You are the head of the project selection team at simsox

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CHAPTER TWO

Organization Strategy and Project Selection

Organization Strategy and Project Selection The Strategic Management Process: An Overview The Need for a Project Portfolio Management System A Portfolio Management System Selection Criteria Applying a Selection Model Managing the Portfolio System Summary Appendix 2.1: Request for Proposal (RFP)

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Strategy is implemented through projects. Every project should have a clear link to the organization's strategy.

Strategy is fundamentally deciding how the organization will compete. Organizations use projects to convert strategy into new products, services, and processes needed for success. For example, Intel's major strategy is one of differentiation. Its projects target innovation and time to market. Currently, Intel is directing its strategy toward specialty chips for products other than computers, such as autos, security, cell phones, air controls. Another goal is to reduce project cycle times. Intel, NEC, General Electric, and AT&T have reduced their cycle times by 20–50 percent. Projects and project management play the key role in supporting strategic goals. It is vital for project managers to think and act strategically Aligning projects with the strategic goals of the organization is crucial for project success. Today's economic

climate is unprecedented by rapid changes in technology, global competition, and financial uncertainty. These conditions make strategy/project alignment even more essential for success. Ensuring a strong link between the strategic plan and projects is a difficult task that demands constant attention from top and middle management. The larger and more diverse an organization, the more difficult it is to create and maintain this strong link.

Companies today are under enormous pressure to manage a process that clearly aligns projects to organization strategy. Ample evidence still suggests that many organizations have not developed a process that clearly aligns project selection to the strategic plan. The result is poor utilization of the organization's resources—people, money, equipment, and core competencies. Conversely, organizations that have a coherent link of projects to strategy have more cooperation across the organization, perform better on projects, and have fewer projects. How can an organization ensure this link and alignment? The answer requires integration of projects with the

strategic plan. Integration assumes the existence of a strategic plan and a process for prioritizing projects by their contribution to the plan. A crucial factor to ensure the success of integrating the plan with projects lies in the creation of a process that is open and transparent for all participants to review. This chapter presents an overview of the importance of strategic planning and the process for developing a strategic plan. Typical problems encountered when strategy and projects are not linked are noted. A generic methodology that ensures integration by creating very strong linkages of project selection and priority to the strategic plan is then discussed. The intended outcomes are clear organization focus, best use of scarce organization resources (people, equipment, capital), and improved communication across projects and departments.

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Why Project Managers Need to Understand Strategy Project management historically has been preoccupied solely with the planning and execution of projects. Strategy was considered to be under the purview of senior management. This is old­school thinking. New­school thinking recognizes that project management is at the apex of strategy and operations. Aaron Shenhar speaks to this issue when he states, “… it is time to expand the traditional role of the project manager from an operational to a more strategic perspective. In the modern evolving organization, project managers will be focused on business aspects, and their role will expand from getting the job done to achieving the business results and winning in the market place.”1 There are two main reasons why project managers need to understand their organization's mission and

strategy. The first reason is so they can make appropriate decisions and adjustments. For example, how a project manager would respond to a suggestion to modify the design of a product to enhance performance will vary depending upon whether his company strives to be a product leader through innovation or to achieve operational excellence through low cost solutions. Similarly, how a project manager would respond to delays may vary depending upon strategic concerns. A project manager will authorize overtime if her firm places a premium on getting to the market first. Another project manager will accept the delay if speed is not essential. The second reason project managers need to understand their organization's strategy is so they can be

effective project advocates. Project managers have to be able to demonstrate to senior management how their project contributes to their firm's mission. Protection and continued support come from being aligned with corporate objectives. Project managers also need to be able to explain to team members and other stakeholders why certain project objectives and priorities are critical. This is essential for getting buy­in on contentious trade­ off decisions. For these reasons project managers will find it valuable to have a keen understanding of strategic

management and project selection processes, which are discussed next.

The Strategic Management Process: An Overview Strategic management is the process of assessing “what we are” and deciding and implementing “what we intend to be and how we are going to get there.” Strategy describes how an organization intends to compete with the resources available in the existing and perceived future environment.

