Project ManagementA Managerial Approach

Project ManagementA Managerial ApproachChapter 2

Project Selection

Project Selection Procedure: A Cross- Industry SamplerHoechst AG, a pharma firm uses a scoring portfolio model with 119 questions in five major categories i.e: business strategy fit, probability of technical success, commercial success, strategic leverage and reward to the company. Within each of these factors there are specific questions which are scored on a 1-10 by the management.The Royal Bank of Canada uses the foll criteria for portfolio scoring: Project importance( strategic importance, magnitude of impact and economic benefits) ease of doing (cost of development, project complexity and resource availability) Expected annual expenditure and total project spending are then added to this rank ordered list to prioritize project options.

Project SelectionProject selection is the process of evaluating individual projects or groups of projects, and then choosing to implement some set of them so that the objectives of the parent organization will be achievedManagers often use decision-aiding models to extract the relevant issues of a problem from the details in which the problem is embeddedModels represent the problems structure and can be useful in selecting and evaluating projects

Criteria for Project Selection Models (Souder)Realism - reality of managers decisionCapability- able to simulate different scenarios and optimize the decisionFlexibility - provide valid results within the range of conditionsEase of Use - reasonably convenient, easy execution, and easily understoodCost - Data gathering and modeling costs should be low relative to the cost of the projectEasy Computerization - must be easy and convenient to gather, store and manipulate data in the model

Key issues in Project analysisMarket analysisProduction Factors /Technical analysisFinancial analysisEconomic analysisEcological analysisPersonnel factors

Marketing Factors Size of potential market for outputProbable market share of outputTime until market share is acquiredImpact on current product lineConsumer acceptanceImpact on consumer safetyEstimated life of outputSpin-off project possibilities

Production factors Time until ready to installLength of disruption during installationLearning curve-time until operating as desired.Effects on waste & rejectsEnergy requirementsFacility & other equipment requirementsSafety of processOther applications of technologyChanges in cost to produce a unit output

PRODUCTION FACTORS (contd.)Change in raw material usageAvailability of raw materialsRequired development time & costImpact on current suppliersChange in quality of output

Financial Factors ProfitabilityImpact on cash flowsPayout periodIn entrepreneurship, a period of time in which cash flow is negative. This especially applies to an early part of a company's history before it has recovered start up costs and operating expenses. Cash requirementsTime until break-evenSize of investment requiredImpact on seasonal &cyclic fluctuations

Personnel factorsTraining requirementsLabour skill requirementsAvailability of required labour skillLevel of resistance from current work forceChange in size of labour forceInter & intra group communication requirementsImpact on working conditions

Administrative & Miscellaneous factors

Meet govt. safety,environmental standardsImpact on information systemReaction of stock holders & securities marketPatent & trade secret protectionImpact of image with customers, suppliers & competitorsDegree to which we understand new technologyManagerial capacity to direct & control new process

Nature of Project Selection Models2 Basic Types of ModelsNumericNonnumericTwo Critical Facts:Models do not make decisions - People do!All models, however sophisticated, are only partial representations of the reality the are meant to reflect

Nonnumeric ModelsSacred Cow - project is suggested by a senior and powerful official in the organizationOperating Necessity - the project is required to keep the system runningCompetitive Necessity - project is necessary to sustain a competitive positionProduct Line Extension - projects are judged on how they fit with current product line, fill a gap, strengthen a weak link, or extend the line in a new desirable way.Comparative Benefit Model - several projects are considered and the one with the most benefit to the firm is selected

Numeric Models: ScoringUnweighted 0-1 Factor ModelUnweighted Factor Scoring ModelWeighted Factor Scoring ModelConstrained Weighted Factor Scoring ModelGoal Programming with Multiple Objectives

NUMERIC MODELS-SCORING

UNWEIGHTED 0-1 FACTOR MODEL -A set of relevant factors is selected by management & then listed in a preprinted form. One or more raters score the project on each factor, whether or not it qualifies for an individual criterion.

