2023

PROJECT
MANAGEMENT
COURSE FOR ROLE BASED CERTIFICATION FOR SBI
ENGINEERS AND FIRE OFFICERS

National Productivity Council

(Under DPIIT, Ministry of Commerce & Industry)
SB-96, Bapu Nagar, JLN Marg, Jaipur – 302015
Phone: 0141-2702935, 2703573
Email: [email protected]
Web: www.npcindia.gov.in
Table of Contents

Definition, Concepts and Phases ............................................................... 3

Project Feasibility & Appraisal................................................................. 10
Project Approval – Key Criteria ............................................................... 16
Network Techniques – PERT/CPM ........................................................... 21
PERT/CPM Applications .......................................................................... 31
Clean Sheet Capital Redesign (CSCR) ....................................................... 45
ZOPP (Objectives Oriented Project Planning) .......................................... 53
Theory of Constraints .............................................................................. 60

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 PROJECT MANAGEMENT - DEFINITION, CONCEPTS AND PHASES

What is Project Management? also try to find out if changes in the project
environment had required us to change our
Project Management is often described as the objectives and whether we had reacted to this
process of planning and directing a project from promptly and wisely. Thus we see that good
its inception to its completion and in a given time project management requires alternatives in
at a given cost for a given product. This simplistic detecting unexpected situations, ability to find
definition ignores a few very important points. good solutions to problems that have occurred,
The following paragraphs explain why. and foresight to re-plan under the changed
circumstances.
First of all the time and cost estimates of a
project are based on assumptions taken at the So far we have been talking about processes
time of making the estimates. The actual time (ways of doing things), technical problems, and
schedule and the costs incurred will always vary how to solve them. A project also requires human
from forecast values. It is, therefore, unrealistic to inputs and has human problems, and these
expect a project to be completed exactly as problems may be even more difficult to solve
planned. Time, cost, the project scope and than technical ones. No project can be successful
project objectives may frequently be traded off without the people motivated to work towards its
against each other. For example, time and cost objectives. Project Management must, therefore,
may be saved at the expense of the quality and be able to realise and understand the motives
scope of the project, or, if the latter remains and behaviour of all those who have an input to
unchanged, time may be reduced at the expense the project, it must steer the project to its desired
of cost, and vice versa. Thus it is almost objective amidst often conflicting gaols of the
inevitable that the cost, time, quality and scope of various parties involved.
the completed project will differ somewhat from
original estimates. It is also possible that the Having described in general what is required of
original estimates themselves are biased to start project management, we may now try to define
with, thus providing an erroneous base for project management by outlining more
comparison. specifically what it is supposed to do.

If completion time, cost and quality of the end In broad terms project management plans and
product are not reliable measures themselves for directs the process of development of a project to
gauging the efficiency of project management, enable it to reach in the best possible way and
we may ask ourselves how else this can be done. with the best possible result, the intended
The answer to this question will bring us a little objective of the project.
closer to the understanding of what project
management is about. To assess how well a Specific activities of project management as
project has been managed we have to examine outlined in the following chart will show that these
the course of a project's development to find out activities form the dynamic cycle of planning
if we could have detected early any situation, that direction of work according to plan, monitoring
had made us deviate from our original plan, and if achievement and detecting changes in the
we could have come up with solutions that would environment, and feedback for re-planning.
have led us to a better end position. We might

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 PM: Definition, Concepts and Phases

The Cyclic Process of Project Management

PLANNING
Set Objective
Survey Resources
Formulate Strategy

CONTROL EXECUTION
Measure Achievement Allocate Resource
Compare with Goal Guide Execution
Report, Resolve Co-ordinate Efforts
Problems Motivate Staff

When Is Project Management Needed? It must be emphasized, that the nature of the
work involved in project management can be
If project management is intended to serve the vastly different from that of functional operations,
above purposes, it becomes apparent that it will and it is not often possible to find someone who
be needed from the time when the project is first is well versed in both types of work. Thus
conceived. At this point one might question if assigning the responsibility of project
there is a real need to give to a person entrusted management to a functional "operations"
with the management of a project, the title of manager may often backfire. Table on next
Project Manager. The Project Manager is actually paragraph shows some of the difference between
the person in charge of the project management, the nature of the two types of work. Even when a
and as long as he does this he is the project suitable candidate is available he may not be
manager, no matter what his official title may be. able to find sufficient time for his additional
However, it is necessary to ensure that duties, and the performance of one duty may
everybody concerned with the project, including have to be sacrificed for that of the other.
the individual himself, knows that he has the It is usual, however, to assign some of the duties
responsibility and authority to manage the of project management to functional manager
project, and sometimes bestowing a title such as during the early stages of a project (usually the
project manager, project co-ordinator, or project planning stage) when the demand on time for
director helps. project management is not too severe, and the
In many organisations, individuals who have future of the project is less certain. As the project
other functional duties in the organisation develops, appointment of a full time project
manage projects, particularly in the early stages. manager is often justified. The time when this
There is no strict rule against this practice, stage is reached depends on the size and
provided that the candidate: complexity of the project. Such an arrangement
1. knows how to manage the project, and may cause some inconvenience and loss of
2. has sufficient time and energy to manage the efficiency during the changeover period. In
project, while taking care of his other duties. addition, there is the danger that the incumbent
project manager (and his organisation) would fail Any savings from the late hiring of a full time
or refuse to recognise the limit of his capacity and project manager should therefore, be carefully
cause such delay in the changeover as to be weighed against possible losses to the project
detrimental to the project and the organisation. due to lack of proper project management.

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 PM: Definition, Concepts and Phases

Difference in the nature of the activities for

Enterprise Operation & Project Development

Enterprise Operation Project Development

Repetitive One time

Comparatively low resources use rate High resource use rate
Process becomes familiar Each project has different problems
Statistical data available and useful for decision making Statistical data of limited use in project
Work teams well established New people for each project
Errors not too costly High penalty for wrong decisions

factors can affect them so that he can advise

What should a Project Manager Know? decision makers on what action to take.
Because of the complexity of most projects, the
To manage a project effectively a project task of ensuring that all project management
manager must know: functions are carried out well becomes
1. the project and understand its objectives; formidable and almost impossible without
2. the systematic processes for managing systematic organisation of the work. A systematic
projects; and process of project management consists
3. how to get the project to reach its desired essentially of a set of established methods and
objective through people. guide-lines to aid the project manager to plan
logically, to identify problems easily and promptly
Just as a good salesman must know well the and to solve problems rationally. The basic
product he sells, it is essential for a project elements of a systematic process for project
manager to have a through understanding of the management are:
project he manages. This understanding should 1. Planning and scheduling (and re-scheduling)
not be limited only to the physical features of the 1. Executing the plan (allocating work)
project as others have planned it, but should also 1. Monitoring and reporting: Progress (time)
extend to the philosophy of developing the Cost, Value of work done.
project. He should know the answers to such 1. Analyzing the situation, identifying and solving
questions: problems.
• What is the project for? The success of a management process will
• Why is it required? depend not only on its effectiveness but also on
• Who does it serve? how well the people doing the work know about
• How is it justified? it. Process effectiveness refers to the ease of
• How is it going to be used? clarity with which the process can be applied and
The reason is, as previously said, one may not the results achieved. A good process is usually
really want the project exactly as planned. What one which requires the minimum input to achieve
one really wants is the best possible result, and the best possible results. Cooperation from all
this may mean having to modify the project and project workers is essential, and for this to
its objectives during the process of its happen, it is necessary to get everyone in the
development. Although a project manager is not project to be involved in the process as early as
normally authorised to modify project objectives, possible. A key point to keep in mind is that
he should be aware of what and how external people will have to accept the process before
they can or will cooperate in it. Cooperation is of the project so that they will report faithfully and
particular importance in the reporting elements of punctually.
the process. These constitute the important A project manager's problems in managing
information link between project management human resources are considerably different from
and those who are carrying out the project. The those of a functional manager in organisation.
project manager must make sure that he has Apart from a handful of staff who form the project
gained the confidence of all those who work on management team (those who assist him in

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 PM: Definition, Concepts and Phases

running the project management process), the • He wants to be on top of every detail of the
project manager often has no direct authority project;
over those who work on the project. In addition, • He secretly wishes to manage the project
he has to deal with people who do not work himself because of the challenge it offers.
directly on the project but whose support and
sometimes-input are vital to the success of the
project. CONCEPTS OF PROJECT MANAGEMENT

Project Management and the PROJECT

Organisation
A project is the efforts made by an organisation
At all stages a project is intimately connected through a set of activities to achieve a well
with the ongoing organisation to which it belongs. defined goal. A project has a definite beginning,
The project is the instrument through which an ending and cost. Besides, it is generally, but not
organisation attempts to reach its long-term necessarily always, a one-time effort. A project
objectives. The success or failure of a project could be the commissioning of a new telephone
therefore has an important impact on the future of exchange or a transmission system, the
the organisation, for this reason project development of a new product the performing of
management, which is responsible for developing open heart surgery, the major overhauling of a
the project should work hand in hand with the giant production plant or for that matter any major
general management of ongoing operations. task.
An organisation's chief executive (sometimes an
executive committee) is in effect the Chief Project PROJECT MANAGEMENT
Manager, for he is ultimately responsible for the
success or failure of the project and its impact on Whatever the project be, the Management will
the entire organisation. He may delegate some of have to take the right decisions at various stages
the responsibilities pertaining to particular during the course of execution of a project so that
projects to persons whom we call project all the available resources are utilised to the
managers, much in the same way as operational utmost advantage resulting in optimum efficiency
responsibilities are delegated to functional or in terms of cost, time, quality and quantity in
divisional managers. The extent of this delegation achieving the objectives. This necessitates a
whether broad or restrictive, depends very much scientific method of approach to Project
on the chief executive's style of management. In Management, which will have to be done by
any case the chief executive must recognise that taking decisions of three distinct natures of
some project management responsibility still planning, execution and control. Every project
remains with him, and must therefore plan his has to be planned well in advance and all the
work schedule accordingly. It follows that by eventualities must be foreseen. At this stage right
allowing a project manager to share more decisions will enable the management to be well
responsibility, the chief executive will in fact be equipped if and when the eventualities occur.
lightening his own workload. However, he Further during its execution, right decisions,
sometimes tends to restrict the responsibilities he executive and controlling in nature, will result in
delegates to the Project Manager for the higher productivity. After the project is over it will
following reasons: be worth while to review it so that the many piece
• He lacks a proper understanding of the of valuable information resulting from the review
function of project manager; may be cogently recorded and passed on to the
• He does not have confidence in his project managements of similar future projects. Thus the
manager, who is relatively new in the phrase Project Management in its totality means
organisation; the efficient planning, execution, control and
review of a project undertaken.

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 PM: Definition, Concepts and Phases

SPECIAL FEATURES OF PROJECT At this stage, since we may know the precise
MANAGEMENT financial implication of the project, only an
administrative approval is obtained from the top
Modern concept of Project Management imposes level management. That is, rough estimates
a logical discipline upon decision making. based on past norms and estimates along-with
Therefore it enables the management to feasibility reports are submitted for approval.
programme the various activities logically and While a project is in this phase it should have a
control them effectively. At the planning stage the high degree of flexibility in case of major works
project is broken down into its component so that alternate designs
activities in order to establish the logical of equipments can be introduced to achieve
sequence in which they must be carried out and better economy and performance efficiency.
their interrelationships. By estimating the duration
of each activity the project duration is Definition Phase
determined. This also identifies the critical and
non-critical activities and thus enables the After the conception of the project, the various
Management to decide about the degree of component activities take a definite shape in this
control to be exercised for various activities phase. The same group of people, who worked
during execution. The demand for resources is on the conceptual phase should also work on this
predicted period by period. This helps in the phase for all projects.
better deployment and utilization of resources.
During the execution stage a continuous Objectives of this phase are
comparison is made between what was planned • Finalisation of design of equipment after
and what is happening and corrective actions are detailed consideration.
immediately taken so that the completion date of • Thorough analysis and assessment of
the project is not affected. After the project is financial implications.
completed a review is made to assess the extent • Preparation of Cost Estimates
of deviation from the planning duration and cost • Precise assessment of manpower
and the reasons thereof. These are classified as requirements
controllable and uncontrollable. Therefore, the • Preparation of a detailed plan for the
experience and knowledge thus gained is built up execution of the project (e.g. PERT ing of the
so that it may be used in similar projects to be project).
taken up in future. • The scheme proposals, accompanied by the
PERT NETWORK of the project is submitted
PHASES IN PROJECT MANAGEMENT to the top level management for obtaining
financial sanction. This marks the culmination
Conceptual Phase of the definitive phase.

Based on the demands for, say, additional Organising Phase

telephone lines or microwave channels a project
is conceived, or we might say, conception itself is This phase immediately precedes the execution
the first step in the planning of project. of the project. By the end of this phase the
At this stage a project is considered from three Management is ready in all respects to embark
angles upon the execution of the project.
1. Economic considerations and social needs During this phase
1. Cost benefit ratio • Tenders are floated and contracts awarded
1. Technological considerations • The field staff who are to work on the project
Items (1) and (2) above helps to decide where to are selected and briefed.
have a particular project in case more than one • Site offices set up.
places are considered. Besides, the priorities of From the master network sub-networks are
various projects also can be decided now drawn up. These sub-networks assist in
according to the availability of funds. achieving the best utilization of the available
manpower.

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 PM: Definition, Concepts and Phases

PROJECT MANAGEMENT

CONTROL

MONITORING

PROJECT PLANNING EXECUTION EVALUATION

CONCEPTION

CONCEPTUAL DEFINITION OPERATING EVALUATION

PHASE PHASE PHASE PHASE

ORGANISING
PHASE

Operating Phase • Classify the reasons for deviation as

Controllable and Uncontrollable
Execution and control are the two managerial • Highlight specific difficulties faced by the field
activities in this phase of a project. Control is staff during execution and the corrective
achieved through periodical reviewing and action taken.
applying corrective measures. This phase covers • The controllable reasons are identified and
the execution of the project up to its completion. are made available to the executive of future
The completion report indicates the date of projects.
completion of the project, comparison between
the actual and estimated costs, justification for Thus the Evaluation Report will highlight project
deviations if any, and the value of addition to the experience and will be of great help in the
assets of the department. execution of the future projects and, therefore,
provides a sort of link with future projects for
The evaluation report will sharing the experience and knowledge gained
• Compare the planned and actual expenditure from completed projects.
• Analyse the reasons for deviations

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 PM: Definition, Concepts and Phases

INTEGRATED PROJECT MANAGEMENT CYCLE

Stage or Cycle Major task & Activities

Project identification Identify opportunities for new ventures, Estimate other resources
and definition diversification or expansion of existing
activities Evaluate current assets,
Initially define purpose, objective and resource commitments and
scope of the project. magnitude of external financing.
Establish need for justification for the Identify potential sources of
the project funding
Determine potential profits, returns or Obtain preliminary assessment of
benefits technical & managerial feasibility.
Estimate "order of magnitude" costs Consider appropriate alternative
locations.
Project formulation, Define project objectives and targets Analyse technical, commercial,
preparation and Define Project components and elements economic, financial, locational and
feasibility managerial feasibility
Perform market or demand studies Obtain preliminary review by
Prepare project justification potential funding sources, govt.
Prepare cost, return, borrowing estimates agencies or other sponsors
and preliminary financial plan.
Project Design Identify specific activities, tasks to be Prepare initial production resource
performed input and distribution plans.
Select site for project location Determine labour, managerial and
personal needs.
Prepare blueprints and specifications for Analyse alternative, organisational
equipments and facilities. Arrangements for implementation.
Prepare operating plans, work schedules, Prepare formal operations plans.
life of the project budget
Estimate technological requirements and
make plans for technology acquisition.
Appraisal, selection, Establish credit worthiness Secure govt. clearance & licences,
negotiation & approval Negotiate, Sign loan agreements.
Project activation Establish or define project management Requests bids and tender contracts
and organisation and organisation plans for construction and other work
Clear import licences & export requirements
Recruit and train personnel Set up management production
Arrange for procurement of facilities Establish Marketing & distribution
equipment , supplies and materials channels
Implementation Procure resources, raw materials Establish accounting disbursement
operation and and supplies and payment procedure
control Test and adapt technologies and Create monitoring inventory, control
managerial arrangements programming procedures
Adjust production and distribution Establish repair and maintenance
procedures. procedures.
Completion output Plan for transition to full scale. Establish arrangements for loan
diffusion, transition Production loan close out. repayment
to normal Initiate loan close out. Train & redeploy project personnel.
administration Begin transfer of excess
personnel assets to services users
Project Evaluation Perform audits & post assessments Activate organisation for full scale
and follow up production

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 Project Feasibility & Appraisal

PROJECT - FEASIBILITY & APPRAISAL

Definition study-organisational and managerial study,

estimation of social-economic benefits etc.
A feasibility study is defined as the systematic The management may undertake this by
gathering and analysis of data and the itself, or hire outside consultants and/or do
formulation of conclusion therefrom. Its purpose this jointly. It may even go to government
is to find out whether or not a project is feasible agencies that may assist in some aspects of
and if found feasible, to determine the degree of the study.
profitability/success. 2. Appraisal of the feasibility study to make a
It is significant because it puts down on paper the decision whether to go ahead or not; or to test
pros and cons of a project. It is no guarantee of out the basic hypotheses; or to shelve it
success but it charts significant bench marks for temporarily; or to go into a joint venture or
gaining success. consortium with other groups, local or foreign.
There are many complications in the
Its Uses Are appraisal aspect-depending on who's doing
For the proponents, as (i) basis for selecting a the appraisal and the criteria used. Appraisal
good venture, and (ii) basis for implementing and is evaluation of the feasibility study prior to
long-range planning. execution while evaluation is appraising the
For creditors and investors it is a (i) basis for profit after its implementation. Many people
deciding whether to grant financing, and (ii) basis use the words appraisal and evaluation
for determining the amount and terms of interchangeably but the agreed definition is
financing. For the national economy, it minimizes that appraisal refers to pre-operation review
the risks of failure as well as eliminates a poor and evaluation to post-operation review.
venture.
The major parts of a study are: A good report possesses the following features:
• Engineering and Technical • It is comprehensive; it is total and zeroed on
• Organisational Management and Personnel requirements of project proponent.
• Financial • It is objective; concretely documented, it
• Social Desirability points out pros and cons of project.
• It is simple, non-technical language wherever
I Work of Project Management Prior to feasible.
Full Operation of Project .
II At Full Operational Status
During the pre-operating period, the project
management team is required to oversee the The feasibility study should likewise focus on the
feasibility study and undertake decisions and management, organisational and personnel
executive actions leading upto the full launching structures at full operational status. At this stage,
of the project. a number of issues have to be resolved in the
Specifically, depending on the complexity of the feasibility study. In real life, cutting off a number
project, the project management team is of activities and defining them as strictly pre-
accountable for: operating activities, is not very easy to do and
some times not practical. Often, these activities
1. The feasibility study, including where will slide into each other, either in a sequence or
necessary the studies that lead to the full at parallel levels. Whatever stages they come in,
blown feasibility study such as the concept it is always useful to be fully aware of these
paper or position paper, the pre-feasibility or components theoretically. This enables one to
prima facie study, and the specialised or use the systems approach in going about the
sectoral studies that go into the feasibility management study.

