Project portfolio management

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Project Portfolio Management (PPM) is a term used by project managers and project management (PM)

organizations to describe methods for analyzing and collectively managing a group of current or proposed
projects based on numerous key characteristics. The fundamental objective of PPM is to determine the optimal
mix and sequencing of proposed projects to best achieve the organization's overall goals - typically expressed
in terms of hard economic measures, business strategy goals, or technical strategy goals - while honoring
constraints imposed by management or external real-world factors. Typical attributes of projects being
analyzed in a PPM process include each project's total expected cost, consumption of scarce resources
(human or otherwise) expected timeline and schedule of investment, expected nature, magnitude and timing of
benefits to be realized, and relationship or inter-dependencies with other projects in the portfolio.

The key challenge to implementing an effective PPM process is typically securing the mandate to do so. Many
organizations are culturally inured to an informal method of making project investment decisions, which can be
compared to political processes observable in the U.S. legislature. [citation needed] However this approach to making
project investment decisions has led many organizations to unsatisfactory results, and created demand for a
more methodical and transparent decision making process. That demand has in turn created a commercial
marketplace for tools and systems which facilitate such a process.

Some commercial vendors of PPM software emphasize their products' ability to treat projects as part of an
overall investment portfolio. PPM advocates see it as a shift away from one-off, ad hoc approaches to project
investment decision making. Most PPM tools and methods attempt to establish a set of values, techniques and
technologies that enable visibility, standardization, measurement and process improvement. PPM tools attempt
to enable organizations to manage the continuous flow of projects from concept to completion.

Treating a set of projects as a portfolio would be, in most cases, an improvement on the ad hoc, one-off
analysis of individual project proposals. The relationship between PPM techniques and existing investment
analysis methods is a matter of debate. While many are represented as "rigorous" and "quantitative", few PPM
tools attempt to incorporate established financial portfolio optimization methods like modern portfolio
theory or Applied Information Economics, which have been applied to project portfolios, including even non-
financial issues.[1][2][3][4]

Contents
 [hide]

1 Controversy over the "investment discipline" of

 PPM

2 Optimizing for payoff

3 Resource allocation

4 Pipeline management

5 Organizational applicability

6 References

7 Further reading

8 See also

[edit]Controversy over the "investment discipline" of PPM

Developers of PPM tools see their solutions as borrowing from the financial investment world. However, other
than using the word "portfolio", few can point to any specific portfolio optimization methods implemented in their
tools.

A project can be viewed as a composite of resource investments such as skilled labour and associated
salaries, IT hardware and software, and the opportunity cost of deferring other project work. As project
resources are constrained, business management can derive greatest value by allocating these resources
towards project work that is objectively and relatively determined to meet business objectives more so than
other project opportunities. Thus, the decision to invest in a project can be made based upon criteria that
measures the relative benefits (eg. supporting business objectives) and its relative costs and risks to the
organization.

In principle, PPM attempts to address issues of resource allocation, e.g., money, time, people, capacity, etc. In
order for it to truly borrow concepts from the financial investment world, the portfolio of projects and hence the
PPM movement should be grounded in some financial objective such as increasing shareholder value, top line
growth, etc. Equally important, risks must be computed in a statistically, actuarially meaningful sense.
Optimizing resources and projects without these in mind fails to consider the most important resource any
organization has and which is easily understood by people throughout the organization whether they be IT,
finance, marketing, etc and that resource is money.

While being tied largely to IT and fairly synonymous with IT portfolio management, PPM is ultimately a subset
of corporate portfolio management and should be exportable/utilized by any group selecting and managing
discretionary projects.[citation needed] However, most PPM methods and tools opt for various subjective weighted
scoring methods, not quantitatively rigorous methods based on options theory, modern portfolio theory, Applied
Information Economics or operations research.
Beyond the project investment decision, PPM aims to support ongoing measurement of the project portfolio so
each project can be monitored for its relative contribution to business goals. If a project is either performing
below expectations (cost overruns, benefit erosion) or is no longer highly aligned to business objectives (which
change with natural market and statutory evolution), management can choose to decommit from a project and
redirect its resources elsewhere. This analysis, done periodically, will "refresh" the portfolio to better align with
current states and needs.

