From static project budget to dynamic management tool

Introduction

From static project budget to dynamic management tool
Roberto Bravo, MBA, M. Sc. Eng.
Vice President, Information Technology
Chief Information Officer, FirstOntario Credit Union, Canada

Abstract

Project budgets are traditionally “negotiated” as targets and essentially surge from a given expense budget projected growth based on costs of the previous year. Growing costs of projects started in previous years may not be accompanied by updated revenue plans. The presenter will show how to apply project budget tools as a Dynamic Project Management to measure of project success and viability.

A new method of risk management developed in the 1990s, introduced to the research and investment community by Harry Markowitz, know as modern portfolio theory can be applied to any asset class like a project with extremely successful results. The underlying theory of investments and the principles of diversified portfolios of Markowitz is used to demonstrate how to manage the projects dynamically across diverse programs and enhancing the measurement that can be delivered by earned value.

The seminar attendee will be able to develop realistic project plans that include the current and future budget constraints, plan for future project evolution and by using ratios make decisions on the future of multiyear projects in growth driven organizations (pharmaceutical, financial, technology).

Introduction

Traditional project forecasting does not ensure long term project viability in growth driven organizations. The presenter discusses how growth driven organizations may look at project budgets for future years as a Dynamic Project Management Tool based on indicators and growth ratios and how different projects have different costs approvals based on the growth ratio of the business unit. Furthermore flexible agile project organizations require a decentralized business responsibility to the business unit level to ensure the project structure follows responsibly those ratios ahead of time to ensure the life of the project.

Main drivers for change

As organization's operating, maintenance and capital budgets represent an increasing share of the total corporate budget, project management offices (PMO's) are under progressively more pressure to manage the projects as a business investment center. In doing so, executives and their business peers must rationalize investment choices and be able to manage the ‘portfolio mix’ of project assets to optimize the value to the business.

This means that the PMO must know, at any time, their:

  • Current projects and programs (earned value, timeframes, resources) status and dollar value
  • Projects that have a diminishing value
  • Projects which can be leveraged to increase value
  • Project interrelations
  • Program & Project status, schedules and dependencies
  • Risks, benefits and cost impacts of all programs and projects under consideration and underway.

The dynamic management process

Dynamic project portfolio analysis enables intuitive categorization, valuation and assessment of project and asset portfolios (and views) to optimize business impact.

Portfolio management should be established on a framework-based toolset that provides the decision-making analysis to balance investment risks and costs with business value. PMOs may want to adopt a portfolio management methodology and related processes that allow for the effective and efficient categorization of all projects. The portfolio management process could provide sufficient analytical data to support mean to prioritizing and sequencing the development and utilization of projects. Therefore, PMOs can clearly articulate to the business the relevant risk-benefits tradeoffs and ensure the right projects are being funded, at the right time, at the right level of investment.

Key to the budgeting and planning process is the ability to develop and to compare scenarios (e.g., what-ifs) that enable the selection of appropriate changes. In doing so, some of the metrics used in dynamic portfolio management include risk, timing, and reward valuation techniques, budget control/impact, resource forecasting and multiple views that highlight key comparisons (e.g., cross-portfolio interdependencies).

The needed information to make the right decisions at the right time

Projects and programs represent a significant piece of the overall business operating and maintenance budget. In good economic times, and increasingly more so during economic downturns, PMOs are under pressure to answer the question posed by the Corporate Leadership Team and the Board of Directors: Is the business deriving the maximum value from its projects?

Unfortunately, many of these same business leaders lack the information, processes, and toolsets to evaluate the project investment portfolio and therefore choose the appropriate options.

Business decisions to cut spending by a percentage across the board based on last years budget can be better managed with portfolio management. These cuts can be achieved by analyzing the business effects of individual line of business spending alternatives, and choosing the appropriate course of action based on financial realities instead of emotion. Therefore, savvy PMOs will adopt a portfolio management prioritization process that informs, qualifies and quantifies investments and demonstrates alignment with an ever-changing business focus. Governance coupled with portfolio management qualification, facilitates a greater return on investment that decision based on the previous year budget as increment or decrement.

