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Project Prioritization - The Cost Of Strategy
- 1. 1 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © PROJECT PRIORITIZATION – THE COST OF STRATEGY (OR, THE MORE OF EVERYTHING YOU WANT, THE LESS OF ANYTHING YOU’LL GET) PROJECT & PORTFOLIO VALUE CREATION
- 2. 2 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Decision-making for portfolio selection – Is it always objective, rational, and defensible? “This platform is absolutely crucial to our company; without it, we can kiss our future goodbye” “I know the NPV doesn’t add up but this project is filled with strategy” “We must be able to afford this project; let’s just cut every other project investment by 10%” “You know who will be most upset if we don’t select and prioritize this project” “I’m really not interested in how much financial value we forego if we selected this highly strategic project” “If you don’t say anything negative about my project, I promise I’ll reciprocate” “We have a great portfolio; that’s why everything is a priority” “No-one can argue that this project is a sure bet; let’s just do it”
- 3. 3 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Value Creators ‘R’ Us – the company wants to maximize value by selecting projects with the highest strategic and financial value GOAL: MAXIMIZE STRATEGIC & FINANCIAL VALUE STRATEGIC VALUE (50%) LEADERSHIP DIFFERENTIATION & COMPETITIVE ADVANTAGE FINANCIAL VALUE (50%) NPV
- 4. 4 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Strategic and financial value are equally weighted criteria – categorical descriptors and numerical values for each project The company has a need for $200M to fund all of its projects in 2016 but it has a limited budget of $125M. So, Value Creators ‘R’ Us wants to prioritize its projects on the basis of strategic and financial value for portfolio selection
- 5. 5 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Non-linear ascending utility functions for both strategic and financial decision criteria
- 6. 6 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Strategic and financial value are equally weighted criteria – conversion to raw utility scores
- 7. 7 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Strategic and financial value are equally weighted criteria – conversion to weighted utility scores
- 8. 8 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Based on maximizing strategic and financial value, the top 5 projects can be funded until the budget constraint is met Prioritization based on strategic and financial decision criteria results in a portfolio that is worth $9.479 B in NPV
- 9. 9 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Value Creators ‘R’ Us – What happens if the company maximizes value by selecting projects with the highest financial value only? GOAL: MAXIMIZE FINANCIAL VALUE FINANCIAL VALUE (100%) NPV
- 10. 10 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Based on maximizing financial value only, the top 5 projects can be funded until the budget constraint is met Prioritization based on financial decision criterion alone results in a portfolio that is worth $13.012 B in NPV (NB: If prioritization is based on NPV – and not on NPV utility – the order of the bottom 3 projects would be A, E, I)
- 11. 11 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Caveat emptor! – strategy is not unimportant but make sure you quantify how much financial value you are willing to forego Few would argue that if you lose your strategic intent, you could end up with a Sisyphean task of keeping your business healthy and profitable But, to blindly use ‘strategy’ as an unqualified decision-making attribute without quantifying its business impact, could be equally deleterious Moreover, this generally opens the decision-making forum to politics, advocacy, and nitpicking The case study of Value Creators ‘R’ Us demonstrates the following: Trying to maximize the value of everything (e.g. strategic and financial value) generally forces you to accept sub-maximum value of anything (e.g. financial value) The difference in financial value (NPV) between a portfolio selected on the basis of strategic and financial value $(9.5 B) and one selected on the basis of financial value alone ($13.0 B) is $3.5 B. Can your organization forego this type of financial value? How do most (but certainly not all) of your stakeholders assess your performance – on the attainment of strategic or financial goals? Recommendation: In order to obviate the impact of politics during your portfolio selection, use ‘strategy’ as a pre-filter and then prioritize your projects on financial decision criteria alone Projects deemed to be truly ‘strategic’ should become policy decisions – and therefore funded – without becoming an active part of the prioritization framework Otherwise, you risk funding a ‘more strategic project’ that is below the budget line at the expense of a ‘lesser strategic project’ that is legitimately above the budget line Lastly, minimize the impact of politics, advocacy, and nitpicking on your decision-making.
