greater the uncertainty and its impact on project NPV Tornado Diagram Analysis Local Market Teams reduce Volume at Maturity uncertainty by strengthening their assumptions. They conduct a customer satisfaction and willingness-to-pay survey for the new product. Based on this information, the team can narrow its assumptions, thereby reducing uncertainty and improving project net present value (NPV). 10 Indicators Volume at Maturity Price at Maturity Unit Cost at Maturity Impact of Cannibalization Development Costs Capital Investment Impact of Technical Failure on Sales Product Life Cycle Shape Incremental Selling Manpower Promotion Costs Combined Uncertainty 100,000 NPV ($ Millions) 0 1 2 3 4 5 6 $7.5 Before Action (Illustrative) 200,000 $10.5 10 Indicators Price at Maturity Unit Cost at Maturity Impact of Cannibalization Volume at Maturity 100,000 Combined Uncertainty After Action (Illustrative) NPV ($ Millions) 0 1 2 3 4 5 6 $7.5 $7.5 150,000 $10.5 $10.5 175,000 200,000 Combined Uncertainty depicts the range of NPV values based on a statistical analysis of all the uncertainties. The longer the bar, the greater the team s uncertainty about its assumptions, and the lower the expected value of the project. Base Case NPV ($3.3M) Uncertainty for Volume at Maturity narrows from $4.1 M to $2.0 M NPV The Combined Uncertainty decreases Base Case NPV Before Action ($3.3M) Base Case NPV After Action ($4.0M) and the expected project value improves from $3.3 M to $4.0 M.

6 key takeaway: Continuously assess individual project values to validate progress The Global Business Line Management Team uses project financial statements to monitor year-on-year performance Project Financial Statement Illustrative Illustrative 18 Annual Baseline values are the input Target Line values from when a project Project X is approved. The baseline Project X values also incorporate any Above annual target line approved changes. Baseline Current 2010 PMF Performing better than Submission Submission Submission its project plan 12 Project Change is positive; Expected Value (NPV $ Millions) 4.34 6.11 7.01 Current changes less than 10% Project Value are; not out of scope Expected Cost (total costs 0.34 0.43 0.27(NPV $ million) $ millions) Project X Project Y Productivity (NPV/expected cost) 6.11 The greater the value, the greater 12.65 14.30 25.43 6 the profit margin for the product Project Y falls far below its annual target IRR (Internal Rate of Return Yield line and is performing beneath the 0.73 1.01 4.68 of the investment) minimum standard Years to PayBack (# of years) 3.7 3.1 1.3 Greater than 10% decrease in value Cost Budget 2010 (Annual $ spent 0 Requires in-depth project review Financials should improve 0.06 as 0.21 0.17 millions) 0 4.34 6 12 18 uncertainties are reduced and Baseline Project Value Cost Budget 2011 projects move to completion. 0.01 0.15 0.15 (NPV $ million) Cost Budget 2012 0.00 0.14 0.15 Average Products Number of Products 2 2 3 In-Depth Project Y Review The GBLMT focuses on projects with a 10% +/- change global Expected Products business Values line management 2.17 team 3.05 2.34 in NPV. Global Expected Business Commercial Line Management Value Given Teams evaluate 3.91 project performance 3.44 2.55 Local Market Teams root cause the change in project on three Technical levels: project, Success product line, and portfolio. The GBLMT value (e.g., invalid assumptions, technical issues, cost evaluates Probability Global of Project Technical Success Success leaders progress 0.60 in managing 0.95 the value 0.95 overruns, competitor action) and determine whether and uncertainties Expected Products of their Cost individual projects. 0.17 0.21 0.09 performance can improve by the next annual review. The GBLMT prescribes next steps ranging from risk Cost Budget 2010 0.03 0.11 0.06 mitigation to project termination. Cost Budget 2011 0.00 0.08 0.05 Cost Budget 2012 0.00 0.07 0.05 and value-tracking charts to provide visibility into projects expected performance over time Project Value-Tracking Chart

7 key takeaway: Assess each business unit s portfolio by value and risk to allocate further funding Global Business Line Management Teams use the CFO charts, Commercial Uncertainty charts, and other considerations to conduct annual portfolio assessments and submit a prioritized project list to the Portfolio Management Forum 100 80 60 Cumulative Project Value (NPV $Million) 40 Productivity Prioritization Projects are prioritized based on investment productivity, from most to least productive, and plotted in the CFO chart. 20 Project C Project A Project X CFO Chart Illustrative Project Y Project F Project D Project Z 0 0 1 2 3 4 5 6 Cumulative Project Cost (NPV $Million) Interpreting the CFO Chart High Productivity Projects (X, A, C) create the most value per unit cost. Project X has an NPV of ~$28 M, with costs of $200K, resulting in a productivity ratio of 140:1. Marginal Projects (Y and F) are still productive projects, but may not stack up when compared across all business units. Low Productivity Projects (D and Z) produce the least value per unit cost and are at risk of losing funding. Cumulative Project Value 100 80 60 Risk Prioritization Project prioritizations are adjusted based on considerations such as risk versus return. Project X Project A Project C Project Y Project F Project D Commercial Uncertainty Chart Illustrative Range of Uncertainty NPV ($ Million) -20 0 20 40 60 80 High Value Low Value The Commercial Uncertainty chart complements the CFO chart by illustrating the risks associated with each project. Based off this analysis, teams can adjust projects prioritization in the funding queue. additional assessment tools The portfolio management system allows DAS to easily assemble projects into portfolios and 40compare across all BU s. The value and risk tools are the primary considerations along with: Market timing Probability of Technical Success chart 20 Expected Project Value chart Cash Flow Source: Dow AgroSciences 0 LLC; SmartOrg; Growth Team Membership research. 0 1 2