Two major dimensions of strategic management are responding to changes in the external environment and allocating scarce resources of the firm to improve its competitive position. Constant scanning of the external environment for changes is a major requirement for survival in a dynamic competitive environment. The second dimension is the internal responses to new action programs aimed at enhancing the competitive position of the firm. The nature of the responses depends on the type of business, environment volatility, competition, and the organizational culture. Strategic management provides the theme and focus of the future direction of the organization. It supports

consistency of action at every level of the organization. It encourages integration because effort and resources are committed to common goals and strategies. See Snapshot from Practice: Does IBM's Watson's Jeopardy Project Represent a Change in Strategy? It is a continuous, iterative process aimed at developing an integrated and coordinated long­term plan of action. Strategic management positions the organization to meet the needs and requirements of its customers for the long term. With the long­term position identified, objectives are set, and strategies are developed to achieve objectives and then translated into actions by implementing projects. Strategy can decide the survival of an organization. Most organizations are successful in formulating strategies for what course(s) they should pursue. However, the problem in many organizations is implementing strategies —that is, making them happen. Integration of strategy formulation and implementation often does not exist.

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SNAPSHOT FROM PRACTICE Does IBM's Watson's Jeopardy Project Represent a Change in Strategy?*

IBM's investment in artificial intelligence paid off. In February 2010, millions of people were glued to their television sets to watch IBM's Watson outclass two former champion contestants on the Jeopardy quiz show. Watson performed at human expert levels in terms of precision, confidence, and speed during the Jeopardy quiz show. Does Watson represent a new strategic direction for IBM? Not really. The Watson project is simply a manifestation

of the move from computer hardware to a service strategy over a decade ago.

WATSON PROJECT DESCRIPTION Artificial intelligence has advanced significantly in recent years. Watson goes beyond IBM's chess­playing supercomputer of the late 1990s. Chess is finite, logical, and reduced easily to mathematics. Watson's space is ill­ defined and involves dealing with abstraction and the circumstantial nature of language. Since Watson's system can understand natural language, it can extend the way people interact with computers. The IBM Watson project took three intense years of research and development by a core team of about 20. Eight

university teams working on specific challenge areas augmented these researchers. Watson depends on over 200 million pages of structured and unstructured data and a program capable of running

trillions of operations per second. With this information backup, it attacks a Jeopardy question by parsing the question into small pieces. With the question parsed, the program then searches for relevant data. Using hundreds of decision rules, the program generates possible answers. These answers are assigned a confidence score to decide if Watson should risk offering an answer and how much to bet.

WHAT'S NEXT? Now that the hype is over, IBM is pursuing their service strategy and the knowledge gained from the Watson project to real business applications. Watson's artificial intelligence design is flexible and suggests a wide variety of opportunities in industries such as finance, medicine, law enforcement, defense. Further extensions to handheld mobile applications that tap into Watson's servers also hold great potential. IBM identified the obvious lowest hanging apples on the tree as providing healthcare solutions and has begun design of such a program.

© Sean Gallup/Getty Images

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To create a “doctor's consultant” program would likely follow a design platform similar to Watson's. For example, it would be able to:

Data mine current medical documents to build a knowledge base Integrate individual patient information Use system's complex analytics to select relevant data Use decision rules to provide physicians with diagnostic options Rank options with confidence levels for each option.

Creating a doctor's consultant solution will not replace doctors. Although the system holds tremendous potential, it is manmade and depends on the database, data analytics, and decision rules to select options. Given the doctor's consultant input, a trained doctor makes the final patient diagnosis to supplement physical examination and experience. The Watson project provides IBM with a flexible component to continue their decade­old strategy, moving IBM

from computer hardware to service products.

* Ferrucci, et al. “Building Watson,” AI Magazine. vol. 31, no. 3. Fall 2010.

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The components of strategic management are closely linked, and all are directed toward the future success of the organization. Strategic management requires strong links among mission, goals, objectives, strategy, and implementation. The mission gives the general purpose of the organization. Goals give global targets within the mission. Objectives give specific targets to goals. Objectives give rise to formulation of strategies to reach objectives. Finally, strategies require actions and tasks to be implemented. In most cases the actions to be taken represent projects. Figure 2.1 shows a schematic of the strategic management process and major activities required.

FIGURE 2.1 Strategic Management Process

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Four Activities of the Strategic Management Process The typical sequence of activities of the strategic management process is outlined here; a description of each activity then follows:

1. Review and define the organizational mission. 2. Analyze and formulate strategies. 3. Set objectives to achieve strategy. 4. Implement strategies through projects.

