Valuing project management--an ROI approach

Description:

Project managers are under great pressure to demonstrate the value of their work in tangible ways. As project managers we must return not only the direct and indirect costs related to our services, but also the profit which would have been derived if that money had been invested in other activities. That is, the application of resources to project management is subject to the same financial rigor as any other investment decision. While project management investment can be estimated easily, the returns are not so clearly defined. This highly interactive session will cover identification of sources of the financial returns from effective project management, and various methods for quantifying those returns. A case study will be used so that participants can see the methods in action, calculating a RoI.

Crawford and Pennypacker (2001), Ibbs (1997) and others have amply demonstrated the value of project management both in perceived improvement in Return on Investment and other measures of organisational efficiency and effectiveness. While these studies demonstrate truths that we, as project managers, hold to be self evident, that following the project management processes are of great benefit to the organisation, they do not necessarily demonstrate the benefits of dedicated project management. All too often we hear of project management duties being assigned to someone who has demonstrated technical or marketing credentials but few, if any, of the competencies required of a successful project manager.

It is not unreasonable for our executives to be disenchanted with project management. More often than not, projects are delivered late, over budget and off scope. In short, they do not deliver the value that the stakeholders demand. The Standish Group has estimated that “70% of IT and e-commerce projects either fail or are completed over budget with less functionality than planned.” (2003)

It matters little whether the problem was in the expectation or the delivery, for control of both is in the project managers' purview. As an instructor of both fledgling and experienced project managers, I often start a session by asking the following question, “How many of you have ever worked on a project which was delivered in scope, on time, and at or below budget?” Typically only one, two or three hands will be raised in an audience of 20 or more participants. In answer to the follow up question, “How often has that happened?”, the most common answer is “rarely.” Frequency of success does not seem to be highly correlated with degree of experience, although this is solely my impression, wholly unsupported by any hard data.

If, therefore, a senior manager, client, or other decision making stakeholder sees project management as process for reaching a goal, a cost centre if you will, why not manage the project in the least expensive way. Why pay $150,000 to $250,000 for project management?

Recently, we have seen project management articles (Crawford & Pennypacker, 2001; Stewart, 2001) which propose the use of a “balanced scorecard”, first described by Kaplan and Norton (1992), to demonstrate the value of project management. The technique suggests that the value of project management is best described by considering four perspectives, viz. financial, customer, internal processes, growth and learning. The metrics suggested however, are qualitative – green, yellow and red lights, signifying conformance to expectations, monitoring and correcting observed variance from expectations and serious deficiencies. While this is indeed a very valuable technique, it begs the question. Why do we need professional project managers in order to change lights to green, and how much should we pay for project management? Financial questions require financial answers. Ibbs (2003) put it well. He suggests that once we have provided a quantitative answer, the balanced scorecard provides the “icing on the cake”. How then do we provide a quantitative answer to justify the cost of project management?

There are several applicable, commonly used, financial measures. They have much in common and each uses cost and revenue figures as input.

Benefit/Cost Ratio* = Amount of revenue and cost savings expressed as a ratio to cost

Payback period = The time it will take for the benefits to repay the costs

RoI^† = Amount of gain, expressed as a percentage, earned on a capital investment

IRRI^‡ = Annual rate of earnings on an investment

RoCEI = Return on Capital Employed§

EVA** = An unconventional economic measure which relates economic gain to the cost of capital

The choice of RoI or another financial measurement depends on your organisations and your clients' preferences. There is a large body of literature on the problems of applying RoI and its equivalents to “soft” data. (Fitz-Enz, 2000; Phillips, 1998) The key, of course, is to note that project management is not solely a cost item but that it contributes the numerator as well as the denominator in the well-known Benefit/Cost ratio. The calculation of cost is fairly straightforward. Our problem, and the one I'd like to discuss today, is how we can quantify the benefits. Our discussion will, in no way, suggest replacement of the balanced scorecard. Indeed, the approach described suggests a way to develop metrics, which would be appropriate for inclusion in the scorecard.

The process of describing the benefits of project management in monetary terms is not unlike other processes used by project managers. First one must identify potential benefits, then analyse and quantify them and finally establish baselines and monitoring systems to ensure that they are not forgotten or ignored as the project progresses.

Identification – The benefits of project management and their associated metrics will depend on the nature of the project, the organisation's strategy and objectives, management style, corporate culture and a variety of other factors. Therefore, each project team must identify its own list. Which of the many identification tools available you choose to apply is a matter of your own comfort and style, but the following matrix (Figure 1), modelled after Customer Service Solutions' Major Values Indicator Matrix (Ganon, 2002), serves as an effective guide. Note that these questions are not intended to quantify the benefits, only to help you identify them. Neither is the guide intended to be comprehensive, as it must be reconfigured to represent you organisation's needs. One might, for example, create a column for “growth and learning” to keep aligned with a balanced scorecard approach.