8 key takeaway: Focus budget allocation on high-value, strategically aligned projects A two-pass funding process first funds high productivity, strategically aligned projects and then the best of the rest Two-Pass Annual Portfolio Funding Process Hold Annual Funding Meeting Fund the Best Projects Fund the Best of the Rest Projects Finalize Project List The Portfolio Management Forum (PMF) meets annually to evaluate the complete innovation portfolio and make cross business unit funding decisions. The PMF compares the available budget to the requested funding and determines which projects to fund on the first pass. Innovation Budget: $175 M The Portfolio Management Forum Requested project funding: $200 M The PMF approves a predetermined percentage of the projects each business unit prioritizes as most valuable (represented by the green bars below). BU BU BU BU Line 1 Line 2 Line 3 Line 4 High Value + + + = $160M ($15M still to be allocated) Low Value The PMF determines it will fund 80% ($160M) of the project requests. This first pass quickly turns the funding conversation to the projects on the margin. In doing so, the PMF can examine these projects more closely and make decisions to maximize value. Still-unfunded projects from all BU s are pooled and compete for the remaining budget. Best of the Rest Illustrative Project BU Cost ZZ Rice $2 M Z Q AA Small Grains Insect Control Corn Herbicides $2 M $3.5 M $2.5 M B Pest Mgmt. $2.5M K L Small Grains Corn Herbicides AD Turf $2.5 M $15 M Decisions are finalized and communicated to the business units within 48 hours of the meeting. The PMF also puts 10 projects on a waiting list for possible off cycle funding. Should spending or viability of a funded project change resulting in a budget gain, the PMF selects the next feasible project. From: The PMF To: Business Unit Subject: Alternates From: The PMF To: Business Unit Subject: Approved Projects Approved Projects: Project X Project A Project C Project Y Rejected Projects: Project F Project D Project Z

9 Business Results Dow AgroSciences has increased project management efficiency and value capture Improved Project Success The portfolio management system enables Project Success Leaders to make accurate forecasts and increase captured value from each project. Average % Captured of Forecasted Sales and Margin 100% 50% Margin Sales Margin Sales 0% Pre-Portfolio Management System Post-Portfolio Management System leading to greater sustained value in its portfolio over time, as well as the attainment of its growth goals Sales CAGR EBIT* CAGR 25% Sales CAGR 25% Sales CAGR 20% 20% 15% 15% 10% 10% 5% 5% 0% CAGR Goal 2001 2010 CAGR Actual 2001 2007 0% CAGR Goal 2001 2010 CAGR Actual 2001 2007 * Non-GAAP financial measure; excludes certain items.

10 Profiled Company Perspective Key Lessons Learned Successfully combining portfolio and project management requires the right balance of people, process, and systems. The appropriate balance depends on your situation, but over or under resourcing any one of these areas tends to undermine the success of the others. Data modeling is an effective way to reduce effort and save time without a corresponding loss in information. Less can be more when you avoid focus on a single, perfect number. --Allowing users to reflect uncertainty in their inputs generates more realistic values and data ownership. The inputs also show project teams where they should try to reduce project uncertainty and improve project value. A system that is transparent to all stakeholders provides tremendous benefits. --Clear project metrics provide team members immediate feedback on their projects. Paired with investment guidelines, teams gain a frame of reference for the difference between marginal and acceptable projects. --A straightforward project approval process and clear prioritization criteria build trust for the process among stakeholders. Consensus on which projects should be funded, rejected, or discontinued is much easier to achieve when everyone is referencing the same information. Strategy should be set at a corporate (i.e., global) level, and local market teams should own execution. That said, the global team should not handle decision-making for local market projects. Local teams appreciation for region-specific nuances is critical to accurately predicting how a project might sell within a given market. Not all portfolio management technology solutions are created equal. Finding the right software designed for the task is important. Dow AgroSciences was looking for tools to aid in portfolio and project management; tracking project value, identifying uncertainties, and presenting alternatives through quantitative modeling. Dow chose Portfolio Navigator by SmartOrg because of this.

11 Supporting Tools & Resources Example: Project Financial Statement Illustrative Project X Baseline Project Value Current Project Value Submission Project Expected Value (NPV $ Millions) 4.34 6.11 Expected Cost (total costs $ millions) 0.34 0.43 Productivity (NPV/expected cost) The greater the value, the greater the profit margin for the product 12.65 14.30 IRR (Internal Rate of Return Yield of the investment) 0.73 1.01 Years to PayBack (# of years) 3.7 3.1 Cost Budget 2010 (Annual $ spent millions) 0.06 0.21 Cost Budget 2011 0.01 0.15 Cost Budget 2012 0.00 0.14 Average Products Number of Products 2 2 Expected Products Values 2.17 3.05 Expected Commercial Value Given Technical Success 3.91 3.44 Probability of Technical Success 0.60 0.95 Expected Products Cost 0.17 0.21 Cost Budget 2010 0.03 0.11 Cost Budget 2011 0.00 0.08 Cost Budget 2012 0.00 0.07

Supporting Tools & Resources SmartOrg 12 SmartOrg Inc. SmartOrg, Inc. is a leading provider of decision support software that optimizes project/portfolio economic value from concept to commercialization. Customers include Boeing Commercial Airplanes, Chevron Technology Company, Dow AgroSciences, Bayer CropScience, Hewlett-Packard and like companies in the U.S. and Europe. The flagship application, Portfolio Navigator, is installed on company servers or hosted by SmartOrg. The system stands alone or is integrated with resource management applications such as SAP PPM. For additional information, please visit www.smartorg.com or send email to info@smartorg.com