Review and Define the Organizational Mission The mission identifies “what we want to become,” or the raison d’être. Mission statements identify the scope of the organization in terms of its product or service. A written mission statement provides focus for decision making when shared by organizational managers and employees. Everyone in the organization should be keenly aware of the organization's mission. For example, at one large consulting firm, partners who fail to recite the mission statement on demand are required to buy lunch. The mission statement communicates and identifies the purpose of the organization to all stakeholders. Mission statements can be used for evaluating organization performance. Traditional components found in mission statements are major products and services, target customers and

markets, and geographical domain. In addition, statements frequently include organizational philosophy, key technologies, public image, and contribution to society. Including such factors in mission statements relates directly to business success. Mission statements change infrequently. However, when the nature of the business changes or shifts, revised

mission and strategy statements may be required. See Snapshot from Practice: HP's Strategy Revision as an example of a mission and strategy revision. More specific mission statements tend to give better results because of a tighter focus. Mission statements

decrease the chance of false directions by stakeholders. For example, compare the phrasing of the following mission statements:

Provide hospital design services. Provide data mining and analysis services. Provide information technology services. Increase shareholder value. Provide high­value products to our customer.

Clearly, the first two statements leave less chance for misinterpretation than the others. A rule­of­thumb test for a mission statement is, if the statement can be anybody's mission statement, it will not provide the guidance and focus intended. The mission sets the parameters for developing objectives.

Analyze and Formulate Strategies Formulating strategy answers the question of what needs to be done to reach objectives. Strategy formulation includes determining and evaluating alternatives that support the organization's objectives and selecting the best alternative. The first step is a realistic evaluation of the past and current position of the enterprise. This step typically includes an analysis of “who are the customers” and “what are their needs as they (the customers) see them.”

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SNAPSHOT FROM PRACTICE HP's Strategy Revision*

August 18, 2011, Hewlett Packard announced a dramatic change in strategy. Leo Apotheker, CEO of the world's largest seller of personal computers, decided to exit the low margin PC unit. He wanted to redirect HP to business software, networking, and storage, which carry higher margins. Unfortunately, Apotheker failed to communicate the strategic change effectively, lost credibility, and was dismissed. He was replaced by Meg Whitman, while controversy over the company's haphazard direction continued.

THE PC MARKET Fundamentally, the PC has become a commodity. Although the HP personal computer unit represents nearly a third of total revenue and about 19 percent of HP's profit, growth and profits are slowing. Increased competition from Asia, for example, Lenovo, will continue to erode margins. More importantly, increasing use of smartphones and tablets is already cannibalizing the PC market.

FUTURE MARKETS In HP's words, their new corporatewide mission is to provide seamless, secure, context­aware experiences for a connected world.* Business software, networking, and storage can be nicely connected for a grand corporate strategy to meet the new mission. IBM, Google, Oracle, and Microsoft already dominate the software industry. They and others are all moving to

collect and use unstructured data to enhance decision making and/or client requests across numerous industries. All are developing better search engines to sort through any manner of data for information relevant to the search. These dominant players leave HP in a catch­up mode. HP's plan to compete requires quick action. Executing the software strategy will require purchasing smaller firms or

developing collaborative relationships to acquire specific expertise. HP has made two purchases to buttress the new strategy. Autonomy Corporation, UK, will concentrate on mining and searching large structured and unstructured data. Their purchase of Vertica provides an analytics platform for large structured and unstructured data. We can expect to see more purchases that connect software, storage, and networking, which will complement HP's current expertise in the server business.

EXECUTING STRATEGY HP faces risks. HP has bet the farm on this revised strategy that looks similar to what IBM started over a decade ago. IBM has spent billions and ten years of development to perfect their systems (see previous Watson Snapshot). HP is in a “follower” position. This means gaining market share from tough rivals such as IBM, Apple, Google, Oracle, and Cisco. Can HP afford to go face­to­face with others in stronger cash positions? Can HP sell off its PC division at a reasonable price? HP must move quickly to catch up. Executing the new mission statement presents numerous leadership challenges.

The changes in HP strategies over the last 15 years have caused confusion and a loss of employee loyalty. Additional changes in organizational culture, along with many new mission critical projects, will place further stress on the organization. HP must be vigilant in selecting, prioritizing, and balancing organizational risk for all projects. HP needs to communicate a coherent strategy that can be executed consistently over time. Although there are outsiders who have praised or criticized the new strategy, we must wait and see how the details

unfold. HP's strategic moves will make interesting case studies for years to come.

* HP website, HP newsroom.

