Ch02

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Copyright 2012 John Wiley & Sons, Inc.

Part I

Project Initiation

22--22

Project Management

Copyright 2012 John Wiley & Sons, Inc.

Chapter 2

Strategic

Management and

Project Selection

22--44

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

22--66

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?

22--77

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

22--88

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

22--1010

Model Criteria

Realism

Capability

Flexibility

Ease of use

Cost

Easy computerization

22--1111

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

22--1212

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

22--1414

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

companys position in the marketplace

22--1515

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

22--1616

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

22--1818

Payback Period

The length of time until the original

investment has been recouped by the

project

A shorter payback period is better

22--1919

Payback Period Example

4000,25$

000,100$PeriodPayback

FlowCash Annual

CostProject PeriodPayback

22--2020

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

22--2222

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

22--2323

NPV Formula

NPV (project) 0

1 1

nt

tt

FA

k

22--2424

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

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NPV Example

939,1$

03.015.01

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

8

1

tt

22--2626

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)

22--2727

Profitability Index

a k a Benefit cost ratio

NPV divided by initial cash investment

Ratios greater than 1.0 are good

22--2828

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

22--3030

Scoring Models

Unweighted 01 factor model

Unweighted factor model

Weighted factor model

22--3131

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

22--3232

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

22--3434

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

22--3535

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

22--3636

Weighted Factor Model Example

Figure B Page 60

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22--3737

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

22--3838

Disadvantages of Scoring Models

Relative measure

Linear in form

Can have large number of criteria

Unweighted models assume equal

importance

22--3939

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

22--4040

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

22--4242

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

22--4343

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

22--4444

Project Portfolio Process Steps

1. Establish a project council

2. Identify project categories and criteria

3. Collect project data

4. Assess resource availability

5. Reduce the project and criteria set

6. Prioritize the projects within categories

7. Select the projects to be funded and held in reserve

8. 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

22--4646

Step 2: Identify Project Categories and Criteria

Derivate projects

Platform projects

Breakthrough projects

R&D projects

22--4747

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

22--4848

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

22--5050

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

22--5151

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

22--5252

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

22--5454

Project Proposal Contents

Cover letter

Executive summary

The technical approach

The implementation plan

The plan for logistic support and

administration

Past experience