Chapter 2

Strategic Management and

Project Selection

Copyright 2009 John Wiley & Sons, Inc.

Rapid adoption of project management
means

There are many projects that fall outside the

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

1. 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
2.1 Project Management Maturity

Project management maturity refers to

mastery of skills required to manage
project competently
Number of ways to measure
Most organizations do not do well
PMBOK knowledge areas to assess
the PM maturity

Integration Human resources

Scope Communication
Time Risk and
Cost Procurement
Quality
Process or lifecycle used to measure
PMM

Initiating
Planning
Executing
Controlling
Closing and
Project-driven organizational
environment
Five Levels of PMM

Ad-hoc
Planned
Managed
Integrated
Sustained
2.2 Project Selection

Meaning: Project selection is the

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

Project selection
Evaluating
Choosing
Implementing
Same process as other business
decisions
Types of Companies

Companies considering projects fall into

two broad categories:
1. 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 firms projects should
be centrally maintained
2.3 The Nature of Project Selection
Models

Models turn inputs into outputs

Managers decide on the values for the inputs
and evaluate the outputs
The inputs never fully describe the situation
The outputs never fully describe the
expected results
Models are tools
Managers are the decision makers
Different Factors Affecting
Outcome
Many factors affect the outcome of a project
Some are one-time factors
The cost of an item
Others are reoccurring
Maintenance

Not all factors are equally important

Critical factors on one project may be trivial
on another project
Project Evaluation Factors
Production factors
Time until ready to install
Length of disruption during
installation
Learning curve
Effects on wastes and
rejects
Energy requirements
Facility and other
equipment requirements
Safety of process
Other applications of
technology
Change in cost to produce
a unit output
Change in raw materials
usage
Availability of raw materials
Required development time
and cost
Impact on current suppliers
Changes in quality of output
 Marketing factors

Size of potential Consumer

market for output acceptance
Probable market Impact on consumer
share of output safety
Time until market Estimated life of
share is acquired output
Impact on current Spin-off project
product line possibilities
 Financial Factors

Profitability,
net Time until break-
present values of even
investment Size of investment
Impact on cash required
flows Impact on seasonal
Payout period and cyclical
Cash requirements fluctuations
 Personnel Factors

Training requirements Change in size of labor

Labor skill force
requirements Inter and intra-group
communication
Availability of
requirements
required labor skills Impact on working
Level of resistance
conditions
from current work
force.
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
companys 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 todays dollars
Also know as discounted cash flow or just
discounting
Widely used to evaluate projects
Includes the time value of money
Includes all inflows and outflows, not just the
ones through payback point
Discounted Cash Flow Continued

Requires a percentage to use to reduce

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

Ft
NPV (project) A0 t 1
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 IRRs, this is not a practical issue
Finding the IRR requires a financial calculator
or computer
In Excel =IRR(Series,Guess)
Profitability Index

a.k.a.Benefit cost ratio

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

Easy to use and understand

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

Ignore non-monetary factors

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

Unweighted factor model

Weighted factor model
Unweighted Factor Model

Each factor is weighted the same

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

Figure 2-2
Weighted Factor Model

Each factor is weighted relative to its

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

Figure B
2.5 Analysis Under UncertaintyThe
Management of Risk

Everything to do with projects is risky

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

What the decision maker does

What nature does
Uncertainty

1. Pro forma financial statements

2. Risk analysis
3. Simulation (requires detailed
probability information)
2.6 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
2.7 Project Portfolio Process (PPP)

Links projects directly to the goals and

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

1. 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

Organizations 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
2.8 Project Proposals

The project proposal is essentially a project

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

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