Managing Projects for Value

CHAPTER 1

Understanding Project Value

Whether stated or implied, every organization has some purpose or mission that drives achievement. Likewise, each possesses some vision for the future that inspires, motivates, and attracts stakeholders. From vision and mission, opportunity can be revealed. To exploit opportunities, goals are developed.

CONCEPTS IN MANAGING PROJECTS FOR VALUE

Five key concepts guide the management of projects for value.

Concept 1: Projects Derive Their Value from Goal Achievement

Goals represent that portion of the opportunity value that can be transferred into the business. Goals are the state or condition to which organizations aspire; thus, value is attached to their achievement. Insofar as proposed projects are deemed necessary to achieve goals, projects are valuable to the organization (see Figure 1-1).

Said another way, projects are not valuable in and of themselves; they only acquire value from the role they play in exploiting opportunity. This idea forms the first of five concepts in managing projects for value: A project’s value is derived from the value obtained by reaching goals (Figure 1-2).

Concept 2: Projects Are Investments Made by Management

By definition, projects begin and projects end,¹ but business goes on. For projects to exist, a deliberate assignment of resources must occur. In return for these resources, there is an expectation of a deliverable with benefits attached. Thus, projects can be seen as investments: principal applied, time expended, and return expected. For purposes of this book, the project sponsor is the project investor with authority to commit resources and charter the project. The charter becomes the investment agreement, specifying the value expected, the risk allowed, the resources committed, and the project manager’s authority to apply organizational resources.

FIGURE 1-1   Business goals are the source of value for projects

FIGURE 1-2   Concepts in managing projects for value

Concept 3: Project Investors/Sponsors Tolerate Risk

The concept of investment is that a commitment is made in the present time with an expectation of a future reward. The displacement of the future from the present introduces the possibility that unfavorable outcomes could occur (see Figure 1-3). Risk is the word used to capture the concept of potentially unfavorable outcomes. Project sponsors, acting as investors, embrace and understand risk as an unavoidable aspect of pursuing reward. Although project investors/sponsors tolerate risk, they do not manage it. Instead, the project manager manages the risk of achieving successful deliverables. Once the project itself is complete, a benefits manager manages the risk of achieving the operational value of the project.

As individuals, project investors/sponsors have different attitudes regarding risk. For instance, objective investors/sponsors are indifferent to the specific nature of risk, judging only the risk-adjusted value. In effect, different risks of the same value or impact are judged equally.

Risk-averse project investors/sponsors seek a balance of risk and reward. Risk-averse investors/sponsors are not necessarily risk avoiders, but they do avoid risks that cannot be afforded if the risk comes true, or cost more if the risk comes true, than the value of the try.

FIGURE 1-3   Time adds uncertainty to outcomes

The following example illustrates this concept. In a coin toss, the bet is that heads gets $200 and tails gets $0. The expected value is $100 since half the time $200 will come up and half the time $0 will come up. The value of the try is negligible; nothing but a little time is lost if tails comes up. Suppose the bet is changed so that heads gets $400 and tails pays $200 for the same average outcome of $100. The risk-averse investor may not play the second bet even though it has the same positive expected value as the first because of the investor’s aversion to even a 50 percent chance of losing $200 and a judgment that the entertainment value of the try is not worth $200.²

Figure 1-4 illustrates the concept of risk aversion applied to projects. Even though Project 2 has a higher expected return, its risk is beyond a threshold of affordable risk compared with Project 1. The risk-averse manager will approve Project 1 and disapprove Project 2.

Concept 4: The Investment Equation Becomes the Project Equation

The traditional investment equation of total return equals principal plus gain is transformed into the project equation of project value is delivered from resources committed and risks taken. This equation is the project manager’s math. Many persons use the terms benefits, return, and value somewhat interchangeably even though they have different meanings.

FIGURE 1-4   To be risk-averse means there are risks that will not be taken

This book employs the following definitions:

Benefits are the mechanism for recovering project investment. For example, a project might be chartered to reduce production costs. Reduced production costs are the benefits that pay for the project investment.

Return is the rate of change of a financial metric; for example, percentage incremental profit per period generated after the project is completed.

Value is the need being satisfied by the project and the source of improved wealth in the business. In this project example, the business need may be to retain the production capability for customer