- 12. 12 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Value Creators ‘R’ Us – a recommended approach to maximizing financial value GOAL: MAXIMIZE FINANCIAL VALUE SUBJECT TO PRE- DETERMINED STRATEGIC CONSIDERATIONS FINANCIAL VALUE (100%) NPV
- 13. 13 Copyright 2016 Project & Portfolio Value Creation. All rights reserved. © Decision-making for portfolio selection – striving to make it more objective, rational, and defensible “If this platform is absolutely crucial to our company; let’s make it a policy decision” “I know the NPV doesn’t add up but strategy won’t necessarily make it a better financial contributor” “We must be able to afford this project; but cutting every other project investment by 10% can harm some projects irreparably” “You know who will be most upset if we don’t select and prioritize this project but we have to defend our recommendations” “Before deciding on this highly strategic project, I’d really like to know how much financial value we forego if we select it” “If I say something negative about any project in the portfolio – including mine – it’s because I want what’s best for the portfolio” “We have a great portfolio; but everything can’t be a priority” “No-one can argue that this project is a good bet; I just can’t predict if it will succeed”
Notas del editor
- This presentation will examine portfolio selection through the popular lens of project prioritization or ranking. In it, I will look at project ranking on the basis of strategic and financial decision criteria and calculate the financial value created by such a methodology. By way of comparison, I will then rank projects on the basis of a single financial criterion and run the corresponding calculation. What I hope to demonstrate is that while strategic considerations are doubtless important to the sustainability of business excellence, there can often be a cost associated with portfolio selection on the basis of non-financial decision criteria. The challenge, in my view, is to quantify the financial impact of all relevant aspects of your decision-making before you commit to a decision. And no, this presentation does not imply that strategic considerations are unimportant to portfolio selection. So, let’s begin by taking a look at some of the common pitfalls of project selection when decisions are made on non-financial criteria.
- I’m sure that the vast majority of you have encountered one or other of these statements during a project selection review. One of my all time favorites is this one this one “I know the NPV doesn’t add up, but this project is filled with strategy”. By the way, this one is not far behind “We must be able to afford this project; let’s just cut every other project investment by 10%”.
- So, here’s a case study of Value Creators ‘R’ Us that wants to select its portfolio by rank ordering projects on the basis of both strategic and financial criteria. Further, the company has decided that it will measure strategic value on the basis of Leadership Differentiation & Competitive Advantage and it will measure financial value on the basis of Net Present Value or NPV. Naturally, the company wants to maximize both strategic and financial value and it has decided that both components are equally important to decision-making. Consequently, both goals are equally weighted at 50%.
- This table of data shows – for each of the 10 projects in the portfolio (HERE) - the categorical descriptors (in this column) for Leadership Differentiation & Competitive Advantage as well as the numerical values (in this column) for NPV. In the final column, we see the 2016 cost associated with each project. Note (ANIMATION) that while the entire portfolio requires $200M, the budgetary constraint for 2016 is $125M. Now, how do we convert these categorical descriptors (HERE) and numerical values (HERE) to a common currency that facilitates an apples-to-apples comparison between all projects?
- Well, we need to create a utility function that measures the level of ‘usefulness’ or ‘attractiveness’ or ‘value’ for each of the decision criteria, while taking into account the organization’s risk preference. So, this organization has chosen to measure the attractiveness of Leadership Differentiation & Competitive Advantage along 5 categorical thresholds i.e. Low Comparative, High Comparative, Low Competitive, High Competitive, and Absolute. Once each threshold is well defined, a utility score from 0-10 is assigned to each threshold. Note: this organization has decided that, based on its risk preference, there is a disproportionate jump in value between a Low Competitive score (HERE) and a High Competitive score (HERE). (ANIMATION) Likewise, a utility function is created for NPV. This one is easier to construct because the numerical values are readily quantifiable. The common currency therefore, for both utility functions is a util.