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The next step is an assessment of the internal and external environments. What are the internal strengths and weaknesses of the enterprise? Examples of internal strengths or weaknesses could be core competencies, such as technology, product quality, management talent, low debt, and dealer networks. Managers can alter internal strengths and weaknesses. Opportunities and threats usually represent external forces for change such as technology, industry structure, and competition. Competitive benchmarking tools are sometimes used here to assess current and future directions. Opportunities and threats are the flip sides of each other. That is, a threat can be perceived as an opportunity, or vice versa. Examples of perceived external threats could be a slowing of the economy, a maturing life cycle,

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exchange rates, or government regulation. Typical opportunities are increasing demand, emerging markets, and demographics. Managers or individual firms have limited opportunities to influence such external environmental factors; however, in recent years notable exceptions have been new technologies such as Apple using the iPod to create a market to sell music. The keys are to attempt to forecast fundamental industry changes and stay in a proactive mode rather than a reactive one. This assessment of the external and internal environments is known as the SWOT analysis (strengths, weaknesses, opportunities, and threats). From this analysis, critical issues and strategic alternatives are identified. Critical analysis of the strategies

includes asking questions: Does the strategy take advantage of our core competencies? Does the strategy exploit our competitive advantage? Does the strategy maximize meeting customers’ needs? Does the strategy fit within our acceptable risk range? These strategic alternatives are winnowed down to a critical few that support the basic mission. Strategy formulation ends with cascading objectives or projects assigned to lower divisions, departments, or

individuals. Formulating strategy might range around 20 percent of management's effort, while determining how strategy will be implemented might consume 80 percent.

Set Objectives to Achieve Strategies Objectives translate the organization strategy into specific, concrete, measurable terms. Organizational objectives set targets for all levels of the organization. Objectives pinpoint the direction managers believe the organization should move toward. Objectives answer in detail where a firm is headed and when it is going to get there. Typically, objectives for the organization cover markets, products, innovation, productivity, quality, finance, profitability, employees, and consumers. In every case, objectives should be as operational as possible. That is, objectives should include a time frame, be measurable, be an identifiable state, and be realistic. Doran created the memory device shown in Exhibit 2.1, which is useful when writing objectives.2 Each level below the organizational objectives should support the higher­level objectives in more detail; this

is frequently called cascading of objectives. For example, if a firm making leather luggage sets an objective of achieving a 40 percent increase in sales through a research and development strategy, this charge is passed to the marketing, production, and R&D departments. The R&D department accepts the firm's strategy as their objective, and their strategy becomes the design and development of a new “pull­type luggage with hidden retractable wheels.” At this point the objective becomes a project to be implemented—to develop the retractable wheel luggage for market within six months within a budget of $200,000. In summary, organizational objectives drive your projects.

EXHIBIT 2.1 Characteristics of Objectives

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Implement Strategies through Projects Implementation answers the question of how strategies will be realized, given available resources. The conceptual framework for strategy implementation lacks the structure and discipline found in strategy formulation. Implementation requires action and completing tasks; the latter frequently means mission­critical projects. Therefore, implementation must include attention to several key areas. First, completing tasks requires allocation of resources. Resources typically represent funds, people,

management talents, technological skills, and equipment. Frequently, implementation of projects is treated as an “addendum” rather than an integral part of the strategic management process. However, multiple objectives place conflicting demands on organizational resources. Second, implementation requires a formal and informal organization that complements and supports strategy and projects. Authority, responsibility, and performance all depend on organization structure and culture. Third, planning and control systems must be in place to be certain project activities necessary to ensure strategies are effectively performed. Fourth, motivating project contributors will be a major factor for achieving project success. Finally, areas receiving more attention in recent years are portfolio management and prioritizing projects. Although the strategy implementation process is not as clear as strategy formulation, all managers realize that, without implementation, success is impossible. Although the four major steps of strategic management process have not been altered significantly over the years, the view of the time horizon in the strategy formulation process has been altered radically in the last two decades. Global competition and rapid innovation require being highly adaptive to short­run changes while being consistent in the longer run.

The Need for a Project Portfolio Management System Implementation of projects without a strong priority system linked to strategy creates problems. Three of the most obvious problems are discussed below. A project portfolio system can go a long way to reduce, or even eliminate, the impact of these problems.

Problem 1: The Implementation Gap In organizations with short product life cycles, it is interesting to note that frequently participation in strategic planning and implementation includes participants from all levels within the organization. However, in perhaps 80 percent of the remaining product and service organizations, top management pretty much formulates strategy and leaves strategy implementation to functional managers. Within these broad constraints, more detailed strategies and objectives are developed by the functional managers. The fact that these objectives and strategies are made independently at different levels by functional groups within the organization hierarchy causes manifold problems. Some symptoms of organizations struggling with strategy disconnect and unclear priorities are presented

here.

Conflicts frequently occur among functional managers and cause lack of trust. Frequent meetings are called to establish or renegotiate priorities. People frequently shift from one project to another, depending on current priority. Employees are confused about which projects are important. People are working on multiple projects and feel inefficient.

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Resources are not adequate.

