OK, I think it is time to talk about where projects come from…
Projects often come from the desire to gain benefits and value. Some projects are regulatory or non-discretionary, such as addressing a safety risk, but these can be viewed as the desire to avoid financial penalties, business restrictions or reputation damage.
Increasingly we hear about the triple-bottom-line or P.P.P. Both terms refer to People, Profit, and the Planet. So beyond pure profit, organizations are also progressively looking to undertake projects to help people and the planet. Sometimes a fourth P for Purpose is used, but purpose often relates back to helping people or the planet. While this module and the exam focus on financial analysis, it is useful to be aware of these other increasingly significant elements.
3.2.1 Investigate that Benefits are Identified
Let’s start by defining some concepts and terms.
Business Value. This is a non-precise term that contains concepts such as:
- Customer value
- Shareholder value
- Channel partner value
- Employee knowledge
- Organizational intellectual property value
As we see from the list above, business value can be non-financial or difficult to initially quantify such as having a product offering in a new market. Some car manufacturers have spent billions developing electric vehicles, with no positive cash flow yet. However, the shareholder perception of not having products in this space or getting left behind when they become more profitable justifies the expenditure.
Value Analysis. The process of examining each element of business value to understand the cost and benefit. The goal is to optimize (increase the benefits and reduce the costs) the overall business value.
Traditional projects may also identify in which project phase the benefits will be delivered.
Agile projects often prioritize their product backlog based on business benefits, so they deliver the highest value items first.
However, as we saw with the discussion of value analysis, the business benefit is only part of the complete picture. We also need to factor in the cost to develop those features. Value is often expressed as
Value = Benefit – Cost
So a more accurate way to depict the agile prioritization would be net of costs.
In the graph above, the last feature costs more to develop than it delivers in value. So, this should probably be cut from scope unless it has some non-financial benefit. This introduces another topic we need to be aware of, Benefit-Cost Analysis
Also called Cost-Benefit Analysis, this is the process of examining the pros and cons, strengths and weaknesses of alternatives to find the best approach for achieving benefits while preserving savings. It helps us compare several potential projects and choose the best one or ones to authorize.
Of course, the accuracy of the analysis depends upon the quality of the input data. If groups artificially inflate the business case of their initiative so it looks more attractive and wins funding this will likely cause problems when the project benefits fail to be delivered. Value Performance Analysis feeds back the actual business benefits into strategic planning.
3.2.2 Document Agreement on Ownership for Ongoing Benefit Realization
Since benefits and value drive so much project effort and expenditure, it is important to have a firm handle on understanding what is expected, who owns it, and how we will measure it. That way, we will know when we are done and if it was successful.
Identifying and attempting to quantify the project benefits and value may highlight gaps or flaws in the business justification. It is much better to find out about deficiencies early to divert funds elsewhere rather than go through the trouble of making something only to discover this later.
Of course, some benefits are intangible or based on speculative information. Spending $10 million to develop a language learning application is great if it becomes more popular than, say, DuoLingo, but not so good if only a couple of thousand people download it. Project managers need to understand the basics of estimating the return on investment, decision tree analysis, risk and uncertainty.
Projects typically form part of a larger system called “Organizational Project Management (OPM) and Strategies”. In this larger ecosystem, organizations use portfolios, programs, and projects to deliver strategic objectives. Or in other words, companies determine what they want to achieve (strategies) and use portfolios, programs and projects to make those things happen.
Here we see Strategy feeding into a Portfolio where decisions about what to fund are made based on maximizing the likely value. These value decisions result in Programs and Projects that (hopefully) deliver the anticipated benefits. Nothing is guaranteed though and so there is an inner cycle of feeding business impacts back into the value decision process and making adjustments to programs and projects.
When projects complete, they typically hand over their new product or service to Operations, where the bulk of the business value realization occurs. Finally, value performance analysis feeds actual results of achieved value back to the Strategy process.
The main components are:
Strategy – Deciding what to work on. This includes creating strategies to maximize value.
Portfolio Management – Aligning work streams (portfolios) with the organizational strategies by selecting the right programs or projects, prioritizing this work, and providing the needed funding and support.
Program management – harmonizes its program components and manages interdependencies between initiatives to realize the specified benefits.
Project management – enabling the achievement of organizational goals and objectives.
