There's never a shortage of projects, but there's not enough time, money, and staff in the world to do them all. Before you begin managing a project, make sure it earns its place in the project portfolio. Throwing darts or pulling petals off daisies isn't the answer. You're better off knowing what's important to your organization, and picking projects that support those objectives.
Project selection criteria are just as helpful once projects are underway, because projects don't always deliver what they promise. If a project isn't meeting expectations, you can decide whether to give it time to recover or cut it loose. Similarly, if a juicy new project appears, you can compare its potential results to those of projects already in progress to see if it makes sense to swap it for a project that's partially complete.
Selection criteria can save time and effort before the selection process even starts. People thinking about proposing a project can evaluate potential results before facing the selection committee. If the results don't pass the test, there's little point in presenting the project to management.
To make good decisions, you need some kind of consistent selection process, whether you're a small business owner allocating limited resources or a committee setting up a multiproject portfolio. You can evaluate the candidates, and choose the projects with the most compelling results. When you run out of money and resources, you can put any remaining winners on the waiting list.
Some projects are no-brainers, like the ones needed to satisfy government regulations. For example, companies that want to stay in business have to conform to the accounting requirements of the Sarbanes-Oxley Act. On the other hand, you can cull projects by picking the ones that support the organization's mission and business objectives. If your company dabbles in widgetry, the goal might be getting your tools to market before the competition. In the healthcare industry, safety trumps speed, because recalling devices already implanted in people is going to hurt the patients and the company pocketbook. Any time you begin to describe a project by saying, "It would be nice…" you may as well stop right there—unless you can link the project to quantifiable business objectives as well.
1. Someone proposes a project. Project sponsors or project managers usually prepare a proposal to sell the project to the review board—why the project is worthwhile, what benefits it provides, and how it fares against the selection criteria.
2. The project review board evaluates proposals. The project review board meets on a regular schedule to evaluate proposed projects. People who propose projects get a chance to make their pitch, which usually includes rigorous Q&A sessions with the board members to clarify ambiguous points. After the presentations, the board discusses the mer-its of the projects, how they fit with the business objectives, as well as any conflicts or issues they see.
3. The board approves or rejects projects. The board decides which projects get to move forward, and notifies proposers of the fate of their projects, preferably with reasons for the decision.
Here are some of the more common business objectives that trigger projects:
Increase market share
Reduce price to remain competitive
Reduce time to market
Increase customer satisfaction
Increase product quality or safety
Satisfy regulatory standards
Although some projects get a free pass due to regulatory requirements or because the CEO says so, most have to earn their spot in the project line-up. Because business objectives vary, you need some sort of common denominator for measuring results—which often comes down to money. This section describes the most common financial measures that executives use, and the pros and cons of each.
Whether you're trying to increase revenue, reduce costs, or improve product quality, you can usually present project benefits in dollars. The winner is the project that makes the most of the money spent on the project. Of course, to calculate financial results, you need numbers; and to get numbers, you must do some prep work and estimating (Ways to Estimate Work). You don't need a full-blown project plan (Project Planning in a Nutshell) to propose a project, but you do need a rough idea of the project's potential benefits and costs. That's why many organizations start with feasibility studies—small efforts specifically for determining whether it makes sense to pursue a project further.
If some business objectives are way more important than others, you may want to evaluate the projects that support those killer objectives first. Then, if you have money and resources left over, you can look at projects in other areas of the business.
Risk is another consideration in selecting projects. Suppose a project has mouth-watering financial measures and heart-stopping risks. Project proposals should include a high-level analysis of risks (Managing Quality), so the selection committee can make informed decisions.
Payback period is the time a project takes to earn back what it cost. Consider a project that reduces warranty repairs by $10,000 each month, and costs $200,000 to implement. The payback period is cost of the project divided by the money earned or saved each month:
Payback period = $200,000 / $10,000 per month = 20 months
Payback period has simplicity on its side. The data you need is relatively easy to obtain, and nonfinancial types can follow the math. But if you get really finicky about it, payback period has several limitations:
It assumes enough earnings to pay back the cost. If your company stops selling the product that the warranty repair project supports, the monthly savings may not continue for the calculated payback period, which ends up costing money.
It ignores cash flows after the payback period ends. Projects that generate money early beat out projects that generate more money over a longer period. Consider two projects, each costing $100,000. Project #1 saves $20,000 each month for only 5 months. Project #2 saves $10,000 each month for 24 months. Project #1's payback period is 5 months compared to Project #2's 10 months. However, Project #2 saves $240,000, whereas Project #1 saves only $100,000.
