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Project Management in Practice

Fifth Edition
Chapter 1
The World of Project
Management

Copyright 2014 John Wiley & Sons, Inc.

Introduction
Examples of projects

Al Maktoom Airport Dubai


Tunnel under the English Channel
Launching Windows 10
Upgrading all users to Windows 10
Plan next Olympic games in London
Organizing an Event

Projects, rather than repetitive tasks, are now the


basis for most value-added in business
-Tom Peters, Management Consultant
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01-0

Why the Emphasis on Project


Management?
Many tasks do not fit neatly into business-asusual
Organizations need to re- assign responsibility
and authority for the achievement of their
goals

1-3

Formal Definition of a Project


A project is a temporary endeavor
undertaken to create a unique product or
service.

Project Management Institute, 2007


1-4

Additional Definitions
A project is a unique venture with a beginning and
an end, conducted by people to meet established
goals within parameters of cost, schedule, and
quality. Buchanan & Boddy 92
Projects are goal-oriented, involve the coordinated
undertaking of interrelated activities, are of finite
duration, and are all, to a degree unique. Frame
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01-0 1-5

Project Definitions Summarized


A project can be considered as any series of activities and tasks that
have:
Specific objective to be completed within certain specifications,
Defined start and end dates,
Funding limits,
Human and nonhuman resources, (human resources are
Knowledge, Abilities, Skills, and Attitude; Non-Human Resources
are time, money, properties, and community facilities).
Multifunctional focus (project team often includes people who
dont usually work together sometimes from different functions
and organizations and across multiple geographies).

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Characteristics of Projects

Unique
Specific deliverables
Specific due date
Multidisciplinary
Complex
Often involve conflicts
Part of programs
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Formal Definition of Project


Management
The application of knowledge, skills, tools,
and techniques to a broad range of activities
in order to meet the requirements of a
particular project.

Project Management Institute, 2007


1-8

Comparison of Project Management


and General Management

Table 1-1
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Project Budgets
Project budgeting differs from standard budgeting
in the way budgets are constructed
Budgets for non-projects are primarily
modifications of budgets for the same activity in
the previous period
Project budgets are newly created for each project
and often cover several budget periods in the
future

1-10

Project Schedules
In manufacturing, the sequence of activities
is set when production line designed
Sequence is not altered or changed for the same
product

Each project has a schedule of its own


Previous projects with deliverables similar to
current one may provide a rough template
However, specifics unique to project at hand
1-11

Project Organizational Structure


Routine work of organizations takes place within a
well-defined structure
The divisions, departments, sections, and similar
subdivisions of the total unit

Typical project cannot thrive in this structure


The need for technical knowledge, information,
and special skills requires that departmental lines
be crossed
Another way of describing the multidisciplinary
character of projects
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Globalization
When large firms establish manufacturing plants
or distribution centers in different countries, a
management team is established on site
For projects, globalization has a different meaning
Members of project teams may be spread across
countries and speak different languages
Some project team members may never have a
face-to-face meeting
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Negotiation
With little authority, the project manager
depends on negotiation skills to gain the
cooperation of departments in the
organization
Those departments have their own
objectives, priorities, and personnel
The project is not their responsibility and
the project tends to get the leftovers
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Three Different Types of Negotiation


1. Win-win
2. Win-lose
3. Lose-lose

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Three Goals of Project Management


1. Scope
2. Cost
3. Time

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Scope, Cost, and Time


Project Performance Targets

Figure 1-1
1-17

Uncertainty
All projects are always carried out under
conditions of uncertainty
Project management is all about managing projects
uncertainty

Effective project management requires an ability


to deal with uncertainty
Projects are complex and include interfaces,
interdependencies, and assumptions, which may
turn out to be wrong
People add to the uncertainty
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Uncertainties Encountered in Project


Management
Time required to complete a project
Availability and cost of key resources
Timing of solutions to technological
problems
Macroeconomic variables
The whims of clients
Actions taken by competitors
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Can Uncertainty be Eliminated?


No, uncertainty cannot be eliminated
However, if managed properly, it can be
minimized

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Managing Risk
The first step in managing risk is to identify
potentially uncertain events and likelihood of
occurrence
Called risk analysis

Different organizations approach this differently


The essence of risk analysis is to make
assumptions about key risk parameters and to use
models to evaluate the desirability of certain
managerial decisions
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Fourth Project Goal


There is a relationship between uncertainty
and the three traditional project goals
Therefore, we adopt the view in this book
that managing uncertainty is a fourth goal
of project management
Thus, the primary role of the project
manager is to effectively manage the tradeoffs between cost, time, scope, and risk
1-23

Why is Project Management


Important?
1.
2.
3.