As project managers, we get involved at the last step, turning the hopes, dreams and aspirations of strategy into real results and outcomes. However, it is important that we understand the language and definitions of many of these pre-project planning activities.
Who owns the benefits delivered by the project is typically part of the Business Management Plan. The Business Management Plan, along with the Business Case, are inputs to the Project Charter.
Benefits Management Plan. A description of how and when the projects’ benefits will be obtained and measured. It typically contains sections including:
- Strategic alignment – How the project and its benefits align with the strategies of the organization and which group owns the benefits.
- Target benefit – The expected tangible and intangible business value to be achieved by the project.
- Timeframe – When the benefits will be delivered (short-term and long-term)
- Metrics – How the benefits will be measured. Both direct and indirect measures.
- Risks – Any risks associated with achieving the identified benefits.
- Assumptions – Any underlying assumptions the benefits management plan rely on.
Organizations using agile or hybrid approaches may use a portfolio Kanban system to manage ideas through the stages: capture, evaluation, selection, sequencing, and delivery system.
Using portfolio kanban system, all ideas are welcome into the input funnel and there is no limit on the number of ideas that can be submitted. A high-level feasibility evaluation is performed, and a Go/No Go decision is made moving approved candidates into the Shortlisted Ideas category. Here a value statement is created and the understanding refined. The number of items is limited to keep workloads manageable and flowing quickly.
The next stage, Prioritize Ideas, sorts them by business value and then, based on capacity, the highest business value ideas are selected for delivery. They are placed in the program backlog and moved into the development stage when teams become available.
3.2.3 Verify a Measurement System is in Place to Track Benefits
Projects use many tools and techniques to measure and track benefits. Listed below are the popular ones we need to know about.
Return on Investment (ROI)
The return on investment is a financial measure of the gain (or loss) from an investment compared to the amount of money invested. Also known as the rate of return and usually expressed as a percentage. A high, positive ROI rate is a good investment, and a low or negative ROI is a lousy investment.
A practical way to understand the variety of financial tools used to evaluate value is with a mini-case study and plenty of pictures.
Paid Pig Feeder Project
Suppose we were developing a project to select, install, test and deploy a new pig food vending machine at a petting zoo. The idea is that people can pay by coins or credit card and get a cup of food to go feed the pigs. We need to feed the pigs anyway, but this way we can get other people to do it and charge them for the process. The basic schedule and estimated financial data are shown below.
The colored bars at the top of the graph depict the tasks of starting the project, gathering requirements, evaluating machines, purchasing, installing and testing in mid-May (shown by the black diamond.) The orange task after deployment shows the first 45 days of use during which time we are responsible for supervising its use and the pig’s health.
The blue line shows the total cumulative spend over the length of the project. The red line shows the total income gained from the pig feeder that starts immediately after deployment.
In the image above, the added green data series shows Net Cashflow (Total Spend – Total Income). We can see this line passes through zero indicating we have paid back the project expenditure and have broken even around the start of July. (This is a very short payback period, but perhaps we have very hungry pigs and very expensive pig food!)
It would seem like the payback period ends in July, but because of inflation, the future value of money is not as valuable as having that same money today. We measure the impacts of time and inflation on future values using the concept of Present Value.
The current value of a future amount of money. The formula for Present Value (PV) is
So, the present value of $50,000 received in 5 years time with an inflation rate of 7% would be
This means given the choice of receiving $36,000 today or $50,000 in 5 years, we should opt for $36,000 if we believe the inflation rate will be 7%.
When we want to evaluate an income stream, we use a string of these Present Value calculations in a technique called Net Present Value.
Net Present Value
Net Present Value is the sum of the outputs and inputs, all adjusted for todays value using the Present Value formula we just looked at.
As an example, let’s assume we have a project that costs $150,000 in the first year and then returns $40,000 for the next 4 years, with a discount rate (inflation/interest rate) of 5%.
Here the NPV = -$150,000 + $40,000/(1+0.05) + $40,000/(1+0.05)2 + $40,000/(1+0.05)3 + $40,000/(1+0.05)4 + = -$8,162
We might have thought it should have broken even since 4 years x $40K = $160K and it only costs us $150K but because those future $40,00 payments get discounted, it does not and after 4 years we are still down $8,162.
