Part I Project Initiation © 2012 John Wiley & Sons Inc.

Project Management

Strategic Management and Project Selection Chapter 2 Strategic Management and Project Selection © 2012 John Wiley & Sons Inc.

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

Project Results 30 Percent canceled midstream Over half of completed projects came in up to190 percent over budget Over half of completed projects came in up to 220 percent late

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

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

Types of Companies Companies considering projects fall into two broad categories: Companies whose core business is completing projects Companies whose core business is something else They can also be broken down as: Companies looking at projects to do for others Companies looking at projects to do for themselves

Model Criteria Realism Capability Flexibility Ease of use Cost Easy computerization

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

Numeric Models Models that return a numeric value for a project that can be easily compared with other projects Two major categories: Profit/profitability Scoring

Profit/Profitability Models 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

Scoring Models Unweighted 0–1 factor model Unweighted factor model

Unweighted 0-1 Factor Model Factors selected Listed on a preprinted form Raters score the project on each factor Each project gets a total score Main advantage is that the model uses multiple criteria Major disadvantages are that it assumes all criteria are of equal importance

Unweighted 0-1 Factor Model Example Figure 2-2

Unweighted Factor Scoring Model Replaces X’s with factor score Typically a 1-5 scale Column of scores is summed Projects with high scores are selected

Unweighted Weighted Factor Model Each factor is weighted the same Less important factors are weighted the same as important ones Easy to compute Just total or average the scores

Weighted Factor Model Each factor is weighted relative to its importance Weighting allows important factors to stand out A good way to include nonnumeric data in the analysis Factors need to sum to one All weights must be set up, so higher values mean more desirable Small differences in totals are not meaningful

Weighted Factor Model Example Figure B Page 60

Advantages of Scoring Models Allow multiple criteria Structurally simple Direct reflection of managerial policy Easily altered Allow for more important factors Allow easy sensitivity analysis

Disadvantages of Scoring Models Relative measure Linear in form Can have large number of criteria Unweighted models assume equal importance

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 Pro forma documents

The Project Portfolio Process (PPP) Links projects directly to the goals and strategy of the organization Means for monitoring and controlling projects

Symptoms of a Misaligned Portfolio More projects Inconsistent determination of benefits Projects that don’t contribute to the strategy Competing projects Costs exceed benefits No risk analysis of projects Lack of tracking against the plan No client for project

Purpose of Project Portfolio Process Identify nonprojects Prioritize list of projects Limit number of projects Identify the real options for each project Identify projects with good fit Identify co-dependent projects

Purpose of Project Portfolio Process Continued Eliminate risky projects Eliminate projects that skip the formal selection process Keep from overloading the organization To balance the resources with needs To balance returns To balance short-, medium-, and long-term returns

Project Portfolio Process Steps Establish a project council Identify project categories and criteria Collect project data Assess resource availability Reduce the project and criteria set Prioritize the projects within categories Select the projects to be funded and held in reserve Implement the process

Step 1: Establish a Project Council Senior management The project managers of major projects The head of the Project Management Office Particularly relevant general managers Those who can identify key opportunities and risks facing the organization Anyone who can derail the PPP later on

Step 2: Identify Project Categories and Criteria Derivate projects Platform projects Breakthrough projects R&D projects

Step 3: Collect Project Data Assemble the data Document assumptions Screen out weaker projects The fewer projects that need to be compared and analyzed, the easier the work of the council

Step 4: Assess Resource Availability Assess both internal and external resources Assess labor conservatively Timing is particularly important

Step 5: Reduce the Project and Criteria Set Use strengths Synergistic Dominated by another Has slipped in desirability Organization’s goals Have competence Market for offering How risky the project is Potential partner Right resources Good fit

Step 6: Prioritize the Projects Within Categories Apply the scores and criterion weights Consider in terms of benefits first and resource costs second Summarize the returns from the projects

Step 7: Select the Projects to be Funded and Held in Reserve Determine the mix of projects across the categories Leave some resources free for new opportunities Allocate the categorized projects in rank order

Step 8: Implement the Process Communicate results Repeat regularly Improve process

Project Proposals 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