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Figure 1
Main elements of Project Evaluation
The inputs:
the data on important aspects of the projects and the business environment
which are needed to analyze them. The inputs will be assembled from various
sources, and care should be taken to ensure its certainty, although some inputs
will surely be very subjective. At the end of the day, an evaluation can only be
as good as the data that go into it.
Table 1
Typical inputs to Project Evaluation
Typical inputs
Technological the technical activities which will have to be undertaken, maturity of
technology, company's technological position
Internal
Financial
Market
Business
clarification of objectives, fit with company's strategy, level of topmanagement support, key success factors
Weighting: as certain data may be given more relevance than other (eg of
market inputs compared with technical factors), in order to reflect the
company's strategy or the company's particular views. The data is then
processed to arrive at the outcomes.
Many techniques include balancing between projects, as the relative value of a
project with respect to other projects is an important factor in situations of
Specific techniques
Project evaluation methods have evolved in response to changing needs, although 'old'
techniques are still in use today. The earlier methods were based on financial
assessment, and even now this forms the back-bone of most practical methods.
One basic classification of all potential techniques might be:
Techniques mainly or uniquely based on a financial assessment.
Short description
Among the longest established, easily-applied methods
Criticised as of limited accuracy
The key is the ratio (financial benefit) /(cost) in which the
estimations of benefits should be agreed by marketing
Score index
methods
Mathematical
methods
Check-lists
Relevance and
decision trees
Multicriteria &
table methods
number of criteria
Various criteria may be used such as economic and
financial factors and concepts or decision theory
The scoring of criteria is usually complemented with the
use of weight factors in order do distinguish
the importance of each criteria
QFD
Experience based
methods
Vision
Many techniques used today are totally or partially software based, which have
some additional benefits in automating the process. In any case, the most
important issue, for any method, is the managers' interpretation of the direct
outcomes.
There is no best technique. The extent to which different techniques for project
evaluation can be used will depend upon the nature of the project, the information
availability, the company's culture and several other factors. This is clear from the
variety of techniques which are theoretically available and the extent to which they
have been used in practice. In any case, no matter which technique is selected by a
company, it should be implemented, and probably adapted, according to the particular
needs of that company.
Checklist
A checklist is a reminder of the factors (a list of factors) which are important in
making a decision. Most useful criteria for evaluating any type of research or
development project are essentially independent of the business field and the business
strategy. These criteria include technical and commercial details, research and
development realities, legal and financial factors, company targets and company
strategy, etc.
The requirements for the use of this technique are minimal, and the effort involved in
using it is normally low. Another advantage of the technique is that it is very easily
adaptable to the company's way of doing things. However, checklist can be a starting
point for more sophisticated methods where the basic information can be used for
better focus. One simple and useful example is a SWOT analysis, where projects are
assessed for their Strengths, Weaknesses, Opportunities and Threats.
Therefore, this technique can be developed further and the analysis interaction and
feedback can be easily managed using simple information technology. Different ways
to sophisticate the technique might be:
To include some quantitative factors among the whole list of factors.
To assign different weights to different factors.
A value in this technique lies in its simplicity but by the appropriate choice of factors
it is possible to ensure that the questions address, and are answered by, all functional
areas. When used effectively this guarantees a useful discussion, an identification and
clarification of areas of disagreement and a stronger commitment, by all involved, to
the ultimate outcome.
Checklist example
Table 3 shows an example of a checklist, developed by the Industrial Research
Institute, that, in princpiple, could be applied to any type of R&D activities: research,
product development and process development.
Table 3
List of potential factors for project evaluation
Corporate Objectives
Cost savings
Capability of manufacturing product
Facility and equipment requirements
Availability of raw material
Manufacturing safety
Financial
Profitability
Capital investment required
Annual (or unit) cost
Rate of return on investment
Unit price
Payout period
Utilization of assets, cost reduction and cash-flow
Using the list of table 3 as a reference, any company should be able to develop its own
checklist. This adaptation could take several forms:
By sophisticating the checklist as suggested above.