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 Project Feasibility & Appraisal

III Project Management industries or sectors. The management audit will

Organisation Alternatives examine the project objectives, procedures,
delegation of responsibility, the standards and
At the pre-operational stage of a venture, project accomplishment against milestones or objectives
management allows two key options as to incorporated in the project work plan.
organisational alternatives. There is the
projecticized unit in which a task force or IV Focussing On Key Aspects Of
management team with temporary lease of life The Total Feasibility Study
begins the project and sees it through up to
testing and installation then turns it over to a full The project management team should always be
time organisation for its maintenance and on the look-out for key aspects on preparing the
stabilization. At that point, techniques of a project feasibility study such as
management stop and the methods of business
administration for on going concerns take over. 1. Assigning Priorities: Some feasibility research
The projecticized unit is thus a "Company within teams tend to be so detailed in all parts of the
a company" with its own complement of people study that it may end up as a heavy series of
answerable to a project manager and working volumes detailing every part of the project yet we
within a defined budget and timetable for defined know that in real life each project has priority
outputs or objectives. It breaks up once it areas and concentrating on one of them will be
achieves its objectives and the members go back more useful than coming up with thick reports.
to their mother units, if they are drawn from an
existing organisation; or they go back to their 2. Being Practical: Depending on the total project
previous work; or they are amalgamated into the cost, the feasibility study should be assessed in
ongoing venture now on its normal operations. terms of manpower, man-hours, and cost, from 1
The other form is the matrix organisation, drawn to 3 percent of total project cost may be useful
from people already working in the existing rule of thumb for costing a feasibility study.
organisation. They work under a project manager
adding particular functional inputs to the project 3. Being logical and sequential in the
team. There are problems that arise in this set- Presentation: Of course, the iterative nature
up, just as there are also complications in the of feasibility studies makes it difficult to say
projecticized unit. But they afford flexible that a study should proceed strictly in 1-2-3-
organisational calls for pre-operating phases of a order, but still it is useful for proper
project or for new projects within existing perspectives and understanding of the project
corporations. idea as it is unfolded in real and practical
There are variations of these two options: operational terms.
Whatever the organisational structure envisioned,
it is practical to layout the total organisational 4. Writing in Simple English: Technical portions
chart for full operations level of the enterprise. should be prepared by technically experienced
This enables the proponent to see the people true; but sometimes it will be useful to
magnitudes of the project. Needless to say, the rewrite these technical portions if they are to be
full complement usually is filled up after several included in the main body and the real hard stuff
years of operations. To demonstrate the gradual can be included as an appendix or annex.
manning of the chart, a year by year series of
charts should be prepared to show which slots 5. Assuring the government that the project idea
will be filled up by qualified people over time. is part of a broader development plan either of
Auditing Management Itself: government or the private entity undertaking the
A new venture may have its new directors to project. This is to ensure that it is within
manage the project or turn it over to a development priorities.
management consulting firm or hire a team of
consultant for a definite number of years. 6. Making sure that all feasible alternatives or
Whatever the procedures, it is useful to options were studies: Prior to the completion of
undertake a proper management audit if the the feasibility study. Alternative such as a choice
organisation is an existing one or a new one of process; size; location; organisational structure
involving experienced people from different etc.
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 Project Feasibility & Appraisal

7. Specifying the steps that must take place after Management

the feasibility study and after the study is able to Management Competence: One of the most
draw the funding and other resources needed to important factors on which the success of a
convert it from a study into a project reality. That project depends is managerial competence. the
is, from a pre-operating stage how does it now management should be capable of not only
proceed to a fully operating stage? implementing the project but also operating it
profitably thereafter. In particular, this will call for
PROJECT APPRAISAL an awareness on their part of the market
situation, initiative to change the product-mix or
Introduction take up diversified lines of manufacturing at the
right time assessment of managerial competence
The word 'project', as used by World Bank, etc., is difficult and to some extent subjective. A fairly
has a wider meaning in that it refers to good idea can be formed from a study of the
investment in several areas of economic working results of existing concern with which the
development including agriculture, education, promoters are associated, their bio-data
transportation and industry, however, in the (especially in the case of technical
parlance of all India term lending institutions, entrepreneurs) and banker's report. A site
project refers to an industrial project engaged in inspection will be particularly useful in this
the processing, preservation and manufacturer of connection as it affords an opportunity of intimate
goods or in mining or transport. Four stages can contacts with the promoters.
generally be identified in the evolution of an Management set-up: Management set up of a
industrial project. these are (i) Identification, (ii) project is considered from the view-point of
preparatory work,(iii) procurement of funds, and composition of the board of directors. As there is
(iv) implementation. An entrepreneur (or a group a tendency to confine the board to family
of entrepreneurs) conceives the idea of setting up members, broad basing of the Board, to include
an industrial project after an assessment, which professional experts in the line, is generally
indicates that there is demand for the product to insisted on. IDBI also retains the right to appoint
be manufactured and the profit margin would be nominees on the Boards of the assisted
attractive. He, however, has to choose the project companies.
according to his financial resources as generally Collaboration: Collaboration could be either
he is required to invest 16-20 % of the project technical or technical and financial. The terms of
cost. After identifying the project, he has to do foreign the terms of foreign collaboration are to
certain preparatory work. This would include be approved by the Central Government.
obtaining letter of intent/industrial licence Collaboration agreements have a period of
arranging foreign collaboration and preparation of validity generally of 5 years from the date of
project report by engaging a consultant if commercial production with an option for
necessary. The stage is now ripe for him to renewal. The fees payable include a lump sum
approach financial institutions for assistance payment as well as royalty at 3-5 % of the ex-
where the project will be subject to appraisal factory selling price of the product excluding cost
before a decision to assist it is taken. The project of imported components. The terms of
has to satisfy national priorities and should not be collaboration provide for sending foreign
on the negative list of the government as regards technicians for erection/supervision and training
allocation of financial resources. of Indian engineers including training abroad. The
financial institution satisfied itself regarding the
Appraisal ability and standing of the collaborators by
obtaining detailed write-up on their activities and
Appraisal is a comprehensive and systematic their association with similar projects in India and
review of all aspects of the project. The appraisal abroad. Information on the collaborating firms is
of a project is done in five different areas , viz. (a) also collected through the Indian embassies.
Management (b) Technical (c) Commercial (d)
Financial and (e) Economic.

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 Project Feasibility & Appraisal

Technical Aspects entrepreneur would however, be well advised to

(i) Location: Adequacy of land, cost of make an independent market survey by
development and proximity to raw contacting the potential users of the product and
materials/market and transport facilities are computing the aggregate demand from the
reviewed. A site inspection is carried out in an results of the sample survey. The existence of
overwhelming majority of proposals other competitors and possible substitutes for the
(ii) Availability of raw materials: In the case of product is to be reckoned with in assessing the
certain industries like cement primary demand. The production programme will have to
aluminium the location is determined with be arrived at, based on the assessed capacity of
reference to availability of raw materials. the market to absorb the product. This will form
Fertilizer plants based on naphtha are the basis for estimating the profitability of the
similarly located close to refineries. A study of project.
the various raw materials required for the
project the sources of supply consumption per Financial Aspects
unit of finished product and prevailing prices The aim of the exercises here is to assess the
is carried out. project cost, evolve a suitable financing pattern
iii) Technology and manufacturing process: It is and to estimate the working result of the project.
to be ensured that the manufacturing process to Project Cost
be adopted is modern and at the same time The project cost is calculated under the following
appropriate to the level of economic development heads
of the country. When sophisticated or new a) land and site development
process is to be adopted the advice of a b) civil construction
committee of technical experts is sought before c) plant and machinery including
the proposal is put up, to the sanctioning installation and erection,
authority. d) technical know-how consultancy fees,
iv) Plant & Machinery: The list of plant and e) preliminary and preoperative expenses,
machinery is scrutinized with reference to their a) miscellaneous fixed assets,
adequacy, balancing of section-wise capacity g) contingencies and
basis of selection and reasonableness of cost. h) margin for working capital
v) Essential Services: Requirement of power, Site development expenses will include provision
water and fuel are ascertained and the company for levelling roads and conveyance charges.
is required to get firm commitments for supply While estimating the cost of buildings, due
thereof. provision will have to be made for godowns,
vi) Organisation: The company is asked to spell quarters for staff railway siding and architect's
out the proposed organisation for implementing fees. The cost of plant and machinery should be
and operating the project. Appointment of key bifurcated into imported and indigenous groups
personnel right from inception is insisted on in the and provision will have to be made for customs
case of big projects. duty, sales tax and freight. It is the practice of the
vii) Project Scheduling: After taking into account all-India institutions to include the cost of
the period of construction of buildings, delivery of equipment for supply of power and water under
vital machinery etc., a schedule of construction of miscellaneous assets, although the
the project is drawn up. Big projects make use of entrepreneurs sometimes add the cost of
CPM technique to keep a watch on their electrical installation to the cost of plant and
implementation. machinery. The preliminary and preoperative
expenses will include brokerage and commission
Commercial Aspects on underwriting capital issues expenses and
This is again one of the most important factors for interest during construction and other
the success of the project as the existence of establishment expenses. A contingency provision
good demand will generally assure the project of of 5 to 10 % is made on non-firm cost. While
remunerative prices and viability in the long run. calculating margin for working capital the
Forecast of demand is a somewhat difficult task prevailing margins stipulated by RBI should be
in India, due to lack of various Government taken note of.
publications. Planning commission documents
give some indication of potential demand. The
National Productivity Council 13
 Project Feasibility & Appraisal

Source of Finance Unsecured loans used for financing the scheme

Various sources from which funds can be raised may also be considered as debt. Equity will
for meeting the project cost are as follows include free reserves and central subsidy and in
i) Capital equity and preference the case of existing concerns with losses, it is
ii) Internal accruals arrived at after deducting carried forward losses.
iii) Terms loans The usually accepted ratio for small scale project
iv) Debentures is 3:1 and for medium - scale projects 2:1.
v) Unsecured loans and According to recent Government instructions, a
vi) Current liabilities higher promoters' contribution and more
The basic objective in arriving at a financing plan favourable debt equity ratio are to be insisted on
is to minimise the cost of funds to the company. in the case of projects promoted by large
Of the several the tax factors is the most industrial houses.
important. The fact that the interest paid on Profitability estimates and cash flow: The
borrowed funds is a deductible expense for tax fundamental assumptions which are to be
purposes makes debt a cheaper source of critically examined while working out profitability
finance. Please see worked example in estimates are (a) the selling price of the finished
annexure. However, equity capital has the products, (b) the cost of basic raw materials, and
advantages that (i) dividend is payable only out of (c) the build-up of capacity. Where there is
profits and hence there is no commitment to pay government control on prices, this has to be
in periods of adversity and (ii) funds are available taken into account. The preparation of the cash
permanently as there is no obligation to return flow statement will help to determine the amounts
the money; hence a careful balance has to be of annual instalments in which the term loan is to
struck between equity and debt. Two important be repaid, after taking into account the
criteria are applied by the institutions in regard to requirements of internal generation for building
the financing plan up inventories.
Promoters' contribution. It is necessary to ensure Economic Aspects: While the viability of the
that the promoters have a reasonable financial projects is established on the basis of the
stake in the project. The current norms are 20 % estimated working results, it is also necessary to
of project cost for units in on backward areas, assess the benefits accruing to the nation and
17.5% for units in backward areas and 15 % for the desirability of the project from the national
technician oriented scheme. Special point of view. Two exercises are carried out in
concessional minimum of 10% is acceptable for this regard: (i) Internal rate of return which
project in north eastern and Himalayan hilly determines the return on the total funds
areas. In the case of proprietary and partnership employed in the project as a whole and whether it
firms, where the promoters' contribution and corresponds to the growth rate envisaged in the
equity are practically the same, debt-equity ratio five year plans and (ii) the foreign exchange rate
should be the overriding criteria. which determines whether it is worthwhile to
Debt-equity ratio: All term loans, deferred credits create capacity for domestic production or to
and preference capital whose redemption period continue to import the product.
is less than 12 years are treated as debt.

National Productivity Council 14

 Project Feasibility & Appraisal

ANNEXURE
CHOICE OF SOURCES OF FUNDS

The basic objective in arriving at a financing plan is to minimise the cost of capital to the company. Of the
several factors influencing the cost of the capital tax factor is the most important one. The fact that the
interest paid on borrowed capital is a deductible expense for tax purposes makes debt a cheaper source of
finance. The following example illustrates the relative profitability of the same project under three alternative
schemes of financing

SCHEME A B C
(Rs. in Lakhs)
Debt (Rate of interest at 10%) 30.00 70.00
Equity 100.00 70.00 30.00
Total Investment 100.00 100.00 100.00
Estimated profit (before interest and tax) 15.00 15.00 15.00
Less Interest on debt - 3.00 7.00
Profit before tax 15.00 12.00 8.00
Less tax at say 50% 7.50 6.00 4.00
7.50 6.00 4.00
Return on equity(item 8 as percentage of item 2) 7.5% 8.6% 13.3%

The return on equity increases from 7.5 % under scheme 'A' to 13.3 % under scheme "C" for two reasons: (i)
tax outgo is less by Rs.3.5 lakhs and (ii) profit after tax is earned on a very narrow equity base of Rs.30
lakhs as against Rs.100 lakhs under scheme 'A'.
It would appear from the above that the best way to maximise return on equity is to finance the scheme
predominantly through debt. However, the major drawback of doing this would be the fact that interest on
debt is a fixed cost based on time rather than earnings. The project under scheme 'C' for instance, would
have to pay Rs.7.00 lacs as interest whether the profit is Rs 15 lacs or Rs 4 lacs in the latter case, the
shareholders would suffer a loss.

