Part I Project Initiation

Project Management

Strategic Management and Project Selection Chapter 2 Strategic Management and Project Selection

Problems With Multiple Projects Delays in one project delays others Inefficient use of resources Bottlenecks in resource availability

Project Results 30% canceled midstream Over half of completed projects came in up to 190% over budget 220% late <50% of strategic projects successful

Challenges Making sure projects are closely tied to goals and strategy. How to handle the growing number of projects? How to make these projects successful?

Project Management Maturity Project management maturity refers to the mastery of skills required to manage projects competently Number of ways to measure Most organizations do not do well Maturity can be rated in levels Initial  Repeatable  Defined  Managed  Optimizing

Project Selection and Criteria of Choice Evaluating Choosing Implementing Same process as other business decisions

The Nature of Project Selection Models Models turn inputs into outputs Managers decide on the values for the inputs and evaluate the outputs The inputs never fully describe the situation The outputs never fully describe the expected results Models are tools Managers are the decision makers

Types of Project Selection Models Nonnumeric models Numeric models

Nonnumeric Models Models that do not return a numeric value for a project to be compared with other projects These are really not “models” but rather justifications for projects Just because they are not true models does not make them all “bad”

Types of Nonnumeric Models Sacred Cow A project, often suggested by the top management, that has taken on a life of its own Operating Necessity A project that is required in order to protect lives or property or to keep the company in operation Competitive Necessity A project that is required in order to maintain the company’s position in the marketplace

Types of Nonnumeric Models Continued Product Line Extension Often, projects to expand a product line are evaluated on how well the new product meshes with the existing product line rather than on overall benefits Comparative Benefit Projects are subjectively rank ordered based on their perceived benefit to the company Sustainability Focusing on long-term profitability rather than short-run payoff

Numeric Models Models that return a numeric value for a project that can be easily compared with other projects Major types Profit/profitability Real Options Scoring Window-of-opportunity analysis Discovery-driven planning

Numeric Models: Profit/Profitability Models that look at costs and revenues Payback period Discounted cash flow (NPV) Internal rate of return (IRR) Profitability index NPV and IRR are the more common methods

Payback Period The length of time until the original investment has been recouped by the project A shorter payback period is better

Payback Period Example

Payback Period Drawbacks Does not consider time value of money More difficult to use when cash flows change over time Less meaningful for longer periods of time (due to time value of money)

Discounted Cash Flow The value of a stream of cash inflows and outflows in today’s dollars Also know as discounted cash flow or just discounting Widely used to evaluate projects Includes the time value of money Includes all inflows and outflows, not just the ones through payback point

Discounted Cash Flow Continued Requires a percentage to use to reduce future cash flows This is known as the discount rate The discount rate may also be known as a hurdle rate or cutoff rate There will usually be one overall discount rate for the company

NPV Formula

NPV Formula Terms A0 Initial cash investment Ft Cash flow in time period t (negative for outflows) k The discount rate t The number of years of life A higher NPV is better Higher the discount rate lower the NPV

NPV Example

Internal Rate of Return [IRR] The discount rate (k) that causes the NPV to be equal to zero The higher the IRR, the better While it is technically possible for a series to have multiple IRR’s, this is not a practical issue Finding the IRR requires a financial calculator or computer In Excel “=IRR(Series,Guess)”

Profitability Index a k a Benefit cost ratio NPV divided by initial cash investment Ratios greater than 1.0 are good

Advantages of Profitability Models Easy to use and understand Based on accounting data and forecasts Familiar and well understood Gives a go/no-go indication Can be modified to include risk

Disadvantages of Profitability Models Ignore nonmonetary factors Some ignore time-value of money Biased toward the short-term Payback ignores cash flow after payback IRR can have multiple solutions All are sensitive to errors Nonlinear Dependent on determination of cash flows

Numeric Models: Real Options Positions the organization to capitalize on future opportunities Utilized to reduce both technological and commercial risk

Risk Considerations in Project Selection Both costs and benefits are uncertain Benefits are more uncertain There are many ways of dealing with risk Can make estimates about the probability of outcomes Subjective probabilities Uncertainty about: Timing What will be accomplished? Side effects

Project Bids and RFPs The project proposal is essentially a project bid Putting together a project proposal requires a detailed analysis of the project Project proposals can take weeks or months to complete A more detailed analysis may result in not bidding on the project

Project Proposal Contents Cover letter Executive summary The technical approach The implementation plan The plan for logistic support and administration Past experience