NPV can be especially helpful when comparing projects with different timeframes or deliver value at different times. For example, what if we are trying to choose between a project that we expect will deliver a 10%ROI in 12 months and one that we expect will deliver a 17% ROI in 36 months? Does inflation and interest over the longer period cancel the higher ROI of the second project? To find out, we would calculate the NPV of the two projects, and see which one has more value in today’s money.
Internal Rate of Return (IRR)
This one might sound complex to begin with, but it is quite simple. It is the interest rate that would be required to plug into the NPV formula to make the payback period the end of your project. Or make the net present value of all cash flow equal to zero by the end of you project.
It gives us a single figure for comparing the financial return of projects. If project A has an IRR of 20% and project B has an IRR of 25% then we should invest in project B (all other factors being equal).
For more on IRR see this article.
Hybrid and Agile often try to deliver value as early as possible. For our Pig Feeder project, if it were handling the payments that was dictating the completion date, maybe we can get one of the payment methods (coins or credit card) completed sooner. It would not provide all the business benefits but would allow for some income to be achieved while work continued on adding the other payment method. (Or sell pig food first and also add goat food later.)
This incremental delivery schedule with initially reduced earnings is shown below.
In this scenario, we have an initial delivery in April that starts to generate a small income followed by the second delivery in mid-May that delivers the remaining benefits. This shortens the payback period even more.
3.2.4 Evaluate Delivery Options to Demonstrate Value
Often the project benefits are not delivered until the end of the project. Occasionally it can be long after the project has finished that the benefits are seen. That can be too long for sponsors and senior stakeholders to wait and so we often want interim measures and demonstrations of value.
Agile projects demonstrate new features at the end of every Sprint or iteration (typically every 1-2 weeks). This demonstration of functionality shows what the project team has been working on, the elements that have been completed, and can discuss priorities for upcoming work.
Demonstrations provide an opportunity for obtaining feedback from interested stakeholders. This includes validation of suitability ( we hear things are going well) or potential issues (people report things are not looking so good). Both types of feedback are valuable. If changes need to be made, it is better to learn about them as early as possible.
Net Promoter Score (NPS)
Net Promoter Score is a measure of a customer’s willingness to recommend a product or service to a friend or colleague. NPS has been widely adopted by Fortune 500 companies and many other organizations. It is a good proxy for overall satisfaction because the person being questioned needs to consider the whole picture then decide if they would recommend it. The “…to a friend or colleague” component may also help bring in core subjective qualities that a purely analytical assessment might miss.
NPS is calculated by calculated based on responses to a single question: “How likely is it that you would recommend our company/product/service to a friend or colleague?” The scoring for this answer is usually based on a 0 to 10 scale. Where 0 = “No-way/never” and 10 = “Absolutely/every-time.” Using the scores, people are divided into the following categories:
The final NPS Score = % of Promoters – % of Detractors
So, if we asked 5 people at our Sprint Demo “How likely is it that you would recommend our pig food vending machine at the petting zoo to a friend or colleague?” and received the following scores:
Stakeholder 1 = “4”
Stakeholder 2 = “7”
Stakeholder 3 = “9”
Stakeholder 4 = “10”
Stakeholder 5 = “8”
We would have 1 Distractor, 2 Promoters (and 2 Passives). Our NPS Score would be:
NPS = % of Promoters – % of Detractors
NPS = (2 out of 5 = 40%) – ( 1 our of 5 = 20%)
NPS = 40% -20%
NPS = 20
Note: NPS is usually displayed as number, not a percentage. So in the example, above the NPS score is 20.
So, is this a good score or a poor one? It depends and is more useful as a trend metric. NPS ranges between −100 (all respondents are “Detractors”) and +100 (all respondents are “Promoters”). A good score is simply one whose trend is better than how we were doing before. Or we can see if we are scoring better than our competitors in the same industry, by measuring in a double-blind survey.
A/B testing, also known as split-run testing, is a way of comparing two design choices. A/B tests consist of a randomized experiment with two variations of the design being tested, design A and design B. For instance, our “A” design could be a screen with a blue button, and our “B” design the same screen but with a green button.