By choosing part of or adding different factors that better suit the company and
its environment. For example, if the company strongly relies on external
resources, either from other companies or from technological infrastructures,
either for the development or for the production activities, this should probably
be reflected in the list.
Cash Inflow
1997
C0
B0
B1-C1
1998
C1
B1
B2-C2
1999
C2
B2
B3-C3
2000
C3
B3
B4-C4
When portrayed as a cash flow diagram a typical project might look as shown
in figure 3.
Figure 3
Diagram to plot the evolution of cash flow over time
A frequently used form of analysis applied to this data is to calculate the break even
point. This is the point at which the cumulative net cash flow is equal to zero and
hence the cash inflow has covered all the cash outflows (see figure 4).
Figure 4
Break even point
The reason for this measure being seen as important is that the shorter the time scale
to break-even, or payback, the less risk there is that the environment will change
dramatically and hence seriously affect the estimates used in the cash flow
projections. However, the analysis completely ignores the likely returns after the
break even point and therefore is not really a good indicator of the real potential of a
project. In some cases, people choose to ignore the time value of money, although it is
not difficult to handle this by including cost of capital payments on the net cash
outflows as part of the costs.
An easier way to do this, however, and one commonly encountered is to use the
discounted cash flow approach. Here the cost of capital is incorporated directly into
the calculation in a way which also takes into account the actual year of expenditure.
The result is a figure which represents the present value of both the cost and benefit
stream and ultimately a net present value which is the difference between the two. For
example:
A net present value greater than zero therefore indicates that a project will produce a
surplus after all costs are paid and is therefore likely to be worth undertaking. It is also
possible to calculate a Benefit to Cost ratio which can provide another indication of
value.
In some cases it may not be easy to identify the true cost of capital and at the same
time some people prefer to think in terms of rate of return on investment (ROI). In
such circumstances it is not difficult to identify what has been termed the internal rate
of return which is calculated by setting PVB = PVc and solving the resulting equation
for i. This can be done very simply, as can the NPV calculation, using widely
available computer programmes.
Decision analysis
There is inevitably uncertainty surrounding the information which is used in any
evaluation exercise. The extent of this will depend upon the type of project and the
environment in which the organisation operates. One way of incorporating this into
the evaluation procedure is through the use of probability estimates. This can be done
in a number of different ways. For example, it is possible to adjust the calculations
made by other techniques using estimates of the probability of commercial success
and/or of technical success to create a rank index as follows
Rank Index = Pt PB (B-C)
The potential variability in costs and benefits is very likely to be influenced by the
time to completion and by the competitive environment. It is possible to take this into
account using a simple 3 estimate approach. This requires that people are prepared to
consider pessimistic and optimistic values as well as the most likely. This approach
has been used in the planning of highly complex technical projects as is described in
the project planning section.
However these methods tend to ignore the multi stage process which most projects go
through. A useful way of illustrating this is through the use of the decision tree
approach. Figure 5 clearly illustrates that it is possible to stop a project at intermediate
stages if progress is not up to expectations. In this case there are few stages and
following each one there is an estimate showing the probability of success (s) or of
failure (f).
Figure 5
Example of a decision tree
People who are not committed to the process and who provide information
without due thought to its likely accuracy and the effect of this on the selection
decision.
Unnecessary change of goals and resource conflicts with other projects which
will lead to an inability to achieve the desired outcomes.
The technique becoming a routine that the project has to suffer, being not
applied with the intensity and effort required. Furthermore, any technique needs
to be applied rigurously to avoid that those with a long experience in dealing
with it can learn how to 'cheat' it.
Changes occuring in the company context should have an impact in the
application of project evaluation. Although there might be a learning process
involved in order to master the technique, hence requiring it is applied
consistently over a period of time, at the same time it needs to continuosly
adapt itself to every new situation.
Further information
The report: EIRMA Working Group 47, 'Evaluation of R&D projects'. It
provides an overall explanation and analysis of project evaluation specific
techniques, including both a method to assess which technique might be more
suitable for a specific company and context, and specific cases of application in
companies.
The application of simple financial methods can be seen in many books either
on financial management or on project evaluation.