Chapter 2

Strategic Management and

Project Selection

Copyright 2009 John Wiley & Sons, Inc.

Problems With Multiple Projects

1. Delays in one project delays others

2. Inefficient use of resources
3. Bottlenecks in resource availability
Project Results

 30Percent late
 Over half 190 percent over budget
 Over half 220 percent late
Challenges

 Making sure projects closely tied to

goals and strategy
 How to handle growing number of
projects
 How to make projects successful
Project Management Maturity

 Project management maturity refers to

mastery of skills required to manage
project competently
 Number of ways to measure
 Most organizations do not do well
Project Selection and Criteria of
Choice

 Project selection…
– Evaluating
– Choosing
– Implementing
 Same process as other business
decisions
Types of Companies
 Companies considering projects fall into
two broad categories:
1. Companies whose core business is completing
projects
2. Companies whose core business is something
else
 They can also be broken down as:
1. Companies looking at projects to do for others
2. Companies looking at projects to do for
themselves
Project Companies

 Mustselect which projects they will bid on

 Generally based on…
– Their expertise
– Resource they have availability
– Their chance of winning bid
 Preparinga bid is expensive
 They do not want to waste that effort on bids
where they are unlikely to be successful
Non-Project Companies

 Must decide which potential projects

they will pursue
 Available capital is the major constraint
 Profitability is often the major criteria
 Must evaluate approaches when there
is more than one project that can
accomplish a goal
Models

 Models are used to select projects

 All models simplify reality
 That is, they only look at the key
variables involved in a decision
 The more variables included in a
model, the more complex it becomes
 Simpler models usually work better
Types of Models

 Stochastic Model
– A model that includes the probabilities of events
occurring within the model. In other words, the
same inputs might yield different outputs at
different runs. Also known as a probabilistic
model.
 Deterministic Model
– A model that does not include probabilities. Given
the same inputs, the outputs will always be the
same.
Criteria For Project Selection
Models

 Companies only want to undertake successful

projects
 Projects that fail waste resources and hurt
profitability and competitiveness
 Projects that succeed improve profitability and
competitiveness
 It is not possible to know ahead of time if a project
will succeed or fail
 In fact, there is a continuum of possible results from
total success through absolute failure
Criteria (Continued)

 Companies need a way of weeding out the

bad projects while keeping the good ones
 No model can predict with absolute certainty
 No model could predict
– The Exxon Valdez wreck
– The explosion of the Challenger
 What we want is a model with a “good batting
average”
Model Criteria

 Realism
 Capability
 Flexibility
 Easy to use
 Inexpensive
 Easy to implement
Realism

 Needs to include all objectives of the firm

 Needs to include the firms expertise as well
as its limitations
 Needs to report results in a fashion that
allows different projects to be compared, e.g.
how do we compare a project to lower
production cost and one to raise market
share
Capability

 Model
needs to be sophisticated
enough to deal with all projects
– Varying resource requirements
– Varying time periods
– Varying probabilities of success
 Needs to be able to select the optimum
projects among all contenders
Flexibility

 Needs to be able to work with all

projects
 Needs to be updated as the firm and its
environment evolves
Easy to Use

 Needs to be quick to gather the data

and easy to use
 Easy to be able to “fit” the project in the
model
Inexpensive

 Do not want the model to eat up all the

savings that result from using the
model
 Expenses include the cost of writing
and maintaining the model
 Also includes the expense of gathering
the data needed by the model
Easy to Implement

 This is less of an issue with modern

spreadsheets
 However, a model to be used to
evaluate all the firm’s projects should
be centrally maintained
The Nature of Project Selection Models

 Models turn inputs into outputs

 Managers decide on the values for the inputs
and evaluate the outputs
 The inputs never fully describe the situation
 The outputs never fully describe the
expected results
 Models are tools
 Managers are the decision makers
Different Factors Affecting
Outcome

 Many factors affect the outcome of a project

– Some are one-time factors
 The cost of an item
– Others are reoccurring
 Maintenance

 Not all factors are equally important

 Critical factors on one project may be trivial
on another project
Types of Project Selection Models

 Nonnumericmodels
 Numeric models
Nonnumeric Models

 Models that do not return a numeric

value for a project that can be
compared with other projects
 These are really not “models” but rather
justifications for projects
 Just because they are not true models
does not make them all “bad”
Types of Nonnumeric Models
 Sacred Cow
– A project, often suggested by top management,
that has taken on a life of its own. It continues, not
due to any justification, but “just because.”
 Operating Necessity
– A project that is required in order to protect lives
or property or to keep the company in operation.
 Competitive Necessity
– A project that is required in order to maintain the
company’s position in the marketplace.
Types of Nonnumeric Models Continued

 Product Line Extension

– Often, projects to expand a product line are
evaluated on how well the new product meshes
with the existing product line rather than on
overall benefits.
 Comparative Benefit
– Projects are subjectively rank ordered based on
their perceived benefit to the company.
Numeric Models

 Models that return a numeric value for

a project that can be easily compared
with other projects
 Two major categories:
1. Profit/profitability
2. Scoring
Profit/Profitability Models

 Models that look at costs and revenues

– Payback period
– Discounted cash flow (NPV)
– Internal rate of return (IRR)
– Profitability index
 NPV and IRR are the more common
Payback Period

 The length of time until the original

investment has been recouped by the
project
 A shorter payback period is better
Payback Period Example

