Financial models, right questions, good decisions
by Greg Githens, PMP
THE DILBERT CARTOON accompanying this article suggests the underlying tension between financial performance and qualitative, but nevertheless important, organizational capabilities. The cartoon reveals a common and recognizable issue: financial metrics like Return on Investment (ROI) and Net Present Value (NPV) create cynicism and are often meaningless and even counterproductive. The financial character's arrogant and smug tone suggests a common misconception: that managers can quantify “what's important” merely through financial data.
Of course, justifying project management is an important, current, and relevant topic. However, organizations are not asking the right questions. Is project management's ROI relevant? Does the accounting method help us understand our organization's present and future performance? Do our metrics enable better decisions? As organizations transform from traditional industrial hard-asset organizations to information-age, knowledge-based organizations, managers need to continuously validate their performance models, metrics and assumptions.
Traditional, backward-looking metrics were developed for traditional capital asset-intensive organizations, not today's knowledge-driven companies. They tend to preserve the status quo, emphasize capital investment over intellectual investment, and yield predictable, low-risk decisions and easily copied competencies. Traditional metrics simply cannot capture the complexity and value-added of today's process-oriented firm.
I hear executives ask, “How much money am I going to spend? What is the ROI on this project management stuff?” They implicitly fear that they will waste money and become embarrassed. I understand their desire to avoid spending money, but they forget that many benefits are qualitative. Further, they discount the relationship between short-term performance, capabilities, and sustainable competitive advantage. People's knowledge and customer loyalty are invisible assets.
Financial performance is the output; capabilities (like project management) are inputs. Project management is a constellation of disciplines that organizations use for a number of purposes such as revenue growth, cost reduction, system design, and system deployment. Thus, project management is a multifaceted capability. Financial performance is just one of many relevant goals, and it is extremely difficult to build a simple, accurate financial model that links project performance to good financial performance.
A Balanced Scorecard
Enterprises, programs, and projects do not need hundreds of metrics, just a balanced approach. Starting in the early 1990s, executives of progressive companies recognized that focusing on return-on-investment objectives and budgeted profit targets was leading to pathological behaviors within the organization.
AT&T, Chiron Diagnostics, and IBM are just a few of the major corporations that have been moving from short-term financial measures to the Balanced Scorecard concept (see Robert Kaplan and David Norton's book The Balanced Scorecard: Translating Strategy into Action, 1996, Harvard Business School Press). It supplements traditional financial measures with those of customers, internal business processes, learning and growth. It links long-term strategy with short-term vision and actions.
Exhibit 1. Project cost overruns are related to planning effort. Data from the project portfolio of one organization in NASA shows that under-investing in planning increases the probability of cost overrun. Note the variation in financial outcomes: the less you plan, the more risk of cost overrun.
Exhibit 2. AT&T, one of the leading project management organizations, uses a selection model that includes metrics for people and customers, as well as financial performance. The ideal project contributes economic value added, customer value added, and people value added.
The Balanced Scorecard provides a holistic model of organizational performance. If you accept that project management is an organizational capability, then the Balanced Scorecard holds great promise for understanding how project management contributes to long-term organizational performance. Here is a brief summary of Balanced Scorecard and possible contributions of project management capability:
■ Customer Value. The project is the front line of customer contact. Project participants sense and respond to customer opportunity, thus building sustainable relationships and customer loyalty.
■ Innovation. Projects and the products they create are instruments of innovation.
■ Internal Process. Organizations have increased their emphasis on repeatable process management to focus on knowledge capture and transfer. For example, the project initiation process is a key to balancing customer demands and technology advancement. Poor processes explain why many companies have insufficient resources, popcorn priorities, and little focus. (One caution: Overly codified processes can smother individuality and genius.)
■ People. People create knowledge. They are the primary source of competitive advantage for many firms. Those of us in the services business know that clients don't hire companies, they hire individuals.
■ Financial. The outcome of the strategies and capabilities of the firm—over the long term, the organization's stakeholders are rewarded by the its investment in its capabilities.