Shortened product life cycles (IT and Electronics industries)


Narrow product launch windows (Dont miss the promised date)
Increasingly complex technical requirements for most products
(Design and Production are complex)
4. Emergence of global markets in terms of customers and
competitors (Project management techniques help organizations
respond quickly to different needs)
5. Economic period marked by low inflation which limit the ability
of organizations to maintain profitability by passing cost increases
(doing things better)
Successful companies have made project management a key aspect of
their operating philosophies.
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Project Success Rates


Software & hardware projects fail at a 65% rate,
Over half of all IT projects become runaways,
Only 30% of technology-based projects and programs are
a success.
Only 2.5% of global businesses achieve 100% project
success and over 50% of global business projects fail,
Average success of business-critical application
development projects is 32%, and
Approximately 42% of the 1,200 Iraq reconstruction
projects were eventually terminated due to
mismanagement or shoddy construction
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Trends in Project Management

Achieving strategic goals


Achieving routine goals
Improving project effectiveness
Accelerated Projects
Virtual projects
Quasi-projects

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Abilities Needed For Effective


Project Management

Ability to resolve conflicts


Creativity and flexibility
Ability to adjust to change
Good planning skills
Negotiation skills

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The Life Cycle of Projects


All organisms have a life cycle, they are born,
grow, wane, and die
So do projects

Some projects follow an S-shaped curve


They start slowly, develop momentum, and then finish
slowly

Other project follow a J-shaped curve


They start slowly , proceed slowly, and then finish
rapidly
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The Project Life Cycle

Figure 1-2
1-29

An Alternate Project Life Cycle

Figure 1-3
1-30

Project Management Life Cycle


Planning

Execution

Delivery

Level of effort

Conceptualization

1. Goals
2. Specifications
3. Scope
4. Responsibilities
5. Teams

1. WBS
2. Budget
3. Resources
4. Risks
5. Schedule

1. Status reports
2. Change Orders
3. Quality Audits
4. Contingencies

1. Train user
2. Transfer documents
3. Release resources
4. Reassign staff
5. Lessons learned
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Project Life Cycle Activities and Challenges


Client Interest

Intensity
level

Resources
Creativity

Uncertainty
Conceptual

Planning

Execution

Termination

Time

Project Life Cycles and Their Effects


1-32

Selecting Projects To Meet


Organizational Objectives
Project selection is process of evaluating projects
and choosing them so firm objectives are met
Ensure that several conditions are considered
1.
2.
3.
4.

Is the project potentially profitable?


Is the project required?
Does firm have the skills to complete the project?
Does the project involve building strategic
competencies?
5. Does it have capacity to carry out the project?
6. Can project be economically successful?
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Projects Selection
Project literature shows that there are more than one hundred
tools and techniques which help the organizations in selecting
projects for its project portfolio. Each tool and technique has its
own advantages and disadvantages.
Normally, organizations do not apply only one tool or technique
but a set of tools and techniques
This requires organizations to adapt or develop a
comprehensible framework for project portfolio selection.

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Projects Selection
Screening models help managers pick winners from a pool of projects.
Screening models are numeric or nonnumeric , financial and
nonfinancial .
Screening models should have:
1. Realism: selection criteria must also be reasonable and reflect
organizational objectives, including a firms strategic goals and
mission.
2.

Flexibility: should be easily modified if trial applications require


changes

3.

Cost effectiveness: screening models should be cost effective. The


cost of obtaining selection information and generating optimal results
should be low enough to encourage use of the models rather than
diminish their applicability.

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Projects Selection
Screening models should have:
4. Ease of use: screening models must be simple enough to be used by
people in all areas of the organization and be clear and easily
understood by organizational members.
5. Capability: screening model must allow the company to use it as
widely as possible in order to cover the greatest possible range of
project types.
6. Comparability: screening models should be broad enough to be
applied to multiple projects. A useful model must support general
comparisons of project alternatives.

