11

Project Management: A Project Management: A Managerial ApproachManagerial Approach

Chapter 2 – Strategic Management Chapter 2 – Strategic Management and Project Selectionand Project Selection

22

OverviewOverview

• Project Selection and CriteriaProject Selection and Criteria

• Project Selection ModelsProject Selection Models

• Uncertainty and RiskUncertainty and Risk

• Information for Project SelectionInformation for Project Selection

• Project Portfolio Process (PPP)Project Portfolio Process (PPP)

• Project ProposalsProject Proposals

33

Project Maturity and RealityProject Maturity and Reality

• Many projects fall outside company Many projects fall outside company missionmission

• Projects without organizational Projects without organizational goal/objective “fit”goal/objective “fit”

• Project budgets not tied to cost-Project budgets not tied to cost-benefit analysisbenefit analysis

44

Multiple Project Management Multiple Project Management IssuesIssues

• Delays in one project impacting Delays in one project impacting othersothers– Resource conflictsResource conflicts– Technology dependenciesTechnology dependencies

• Lack of resource “smoothing”Lack of resource “smoothing”– Peaks and valleys of resource utilizationPeaks and valleys of resource utilization

• Bottlenecks with scarce resourcesBottlenecks with scarce resources– Lack of workaroundsLack of workarounds

55

Project SelectionProject Selection

• Evaluation process -- individual Evaluation process -- individual projects or groups of projectsprojects or groups of projects

• Choosing some set of project optionsChoosing some set of project options

• Organizational objectives achievedOrganizational objectives achieved

• Managers use decision-aiding modelsManagers use decision-aiding models

• Models represent the problem’s Models represent the problem’s structurestructure

• Aid in evaluating risks and optionsAid in evaluating risks and options

66

Criteria for Project Selection Criteria for Project Selection ModelsModels

• RealismRealism - reality of manager’s decision - reality of manager’s decision

• CapabilityCapability- able to simulate different scenarios and - able to simulate different scenarios and

optimize the decisionoptimize the decision

• FlexibilityFlexibility - provide valid results within the range of - provide valid results within the range of

conditionsconditions

• Ease of UseEase of Use - reasonably convenient, easy execution, and - reasonably convenient, easy execution, and

easily understoodeasily understood

• CostCost - Data gathering and modeling costs should be low - Data gathering and modeling costs should be low

relative to the cost of the projectrelative to the cost of the project

• Easy ComputerizationEasy Computerization - must be easy and convenient to - must be easy and convenient to

gather, store and manipulate data in the modelgather, store and manipulate data in the model

77

Nature of Project Selection Nature of Project Selection ModelsModels

– 2 Basic Types of Models2 Basic Types of Models•NumericNumeric

•Non-numericNon-numeric

– Two Critical Facts:Two Critical Facts:•Models do not make decisions - People do!Models do not make decisions - People do!

•All models are only partial representations All models are only partial representations of realityof reality

88

Non-Numeric ModelsNon-Numeric Models• Sacred CowSacred Cow - - project is suggested by a senior and project is suggested by a senior and

powerful official in the organizationpowerful official in the organization

• Operating NecessityOperating Necessity - - the project is required to the project is required to keep the system runningkeep the system running

• Competitive Necessity Competitive Necessity - - project is necessary to project is necessary to sustain a competitive positionsustain a competitive position

• Product Line ExtensionProduct Line Extension - - projects are judged on projects are judged on how they fit with current product line, fill a gap, strengthen how they fit with current product line, fill a gap, strengthen a weak link, or extend the line in a new desirable way.a weak link, or extend the line in a new desirable way.

• Comparative Benefit ModelComparative Benefit Model - - several projects are several projects are considered and the one with the most benefit to the firm is considered and the one with the most benefit to the firm is selectedselected

99

Q-Sort – A Comparative Benefit Q-Sort – A Comparative Benefit TechniqueTechnique• Usually undertaken by a selection Usually undertaken by a selection

committeecommittee• Project descriptions on separate cardsProject descriptions on separate cards• Divide into high and low benefit groupsDivide into high and low benefit groups• Form a medium benefit/priority group from Form a medium benefit/priority group from

a selection of high and low projectsa selection of high and low projects• Subdivide remaining high level projects into Subdivide remaining high level projects into

very high priority and high priorityvery high priority and high priority• Repeat subdivision for low level projectsRepeat subdivision for low level projects• Review the ranking for appropriateness and Review the ranking for appropriateness and

consistencyconsistency

1010

Q-Sort Project SelectionQ-Sort Project Selection

1111

Numeric Models: Numeric Models: Profit/ProfitabilityProfit/Profitability

– Payback periodPayback period - - initial fixed initial fixed investment/estimated annual cash inflows from the investment/estimated annual cash inflows from the projectproject

– Average Rate of Return Average Rate of Return - - average annual average annual profit/average investment profit/average investment

– Discounted Cash Flow -Discounted Cash Flow - Present Value Present Value Method Method

