Part I

Project Initiation

Copyright 2012 John Wiley & Sons, Inc.

Project Management

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Chapter 2

Strategic Management and Project Selection

Copyright 2012 John Wiley & Sons, Inc.

Problems With Multiple Projects

Delays in one project delays others Inefficient use of resources Bottlenecks in resource availability

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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

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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?

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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

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Project Selection and Criteria of Choice

Project selection

Evaluating Choosing Implementing

Same process as other business decisions

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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 Companies looking at projects to do for others Companies looking at projects to do for themselves

They can also be broken down as:

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Model Criteria

Realism Capability Flexibility Ease of use Cost Easy computerization

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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

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Types of Project Selection Models

Nonnumeric models Numeric models

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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

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Types of Nonnumeric Models

Sacred Cow

A project, often suggested by the top management, that has taken on a life of its own A project that is required in order to protect lives or property or to keep the company in operation

Operating Necessity

Competitive Necessity

A project that is required in order to maintain the companys position in the marketplace

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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 Projects are subjectively rank ordered based on their perceived benefit to the company

Comparative Benefit

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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

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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

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

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Payback Period Example

Project Cost Payback Period Annual Cash Flow $100,000 Payback Period 4 $25,000
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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)

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Discounted Cash Flow

The value of a stream of cash inflows and outflows in todays 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

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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

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NPV Formula

NPV (project) A0
t 1

1 k

Ft

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NPV Formula Terms

A0 Ft Initial cash investment 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
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NPV Example
$25,000 NPV (project) $100,000 t 1 0.15 0.03 t 1 $1,939
8

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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 IRRs, this is not a practical issue

Finding the IRR requires a financial calculator or computer In Excel =IRR(Series,Guess)

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

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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

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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
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Scoring Models
Unweighted 01 factor model Unweighted factor model Weighted factor model

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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
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Unweighted 0-1 Factor Model Example

Figure 2-2

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Unweighted Factor Scoring Model

Replaces Xs with factor score

Typically a 1-5 scale

Column of scores is summed Projects with high scores are selected

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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

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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
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Weighted Factor Model Example

Figure B Page 60

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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

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Disadvantages of Scoring Models

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

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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 Timing What will be accomplished? Side effects

Uncertainty about:

Pro forma documents

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The Project Portfolio Process (PPP)

Links projects directly to the goals and strategy of the organization Means for monitoring and controlling projects

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Symptoms of a Misaligned Portfolio

More projects Inconsistent determination of benefits Projects that dont contribute to the strategy Competing projects Costs exceed benefits No risk analysis of projects Lack of tracking against the plan No client for project

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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

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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 longterm returns

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Project Portfolio Process Steps

1. 2. 3. 4. 5. 6. 7. 8.

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
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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

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Step 2: Identify Project Categories and Criteria

Derivate projects Platform projects Breakthrough projects R&D projects

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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

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Step 4: Assess Resource Availability

Assess both internal and external resources Assess labor conservatively Timing is particularly important

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Step 5: Reduce the Project and Criteria Set

Organizations goals Have competence Market for offering How risky the project is Potential partner Right resources Good fit

Use strengths Synergistic Dominated by another Has slipped in desirability

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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

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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

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Step 8: Implement the Process

Communicate results Repeat regularly Improve process

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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

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Project Proposal Contents

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

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