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Selection Methods

There are many different methods for


selecting projects
They may be grouped into two
fundamental types
1. Nonnumeric: does not use numbers for
evaluation
2. Numeric: uses numbers for evaluation

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Nonnumeric Selection Methods


The Sacred Cow: a pet project advocated by a
senior executive of the firm.
The operating/competitive necessity
Comparative benefits
Rank-ordering a small number of projects is not
difficult
When the number of projects exceeds 15 or 20, the
difficulty of ordering the group rises rapidly
A Q-sort is a convenient way to handle the task
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The Q-sort Method

Figure 1-4
1-39

Numeric Selection Methods

Financial assessment methods


1. Payback period
2. Discounted cash flow
3. Future opportunity analysis

Scoring methods
1. Unweighted 0-1 factor method
2. Weighted factor scoring method

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Projects Selection Models


There are many different methods for selecting projects
Nonfinancial Models which include
Checklist
Simplified scoring or multi-weighted scoring models
Profile models
Financial Models the preferred method for evaluating projects
Payback model
Net present value (NPV)
Internal rate of return
Options models

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Checklist Model
A checklist is a list of criteria applied to
possible projects.
Requires agreement on criteria
Assumes all criteria are equally important

03-

1-42

Simplified Checklist Model for Project


Selection

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Checklist Model
This model is very subjective, usually used in screening
projects
Terms are inexact and subject to misinterpretation or
misunderstanding.
Checklist screening models also fail to resolve trade-off
issues. What if our criteria are differentially weighted
that is, what if some criteria are more important than
others?
Checklists are valuable for screening projects, recording
opinions, and encouraging discussion
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Simplified Scoring Models


Each project receives a score that is the weighted
sum of its grade on a list of criteria.
Scoring models require:
agreement on criteria
agreement on weights for criteria
a score assigned for each criteria

Score (Weight Score)


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Simplified Scoring Models

Relative scores can be misleading!


1-46

Multi-Weighted Scoring Model

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Multi-Weighted Scoring Model

1-48

Profile Models
Show risk/return options for projects.
X

Maximum
Desired Risk

X
Risk

Rating each
project on
criteria

X1
Minimum
Desired Return

Criteria
selection as
axes

Return

Figure 3.4

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1-49

Profile Models
Show risk/return options for projects.
X

Maximum
Desired Risk

X
Risk

the efficient frontier


is the set of project
portfolio options that
offers either a
maximum return for
every given level of
risk or the minimum
risk for every level of
return.

Efficient Frontier

X1
Minimum
Desired Return

Return

Figure 3.4

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Profile Model Example


Suppose that a company has identified two new project alternatives and we
wish to use risk/return analysis to determine which of the two projects
would fit best with our current project portfolio.
Return is assessed in terms of the profit margin we expect to achieve on the
projects.
Risk is evaluated in terms of four elements:
(1) technical riskthe technical challenge of the project,
(2) capital riskthe amount invested in the project,
(3) safety riskthe risk of project failure, and
(4) goodwill riskthe risk of losing customers or diminishment of
our companys image.
The magnitude of each of these types of risk is determined by applying a
low, medium, high risk scale where 1 = low, 2 = medium, and 3 = high.
1-51

Profile Model Example


After conducting a review of likely profitability for both the projects and
evaluating their riskiness, we conclude the following:
Risk
Project Saturn
Project Mercury

Return Potential
10
23%
6
16%

How would we evaluate the attractiveness of either Project Saturn or


Project Mercury?

1-52

Profile Model Example

1-53

Financial Models
Based on the time value of money principal
Payback period
Net present value
Internal rate of return
Options models
All of these models use discounted cash flows
In finance, discounted cash flow (DCF) analysis is a method of valuing a
project, company, or asset using the concepts of the time value of money. All
future cash flows are estimated and discounted by using cost of capital to
give their present values (PVs).

03-

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Payback Period
This is one of the most common evaluation
criteria used by engineering and resource
companies.
Determines how long it takes for a project to
pay back its initial investment
Investment

Payback Period

Annual Cash Savings

Cash flows should be discounted


Lower numbers are better (faster payback)
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The Payback Period Method


Disadvantages:

Ignores the time value of money (non discounted)


Ignores cash flows after the payback period
Biased against long-term projects
A project accepted based on the payback criteria may
not have a positive NPV

Advantages:
Easy to understand
Biased toward liquidity

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Example
Calculation of the payback period for a given investment proposal.
a) Prepare End of Year Cumulative Net Cash Flows
b) Find the First Non-Negative Year
c) Calculate How Much of that year is required to cover the previous period negative
balance
d) Add up Previous Negative Cash Flow Years
Initial
Investment

Alternative A
(45,000) 10,500

11,500

10

12,500 13,500 13,500 13,500 13,500 13,500 13,500 13,500

End of Year Cummulative Net Cash Flow


(45,000) (34,500) (23,000) (10,500)
Pay Back Period
Fraction of First Positive Year
Pay Back Period

Annual Net Cash Flows


4
5
6
7

3,000 16,500 30,000 43,500 57,000 70,500 84,000


b
0.78
3.78

c)

0.22 = 3,00/13,500

d)

4 - 0.22

1-57

Payback Period Example


A project requires an initial investment of $200,000 and will
generate cash savings of $75,000 each year for the next five
years. What is the payback period?