Historically, many organizations were criticized for focusing on "doing the wrong things well." PPM attempts to
focus on a fundamental question: "Should we be doing this project or this portfolio of projects at all?" One
litmus test for PPM success is to ask "Have you ever canceled a project that was on time and on budget?" With
a true PPM approach in place, it is much more likely that the answer is "yes." As goals change so should the
portfolio mix of what projects are funded or not funded no matter where they are in their individual lifecycles.
Making these portfolio level business investment decisions allows the organization to free up resources, even
those on what were before considered "successful" projects, to then work on what is really important to the
organization.

[edit]Optimizing for payoff

One method PPM tools or consultants might use is the use of decision trees with decision nodes that allow for
multiple options and optimize against a constraint. The organization in the following example has options for 7
projects but the portfolio budget is limited to $10,000,000. The selection made are the projects 1, 3, 6 and 7
with a total investment of $7,740,000 - the optimum under these conditions. The portfolio's payoff is
$2,710,000.
Presumably, all other combinations of projects would either exceed the budget or yield a lower payoff.
However, this is an extremely simplified representation of risk and is unlikely to be realistic. Risk is usually a
major differentiator among projects but it is difficult to quantify risk in a statistically and actuarially meaningful
manner (with probability theory, Monte Carlo Method, statistical analysis, etc.). This places limits on the
deterministic nature of the results of a tool such as a decision tree (as predicted by modern portfolio theory).

[edit]Resource allocation

Resource allocation is a critical component of PPM. Once it is determined that one or many projects meet
defined objectives, the available resources of an organization must be evaluated for its ability to meet project
demand (aka as a demand "pipeline" discussed below). Effective resource allocation typically requires an
understanding of existing labor or funding resource commitments (in either business operations or other
projects) as well as the skills available in the resource pool. Project investment should only be made in projects
where the necessary resources are available during a specified period of time.
Resources may be subject to physical constraints. For example, IT hardware may not be readily available to
support technology changes associated with ideal implementation timeframe for a project. Thus, a holistic
understanding of all project resources and their availability must be conjoined with the decision to make initial
investment or else projects may encounter substantial risk during their lifecycle when unplanned resource
constraints arise to delay achieving project objectives.

Beyond the project investment decision, PPM involves ongoing analysis of the project portfolio so each
investment can be monitored for its relative contribution to business goals versus other portfolio investments. If
a project is either performing below expectations (cost overruns, benefit erosion) or is no longer aligned to
business objectives (which change with natural market and statutory evolution), management can choose to
decommit from a project to stem further investment and redirect resources towards other projects that better fit
business objectives. This analysis can typically be performed on a periodic basis (eg. quarterly or semi-
annually) to "refresh" the portfolio for optimal business performance. In this way both new and existing projects
are continually monitored for their contributions to overall portfolio health. If PPM is applied in this manner,
management can more clearly and transparently demonstrate its effectiveness to its shareholders or owners.

Implementing PPM at the enterprise level faces a challenge in gaining enterprise support because investment
decision criteria and weights must be agreed to by the key stakeholders of the organization, each of whom may
be incentivised to meet specific goals that may not necessarily align with those of the entire organization. But if
enterprise business objectives can be manifested in and aligned with the objectives of its distinct business unit
sub-organizations, portfolio criteria agreement can be achieved more easily. (Assadourian 2005)

From a requirements management perspective Project Portfolio Management can be viewed as the upper-most
level of business requirements management in the company, seeking to understand the business requirements
of the company and what portfolio of projects should be undertaken to achieve them. It is through portfolio
management that each individual project should receive its allotted business requirements (Denney 2005).

[edit]Pipeline management

In addition to managing the mix of projects in a company, Project Portfolio Management must also determine
whether (and how) a set of projects in the portfolio can be executed by a company in a specified time, given
finite development resources in the company. This is called pipeline management. Fundamental to pipeline
management is the ability to measure the planned allocation of development resources according to some
strategic plan. To do this, a company must be able to estimate the effort planned for each project in the
portfolio, and then roll the results up by one or more strategic project types e.g., effort planned for research
projects. (Cooper et al. 1998); (Denney 2005) discusses project portfolio and pipeline management in the
context of use case driven development.

[edit]Organizational applicability
The complexity of PPM and other approaches to IT projects (e.g., treating them as a capital investment) may
render them not suitable for smaller or younger organizations. An obvious reason for this is that a few IT
projects doesn't make for much of a portfolio selection. Other reasons include the cost of doing PPM—the data
collection, the analysis, the documentation, the education, and the change to decision-making processes.