Because clear linkages do not exist, the organizational environment becomes dysfunctional, confused, and ripe for ineffective implementation of organization strategy and, thus, of projects. The implementation gap refers to the lack of understanding and consensus of organization strategy among top and middle­level managers. A scenario the authors have seen repeated several times follows. Top management picks their top 20 projects

for the next planning period, without priorities. Each functional department—marketing, finance, operations, engineering, information technology, and human resources—selects projects from the list. Unfortunately, independent department priorities across projects are not homogenous. A project that rates first in the IT department can rate 10th in the finance department. Implementation of the projects represents conflicts of interest with animosities developing over organization resources. If this condition exists, how is it possible to effectively implement strategy? The problem is serious. One

study found that only about 25 percent of Fortune 500 executives believe there is a strong linkage, consistency, and/or agreement between the strategies they formulate and implementation. In another study of Deloitte Consulting, Jeff MacIntyre reports, “Only 23 percent of nearly 150 global executives considered their project portfolios aligned with the core business.”3 Middle managers considered organizational strategy to be under the purview of others or not in their realm of influence. It is the responsibility of senior management to set policies that show a distinct link between organizational strategy and objectives and projects that implement those strategies. The research of Fusco suggests the implementation gap and prioritizing projects are still overlooked by many organizations. He surveyed 280 project managers and found that 24 percent of their organizations did not even publish or circulate their objectives; in addition, 40 percent of the respondents reported that priorities among competing projects were not clear, while only 17 percent reported clear priorities.4

Problem 2: Organization Politics Politics exist in every organization and can have a significant influence on which projects receive funding and high priority. This is especially true when the criteria and process for selecting projects are ill­defined and not aligned with the mission of the firm. Project selection may be based not so much on facts and sound reasoning, but rather on the persuasiveness and power of people advocating projects. The term “sacred cow” is often used to denote a project that a powerful, high­ranking official is advocating.

Case in point, a marketing consultant confided that he was once hired by the marketing director of a large firm to conduct an independent, external market analysis for a new product the firm was interested in developing. His extensive research indicated that there was insufficient demand to warrant the financing of this new product. The marketing director chose to bury the report and made the consultant promise never to share this information with anyone. The director explained that this new product was the “pet idea” of the new

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CEO, who saw it as his legacy to the firm. He went on to describe the CEO's irrational obsession with the project and how he referred to it as his “new baby.” Like a parent fiercely protecting his child, the marketing director believed that he would lose his job if such critical information ever became known. Project sponsors play a significant role in the selection and successful implementation of product innovation

projects. Project sponsors are typically high­ranking managers who endorse and lend political support for the completion of a specific project. They are instrumental in winning approval of the project and in protecting the project during the critical development stage. The importance of project sponsors should not be taken lightly. For example, a PMI global survey of over 1,000 project practitioners and leaders over a variety of industries found those organizations having active sponsors on at least 80 percent of their projects/programs have a success rate of 75 percent, eleven percentage points above the survey average of 64 percent. Many promising projects have failed to succeed due to lack of strong sponsorship.5 The significance of corporate politics can be seen in the ill­fated ALTO computer project at Xerox during the

mid­1970s.6 The project was a tremendous technological success; it developed the first workable mouse, the first laser printer, the first user­friendly software, and the first local area network. All of these developments were five years ahead of their nearest competitor. Over the next five years this opportunity to dominate the nascent personal computer market was squandered because of internal in­fighting at Xerox and the absence of a strong project sponsor. (Apple's MacIntosh computer was inspired by many of these developments.) Politics can play a role not only in project selection but also in the aspirations behind projects. Individuals

can enhance their power within an organization by managing extraordinary and critical projects. Power and status naturally accrue to successful innovators and risk takers rather than to steady producers. Many ambitious managers pursue high­profile projects as a means for moving quickly up the corporate ladder. Many would argue that politics and project management should not mix. A more proactive response is that

projects and politics invariably mix and that effective project managers recognize that any significant project has political ramifications. Likewise, top management needs to develop a system for identifying and selecting projects that reduces the impact of internal politics and fosters the selection of the best projects for achieving the mission and strategy of the firm.