Copyright 2013 Pearson Education, Inc. Publishing as Prentice Hall

03-

1-58

Payback Period Example


A project requires an initial investment of $200,000 and will
generate cash savings of $75,000 each year for the next five
years. What is the payback period?
Year

Cash Flow

Cumulative

($200,000)

($200,000)

$75,000

($125,000)

$75,000

($50,000)

$75,000

$25,000

25, 000
3
2.67 years
75, 000
Copyright 2013 Pearson Education, Inc. Publishing as Prentice Hall

Divide the
cumulative amount
by the cash flow
amount in the third
year and subtract
from 3 to find out
the moment the
project breaks even.
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Payback Period Example

1-60

Discounted Payback Period Example


An initial investment of $2,324,000 is expected to
generate $600,000 per year for 6 years.
Calculate the discounted payback period of the
investment if the discount rate is 11%.
Solution Step 1: Prepare a table to calculate
discounted cash flow of each period by
multiplying the actual cash flows by present value
factor. Create a cumulative discounted cash flow
column.
61

1-61

Discounted Payback Period Example

62

1-62

Net Present Value


The difference between the present value of cash inflows and
the present value of cash outflows. NPV is used in capital
budgeting to analyze the profitability of a
projected investment or project.
Projects the change in the firms stock value if a project is
undertaken.
NPV = Present Value (Cash Benefits) - Present Value (Cash Costs)

Higher and postive


NPV values are
better!
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Discounted Cash Flow


n

Ft
NPV (project) - I 0
t
t 1 (1 k )
where
I0 = The initial investment
Ft = The net cash flow in period t
k = The required rate of return or hurdle rate
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Net Present Value


Ft
NPV I o
(1 r pt )t
where
Ft = net cash flow for period t
R = required rate of return

Higher and postive


NPV values are
better!

I = initial cash investment


Pt = inflation rate during period t

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NPV Example
You are looking at a new project and have estimated
the following cash flows:

Year 0:
Year 1:
Year 2:
Year 3:

CF = -165,000
CF = 63,120
CF = 70,800
CF = 91,080

Your required return for assets of this risk is 12%.


This project will be the example for all problem
exhibits in this chapter.

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Computing NPV for the


Project
Using the formula:

CFt
NPV
t
(
1

R
)
t 0

NPV = -165,000/(1.12)0 + 63,120/(1.12)1 + 70,800/(1.12)2 +


91,080/(1.12)3 = 12,627.41

1-67

Net Present Value Example


Should you invest $60,000 in a project that will return $15,000
per year for five years? You have a minimum return of 8% and
expect inflation to hold steady at 3% over the next five years.

The NPV
column total is
negative, so
dont invest!

1-68

Net Present Value Example

Note that
totals are
equal, but
NPVs are
not
because of
the time
value of
money.
1-69

Internal Rate of Return


Most important alternative to NPV
Widely used in practice
Internal rate of return (IRR) for an investment is the
percentage rate earned on each dollar invested for each period
it is invested
A project must meet a minimum rate of return before it is
worthy of consideration.

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Internal Rate of Return


Higher IRR values are
better!

ACFt
IO
n 1 (1 IRR )t
where
t

ACFt = annual after tax cash flow for time period t


IO = initial cash outlay
n = project's expected life
IRR = the project's internal rate of return
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NPV vs. IRR


NPV: Enter R (rate of
return), then solve for NPV
n
CFt
NPV

t
t 0 (1 R )

IRR: NPV = 0, solve for IRR.


CFt
0

t
t 0 (1 IRR )
n

1-72

Project IRR Example


Mr. A is considering investing $250,000 in a project. The cost of capital
for the investment is 13%.
Following cash flows are expected from the investment:
Year

-250,000

50,000

100,000

200,000

Calculate the IRR for the proposed investment and interpret your
answer

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Project IRR Example


Solution
Step 1: Select 2 discount rates for the calculation of NPVs
We can take 10% (R1) and 20% (R2) as our discount rates.