We present one sample of a randomized audience with design “A” and the other sample with design “B”. Whichever design gets the most clicks is deemed the more successful design. In the example above, the green button received more clicks so would be regarded as the preferred design. Companies such as Facebook, Amazon and Google run thousands of A/B tests daily to optimize engagement.
3.2.5 Appraise Stakeholders of Value Gain Progress
Some more techniques we need to understand for assessing value and options include:
- Expected Monetary Values (EMV)
- Decision Tree Analysis
Expected Monetary Value (EMV)
Expected monetary value calculates the average financial outcome for future scenarios based on likelihood and estimated value. EMV is calculated by multiplying the monetary value of an outcome by the probability of its occurrence. So, if we think an opportunity may return $2 million dollars if it is realized and there is a 50% likelihood of it occurring then the expected monetary value (EMV) would be:
EMV = $2,000,000 x 50% = $1,000,000
EMV can be used for opportunities that have positive values and threats that have negative values. So, if we thought the threat of a project delay for the vending machine delivery would cost us $4,000 and the probability of the delay is 75%, then:
EMV = -$4,000 x 0.75 = -$3,000
EMV is often used for quantitative risk analysis and for evaluating project options or decisions in the next process discussed, Decision Tree Analysis.
Decision Tree Analysis
A decision tree is a branching model showing decisions and their possible outcomes. It includes the chance of event outcomes, costs, and value. Decision Tree Analysis is the process of using a decision tree to analyze one or many decisions. It can be used to evaluate project options and decisions.
Consider for the Pig Feeder project; we have a choice to buy a fancy new specialized vending machine that will be branded with custom signage or use an old drink vending machine. The custom machine is designed to handle various package sizes but is not guaranteed for sticky products. If we use the bottle-vending machine, we will package the pig food in bottle-shaped containers.
A new vending machine with custom graphics costs $20,000 and is guaranteed to operate or the manufacturer will issue a refund minus a restocking fee and graphics fee of $10,000. We project $60,000 of sales with a custom machine and are 80% confident it will work. Without custom graphics, we expect $40,000 in sales using the drinks vending machine and are 60% confident it will work. If it fails, we cannot return it after it has been tested with pig food. These options are shown below.
The decision tree shows the two choices, “Buy custom machine”, and “Buy drinks machine” along with the chances of success and final node values. The top node showing $40,000 is calculated from revenue $40,000 – cost of machine $20,000. The two machine options are assessed using Expected Monetary Value (outcome x probability.) Using EMV we calculate the value of the custom vending machine option at +$34,000 and the value of the vending machine option as +$33,000.
So, it would seem (from a bunch of guesses multiplied together) that buying a custom vending machine is slightly better. However, what if our 80% / 20% likelihood of success for the custom vending machine was more like 90% / 10%? We would have to redo the calculations to see what impact it had. As we would with every other variation we want to evaluate. This is where simulations are powerful.
Simulation is an analysis technique where a computer model is run many times varying the input data based on input ranges, probability distributions and even probabilistic branches. A popular form of simulation is a Monte Carlo Simulation which uses random values between input ranges and re-runs a set of calculations to model many possible outcomes.
Using Monte Carlo simulation we could run 1,000 experiments where the probability of success for our custom vending machine varied between 65% and 95% with a strong preference (probability distribution) for values in the 75% – 85% range. We could also vary the projected revenue figures for both custom and drinks vending machines.
Varying all the input values at random between our likely ranges, Monte Carlo simulation analysis in a project management tool or simple Excel spreadsheet could quickly model 50,000 different scenarios and average EVM figures for both options. This weighted average may be quite different from the single path through the decision tree we calculated by hand.
Deliverables and Tools
- Benefits Management Plan
- Benefit Cost Analysis
- EVM, ETC analysis
- ROI, IRR, NPV calculations
- Decision Tree Analysis, EMV
- Monte Carlo
- Net Promoter Score
- A/B Testing
- Value Analysis
- Cost Analysis
- 1.3 Support team performance
- 1.7 Address and remove impediments/obstacles for the team
- 2.3 Assess and manage risks
- 2.7 Plan and manage quality of products/deliverables
- 2.8 Plan and manage scope
- 2.9 Integrate project planning activities
- 2.10 Manage project changes
- 2.14 Establish project governance structure
- 3.3 Evaluate and address external business environment changes for impact on scope
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