Copyright 2009 John Wiley & Sons, Inc.

Project Management

Selecting Projects Strategically

Ch #-Ch #-22

Problems With Multiple Projects

1. Delays in one project delays others because of common resource needs or technological dependencies

2. Inefficient use of resources

3. Bottlenecks in resource availability

Ch #-Ch #-33

Project Results

30 Percent canceledOver half 190 percent over budgetOver half 220 percent late

Ch #-Ch #-44

Challenges

Making sure projects closely tied to goals and strategy

How to handle growing number of projects

How to make projects successful

Ch #-Ch #-55

Project Management Maturity

Project management maturity refers to mastery of skills required to manage project competently

Number of ways to measureMost organizations do not do well

Ch #-Ch #-66

Project Selection and Criteria of Choice

Project selection…– Evaluating– Choosing – Implementing

Same process as other business decisions Projects that are consistent with the strategic

goals of the organization should be selected

Ch #-Ch #-77

Examples of Project Selection

A manufacturing firm chooses which machine to adopt in a process

A TV station selects which comedy show to run

A construction firm selects the best subset of potential projects

A hospital finds the best mix of beds for a new wing

Ch #-Ch #-88

Types of Companies

Companies considering projects fall into two broad categories:

1. Companies whose core business is completing projects

2. Companies whose core business is something else

They can also be broken down as:1. Companies looking at projects to do for others2. Companies looking at projects to do for

themselves

Ch #-Ch #-99

Project Companies

Must select which projects they will bid on Generally based on…

– Their expertise– Resource they have availability– Their chance of winning bid

Preparing a bid is expensive They do not want to waste that effort on bids

where they are unlikely to be successful

Ch #-Ch #-1010

Non-Project Companies

Must decide which potential projects they will pursue

Available capital is the major constraintProfitability is often the major criteriaMust evaluate approaches when there

is more than one project that can accomplish a goal

Ch #-Ch #-1111

Models

Models are used to select projectsAll models simplify realityThat is, they only look at the key

variables involved in a decisionThe more variables included in a

model, the more complex it becomesSimpler models usually work better

Ch #-Ch #-1212

Types of Models

Stochastic/Probabilistic Model– A model that includes the probabilities of events

occurring within the model. In other words, the same inputs might yield different outputs at different runs.

Deterministic Model– A model that does not include probabilities. Given

the same inputs, the outputs will always be the same.

Ch #-Ch #-1313

Criteria For Project Selection Models

Companies only want to undertake successful projects

Projects that fail waste resources and hurt profitability and competitiveness

Projects that succeed improve profitability and competitiveness

It is not possible to know ahead of time if a project will succeed or fail

In fact, there is a continuum of possible results from total success through absolute failure

Ch #-Ch #-1414

Criteria (Continued)

Companies need a way of weeding out the bad projects while keeping the good ones

No model can predict with absolute certainty What we want is a model with a “good batting

average”

Ch #-Ch #-1515

Model Criteria

RealismCapabilityFlexibilityEasy to use InexpensiveEasy to implement

Ch #-Ch #-1616

Realism

Needs to include all objectives of the firm Needs to include the firms expertise as well

as its limitations Needs to report results in a fashion that

allows different projects to be compared, e.g. how do we compare a project to lower production cost and one to raise market share

Ch #-Ch #-1717

Capability

Model needs to be sophisticated enough to deal with all projects– Varying resource requirements– Varying time periods– Varying probabilities of success

Needs to be able to select the optimum projects among all contenders

Ch #-Ch #-1818

Flexibility

Needs to be able to work with all projects

Needs to be updated as the firm and its environment evolves

Ch #-Ch #-1919

Easy to Use

Needs to be quick to gather the data and easy to use and understand

Easy to be able to “fit” the project in the model

Ch #-Ch #-2020

Inexpensive

Do not want the model to eat up all the savings that result from using the model

Expenses include the cost of writing and maintaining the model

Also includes the expense of gathering the data needed by the model

Ch #-Ch #-2121

Easy to Implement

This is less of an issue with modern spreadsheets

However, a model to be used to evaluate all the firm’s projects should be centrally maintained

Ch #-Ch #-2222

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

Ch #-Ch #-2323

Different Factors Affecting Outcome

Many factors affect the outcome of a project– Some are one-time factors

The cost of an item

– Others are reoccurring Maintenance

Not all factors are equally important Critical factors on one project may be trivial

on another project

Ch #-Ch #-2424

Predictors of Project Success

Expected profitability Technological opportunity Development risk Appropriateness of the project for the

organization

Ch #-Ch #-2525table_02_01

Project Evaluation Factors

Ch #-Ch #-2626

Types of Project Selection Models

Nonnumeric modelsNumeric models

Ch #-Ch #-2727

Nonnumeric Models

Models that do not return a numeric value for a project that can 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”

Ch #-Ch #-2828

Types of Nonnumeric Models

Sacred Cow– A project, often suggested by top management,

that has taken on a life of its own. It continues, not due to any justification, but “just because.”

