Portfolio Management - A Financial Approach - Part 1

Introduction

Sometimes it is not just enough do projects right. Sometimes It is compelling do the right projects. 

Let’s summarize on a graphic this affirmation. Take a look at Figure 1. On the x axis we can find the presence of appropriate or inappropriate projects in the portfolio and on the y axis the quality of the related project management activities. The graphic can be splitted in four quadrants.

Figure 1.

A - High expense and low income This is clearly the worst situation where one can be. Not appropriate and poorly managed projects. The portfolio suffer from a waste of resources due to poor management activities and from low income due to selection of inadequate projects.

B - Low expense and low income Wrong projects but managed well enough to contain the losses.

C - Low expense and high income This is the best situation. projects accurately selected and managed with reliable processes. 

D - High expense and high income Here the portfolio still suffer from a waste of resources due to poor management activities but it can count on high incomes due to a good projects selection.

It is generally true that everyone’s objective should be to create a portfolio placed in the C quadrant but in times of economic and financial downturn, this may become a matter of pure survival. Please take a look at Figure 2. In part (a), where the weather is fine and the sun shines on your economic situation, you can take the risk to fire some blank cartridges. This is not recommended but there is room for taking additional risks and make some wrong decisions.  when the rain comes in, as depicted in part (b), that it is no more an opportunity and when the mud starts to hit the fan, you are compelled to do better (better projects) with less (better project management). Even a portfolio placed in the quadrant C could not be safe and remunerative enough.

Figure 2.

So how to choose worthy projects to build a portfolio or better, how to choose projects more appropriate for given enterprise environmental factors?

There is a lot in literature about project selection methodologies. In these series of posts I will suggest a method based on some financial considerations. In this and other posts of the series there will be occasional references to statistical elements and concepts. I won’t explain in details each one of them (otherwise I probably would end up with an encyclopedia...) I will provide instead some reference links the first time each concepts is introduced.

Return estimation of a single project

Think of each project like a kind black box. You do not have the slightest idea of what happens inside them, you just know that they absorb resources (money, people, materials...) and that will generate (hopefully) benefits (money, services...).

Return: mean and standard deviation

The first step is to evaluate each project return as the difference of the expected benefits and the required investments, divided by the required investments. All the elements in the ratio should be reconducted to present discounted values. 

Figure 3.

The more you will be able to translate resources and benefits into money, the better you will be able to evaluate the project’s return.

Since the evaluation is based on economic projections and on high level project planning, the best way to do it is to derive a return PDF (Probability Density Function) with the aid of statistical techniques, like Monte Carlo simulations. In Figure 3 is reported an example of return PDF for a fictional project. A PDF is an analytic function that associates to a value on the x axis (in this case the project return) its probability density of occurrence. As an example, according to the return PDF depicted in Figure 3, there is a probability around 8% to achieve a return around 2% from the project. I used the word "around" and not "equal" given the subtle difference between continuous and discrete PDFs.

At this point it is possible, starting from the return PDF, evaluate for each project the mean return value and its standard deviation, that can be directly associated with the estimation uncertainty and with the project’s risk.

In Table 1 depicted in Figure 4 there is a representation of the previous evaluations for some fictional projects.

Figure 4.

Return covariance

The more the covariance of two random variables is great in absolute value, the more these two variables tend to change toghether. That is, if two random variables show great covariance in absolute value, when one of the two variables changes its value, the other one changes it with high probability. If two random variables show small covariance in absolute value, when one of the two variables changes its value, the other one is not bound to change with high probability. If the covariance is equal to zero then the two random variables are independent, that is to say that the behavior of one of them does not influence the other one.

The sign of the covariance shows if two random variables change accordingly. That is, a positive covariance states that two random variables assume great or small values together. A negative covariance states that while one of the two random variables increases (or lessens) its value, the other one lessens (or increases) it. The situation is summarized in Figure 4 Table 2, considering two random variables named x and y. The relationship is symmetric even if, for sake of simplicity, just one part of it is showed.

Assuming the return of each project as a random variable, the estimation of the covariance between each couple of projects is fundamental to properly set up a project portfolio, because it is important to know how the success or the failure of each project could affect the entire portfolio performance. 

Just to make a simple example, if a portfolio contains many projects that show a high degree of positive covariance,  a single project failure could severely affects the performance of the entire portfolio or, vice versa, a single project success could boost the entire portfolio’s return.

In the next post we will see how to select projects that shall be included in a given portfolio given a risk/uncertainty profile, using the statistical concepts here exposed.

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Output, Outcome and Benefit - Managing today to shape the future

One of the most interesting and fascinating themes in Prince2 project management approach is, for what I am concerned, the business case one.

I find extremely interesting the constant focus on the project's business case and the continued assessment of the project justification, viability, and sustainability.

Also, I have been so impressed by the distinction between Output, Outcome, and Benefit.

Figure 1.

Output Each specialist product that the project has to deliver, be it tangible or intangible. Outputs are commonly delivered after the project’s closure and sometimes even during the project’s life.