Problem 3: Resource Conflicts and Multitasking Most project organizations exist in a multiproject environment. This environment creates the problems of project interdependency and the need to share resources. For example, what would be the impact on the labor resource pool of a construction company if it should win a contract it would like to bid on? Will existing labor be adequate to deal with the new project—given the completion date? Will current projects be delayed? Will subcontracting help? Which projects will have priority? Competition among project managers can be contentious. All project managers seek to have the best people for their projects. The problems of sharing resources and scheduling resources across projects grow exponentially as the

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number of projects rises. In multiproject environments the stakes are higher and the benefits or penalties for good or bad resource scheduling become even more significant than in most single projects. Resource sharing also leads to multitasking. Multitasking involves starting and stopping work on one task to

go and work on another project, and then returning to the work on the original task. People working on several tasks concurrently are far less efficient, especially where conceptual or physical shutdown and startup are significant. Multitasking adds to delays and costs. Changing priorities exacerbate the multitasking problems even more. Likewise, multitasking is more evident in organizations that have too many projects for the resources they command. The number of small and large projects in a portfolio almost always exceeds the available resources (typically

by a factor of three to four times the available resources). This capacity overload inevitably leads to confusion and inefficient use of scarce organizational resources. The presence of an implementation gap, of power politics, and of multitasking adds to the problem of which projects are allocated resources first. Employee morale and confidence suffer because it is difficult to make sense of an ambiguous system. A multiproject organization environment faces major problems without a priority system that is clearly linked to the strategic plan. In essence, to this point we have suggested that many organizations have no meaningful process for

addressing the problems we have described. The first and most important change that will go a long way in addressing these and other problems is the development and use of a meaningful project priority process for project selection. How can the implementation gap be narrowed so that understanding and consensus of organizational

strategies run through all levels of management? How can power politics be minimized? Can a process be developed in which projects are consistently prioritized to support organizational strategies? Can the prioritized projects be used to allocate scarce organizational resources—for example, people, equipment? Can the process encourage bottom­up initiation of projects that support clear organizational targets? What is needed is a set of integrative criteria and a process for evaluating and selecting projects that support

higher­level strategies and objectives. A single­project priority system that ranks projects by their contribution to the strategic plan would make life easier. Easily said, but difficult to accomplish in practice. Organizations that managed independent projects and allocated resources ad hoc have shifted focus to selecting the right portfolio of projects to achieve their strategic objectives. This is a quickening trend. The advantages of successful project portfolio systems are becoming well recognized in project­driven organizations. See Exhibit 2.2, which lists a few key benefits; the list could easily be extended. A project portfolio system is discussed next with emphasis on selection criteria, which is where the power of

the portfolio system is established.

EXHIBIT 2.2 Benefits of Project Portfolio Management

Builds discipline into project selection process. Links project selection to strategic metrics. Prioritizes project proposals across a common set of criteria, rather than on politics or emotion. Allocates resources to projects that align with strategic direction. Balances risk across all projects. Justifies killing projects that do not support organization strategy. Improves communication and supports agreement on project goals.

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A Portfolio Management System Succinctly put, the aim of portfolio management is to ensure that projects are aligned with strategic goals and prioritized appropriately. As Foti points out, portfolio management asks “What is strategic to our organization?” (2002) Portfolio management provides information that allows people to make better business decisions. Since projects clamoring for funding and people usually outnumber available resources, it is important to follow a logical and defined process for selecting the projects to implement. Design of a project portfolio system should include classification of a project, selection criteria depending

upon classification, sources of proposals, evaluating proposals, and managing the portfolio of projects.

Classification of the Project Many organizations find they have three basic kinds of projects in their portfolio: compliance (emergency— must do), operational, and strategic projects. (See Figure 2.2.) Compliance projects are typically those needed to meet regulatory conditions required to operate in a region; hence, they are called “must do” projects. Emergency projects, such as building an auto parts factory destroyed by tsunami, is an example of a must­do project. Compliance and emergency projects usually have penalties if they are not implemented. Operational projects are those that are needed to support current operations. These projects are designed to improve efficiency of delivery systems, reduce product costs, and improve performance. Some of these projects, given their limited scope and cost, require only immediate manager approval, while bigger, more expensive projects need extensive review. Choosing to install a new piece of equipment would be an example of the latter while modifying a production process would be an example of the former. Total quality management (TQM) projects are examples of operational projects. Finally, strategic projects are those that directly support the organization's long­run mission. They frequently are directed toward increasing revenue or market share. Examples of strategic projects are new products, research, and development. For a good, complete discussion on classification schemes found in practice, see Crawford, Hobbs, and Turne. Frequently, these three classifications are further decomposed by product type, organization divisions and

functions that will require different criteria for project selection. For example, the same criteria for the finance or legal division would not apply to the IT (information technology) department. This often requires different project selection criteria within the basic three classifications of strategic, operational, and compliance projects.

FIGURE 2.2 Portfolio of Projects by Type

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Selection Criteria Although there are many criteria for selecting projects, selection criteria are typically identified as financial and nonfinancial. A short description of each is given next, followed by a discussion of their use in practice.