National Productivity Council 15

 Project Approval

PROJECT APPROVAL: THE KEY CRITERIA

sales less expenditures related to the operation
CAPITAL BUDGETING DECISIONS of the project). The second is the cash flow from
capital investments and disposal. The third
Corporate managers are continuously looking for results from the changes in working capital (net
tangible and intangible assets that can increase changes in short-term assets and liabilities). And
the value of their company and result in an last there are the additional corporate tax
increase of shareholders wealth. Capital payments of the company resulting from the
budgeting is concerned with identifying and implementation of the project.
valuing potential investment opportunities to If the project is not expected to continue
enable the management to make sound operations after the end of the forecasting
investment decisions. The concept of present horizon, the salvage value of assets need to be
value (PV) and net present value(NPV) form the estimated. If management expects the project to
basis for the valuation of real assets and last longer than the forecasting horizon, a
investment decision-making. In this section, we continuation value for the project has to be
have to develop these concepts into managerial established. The salvage or continuation value
decision making tools that are widely used by with its tax implications is then entered into the
corporations for the analysis of real assets with valuation model as the last expected cash inflow
expected multi-period pay off. Essentially, the from the project.
method makes a comparison between the cost of
an investment and the present value of uncertain Estimating the discount rate
future cash flows generated by the project. There
are (at least) four major steps in a discounted The concept of present value includes the notion
cash flow analysis for a proposed project. of the opportunity cost of capital. The appropriate
First assuming that the project is all equity discount rate, or the cost of capital, must first of
financed (i.e. all the necessary capital is provided all compensate shareholders for the foregone
by the shareholders), forecasts are needed as to return they could achieve on the capital market
what the expected incremental cash flows would by investing in some risk free assets. It has also
be to the shareholders if the project was to compensate them for the risk they are
accepted. Second, an appropriate discount rate undertaking by investing in this project rather
should be established that reflects the time value than in a risk-free financial asset. Thus, the cost
and risk of the project, and therefore can be used of capital is determined by the rate of return
for the calculation of the present value of investors could expect from an alternative
expected future cash flows. Third, based on the investment with a similar risk profile. Fortunately,
value additivity of present values, the NPV of the the rich menu of traded financial assets provides
project is to be calculated. Finally, a decision managers with the opportunity to estimate the
needs to be made on whether to go ahead with right rate.
the project or not.
Calculating Net Present Value
Estimating Incremental after-tax cash Once the cash flow forecasts are finalised and
flow the appropriate discount rate is established, the
calculation of a project's NPV is a technical
Before starting to build the actual cash flow matter. All future cash flows need to be
model of the project and doing the forecasting discounted to arrive at their present values, and
exercise, some significant technical decisions by adding them up, together with the present
must be made. The analyst has to decide how to value of the necessary capital outlay, the NPV of
treat inflation. The cash flow model can be built in the project is achieved. By denoting the expected
nominal terms or the real terms (i.e. net of cash flow of the project in period t by Ct, and the
inflation). Both approaches have advantages and present value of the necessary investment by Co
disadvantages from practical aspects, but the (which has a negative sign), and the discount
important point is to be consistent throughout the rate as r, the NPV of the project is
model. Then, an appropriate forecasting time NPV = Co + C1 + C2 + + Cn + n Ci
horizon needs to be selected. Occasionally this (1+r) (1+r)2 (1+r)n t+0 (1+r)n
can be easy, because the economic life of assets Note that this traditional NPV model framework
under consideration is known, but at other times assumes that all future cash flows can be
an arbitrary decision is necessary. The discounted by the same discount rate, which for
incremental cash flows that companies forecast some projects might be too restrictive. However,
consist of four elements. The first is the cash flow the model can accommodate discount rates that
from operations (i.e. the cash flow generated by

National Productivity Council 16

 Project Approval

vary from period to period as well as cash flow product drops below, or the amount of fixed costs
profiles with more than one change in the sign. exceed, a certain level, which are called the
break-even market share or break-even fixed
Decision Criteria cost, the company starts losing money on the
Based on the DCF analysis of project proposals, project. The concept of financial break-even or
the decision criterion that follows is relatively investment projects is therefore looking at where
straightforward. Assuming that the company the project recovers its opportunity cost as
operates in a capital market environment where opposed to accounting break-even analysis,
access to capital is not limited, the management which focuses on historical costs.
should accept all projects with positive net
present values and thereby maximise the Scenario Analysis
company's value. The previous two project analysis tools are
concerned with only one underlying factor at a
Project Analysis time, thereby treating them as non-interrelated.
Project analysis tools are widely used methods However, companies often find that certain
developed to provide managers with a deeper market events would result in a change of several
insight and better understanding of the financial underlying variables at the same time. If, for
aspects of investment projects, as well as to shed example, there is a threat of a new competitor
some light on the assumptions behind expected entering an existing market then the market
cash flow forecasts. They can enhance the share of the company as well as the product
confidence of managers in the DCF analysis and price is expected drop. Scenario analysis allows
point-out major risk factors that can potentially management to investigate the effect of potential
jeopardise the expected outcome of the future scenarios of events, which are translated
investment. into the CDF valuation model as consistent
changes of various combinations of the
Sensitivity Analysis underlying variables.
Sensitivity analysis is a very useful tool to identify
key variables or value drivers of projects and Alternative decision criteria
focus managerial attention on the most important
components of forecasts that are underlying the Companies of all sizes and sectors have long
expected incremental project cash flows. The been using a number of other decision criteria to
analysis is carried out by measuring the change evaluate their capital investment projects either
in the value of the project after shifting the value as a supplement to, or worse, as a substitute for
of one underlying variable up or down, the NPV rule. Let us briefly summarise how some
corresponding to a more optimistic or pessimistic of these criteria work and compare them with
forecast. The magnitude of the change in the net NPV.
present value shows the sensitivity of the project
to that particular underlying variable. Payback and discounted payback
If, for example, the NPV proves more sensitive to The simple payback period of a project is defined
the market share of the company and to the as the expected number of years it takes for the
amount of fixed costs than to the price of the company to recover its initial investment outlay
product, then management should focus on the by implementing the project. The decision
reliability of market share estimates and fixed criterion is then given as a maximum number of
cost forecasts, as well as concentrate efforts years, or cut-off period, above which capital
during the implementation to improve these investment proposals should be rejected. this
factors. implies that the shorter the payback period, the
better the project is. However, there are two
Break-even Analysis major short comings to this rule. First, it fails to
Break-even analysis goes one step further. It recognise the time value of money. No investors
points out the critical value of each underlying would be satisfied by investing Rs.100 today and
variable at which the project's NPV is zero. receiving exactly the same amount a year from
Referring back to the previous example, it would now and nothing
tell management that if the market share of the
afterwards, even though the investment has a money. This method involves the calculation of
one year payback period. Second, the rule the payback period in terms of the present value
disregards expected cash flows from the project of future cash flows generated by the project.
after the cutoff period. It prefers projects with However, the rule still does not give any weight to
large payoffs in the early years and perhaps cash flows after the arbitrary cut off date.
nothing later to long term projects with gradually Therefore, its use should be restricted to
increasing positive cash flows. comparing projects with very similar even cash
Companies often use the discounted payback flow profiles. One example could be parts of the
rule to correct for disregarding the time value of property sector, where a number of investments

National Productivity Council 17

 Project Approval

are expected to produce long term evenly Expanding the frontiers of Capital
distributed rental income. Budgeting Criteria
As mentioned earlier, however, the assumptions
Internal rate of Return underlying the DCF analysis represent a static
The internal rate of return IIRR) of a project is approach to decision making, and can be very
defined as the discount rate that makes the restrictive in some case. the replacement of
project's NPV=0, thus obtained by solving the uncertain future cash flows by their expected
following equation for r: value and the use of a single discount rate ignore
the possibility of active managerial actions over
O = Co + C1 + C2 +.+ Cn the lifetime of the project. For example,
(1+r) (1+r)2 (1+r)n managers take actions aimed at cutting the
losses due to unfavourable market events and
For most projects the IRR rule gives an identical retaining or improving profits following favourable
answer to the question whether it should be changes. This can change the risk profile of the
accepted or rejected. However, for some others, project. Also, the standard DCF analysis works in
the use of IRR is not appropriate, or needs to be terms of making a decision now or never. It
used with great care. these exemptions include ignores the opportunity managers may take to
projects where, instead of an initial investment, delay some strategic decisions pending the
the cash flow of the project changes sign more outcome of future events.
than once over the forecasting period or when To overcome these drawbacks, various attempts
the company is ranking mutually exclusive
have been made to develop more sophisticated
projects either because of technical or capital
constraints. decision criteria and investment analysis
methods. these include decision tree analysis,
Profitability Index the use of certainty equivalent cash flows and the
The profitability index (PI) of a project is defined application of option pricing theory in the
as the ratio between the present value of future valuation of real assets. The application of these
cash flows from the project and the initial
methods have proved to be helpful complements
investment (where Co is assumed to be
negative). to DCF analysis.

n
I+1 C1 THE MERITS OF PROJECT
PI = (1+r)n = PV FINANCE
-Co -Co
In the usual case, lenders to a company have
The rule says that all projects with a profitability collectively a claim on its cash flows as a whole,
index higher than 1 should be accepted, which is except for lenders to a subsidiary where there is
identical to the outcome of applying the NPV rule, no explicit or implicit guarantee (in the form of a
since if PI>I it means that PV> -Co, and thus "letter of comfort", for example) by the parent
NPV > O. However, the profitability index is not company. It is also from the company as a whole
useful when applied to ranking mutually exclusive that the dividends are paid.
projects since it captures the profitability, but not In the case of project finance, on the other hand,
the scale, of projects. both lenders and equity investors look only to the
cash flows of the project concerned (often a
Accounting Measures large-scale undertaking such as oil exploration or
development or tunnel building) for their returns.
There are a number of accounting measures This, too, differs from the case with a normal
used in the process of investment decision subsidiary, the operations of which are rarely
making, such as the return on investment (ROI) confined to a single identifiable project. Where
or average book return on investment. The major such a project is being initiated or spun off by a
problem with these measures in general is that "parent" company, the suppliers of finance to the
they are based on book values that are often project have no recourse, in the classic version of
liable to arbitrary selection of accounting policies project financing, to the "parent" company. Hence
(for example on depreciation schedules). In the American term "non-recourse financing" for
addition, book values and book income do not this situation. But hybrids have also been
reflect the time value of money, therefore various developed where the "parent" company or
adjustments are needed to arrive at meaningful sponsoring organisation offers some form of
results. This means the DCF analysis is clearly minimum guarantee.
preferable to accounting measures in setting
investment decision criteria.

National Productivity Council 18

 Project Approval

Why Project Financing? There are several advantages of separate project

financing to a sponsoring company, which will be
an equity investor in the project. In the pure non- the limit to debt set by the company's debt
recourse case, the confinement of the debt convents. In so far as debt financing provides
liability to the project means that it falls outside benefits to the company's shareholders, in the
form of tax saving for example, this is a benefit In short, project financing can make it possible for
to the company's shareholders they could not very large projects to be undertaken, enlarge
obtain if the company were already at its debt debt capacity without increasing the risks to the
limit. company of insolvency or financial distress,
ameliorate problems of "agency costs" arising
Moreover, if the cash flows of the project turn out from the possible "asymmetry of information"
to be insufficient to service the debt, the company between the company and lenders and between
is insulated against the "financial distress" it shareholders and managers, and draw on
might otherwise suffer. Because of this, and outside specialist operating and managerial skills
perhaps also because of a reduced fear on the as well as outside finance.
part of the stock market that it was not being told There is also one further and more subtle
the whole story, the failure of a separate project possible advantage to both potential lenders and
might have less effect on the sponsoring shareholders.
company's share price than in the case of an
integrated company. (but separate project Project financing enlarges the range of choice of
financing deprives the company of some of the both, by separating the cash flows and making it
advantages of pooling - the company has less unnecessary for any particular set of investors to
protection against fall in the profits of its "own" depend on all of them.
operations.) In technical terms, this is making markets more
"complete", which is usually to the advantage of
Second, the performance of the managers of a society. Investors can still, if they wish, obtain the
project may be more visible and therefore more advantages of risk-spreading that a diversified
accurately assessable than that of those who are company can provide by investing in a range of
part of a diversified company. And if they are activities themselves; but unlike the case of
remunerated accordingly, their performance may investments in a diversified company, investors
be better than if the project were "within" the are given the choice.
company, to the benefit of both shareholders and
lenders involved in the project. Conditions for Successful Project
The possible conflict of interest between Financing
shareholders and managers is further reduced
where, as in the normal case, the final proceeds There are several requirements. First, the project
of the project are paid out to shareholders, say of must be operationally a stand alone venture,
a joint venture, who then can decide as to their usually with a definable termination date and with
reinvestment. an agreed basis for returning both ongoing and
final surplus cash-flows to investors. This
Third, project financing is a particularly suitable requires there to be a separate legal entity for the
vehicle for the financing of some forms of joint project, with a finite life linked to the original
venture and of projects that are very large in purpose of the project. Costs and revenues of the
relation to the size of the "parent" company or project must depend on the project alone: there
where special operating skills are called for that must be no interconnections with the costs or
are not fully available within the company. revenues of the "parent" company. But if the
Of course, the inability to draw upon the latter provides services to the project they must
revenues of the "parent" company is a be clearly definable and priced in an agreed
disadvantage to lenders and this will influence manner.
the terms on which they are prepared to lend. But Second- and this is usually a condition needed to
lenders also gain, not only from the greater make the first apply - the success of the project
transparency of managerial performance and the depends on clearly understood factors, such as
likelihood of their being less "managerial slack" the market price of a mineral in a mining project.
but from the fact that surplus cash flows cannot Third, it must be possible for lenders and equity
be siphoned off to finance dividends or other holders to understand the apportionment not only
activities in the "parent" company. In this respect, of the surplus cash flows from the project but also
too, the project's equity holders are shielded from the risks arising from it; otherwise it may be
conflicts of interest between themselves and difficult to obtain support for it.
possibly self-seeking managers more concerned
with empire-building than with adding value for Of course, it goes without saying that the parties
shareholders. of such a project are being unwise if they do not
fully examine the risks they may be bearing, by

National Productivity Council 19

 Project Approval

subjecting their cash flow forecasts to a range of by identifying the so-called critical variables
assumptions concerning pre-production delays, involved and then by deciding how uncertainity
capital and operating costs, volumes and prices, as to their values might best be dealt with.
Project financing has taken many forms. There simple terminable partnership formed for a
have been projects initiated by a single company, specific venture inadequate.
as in the case of BP's North Sea oil fields Over the past 20 years, however, there has been
(involving a syndicate of 66 banks) and various a revival of project financing in order to undertake
mining projects, those organized by a non
very large projects (the Channel Tunnel is one
operating sponsor or group of sponsors, joint
ventures and forms of partnership. example) and to finance other joint ventures and
The oldest examples of project financing go back co-operative arrangements in which companies
to medieval times, when Italian bankers would can pool resources and yet each make their
finance mining and other ventures. The most distinctive contribution. Other examples include
common form of early project, however, was the oil fields, pipeline projects, a variety of power
overseas trading venture on a voyage basis,
generation projects in the US in particular, and
using the finite-life partnership as its legal form.
This was superseded by the joint stock form of joint research and development projects. In most
continuing organisation when the necessities of such cases debt finance is provided by a group of
scale, complexity and continuity rendered the banks.

National Productivity Council 20

 Network Techniques

NETWORK TECHNIQUES - PERT/CPM

Historical Development of Project Basic Concept of PERT & CPM

Management Both PERT and CPM proceeded from the basic
Management today is faced with unprecedented concept of using a Network as a model for an
and complex problems in the planning and actual project. The predominant point in using
execution of projects. For long the traditional these systems of network planning technique
methods of planning and control using bar charts was the minimisation of the project duration.
failed to cope up with the changing realities of Network planning techniques have their
modern business life. Having recognised the applications in planning projects which have
limitations of these methods, two arms of precisely defined start and end points. They are
consultants in USA applied themselves most successful where the problem is one of
independently in 1957 to the task of devising a coordinating and controlling a large number of
better system of project planning using the basic concurrent activities directed towards the same
principle known to mathematicians as the Theory goal. They can only help in planning how to carry
of Networks. out what has been already decided.
One of these projects was the design and Network planning technique takes into account
development of the Polaris Missile. With the the need for planning in its true sense of first
object of meeting a specified date for the project placing in their logical order the activities in the
two years in advance of the earliest possible date project. It enforces a discipline which
predicated by the traditional planning methods, automatically shows how each activity is
Booz, Allen and Hamilton, consultants together dependent on the other. A system is thereby
with the US Naval Department devised in 1958, provided for monitoring the progress of the
the well known system of Network Planning project, for forecasting the effects of snags on the
which was given the name PERT (Programme project as a whole and for deciding which
Evaluation and Review Technique). activities should have priority for resources. The
The second of these projects embraced the work action necessary to avoid a crisis can be taken
involved in a chemical plant overhaul. It was well in advance, resources are better utilized,
initiated by the DUPONT Chemical Co. in completion date can be predicted with confidence
America with the object of reducing the length of and achieved.
time, a chemical plant would be out of
commission during a major overhaul. The Distinction between PERT & CPM
Remington Rand Corporation provided the The essential feature of the Polaris Missile
computer know-how and together with DUPONT, Project was that much of the work to be done
they devised the system of network planning was research and development work, and,
known as CPM (Critical Path Method). therefore, not easy to define either in terms of
Subsequently few more techniques were time required or resources required. The events
developed using the concept of PERT/CPM for were however readily definable. In other words it
specialised purposes. One of them named was much easier to say that component X had to
'RAMP' deals with the resource allocation and be completed and tested before sub assembly Y
levelling for the expensive and critical equipment could be built, than to define with any degree of
needed for execution of projects by an certainty the time required or the work involved in
agency(ies) working on number of projects at the completing and testing component X or building
same time. RAMP stands for "Resource sub-assembly Y. It was in this essentially
Allocation for Multi-Projects". Second technique uncertain situation that the PERT system was
known as "LESS" denoting, "Least cost developed, in order to deal with these
estimating and scheduling" was developed for uncertainties some basic assumption were made
completing the project with minimum possible as to the statistical probabilities of completing
cost without regard to the completion time. This each activity in a particular time.
was found useful for non revenue projects.

National Productivity Council 21

 Network Techniques

The basic concept of PERT is to calculate the network by specified target dates having regard
probabilities of reaching particular events in the
to the possible variations in the activities times. • What other activity(ies) can be taken up
PERT is based on probabilistic estimate of time while this activity is being done.
duration of various activities. The system is (Subsequent).
predominantly concerned with events and is It is to be noted that concurrence is only a
therefore, an event oriented system. PERT has relationship of logic, not of time. Duration of each
its applications in those projects in which there is activity does not come into picture at this stage,
some uncertainty about the activities but the but only the logical sequence of the individual
necessary resources including money are always activities. The network diagram is a graphical
available as required. representation of the inter-dependency of all the
CPM In contrast to the inherent uncertainties activities of a project.
surrounding the activities of the development
project like Polaris Project, the times required for Time Estimation
the tasks or activities for construction project are Estimates of the time required to perform each of
reasonably amicable to estimation within the network activities are made, these estimates
acceptable limits of accuracy by the use of are based upon manpower and equipment
appropriate techniques. CPM is based on availability and certain assumptions that may
deterministic estimate of time duration for each have been made in planning the project in step-I.
activity. The basic concept of CPM is to calculate
the project duration which will result in the Critical Path Analysis
minimum overall project cost assuming that there This involves the computations of the earliest and
is an approximately linear and measurable the latest allowable start and finish times for each
relationship between the time and direct cost of activity in order to identify the critical path through
each activity. The system is predominantly the network and indicate the amount of slack time
concerned with activities and is therefore, an associated with the critical paths.
activity oriented system.
CPM has its application in projects where the Resource Allocation and Levelling
activities are definable and measurable and After determining the critical path, the resources
minimum overall cost is of utmost importance. namely manpower and equipment are allocated
to the various activities. these resources are
Basic Steps involved in the application of levelled out as far as possible through out the
PERT for Project Management. project in order to achieve optimum utilisation of
the resources. This provides the basis for
Project Planning determination of the initial scheduled completion
The activities making up the project are defined of the project.
and their dependency upon one another is shown
explicitly in the form of a network diagram. PERT Cost and Crashing
Whether a certain project will have two hundred If the scheduled completion time of the project as
activities or two thousand activities depends upon determined in step 4 is satisfactory, the final
the degree of detail desired by the management. project planning and scheduling for the execution
The rule to follow is that an activity should may be prepared.
represent the smallest unit over which control is However, in case it is found necessary or
desired. Hence, a thorough knowledge of the considered desirable to reduce the project
project in hand is essential to breakdown the completion time, the crashing of the activities on
whole project into a number of activities. All the critical path and their associated cost of
these activities are inter-related. In order to crashing are considered, this could enable the
determine the inter-dependency relationship, determination of the optimum time and cost of the
each activity is examined in relation to other project. A final schedule for the execution of the
activity in the light of the following questions. project is then worked out.
• whether other activity(ies) must be
completed before this activity can start Project Control
(Precedence). When the network plan and schedule have been
developed to a satisfactory extent, they are
National Productivity Council 22
 Network Techniques

prepared to a final form for use in the field. The manpower, equipment etc. and analysing the
project is controlled by checking progress against efforts of delays. Whenever major changes are
the schedule, assigning and scheduling the
made in the schedule, the network is, revised complete building acquire land, cut over of an
accordingly and new schedule is computed. exchange are events.