Outcome Results of the changes derived from the use of the project's specialist outputs by the users. Outcomes typically start to be achieved after the handover of the project's specialist products to users.

Benefit Measurable improvement resulting from an Outcome. If the outcome is perceived as a disadvantage, we are dealing with what is called a dis-benefit. Benefits generally start to be achieved after the Outcomes and (should) continue to be achieved for a time span planned in advance. Prince2 states the establishment of a specific plan that describes the methods and times to verify the achievement of the expected benefits.

In Figure 2 we can see a quantitative representation of the relationship between these three ideas. Obviously, the exact Outcomes/Benefits realization times heavily depend on the project’s characteristics and peculiarity. 

Figure 2.

Let’s make a simple example to better clarify this view.

The Buymybooks Limited is a small company that sells books via the internet. Orders are collected by means of their internet site but after the initial collecting phase, orders are printed and processed manually. Also, Buymybooks Limited does not have a software to manage its books warehouse.

Their sell and delivery processes are highly inefficient, resulting in delivery errors, high costs, high customers turnover, and progressive reduction in the market share.

To face this situation, the board of director has decided to introduce a management software system to manage the sale and delivery processes.

Output of the project will be an integrated software management system (orders and warehouse management). 

Outcome of the project will be an improvement of Buymybooks Limited sell and delivery processes efficiency.

Benefits of the project will be delivery errors reduction, smaller costs, higher profits and greater customers' fidelity.

So we can agree that there is need to pay a great deal of attention not only to the execution phase of a project but also to the design, support and closure phases. Furthermore, it is of utmost importance check the actual realization of benefits after the project closure. This action should be performed by program or corporate management as prescribed in the project’s documentation. 

As a consequence, I would advise to

1) Have a series of compatible and well-crafted benefits

This seems obvious, but it can be sometimes tricky. I have covered the topic in one old post. It has been conceived for project objectives, but it is well suited for project benefits too.

2) Do not just focus on the outputs delivery

Sometimes, is easy to focus just on output delivery and lose contact with project’s outcomes and benefits. It could happen if outputs are the only substantial point of contacts between the project and the team members (that sometimes ignore the big picture), or between the project and the external stakeholders. 

Also, it is not uncommon to rely just on outputs delivery to measure project’s completion or success.

3) Choose the best possible approach to maximize benefits

Since a significant part of the project’s value will be realized after project’s closure, take care, during project planning, in choosing the best possible project approach to maximize the expected benefits and not just the outputs production. 

In the same way, while drafting the business case, do not take into account just the specialist products realization and delivery costs. Keep an eye also on handover, maintenance and operational costs. 

Manage and execute the project thinking also to the desired outcomes and benefits, trying to increase the probability of success and to maximize their impact on business as usual. 

4) Close a project if it has been proved to be no more justified, viable and sustainable

A project is a mean to reach an objective and not an objective in itself. Stop investing in a project if it is not longer worth it, is not a failure. Honor to the project manager who conscientiously proposes an early closure of its project, out of respect for the corporate vision.

Keep on throwing money out of the window. That surely is a failure.

To keep track of some of this aspects, I suggest the use of two very simple tools.

benefits/benefits matrix (Useful for points 1 and 4)

The first one is a matrix on which all project benefits are listed in columns and rows, sorted by descending importance, from left to right and from top to bottom. Each benefit's importance is recorded near the benefit's code. You can find an example of the benefits/benefits matrix in Figure 3.

At the intersection of each row and column of the matrix, there is a symbol that explains the benefit's relationships. 

Figure 3.

The “+” sign represents a high degree of correlation between two benefits' viability. This bond leads to risky situations because there is a high probability to realize both the benefits (opportunity) or to miss them both (threat). 

The “-” sign accounts for a low consistency between two benefits. This bond leads to risky situations because the realization of one of the two benefit could jeopardize the achievability of the other one.
In the example depicted in Figure 3, the achievability of benefits B2 and B3 is correlated. Benefits B1 and B4 are not consistent, but the real problem is that benefits B2 and B4 are not consistent too and, as a consequence, also benefit B3 is jeopardized. So benefit B4 jeopardizes benefits B2 and B3, that are the most significant benefits of our project.

Especially if one or both the benefits are assessed as paramount, strong “+” or “-” relationships have to be dealt with the greatest attention by the project manager. 

if too much “+” and/or “-” relationships appear in the benefits/benefits matrix, it could be wiser TO conduct an additional analysis of the project's expected benefits and to reassess the project’s riskiness. 

If two benefits do not have specific relationships, the intersection between their columns and lines is left empty. Obviously, the matrix is symmetric by construction and the slashes on the main diagonal are inserted just for the sake of clarity.

Other symbols could be added to account for different relationships, even if I advise to keep things as simple as possible.

Even in this very simple form, this tool could help in identifying dangerous (-) or risky situations (+), and contribute to the definition of the project's objectives.

products/benefits matrix (Useful for points 2 and 3)

The second tool I want to present is a matrix on which all project products (outputs) are listed in rows and all project benefits are listed in columns. Benefits are sorted by descending importance from left to right. Each benefit’s importance is recorded near the benefit's code. You can find an example of the products/benefits matrix in Figure 4.

