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Part I

Project Initiation

Copyright 2012 John Wiley & Sons, Inc.

Project Management

2-2

Chapter 2
Strategic
Management and
Project Selection

Copyright 2012 John Wiley & Sons, Inc.

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

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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 measure
Most 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

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

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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


companys 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

Project Cost
Payback Period
Annual Cash Flow
$100,000
Payback Period
4
$25,000
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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 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
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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) A0
t 1

Ft

1 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 life
A higher NPV is better
Higher the discount rate lower the NPV
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NPV Example
8

$25,000
NPV (project) $100,000
t
t 1 1 0.15 0.03
$1,939

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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 IRRs, 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 ratio


NPV divided by initial cash investment
Ratios 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

01 factor model
Unweighted factor model
Weighted factor model

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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
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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

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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

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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 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
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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

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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 longterm returns
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Project Portfolio Process 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 the projects to be funded and held in
reserve
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
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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 data
Document assumptions
Screen out weaker projects
The 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 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

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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

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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

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
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Project Proposal Contents


Cover

letter
Executive summary
The technical approach
The implementation plan
The plan for logistic support and
administration
Past experience
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