Financial Criteria Financial Models For most managers financial criteria are the preferred method to evaluate projects. These models are appropriate when there is a high level of confidence associated with estimates of future cash flows. Two models and examples are demonstrated here—payback and net present value (NPV).

Project A has an initial investment of $700,000 and projected cash inflows of $225,000 for 5 years. Project B has an initial investment of $400,000 and projected cash inflows of $110,000 for 5 years.

1. The payback model measures the time it will take to recover the project investment. Shorter paybacks are more desirable. Payback is the simplest and most widely used model. Payback emphasizes cash flows, a key factor in business. Some managers use the payback model to eliminate unusually risky projects (those with lengthy payback periods). The major limitations of payback are that it ignores the time value of money, assumes cash inflows for the investment period (and not beyond), and does not consider profitability. The payback formula is

Exhibit 2.3 compares the payback for Project A and Project B. The payback for Project A is 3.1 years and for Project B is 3.6 years. Using the payback method both projects are acceptable since both return the initial investment in less than five years and have returns on the investment of 32.1 and 27.5 percent. Payback provides especially useful information for firms concerned with liquidity and having sufficient resources to manage their financial obligations. Exhibit 2.3 A presents the net present value model.

2. The net present value (NPV) model uses management's minimum desired rate­of­return (discount rate, for example, 20 percent) to compute the present value of all net cash inflows. If the result is positive (the project meets the minimum desired rate of return), it is eligible for further consideration. If the result is negative, the project is rejected. Thus, higher positive NPV's are desirable. Excel uses this formula

I0 = Initial investment (since it is an outflow, the number will be negative) Ft = Net cash inflow for period t k = Required rate of return

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EXHIBIT 2.3 Example Comparing Two Projects Using Payback and Net Present Value Method

Exhibit 2.3B presents the NPV model using Microsoft Excel software. The NPV model accepts project A, which has a positive NPV of $54,235. Project B is rejected since the NPV is negative $31,263. Compare the NPV results with the payback results. The NPV model is more realistic because it considers the time value of money, cash flows, and profitability. When using the NPV model, the discount rate (return on investment hurdle rate) can differ for different

projects. For example, the expected ROI on strategic projects is frequently set higher than operational projects. Similarly, ROI's can differ for riskier versus safer projects. The criteria for setting the ROI hurdle rate should be clear and applied consistently.

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Unfortunately, pure financial models fail to include many projects where financial return is impossible to measure and/or other factors are vital to the accept or reject decision. One research study by Foti showed that companies using predominantly financial models to prioritize projects yielded unbalanced portfolios and projects that aren't strategically oriented (2003).

Nonfinancial Criteria Financial return, while important, does not always reflect strategic importance. The sixties and seventies saw firms become overextended by diversifying too much. Now the prevailing thinking is that long­term survival is dependent upon developing and maintaining core competencies. Companies have to be disciplined in saying no to potentially profitable projects that are outside the realm of their core mission. This requires other criteria be considered beyond direct financial return. For example, a firm may support projects that do not have high profit margins for other strategic reasons including:

To capture larger market share To make it difficult for competitors to enter the market To develop an enabler product, which by its introduction will increase sales in more profitable products To develop core technology that will be used in next­generation products To reduce dependency on unreliable suppliers To prevent government intervention and regulation

Less tangible criteria may also apply. Organizations may support projects to restore corporate image or enhance brand recognition. Many organizations are committed to corporate citizenship and support community development projects. Since no single criterion can reflect strategic significance, portfolio management requires multi­criteria

screening models. These models often weight individual criteria so those projects that contribute to the most important strategic objectives are given higher consideration.

Two Multi­Criteria Selection Models Since no single criterion can reflect strategic significance, portfolio management requires multi­criteria screening models. Two models, the checklist and multi­weighted scoring models, are described next.

Checklist Models The most frequently used method in selecting projects has been the checklist. This approach basically uses a list of questions to review potential projects and to determine their acceptance or rejection. Several of the typical questions found in practice are listed in Exhibit 2.4. One large, multiproject organization has 250 different questions! A justification of checklist models is that they allow great flexibility in selecting among many different types

of projects and are easily used across different divisions and locations. Although many projects are selected using some variation of the checklist approach, this approach has serious shortcomings. Major shortcomings of this approach are that it fails to answer the relative importance or value of a potential project to the organization and fails to allow for comparison with other potential projects. Each potential project will have a different set of positive and negative answers. How do you compare? Ranking and prioritizing projects by their importance is difficult, if not impossible. This approach also leaves the door open to the potential opportunity for power plays, politics, and other forms of manipulation. To overcome these serious shortcomings experts recommend the use of a multi­weighted scoring model to select projects, which is examined next.

