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Project Selection Methods: A Primer for the Project Manager

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Project Selection Methods: A Primer for the Project Manager

Business decisions
The success of an enterprise often hinges on the projects it selects, so this is an area of project management - and indeed business management - that should not be overlooked. While there is no "one size fits all" approach for selecting a project, and organizations will differ widely in how they approach this task, the following may help the project manager be as useful as possible in the process.

I. Understand your role

In reality, project managers rarely get to make actual project selection decisions. These decisions are most often made by the executive leadership, or perhaps the project management office. But this does not mean the PM is left out of the process.

A good project manager should lend their experience and expertise to the selection process, thus offering an educated and unbiased opinion about the pros and cons of various projects. After all, you may be the only person with any real project management experience to weigh in on the decision. As such, you can offer unique insights into the potential benefits and risks of each project (risk and resource requirements especially). Moreover, you can serve as a useful sounding board for ideas from the executive leadership. They may believe a particular project can be done within a specified budget range, for example, but your past experience may suggest otherwise. This is the time to speak up.

You are also in a unique position to help suggest the type of project to be undertaken. Perhaps there are problems or inefficiencies to be resolved within the business, and a solution is needed. Using your experience and understanding of the organizational needs, you may be in an excellent position to suggest the best project approach for a given situation.

II. Understand your organization

As someone with input on project selection matters, you must be especially aware of your organizational environment. What are your key business drivers? What are your strengths and vulnerabilities as an organization? Do you have resource limitations, and if so, where are you lacking?

When performing this analysis, be mindful of past experiences and refer to archived information as much as possible. Whether a prior project went very well or very poorly, there are organizational and environmental factors which likely contributed to the outcome. Consider whether those factors have changed, and be prepared to discuss these matters openly and frankly. After all, if an organization is fundamentally limited in terms of what it can achieve - whether for lack of skilled resources, funding, or otherwise - it is very important to acknowledge this early on. Failure to weigh in candidly could result in a project being doomed to fail before it even kicks off.

Business seminar Part of understanding your organization is recognizing those players who will listen to your input, and whose input will carry weight with other decision makers. Program and portfolio managers, sponsors of past projects, and a host of other people may be very important here, since they are likely to have a high level of influence over the project selection process. When doing so, you should be conscious of what each person's key motivators are. If you are speaking to the chief financial officer, for example, things like payback period and net present value are likely to be most critical. If you are speaking to the chief technology officer, things like resource availability and technical difficulty are likely to be paramount.

III. Understand the key benefit measurement methods

There are complex financial and analytical tools that upper management may use to choose amongst various projects, which are collectively referred to as "constrained optimization methods." They include techniques like integer programming, linear programming and dynamic programming. These complex analyses go beyond the scope of this article, and likely well beyond the scope of your role as a project manager in helping select a project.

Instead, your focus should be on the more simplified techniques which are collectively referred to as "benefit measurement methods." These techniques do not require advanced finance degrees to understand and utilize, and are therefore often favored when choosing amongst various project options.

A. Benefit Cost Analysis

Let's start by reviewing one of the simpler techniques, which is Benefit Cost Analysis. Here we want to determine the overall financial benefit of the project (the total amount of money it will generate) and compare that figure to what we must spend to complete the project.

Thus, if a project costs $1 million dollars to perform, but will return $1.5 million in proceeds, the benefit cost ratio is 3:2, meaning it will return $3 for every $2 invested. This ratio can then be reduced by dividing the benefit value by the cost value (here, 3/2). In this case, the benefit cost ratio can also be expressed as 1.5, meaning we realize $1.50 in returns for every $1 invested. This provides a good indicator of the project's economic viability, but it often does not include the discounted value of the returns (i.e. what the future income is worth in today's dollars, after adjusting for interest and inflation). To provide the most meaningful figures, therefore, the future income should be appropriately discounted before it is compared to the amounts we must spend up front in order to do the project.

B. Payback Period

Investment and Time Another simple technique one might use is called Payback Period, where we determine the amount of time it will take to recoup our initial investment from a project. For example, if we project to spend $500,000 to perform a project, and expect it will return revenue at the rate of $50,000 per year, our payback period would be 10 years (measured from the date of project completion).

But as with the Benefit Cost Analysis, our results here can be misleading because they typically do not factor in the time value of money. Yes, we will ultimately recover $500,000 over 10 years, but that does not equal $500,000 in today's money (because inflation and cost of capital are not usually factored in). We therefore are not really comparing "apples to apples," since the present value of that future revenue stream is actually much less than $500,000 once we discount that figure to present day values.

C. Discounted Cash Flow Analysis

That brings us to our next technique, which is called Discounted Cash Flow Analysis. This tool allows us to determine the present value (in today's dollars) of a future return. To do this calculation, we need to know 3 things: 1) the time it takes to recover the money; 2) the applicable discount rate (usually the prevailing interest rates, which may also factor in inflation costs); and 3) the amount of money we will recover in the future.

Once we know these values, we use the following formula to determine the present value of that future income: PV = FV / (1 + i)n. The "FV" equals the amount of future recovery, while the "i" equals the discount rate and the "n" equals the number of compounding periods (usually years) it takes to recover the future amount. Let's assume that the future value is $1,000, the discount rate is 6% and the number of years to recover that $1,000 is three.

