About 10 years ago I worked at an organization that featured a centralized PMO and required all project managers to go through the following exercise:
- Kickoff the project with the customer
- Document high-level requirements with the customer
- Ballpark a solution and an estimate
- Perform a formal project presentation to a technology council
Two things to understand first before going any further:
- Nearly all projects at this company for the project managers were internal
- The Tech Council was made up of internal executives
The sole purpose of the Tech Council and the PM presentations was to ensure that the project was worthwhile taking on (since everything was internal and really represented a shifting of money from one department to another rather than actual income – except where costs were being saved) and to ensure that legacy technology was not going to be used in a long-term solution when that technology was planning to be phased out and unsupported in the near future.
So, in a sense, the Tech Council was basically a Go/No-Go decision point early in the project. Even though it was early in the project it was a good time to ask:
- Is this problem worth solving?
- Does a potential solution exist?
- Are we going about this solution in the right way?
- Does this fall in line with our overall company goals and mission?
Justification and Feasibility
Buried in these four questions is the addressing of the issues of justification and feasibility. You should address both issues before continuing no matter what customer base you’re servicing – internal or external. If not, you run the risk of wasting time and money on problems that should not or cannot be solved.
Justification—particularly financial justification—is very difficult to assess at the requirements stage, because not much is really known about the project. Nonetheless, it’s wise to try to assess whether or not you can justify continuing the project. You may be able to do this by executing a simple cost vs. benefit analysis.
The benefit component is relatively easy to estimate: it’s the value of satisfying the need. In many cases, this is nothing more than calculating how much the problem is costing today. Estimating the cost of the solution is more difficult because you’re not sure what you’re going to do or how you’re going to do it.
One approach you may wish to consider consists of working backwards through the financial calculations. By doing this, you can determine the most you’d be able to spend on a solution. If none of your proposed solutions can be executed for less than that amount of money, the project will ultimately be unjustifiable—at least from a purely financial standpoint.
The second issue, feasibility, comes down to a basic question: Do you believe that a solution exists? In other words, can this problem even be solved? This step is referred to as verifying feasibility. There can be much subjectivity in this step; you should rely heavily on the judgment of subject matter experts (SMEs).
In reality, the most that you can realistically hope to determine at this point is that the possibility of a solution is thought to exist. That’s OK. As with justification, all you’re trying to do at this point is preclude the expenditure of additional resources and money on problems that have no reasonable solution.
Next, we’ll look at working to identify the best solution for the project and the necessity to proceed. We’ll discuss how you go about reviewing the alternative solutions for your project problem and identifying the best solution with which to move forward.
Finding the Best Solution
Once you fully understand the need and establish that satisfying the need is justifiable and feasible, you’re ready to determine the best way to satisfy that need. Although I’m using the term “you,” proper execution of this step really requires the input of many individuals. If you’re fortunate enough to be involved at this stage of the project’s evolution, you should be actively working toward building a team that can work with you from this point on.
Identify Alternative Solutions
The process of identifying the optimal way to satisfy the project requirements begins with generating a list of potential solutions.
This process can be greatly enhanced in the following ways:
- Do it in a team environment
- Include subject matter experts and stakeholders as appropriate
- Use brainstorming techniques
- Limit further development to only reasonable alternatives
Select the Best Alternative
Obviously, you can’t pursue every idea identified through processes like brainstorming. After soliciting all reasonable alternative solutions, the project team needs to pare the list down to only those that are worthy of further development, investigation, and definition. You can reduce the list by comparing each alternative against predetermined criteria. This is where the Requirements Document begins to add significant value.
The process for selecting the optimum solution begins by evaluating each alternative solution in terms of how well it satisfies the most critical aspects of the project requirements, such as budget constraints or strategic alignment. You may also wish to use other requirements-based considerations, such as the likelihood of technical success or the anticipated impact on existing products.
This initial screening will allow you to shorten the list of potential alternative solutions to a manageable number—I would recommend two to five. At this point, the selection process becomes much more rigorous. Each potential alternative should be evaluated using two basic types of criteria: financial and non-financial.
Now, let's exam using financial criteria like net present value and cost-benefit analysis to try to find the best solution and learn more about using non-financial criteria.
This segment has largely been inspired by Gary Heerkens’ book entitled “Project Management.” Here we are examining the use of financial criteria in determining the best project solution.
Using Financial Criteria for Project Selection
Companies that use project selection and justification methods often rely on financial calculations as a comparative tool and as a basic hurdle for management approval. Basic financial evaluation models—variously known as financial analysis, business case, project financials, or cost/benefit analysis—often include some combination of these four basic metrics: net present value, internal rate of return, payback period, and cash hole.
Let’s take a look at each of these metrics in more detail.
Net present value (NPV). Calculating a project’s NPV answers the question: How much money will this project make (or save)? It’s a calculation in dollars of the present value of all future cash flows expected from a project. It’s roughly analogous to the concept of profit.