Terminologies used in PERT for Network ACTIVITY

Construction Event An activity represents efforts applied over a
An event is point of time indicating the start or period of time and is bound by the events. These
completion of an activity and does not signify any events are referred to as the predecessor and
expenditure of resources. There may be work successor events for the associated activity.
involved in approaching an event but the event Activities are graphically represented by arrows
itself takes no time. An event is generally as shown below:
represented by a circle.
An event in a network is a junction of arrows
denoting two or more activities (except initial and
end event). An activity is bounded by two events. The arrow head points the completion of the
activity. Words like design, procure, test develop,
5 prepare etc. indicates that work is being
accomplished and thus represent activities.
MERGE EVENT: An event which represents the Dummy Activities: Sometimes an arrow is to be
completion of more than one activity is called a used merely to represent dependency of the
merge event. In this case the event would said to activity over another whereas the arrow itself
have occurred when all the activities merging at does neither represent any expenditure of
that event are completed. resources nor it has got any duration. Dummy
11 activities are represented by dotted arrows.

BURST EVENT: An event from which more than

one activity branch off or start and these activities Length and direction of arrow in network do not
later end at some other succeeding events. have any significance. These are varied for the
Events are generally represented by circles with convenience of drawing the network.
events numbers written inside as represented as
following: NETWORK
A network is described as a pictorial
representation of the inter relationship of all
12 required 'events' and 'activities' comprising a
project. The network begins with one starting
point and expands into number of
Events are described by words such as complete
start, issue, approve, tested etc. for example
paths which connects events and is completed 1. Before an activity may begin all activities
again at a instant of time or event where the preceding it must be completed.
project is terminated.
The path is defined as a way through the
network, identified by the event numbers falling 1 2
on the chosen path. In the figure 1-2-3- is a path,
while 1,2,3, are events. Activity (1-2) can only begin when event one is
completed.
1 2 3
2. Length, orientation or shape of the arrow has
no significance. It only implies logical
Network Logics precedence.

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 Network Techniques

3. The beginning of the activity is a tail event that the job began at event 'i' is completed at
while the completion of an activity is a head event 'j'.
event. These are respectively called the 'i' and 'j'
events. 6. Network may have only one initial event and
only one terminal event.
4. No activity may be shown more than once in
the network. 7. Representation of inter-dependency of the
activities should be clearly indicated. Some
5. While drawing network, it is assumed that examples are given below
a) time flows from left to right and
b) head events always have a number higher
than that of the tail i.e. the activity 'i-j' will
always mean

REPRESENTATION INTERPRETATION

A B Activity B depends on A (also

1 2 3 briefly shown as A B)
D
3 C must be completed before either D
1 C 2 or E can start (does not imply
E that D & E start at the same time)
4

1 F H cannot start until both F &

H G are completed. (does not imply
G 3 4 F & G are completed at the same time)
2

1 I & J must be finished before

I K 4 K or L can start. (does not
J 3 L imply that both I & J will
2 be started at the same time)
5

2 3 3

1 4 2

1 4

WRONG RIGHT

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 Network Techniques

5
5

1 2 3 1 2 4

4 3

WRONG RIGHT

2 5 3

1 4 6 5
2
3
1 4 6
7

WRONG RIGHT

8. Keep left to right component in each arrow i.e. always draw event 'j' to the right of event 'i'. This
follows from the fact that events are points in time and once an event (point in time) has been passed it is
impossible to return to it as time itself is unidirectional.

3 3

1 2 1 2

WRONG RIGHT

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 Network Techniques

9. Avoid unnecessary dummies

3
6 1 6
4
1

2 4 2 5

WRONG RIGHT
10. The error of 'dangling' any activity in the network construction should be avoided.
1 2 3

4
Dangling is shown by activity (2-4) which produces no results as regards the entirety of the project. To avoid
dangling the following rule must be followed.

"All events, except at the starting and completion of the whole project must have at least one activity
entering and one activity leaving them. "

11. Numbering of Events:

It is essential that some convention or rule is followed in demonstrating the logical sequence of events in a
given network. This is done by a device called 'Fulkerson's rule'.
The procedure consists of identifying the initial event and than gradually converting the succeeding events
into initial events by deleting the arrows from the precedent event. A number is to be assigned only when by
such deletions, an event is converted into an initial event.
For example, consider a simple network shown in the figure below:

B C 2 5

A D 1 6

E F 3 4

A is an initial event. Hence it is numbered as 1. Connected to A are the events B & E. Delete the arrows
outgoing from A. This results in B & E. Delete the arrows outgoing from B & E (now made 2 & 3) only F
becomes a new initial event as FC arrow is still acting on to event C. Hence number 4 is assigned to F.
Delete arrows FC & CD. C becomes an initial event. Hence C is marked 5. Cancel DF when D becomes the
final event 6.
If there is a series of activities depending on each other in many paths in a network, the paths are taken one
by one and all events are numbered till the merge event as shown below:

4 5 6 7 8

1 3 11 12 13 25 26

2 21 22 23 24
National Productivity Council 26
 Network Techniques

Network Based Project Planning

Objective of Work Scheduling & Networking

1. To provide a discipline for planning 5. To provide current schedules for field

projects and programme. operations.
2. To provide a clear picture of the project or 6. To show which activities or jobs are
programme scope that can be clearly read critical from a schedule stand-point and to direct
and management attention to critical areas.
understood. 7. To provide a framework for improved
3. To provide a vehicle for evaluating scheduling of manpower, equipment and capital
alternative plans and objectives. inputs as the project progress.
4. To pin-point responsibilities of related 8. To train and orient personnel in project
departments, sub contractors, or other implementation and management.
organisations making inputs into the project or
programme.

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 Network Techniques

General Seven-Step Process for Fourth: Make a preliminary schedule (based on

Developing a Chart to Plan and Schedule specific calendar dates). Assume that the
a Project resources from each organisation will be
available in the amounts necessary, at the times
First: Decide the level of detail which is going to estimated.
be displayed on your chart, coordinating with Fifth: Discuss the preliminary schedule with
other divisions, if necessary. representatives from each organisation involved
Second: Identifying the sequence in which the in the project when you get them altogether
various tasks can be logically carried out. This go looking at requests for support (personnel,
to particularly complicated when a number of equipment, money etc.) for a specific time period,
things can be done simultaneously and other there are almost bound to be changes.
organisations are involved. Sixth: Develop a more realistic schedule based
Third: Estimate the elapsed time that each on the above discussions.
activity is likely to take given the conditions under Seventh: Keep revising it until you reach a
which you will be working. consensus of what is possible.

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 Network Techniques

EXERCISE IN NETWORK CONSTRUCTION

1. Construct a network with the following details.

A C (Activity C depends on A)

B D

B C

A D

2. Draw a network with the given particulars:

O P

N P

O Q

P R

Q R

3. Draw a network with the given details:

A C C F

B C D E

A H F E

B H H I

C D G I

C G I E

4. Activity G depends on activities E and F, activity H depends on activity F only.

5. S, T, U are beginning and concurrent activities. Activity V succeeds S. Activity W depends on

activities T, U and V.

6. Activities L and M cannot start until K is complete.

Activity L must be completed before N can start. Activity M must be followed by activity Q. Activities N
and Q must be completed before P can start.

7. Activities R, S and T can start immediately. Activity R must be completed before U and W can start.
Activity V must follow S and precede W. Activities U, W and X must all be completed before Z can start.

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 Network Techniques

8. Activity Duration Dep. on the Completion

A 4 H
B 6 H
C 3 H
D 7 B
E 8 B
F 5 B
G 2 C
H 1 NIL(initial activity)
I 5 A,D
J 6 A,D
K 6 F,G
L 7 I,J
M 4 E,F,G,J
N 3 K
O 1 L,M,N

(O is the concluding activity)

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 PERT Applications

PERT APPLICATIONS IN PROJECT MANAGEMENT

CRITICAL PATH ANALYSIS is known as the earliest event time. Earliest event
time for initial or start event is obviously zero.
For calculating earliest event times for
Objective subsequent events we must begin from initial
event and must end in final event following the
After the arrow diagram has been drawn and the arrow paths. All the activities, one or more,
duration of each activity has been estimated shown terminating at the event must be
either deterministic or probabilistic it is possible to completed before the event occurs and as such
analyse a network. This analysis consists of: the,
1. Calculating the earliest possible and the latest Earliest Event Time = Max of (Earliest Finish
permissible times for each event, assuming that Times for each Activity terminating at that
the time estimates are correct. event)
2. Finding the critical path, which may be defined or, in other words, for calculating the earliest
as the sequence of activities from project start to event time of an event (merge event) at which
project finish that occupies the longest time. two or more activities terminate, find the earliest
In addition to above, the network analysis also finish time for each activity and compare them.
consists of determining various types of floats of The longest time is the earliest time.
spare time available for activities not on critical
path and preparation of working schedule. These, There are a number of ways of recording the
however, will not be discussed in this topic. results, one which is adopted here is to insert the
earliest event time in the left compartment of the
Earliest Event Times two sides of the compartments made in the circle
enclosing event number. Right side of this
The earliest time at which an event can occur (if compartment will be used for recording latest
the estimated duration of each activity is correct) event times
.

Calculation

2 3 3

1 2 5 6
1 9 2
8 4 0

Figure-I

Taking example of the network in Fig.I we can calculate earliest event times for various events starting from
initial event No.1 to the end event No.6 following the arrow path as shown below:

Event No. Earliest Event Time

1 0
2 0+1=1
3 1+2=3
4 1+8=9
5 Max. of (3 + 3, 1+9,9+0) = 10
6 10 + 2 = 12

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 PERT Applications

Earliest event times for all those events are shown in Fig. 2 The total project completion time is 12 units of
time and is presented in the form given below:

3
3
1 2 5 6
0 1 10 12

4
9

This technique of determining the earliest event times is known as the 'method of forward pass.' In forward
pass, calculations must begin from the initial event and must end at the terminal or last event.

Latest Event Times It is found, by a reverse procedure to the

calculation of earliest event times, by subtracting
The latest time at which an event can be allowed the durations of the succeeding activities along
to occur, if overall project time is not to exceed its the longest (time) path starting at the final event.
earliest finish time (assuming the estimated The latest event time for the final event is the
duration of each activity is correct) is called the same as its earliest event time.
latest event time.

Latest event time = minimum of Latest event time for minus Intervening
succeeding event activity duration

Calculations

For the network shown in Fig. 1, the latest event times are:

Event No. Latest event Time

6 12
5 12 - 2 = 10
4 10 - 0 = 10
3 10 - 3 = 7
2 Min. of
(7-2,10-9,10-8) =1
1 1 - 1 =0

The latest event time for all the events are shown in Fig. 3.

3
7
2 3
1 2 5 6
0 1 1 9 10 2 12

8 4 0
10

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 PERT Applications

Figure-3

Critical Path

An examination of network shown in Fig. 4 indicating both earliest and latest event times reveals that for
certain events earliest and latest events time are the same while for the remaining events they are unequal.

3
3 7
1 2 5 6
0 0 1 1 10 10 12 12
4
10 10
Events having the same earliest and latest network event 3 and 4 are non - critical events.
events times are called critical events. In the Difference between latest and earliest event
above network events 1, 2, 5 and 6 are critical times is termed as event floats. For the network
events. Events having unequal earliest and latest shown in Figure 4. floats are indicated in the
event times, are non-critical events. In the above following tabular form.

Event No. Earliest Latest Event Float

Event Time Event Time
1 0 0 0
2 1 1 1-1= 0
3 3 7 7-3= 4
4 9 10 10- 9 = 1
5 10 10 10 -10= 0
6 12 12 12 -12= 0

The critical path lies along those sequential between paths 2-5 and this path is quite
activities joining all the critical events of a considerable viz. 4, sub-critical paths have
network. The sequence of activities from project considerable significance at the time of crashing
start to project finish that occupies the longest of networks. Every network has a minimum of
time is called the critical path. one critical path. In certain networks, along part
An examination of the above table will indicate or all of its length, a critical path may split into two
that 1-2, 2-5, and 5-6 constitute the critical path or more paths and there is no reason why
for the network. dummy activities should not form part of the
Activities lying in the critical path are called critical path. Suppose that in the network shown
'critical activities'. The sum of the durations of all in Fig. 4, by allocating extra resources to activity
the critical activities will be the project time. Any 2-3, its duration could be reduced to 8. Then
delay in any of the critical activities will naturally there would be one more part of critical path viz.
result in a consequential delay in the completion 2-4-5 through a dummy activity 4-5 converting
of the entire project. sub-critical path 2-4-5 into critical path.
Referring to Fig 4, three separate paths connect Identification of the critical path is an important
the events 2 and 5. The direct path 2-5 has first step in the planning and management of a
duration of 9 while the other path viz. 2-4-5 has a project. It will immediately draw the attention of
duration of 8 and path 2-3-5 has duration of 5. the management to these activities which govern
The difference between duration of path 2-5, 2-4- the date of completion of the project. Critical path
5 is very small viz. only 1 and hence this path is has two principle features. First, if the project
called sub-critical path. The path 2-3-5 is not time is to be shortened, one or more of the
called sub-critical path because the difference activities on this longest (time) path must be

National Productivity Council 33

 PERT Applications

shortened. The application of additional effort if the time required for the actual completion of
anywhere else in the network will be useless any activity on the critical path varies from the
unless the critical path is shortened first, second, calculated expected time, this variation will be
reflected in a one-to-one fashion in the
completion of all subsequent events on the
critical path i) All activities in the network under one
item must fall within a work package.
ii) All work packages must be capable of
summarization to an end item sub-division.
PERT COST AND CRASHING
iii) It should be limited to maximum period
of 2 or 3 months.
Introduction
iv) Work package must be built around
continuous path so as to get the maximum
The extension of PERT concept to include cost
coupling benefits.
considerations was a natural one. It is not only
v) A unit or an individual should be given
enough to complete a project on time but this
the responsibility for carrying out the work
must be achieved with optimum cost. The
package.
amount of priority that should be given to the
The normal activity cost is equal to the absolute
achievement of a certain project by a certain date
minimum of direct costs required to perform the
depends on its cost consideration. It could be
activity, and the corresponding activity duration is
worthwhile to advance the completion of the
called the normal time. It is the normal time that
project by certain amount of time if the resultant
is used in the basic CPM/PERT planning and
savings are considerable. Conversely one might
scheduling and the normal cost is the one usually
like to slip a particular project by certain amount
supplied if the activity is being sub-contracted.
of time, if it helps in the completion of a priority
The normal time is actually the shortest time
project and thereby could also help in the
required to perform the activity under the
reduction in the project cost of the project.
minimum direct cost constraint. Ordinarily a
project would not be scheduled for a longer
Time - Cost Relationship
duration then the normal duration time. However,
for various reasons one may be interested in
Activity direct costs include the costs of the
replanning and scheduling the project for a
material, equipment and direct labour required to
shorter duration time. Selection of a certain
perform the activity in question. If the activity is
schedule for a project generally involves a
being performed in its entirety by a subcontractor
comparison of a number of alternatives, each
then the activity direct cost is equal to the price of
with a different relationship between cost and the
the subcontract. Project indirect costs may
time of completion of the activity. A certain
include in addition to supervision and other
activity could be shortened by incurring extra
customary overhead costs, interest charges,
cost in the form of assigning more personnel or
loss of revenue for completing the project after a
scheduling overtime for that activity. When an
specified date etc. Besides there are other
activity is completed in normal schedule time, the
intangible costs like loss of goodwill and public
associated minimum cost could be called 'normal
image apart from depriving the public from the
cost'. When an activity is completed in minimum
benefit accruable as a result of the completion of
possible time, the associated time could be called
the project.
Crash Time and the cost Crash Cost. An activity
could be scheduled for any time between these
Work Break Down: (Work Packages)
normal and crash times. Actual cost-time
relationship curve could be of any shape, but
Since it would not be possible to estimate the
mostly they are linear. However, for optimisation
cost of each activity, therefore, approach used in
problems, we would assume the relationship to
PERT cost is to aggregate a group of activities
be linear with a constant cost slope.
within a network into a cost work package.
Important points to be considered in making the
cost work packages are:

National Productivity Council 34

 PERT Applications

CRASH POINT
Cd

C
O
S
T
NORMAL POINT
Cd
TIME

Project Duration Reduction at Minimum Cost the minimum cost of expediting if first shortened
is determined.
The Normal cost for a project could be obtained The cost slope has to be found by taking the
simply by summing the normal cost of all the differences between normal cost and Crash Cost
activities of the network. In order to shorten the and divide it by the difference between normal
project duration with minimum extra cost, the time and crash time as given below:
critical path is first examined and the activity with

Crash Cost - Normal Cost

Cost Slope/day = Crashing cost/day =
Normal Time - Crash Time

As the total critical path duration is shortened gradually other paths in turn might become critical and they
too have to be examined. Sufficient points could be plotted in this way to show the variation of direct project
costs with time (project duration). Addition of the indirect cost patterns to this curve would give all the
information, a manager requires to select the project schedule balancing the cost and time objectives.