Figure 4.

Each intersection between a row (product) and a column (benefit) contains project's outcome's codes, and represents through which outcome a single product helps to achieve a benefit. The color code states the degree of importance of the product to the expected benefit's realization (e.g., red could mean high, orange average, and yellow low).

We can see, reading the matrix by columns, which product helps to achieve a benefit, and to which degree each product is necessary to this end.

In this way, we can maintain a constant focus not only on project’s outputs but also on project’s benefits, through project’s outcomes.

If we are forced to drop out a product, we can immediately see which benefits are at stake, their importance for the project and how much they are at risk. It is a simple way to depict the effect of a project scope modification on the project benefits.

In the same way, if we decide to sacrifice a benefit, we can immediately evaluate if there should also be a project’s scope modification.

If you feel like to read some suggestion on how to assign importance values to project benefits, please refer to this post. It has been conceived to suggest how to assign qualitative values of impact and probability to project risks, but I think that the content is perfectly adaptable to the current problem.

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Are your project objectives S.M.A.R.T. enough?

I love acronyms.

I have always considered acronyms as incredibly shrewd and useful tools, for communicating and for remembering complex concepts in a simple and effective way.

In this post i will focus on one acronym that I came across the first time while studying Prince2 and that, as often happens, I then met again several times in the following days, even if slightly modified.

The acronym is S.M.A.R.T. and, related to project objectives, stands for Specific, Measurable, Achievable, Realistic, and Time Bound.

Honestly, I have to say that there seems to be no universal agreement on the words whose initials make up this acronym, as you can see by following this link. However, the version presented here is the one that I find more congenial and useful to my needs.

Specific

How could you hit a target, if you do not know where the target is? Or worst, how could you hit it, if you do not even know what the target looks like? In the same way you cannot achieve a objective if you do not provide (or if you have not been provided with) a clear description of the objective itself.

It seems obvious, I think that everyone would agree with the previous statement...but please keep in mind that defining specific objectives for a project is not an easy task.

To state or analyze a clear and well crafted business case, considering all present and future developments, benefits and advantages, requires both great project insight and business vision. You could need the aid of a business analyst and, possibly, great support from your corporate management.

If you have been provided with project documentation, in the form of a charter or of a project brief, take your time to examine it carefully and request clarifications wherever necessary.

Never get tired to inquiring your project's documents because, you know, the devil is in the details.

I believe that not to specify clearly project objectives is not a smart (and obviously not a S.M.A.R.T.) shortcut but the highway to failure.

Measurable

All the objectives must be measurable. Period. Always. Period.

If you do not have measurable objectives, it will be impossible to determine if you have been successful or not. It will also be impossible to determine the degree to which the project has fulfilled its expectations.

Also as you might rationally decide to terminate or to continue the project, if you do not have precise targets to measure progress? How could you reassess  the business case? This could result in a massive expenditure of money without proper justification. Also, if you haven’t properly quantified your objectives, it is consequently impossible to determine their risk exposition and, as a consequence, it is impossible to determine the project’s risk exposition. No good. Believe me. 

The problem here is to find proper ways to measure objectives.

Even this one can be a daunting task, depending on the particular industry you are in.

It is easy to measure the number of defective pieces of equipment coming out from a production line, or the lifetime of a new electric bulb. It is more difficult when it comes to customer satisfaction, software quality, reputation improvement, products quality improvement...In these cases an indirect measure could do the job.

As an example you could measure the number of contacts of your customer service  and put it in relation with an improvement or a worsening of your products.

The bottom line is: everything can be measured, the problem is to identify suitable measurement units. It is a complex problem but is a problem that can be and must be solved.

Achievable

Some objectives just do not go well together. They seem to live in orthogonal dimensions.

Sometimes it seems that a complete scope, a fast time to market, a low budget and an high quality standards mix well...as oil and water.

So take care in having an achievable and consistent set of objectives. If it is not the case, try to reconcile reality with management's desires and expectations.

Never start a project that has not achievable objectives, pretending that everything is just fine and thinking ahead how to justify the unavoidable failure or below average performance.

Realistic

Everyone would like to be in charge of the next multi-billion dollars, thousands resources, hundred contracts project, with all the whistles and bells. Reality is, many times, different. 

The project manager’s duty is to reconcile budget, time, scope, quality and all the other constraints into a shared and satisfying vision, be he/she in charge of a mega project or working in small businesses. The duties of a project manager toward the sponsor and the stakeholders do not change with budget’s size. Again, he/she must reconcile reality with management desires and expectations and must resist the temptation to artificially raise the bar in order to magnify its own role.

Time Bound

Every project should have a starting date and an ending date. Every objective should be achieved in the defined timeframe. Benefits could be achieved later on but a time span have to be defined as well.

This is an important commitment for a project manager.

So there is no point in defining objectives that cannot be achieved in the project timeframe or in the expected time for benefits realization, once project products are released in the operation environment.

Otherwise, an attitude of this kind could frustrate team members, create distrust in corporate management and alienate stakeholders. 

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