Planning: A Vaccination Against Project Failure
The preceding discussion, though important, probably does not help the novice determine how and where to build the business case for project management. I suggest you start with the individual project, and the common issue of project planning. We've all heard the refrain, there's never time to do it right, but always time to do it over!
Cost is one aspect of financial performance—but so is waste. Project planning has cost, often significant, and this cost often does not lead to project success. However when projects fail, practitioners note the waste and claim that good planning would prevent the failure. Cost avoidance (or failure/waste avoidance) is the primary benefit of project planning. Specifically planning lowers risk and helps to manage complexity The discipline and rigor of planning is a vaccination against project failure.
Project planning is what organizations need most and practice least. It is clearly wasteful to plan everything rigorously There is a substantial body of knowledge showing that projects do fail despite extensive planning efforts (for example, the Challenger space shuttle). Organizations need a framework for project planning and answering the payback question.
Exhibit 1 presents cost performance in the project portfolio of one organization in NASA (which is similar to the profile of many commercial organizations as well). The data show that under-investing in planning increases the probability of cost overrun. Some projects had relatively little planning investment, and had good financial performance.
The Essence: Good Decisions
If project management is to become a core competency, and not just “schedule mechanics,” organizations need to recognize it as one enabler of a good decision-making process. We expect good decisions to cause effective organizational performance, including financial performance. The project manager is the leader of the project's decision-making process.
Here are four guidelines for promoting project management as a fundamental of good decision-making.
Creating Value is the Core of Sustainable Competitive Advantage. Organizations want their performance measurement systems to tell them where value is being created, where improvement is needed, and where the firm's strategies are being successfully implemented. Value propositions are a critical issue in project selection. AT&T, one of the leading project management organizations, uses a selection model that includes metrics for people and customers, as well as financial performance. Exhibit 2 is a simple illustration of AT&T's model of economic value added, customer value added, and people value added.
The Balanced Scorecard approach holds great promise for understanding how project management contributes to long-term organizational performance.
Measure Effectiveness First and Efficiency Second. The simplest question for effectiveness is: did you succeed or fail, and how do you know?
The project manager must be willing to assume accountability for the performance of the project. It is helpful to identify a criterion for a good decision: those that increase the probability of success and decrease the probability of failure. Excellent project managers are those who address success and failure and take the time to select the right process.
Efficiency metrics should stimulate understanding about processes. John Goodpasture of Lanier Worldwide reminds us, “The real purpose of measures is to stimulate improvement in project performance” (“Earned Value—The Next Generation: A Practical Application for Commercial Projects,” Proceedings of the Annual Seminars and Symposium, PMI, 1997).
Robust Action, Not Reaction. One goal of an effective organization is balancing metrics for short-term and long-term performance. Eccles, Nohria, and Berkley, in their book Beyond the Hype; Rediscovering the Essence of Management (1992, Harvard Business School Press) define robust action as “action that accomplishes short-term objectives while preserving long-term flexibility.” Projects are temporary, so short-term focus is natural. The competencies and capabilities of the organization (a long-term factor) influence the project's performance. Projects create new capability. Therefore, projects are elements of robust action strategies.
Reader Service Number 5020
Inappropriate metrics often cause dysfunctional behaviors and thus poor enterprise performance. Andy Inkeles, a manager in Boeing's Delta III Launch Vehicle Program, notes “good metrics cause action, bad metrics cause reaction.” Our metrics and financial models should encourage robust action.
Develop Proficiency in Asking the Right Questions. In the past, one of the prime executive responsibilities was to “set the direction for the project” and answer questions. This led to paternalistic cultures where subordinates asked questions of “powerful and omniscient” managers, who had the answers (or at least made decisions). The truth was that many of these managers were clueless. Now, the organization is too complex and fast moving for executives to have all the answers. Now, it's essential that executives have the right questions! The project team provides the answers.
PROJECT MANAGERS AND PROGRAM MANAGERS increasingly participate in and even lead the discussion of strategy formulation and implementation. Because project managers and teams develop the answers, they must push back on poor decision-making. Good decisions demand good models and data. Both project managers and executives need to become proficient in asking the right questions.■
PM Network • July 1998