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.

Ch #-Ch #-2929

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.

Ch #-Ch #-3030

Numeric Models

Models that return a numeric value for a project that can be easily compared with other projects

Two major categories:1. Profit/profitability

2. Scoring

Ch #-Ch #-3131

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 more common

Ch #-Ch #-3232

Payback Period

The length of time until the original investment has been repaid by the project

A shorter payback period is better

Ch #-Ch #-3333

Payback Period Example

4000,25$

000,100$PeriodPayback

FlowCash Annual

CostProject PeriodPayback

Ch #-Ch #-3434

Payback Period Drawbacks

1. Does not consider time value of money

2. More difficult to use when cash flows change over time

3. Less meaningful over longer periods of time (due to time value of money)

4. Ignores cash flows beyond payback period

Ch #-Ch #-3535

Discounted Cash Flow

The value of a stream of cash inflows and outflows in today’s dollars

Also known as net present value (NPV) 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

Ch #-Ch #-3636

Discounted Cash Flow Continued

Requires a percentage to use to reduce future cash flows– This is known as the discount rate or

hurdle rate or cutoff rateThere will usually be one overall

discount rate for the company

Ch #-Ch #-3737

NPV Formula

n

t tt

k

FA

101

(project) NPV

A0 Initial cash investmentFt The cash flow in time period t (negative for

outflows)k The discount raten The number of years of life

Ch #-Ch #-3838

NPV Formula Terms

A project is acceptable if NPV is positive A higher NPV is better The higher the discount rate, the lower the

NPV

Ch #-Ch #-3939

NPV Formula Including Inflation

0 1NPV (project)

1

n ttt

t

FA

k p

pt Predicted rate of inflation during period t

Ch #-Ch #-4040

NPV Example

A project requires $100,000 investment with a net cash inflow of $25,000 per year for a period of eight years, a required rate of return of 15% and an inflation rate of 3% per year.

Ch #-Ch #-4141

NPV Example

939,1$

03.015.01

000,25$000,100$ (project) NPV

8

1

t

t

Ch #-Ch #-4242

table_02_02

NPV Example

Ch #-Ch #-4343

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 IRR can also be found by trial and error In Excel “=IRR(Series,Guess)”

Ch #-Ch #-4444

Profitability Index

a.k.a. Benefit cost ratioNPV of all future cash flows divided by

initial cash investmentRatios greater than 1.0 are good

Ch #-Ch #-4545

Advantages of Profitability Models

Easy to use and understandBased on accounting data and

forecastsFamiliar and well understoodGive a go/no-go indicationCan be modified to include risk

Ch #-Ch #-4646

Disadvantages of Profitability Models

Ignore non-monetary factorsSome ignore time value of moneyDiscounting models (NPV, IRR) are

biased to the short-termPayback models ignore cash flow after

paybackSensitive to error in data

Ch #-Ch #-4747

Scoring Models

Unweighted factor modelWeighted factor model

Ch #-Ch #-4848

Unweighted Factor Models

Each factor is weighted the sameEasy to computeJust total or average the scores

Ch #-Ch #-4949

Unweighted 0-1 Factor Model Example

Figure 2-2

Ch #-Ch #-5050

Unweighted Factor Scoring Model

Give a score (point) to each criterion and sum them up

Select the project with the highest total score

Generally a five-point scale is used

Ch #-Ch #-5151

Unweighted Factor Scoring Model Example

Criterion: estimated annual profits

Score Performance level

5 Above $1,100,000

4 $750,001 to $1,100,000

3 $500,001 to $750,000

2 $200,000 to $500,000

1 Less than $200,000

Ch #-Ch #-5252

Unweighted Factor Scoring Model Example

Criterion: no decrease in quality of the final product Score Performance level

The quality of the final product is5 significantly and visibly improved4 significantly improved but not visible to buyer3 not significantly changed2 significantly lowered but not visible to buyer1 significantly and visibly lowered

Ch #-Ch #-5353

Weighted Factor (Scoring) Model

Each factor is weighted relative to its importance– Weighting allows important factors to stand out