TOTAL COST

C
O INDIRECT COST
S
T

DIRECT COST

Fig.2: Total Project Cost

b) those related to the necessary efficiency

Network Cost Control of the system.
The basic organisational problem is the conflict
In theory, the concept of cost control based on between the project approach of network cost
the project network is simple, but the design and control and the functional approach of cost
the implementation of a practical cost control accounting procedures found in most industries.
system is not readily accomplished. the basic The input to a network system requires the
problem facing the designer or a cost control development of an activity accounting procedure
system based on network approach are by which actual expenditure data are coded to
a) those related to Organisational Conflicts provide association with activities in the project
and network. The output for the system likewise must
be project-oriented to provide project summary
National Productivity Council 35
 PERT Applications

reports, organised by time period, are as of The PERT/cost procedure requires an input cost
responsibility, and technical sub divisions of the data in addition to the time data required by basic
project. PERT. This cost data is generally collected for
The efficiency of system is also a problem small groups of related activities called work
because the level of detail is simultaneously a packages rather than for single activities, so as
promise as well as an interest hazard. A network not to impose an undue accounting burden. Cost
cost control system can easily require routine estimates are obtained only after a satisfactory
input data in quantities and frequency that project schedule has been developed since any
personnel find extremely burdensome. Unless schedule change will normally affect cost. As the
the requirements are reduced and procedures project progresses, actual accrued costs are
simplified, the system will come to an early end. gathered for each cost collection point and
revised
Estimates are submitted as required. costs of activities not completed, the following
computations may be made:
A number of useful and informative reports can i) Summation of all actual costs.
be generated from this data. the basic output is a ii) Summation of budgeted costs of this
status report, which combines time and cost data point in time.
for each cost collection point. This enables the iii) Summation of budgeted costs for all
manager to identify activity groups which are activities completed and proportional costs of
contributing to actual or potential schedule activities partially completed. This figure is called
slippages or cost over-runs and also to compare 'planned cost of work completed 'or' value of
the time and the cost status of any given activity work'.
group. In addition to the output obtained from a iv) Computation of difference in actual
time - oriented network, this report shows the costs and planned cost of work completed;
original cost estimate, the actual costs incurred, computation of both money value and percentage
revised estimates, if any, and the anticipated of planned cost of work completed.
under-run or over-run. v) Computation of a projection of ultimate
Provision is made for summarization of the time costs of the total project.
and cost data at various level of management so The sum of actual and latest revised estimated
that each level of management is presented with of future costs may then be compared with the
only that amount of detail with which it is directly contracted total cost for the project, to indicate
concerned. Upon receipt of all input data on the the amount of the expected over-run or under-
progress and expenditure as of the reporting run.
data, and any revised estimates of duration or

Example
Consider the following network. The cost data and the possibility of crashing the various activities is given in
Table-I. Determine the optimum time for completion of the project:

B1 E H
B 3 4 6 8
4 7 12 5
1 I K
A F 15 14 6
D G J
8 2 6 5 7 7 8 9

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 PERT Applications

Cost Data for Normal & Crash Cost of Activities

Activity Time Work Cost(Thousand) Cost of Crashing\

in Normal crash Normal Crash week

A(1-2) 8 3 7.0 10.0 Rs. 600

B(1-3) 4 2 6.0 8.0 1000
B1(3-4) 7 5 2.5 3.0 250
D(2-5) 6 1 9.0 11.5 500
E(4-6) 12 8 10.0 16.0 1500
F(5-6) 15 10 12.0 16.0 800
G(5-7) 7 6 12.0 14.0 1000
H(6-8) 5 5 10.0 - -
I(7-8) 14 7 6.0 7.4 200
J(7-9) 8 5 6.0 12.0 2000
K(8-9) 6 4 6.0 7.8 900

activity J joins critical path after completion of

Optimum project duration should be determined activity K which follows I, accordingly the float of
as follows: J shall also be reduced by I week, Follow up the
procedure in the first stage, duration of I reduced
Determine critical path and prepare the squared to 13 and float of paths DFH and GJ are reduced
Network. to 13 and float of paths DFH and GJ are reduced
From the cost data, find out the cost of Crashing to 10 and 11 respectively.
per week for various activities (by cost slope). Now there are two critical paths, locate the next
Compare the cost slope of the activities on the activity on critical paths(s) which has least cost
critical path and select the one with least cost slope. D has cost slope of Rs.250 week. Another
slope. alternative being crashing of A which is
Find the degree of crashing possible for the expensive. Crashing of any other activity in each
activity. Crash this activity to the extent that of the critical paths. The total cost of which is
another path does not become critical. In this more than cost of crashing D. Though activity D
example among critical activities I has least cost could be crashed from 12 weeks, but since after
slope and length it could be crashed by one crashing it by 2 weeks, the path AP, E, H
week, but crashing it by only one week make originating along with D and joins at critical path
another path namely ADFHK critical. Therefore, also becomes critical path. Thus we should
in the first stage crashing of I would be done only decide to crash D only by two weeks. Accordingly
by one week. the duration of D is reduced from 6 weeks to 4
Strike off the duration of I and replace by 13 weeks and float of path AP EH is reduced to
weeks instead 14 weeks. The float of all the zero.
paths which are either originating from I or before There are three critical paths now in order to
the start and I and joining the critical path after further reduce the project duration, alternatives
the completion of activity I or simultaneously with are either crash A or at least one activity each of
I would be reduced by 1 week. In this case the two critical paths A, B1, EH, K and ADGIK or
activity of path F, H joins critical path at the ADEIK and ADGIK or one activity each of the
completion of I, therefore, the float of this path three critical paths. The alternatives alongwith
would be reduced by one week. Similarly the details of activities with cost are given in Table-II.

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 PERT Applications

Alternatives Activity(ies) Cost of Crashing/ Remarks

to be crashed Week

1 A 600 CRASHING UPTO 4 WEEKS

2 K 900 CRASHING UPTO 2 WEEKS
3 i OR D, B1& I 750
ii OR D&E 1750
iii B&A 1600
4i B,F & G 1000+800+2000=3800
ii B,F & i 1000+800+200=2000
5 i OR B1,F & G 250+800+2000=3050
ii OR B1,F & I 250+300+200=1250
iii OR E,F & G 1500 + 800 + 2000 = 4300
iv OR E,F & I 1500 + 800 + 200 = 2500

Keeping in view the above, the first alternative of For further crashing, we noticed that B1 cannot
crashing A by 4 Weeks only is most favourable. be further crashed. This, therefore should be
This leads to the reduction of float for B to zero circled indicating that no further crashing of B1 is
and any further crashing on a would also require possible. Therefore, alternatives 3 i x iii, 4 i x ii, 5
crashing of B and this cost Rs. 1600 per week. iii and iv mentioned in Table II only are available
This cost is higher than the cost of other available for crashing at the cost indicated therein. In
alternatives, second preference will be for addition one more alternative of crashing B & A
crashing D & B1 at a cost of Rs.750 week for 2 with a cost/week of Rs.1600 (3iii) would reduce
weeks as B could be crashed only by two weeks. the project duration. Accordingly the selection of
Third would be for K for 2 weeks at a cost of alternatives will be in the order of B & A, E & D
Rs900/week. and E, F & I respectively.

The final result as discussed above is given in below

S.No. Activity Cost slope/ Cost of No. of Addl.

to be Crashed week Crashing weeks cost

1 I 200 200 1 200

2 D 250 250 2 500
3 A 600 600 4 2400
4 D&B 250+500 750 2 1500
5 K 900 900 1 1800
6 B&A 1000+600 1600 1 1600
7 E&D 1500+250 1750 1 1750
8 E,F & I 1500+300+200 2500 3 7500

16 17250

As is evident from above discussion, the crashing of the project as listed above has been keeping in view
the addl. cost for each stage of crashing. Therefore, in case we wish to complete the project in 3-4 weeks,
we could stop at sl. no. 3 for crashing. This would ensure the minimum addl. cost of crashing the project by
7 weeks which is this works out to only 3000 as compared to addl. cost of Rs. 17250 for crashing the project
by 16 weeks.
The crashing of the project completion time could also be attempted using the squared network as shown in
Annexure-I.
The overall cost of the project for various project duration is shown below in the table.

The overhead charges have been taken as Rs.1000 per week.

National Productivity Council 38
 PERT Applications

Project Activity Direct Indirect Total

Duration crashed cost cost

28 E&D 96250 28000 124250

29 B&A 94500 29000 123500
30 K 92000 30000 122000
32 D& B1 91100 32000 123100
34 A 89600 34000 123600
38 D 87200 38000 125200
40 I 86700 40000 126700
41 NORMAL 86500 41000 127000

From the table given above, it could be seen that optimum project duration for this case is 30 weeks. These
figures have been plotted on a curve, shown in annexure-II.
Further it may be seen that at a point in the project duration where the direct cost of crashing exceed the
saving in the indirect cost, that indicates that further crashing would not be useful.

SQUARED NETWORK
ANNEXURE-I

B D E

4 3 5 11 8
F H O

A C G I K

4 3 421 10 84
J

8 11 9

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44

The above squared network at a glance indicates the following:

i) Duration of each activity on time scale.

ii) Interdependencies of the various activities
iii) The critical path
iv) Total duration time of the project
v) The various floats with their time duration.

National Productivity Council 39

 PERT Applications

How to Prepare a Squared Network

i) Determine project duration from the critical path of the network diagram, and select the suitable scale.
ii) Draw the critical path in the center of the graph sheet in a straight line against the time scale as far as
possible
iii) Develop non-critical or secondary paths above and below the critical path, showing constraints as
vertical.
iv) Show direction of dummies correctly by an arrow with dotted lines.
v) Make the bars proportional in length to their activity duration on the time scale.

PROJECT DURATION Vs COST OF PROJECT

129000

128500

128000

127500

127000

126500

126000

125500

125000

124500 C
O
124000 S
T
123500
I
123000 N

122500 Rs.

26 28 30 32 34 36 38 40 42 44
Duration

RESOURCE LEVELLING
PROCEDURE

Proper allocation of existing resource is an particular resource is scarce or very costly. For a
eternal problem posed to the management. The project, the ultimate cost will depend upon the
problem demands more attention when the utilisation of resources and thereby dependent on
National Productivity Council 40
 PERT Applications

project plan. Network technique makes the job STEP-III

similar and easier. Holding the last activity fixed, repeat step 2 on
One of the two basic problems involved here is, the next to the last activity in the network taking
project duration being fixed, to level their advantage of any slack that may have been
resources demand avoiding peaks and valleys as made available to it by the rescheduling in Step
far as possible. Other is with a fixed availability of II.
certain resources to minimise the project STEP - IV
duration. The first problem arises when one is Continue Step III until the first activity in the list
able to procure sufficient resources to undertake has been considered: this completes the first
the project but would like to utilise them at a rescheduling cycle.
relatively constant rate. The second problem STEP -V
occurs when one has an existing pool of Carry-out additional re-scheduling cycles by
resources and likes to plan the activities so that repeating steps II through IV until no further
project duration is minimum. reduction in the total sum of squares of resource
A systematic procedure developed by Burgess is requirements is possible, noting that only
being widely used for tackling resources levelling movement of an activity to the right (schedule
problem. This method utilise a measure of later) is permissible under this scheme.
effectiveness given by the sum of the squares of STEP-VI
the resource requirements for each day in the If this resource(s) is particularly critical, repeat
project schedule. The Burgess procedure is steps I through V on a different ordering of the
given in the following steps. activities which, of course must still list the
activities in order of precedence.
BURGESS LEVELLING PROCEDURE STEP-VII
STEP-I: Choose the best schedule of those obtained in
List the project activities in order of precedence steps V and VI.
by arranging the arrow head numbers in STEP-VIII
ascending order, and when two or more activities Make final adjustments to the schedule chosen in
have the same head number list them so that the step VII, taking into account factors not
arrow tail numbers are also in ascending order. considered in the basic scheduling procedure.
(This assumes that the network events are Considering again the example presented in Fig.
numbered so that activity tail numbers are always 1. Suppose all activities are rescheduled as early
less than the head numbers). Add to this listing as possible. The results of this schedule are
the duration, early start, and slack values for shown in Fig.2. The resource requirements for
each activity. this schedule are quite irregular in time and
STEP-II: require a maximum of 14 and 8 units of
Starting with the last activity, (the one at the resources A and B respectively. This schedule
bottom of the diagram) schedule it to give the can obviously be improved. The application of the
lowest total sum of squares of resource Burgess procedure will produce the results given
requirements for each time unit. If more than one and summarized in Fig. 3. The details of
schedule gives the same total sum of squares, obtaining Fig. 3 from fig. 2 ill be left as an
then schedule the activity as late as possible to exercise for the reader.
get as much slack as possible in all proceeding
activities.
Step-1
The result shown in Fig. 3 can be compared with Schedule all jobs at early start, and plot
a second procedure developed by Wiest for manpower requirements in each step for each
which the steps are given below: day.
Step-2
WIEST LEVELLING PROCEDURE Calculate peak manpower requirements in each
shop and set 'trigger levels' for all shops one unit
The inputs to this procedure are the same as for below their respective peaks.
the Burgess procedure. The procedure consists Step-3
of the following six steps. Once again start scheduling jobs in technological
order, calculating the manpower or loading charts
National Productivity Council 41
 PERT Applications

simultaneously. Stop when the trigger level of additional peaks are generated, apply the
any shop (call its) is exceeded. procedure of (4) If all the jobs are successfully
Step-4 scheduled then lower the trigger levels of all
Examine the jobs that are active on the peak day shops one more unit and return to 3). As soon as
in shops. Compile a list of jobs which have no further reduction in trigger level is possible,
sufficient slack to move them beyond the peak then print out the schedule.
day without delaying the due date, and arrange
them in descending order to their total slack. Pick Step-6
one of these jobs (by a selection process that Repeat the above process (as many times as is
favour the jobs highest on the list), and move it to computationally feasible). Because of the random
right on the schedule chart a random number of elements in the programme it is likely that
days between the minimum move necessary to different schedules will result from each
push the job past the peak day and the maximum application of the program. Select as the final
move necessary to push the job past the peak schedule the one having the lowest manpower
day and the maximum move allowed by its total costs which are assumed to be proportional to
slack. the trigger levels i.e. sufficient men are hired to
Step-5 meet peak loads and are paid whether ideal or
Continue with the scheduling of other jobs and active on all days.
plotting of the manpower loading chart. If

1 4 2
2 2 2 6 6

6
0 2 3 5 4 4 5 4 8
00 2 2 7 8 12 12 16 16
1 8
6 3 7 5
1 7 10 10

Fig. 1

PROJECT MONITORING &

CONTROL

Scheduling
The activities of the project network are In large projects it may be advisable to use
scheduled, that is the starting and completion 'project calendar’ for ease of computation and to
time of each activity is decided after drawing the facilitate all project personnel understanding the
network. The scheduling of individual activity are activity times in the same way. The project
guided and restricted by the following calendar is developed by numbering the calendar
consideration: months serially starting from the month of which
the project is started. For example in a project
a) Project duration (critical path) where the work was started on August 79, the
b) Resources allocation (availability) project calendar would be as under:
c) Resources levelling (administrative
convenience) August 79 - 1 January 80 - 6
d) Weather line and other constraints Sept. 79 - 2 January 81 -18
e) Desired mile stone events Oct. 79 - 3 January 82 -30
f) Project funding.
All schedules, computation of project times etc.
will then be made with the project calendar only.
The main advantages would be that the unit of
National Productivity Council 42
 PERT Applications

reference for all divisions of the project would be October 81 (27th month and requires 17 months
same and the case of computations like finding to complete (27 plus 17 = 44th month).
the completion time of an activity which starts on The net work times computed are than referred in
this project calendar base (or usual calendar).
This is done by substituting the calendar dates on d) lead time required for remedial actions
network timings of start and finish times of etc.
activities. This becomes the chronological
schedule for the activities and events. For this, TIME
separate instructions can be extracted and
issued to the concerned divisions as to when The time aspect of the project is monitored by
each activity should be started and completed obtaining Activity Status report which gives the
etc. information about the following:
- The list of activities completed
Review of Monitoring - the activities under progress and time
During the implementation (operation stage) the required to complete them and the forecast about
Time, cost and performance aspects of the the duration etc. of the future activities.The
project are periodically monitored to know the activity status is incorporated on the network to
status of the project and to plan remedial actions enumerate the project duration and use of float.
if necessary. The frequency of monitoring is Changes required in future work to maintain the
decided based on the following considerations. project duration are planned and new schedule is
a) variations (fluctuations) of the above prepared. Care is taken to follow activities in
aspects critical path and also the near critical activities
b) criticality of changes (with less float) closely.
c) sensitivity of the changes on the total
project expectations
money required to complete them. It can then be
COST plotted against planned cost to see the under-run
or over-run of expenditure as on date and also a
Cash/expenditure budgets are prepared on the forecast of total project cost variation.
basis of the activity schedule. An interesting Separate proforma have to be used to evaluate
feature of the budget is that for desired project the project cost for (i) work done through
duration the cumulative cost or expenditure curve contractors and (ii) work done departmentally.
can be drawn (within limits) for the entire project The report apart from showing the actual cash
duration. Since the critical activities are fixed, outflow, includes the cost of work completed but
one curve can be drawn by scheduling all non- not paid yet (liability) etc.
critical activities to start on their earliest start Apart from controlling the total project cost it is
dates and another curve by scheduling them to also necessary to generate information about
start on their latest start dates. In both cases the high cost activities (may not be in critical path)
curves are drawn by identifying the number of and control them to ensure effective cost control.
activities to be carried out in the month, the total The high cost activities are identified through
expenditure for the month and accumulating this ABC analysis of individual activity costs.
monthly expenditure for the subsequent months.
The monthly cumulative expenditure when PERFORMANCE
plotted on a graph against time in X-axis takes
the form of an Hysterisis Loop The comparison of planned cost and actual cost
allows the project leader to know only the
Whatever may be the schedule of the non critical consumption pattern of money and other
activities, the project cumulative cost will fall resources. It does not provide any knowledge of
within these curves only. Use of this curve performance of the project; the value of work
permits adoption of control by exception principle. completed. To get a clear picture which could
The cost control system necessitates an activity- lead to meaningful decisions, the cost curves
wise expenditure booking and reporting system. should always be seen along with the
The report should indicate the amount already performance curve or the 'value of work'
spent on each activity and a forecast of balance curve/report.
National Productivity Council 43
 PERT Applications

The performance curve is prepared on the basis on the basis of percentage of work completed
of the periodical performance sent from field. The (and not just the payment made).
field reports give the quantum of work completed

The information is then compiled at the project

monitoring cell with due weightage to the
individual activities (if the reports are on the basis
of percentage of work completed. In case the
performance are presented in terms of standard
cost, then they may have to be simply added to
get the performance status. The figure 2 shows a
typical curve.