The internal rate of return (IRR). Calculating the IRR answers the question: How rapidly will the money be returned? It’s a calculation of the percentage rate at which the project will return wealth. It’s roughly analogous to the effective yield of a savings account.
Payback period. Calculating this metric (also known as the time to money or breakeven point) answers the question: When will the original investment (the amount spent on the project) be recovered through benefits? It’s typically expressed in months or years.
Cash hole. Calculating the cash hole (also known as the maximum exposure) answers the question: What're the most we’ll have invested at any given point in time? It’s expressed in terms of dollars.
Performing a Financial Analysis (or Cost vs. Benefit Analysis)
Each of the four financial metrics identified previously can be determined by performing financial analysis.
Although you may not be intimately involved in performing a complete financial analysis, as a savvy project manager you should understand how it’s done and the terminology involved.
Read: Project Financial Management Contingence
The basic financial analysis process is not as difficult as many think. It consists of four basic steps.
Step 1: Identify the Sources of Cash Flows (Inflows and Outflows)
Executing a project causes money to flow out and in. Cash inflows are any financial benefits that can be claimed as a result of executing your project: e.g., an increase in revenue from sales, a reduction in production or operating costs, material savings, and waste reduction. Cash outflows are any expenditures or losses due to the project or its downstream effects. The most obvious cash outflow is the cost of the project itself. However, an increase in operating costs due to the project would also be a cash outflow.
Step 2: Estimate the Magnitude of Specific Cash Flows
In some cases, it will be fairly straightforward to estimate cash flows. In other cases, it may be very difficult. For example, consider how confident you would feel in placing a specific dollar value on these benefits:
- Increased output due to enhanced employee satisfaction
- Improvement in vendor delivery reliability
- Improvement in workforce safety
- Increase in user comfort or convenience
- Reduction in potential legal action against your organization
In estimating some of these types of cash flows, it can be very useful to rely on historical data or benchmark data.
Step 3: Chart the Cash Flows
After you’ve estimated the magnitude of all cash flows, you can chart all cash outflows and inflows year by year throughout the useful life of the project.
Step 4: Calculate the Net Cash Flow Using an Agreed-upon Discount Rate
Because the value of a dollar in the future is less than the value of a dollar today, the value of future cash flows must discounted. In simple terms, it is what the investor (your company) could expect to receive from any other investment that is consistent with its risk tolerance.
An NPV greater than zero indicates that your project is expected to provide a financial return that exceeds the organization’s investment expectations, so your project is likely to be approved (if there’s enough cash to fund it).
Let's continue and discuss the project decision process by examining the non-financial criteria for project selection.
In this segment, we’ll look at the non-financial criteria for selecting projects to proceed with. Basically, here we’re looking at weighted factor scoring to identify whether a project should move forward.
Using Non-Financial Criteria for Project Selection
Financial models express costs and benefits in dollars and cents. As mentioned earlier, estimating certain kinds of benefits in financial terms can be quite difficult or uncomfortable. In other situations, accurate data may be obtainable, but only by conducting expensive tests, studies, or surveys.
Whenever the process of getting good financial data is difficult, expensive, or time-consuming, using a weighted factor scoring model (decision matrix) may be a reasonable option for selecting the best alternative solution.
The figure below shows a decision matrix constructed to determine the preferred model of automobile. We’ve identified six attributes that are meaningful to us: cost, comfort, style, handling, reliability, and resale. We then weight each attribute by assessing relative importance to it. The weights must total 1.
To use a decision matrix, you need to establish a scale for rating each alternative for each attribute. (The example shown uses a five-point rating scale.) You must define the scale so that everyone has a common understanding of what each rating number—0, 1, 2, 3, 4, 5—represents.
Once you’ve established the relative weighting and the rating scale, it’s merely a question of filling in the blanks to determine the best alternative. In our example, using six weighted attributes and a five-point scale, the Lincoln Town Car was determined to be the best alternative.
Use of a weighted factor scoring model offers several advantages:
- It allows for using multiple criteria, including financial data. The attributes you select could include any combination of the four financial metrics presented in this chapter.
- It is easy to construct and to interpret.
- It allows for management input. Management can determine the appropriate attributes and the relative weighting. In fact, involving management in constructing the matrix may streamline the project approval process.
- It is well suited to what-if studies and sensitivity analysis. Trade-offs between criteria are readily observable.
There are also some disadvantages:
- The process relies almost entirely upon the subjective measure, thus opening it up to questions of bias, halo effects, and reliance on opinion or judgment.
- The result obtained is only a measure of relative attractiveness. There is no absolute verification that any of the alternatives identified is a justifiable investment from a business perspective.
- All attributes are assumed to be independent; there are no allowances made for interdependencies between or among factors.