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1 & 2. Exposure and Risk:

Exposure is a measure of the sensitivity of the value of a financial item (asset, liability or
cash flow) to changes in the relevant risk factor while risk is a measure of variability of the
value of the item attributable to the risk factor. Let us understand this distinction clearly.
April 1993 to about July 1995 the exchange rate between rupee and US dollar was almost
rock steady. Consider a firm whose business involved both exports to and imports from the
US. During this period the firm would have readily agreed that its operating cash flows were
very sensitive to the rupee-dollar exchange rate, i.e.; it had significant exposure to this
exchange rate; at the same time it would have said that it didn’t perceive significant risk on
this account because given the stability of the rupee-dollar fluctuations would have been
perceived to be minimal. Thus, the magnitude of the risk is determined by the magnitude of
the exposure and the degree of variability in the relevant risk factor.

3. Hedging:

Hedging means a transaction undertaken specifically to offset some exposure arising out of
the firm’s usual operations. In other words, a transaction that reduces the price risk of an
underlying security or commodity position by making the appropriate offsetting derivative
transaction.

In hedging a firm tries to reduce the uncertainty of cash flows arising out of the exchange
rate fluctuations. With the help of this a firm makes its cash flows certain by using the
derivative markets.

4. Speculation:

Speculation means a deliberate creation of a position for the express purpose of generating
a profit from fluctuation in that particular market, accepting the added risk. A decision not
to hedge an exposure arising out of operations is also equivalent to speculation.
Opposite to hedging, in speculation a firm does not take two opposite  positions in the any
of the markets. They keep their positions open.

5. Call Option:

A call option gives the buyer the right, but not the obligation, to buy the underlying
instrument. Selling a call means that you have sold the right, but not the obligation, to
someone to buy something from you.

6. Put Option:

A put option gives the buyer the right, but not the obligation, to sell the underlying
instrument. Selling a put means that you have sold the right, but not the obligation, to
someone to sell something to you.

7. Strike Price:

The predetermined price upon which the buyer and the seller of an option have agreed is
the strike price, also called the ‘exercise price’ or the striking price. Each option on an
underlying instrument shall have multiple strike prices.

8. Currency Swaps:

In a currency swap, the two payment streams being exchanged are denominated in two
different currencies. Usually, an exchange of principal amount at the beginning and a re-
exchange at termination are also a feature of a currency swap.

A typical fixed-to-fixed currency swaps work as follows. One party raises a fixed rate liability
in currency X say US dollars while the other raises fixed rate funding in currency Y say DEM.
The principal amounts are equivalent at the current market rate of exchange. At the
initiation of the swap contract, the principal amounts are exchanged with the first party
getting DEM and the second party getting dollars. Subsequently, the first party makes
periodic DEM payments to the second, computed as interest at a fixed rate on the DEM
principal while it receives from the second party payment in dollars again computed as
interest on the dollar principal.  At maturity, the dollar and DEM principals are re-
exchanged.

A floating-to-floating currency swap will have both payments at floating rate but in different
currencies. Contracts without the exchange and re-exchange do exist. In most cases, an
intermediary- a swap bank- structures the deal and routes the payments from one party to
another.

A fixed-to-floating currency swap is a combination of a fixed-to-fixed currency swaps and a

fixed-to-floating interest rate swap. Here, one payment stream is at a fixed rate in currency
X while the other is at a floating rate in currency Y.
9. Futures

Futures are exchanged traded contracts to sell or buy financial instruments or physical
commodities for future delivery at an agreed price. There is an agreement to buy or sell a
specified quantity of financial instrument/commodity in a designated future month at a price
agreed upon by the buyer and seller. The contracts have certain standardized specification.

10. Transaction Exposure

This is a measure of the sensitivity of the home currency value of the assets and liabilities,
which are denominated, in the foreign currency, to unanticipated changes in the exchange
rates, when the assets or liabilities are liquidated. The foreign currency values of these
items are contractually fixed, i.e.; do not vary with exchange rate. It is also known as
contractual exposure.

Some typical situations, which give rise to transactions exposure, are:

(a)  A currency has to be converted in order to make or receive payment for goods and
services;

(b)  A currency has to be converted to repay a loan or make an interest payment; or

(c)  A currency has to be converted to make a dividend payment, royalty payment, etc.

Note that in each case, the foreign value of the item is fixed; the uncertainty pertains to the
home currency value. The important points to be noted are (1) transaction exposures
usually have short time horizons and (2) operating cash flows are affected.

