ISE 440 Ch. 2 Strategic Management & Project Selection PDF

Chapter 2: Strategic Management and Project Selection Project Management: A Managerial Approach, Wiley, 9th Ed. By Meredith, J.R., Mantel, S.J., and Shafer, S.M. Slides are modified by Dr. Yasser Almoghathawi ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 1 Outline ▪ Introduction ▪ Project...

Chapter 2: Strategic Management and Project Selection Project Management: A Managerial Approach, Wiley, 9th Ed. By Meredith, J.R., Mantel, S.J., and Shafer, S.M. Slides are modified by Dr. Yasser Almoghathawi ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 1 Outline ▪ Introduction ▪ Project Selection ▪ Selection Models • Non-numeric models • Numeric models ▪ Project Portfolio Management (PPM) ▪ Project Proposals ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 2 Introduction ▪ Often there are multiple options for the organizations ▪ “It is the portfolio of projects that determines an organization’s success, not the completion of an individual project” ▪ Given that the organization has an appropriate mission statement and strategy, projects must be selected that are consistent with the strategic goals of the organization ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 3 Introduction ▪ Problems with Multiple Projects: • Delays in one project cause delays in other projects • Inefficient use of corporate resources • Bottlenecks in resource availability or lack of required technological inputs ▪ Challenges • Making sure projects are closely tied to goals and strategy • How to handle the growing number of projects? • How to make these projects successful? ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 4 Introduction ▪ Project Management Maturity • Project management maturity refers to the mastery of skills required to manage projects competently • Number of ways to measure • Most organizations do not do well • Maturity can be rated in levels: Initial → Repeatable → Defined → Managed → Optimizing ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 5 Introduction ▪ Project Management Maturity • Maturity can be rated in levels: ▪ Initial: there is no formal process for managing projects ▪ Repeatable: has procedures in place for planning, scheduling, tracking, and estimating; but the data are not integrated ▪ Defined: the firm has integrated systems for tracking and managing projects, but are not routinely understood and used for controlling projects ▪ Managed: systems are installed and used to manage and control projects. The project success rate is high ▪ Optimizing: has integrated databases, which contains historical information to allow continued improvement of the project management system ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 6 Introduction ▪ Project Management Maturity • Another maturity measure, PM3®: ▪ Ad-hoc: disorganized, accidental successes and failures ▪ Abbreviated: some processes exist, inconsistent management unpredictable results ▪ Organized: standardized processes, more predictable results ▪ Managed: controlled and measured processes, results in line with plans ▪ Adaptive: continuous improvement in processes, success is normal, performance keeps improving ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 7 Introduction ▪ Rarely a project manager is involved in project selection, but it is important to the success of the PM that he/she fully understands the parent organization’s objectives in undertaking that project ▪“The project manager who does not understand what a given project is expected to contribute to the parent organization lacks critical information needed to manage the project in order to optimize its contribution to the parent organization” ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 8 Project Selection ▪ Project selection is the process of evaluating proposed projects, and then choosing to implement some of them so that the objectives of the parent organization will be achieved ▪ Project selection • Evaluating • Choosing • Implementing ▪ Project selection is usually based on models ▪ Same process as other business decisions ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 9 Model Criteria ▪ Realism: decision situation, limitation and risks ▪ Capability: capable to handle multiple factors internal/external ▪ Flexibility: easy to modify and adopt changes ▪ Ease of use: easy to execute, short time ▪ Cost: low-cost relative to benefits ▪ Easy computerization: easy to gather and store data in database ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 10 Models Nature/Limitations ▪ 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 ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 11 Types of Project Selection Models ▪ Non-numeric models ▪ Numeric models ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 12 Non-Numeric Models ▪ Models that do not return a numeric value for a project to 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” ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 13 Types of Non-Numeric Models ▪ Sacred Cow • A project, often suggested by the top management, that has taken on a life of its own ▪ Operating Necessity • A project that is required in order to keep the company in operation ▪ Competitive Necessity • A project that is required in order to maintain the company’s position in the marketplace ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 14 Types of Non-Numeric Models ▪ Product Line Extension • Often, projects are taken to expand a product line • What will be the likely impact on the total system performance if the new product is added to the line ▪ Comparative Benefit • Projects are subjectively ordered based on their perceived benefits to the company ▪ Sustainability • More and more organizations are focusing on sustainability, a crucial parameter for project selection • Focusing on long-term profitability rather than short-run payoff ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 15 Types of Non-Numeric Models ▪ Q-Sort Method ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 