Project________Rater_________Date__________

QualifyDoes not qualifyPotential market size*Time to break-even less than 3 years*No quality compromise*Need for external consultants*Impact on work force safety*Estimated annual profits $250,000*Total42

UNWEIGHTED FACTOR SCORING MODEL-the earlier model had the drawback of considering all criteria equally important & involves no gradation of the degree to which a specific project meets the various criteria. This model addresses the second drawback by constructing a simple linear measure of the degree to which the project being evaluated meets each of the criteria contained in the list

Unweighted Factor Scoring model.Eg: Potential market size: Total score should exceed some set critical value

ScorePerformance level5Very goodGrows by 40%4GoodGrows by 25%3FairGrows by 10%2PoorNot affected at all1Very PoorNegatively affected

WEIGHTED FACTOR SCORING MODELNumeric weights reflecting the relative importance of each individual factor are added.It is the sum of products of scores and weights on each criterion.It is also useful for improvement of the project.The weight may be generated by any of the following techniques: Delphi technique (developing numerical values which are equivalent to subjective , verbal measures of relative value.)Analytical hierarchy processSuccessive comparison / pair wise comparisons

ExerciseUse a weighted scoring model to chose an automobile. The performance measures and scores, as also the relative weights of each criterion are shown in the following table.

Performance measures and scores for automobile selection

The criteria and weights for automobile purchase are given below.----------------------------------------------------CriteriaWeightABC D------------------------------------------------------------------------Appearance.13325Braking.071314Comfort.174243Cost, operating.122542Cost, original.24 1432Handling.172215Reliability.123432------------------------------------------------------------------------Develop a weighted scoring model for making an automobile choice.

Scores for automobilesA=2.23B=3.23C=2.68D=3.10B is the best option

Sensitivity analysisA weighted scoring model can also be used for project improvement.For any given criterion, the difference between the criterions score and the highest possible score on that criterion , multiplied by the weight of the criterion , is a measure of the potential improvement in the project score that would result, were the projects performance on the specific criterion sufficiently improved.It may be that such an improvement is not feasible.Such an analysis yields valuable statement of comparative benefits of project improvements.By adding resources we can study the degree to which a projects score is sensitive to attempts for improvement.

CONSTRAINED WEIGHTED FACTOR SCORING MODEL-

Involves constraints representing project characteristics that must be present or absent in order for the project to be acceptable.In is the sum of products of scores and weights on each criterion, multiplied by a value of 1(if the ith project satisfies the kth constraint & 0 if it does not) Other elements in this model are the same as in the previous model . A company may have decided that they would not undertake any project that would significantly lower the quality of the final product.

Profit / profitability Pay back periodAverage Rate of returnDiscounted cash flowInternal rate of returnProfitability Index

Payback periodPayback Period=Initial fixed investment/estimated annual net cash inflowIt is the no. of years required for the project to repay the initial fixed investment.The faster the investment recovered , the less the risk.

Average Rate of ReturnAverage rate of return= Average Annual Profit/initial or avg. investmentDoes not take into account the time value of money.

ExerciseInitial fixed investment=$5,00,000Annual net cash inflow=$1,00,000Average annual profits=$70,000Calculate the payback period & Average Rate of return.

Discounted Cash flow/NPV

Determines the NPV of all cash flows by discounting them by required rate of return.Ft=net cash flow in period tk=required rate of returnI0=Initial cash investment

Internal Rate of Return (IRR)IRR=discount rate that equates the presentvalues of the cash inflows and outflows. IRR is simply the rate of return that the firm earns on its capital budgeting projects.

Profitability indexPresent value of all future expected cash flows divided by initial cash investment.

Question- Consider the following 2 projects- Project AProject BInitial value of investment Rs. 5,00,000 Rs.11,00,000Present value of cash inflowsRs.6,00,000 Rs. 12,50,000NPV Rs.1,00,000 Rs. 1, 50,000Which model will you chose to evaluate the 2 projects. Why?

Solution-Comparing NPV, project B will score high.However, NPV is only an absolute figure.For an investment of 5Lakh, Project A offers NPV of Rs. 1 lakh, whereas for investment of 11 lakh, B offers NPV of 1.5 lakh.In such a situation, PI is a better indicator.PI=PV of cash flow/Initial cash outflow.PI for A=1.200 and PI for B=1.136Since PI of A is more than that of B, A is a better project.

Advantages of Numeric ModelSimple to use and understand.Readily available accounting data to determine cash flow.Direct reflection of managerial policy.Easily altered to accommodate changes in environment or managerial policy.Can assess project risk.Weighted scoring models allow for the fact that some criteria are more important than the others.Allow sensitivity analysis. The tradeoffs between different criteria are readily available.