Project decisions based on dynamic portfolio allocation

The need for many organizations to make increasingly holistic decisions, covering the lines of business unit needs, corporate requirements, infrastructure and local, regional, and global concern, drives the need for new investment processes and analytical decision-support tools. The natural approach for most businesses is adopting portfolio management.

The Project portfolio is a managed set of Projects mapped to investment strategies (based on risk tolerance and business goals), according to an optimal mix (the percentage or range of investment made in each business area), based on assumptions about future performance, (strategic and tactical growth expectations of the business), to maximize the value/risk tradeoffs (ensuring that the selected investments provide the desired level of business value for the cost and risk involved) in optimizing the organization's return on investment.

Portfolio management provides the corporation with a disciplined framework to leverage management processes, asset investment and deployment decisions.

Quantifying the Business Impact

Portfolio management techniques go beyond measuring cost reductions and when PMOs are asked to justify services and value to the corporation the methodologies presented here save time and effort.

A valuation process (incorporating a prioritization and selection decision model) is emerging in organizations employing project portfolio management that includes various factors that are weighed to ensure the right mix of investments in projects. These multiple dimensions comprise term, duration, risk, size, scope, expense, lifecycle, planning horizon and capabilities to maximize corporate, line of business and shareholder value from project investments.

Leading organizations create enterprise program management offices (EPMOs) to better manage all project portfolios across the enterprise and enable upper management to better prioritize resource allocation across projects, infrastructure, and other areas. Improved project and program management tools will help support coordination across project management and asset lifecycle processes.

Dynamic Portfolio Management and Project Managers

There is a degree of controversy over the Portfolio Management as a panacea to all business ailments or elimination of all project management. Portfolio management can certainly improve the project selection but project management ensures that the project is well run.

Some confusion exists over the aggregate of projects as portfolio management vs. project management. This view is incorrect because portfolio management is used to choose the right investments as they impact business performance (i.e., “do right things”) meanwhile project management ensures that those investments are properly acted upon (i.e., “do things right”).

Project managers may only be interested in the success of their current projects and therefore need to be sold on the benefits of their active use of portfolio management. Getting project managers on board takes time and a conscious effort to enhance their ability to understand the big picture and understand project interdependencies beyond programs.

Some portfolio management tools provide a document management system that can be used to help project managers by providing templates for project initiation, status reporting, schedule tracking, etc., with standard formats, and knowledge built into the tools. The inclusion of resources into the portfolio makes it easier to negotiate resources for a project, based on skills, experience and availability, so less disputes between projects for specific individuals result.

Portfolio management enhances intra project communications. Project team members like it because they have better visibility to the whole project, seeing status, schedule, changes, today's tasks, etc. in addition to how their project fits into the broader landscape of the business strategy. Portfolio management provides a framework within which to quickly create the alignment between business objectives and project by focusing on business value.

Project managers gain through portfolio management greater visibility into project activities (where money is spent and where value is achieved) and by analyzing asset portfolios investment/return, executives are improving strategic planning abilities (i.e. migration plans, value flows, performance targets, growth predictions). This reduces the risk of decision making.

Dynamic Portfolio Management and the executive team

The executive team realizes the highest value from project portfolio management as it facilitates the audit and justification of decisions in relation to business relevance of and changed products and services.

Business executives in companies already using project portfolio management are becoming more knowledgeable about how project impacts innovation and business growth, understanding the value and risk tradeoffs on investment decisions and how those decisions will impact the business. In short, project portfolio management is allowing these managers to manage the business. The reason are that executives have with portfolio management information they have never seen before, enhancing their
understanding of decision impacts and improving the quality of decisions. The main saving comes from project scope overlap and similar work performed across the organization as connections between projects become more evident and redundancy and inefficiencies in resources utilization is eliminated.

Value in Portfolio Management beyond budget tool and as an operational tool

North American companies have spent an estimated of more than $1 trillion on IT projects and surrendered nearly $300B on late, over-budget, or failed implementations during the years 1999 to 2001.

