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Chapter 2

Strategic Management and


Project Selection

Copyright 2009 John Wiley & Sons, Inc.

Rapid adoption of project management


means
There

are many projects that fall outside the


organizations stated mission;
There are many projects with funding levels
that are completely unrelated to the strategy
and goals of the organization; and
There are many projects with funding levels
that are excessive relative to their expected
benefits.

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

2.1 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

PMBOK knowledge areas to assess


the PM maturity
Integration
Scope
Time
Cost
Quality

Human

resources
Communication
Risk and
Procurement

Process or lifecycle used to measure


PMM
Initiating
Planning
Executing
Controlling
Closing

and
Project-driven organizational
environment

Five Levels of PMM


Ad-hoc
Planned
Managed
Integrated
Sustained

2.2 Project Selection


Meaning:

Project selection is the


process
of
evaluating
individual
projects or groups of projects and
choosing to implement some set of
them so that the objectives of the
parent organization will be achieved.

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

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

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

(Continued)

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

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 firms projects should
be centrally maintained

2.3 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

Different Factors Affecting


Outcome
Many

factors affect the outcome of a project

Some are one-time factors


The

cost of an item

Others are reoccurring


Maintenance

Not

all factors are equally important


Critical factors on one project may be trivial
on another project

Project Evaluation Factors

Production factors

Time until ready to install


Length of disruption during
installation
Learning curve
Effects on wastes and
rejects
Energy requirements
Facility and other
equipment requirements

Safety of process
Other applications of
technology
Change in cost to produce
a unit output
Change in raw materials
usage
Availability of raw materials
Required development time
and cost
Impact on current suppliers
Changes in quality of output

Marketing factors
Size

of potential
market for output
Probable
market
share of output
Time until market
share is acquired
Impact on current
product line

Consumer

acceptance
Impact on consumer
safety
Estimated
life of
output
Spin-off
project
possibilities

Financial Factors
Profitability,

net
present values of
investment
Impact on cash
flows
Payout period
Cash requirements

Time

until break-

even
Size of investment
required
Impact on seasonal
and cyclical
fluctuations

Personnel Factors
Training

requirements
Labor skill
requirements
Availability of
required labor skills
Level of resistance
from current work
force.

Change in size of labor


force
Inter and intra-group
communication
requirements
Impact on working
conditions

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

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.

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.

Types of Nonnumeric Models


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

Continued

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

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


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

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]


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)

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

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

2.5 Analysis Under UncertaintyThe


Management of Risk
Everything

to do with projects is risky


Some projects, like R&D, are more risky than
others, like construction
Risks include

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)

2.6 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

2.7 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


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
Organizations

goals
Have competence
Market for offering
How risky
Potential partner
Right resources
Good fit

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

2.8 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

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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