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Tenet #3 - Ten Tenets of Portfolio Management

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by Larry Pendergrass, Principal

Tenet #3: Create common valuation.

In last week’s blog I discussed the need for alternatives to accompany an opportunity in which to invest. Require choices from your managers, rather than being put in the position to make simple yes/no decisions. In this week’s blog, I will show how money as a common unit is essential for good decision-making in any PPM process.

Through discussions with key thought leaders and from my own experience in high technology industries, I have developed the following Ten Tenets of Project Portfolio Management. These Tenets are the essential elements that I try to keep foremost in my mind when cultivating a new portfolio management process, improving or improving an existing process. These tenets are:

  1. Align strategy first.
  2. Demand alternatives.
  3. Create common valuation.
  4. Apply uncertainty.
  5. Balance goals.
  6. Use visual analysis.
  7. Design tiered portfolios.
  8. Improve flow.
  9. Monitor rigorously.
  10. Institutionalize learning.

For effective PPM, everyone must speak in common units: money. And all statements must boil down to their impact in money. With a little practice, even the most qualitative statements can be translated into their impact on the project financials.

How often have you heard “…but we have to do this project. It’s essential to our strategy”, or “…it’s critical for our customer”? In spite of the poor financial valuation, many leaders will be swayed by such arguments. And sometimes, it’s the right thing to ignore what the numbers say and go with your gut… if the numbers are not telling you the full story. In these cases, chances are there is some reason, some aspect of the project that is not taken into account in the financial valuation. Examples of valid reasons to fund a project typically not taken into account in the project valuation are:

  • The 5 year gross margins from lost sales to a key customer if this project is not done
  • The fact that this project is “buying an option” for the firm to complete an even more critical follow-on project
  • The risk that the competition completing this project ahead of our firm will have performance “bragging rights” that will impact all sales due to an erosion of brand name
  • If we don’t do this project, I know this team of 20 engineers and managers will choose to all go join our competition down the street.

      I am sure from your experiences you could add other reasons for starting or continuing a financially challenged project. But every time you accept a project in spite of what the financials say, you send a message to your team that with the right hand-waiving, you can get any project through the leadership filter, that there are no rules. You just need to be a good talker, a good advocate of your project. An additional problem is that your gut will sometimes fail you, and you will accept a bad project or reject a good project based on these exceptions.

For continuous improvement of your PPM, a better practice is to ask for an estimate on the financial impact when a subjective exception is given for the financial valuation of a project. Taking the subjective examples above, we can estimate their quantitative impact as follows:

  • There is a 30% probability that we would lose 80% of our sales over the next 5 years to Acme Industries if we don’t do this project. We sell $10M/yr to Acme Industries at 50% gross margins. Therefore, the cost in loss of gross profit of not doing this project is estimated to be $1.2M.
  • Through standard option analysis (outside of the scope of this article), I can value this project at an additional $10M (NPV) due to the option it provides of starting 2 other projects.
  • There is an 85% chance the competition will release the rumored high end product in the next 3 years. It could impact the buying decisions of 10% of our customers. We may lose 50% of those customers for a $10M loss in gross profit over 5 years.
  • We have a 30% chance of losing the team to the competition if we don’t do this project. We could estimate the monetary lost in several categories:
    • Loss of efficient intact team for the next project: $7M due to longer cycle time of another team
    • Loss of key resources and critical knowledge for manufacturing support, risk of line stoppage and cancelled orders: $1M over 3 years
    • Sales lost to competition, made stronger through this team: $4M gross profit over 3 years

Whether or not these exceptions, or their financial estimates ring true for your business is not the point. The examples are shown to indicate that with some effort and practice, qualitative statements can be turned into quantitative estimates that can be included in the financial analysis.

PPM discussions should have one unit of measure: money. Avoid subjective statements that drive decisions. All else should be translated into this one measure and added to the financial analysis for the project to allow for more objective discussion and decision-making.

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