Many of the projects failed, not for lack of money or technology, but for lack of skilled project management and adequate risk management practices.

Once the risk exposures are audited and contingency plans are developed, the organization controls are put in place, there are still unresolved issues with life cycle of assets and products. Portfolio management creates a single source for all existing projects, initiatives and potential investment opportunities. The visibility of relative value of projects that portfolio creates, facilitates the approval of projects that otherwise would not stand on their own and combine the best mix of projects based on easiness, value and priority. There is a clear conflict here between meeting short term financial targets and long term value perspective that portfolio management clears the way towards.

Seeking Toolset Solutions

For decision support, portfolio management toolsets can help decision makers graphically model scenarios for each option being considered by adding, removing, or changing attributes.

Some tools offer the approach to project portfolio as the static Markowitz model, that expands the asset space to include managed portfolios and compute the optimal static portfolio in this extended asset space. The principle is that a static choice among managed portfolios is equivalent to a dynamic strategy. They consider managed portfolios of two types: “conditional” and “timing” portfolios. Conditional portfolios are constructed along the lines of Hansen and Richard (1987). For each variable that affects the distribution of returns and for each basis asset, they include a portfolio that invests in the basis asset an amount proportional to the level of the conditioning variable. Timing portfolios invest in each basis asset for a single period and therefore mimic strategies that buy and sell the asset through time.

Portfolio management and analysis products, however, are maturing to begin addressing enterprise portfolio analysis

Measuring Success

Assessing portfolio management program execution seeks to answer the questions

  • How well is the project portfolio management process being used?
  • What lessons learned can be applied to our process?
  • Is the organization ready for this level of portfolio management?

The success in the use of portfolio management is measured by:

  • Increased ROA
  • Reduction in redundant projects
  • Higher staff utilization (productivity improvements)
  • Behavioral changes such as enterprise collaboration, consistent prioritization criteria and decisions tied to business needs.

Final Words
Benefits in the implementation of Dynamic Portfolio

The use of portfolio management ensures that team members can see what is happening on their project and other projects, therefore they get a better big picture vision with improved intra project communications. The yearly budgeting and funding process is simplifies this way through portfolio management, because the staff is comfortable with collecting project information throughout the year and determining the relative value of projects. When it comes time to prioritize and fund projects, it is easy to determine which ones are the best projects to invest or retire.

Sponsorship of the dynamic portfolio should be an executive level function to enable change, institute governance, and facilitate business decision making integrated with the budgeting process.

References

Oberuc, Richard (2000). Dynamic Portfolio Theory and Management, Mc Graw Hill

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Tallman, Ellis (1992) Human capital investment and economic growth: new routes in theory to address old questions, Economic Review, 1992, issue Sep, pages 1-12

Victoria – Feser, M (2000) Robust portfolio selection, Suisse; Ecole des Hautes Etudes Commerciales, Universite de Geneve, faculte des SES. 102 Bb. Carl-Vogt CH - 1211 Geneve 4, Suisse

Kriens, J. (1994) Differentiability properties of the efficient set in the Markowitz Portfolio Selection Method. No 657 research memorandum from Tilburg University, Faculty of Economics and Business Administration.

Pope, Robin (1999) Reconciliation with the Utility of Chance by Elaborated Outcomes Destroys the Axiomatic Basis of Expected Utility Theory, Discussion Paper from University of Bonn, Germany. Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany.

Markowitz, Harry M. (1952). Portfolio Selection, Journal of Finance, 7 (1), 77-91

Markowitz, Harry M. (1999). The early history of portfolio theory: 1600-1960, Financial Analysts Journal, 55 (4), 5-16

Markowitz, Harry M. (1959). Portfolio Selection, Blackwell

Grinold, Richard (1999). Active Portfolio Management, McGraw Hill

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI or any listed author.

© 2004 Roberto Bravo
Originally published as a part of 2004 PMI Global Congress Proceedings

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