Step 2: Calculate NPVs of the investment using the 2 discount rates


Net Present Value @ 10%
Cash Flow
A
-250,000
50,000
100,000
200,000

Discount Factor
B
1
0.909
0.826
0.751

Present Value
AxB
-250,000
45,450
82,600
150,200
NPV1 28,250

Net Present Value @ 20%


Cash Flow
A
-250,000
50,000
100,000
200,000

Discount Factor
B
1
0.833
0.694
0.579

Present Value
AxB
-250,000
41,650
69,400
115,800
NPV2 -23,150

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Project IRR Example


Solution
Step 3: Calculate the IRR
NPV1 x (R2 - R1)%
Internal Rate of Return

=R1%+

(NPV1 - NPV2)

28,250 x (20 - 10)%

=10%+

(28,250 - (- 23,150))

28,250 x 10%

=10%+

28,250 + 23,150

=10%+ 5.50%

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Internal Rate of Return Example


A project that costs $40,000 will generate cash flows of $14,000
for the next four years. You have a rate of return requirement of
17%; does this project meet the threshold?
Year
0

Net flow
-$40,000

Discount
1.0000

NPV
-$40,000.00

1
2

$14,000
$14,000

0.9009
0.8116

$12,173.91
$10,586.01

$14,000

0.7312

$9,205.23

$14,000

0.6587

$8,004.55

IRR 15%

-$30.30

The project doesnt meet our 17% requirement and should not be
considered further.
03- 1-76

Example of Mutually Exclusive Projects


Period

Project A

Project B

-500

-400

325

325

325

200

IRR

19.43%

22.17%

NPV

64.05

60.74

The required
return for
both projects
is 10%.
Which project
should you
accept and
why?
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Conflict between NPV and IRR


NPV directly measures the increase in value to the firm
Whenever there is a conflict between NPV and another
decision rule, always use NPV

1-78

Options Models
NPV and IRR methods dont account for failure to
make a positive return on investment. Options
models allow for this possibility.
Options models address:
1. Can the project be postponed?
2. Will future information help decide?

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Project Screening
Process

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Project Portfolio Management


Managers routinely pose such questions as the following:

What projects should the company fund?


Does the company have the resources to support them?
Do these projects reinforce future strategic goals?
Does this project make good business sense?
Is this project complementary to other company projects?

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Project Portfolio Management


Portfolio management entails:
Decision Making: often influenced by market conditions, capital availability,
perceived opportunity, and acceptable risk. A variety of project alternatives
may be considered reasonable alternatives during portfolio development.
Prioritization:

Cost: Projects with lower development costs have less upfront risk.
Opportunity: big payout is a strong incentive for funding.
Top management pressure: Political pressure (pet projects)
Risk: payouts must justify some level of acceptable risk-too risky are scratched.
Strategic fit: opportunities are evaluated in terms of their complementarity
either their strategic fit with existing product lines or their ability to augment the
current product family.

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Project Portfolio Management


Desire for portfolio balance: offset risky initiatives by funding other projects
-profitable but low-growth products can be used to fund investment into projects
with high growth prospects.

Review: Projects selected for the firms portfolio are the ones that,

based on those priorities, offer maximum return.


Realignment: a number of important questions should be considered.

Does the new project conform to strategic goals?


Does it represent a new strategic direction for the firm?
Does a new project significantly alter the firms strategic goals?
Does the portfolio now require additional rebalancing?

Reprioritization of a firms projects. If strategic realignment means


shifting the companys focus (i.e., creating new strategic directions),
managers must then reprioritize corporate goals and objectives.

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Project Portfolio

1-84

FIGURE 3.6 GEs Tollgate Process


03-

Phases in New Drug Development

85

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Steps in the Project Portfolio Process


1.
2.
3.
4.
5.
6.
7.

Establish a project council


Identify project categories and criteria
Collect project data
Assess resource availability
Reduce the project and criteria set
Prioritize the projects within categories
Select the projects to be funded and those to be
held in reserve
8. Implement the process
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Categories of Projects
Derivative projects: those that are only
incrementally different from existing offerings
Platform projects: major departures from existing
offerings
The next generation

Breakthrough projects: involving a newer


technology
Possibly a disruptive technology

R&D projects: blue sky or visionary endeavors


1-87

The Materials in This Text


Chapter 2 focuses on the behavioral and structural
aspects of projects and their management
Chapter 3 covers the process of planning and
launching the project, construction of the WBS,
and responsibility charts
Chapter 4 discusses the construction of a project
budget and presents a method of improving ones
estimating skills

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The Materials in This Text Continued


Chapter 5 covers scheduling, PERT, CPM,
and Gantt charts
Chapter 6 covers resource allocation
Chapter 7 covers monitoring and
controlling projects
Chapter 8 deals with evaluating, auditing,
and terminating projects
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Copyright 2014 John Wiley & Sons, Inc.
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