- Based on the utility functions described in the previous slide, each categorical descriptor and numerical value is converted to a raw utility score. For example, a categorical descriptor of ‘Low Competitive’ is worth 5 utils (HERE) while a numerical value between $3,000 B and $3.499 is worth 8 utils (HERE). Parenthetically, the term ‘raw’ is used to describe a score that has not yet been weighted.
- So, let’s go ahead and weight these raw utility scores based on their absolute levels of importance to decision-making i.e. to project prioritization. This is rather easy because, since we have only 1 criterion for each goal and both goals are equally weighted, the absolute weight of each criterion is 50% or 0.5. In this case, the raw scores from the previous slide are weighted at 50% to create the weighted scores shown in this table (HERE).
- A simple rank order or prioritization of the 10 projects in the portfolio is shown here where projects with the highest weighted utility scores (HERE) rise to the top and those with the lowest weighted utility scores (HERE) flow to the bottom. Now, we simply add up the cost of each project from top to bottom until we hit our budget constraint and that occurs (ANIMATION) here. The results is (ANIMATION) that the company can afford to pursue the top 5 projects (HERE) D through I but cannot afford to pursue projects below the red line i.e. projects A through B. The economic results is that this portfolio is worth roughly $9.5 B. This is certainly a good portfolio that best meets the goal of maximizing both strategic and financial value. But, how does this compare with a portfolio that is selected on the basis of financial value alone?
- Well, what this means is that the weight of the single decision criterion – NPV – is now 100%.
- Again, a simple rank order or prioritization of the 10 projects in the portfolio is shown here where projects with the highest weighted utility scores (HERE) rise to the top and those with the lowest weighted utility scores (HERE) flow to the bottom. Now, we repeat the process by simply adding up the cost of each project from top to bottom until we hit our budget constraint and that occurs (ANIMATION) here. The results is (ANIMATION) that the company can afford to pursue the top 5 projects (HERE) D through C but cannot afford to pursue projects below the red line i.e. projects J through A. The economic results is that this portfolio is worth roughly $13 B. This is certainly a good portfolio that best meets the goal of maximizing financial value alone and is a more financially rewarding portfolio than that shown before at $9.5 B. So, which portfolio do you prefer? The one that seeks to attain the highest strategic and financial value OR the one that seeks to attain the highest financial value?
- Clearly, both portfolios are good (i.e. they create a lot of value) and actionable (i.e. they do not violate the year’s budget constraint). So, let’s examine a few considerations more closely.
- A recommended approach to resolving the dilemma surrounding the question as to which is the better portfolio is to use ‘strategic value’ as a pre-filter to project selection. Let me be more explicit. Before prioritizing your projects on one or multiple decision criteria, determine, a priori, if each project fulfills a desired strategic intent i.e. is it ‘on strategy’ or ‘off strategy’. If it is ‘on strategy’, proceed to the prioritization step and stop debating its strategic importance. On the other hand, if it’s ‘off strategy’, there are really 3 major choices – (a) stop investing in it and do not proceed to the prioritization step OR (b) if it is a project that is deemed to be a quasi-policy decision (i.e. irrespective of its strategic value, it must be a part of the prioritization discussion), move to the prioritization step OR (c) if it is a true policy decision, exclude it from the prioritization exercise but account for its funding so you are now working with a budget that is less than $125 M for the reminder of projects because this project must be funded. But, what should be the goal of the prioritization step? To attain the highest strategic and financial value? No, it should be to attain the highest financial value only because you have already filtered away projects that are ‘off strategy’ and accounted for projects that are deemed to be true policy decisions.
- If you are successful is doing that, there is a high likelihood that your portfolio selection process will be much less bogged down in politics and become more objective, rational, and defensible. Lastly, if I go back to my 2 least favorite reasons for project inclusion, I hope we can agree that (HERE) ‘strategic value’ doesn’t necessarily add financial value to a project and, even though I did not touch on the subject of project funding that (HERE) simply cutting every other project by 10% to make way for a particular project is simply poor Portfolio Management practice. So, I hope I’ve given you some food for thought in preparation for the next time you help engage your decision-makers in a project prioritization exercise for portfolio selection. Thank you!