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EXHIBIT 2.4 Sample Selection Questions Used in Practice

Topic Question Strategy/alignment What specific organization strategy does this project align with? Driver What business problem does the project solve? Success metrics How will we measure success? Sponsorship Who is the project sponsor? Risk What is the impact of not doing this project? Risk What is the project risk to our organization? Risk Where does the proposed project fit in our risk profile? Benefits, value, ROI What is the value of the project to this organization? Benefits, value, ROI When will the project show results? Objectives What are the project objectives? Organization culture Is our organization culture right for this type of project? Resources Will internal resources be available for this project? Approach Will we build or buy? Schedule How long will this project take? Schedule Is the time line realistic? Training/resources Will staff training be required? Finance/portfolio What is the estimated cost of the project? Portfolio Is this a new initiative or part of an existing initiative? Portfolio How does this project interact with current projects? Technology Is the technology available or new?

Multi­Weighted Scoring Models A weighted scoring model typically uses several weighted selection criteria to evaluate project proposals. Weighted scoring models will generally include qualitative and/or quantitative criteria. Each selection criterion is asssigned a weight. Scores are assigned to each criterion for the project, based on its importance to the project being evaluated. The weights and scores are multiplied to get a total weighted score for the project. Using these multiple screening criteria, projects can then be compared using the weighted score. Projects with higher weighted scores are considered better. Selection criteria need to mirror the critical success factors of an organization. For example, 3M set a target

that 25 percent of the company's sales would come from products fewer than four years old versus the old target of 20 percent. Their priority system for project selection strongly reflects this new target. On the other hand, failure to pick the right factors will render the screening process “useless” in short order. See Snapshot from Practice: Crisis IT. Figure 2.3 represents a project scoring matrix using some of the factors found in practice. The screening

criteria selected are shown across the top of the matrix (e.g., stay within core competencies … ROI of 18 percent plus). Management weights each criterion (a value of 0 to a high of, say, 3) by its relative importance to the organization's objectives and strategic plan. Project proposals are then submitted to a project priority team or project office.

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SNAPSHOT FROM PRACTICE Crisis IT

In May 2007, Frontier Airlines Holdings hired Gerry Coady as chief information officer (CIO). Nearly a year later the airline filed for bankruptcy under Chapter 11. In an interview Coady describes how he managed IT projects during the bankruptcy and recession crisis of 2008–2009. Fundamentally, Coady faced a situation of too many projects and too few resources. Coady used a strategy of

focusing on reducing the number of projects in the portfolio. He put together a steering committee of senior management that reviewed several hundred projects. The end result was a reduction to less than 30 projects remaining in the portfolio.

How Can You Get to a Backlog of over 100 Projects? “There are never enough resources to get everything done.” Backlogs build over time. Sacred cow projects get included in the selection system. Projects proposed from people who have left the airline still reside in the project portfolio. Non­value­added projects somehow make their way into the project portfolio. Soon the queue gets longer. With everyone in IT working on too many projects concurrently, project completion and productivity are slow.

Which Projects Remain? To cut the number of projects, the steering committee used a weighting scheme that reflected the airline's priorities, which were: fly safe, generate revenue, reduce costs, and customer service. The weighting scheme easily weeded out the fluff. Coady noted that “by the time you get to the 20s the margin of differentiation gets narrower and narrower.” Of the remaining projects, project sponsors had to have solid justification why their project is important. Reduction of the number of projects places emphasis on high value projects.

© PRNewsFoto/Genesis, Inc.

What Advice Does Coady Have for Crisis Management? In times of crisis, it is easier to take bold steps to make changes. But you need to have a clear vision of what you should be focusing on with the resources available. Coady suggests, “It comes back to really having a good idea of what the initial business case for a project is and what resources it is consuming, both people and otherwise.”

Source: Worthen, B., “Crisis IT,” The Wall Street Journal, April 20, 2009, p­R6.

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FIGURE 2.3 Project Screening Matrix

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Each project proposal is then evaluated by its relative contribution/value added to the selected criteria. Values of 0 to a high of 10 are assigned to each criterion for each project. This value represents the project's fit to the specific criterion. For example, project 1 appears to fit well with the strategy of the organization since it is given a value of 8. Conversely, project 1 does nothing to support reducing defects (its value is 0). Finally, this model applies the management weights to each criterion by importance using a value of 1 to 3. For example, ROI and strategic fit have a weight of 3, while urgency and core competencies have weights of 2. Applying the weight to each criterion, the priority team derives the we