UPDATING

Based on the Time Cost performance reports

compiled the project cell updates the project. The
changes are incorporated in the project network
to forecast the probable variations in the project
duration, cost of project, mile stones etc.
Remedial measures are then developed in
consultation with the project personnel to reduce
the delay in project and the overrun of total
project cost. With the recommended changes the
project duration and cost are estimated and also
the new activity schedules are released.
This process of scheduling, reviewing and
updating is continued till the completion of the
project.

National Productivity Council 44

 CSCR

CSCR- IMPROVING CAPITAL PRODUCTIVITY OF PROJECTS

In the early part of 1990s, one of the world's Carter says that using CSCR methodology
leading industrial companies was considering the across a wide band of industries, it is possible to
construction of a new plant which was to cost identify capital savings in the order of 20 to 45
well in excess of half a billion dollars. However, per cent. What's more, it recognised the potential
senior management and the board were to boost revenues and reduce operating costs.
uncomfortable with the project's overall Overall, expected net present value was
economics and decided to fundamentally rethink improved by a range of 35 to 80 per cent of the
the investment. Two years later, the plant was initial proposed capital.
opened at a capital cost of $350 million, 40
percent below the estimate first proposed. Getting to the root of the problem:
Capacity is the same as originally planned, but
production unit cost is 30 per cent lower than the To instigate CSCR, CEOs must first recognise
company's other operations and control over where and how much value is lost. "Our
product quality - a key factor in customer experiences reveal two fundamental mistakes
satisfaction - is considerably better. What's more, that prevent companies from making the most of
the plant is more compact and much simpler to their major investments: senior executive input
operate and maintain. It wasn't any slight of hand, and inappropriate functioning of project teams,
although it looked like one. There was no says Carter." The first mistake occurs early
revolutionary technology in place, nor were there in the piece when the project is still being
any change in product mix specifications. what conceived. In order to get a better feel for what's
did change was the management's attitude and involved, top management will ask a team to
approach to the project based on its recognition conduct some form of pre-feasibility study. In this
that more value could be extracted. And it did initial work, some crude assumptions include
demonstrate the precept that management's choice of market, overall product specifications,
insight and determination could dramatically basic technology, target capacity and time of
improve the productivity of capital spent on major market entry all strategic, senior management
projects. level choices. It is on the basis of these crude
assumptions the project looks feasible, the team
McKinsey principal Jeremy Carter from the firm's is encouraged to proceed and the excitement
Melbourne office has done some interesting work starts to build.
to build a new methology- Clean Sheet Capital
Redesign (CSCR)- which has the potential of Explains Carter, "Too little attention and effort is
transforming major capital projects and enabling then paid to revisiting the early, big assumptions.
your firm to get a lot more out of your major Instead, the project team moves on quickly to
projects. working on the assets rather than concentrating
on the business." As a result, the major strategic
In fact, it may be a hometruth. But CEOs in assumptions are not fully optimised even though
capital intensive industries have begun to they have the greatest impact on the net present
recognise that capital productivity is often the key value of the project. Companies pay a huge price
to profit and growth. The degrees of freedom to for too few or ineffective iterations between the
improve a project's economics are much greater project team room and the board room.
before the first sod has been turned after the
plant has been built. Conversely, even the best The second problem becomes obvious later in
operations manager cannot extract enough value the overall process. Large design teams are
from labour productivity to compensate for a pulled together but they just don't function as if
poorly located, poorly designed plant. Says they are supposed to make money for
Carter, "It is not surprising then, to see superior shareholders. As Carter says, "The objective
market performance in capital-intensive function they work to does not focus attention on
industries correlate strongly with productive use the business (as opposed to the engineering)
of capital." In pulp and paper, one high- implications of changes made." As a result,
performing company owes its success to making sure the plant works and staying on
systematically challenging the cost of bringing schedule starts to predominate in the team's
new capacity on stream. During the last 15 years, thinking. Problems start to get resolved by adding
this company's new plants have beaten industry- a little extra to the design, little extras that swiftly
accepted norms for capital cost per tonne of add up and compound. In addition, a lot of great
annual capacity by an average of 20 per cent. In ideas are put aside 'for now' and unfortunately
electric utilities, total returns to shareholders are 'forgotten' until it is too late.
strongly correlated with asset turns, again
proving the value of making capital work hard.
National Productivity Council 45
 CSCR

The standard reductionist approach to project project's life: Business redesign, process
complexity is not conducive to economic break redesign and engineering redesign.
through thinking. Project team structures • Business redesign
encourage independent thinking by breaking the Building a brilliant business case: Business
overall design into pieces that can be assigned to redesign is about superior strategy. The
individuals. Many project engineers have learnt to objectives are to
be comfortable with this way of working. They 1 Craft a value creating link between target
then find it frustrating to have their judgement markets and resources and
challenged and to be required to explicitly 2 Optimise an internally consistent set of major
evaluate the risks associated with ideas. Lots of commercial decisions
opportunities to improve a project's economics
are foregone as a result. To put it simply, Business redesign is about
Project teams tend to suffer from having a single, devising a superior strategy. The business case
technically oriented frame or reference or is subjected to intense scrutiny by senior
'literacy'. This is not surprising, since most team management before the project team is allowed
members have a very similar engineering- to indulge in working on the assets. By
intensive background. The net effect though, is multiplying and accelerating the iterations
that any project engineers are far more between the broad room and project team room,
comfortable with mass-flow balances then with senior management can put a lot of emphasis on
NPV trade-offs. In addition, they often resent the key levers of value creation. In some cases,
having commercial people question the economic this might mean not owing, not even building, any
consequences of engineering decisions since the assets.
'bean-counters' don't understand the technical • In process redesign
implications of design choices. A sound The challenge is to match the project scope
engineering or technical 'literacy' is an absolute tightly with the optimised business case. The size
pre-requisite for success; it is not sufficient, and nature of the project's major component
however, to create great new business. pieces are redefined in the light of a more
• But there's hope round the corner. Insufficient focused strategy. In addition, interface
top-management input and inappropriate inefficiencies are eliminated.
functioning of project teams can be • Engineering Redesign
addressed with a systematic rethink of what a Ensures that the third and final phases of the
company is planning to build and why. The project's life is highly structured commercial, as
aim of Clean Sheet Capital redesign is well as technical, review of every aspect of the
simple: to extract maximum returns from a project. Here, the objective is to relentlessly
given project. Starting with a clean sheet, tighten the screws on the unnecessary costs that
management can focus the project team on all too often creep in during the detailed
the major value levers, rather than simply engineering work.
trying to fine-tune what has been presented to
them. Fundamental redesign, however, A major project like Australia’s North West Shelf
requires fundamental shifts in project Gas Project which cost the partners A$12 billion -
management processes. Enhanced project is a strategic conduit linking an uncertain
management processes are necessary: resource to uncertain resource to uncertain
Most companies recognise three broad phases in markets. The market for LNG in Asia is uncertain
a project's life prior to construction. An initial because economic growth rates are
business concept phase is followed by a period unpredictable; nations adjust their preferred mix
during which the project scope is tightly defined. of imported fuels from time to time; and a pan-
Once the scope is finalised, detailed engineering Asian network of gas pipelines remains a
is carried out. The Clean Sheet Capital Redesign possibility. The resource is inherently uncertain
methodology seeks to dramatically improve the because reserves are never really fully known;
effectiveness - measured in terms of shareholder geological anomalies may make extraction more
wealth creation - of these phases. Thus, CSCR is difficult and more expensive than expected; and
a suite of mutually reinforcing management adjacent deposits may be discovered. Getting the
processes that apply at different stages of a assets in between right is no mean feat,
especially when they cost billion of dollars.

National Productivity Council 46

 CSCR

National Productivity Council 47

 CSCR

The selection of a site for a major new plant about limiting the proliferation of ugly steel
illustrates the challenge of optimising an structures across the country.
internally consistent set of major commercial In most cases, of course, fixed assets will be
decisions. One site may be optimal from a cost of necessary to create a new business. Explains
energy standpoint. Another may offer an Carter, However, there is still considerable
attractive cogeneration opportunity or provide benefit to be derived from challenging the
access to cheaper raw materials. Yet another timings, volume and sequencing of market entry."
may beat them all because of infrastructure Players in the pulp and paper industry have long
support and tax regime that the host government suffered from lemming-like capacity additions as
is willing to provide. Too often, project teams are prices rise in the business cycle. One company
in a hurry to choose a site so that they can get on which out-poerforms the pack of capital
with the engineering. However, early commitment productivity has bucked the trend by making
to a location substantially weakens the project counter cyclical investments in capacity and by
owner's negotiating position with other requiring that assets earn satisfactory returns
stakeholders. Such uncertainties confronted the under the most adverse business circumstances.
project teams considering the timber plant, the A telecommunications project team developing a
mines, the refinery and even the broad-based network discovered that the
telecommunications network. Insufficient senior revenue potential for different nodes varied by a
management attention meant that some of the factor of two while the construction costs varied
most critical trade-off decisions in the life of the by a factor of five. This insight caused a complete
project were being resolved at the wrong level in rethink of the sequence in which the nodes were
the organisation. Conversely, bringing the built across the country.
respective companies' best intellect to bear at Each of these changes to the business case was
this stage yielded superior strategies. worth many tens of millions of dollars to the
project owners. All of them originated from a
The key to major improvements were fundamental shift in mind-shift from 'we build big
• Challenging the need for assets to create a projects' to 'create great business'.
business
• Streamlining business systems for selected Streamline the business system for
customers selected customers
• Extracting full value from flexibility
There is a tendency for project teams to think of
Think business, not assets the plant's output as a commodity that cannot be
differentiated. As a result, too little attention is
A project team almost invariably starts work devoted to customer selection and to tailoring the
thinking about the assets. What are we going to business system. The designers of an Australian
build, and how big will it be. An examination of medium density fibreboard (MDF) plant
the business case underlying project proposals, concluded initially that they should focus on the
however will question whether the assets should local market because MDF exporters were
even be built. Sometimes there is a better getting poor margins. Then they found one
alternative to capital investment as a means of competitor - a Japanese timber and housing
market entry. construction company - doing much better. This
company has recognised the needs of Japanese
The project team at the telecommunications households for compact furniture and fittings. The
company began questioning whether it really business system has been configured
needed to build an entire new mobile phone accordingly, all the way back to forests in New
network. Could it not share at least share part of Zealand. Forestry practices are designed to
a competitor's infrastructure. The apparent deliver the right density of wood. Plant
obstacles were the need to differentiate service configuration is optimised to Japanese building
to customers, competitor's unwillingness to co- sizes. Logistics strategies aim to minimise
operate and regulatory objections. On transport and handling costs, and end-market
investigation, however, none of these obstacles distribution avoids the traditional Japanese
proved insurmountable. Service differentiation did intermediaries. A 30 per cent reduction in
not depend on building a separate network and delivered costs has resulted from this meticulous
one competitor actually welcomed the prospect of attention to detail. In addition, a price premium is
earning extra revenue from renting out spare achieved as a reward for consistency of product
capacity on less used parts of its network. For its quality.
part, the regulator understood that competition Application of these concepts fundamentally
did not depend on each player owning its own enhanced the Australian MDF plant's economics.
network in totality and was much more concerned

National Productivity Council 48

 CSCR

Streamline the industry chain "The CSCR approach places a lot of emphasis
on hunting out lazy capital and optimising across
Coal is typically viewed as a pure commodity, interfaces. CSCR also seeks to identify low cost
with little opportunity for tailoring products to solutions to managing risk. Finally, it requires that
individual customers. Received wisdom in the competitiveness be proven, rather than assumed,
company developing a coal deposit in Indonesia before an activity is set up inhouse.
was that no power station would be willing to
enter into a sole supplier relationship. Capacity is a major driver of capital cost. This
Nevertheless, the project team recognised that means capital spend can be reduced by avoiding
this type of relationship was the key to unlocking bottle-necks wherever possible and using
the economic benefits of low ash fuel. The theory capacity to full. It is unrealistic, of course, to
is quite simple. A new power station that uses a imagine that a plant will never suffer from bottle-
single source of low ash coal can avoid a lot of necks; capacity expansions, technological
expensive handling and particulate removal developments and unexpected production
equipment. The lower ash handling and waste challenges are bound to throw the system out of
disposal load also reduces operating costs while balance at some stage during the life of plant.
availability is improved because slagging Nevertheless, due attention to lazy capital during
decreases. the process redesign phase will pay dividends in
three important ways. First, it will minimise the
Extract full value from flexibility amount of capital that is planned lazy. After 10
years on the drawing board, the technical experts
Left to its own devices, a project team is likely to were convinced that the main circuit in the
deal with the uncertainty at each end of the chemicals plant had been optimised. Undaunted,
strategic conduit by building more flexibility into the project team used a dynamic model to
the project design. This added flexibility is likely stimulate operations over several years,
to be expensive and occasionally it misses the incorporating uncertainties such as unplanned
mark. Senior management input on what really maintenance. A wide range of capacity, spring
matters and clever use of information technology surge and maintenance schedule combinations
can often allow more value to be extracted from were investigated. Many size adjustments
an asset. resulted - most of them downwards - and a
number of unnecessary surge items were
A timber project team, realised that profitability eliminated. The base case design was improved
would be enhanced if the traditional emphasis on by $ 40 million (Australian) without any operating
throughput was shifted to maximising the return risk.
from each processed log. Accordingly, they
developed a simple optimisation tool that Anticipating future expansions is a second major
combines information from three sources - log source of lazy capital. In one, situation, the
availability by grade, spot prices for final design team had to work out how to cope with a
products, and customer order status. This allows doubling of volume through the pipeline linking
instant decisions on optimal log and cutting the plant to its shipping port, three of four years
pattern selection. It also provides critical input to into the project's life. The conventional response
felling and pruning decisions in the forest. Some would be to increase the diameter of the pipe.
minor capital savings were made in equipment However, the CSCR philosophy resents waste
selection and plant layout. More importantly, and team members were concerned about the
though, all key aspects of managing the business pipeline working at half capacity in its first few
can now be adapted constantly to changing years. The sequential introduction of viscosity
market conditions allowing higher profits to be modifiers and higher-pressure pumps minimised
generated. lazy capital and improved project NPV by 10
million dollars.
HUNTING OUT LAZY CAPITAL Fibre trunk routes in a typical broadband network
carry telephone traffic and video signals from the
During the second phase of CSCR, process telephone switch and the cable head-end out to
redesign, the challenge is to match the project nodes for local distribution. To provide basic
scope tightly with the optimised business case. services such as multi-channel TV and standard
The changes to the business case almost telephony these trunk route require only limited
invariably require a serious rethink of the bandwidth (500 Mhz analogue for TV and 0.5 -
proposed flow sheet. This starts with a review of 1.0 Gbit/sec) for telephony. However, in a future
each of the major component pieces and world of true video-on-demand, 500 times more
progresses to the task of optimising the entire capacity would be needed. For this reason,
system. In an interview with The Strategist, network designers like to include a spare section
McKinsey principal Jeremy Carter, one of the of plastic duct in each trunk route to allow for
initiators of the CSCR methodology, explained, future capacity requirements. This is costly,