It ignores the time value of money. There's a price to pay for using money over a period of time, just like the interest you pay on the mortgage on your house. Payback period doesn't account for the time value of money, because it uses the project cost as a lump sum, regardless how long the project takes and when you spend the money. The measures in the next sections are more accurate when a project spends and receives money over time.
Net present value (NPV) takes the time value of money into account, so it provides a more accurate picture of financial performance than does payback period. The time value of money is another way to say that money isn't always worth the same amount—money you earn in the future isn't as valuable as money you earn today. For example, the value of your salary goes down as inflation reduces what each dollar of your paycheck can buy each year. Conversely, you pay a price for using money, which is exactly like the interest you pay on a house mortgage.
NPV starts by combining project income (earnings or savings) and costs into cash flows. If you earn $4,000 one month and spend $3,000 on living expenses, your net cash flow is $1,000. Then, NPV uses a rate of return to translate the cash flows into a single value in today's dollars. If NPV is greater than zero, the project earns more than that rate of return. If NPV is less than zero, the project return is lower. Where does this magical return come from? In most cases, you use the rate of return that your company requires on money it invests. For example, if your company demands a 10 percent return to invest in a project, you use 10 percent in the NPV calculation. If the NPV is greater than zero, the project passes the company's investment test.
NPV has two drawbacks. First, it doesn't tell you the return that the project provides, only whether the project exceeds the rate of return you use. You can compare NPV for several projects and pick the one with the highest value, but executives like to see an annual return. The second drawback is that NPV is hard to explain to non-financial folks. (Luckily, however, most people picking projects are well-versed in financial measures.)
Figure 1-2 uses the purchase of a machine as a simple example of net present value. The machine costs $100,000 and saves $10,000 in production costs each month it operates. The machine is obsolete at the end of the first year, at which point its value as a chic boat anchor is $5,000.
Figure 1-2. The XNPV function interprets negative numbers as money spent—like $100,000 for a new packaging machine. Positive numbers represent money coming in (as a result of the improved equipment). If you spend and earn money on the same date, simply enter the net amount (the income minus the expense). Because NPV in this example is greater than zero, the machine provides a return greater than the required annual 10 percent return.
To avoid frenetic finger-work calculating NPV on a handheld calculator, try the XNPV function in Microsoft Excel. You provide the required rate of return, the cash flows the investment delivers, and the dates on which they occur (remember the value of money changes over time). The XNPV function does the rest.
If cash flows occur on a regular schedule like once a month, you can use the Excel NPV function, which doesn't even require dates. The NPV function assumes a regular schedule, and you simply input the rate of return between each cash flow. If the annual rate is 10 percent and you have monthly cash flows, you enter the rate as 10 percent divided by 12, or .833 percent. The biggest drawback to the NPV function is that it accepts no more than 29 values, which isn't enough for monthly cash flows for several years.
In an Excel workbook, fill in one cell with the rate of return you want to use, and then enter the cash flows and dates in two of the workbook columns, as shown in Figure 1-2.
The dates and cash flows don't have to be side by side, but you can read the workbook more easily when they are.
In Excel 2007, select the cell in which to insert the function, and then click the Formulas tab. On the left side of the ribbon, click Insert Function.
In Excel 2003, you choose Insert → Function. In either version of Excel, the Insert Function dialog box opens with the "Search for a function" box selected.
In the "Search for a function" box, type XNPV.
Click OK to insert the function into the cell, and then fill in the boxes for the function arguments.
In addition to adding the function to the cell, Excel opens the Function Arguments dialog box, shown in Figure 1-3, which presents the three arguments for the function with hints and feedback.
Click OK to complete the function and close the dialog box.
The likely favorite of financial types, internal rate of return (IRR) tells you the annual return that a project delivers, taking into account the time value of money. IRR is like the annual percentage yield (APY) that you earn on a savings account, which includes the compounded interest you earn during the year. If your project delivers an IRR greater than the return your company requires, you're golden.
Figure 1-3. To fill in an argument, click the box, such as Rate. Then, in the worksheet, click the cell (or cells) that contain the input. For example, for Values, you can drag over all the cells that contain the cash flows.
Just like NPV, IRR depends on when cash flows in or out. For example, money you spend up front drags the IRR down more than money you spend later on. Likewise, if a project brings money in early, the IRR is higher than if the income arrives later.
Excel's XIRR function calculates IRR given cash flows and the dates on which they occur, as shown in Figure 1-4. For the mathematicians in the audience, IRR doesn't have a formula of its own. The way you calculate IRR by hand is by running the NPV calculation with different rates of return until the answer is zero—that return is the IRR. The steps to insert the XIRR function into a worksheet are similar to those for XNPV in the previous section.