11. Translation Exposure

Also called Balance Sheet Exposure, it is the exposure on assets and liabilities appearing in
the balance sheet but which is not going to be liquidated in the foreseeable future.
Translation risk is the related measure of variability.

The key difference is the transaction and the translation exposure is that the former has
impact on cash flows while the later has no direct effect on cash flows. (This is true only if
there are no tax effects arising out of translation gains and losses.)

Translation exposure typically arises when a parent multinational company is required to

consolidate a foreign subsidiary’s statements from its functional currency into the parent’s
home currency. Thus suppose an Indian company has a UK subsidiary. At the beginning of
the parent’s financial year the subsidiary has real estate, inventories and cash valued at,
1000000, 200000 and 150000 pound respectively. The spot rate is Rs. 52 per pound
sterling by the close of the financial year these have changed to 950000 pounds, 205000
pounds and 160000 pounds respectively. However during the year there has been a drastic
depreciation of pound to Rs. 47. If the parent is required to translate the subsidiary’s
balance sheet from pound sterling to Rupees at the current exchange rate, it has suffered a
translation loss. The translation value of its assets has declined from Rs. 70200000 to Rs.
61805000. Note that no cash movement is involved since the subsidiary is not to be
liquidated. Also note that there must have been a translation gain on subsidiary’s liabilities,
ex. Debt denominated pound sterling.

12. Contingent Exposure

The principle focus is on the items which will have the impact on the cash flows of the firm
and whose values are not contractually fixed in foreign currency terms. Contingent exposure
has a much shorter time horizon. Typical situation giving rises to such exposures are

1. An export and import deal is being negotiated and quantities and prices are yet not
to be finalized. Fluctuations in the exchange rate will probably influence both and
then it will be converted into transactions exposure.
2. The firm has submitted a tender bid on an equipment supply contract. If the contract
is awarded, transactions exposure will arise.
3. A firm imports a product from abroad and sells it in the domestic market. Supplies
from abroad are received continuously but for marketing reasons the firm publishes
a home currency price list which holds good for six months while home currency
revenues may be more or less certain, costs measured in home currency are
exposed to currency fluctuations.

In all the cases currency movements will affect future cash flows.

13. Competitive exposure

Competitive exposure is the most crucial dimensions of the currency exposure. Its time
horizon is longer than of transactional exposure – say around three years and the focus is
on the future cash flows and hence on long run survival and value of the firm. Consider a
firm, which is involved in producing goods for exports and /or imports substitutes. It may
also import a part of its raw materials, components etc. a change in exchange rate gives
rise to no. of concerns for such a firm, example,

1. What will be the effect on sales volumes if prices are maintained? If prices are
changed? Should prices be changed? For instance a firm exporting to a foreign
market might benefit from reducing its foreign currency priced to foreign customers.
Following an appreciation of foreign currency, a firm, which produces import
substitutes, may contemplate in its domestic currency price to its domestic
customers without hurting its sales. A firm supplying inputs to its customers who in
 turn are exporters will find that the demand for its product is sensitive to exchange
rates.
2. Since a part of inputs are imported material cost will increase following a
depreciation of the home currency. Even if all inputs are locally purchased, if their
production requires imported inputs the firms material cost will be affected following
a change in exchange rate.
3. Labour cost may also increase if cost of living increases and the wages have to be
raised.
4. Interest cost on working capital may rise if in response to depreciation the
authorities resort to monetary tightening.
5. Exchange rate changes are usually accompanied by if not caused by difference in
inflation across countries. Domestic inflation will increase the firm’s material and
labour cost quite independently of exchange rate changes. This will affect its
competitiveness in all the markets but particularly so in markets where it is
competing with firms of other countries
6. Real exchange rate changes also alter income distribution across countries. The real
appreciation of the US dollar vis-à-vis deutsche mark implies and increases in real
incomes of US residents and a fall in real incomes of Germans. For an American firm,
which sells both at home, exports to Germany, the net impact depends upon the
relative income elasticities in addition to any effect to relative price changes.

Thus, the total impact of a real exchange rate change on a firm’s sales, costs and margins
depends upon the response of consumers, suppliers, competitors and the government to
this macroeconomic shock.

In general, an exchange rate change will effect both future revenues as well as operating
costs and hence exchange rates changes, relative inflation rates at home and abroad,
extent of competition in the product and input markets, currency composition of the firm’s
costs as compared to its competitors’ costs, price elasticities of export and import demand
and supply and so forth.