– Internal Rate of Return -Internal Rate of Return - Finds rate of return Finds rate of return that equates present value of inflows and outflowsthat equates present value of inflows and outflows

– Profitability IndexProfitability Index - - NPV of all future expected NPV of all future expected cash flows/initial cash investmentcash flows/initial cash investment

1212

Financial Selection CriteriaFinancial Selection Criteria

• Payback ModelPayback Model– Time to recover project investmentTime to recover project investment

• Investment €/Annual Net Savings = PBInvestment €/Annual Net Savings = PB

– Widely usedWidely used– Emphasis on Cash FlowEmphasis on Cash Flow

• Net Present Value (NPV)Net Present Value (NPV)– Desired rate of returnDesired rate of return

•(Est. Annual Cash Flow/Project Cost) X 100 (Est. Annual Cash Flow/Project Cost) X 100 = RoR= RoR

– Compare “RoR” of project(s) to “target”Compare “RoR” of project(s) to “target”

1313

Payback PeriodPayback Period

• Estimated project costs: €100,000Estimated project costs: €100,000

• Annual cash inflows: €25,000Annual cash inflows: €25,000

• Payback period: €100,000/€25,000 = Payback period: €100,000/€25,000 = 4 yr4 yr

• Rapid payback reduces risk to the Rapid payback reduces risk to the firmfirm

1414

Average Rate of ReturnAverage Rate of Return

• Emphasises the annual profitability Emphasises the annual profitability of the project investmentof the project investment

• Annual profits: €15,000Annual profits: €15,000

• Average Rate of Return: Average Rate of Return: €15,000/€100,000 = 0.15 (15%)€15,000/€100,000 = 0.15 (15%)

• Simple but ignores impact of inflation Simple but ignores impact of inflation or cost of financeor cost of finance

1515

Net Present Value (NPV)Net Present Value (NPV)

• Also known as Also known as Discounted Cash FlowDiscounted Cash Flow (DCF) (DCF)

• NPV discounts the value of future returns NPV discounts the value of future returns by taking into account the predicted by taking into account the predicted inflation rate pinflation rate pii

for each period ifor each period i

• Initial investment IInitial investment Ioo is a negative cash flow is a negative cash flow

• NPV = INPV = Ioo + + ΣΣ F Fii / (1 + p / (1 + pii))ii

• FFii is the cash inflow in the period i is the cash inflow in the period i

1616

NPV Example with IIRNPV Example with IIR

• A required A required Internal Rate of ReturnInternal Rate of Return (IRR), k, (IRR), k, may be incorporated in an NPV determinationmay be incorporated in an NPV determination

• NPV = INPV = Ioo + + ΣΣ F Fii / (1 + k + p / (1 + k + pii))ii

• €€100,000 investment predicted to produce a 100,000 investment predicted to produce a net cash inflow of €25,000 pa for period of 8 net cash inflow of €25,000 pa for period of 8 years with pyears with pii = 3% pa and k = 15% = 3% pa and k = 15%

• NPV = - €100,000 + NPV = - €100,000 + ΣΣ €25,000 / (1 + 0.15 + €25,000 / (1 + 0.15 + 0.030.03ii))II = + €1,939 = + €1,939

• Since this figure is positive the project meets Since this figure is positive the project meets the financial requirement for selectionthe financial requirement for selection

1717

Internal Rate of Return (IRR) Internal Rate of Return (IRR) and Profitability Index (PI)and Profitability Index (PI)

• Given a set of expected cash inflows and Given a set of expected cash inflows and outflows for a project, the IRR is the outflows for a project, the IRR is the discount rate that equates the present discount rate that equates the present values of the two sets of flows.values of the two sets of flows.

• The value of IIR may be determined by The value of IIR may be determined by trial and error or using (say) Exceltrial and error or using (say) Excel

• The Profitability Index is the NPV of all The Profitability Index is the NPV of all future cash inflows divided by the initial future cash inflows divided by the initial cash investment – if PI > 1 the project may cash investment – if PI > 1 the project may be acceptedbe accepted

1818

Numeric Models: ScoringNumeric Models: Scoring• Unweighted 0-1 Factor ModelUnweighted 0-1 Factor Model

• Unweighted Factor Scoring ModelUnweighted Factor Scoring Model

• Weighted Factor Scoring ModelWeighted Factor Scoring Model

• Constrained Weighted Factor Scoring ModelConstrained Weighted Factor Scoring Model

• Goal Programming with Multiple ObjectivesGoal Programming with Multiple Objectives

Chapter 2-6

1919

Risk Versus UncertaintyRisk Versus Uncertainty

• Analysis Under Uncertainty - The Analysis Under Uncertainty - The Management of RiskManagement of Risk– The difference between risk and uncertaintyThe difference between risk and uncertainty

•RiskRisk - when the decision maker knows the - when the decision maker knows the probability of each and every state of nature probability of each and every state of nature and thus each and every outcome. An and thus each and every outcome. An expected value of each alternative action can expected value of each alternative action can be determinedbe determined

