Part I

Project Initiation

© 2012 John Wiley & Sons Inc.

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Project Management

Chapter 2

Strategic Management and Project Selection

© 2012 John Wiley & Sons Inc.

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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 midstreamOver half of completed projects came in

up to190 percent over budgetOver 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 measureMost 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

They can also be broken down as:– Companies looking at projects to do for others– Companies looking at projects to do for themselves

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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 modelsNumeric 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

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

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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

Comparative Benefit– Projects are subjectively rank ordered based

on their perceived benefit to the company

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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

4000,25$

000,100$PeriodPayback

FlowCash Annual

CostProject PeriodPayback

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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 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

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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) 0

1 1

nt

tt

FA

k

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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 lifeA higher NPV is betterHigher the discount rate lower the NPV

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NPV Example

939,1$

03.015.01

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

8

1

t

t

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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 IRR’s, 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 ratioNPV divided by initial cash investmentRatios 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 0–1 factor modelUnweighted factor modelWeighted factor model

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Unweighted 0-1 Factor Model

Factors selected– Listed on a preprinted form

Raters score the project on each factorEach project gets a total scoreMain advantage is that the model uses

multiple criteriaMajor 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 X’s with factor score– Typically a 1-5 scale

Column of scores is summedProjects with high scores are selected

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Unweighted Weighted Factor Model

Each factor is weighted the sameLess important factors are weighted the

same as important onesEasy to computeJust 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

Uncertainty about:– Timing– What will be accomplished?– Side effects

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 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

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Purpose of Project Portfolio Process

Identify nonprojectsPrioritize list of projectsLimit 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 projectsEliminate projects that skip the formal

selection processKeep from overloading the organizationTo balance the resources with needsTo balance returnsTo balance short-, medium-, and long-

term returns

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Project Portfolio Process 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 the projects to be funded and held in

reserve8. Implement the process

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Step 1: Establish a Project Council

Senior managementThe project managers of major projectsThe head of the Project Management

OfficeParticularly relevant general managersThose who can identify key opportunities

and risks facing the organizationAnyone 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 dataDocument assumptionsScreen out weaker projectsThe 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 conservativelyTiming is particularly important

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Step 5: Reduce the Project and Criteria Set

Organization’s 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 weightsConsider in terms of benefits first and

resource costs secondSummarize 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 resultsRepeat 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 letterExecutive summaryThe technical approachThe implementation planThe plan for logistic support and

administrationPast experience