16 Numeric Models ▪ Models that return a numeric value for a project that can be easily compared with other projects ▪ TWO major categories: • Profit/Profitability • Scoring ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 17 Numeric Models: Profit/Profitability ▪ Models that look at costs and revenues: I. Payback period II. Discounted cash flow (NPV) III. Internal rate of return (IRR) IV. Profitability index ▪ NPV and IRR are the more common methods ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 18 Numeric Models: Profit/Profitability I. Payback period • The length of time until the original investment has been recouped by the project • A shorter payback period is better • Example: Payback Period = Project Cost = Annual Cash Flow $100,000 $25,000 = 4 years • Drawbacks: ▪ Does not consider time value of money ▪ More difficult to use when cash flows change over time ▪ Less meaningful for longer periods of time (due to time value of money) ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 19 Numeric Models: Profit/Profitability II. Discounted Cash Flow • The value of a stream of cash inflows and outflows in today’s dollars • Also know as Net Present Value (NPV) method 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 • Requires a percentage to use to reduce future cash flows ▪ This is known as the discount rate • The discount rate may also be known as a hurdle rate or cutoff rate • There will usually be one overall discount rate for the company ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 20 Numeric Models: Profit/Profitability II. Discounted Cash Flow • NPV Formula 𝑛 𝐹𝑡 NPV (project) = 𝐴0 + ෍ 1+𝑘 𝑡 𝑡=1 𝐴0 𝐹𝑡 𝑘 𝑡 Initial cash investment Cash flow in time period 𝑡 (negative for outflows) The discount rate/ interest The number of years of life • A higher NPV is better • Higher the discount rate lower the NPV ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 21 Numeric Models: Profit/Profitability II. Discounted Cash Flow • NPV Formula 𝑛 𝐹𝑡 NPV (project) = 𝐴0 + ෍ 1 + 𝑘 + 𝑝𝑡 𝑡 𝑡=1 𝐴0 𝐹𝑡 𝑘 𝑡 𝑝𝑡 ISE 440 - Term 231 Initial cash investment Cash flow in time period 𝑡 (negative for outflows) The discount rate/ interest The number of years of life Predicted rate of inflation during period 𝑡 Dr. Yasser Almoghathawi, KFUPM 22 Numeric Models: Profit/Profitability II. Discounted Cash Flow • NPV Formula 𝑛 𝐹𝑡 NPV (project) = 𝐴0 + ෍ 1 + 𝑘 + 𝑝𝑡 𝑡 𝑡=1 • Example: 8 $25,000 NPV project = −$100,000 + ෍ 1 + 0.15 + 0.03 𝑡 𝑡=1 = $1,939 ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 23 Numeric Models: Profit/Profitability III. 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)” ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 24 Numeric Models: Profit/Profitability IV. Profitability Index • aka Benefit-cost ratio • PV divided by initial cash investment • Ratios greater than 1.0 are good ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 25 Numeric Models: Profit/Profitability ▪ Advantages of Profitability Models • Easy to use and understand • Based on accounting data and forecasts • Familiar and well understood • Gives a go/no-go indication • Can be modified to include risk ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 26 Numeric Models: Profit/Profitability ▪ Disadvantages of Profitability Models • Ignore nonmonetary factors • Biased toward the short-term • Payback ignores cash flow after payback • All are sensitive to errors • Dependent on determination of cash flows ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 27 Numeric Models: Scoring ▪ Mimics how managers actually evaluate investments ▪ To cover drawback of single criteria, uses multiple criteria • Can utilize both monetary and qualitative factors ▪ Three scoring models A. Unweighted 0–1 factor model B. Unweighted factor model C. Weighted factor model ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 28 Numeric Models: Scoring A. Unweighted 0–1 factor model • Factors selected ▪ Listed on a preprinted form • Raters score the project on each factor • Each project gets a total score • Main advantage is that the model uses multiple criteria • Major disadvantage is that the model assumes all criteria are of equal importance ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 29 Numeric Models: Scoring A. Unweighted 0–1 factor model ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 30 Numeric Models: Scoring B. Unweighted factor model • Replaces X’s with factor score: ▪ Typically, a 1-5 scale (where 5 is very good, 4 is good, 3 is fair, 2 is poor, 1 is very poor) • Column of scores is summed • Projects with high scores are selected • It ensures that each criterion performance measure utilizes the full scale of possible values, a desirable characteristic for performance measures ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 31 Numeric Models: Scoring B. 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 ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 32 Numeric Models: Scoring B. Unweighted factor model • Replaces X’s with factor score ▪ Typically, a 1-5 scale (where 5 is very good, 4 is good, 3 is fair, 2 is poor, 1 is very poor) Estimated annual profits in dollar ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 33 Numeric Models: Scoring B. Unweighted factor model • Replaces X’s with factor score ▪ Typically, a 1-5 scale (where 5 is very good, 4 is good, 3 is fair, 2 is poor, 1 is very poor) No decrease in quality of the final product ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 34 Numeric Models: Scoring C. Weighted factor model • Each factor is weighted relative to its importance ▪ Weighting allows important factors to stand out • A good way to include nonnumeric 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 ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 35 Numeric Models: Scoring C. Weighted factor model • Example: ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 36 Numeric Models: Scoring ▪ Advantages of Scoring Models • Allow multiple criteria • Structurally simple • Direct reflection of managerial policy • Easily altered • Allow for more important factors • Allow easy sensitivity analysis ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 37 Numeric Models: Scoring ▪ Disadvantages of Scoring Models • Unweighted models assume equal importance • Relative measure • Consider criteria independent • Can have large number of criteria ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 38 Choosing a Project Selection Model ▪ Weighted scoring models favored: • Allow multiple objectives to be considered • Easily adapted • Not biased toward short-run like the profitability models ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 39 Risk Considerations in Project Selection ▪ Both costs and benefits are uncertain • Benefits are more uncertain ▪ There are many ways of dealing with risk ▪ Can make estimates about the probability of outcomes • Subjective probabilities ▪ Uncertainty about: • Timing • What will be accomplished? • Side effects ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 40 Project Portfolio Management (PPM) ▪ PPM links projects directly to the goals and strategy of the organization ▪ Means for monitoring and controlling projects ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 41 Symptoms of a Misaligned Portfolio ▪ More projects than management expected ▪ Inconsistent determination of benefits; double counting ▪ Projects that don’t contribute to the strategy ▪ Competing projects; no cross-comparison of projects ▪ Costs exceed benefits ▪ No risk analysis of projects ▪ Lack of tracking against the plan, at least quarterly ▪ No identified “client” for many projects ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 42 Purpose of Project Portfolio Process ▪ To identify proposed projects that are not really projects and should be handled through other processes ▪ To prioritize the list of available projects ▪ To limit the number of projects being managed so the important projects get the needed resources and attention ▪ To identify the real options that each project offers ▪ To identify projects that best fit the organization’s goals and strategy ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 43 Purpose of Project Portfolio Process ▪ To identify co-dependent projects ▪ To eliminate projects that incur excessive risk and/or cost ▪ To eliminate projects that skip the formal selection process ▪ To balance the resources with the needs ▪ To balance short-, medium-, and long-term returns ▪ To balance between more risky and less risky projects ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 44 Project Portfolio Process Steps Step 1: Establish a project council Step 2: Identify project categories and criteria Step 3: Collect project data Step 4: Assess resource availability Step 5: Reduce the project and criteria set Step 6: Prioritize the projects within categories Step 7: Select the projects to be funded and held in reserve Step 8: Implement the process ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 45 Project Portfolio Process Steps Step 1: Establish a project council • The purpose of the project council is to: ▪ establish and articulate a strategic direction for those projects spanning internal or external boundaries of the organization ▪ Allocate funds and control the allocation of resources and skills • Members of the project council include: ▪ 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 ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 46 Project Portfolio Process Steps Step 2: Identify project categories and criteria • Based on the extent of product change and process change, they identified four separate categories of projects: ▪ Derivate projects Aggregate Project Plan (Wheelwright et al. (1992) ▪ Platform projects ▪ Breakthrough projects ▪ R&D projects ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 47 Project Portfolio Process Steps Step 2: Identify project categories and criteria • Separate criteria should be made for each category: ▪ Alignment with organization’s strategy/goals ▪ Riskiness ▪ Financial return ▪ Probability of success ▪ Impact on customer ▪ Knowledge acquisition ▪ Availability of resources ▪ etc. ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 48 Project Portfolio Process Steps Step 3: Collect projects’ data • Assemble the data • Document assumptions • Screen out obvious weaker projects • The fewer projects that need to be compared and analyzed, the easier the work of the council ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 49 Project Portfolio Process Steps Step 4: Assess resource availability • Assess both internal and external resources • Assess labor conservatively • Timing is particularly important ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 50 Project Portfolio Process Steps Step 5: Reduce the project and criteria set • Organization’s goals • Good fit • Have competence • Use strengths • Market for offering • Synergistic • How risky the project is • Dominated by another • Potential partner • Has slipped in desirability • Right resources ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 51 Project Portfolio Process Steps Step 6: Prioritize the projects within categories • Apply the scores and criterion weights • Consider in terms of benefits first and resource costs second • Summarize the returns from the projects ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 52 Project Portfolio Process Steps 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 ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 53 Project Portfolio Process Steps Step 8: Implement the process • Communicate results • Repeat regularly • Improve process ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 54 Project Proposals - RFP ▪ 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 ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 55 Project Proposal Contents ▪ Cover letter ▪ Executive summary ▪ The technical approach/plan ▪ The implementation plan ▪ The plan for logistic support and administration ▪ Past experience ISE 440 - Term 231 Dr. Yasser Almoghathawi, KFUPM 56