•UncertaintyUncertainty - when a decision maker has - when a decision maker has information that is not complete and therefore information that is not complete and therefore cannot determine the expected value of each cannot determine the expected value of each alternativealternative

2020

Risk AnalysisRisk Analysis

• Principal contribution of risk analysis is Principal contribution of risk analysis is to focus the attention on understanding to focus the attention on understanding the nature and extent of the the nature and extent of the uncertainty associated with some uncertainty associated with some variables used in a decision making variables used in a decision making processprocess

• Usually understood to use financial Usually understood to use financial measures in determining the measures in determining the desirability of an investment projectdesirability of an investment project

2121

Risk AnalysisRisk Analysis

• Probability distributions are determined or Probability distributions are determined or subjectively estimated for each of the subjectively estimated for each of the “uncertain” variables“uncertain” variables

• The probability distribution for the rate of The probability distribution for the rate of return (or net present value) is then found return (or net present value) is then found by simulationby simulation

• Both the expectation and its variability are Both the expectation and its variability are important criteria in the evaluation of a important criteria in the evaluation of a projectproject

2222

Risk AnalysisRisk Analysis

2323

Aggregate Project PlanningAggregate Project Planning

2424

Project Portfolio Process - Project Portfolio Process - PurposePurpose• Identify Projects that Meet Strategic NeedsIdentify Projects that Meet Strategic Needs

– Support Multiple GoalsSupport Multiple Goals– Direct Organizational ImprovementDirect Organizational Improvement– Enhance/Enable Key AreasEnhance/Enable Key Areas

• Prioritize Potential ProjectsPrioritize Potential Projects– Limit Active Projects to Manageable LevelLimit Active Projects to Manageable Level– Identify Risk-intensive EffortsIdentify Risk-intensive Efforts– Balance Short, Medium, Long-term ReturnsBalance Short, Medium, Long-term Returns

• Reduce Projects from Getting in via Reduce Projects from Getting in via “Backdoor”“Backdoor”

2525

Project Portfolio Process - Project Portfolio Process - StepsSteps

1.1. Establish a Project Management Establish a Project Management “Governance” Structure“Governance” Structure

– Senior Leaders and Technical ExpertsSenior Leaders and Technical Experts

2.2. Identify (Common) Project Selection CriteriaIdentify (Common) Project Selection Criteria– Tied to Strategic Vision, Mission, Goals, Tied to Strategic Vision, Mission, Goals,

ObjectivesObjectives

3.3. Collect Project-specific DataCollect Project-specific Data– Project Attributes Tied to Selection CriteriaProject Attributes Tied to Selection Criteria

4.4. Assess Available ResourcesAssess Available Resources– Internal and ExternalInternal and External– Financial and OtherFinancial and Other

2626

Project Portfolio Process - Project Portfolio Process - StepsSteps

5.5. Reduce Project ListReduce Project List- Screen for Potential “Differentiators”Screen for Potential “Differentiators”

6.6. Prioritize within CategoriesPrioritize within Categories- Assuring Balance of PortfolioAssuring Balance of Portfolio- Avoid Overabundance of Similar ProjectsAvoid Overabundance of Similar Projects

7.7. Select Primary and “Reserve” ProjectsSelect Primary and “Reserve” Projects- Leave Budget for “Surprise” OpportunitiesLeave Budget for “Surprise” Opportunities

8.8. Implement the Project ProcessImplement the Project Process- Communicate Results to Selectees and Non-Communicate Results to Selectees and Non-

selecteesselectees- Fund Projects to Promised LevelsFund Projects to Promised Levels

2727

PPP – Plan of RecordPPP – Plan of Record

2828

Project ProposalsProject Proposals

• Which projects should be bid on?Which projects should be bid on?

• How should the proposal-preparation How should the proposal-preparation process be organized and staffed?process be organized and staffed?

• How much should be spent on How much should be spent on preparing proposals for bids?preparing proposals for bids?

• How should the bid prices be set?How should the bid prices be set?

• What is the bidding strategy? Is it What is the bidding strategy? Is it ethical?ethical?

2929

Project ProposalProject ProposalContentsContents

• Executive SummaryExecutive Summary

• Cover LetterCover Letter

• Nature of the technical problemNature of the technical problem

• Plan for Implementation of ProjectPlan for Implementation of Project

• Plan for Logistic Support & Administration of the Plan for Logistic Support & Administration of the projectproject

• Description of group proposing to do the workDescription of group proposing to do the work

• Any relevant past experience that can be appliedAny relevant past experience that can be applied

3030

Project Selection Evaluation Project Selection Evaluation FactorsFactors• ProductionProduction

– Interruptions, learning, processInterruptions, learning, process

• MarketingMarketing– Customer management issuesCustomer management issues

• FinancialFinancial– Return on investmentReturn on investment

• PersonnelPersonnel– Skills and training, working conditions Project Skills and training, working conditions Project

SelectionSelection

• AdministrativeAdministrative– Regulatory standards, strategic fitRegulatory standards, strategic fit