A good way to include non-numeric 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

Ch #-Ch #-5454

Weighted Factor Model

1

n

i ij jj

S s w

Si Total score of the ith projectsij Score of the ith project on the jth criterionwj Weight of the jth criterion

0 1 and 1j jjw w

Ch #-Ch #-5555

Weighted Factor Model ExampleAutomobile Selection

Table A

Ch #-Ch #-5656

Weighted Factor Model ExampleAutomobile Selection

Table B

Ch #-Ch #-5757

Weighted Factor Model ExampleAutomobile Selection

Figure A

Ch #-Ch #-5858

Weighted Factor Model ExampleAutomobile Selection

Figure B

Ch #-Ch #-5959

Advantages of Scoring Models

Multiple criteria can be usedSimple and easy to understandDirect reflection of managerial policyEasily altered to accommodate changesWeights of criteriaEasy sensitivity analysis

Ch #-Ch #-6060

Disadvantages of Scoring Models

Scores may not directly represent the value or utility

Elements are assumed to be independent

Unweighted models assume equal importance of all criteria

Ch #-Ch #-6161

Analysis Under Uncertainty—The Management of Risk

Everything to do with projects is risky Some projects, like R&D, are more risky than

others, like construction Risks include…

– The timing of the project and its associated cash flow

– Risk regarding the outcome of the project– Risk about the side effects

Ch #-Ch #-6262

Uncertainty

1. Pro forma financial statements, break-even charts

2. Risk analysis

3. Simulation (requires detailed probability information)

Ch #-Ch #-6363

Comments on the Information Base for Selection

A database must be created and maintained to furnish input data

Accounting data Measurements Uncertain information

Ch #-Ch #-6464

Accounting Data

1. Cost and revenue are linear

2. Cost-revenue data derived using standard cost standardized revenue assumptions

3. Costs may include overhead

Ch #-Ch #-6565

Measurements

1. Subjective versus objective

2. Quantitative versus qualitative

3. Reliable versus unreliable

4. Valid versus invalid

Ch #-Ch #-6666

Uncertain Information

Must estimate inputs for risk analysisThese inputs cannot be known exactly Inputs must be adjusted over time

Ch #-Ch #-6767

Project Portfolio Process (PPP)

Links projects directly to the goals and strategy of the organization

Means for monitoring and controlling projects

Ch #-Ch #-6868

Project Portfolio Process (PPP)

Identify non-projects Prioritize the available projects Limit the number of projects Identify the projects that best fit the

organization’s strategy Eliminate projects that incur high cost/risk Keep from overloading the resource availability Balance resources with needs

Ch #-Ch #-6969

PPP Steps

1. Establish a project council2. Identify project categories and criteria3. Collect project data4. Assess resource availability5. Reduce the project and criteria set6. Prioritize the projects within categories7. Select projects to be funded and held in reserve8. Implement the process

Ch #-Ch #-7070

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

Ch #-Ch #-7171

Step 2: Identify Project Categories and Criteria

1. Derivative projects: incrementally different in product and process from existing offerings

2. Platform projects: major departures from existing offerings (ex: a new model of automobile, a new type of insurance plan)

3. Breakthrough projects: newer technology than platform projects (ex: use of fiber optic cables for data transmission, hybrid automobiles)

4. R&D projects: develop new technologies

Ch #-Ch #-7272

fig_02_10

Ch #-Ch #-7373

Step 3: Collect Project Data

Assemble the dataUpdate previous dataDocument assumptionsScreen out weaker projectsThe fewer projects that need to be

compared and analyzed, the easier the work

Ch #-Ch #-7474

Step 4: Assess Resource Availability

Assess both internal and external resources

Assess labor conservativelyTiming is particularly important

Ch #-Ch #-7575

Step 5: Reduce the Project and Criteria Set

Organization’s goals Have competence Market for offering How risky Potential partner Right resources Good fit

Use strengths Synergistic with

other projects Dominated by

another Has slipped in

desirability

Ch #-Ch #-7676

Step 6: Prioritize the Projects Within Categories

Apply the scores and criterion weightsConsider in terms of benefits first,

resource costs secondSummarize the returns from the

projects

Ch #-Ch #-7777

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

Ch #-Ch #-7878

fig_02_11

Ch #-Ch #-7979

Step 8: Implement the Process

Communicate resultsRepeat regularly Improve process

Ch #-Ch #-8080

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

Ch #-Ch #-8181

Project Proposal Contents

Cover letterExecutive summaryThe technical approachThe implementation planThe plan for logistic support and

administrationPast experience