National Productivity Council 49

 CSCR

especially when the extra space required to costs, lower plant utilisation and a serious
house more than a single duct forces reduction in control over the quality of the
construction beyond the pavement and into the product. Today, the mine operates with a larger
street. number of smaller trucks than originally
envisaged. The project's owners are better off to
More often than not the capacity precaution is the tune of about 50 million dollars. The timber
completely unnecessary, In a dedicated 10 plant team realised it should hold inventory in
Mbit/sec path between the head-end and every partly processed form as 'master batches' in the
home passed by the network. This is enough centre of the plant rather than as a finished
fibre to meet expected future needs. For those product. As a result, predicted inventory stocks
who are concerned about future needs that have were slashed by 60 per cent, a six million dollar
not been thought of, developments in warehouse was eliminated and customer service
multiplexing telephony traffic (wave division is improved with much faster lead times.
multiplexing and synchronous digital hierarchy)
promise to make efficient use of basic fibre MANAGE RATHER THAN SUBMIT TO
capacity. The latest research on pure optical RISK
amplifier suggest that the ultimate capacity of a
single fibre could be 1,000 times greater than the As project firms upend the team gets a clearer
1 Gbit/sec available today. picture of the assets that will be put on the
Project start-up, a notoriously difficult period of ground, the tension builds up to `sign off on the
some new operations, is a third major source of scope'. Unfortunately, some of the uncertainties
'lazy' capital. Past experience of problems at this persist. All too often, the way that a team deals
stage often leads companies to allow for them in with these residual risks is to throw money at
both their schedule and economic projections, so them. Alternatively, plants may be designed to
that a lengthy startup period becomes a self- meet a single set of projections about demand
fulfilling prophecy. In semiconductors or zinc and product specification. This leads to a fixed
mining, to cite two examples, plants can take cost components that cannot be tailored to
several years to reach full capacity - which is variations in demand, and highly specialised
plenty of time to have a major impact on the process and equipment which are difficult to
project's economics. The problem is that the best adapt if customers' need change. Both of these
practice is poorly documented, which means approaches to risk are sub-optimal. Getting a
operators of each new plant have to reinvent the better answer depends on improving the dialogue
wheel. Yet with the benefit of hindsight, many between management and project engineers.
start-up problems anew quite avoidable. Poor This generally requires two changes in
circuit designs can be identified with system management's approach as illustrated by one
dynamics models of material flow; construction mining project team. First, engage the the project
contract specifications can prevent the use of team in discussing options rather than
inferior components; specialist start-up managers recommendations. Second, concentrate the
and a few additional employees can overcome team's effort on reducing the risks associated
specialist staff and skill shortages during a start- with low-cost options.
up up period. Even a modest improvement to the
proposed learning curve was worth $ 60 million to STEP 1
the owners of a metallic concentrate project.
Learning while a plant is up and running is The initial plant design submitted to management
unnecessarily expensive ! had a conventional flow sheet with three distinct
crushing stages. This was characterised by the
OPTIMISE ACROSS INTERFACES project team as `low cost low risk'.... and
management was left wondering whether there
Taking a total system perspective, a mining were no better alternatives. There were, but
project team changed its initial decision to management needed to ask to disuss the other
purchase, a mining project team changed its options that had been considered and discarded.
initial decision to purchase 240 tonne haulage In particular, advances in crusher technology and
trucks. The original recommendations recognised the relatively friable ore in the deposit indicated
the superior economics of the largest trucks in that two crushers should suffice.
the world in transporting ore from the pit to the
processing plant. However, the very large haul STEP 2
loads required the plant being designed as a
batch rather than continuous process. The knock On paper, the two crusher option was clearly
on effects were both insidious and severe. The more attractive for shareholders. Yet doubts
most obvious interface problem was a 15 million remained as to whether product quality would be
dollar intermediate stockpile. Beyond this, acceptable to customers. Management broke the
however, were higher operating and maintenance

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 CSCR

deadlock by encouraging the project team to design the plant's layout to allow the third
crusher to be retro-fitted if it were needed The and process redesign phases will make a lot of
cost to the project of buying the option was half a them redundant. It is only in this third and final
million dollars. The original design, complete with stage of CSCR that the project team is finally
three crushers, would have cost an extra $10 allowed to turn its attention to the nitty-gritty. The
million in front capital. By the way, the mine is engineering redesign process challenges the
now operating and the two crushers do the job project team to submit every component to a
just fine. rigorous fit-for-purpose test. It also seeks to
establish a set of fresh activity-based bench
OUTSOURCE NON-CORE ACTIVITIES marks so that designs keep abreast of best
practice.
The conventional approach to big projects,
especially in remote areas, is for the project Design fit-for-purpose components
owner to build, own and operate the whole box
and dice. Though out sourcing has become It is very easy to be glib about the concept of fit-
common practice in some industries, the owners for purpose. Most people assume that their
of heavy plant underestimate its value. Mining designs already match this description.
companies, for example, have long been Unfortunately, their confidence is often misplaced
accustomed to owning, driving and maintaining either because of a tendency to allow a bit extra
haulage trucks as an integral part of their into the design to 'just to be sure', or because this
business. The weight of evidence, however, design is based on ill founded assumptions or
suggests that specialist contractors can be unquestioning of historical practice. Why, for
leaner, hungrier and more cost effective in example, build a railway line that can withstand a
carrying out this set of activities. Since the ore is once-in- 100 year flood when the plant's life is
moved but not transformed during the process, only 15 years and a rapid response capability can
the mining company losses none of its distinctive be counted on. Why waste time incorporating
knowledge provided it retains control of day-to- extra functions in a control dependent that
day mine planning. At one new mine, the NPV operators have no intention using? Why build
benefit of outsourcing the hauling function was walkways on both sides of a conveyor belt if a
estimated at $ 20 million. In our chemicals single walk way is safe and functional?
example, the initial capital estimate included $ 30
million for a lime calcination facility. Sourcing the Benchmark the way things get done
lime from a producer that could achieve
economies of scale represented an attractive The march of time can play tricks on the most
deal for both parties. The chemicals company experienced and capable of project designers.
was able to deter expenditure and improve NPV Major projects are relatively infrequent events so
by $ 10 million. it is not uncommon for people remember a
Systematically examining outsourcing options decision but forget the detailed assumptions
invariably results in a project that is more which under-pinned it. The initial design that a
competitive in the long run - whether or not a thrown together quickly in a pre-feasibility study
specific function wins up in-house. More is far more likely to reflect earlier assets than
importantly, perhaps, outsourcing frees up capital earlier thought processes. Since the technical
and management attention to focus on what the and managerial disciplines advance rapidly all
company is good at and can make money from. the time, relying on what you did last time rather
One major energy company systematically sells than why you did is fraught with danger.
down its equity in established power stations so
that it can invest the capital in the early stages of NOT A PANACEA
new projects.
CSCR is not a quick fix for a project that is
ENGINEERING REDESIGN; TIGHTEN THE struggling to get the board's approval. It is a
SCREWS ON UNNECESSARY COSTS methodology that allows management to begin a
revolution in the way organisations think about
The third phase of CSCR, engineering redesign, their capital spending. This revolution requires
is a highly structured commercial, as well as project teams to embrace radically different
technical review of every aspect of the project. norms of performance, which in turn requires
Here, the objective is to relentlessly tighten the intense attention and consistent support from
screws on the unnecessary costs that all too senior management. Throughout, the team's
often creep in during the detailed engineering attention has to be focussed on making money
work, when the team is under pressure to make for shareholders, and tight management systems
sure the plant works and the project stays on will be required to capture, manage and
schedule. Detailed drawings should be avoided implement ideas for improvement.
up until this point because work in the business
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 CSCR

Embarking on a CSCR effort is therefore not a capital project to life is a people intensive
proposition for the faint-hearted. Bringing a big
process. Accepting the CSCR challenge is, in intensive industries, CSCR could be the single
effect, to embrace a major change program. Our most important lever for increasing shareholder
case studies suggest, however, that the prize will value.
be well worth the effort. For many firms in capital

National Productivity Council 52

 ZOPP

ZOPP - Objectives Oriented Project Planning

ZOPP is the acronym of the German term
* Z iel = Objectives
* O rientierte = Oriented
* P rojekt = Project
* P lanung = Planning

ZOPP is a set of PROCEDURES AND INSTRUMENTS (for objectives-oriented project planning)

ZOPP planning technique is the GTZ"s official project planning system

ZOPP OBJECTIVES

ZOPP was introduced in the GTZ:

•
• To define realistic and definite objectives which can be sustained in the long-term
• To improve communication and cooperation between project, head office and counterpart
organization by means of joint planning and clear documentation/definitions
• To clarify the scope of responsibility of project teams
• To provide indicators as a basis for monitoring and evaluation

ZOPP APPLICATION

* ZOPP is one workable system

* ZOPP is an open system
* ZOPP is as good as the planning team
* ZOPP generates a consensus of different opinions through the planning process
* ZOPP needs realistic application

FEATURES OF ZOPP
1. Gradual procedure through a sequence of successive planning steps
2. Permanent visualization and documentation of all planning steps
3 Team approach

MAIN STEPS OF ZOPP

1. Steps of Analysis

* Participation Analysis
* Problem Analysis
* Objectives Analysis
* Alternatives Analysis

2. Project Planning Matrix

* Objectives/Activities
* Important Assumptions
* Objectively Verifiable Indicators
* Means of Verification

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 ZOPP

PARTICIPATION ANALYSIS

• Gives an overview of all persons, groups, organisations and institutions connected with the
project in any way
• Incorporates the interests and expectations of persons and groups significant to the project

HOW TO DO IT
a) Write down all persons and groups connected with or influenced by the project
b) Categorize them (e.g. beneficiaries, target-groups, actors etc.)
c) Characterize and analyse
d) Identify consequences for the project work (e.g. reactions of project)

DETAILED PARTICIPATION ANALYSIS

Characteristics of the Group

- social characteristics (members, social background, religion, cultural aspects)

- status of the group (formal, informal or other)
- structure (organisation, leaders, etc.)
- situation and problems - group's point of view Interests, motives, attitudes
- Needs and wishes
- Interests (openly expressed, hidden, vested)
- Motives (hopes, expectations, fears)
- Attitudes (friendly/neutral/hostile attitude towards implementing agencies and other
groups)

Potentials:

- strengths of the group (resources, rights, monopolies etc.)

- weaknesses and shortcomings
- what could the group contribute to or withhold from the project
Implications for the Project Planning
- in which way should the group be considered?
- which actions should be taken(in regard to the group)?
- how should the project react towards the group?

PROBLEM ANALYSIS

Is a set of techniques to
- analyse the existing situation surrounding a given problem condition
- identify the major problems in this context
- define the core problem of a situation
- visualize the cause-effect relationships in a diagram (problem tree)

HOW TO DO THE PROBLEM TREE

Step 1 Identify major problems existing within the stated problem situation (brain-storming)
Step 2 Write up short statement of the core problem
Step 3 Write up the cause of the core problem
Step 4 Write up the effects caused by the core problem

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 ZOPP

Step 5 Form a diagram showing the cause and effect relationship in the form of a problem tree
Step 6 Review diagram as a whole and verify its validity and completeness.

Note:
1. Word problems as negative conditions
2. One problem per card
3. Identify existing problems, not possible, imagined or future ones
4. A problem is not the absence of a solution, but an existing negative state.
5. The position on the problem tree does not indicate the importance of a problem.

PROBLEM ANALYSIS: BUS EXAMPLE

Loss of confidence in
bus company
EFFECTS

Passengers hurt or killed People are late

CORE PROBLEM Frequent bus accidents

Drivers not careful Bad conditions of vehicles Bad road conditions

CAUSES
Vehicles too old No ongoing maintenance

OBJECTIVES ANALYSIS
Is a set of techniques to:
- describe the future situation that will be achieved by solving the problems
- identify potential alternatives for the project.

HOW TO DO THE OBJECTIVES TREE

Step 1 Restate all negative conditions of the problem tree into positive conditions that are:
- desirable and realistically achievable
Step 2 Examine the "means-ends" relationships thus derived to assure validity and
completeness of your diagram
Step 3 If necessary:
- revise statements
- add new objectives if these appear to be relevant and necessary to achieve the stated
objective at the next higher level
- delete objectives which do not seem to be expedient or necessary.

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 ZOPP

Objectives analysis: Bus Example

Customers have a better image of the

bus company

Less passengers hurt Passengers arrive at scheduled time

Frequency of bus accidents

considerably reduced

Drivers drive carefully Vehicles kept in Road conditions

and responsibly good condition improved

Old vehicles are regularly Vehicles regularly maintained and

replaced checked

"MEANS - ENDS RELATIONSHIPS"

ALTERNATIVES ANALYSIS
Is a set of techniques to
- identify alternative solutions which could be project strategies
- select one or more potential project strategy
- decide upon one strategy to be adopted by the project

HOW TO DO THE ANALYSIS OF ALTERNATIVES

Step 1 Identify objectives you do not want to pursue (not desirable or achievable)
Step 2 Identify differing "means and ends" ladders, as possible alternative project strategies or
project components
Step 3 Assess which alternative in your opinion (criteria) represents an optimal project strategy
by using criteria such as:
- resources available
- probability of achieving objectives
- political feasibility
- cost benefit ratio
- social risks
- time horizon
- sustainability etc.

PROJECT PLANNING MATRIX (PPM)

The PPM provides a one-page summary

WHY a project is carried out
WHAT the project is expected to achieve
HOW the project is going to achieve these results
WHICH external factors are crucial for the success of the project
HOW we can assess the success of the project
WHERE we will find the data required to assess the success of the project
WHAT the project will cost.

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 ZOPP

PROJECT PLANNING MATRIX

Summary Objectively Means of Important

of Objectives/ Verifiable Verification Assumptions
Activities Indicators
Overall
Goal

Project
Purpose

Results/
Outputs

Activities

ASSUMPTIONS

Definition:

Conditions that must exist if the project is to succeed but which are not under the direct control of
the project:

How to word the assumptions:

- assumptions can be derived from the objective tree

- assumptions will be worded as a positive condition(c.f. objectives)
- assumptions will be weighted according to importance and probability

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 ZOPP

ASSESSMENT OF ASSUMPTIONS

1st Question: "Is the assumption important?"

No
Don't include this one

Yes

2nd Question: "How likely will it occur?"

Almost certain Don't include this one either

Quite likely Put this assumption into your PPM

Project management must monitor it
Not likely

3rd Question: "Can the project strategy be (re-)designed to make this assumption
superfluous?"

No Killer assumption!
Warn decision makers!
Stop!
Yes
Redesign project!
Plan activities to influence assumptions or make them superfluous

OBJECTIVELY VERIFIABLE INDICATORS (OVI's)

- Objectively verifiable indicators define the performance standard to be reached in order

to achieve the objective
- They specify what evidence will tell you if an overall goal, project purpose or result/output
is reached
in terms of
- quantity How much?
- quality How well?
- time By when?
- location/area Where?
- They focus on important characteristics of an objective to be achieved
- They provide a basis for monitoring and evaluation.

OVI's - Steps
Objective: Agricultural production increased

Step 1 Identify indicator: e.g. smallholders increase rice yields

Step 2 Quantify: 10.000 small holders (owning 3 acres or less) increase production by 50 %
Step 3 Set quality: while maintaining same quality of harvest as 1983 crops
Step 4 Specify time frame: between October 1984 and October 1985
Step 5 Set location: Umbia province

COMBINE: 10,000 small holders in Umbia province (owning 3 acres or less) increase their rice
yield by 50 % between October 1984 and October 1985, maintaining the same quality of harvest
as 1983 crops.
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 Theory of Constraints

MEANS OF VERIFICATION (MOV)

Tell Us:
• Where we get the evidence that the objectives have been met
• Where we can find the data necessary to verify the indicator
• Some important questions:
• Are the MOVs available from normal sources? (statistics, observation, records)
• How reliable are the sources?
• Is special data-gathering is required?
• If so, what will it cost?
• Has a new source to be created
If we cannot find an MOV, the indicator has to be changed!

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 Theory of Constraints

THEORY OF CONSTRAINTS

Q: What is the Theory of Constraints? Q: Who is Dr. Goldratt?

A: In broad brush, the Theory of Constraints A: Goldratt is a physicist by education and a
(TOC) is about change and how best to business consultant by profession. His
effect it. More specifically, TOC is a set of theories talk about how to improve
management principles that help to identify manufacturing processes by finding the
impediments to your goal(s) and effect the "bottle- necks in the manufacturing process
changes necessary to remove them. TOC and then exploiting those bottlenecks to
recognises that the output of any system either increase the flow of product through it
that consists of multiple steps where the or bypass it with other systems. He talks in
output of one step depends on the output of terms of throughput (money coming into a
one or more previous steps will be limited business), inventory (the money inside the
(or constrained) by the least productive business) and operating expenses (the
steps. In other words, as paraphrased in money it takes to get inventory turned into
"The Goal", the strength of any chain is throughput. He also talks about problem
dependant upon its weakest link. Where solving -- determining what to change, what
manufacturing is concerned, TOC postulates to change to and how to change using
that the goal is to make (more) money. It current reality trees, future reality trees and
describes three avenues to this goal: 1. the Socratic method. The current reality tree
Increase Throughput 2. Reduce Inventory 3. cuts through the symptoms of a problem to
Reduce Operating Expense As Dr. Goldratt find the core problems. The future reality
notes, the opportunities to make more tree is created by evaporating clouds -- by
money through reductions in Inventory and finding assumptions behind the objections.
Operating Expense are limited by zero. The Then the Socratic method is used to find
opportunities to make more money by ways to overcome those objections
increasing Throughput, on the other hand,
are unlimited. More than that, though, TOC Q: What's a constraint?
challenges us to define a goal and re- A: It is any resource that prevents you or
examine all of our actions and your organisation from increasing
measurements based on how well or how throughput. Technically it is anything that
poorly they serve it. This is done through a prevents you from achieving a higher
set of tools including, o The Socratic method performance relative to the goal. Something
o Goldratt's five focusing steps o might not limit T but might cause OE to
Evaporating Clouds o Reality Trees that increase inordinately and be a constraint
help us identify and resolve bottlenecks. (e.g. environmental legislation). There are
three types of constraints, resource, market,
and policy.