Value is added by project managers in two ways, by acting in ways to create additional value and by acting to reduce or avoid losses. This is akin to the idea that risk must be divided into opportunities and threats. Although it is not necessary, it is nonetheless convenient to separate gain enhancement and cost avoidance benefits at this stage.

Analysis and quantification - Once the major benefits have been identified, one must quantify (monetize) them. Ibbs (2003) describes the relative difficulty of quantifying various benefits as a series of concentric circles.

Level 1 represents the easiest conversion. For example, variance from budget is already in monetary terms, as is any penalty for late delivery or off quality. At level 2, one can still quantify with relative ease, but the calculation is not so direct. Here one might calculate the cost of lateness to include overtime payments, express delivery, reallocating resources, etc. At level 3, we have the least visible connection for quantifying. At this level one considers that lateness may result in loss of shelf space for a new product, missing a key time to market, interfering with resources on another project, or any of a myriad of other effects. The imputed cost of lateness must assume estimates for these impacts.

The “balanced scorecard” handles all of these with ease because there is no attempt to quantify. In order to quantify, especially at level 2 and level 3, we must first choose an appropriate metric. There are several keys to doing this successfully:

• Align the metric to the organisations goals.
• Partner with your client and your financial analysts.
• Start with the level 1 items. It's low hanging fruit.
• Be conservative
• Do not try to quantify everything. Quantify enough to make your point and present the additional benefits in a qualitative format.

Here's an example at level 3.

Project manager: Who will manage this project?

Client: The systems architect.

Project manager: Has she ever managed a complete project before?

Client: Only some small ones.

Project manager: Well you can expect a learning curve here because there are many non-technical issues to manage.

Would you agree that an experienced project manager would spend half as much time on these tasks compared to a technical specialist new to project management?

Client: No. Maybe 2/3 as much.

Project manager: And experience tells me that I could manage this project, and three others like it, during the course of the year, that is, about 500 hours of project management. How much do you pay systems architects and project managers?

Client: The systems architect get Euro 125 / hour (fully loaded) and the project manager earns Euro 80 / hour.

Now we are ready to calculate.

Here we have demonstrated a savings of Euro 53250. There should be little question of buy-in because the client supplied the figures.

As in developing any estimates, various levels of precision obtain, definitive, preliminary and order of magnitude, for example. (PMBOK^®, 2000). While it is always useful to present estimates as a range or with an appropriate adjective, it is important to stay quite conservative in your estimate. Note that even in the example, if we were to apply ± 25% to the effort estimate, we would still have a benefit of nearly Euro 40000. The benefits of project management are so great relative to the costs, that even conservative estimates should win the day and not open you up to undue criticism of you your assumptions.

At this point, one might also point out several other benefits related to the opportunity costs of using the dedicated project manager.

• Since the architect has up to 500 hours more to apply to her speciality, the project may be completed sooner.
• The architect is available to work on other projects instead of managing this one.
• The architect is probably happier doing her own work, therefore more productive.
• An experienced project manager will probably make fewer mistakes and create greater quality and less rework on the project.

While all of these can be quantified, if Euro 53000 + is a convincing figure by itself, you can stop there. There is an old adage in selling, “Don't oversell and don't forget to close the deal.” Remember, the primary reason for this exercise in RoI is helping clients and executives understand the value of the project management discipline.

Evaluation – This final step, monitoring and corrective action, is honoured more in the breach than in practice. RoI and other financial measures are commonly applied during project selection but, benefit baselines are rarely created. Monitoring benefits should not be ignored. Perhaps most important is the role such values play in mid-project evaluation. Periodically one must ask whether the project is worth continuing, should be replaced with a different project or should be aborted. Whether the benefits of professional, dedicated project management are being realised and the cost and difficulty of such management are essential parts of this decision. Project management time and cost reports and the actual value of benefits are needed to guide mid course corrections. The metrics you develop early in the process enable these calculations.

These evaluations are also essential to creating a corporate memory, to enhancing the project manager's credibility and toward developing a corporate culture which values project management.

In sum then, RoI or similar financial metrics can be used for elucidating the value of project management. These techniques will allow the project manager to speak in the language of the decision maker and to enhance the organisation's view of the discipline of project management. In turn, this will allow project managers to help their organisations improve the timeliness, cost effectiveness and quality of projects, and to create greater customer value.

Figure 1: Major Benefits Indicator Matrix