Project Cost
Payback Period 
Annual Cash Flow

$100,000
Payback Period  4
$25,000
Payback Period Drawbacks

1. Does not consider time value of

money
2. More difficult to use when cash flows
change over time
3. Less meaningful over longer periods
of time (due to time value of money)
Discounted Cash Flow

 The value of a stream of cash inflows and

outflows in today’s dollars
 Also know as discounted cash flow or just
discounting
 Widely used to evaluate projects
 Includes the time value of money
 Includes all inflows and outflows, not just the
ones through payback point
Discounted Cash Flow Continued

 Requires a percentage to use to reduce

future cash flows
– This is known as the discount rate
 The discount rate may also be know as
a hurdle rate or cutoff rate
 There will usually be one overall
discount rate for the company
NPV Formula

Ft
NPV (project)  A0  t 1
n

1  k t
NPV Formula Terms

A0 Initial cash investment

Ft The cash flow in time period t (negative for
outflows)
k The discount rate
T The number of years of life

 A higher NPV is better

 The higher the discount rate, the lower the
NPV
NPV Example

8
$25,000
NPV (project)  $100,000  
t 1 1  0.15  0.03
t

$1,939
Internal Rate of Return [IRR]

 The discount rate (k) that causes the NPV to

be equal to zero
 The higher the IRR, the better
– While it is technically possible for a series to have
multiple IRR’s, this is not a practical issue
 Finding the IRR requires a financial
calculator or computer
 In Excel “=IRR(Series,Guess)”
Profitability Index

 a.k.a.Benefit cost ratio

 NPV divided by initial cash investment
 Ratios greater than 1.0 are good
Advantages of Profitability Models

 Easy to use and understand

 Based on accounting data and
forecasts
 Familiar and well understood
 Give a go/no-go indication
 Can be modified to include risk
Disadvantages of Profitability
Models

 Ignore non-monetary factors

 Some ignore time value of money
 Discounting models (NPV, IRR) are
biased to the short-term
 Payback models ignore cash flow after
payback
Scoring Models

 Unweighted factor model

 Weighted factor model
Unweighted Factor Model

 Each factor is weighted the same

 Less important factors are weighted the
same as important ones
 Easy to compute
 Just total or average the scores
Unweighted Factor Model Example

Figure 2-2
Weighted Factor Model
 Each factor is weighted relative to its
importance
– Weighting allows important factors to stand out
A good way to include non-numeric data in
the analysis
 Factors need to sum to one
 All weights must be set up so higher values
mean more desirable
 Small differences in totals are not meaningful
Weighted Factor Model Example

Figure B
Analysis Under Uncertainty—The
Management of Risk

 Everything to do with projects is risky

 Some projects, like R&D, are more risky than
others, like construction
 Risks include…
– The timing of the project and its associated cash
flow
– Risk regarding the outcome of the project
– Risk about the side effects
Risk and Uncertainty

 What the decision maker does

 What nature does
Uncertainty

1. Pro forma financial statements

2. Risk analysis
3. Simulation (requires detailed
probability information)
Comments on the Information Base for
Selection

1. Accounting data
2. Measurements
3. Uncertain information
Accounting Data

1. Cost and revenue are linear

2. Cost-revenue data derived using
standard cost standardized revenue
assumptions
3. Costs may include overhead
Measurements

1. Subjective versus objective

2. Quantitative versus qualitative
3. Reliable versus unreliable
4. Valid versus invalid
Uncertain Information

 Must estimate inputs for risk analysis

 These inputs cannot be known exactly
 Inputs must be adjusted over time
Project Portfolio Process (PPP)

 Links projects directly to the goals and

strategy of the organization
 Means for monitoring and controlling
projects
PPP Steps

1. Establish a project council

2. Identify project categories and criteria
3. Collect project data
4. Assess resource availability
5. Reduce the project and criteria set
6. Prioritize the projects within categories
7. Select projects to be funded and held in reserve
8. Implement the process
Step 1: Establish a Project Council

 Senior management
 The project managers of major projects
 The head of the Project Management Office
 Particularly relevant general managers
 Those who can identify key opportunities and
risks facing the organization
 Anyone who can derail the PPP later on
Step 2: Identify Project Categories and
Criteria

1. Derivate projects
2. Platform projects
3. Breakthrough projects
4. R&D projects
Step 3: Collect Project Data

 Assemble the data

 Document assumptions
 Screen out weaker projects
 The fewer projects that need to be
compared and analyzed, the easier the
work
Step 4: Assess Resource Availability

 Assess both internal and external

resources
 Assess labor conservatively
 Timing is particularly important
Step 5: Reduce the Project and Criteria
Set

 Organization’s goals  Use strengths

 Have competence  Synergistic
 Market for offering  Dominated by
 How risky another
 Potential partner  Has slipped in

 Right resources desirability

 Good fit
Step 6: Prioritize the Projects Within
Categories

 Apply the scores and criterion weights

 Consider in terms of benefits first,
resource costs second
 Summarize the returns from the
projects
Step 7: Select the Projects to be
Funded and Held in Reserve

 Determine the mix of projects across

the categories
 Leave some resources free for new
opportunities
 Allocate the categorized projects in
rank order
Step 8: Implement the Process

 Communicate results
 Repeat regularly
 Improve process
Project Proposals

 The project proposal is essentially a project

bid
 Putting together a project proposal requires a
detailed analysis of the project
 Project proposals can take weeks or months
to complete
 A more detailed analysis may result in not
bidding on the project
Project Proposal Contents

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