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 Theory of Constraints

Q: How does Goldratt define a Jonah is someone who has completed the
"throughput"? Goldratt Institute's two-week Jonah course,
A: In "The Goal", Jonah defines Throughput during which the Jonah learns how to apply
as the rate at which a system generates the five thinking process tools and the
money through sales. As Jonah points out categories of legitimate reservations. A
here, it is critical that we distinguish sales Jonah also applies those tools with at least
from production: While manufacturing some regularity.
operations traditionally measured production
at each stage of production, the only Q: What is "The Goal"?
Throughput that counts is that which comes A: In a concrete sense, it is the title of Dr.
off the end of the line to be sold. Why? -- Goldratt's first book on the Theory of
this serves the goal (see above). Constraints. In that book, the narrator -- Alex
Mathematically, we express Throughput as Rogo -- defines the goal of his
Sales minus the raw material inventory manufacturing company as making money.
content of the sales. In generic terms, Working with an accountant, he settles on
Throughput is a quantitative measure of the three measures for this goal: net profit, ROI,
entity that the organisation seeks to and cash flow. More recently, the goal for a
maximise. Another way of defining profit-making business has been defined as
Throughput as, "The rate at which the making more money both now and in the
organisation creates added value to its future. Also, we have recognised that cash
owners".However, added value is flow is not a measure of the goal but is a
sometimes limited by the global interests of necessary condition. This is something that
the owners. This is the case for any you want in certain limits, not too low, not
department within an organisation that does too high, like blood pressure -- a measure of
not contain any global constraint. One may the goal you want always to increase if you
still attempt to produce better quality and can. Achieving as much as possible from an
faster response - but even here the added entity while minimising the cost to produce
value is restricted by the overall quality and the throughput.
responsiveness of the global system. What
is left is to try and do the same with less Q: How does the Theory of Constraints
expenses. For reasons outlined below, define "Inventory" and "Operating
"Throughput" is one of the most critical Expense"?
elements of TOC. A: Inventory is defined as all funds that the
system has invested in purchasing things
Q: Who or what is a Jonah? that it intends to sell. In other words,
A: Jonah is the name of the physicist that Inventory is the current value of all the
advises Alex Rogo, the narrator of Dr. things that the organisation owns and uses
Goldratt's book, "The Goal", as he attempts to create its product or to deliver its service
to identify and solve the problems plaguing to the market.
his manufacturing plant. In a general sense,
Operating expense is defined as all funds
the system spends in order to turn inventory
into throughput.
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 Theory of Constraints

5. Return to step 1 -- don't let INERTIA

Q: Why are these definitions important? become the system's constraint!
A: Throughput, Inventory, and Operational In "What is this thing called Theory of
Expense are the three operational measures Constraints...?" Dr. Goldratt paraphrases
by which the performance of any profit- these steps more generally as,
making organisation is gauged. From these 1. What to change? - Pinpoint the core
measures, one can define metrics with problems!
which to gauge the performance of smaller 2. To what to change to? - Construct
groups (divisions, departments, teams...) simple, practical solutions!
within the organisation. These metrics are 3. How to cause the change? - Induce the
designed so as to make the goal of each appropriate people to invent such solutions!
local group consistent with the goal of the
organisation. Recall that the goal is to make Q: Can explain these steps in a bit more
money. In "What is this thing called Theory detail?
of Constraints...?" Dr. Goldratt states that A: 1. IDENTIFY the system's constraint. If
there are three avenues open to increase you were to pick a single resource to add
our ability to make money: 1. Increase more of, which one would allow you to
Throughput 2. Reduce Inventory 3. Reduce increase Throughput? Physical in nature, it
Operating Expense as Dr. Goldratt notes, will be, Materials...The input to the process,
the opportunities to make more money Capacity.... Insufficient amount of a specific
through reductions in Inventory and resource relative to market demand,
Operating Expense are limited by zero. The Market......Insufficient sales to consume
opportunities to make more money by available capacity Later works deal with one
increasing Throughput, on the other hand, other kind of constraint: Policy .....Any
are unlimited. Recall that Alex Rogo settled internal or external policy that limits
on three measures -- net profit, ROI, and profitability
cash flow. The first two are described 2. Decide how to EXPLOIT the system's
mathematically as follows: constraint. Determine how to work with the
NP = T – OE system's constraint so as to maximise
ROI = (T - OE) / I throughput. For instance, if the constraint is
Where T is Throughput, OE is Operating a specific raw material, it means ensuring
Expense, and I is Inventory that there is no waste of that material. If the
constraint is in sales, it means deciding how
Q: What are the five focusing steps? to capture more sales. If the constraint is a
A: 1. IDENTIFY the system's constraint. specific internal resource, it means ensuring
2. Decide how to EXPLOIT the system's that it is productive all of the time. Jonah's
constraint. on the TOC list note that this is a difficult
3. SUBORDINATE everything else to the process -- squeezing the most Throughput
above decisions. from the system entails strategic decisions.
4. ELEVATE the system's constraint. -- If in They further note that if any derivative of
any of the previous steps, the constraint has cost accounting is used to make that
been broken: decision, it will not be an optimal decision!

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 Theory of Constraints

3. SUBORDINATE everything else to the clouds, are often indistinct (i.e., people are
above decisions. This is the means by which unable to articulate the real reasons for the
the rest of the organisation is synchronised conflict). The "evaporating" part refers to the
with the capabilities of the constraint and the tool's ability to dissipate the confusion
decisions made regarding how to best utilise surrounding the conflict, clearly identify the
it. For instance, if the constraint is a machine key elements, and provide a means for
on the line, you might establish buffers to resolving the conflict.
protect its ability to produce and base the
release of materials into the plant on the Q: How does the Evaporating Cloud
schedule for that constraint and the amount methodology work?
of buffer time that has been established. A: The method makes more sense when it
This is where most of our common is diagrammed visually through example, but
measures in the plant must be changed. By Mr. Dettmer summarises it as follows:
default, every single resource that is NOT Identify FIVE elements of every conflict
the constraint will do severe damage to the (right-to-left): The 2 Prerequisites that
organisation if they strive for 100% directly conflict with one another, the
utilisation. However, that is exactly how they Requirement each Prerequisite is trying to
are measured! satisfy, and the Objective each Requirement
4. ELEVATE the system's constraint. In is necessary to achieve. Diagram looks like
previous steps, you ensure that the "home plate" lying on its side, pointing left.
organisation is optimised via nothing more Unspoken Assumptions are identified
than policy changes. In this step, you are relating to the arrows connecting each
actually altering the constraint. For instance, element of the EC. Solutions are proposed
when the constraint has been a machine in that replace invalid assumptions.
the plant, this is the step in which you will
add physical capacity. You may do this Q: What is a Reality Tree?
through, - reducing set-up and process A: A Reality Tree is a cause-and-effect tree
times - investing in other process (current or future), construction of which is
improvements - overtime - hiring more staff - governed by rigorous rules of logic (eight of
buying another machine or any other action them). It starts with "roots" in a cause of
that removes the constraint. some kind, develops upward through a
5. Don't let INERTIA become the system's "trunk" and "branches" of several layers of
constraint. Once you have "broken" a
intermediate effects, to the "leaves", which
constraint, go back to Step One! This is a
reminder that all of the policies you have are the ultimate effects. In a Current Reality
established in the organisation based on Tree, the "leaves" are undesirable effects,
one con- straint will likely not apply once the and the "roots" are the core problem or root
constraint lies elsewhere!
causes of the Undesirable Effects. Root
Causes constitute " what needs changing".
Q: What is an Evaporating Cloud?
A Future Reality Tree starts with a pro-
A: This is a term used to describe a
posed solution to a core problem at the
methodology developed by Goldratt to
"root", builds upward through intermediate
resolve conflicts in a "win-win" manner.
effects (the "trunk" and "branches") to
Name relates to the idea that conflicts, like
Desired Effects (the "leaves").
National Productivity Council 63
 Theory of Constraints

Giving it Away a good deal more sense than anything

we've done so far," he stated with
"Are you kidding me? Your people are giving enthusiasm. "Bill, can you please tell us a
product away for nothing?" the CFO grilled little about this TOC thing?" inquired Henry.
the marketing director. "How the hell can we "Sure!" responded the marketing director.
make any money if your sales jerks keep "I'd be happy to," he continued. "It's a
driving our costs through the roof?" he different way of thinking about operations,
bellowed in a rage. "John, please! Calm that's all. We've been thinking in terms of
down," urged Henry, hoping to avoid are optimising every aspect of our business, on
play of the Desert Storm campaign in his the assumption that by optimising everything
own office. "I'm sure that Bill has good we're optimising the whole operation. But
justification. Give him a chance to explain, Goldratt shows why that isn't necessarily
"he encouraged. "Bill, what's going on?" so," explained the director. "You mean that
asked Henry as he stepped between his two it's wrong for me to want engineering,
managers. Raising two boys had prepared manufacturing, sales, and distribution to be
Henry well for the CEO's slot. He'd become efficient?" inquired the CFO in a sceptical
a champ at resolving conflicts, and this job tone. "Well, yes and no," responded the
provided him with daily opportunities to marketing director hesitantly. "It depends on
sharpen those skills. "That's what we're how we define efficiency. For example, if we
doing all right," responded the marketing define efficiency entirely in terms of
director. "We're giving away product. But engineering or entirely in terms of
he's way off target with his conclusions," the manufacturing, then we're making a
marketing director continued. "We're not mistake. But if we define efficiency in terms
driving costs through the roof at all," he of the entire company, and if we make
stated with confidence. "How the ***..." John changes in engineering that improve the
began firing again. But the CEO cut him off company's overall efficiency, then we're
in mid-expletive. "Watch your damn doing the right thing, "he explained. "Well,
language in my office, OK?" Henry that's obvious. But we're already doing this.
exclaimed with a straight face. He needed to Why do you think we have a bottom line
diffuse this encounter, if he was going to get anyway?" asked the CFO sarcastically.
any facts out of the discussion. Humor often "This TOC stuff isn't anything new. We're
served him well in these situations. Both wasting our time here," he concluded. The
managers were silent for a second, until marketing director began to feel his steam
they saw the corner of Henry's mouth turn rising. The CFO was a master at
upward. Both smiled in relief as they assassinating new ideas; claiming that an
recognised the CEO's tactic for what it was. idea was nothing new was his most effective
"All right! All right!" sighed the CFO. "I'm murder weapon. He wielded it frequently
going to sit there and not make a sound. But and with great skill. First he would listen to
what I hear had better make da...er... good an idea, and if he wanted it its head for a
sense to me, or we're going to have some trophy he'd simply claim that there was
problems," he observed. The marketing nothing new about it. So why should he
director prepared to explain his marketing bother continuing the discussion? The
tactics. "OK! You know that last month I marketing director braced himself in
attended a course on TOC ,"he began. But it anticipation of the intellectual slaughter that
wasn't long before the CFO interrupted. surely would follow. But Henry wasn't about
"What the *** Sorry! What is TOC to let any opportunity for improving the
pleeeease?" he inquired in an obviously bottom line escape him. "Just a minute,
impatient tone. The CFO was trying to John," said Henry to the CFO. "I want to
maintain control, and Bill and Henry both hear more about this. Bill, please continue,"
could see that he was trying. That was he said to his marketing director. "Tell us
precisely what worried them. "Sorry! TOC more about this Goldrag guy." "His name is
means the Theory of Constraint," clarified Goldratt," observed the director. "His
the marketing director. "It's a new premise is that we can't achieve optimum
management philosophy that simply makes efficiency at the corporate level by focusing
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 Theory of Constraints

on the efficiency measurements of individual fast enough to meet our manufacturing

operations. Unfortunately, that's exactly needs. But for us right now, the constraint is
what we've been doing with our allocated after the system. It's the market," continued
cost model. We've been calculating local the marketing director. "That's why we have
efficiencies, and we've been making to focus on improving market conditions.
business decisions on the basis of local That's also why I've instructed my sales
efficiency measurements," observed the people to offer free samples to potential new
marketing director. "Oh Great!" interrupted customers at every opportunity, so long as
the CFO. "Now we can't calculate costs the free samples don't interfere with the
anymore, because this Goldberg guy says orders of our current customers." "You're
it's not a nice thing to do," he continued freaking nuts!" declared the CFO. "Do you
sarcastically. "His name is GOLDRATT! And know what each of those samples costs
it has nothing to do with being nice or us?" he demanded. "As it is, our margins are
nasty," declared the marketing director. "It thinner than the hair on a gnat's ass. Our
has everything to do with thinking clearly product cost is $12.50 per unit, and our
and effectively," he voiced adamantly as his wholesale price is $13.75 per unit. Every
stare penetrated to the back of the CFO's time you give away one of your samples
skull. "There are plenty of examples where it you're wiping out the profit that we make
makes sense to measure efficiency only in from ten sales. You're nuts!" announced the
terms of the whole system. Look at power CFO. "I have to admit it Bill," interjected
plants. Trying to optimise the efficiency of Henry. "John does have a point. If the
the boiler, at the expense of the turbine or at members of the board find out that we're
the expense of the whole plant would be giving away our profit, I'll have a tough time
idiotic. The only efficiency measurement that explaining to them that we aren't." "But we
counts is that of the entire power plant," he aren't!" stated the marketing director. "We're
continued. "It's the same with a company. not giving away much at all. Look! Are we
Trying to maximise manufacturing's firing anybody?" he asked. "No, we aren't,"
efficiency measurement at the expense of admitted Henry. "But if this continues much
some other operation's efficiency longer we'll have to resort to drastic
measurement is no optimisation at all. It's a measures just to survive." "I understand,"
mirage." "This is interesting," observed stated the marketing director. "But right now
Henry. "Please keep going, Bill." "There's far we're not firing any one. So our operating
too much material for us to discuss in detail expenses are relatively fixed, aren't they?"
here. But there is one aspect of TOC that is "Yes, I'd have to say that they are. Our
very important to us, here and now," payroll represents the bulk or our operating
continued the marketing director. "It's the expenses, and we're not firing any one. So
concept of a constraint. According to our operating expenses are relatively fixed."
Goldratt, every for-profit company is nothing "Good!" stated the marketing director.
more than a complex, profit-generating "We're making progress." "We're making
system. As such, at any time there is only progress toward the poorhouse. That's what
one thing keeping the system from we're doing," added the CFO. "But go
generating more profit. That limiting factor is ahead. You're doing a good job of burying
the constraint." "There's nothing in our your own argument, so don't stop now," he
system that's keeping us from making more urged. The marketing director ignored the
money," interrupted the CFO. "We just need gratuitous comment as he continued. "We
more paying customers, that's all." "Exactly!" also have excess capacity, right now. Isn't
declared the marketing director. "As I found this true?" he asked. "Yes, of course we
out during the TOC course, the limiting have excess capacity," agreed Henry
factor that Goldratt calls the constraint can ."That's the whole problem. Where are you
be either before the system, within the going with this?" "Well! If we have excess
system, or after the system. An example of capacity, and if our operating expenses are
having a constraint before the system would relatively fixed, then what's our real
be a supplier who can't deliver components

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 Theory of Constraints

cost for producing a little more product than are we going to do then, hire more people?
our customers are buying right now?" "I told Won't that increase our operating
you what our product cost was. Are you expenses?" he asked. "That's the whole
deaf?" interrupted the CFO. The marketing point, you stupid *** !" nearly responded the
director tried hard to not react to the CFO's marketing director before catching himself. It
verbal assault, but his patience was wearing took enormous effort to maintain his control
very thin. "That's not the real cost of as he spoke. "The market is our constraint
producing the extra products that we're right now," he said in an obviously controlled
giving away as free samples," responded tone. "We want to give away free samples to
the marketing director. "If we don't produce potential new customers, so that our orders
the samples, then our operating expenses will pick up. When they do, we'll stop making
are x dollars per month. If we do produce the free samples, and we'll make only the
the samples, then our operating expenses products that we sell for a profit," said the
are still x dollars per month. The only marketing director. "Bill, now you calm
additional cost that we incur by producing down, please!" pleaded Henry, who had
the samples is the cost of the additional raw heard the strain in the marketing director's
material that we use in the samples. That's voice. "I think I understand," he continued.
all," he declared. "What's the raw material "So long as we're not interfering with
content of our product?" he asked of the customer orders, we can use any excess
CFO. The CFO paused briefly, trying to capacity that we have to produce samples
recall the information. "Most of our product for the sales people to give away. I can see
cost is labour," he responded. "We don't why this won't increase our operating
have much raw material content in the expenses," added Henry. "But what
product. It's about$1.50," said the CFO. happens if our current customers find out
"Then we're giving away $1.50 every time that we're giving away product? What's to
that we give away a free sample. We're not prevent them from asking for free samples
giving away $12.50, which is what you said too?" worried Henry. "That could happen,"
earlier," reminded the marketing director. admitted the marketing director. "If our sales
"Bill, I'm a little confused," said Henry as he people gave samples away to everybody, or
requested clarity. "We have a high labour at random, then some of our current
content in our product. Yet you're telling me customers might ask for them regularly,
that we're giving away only the raw material forcing us effectively to offer discounts. But
cost with every sample. Aren't we paying for I've issued clear instructions to avoid this.
labour?" "Of course we are," agreed the The samples are to be given only to
marketing director. "That's precisely the prospective new customers. I've also
point. We're paying for some labour and for required that we track who gets the
some resources that are not producing samples. That way we can keep the free
product for our current customers. That samples program from corrupting our
labour and those resources and the current markets. The idea is to develop new
operating expense that they represent are markets, not to offer discounts within our
with us no matter what. We're paying for current markets, "explained the marketing
them if they produce the samples, and we're director. "Good!" exclaimed Henry. "I like it.
paying for them if they don't produce the Let me know how it works," he said to his
samples. That's why we're not driving costs director. "Now let's break for lunch while the
through the roof. That's also why we're not cafeteria is still open," he suggested. As the
giving away the equivalent of the fully three of them left the executive wing, Henry
allocated product cost with every sample," turned to the CFO. "So tell me, John," he
explained the marketing director. "The said. "Why haven't we heard about this
incremental cost of making the samples is Goldridge guy before?" "Goldratt!"
only the cost of the additional raw material exclaimed the marketing director. "His name
that we use," he continued. "Well, what if our is Eli Goldratt. He's really a nice guy. You
orders pick up, and we have people making should meet him.
your free samples?" asked the CFO. "What

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National Productivity Council 67