Disadvantages It ignores qualitative aspectsThe output of a scoring model is strictly a relative measure. Project scores do not represent the value or utility associated with a project and thus do not indicate whether or not the project should be supportedBiased Other limitations of individual profitability models

Risk Versus UncertaintyAnalysis Under Uncertainty - The Management of RiskThe difference between risk and uncertaintyRisk - when the decision maker knows the probability of each and every state of nature and thus each and every outcome. An expected value of each alternative action can be determinedUncertainty - when a decision maker has information that is not complete and therefore cannot determine the expected value of each alternative

Involved at all stages of project managementWhat is risk?an event about which we are uncertain and the possibility of the result is unfavourable.If it is favourable, it turns out to be an opportunity.PROJECT RISK is the cumulative effect of the chances of an uncertain occurrence adversely affecting the project objectives. Or, the degree to which project objectives are exposed to negative events and their probable consequences, as expressed in terms of scope, quality, time & cost.

Risk

Types of risk

1. Project specific risk- the earnings & cash flows of the project may be lower than expected due to an estimation error or lower quality of management 2. Competitive risk -the earnings & cash flows of the project may be effected by some unanticipated actions of the competitors 3. Industry -specific risk-unexpected technological developments & regulatory changes that are specific to the industry to which the project belongs ,will have an impact on the earnings & cash flows of the project as well

.4. Market risk-unanticipated changes in macroeconomic factors like GDP growth rate, interest rate, inflation etc. have an impact on all projects in varying degrees.5. International risk-in case of foreign projects exchange rate risk /political risk may effect cash flows.An evaluation of potential risks can show at an early stage whether or not a proposal is worth pursuing.The risks can be---1) the project will fail completely2) The project will be compromised on time, cost or both.

Comments on the Information Base for SelectionsAccounting DataMeasurementsSubjective vs. ObjectiveQuantitative vs. QualitativeReliable vs. UnreliableValid vs. InvalidTechnological Shock

Project Portfolio ProcessAn 8 step procedure for selecting , implementing and reviewing projects that will help an organization achieve its goals.

Project Portfolio ProcessEstablish a project councilIdentify project categories and criteria Derivative projects-are projects with objectives or deliverables that are only incrementally different in both product and process from existing offerings.Platform projects-The planned outputs of these projects represent major departures from existing offerings in terms of either the product/service itself or the process used to make and deliver it or both.

Breakthrough projects-These projects typically involve a newer technology than platform projects. It may be a disruptive technology that is known to the industry or something proprietary that the organization has been developing over R&D Projects-are visionary endeavors oriented toward using newly developed technologies, or existing technologies in a new manner.

Collect Project DataAssess Resource AvailabilityReduce the project and criteria setPrioritise the projects within categoriesSelect the projects to be funded and held in reserve.Implement the process.

Project ProposalsWhich projects should be bid on?How should the proposal-preparation process be organized and staffed?How much should be spent on preparing proposals for bids?How should the bid prices be set?What is the bidding strategy? Is it ethical?

Project ProposalContentsExecutive SummaryCover LetterNature of the technical problemPlan for Implementation of ProjectPlan for Logistic Support & Administration of the projectDescription of group proposing to do the workAny relevant past experience that can be applied

Discussion In the next 2 years a large municipal company must begin gas storage facilities as per new govt. regulations. The V.P. incharge of the project feels there are 2 options. One-underground deep storage facility (UDSF) and two-Liquified natural gas facility (LNGF). The V.P has developed a project selection model.Option Initial cost Operating cost Exp Life Salvage valueUDSF 10 L $ $.004 20 yrs10%LNGF 25L$ $.002 15 yrs5Use Souders criteria to evaluate this model.(Realism, Capability, flexibility, ease of use, cost, computerization)

Discussion In the next 2 years a large municipal company must begin gas storage facilities as per new govt. regulations. The V.P. incharge of the project feels there are 2 options. One-underground deep storage facility (UDSF) and two-Liquified natural gas facility (LNGF). The V.P has developed a project selection model.Option Initial cost Operating cost/cu.ft Exp Life Salvage valueUDSF 10 L $ $.004 20 yrs10%LNGF 25L$ $.002 15 yrs5%Use Souders criteria to evaluate this model.(Realism, Capability, flexibility, ease of use, cost, computerization)