Download Strategic Management and Project Selection

Chapter 2
Strategic Management and
Project Selection
Copyright 2009 John Wiley & Sons, Inc.
Problems With Multiple Projects
1.
2.
3.
Delays in one project delays others
Inefficient use of resources
Bottlenecks in resource availability
Project Results
30 Percent late
 Over half 190 percent over budget
 Over half 220 percent late

Challenges
Making sure projects closely tied to
goals and strategy
 How to handle growing number of
projects
 How to make projects successful

Project Management Maturity
Project management maturity refers to
mastery of skills required to manage
project competently
 Number of ways to measure
 Most organizations do not do well

Project Selection and Criteria of
Choice

Project selection…
–
–
–

Evaluating
Choosing
Implementing
Same process as other business
decisions
Types of Companies

Companies considering projects fall into
two broad categories:
1.
2.

Companies whose core business is completing
projects
Companies whose core business is something
else
They can also be broken down as:
1.
2.
Companies looking at projects to do for others
Companies looking at projects to do for
themselves
Project Companies


Must select which projects they will bid on
Generally based on…
–
–
–
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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
Non-Project Companies
Must decide which potential projects
they will pursue
 Available capital is the major constraint
 Profitability is often the major criteria
 Must evaluate approaches when there
is more than one project that can
accomplish a goal

Models
Models are used to select projects
 All models simplify reality
 That is, they only look at the key
variables involved in a decision
 The more variables included in a
model, the more complex it becomes
 Simpler models usually work better

Types of Models

Stochastic 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. Also known as a probabilistic
model.
Deterministic Model
–
A model that does not include probabilities. Given
the same inputs, the outputs will always be the
same.
Criteria For Project Selection
Models

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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
Criteria


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Companies need a way of weeding out the
bad projects while keeping the good ones
No model can predict with absolute certainty
No model could predict
–
–

(Continued)
The Exxon Valdez wreck
The explosion of the Challenger
What we want is a model with a “good batting
average”
Model Criteria
Realism
 Capability
 Flexibility
 Easy to use
 Inexpensive
 Easy to implement

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
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
Flexibility
Needs to be able to work with all
projects
 Needs to be updated as the firm and its
environment evolves

Easy to Use
Needs to be quick to gather the data
and easy to use
 Easy to be able to “fit” the project in the
model

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

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

The Nature of Project Selection Models
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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
Different Factors Affecting
Outcome

Many factors affect the outcome of a project
–
Some are one-time factors

–
Others are reoccurring

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The cost of an item
Maintenance
Not all factors are equally important
Critical factors on one project may be trivial
on another project
Types of Project Selection Models
Nonnumeric models
 Numeric models

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”

Types of Nonnumeric Models

Sacred Cow
–

Operating Necessity
–

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.”
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.
Types of Nonnumeric Models

Product Line Extension
–

Continued
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.
Numeric Models


Models that return a numeric value for
a project that can be easily compared
with other projects
Two major categories:
1.
2.
Profit/profitability
Scoring
Profit/Profitability Models

Models that look at costs and revenues
–
–
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
Payback period
Discounted cash flow (NPV)
Internal rate of return (IRR)
Profitability index
NPV and IRR are the more common
Payback Period
The length of time until the original
investment has been recouped by the
project
 A shorter payback period is better

Payback Period Example
Project Cost
Payback Period 
Annual Cash Flow
$100,000
Payback Period 
4
$25,000
Payback Period Drawbacks
1.
2.
3.
Does not consider time value of
money
More difficult to use when cash flows
change over time
Less meaningful over longer periods
of time (due to time value of money)
Discounted Cash Flow

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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
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 know as
a hurdle rate or cutoff rate
 There will usually be one overall
discount rate for the company

NPV Formula
Ft
NPV (project)  A0  t 1
t
1  k 
n
NPV Formula Terms
A0 Initial cash investment
Ft The 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
The higher the discount rate, the lower the
NPV
NPV Example
8
$25,000
NPV (project)  $100,000  
t
t 1 1  0.15  0.03
 $1,939
Internal Rate of Return [IRR]
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The discount rate (k) that causes the NPV to
be equal to zero
The higher the IRR, the better
–
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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)”
Profitability Index
a.k.a. Benefit cost ratio
 NPV divided by initial cash investment
 Ratios greater than 1.0 are good

Advantages of Profitability Models
Easy to use and understand
 Based on accounting data and
forecasts
 Familiar and well understood
 Give a go/no-go indication
 Can be modified to include risk

Disadvantages of Profitability
Models
Ignore non-monetary factors
 Some ignore time value of money
 Discounting models (NPV, IRR) are
biased to the short-term
 Payback models ignore cash flow after
payback

Scoring Models
Unweighted factor model
 Weighted factor model

Unweighted 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

Unweighted Factor Model Example
Figure 2-2
Weighted Factor Model

Each factor is weighted relative to its
importance
–
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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
Weighted Factor Model Example
Figure B
Analysis Under Uncertainty—The
Management of Risk

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Everything to do with projects is risky
Some projects, like R&D, are more risky than
others, like construction
Risks include…
–
–
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The timing of the project and its associated cash
flow
Risk regarding the outcome of the project
Risk about the side effects
Risk and Uncertainty
What the decision maker does
 What nature does

Uncertainty
1.
2.
3.
Pro forma financial statements
Risk analysis
Simulation (requires detailed
probability information)
Comments on the Information Base for
Selection
1.
2.
3.
Accounting data
Measurements
Uncertain information
Accounting Data
1.
2.
3.
Cost and revenue are linear
Cost-revenue data derived using
standard cost standardized revenue
assumptions
Costs may include overhead
Measurements
1.
2.
3.
4.
Subjective versus objective
Quantitative versus qualitative
Reliable versus unreliable
Valid versus invalid
Uncertain Information
Must estimate inputs for risk analysis
 These inputs cannot be known exactly
 Inputs must be adjusted over time

Project Portfolio Process (PPP)
Links projects directly to the goals and
strategy of the organization
 Means for monitoring and controlling
projects

PPP Steps
1.
2.
3.
4.
5.
6.
7.
8.
Establish a project council
Identify project categories and criteria
Collect project data
Assess resource availability
Reduce the project and criteria set
Prioritize the projects within categories
Select projects to be funded and held in reserve
Implement the process
Step 1: Establish a Project Council
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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
Step 2: Identify Project Categories and
Criteria
1.
2.
3.
4.
Derivate projects
Platform projects
Breakthrough projects
R&D projects
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

Step 4: Assess Resource Availability
Assess both internal and external
resources
 Assess labor conservatively
 Timing is particularly important

Step 5: Reduce the Project and Criteria
Set
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Organization’s goals
Have competence
Market for offering
How risky
Potential partner
Right resources
Good fit
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Use strengths
Synergistic
Dominated by
another
Has slipped in
desirability
Step 6: Prioritize the Projects Within
Categories
Apply the scores and criterion weights
 Consider in terms of benefits first,
resource costs second
 Summarize the returns from the
projects

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

Step 8: Implement the Process
Communicate results
 Repeat regularly
 Improve process

Project Proposals
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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
Project Proposal Contents
Cover letter
 Executive summary
 The technical approach
 The implementation plan
 The plan for logistic support and
administration
 Past experience