PV = FV / (1 + i)n

PV = 1000 / (1 + .06)3

PV = 1000 / (1.06)3

PV = 1000 / 1.191016

PV = $839.62

Make sure you note the correct order of operations here: First, we take 1 plus the discount interest rate. Since the rate is 6%, we express this as .06, and get a sum of 1.06. We then raise this 1.06 to the power equal to the number of periods it takes to recover the future value. Since it is a 3-year recovery period, we would multiply 1.06 by itself three times: (1.06 x 1.06 x 1.06).

Remember not to multiply the 1.06 by 3 - that will not yield the correct figure. We need an exponential value, so we must multiply the 1.06 by itself three times. Our resulting value is 1.191016 (for maximum precision, do not round this number). We then divide the future value of $1,000 by 1.191016, to get a present value of $839.62 (rounded to the nearest cent). We can now say that the $1,000 we will recover in three years is worth only $839.62 in today's dollars, having factored in the time it takes to recover that $1,000, along with the discount rate.

D. Net Present Value (NPV)

net present value Net Present Value is an extension of the Discounted Cash Flow Analysis, which allows us to derive more detailed information. Specifically, Net Present Value allows us to see the net gain or loss that we will incur in each period, which is discounted to today's values. Thus, we project our future gains and expenditures for each year going forward, and discount both to today's values based on the interest rate and time in which those costs/revenues are realized. Our result may look something like this:

Year 1: ($1,000)

Year 2: ($500)

Year 3: $250

Year 4: $500

Year 5: $1,000

Total Net Present Value: $250

In this example, our discounted net returns (revenues minus expenses) were negative for the first 2 years, but ultimately rose to positive $1,000 in year 5. We simply add these five values up to determine the Net Present Value for the project as a whole, which comes out to $250. Thus, after factoring in our net gains/losses for each year, which were discounted to today's dollars, we can say that this project will return enough net revenue to keep up with the cost of capital over time, and still return an additional $250 (assuming our projections are accurate).

Naturally we are looking for the highest Net Present Value we can achieve, but even where the NPV is low, we can say that the project is financially viable. The key is for NPV to not be negative. If it is a negative value that means the discounted revenues will not exceed the discounted expenses over time, which means the project will lose money.

E. Opportunity Cost

In certain scenarios we must choose one project and leave the other possible project behind. In this scenario, we might use Opportunity Cost analysis to help us make our decision. For example, assume Project A has a potential net return of $50,000 and Project B has a potential net return of $100,000. But we cannot do them both. The opportunity cost is the amount of profit we will forego opportunity cost by choosing one project over another. Assuming we opportunity costselected Project B, that means we could not pursue the benefits that Project A offered. Thus, our opportunity cost would be $50,000 - the net amount that Project A would have returned.

Naturally, we want to keep our opportunity costs as low as possible. There will always be opportunity costs when choosing amongst more than one profitable opportunity, but the idea is to minimize that cost as much as possible. This technique is unlikely to be utilized on its own as a project selection tool, but would more likely be used in conjunction with other techniques to help arrive at a decision.

F. Scoring Models

Moving away from the strict financial analyses, another helpful way to evaluate potential projects is to rate them on various weighted criteria, and come up with an overall score. For example, let's choose 5 criteria that are important to us (we will use profitability, technical difficulty, resource strain, risk and stakeholder support for this example).

We then want to weigh these various criteria so that they collectively add up to 100%. So let's say profitability is the most important, so we give it a 40% weight. Next up is technical difficulty, at 20%, followed by resource strain, at 15%, with risk also being weighted at 15% and stakeholder support coming in at 10%.

Next we need to determine how each project scores on these various rankings. We want to identify some consistent values to use here, to ensure the raw scores assigned for each attribute add up to 100 across all projects. For example, if we have 5 possible projects, we might use predetermined scores of, say, 5, 10, 20, 25 and 40, to ensure they collectively will add up to 100 (this aligns with our weighting figures, which also add up to 100).

We then analyze each possible project by multiplying its score for each criterion by the percentage weight that criterion was assigned in order to get a weighted score for that particular project attribute. Let's assume Project A seems highly profitable, so we give it a score of 40 in the profitability column. That 40 then gets multiplied by .4, since we weight the profitability attribute at 40% of the total concern. The combined score for profitability would then be 16.

We then repeat this process for each criterion, and add up the 5 weighted scores to get a total score for Project A. These steps are then repeated for all other project options, to identify the potential project which gets the highest overall score.

This technique is especially useful in cases where organizations place a particularly heavy emphasis on one particular project aspect or constraint. Naturally, these tendencies may change over time. If the organization is currently understaffed, for example, then resource strain will likely be weighted most heavily.

Apart from its ability to weight key concerns as part of the overall score, this technique is also popular because it provides a highly objective way of analyzing potential project options. Once the weights and scores are assigned, we simply let the math decide which project should be chosen.

IV. Conclusion

Business Team Analyzing Graph While project selection decisions are often not left to the project manager, one must still be prepared to advise and consult with others in the organization to help arrive at these decisions. Gathering information and facilitating discussions will be an important part of the PM's role here. The more information, documentation, and analysis performed prior to this discussion, the more weight the PM's opinion will hold. Thus, one must have at least a high-level understanding of the most common project selection methods in order to meaningfully participate in this important process.

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