Project Management One Point Lecture
Project Management One Point Lecture
Lectures on concepts, terms and methods of the
project management
- Latest update
- Calculating real values of activities
– an introduction to the risk-based project value （2016/06/12）
- Calculating real values of activities
- Project scheduling
- Introduction to the basic of scheduling,
and DRAG as the metrics for project delays
- Drag Cost – The true cost that takes
into account delivery schedule effects
- Sunk cost principle and DIPP criteria
for project portfolio management
- Calculating real values of activities
– an introduction to the risk-based project value
- Introduction to the basic of scheduling,
Project scheduling
Introduction to the basic of
scheduling, and DRAG as the metrics for project delays (2016/02/15)
Why do our time schedules always become longer? In order to
make the final delivery date earlier, which part of the schedule
should we tackle ? – These are common questions we face in the
schedule planning.
There are some basic principles in the scheduling we’d better
learn. Plus, there is a metrics that tells us specifically which
part to tackle for shorter schedule. Let me explain in this article.
Suppose we have to deliver a system product. This work is comprised
of just six (6) activities to be done.
1. Basic design (estimated duration = 20 days)
2.1 Hardware purchase (estimated duration = 35 days)
– preceding activity: Basic design
2.2 Hardware Installation (estimated duration = 5 days)
– preceding activity: Hardware purchase
3.1 Detail design (estimated duration = 10 days)
– preceding activity: Basic design
3.2 Software development (estimated duration = 20 days)
– preceding activity: Detail design
4. System test (estimated duration = 15 days)
– preceding activity: H/W Installation, S/W development
Now, how many days will it take to accomplish this work? It
may help us to create a network chart that depicts activities
and their relationships. There are a few styles to draw such network
diagrams. We here choose the Precedence
Diagram which uses boxes for activities and arrows
for preceding relations.
(Fig. 1 Precedence diagram of the activity network)
Within each box we write down activity name in the center and
necessary duration at the bottom. There are also four small spaces
in each box at top-left, bottom-left, top-right and bottom-right.
We have to fill in following dates.
top-left: Early Start (ES)
top-right: Early Finish (EF)
bottom-left: Latest Start (LS)
bottom-right: Latest Finish (LF)
These four dates represents “earliest possible start date”,
“earliest possible finish date”, “latest possible start date”
and “latest possible finish date”. Please remember these terms
as they are the four basic parameters used in the scheduling.
If you are smart enough, you may be able to calculate the entire
duration after looking at the Fig. 1 just for a few seconds. However,
I would like to explain calculation procedure step by step here.
Even for very smart persons, it would be not easy to calculate
duration of a network containing 100 or more activities.
We start with the first activity “Basic design”. Its ES (earliest
start date) is the day 0. Its EF (earliest finish date) is day
20. Then, ES of the following activity “Hardware purchase” should
be day 20. And its EF = 20 + 35 = 55. In this manner, we calculate
ES and EF of all the activities in the order of precedence. This
procedure is called “Forward scheduling”.
By the way, the last activity “System test” has two preceding
activities: H/W Installation and S/W development. They have different
EF dates (60 and 50). Then which number should we take as the
ES value of “System test”? ? Needless to say, the system testing
cannot start unless the both preceding activities finish. Therefore,
we have to take the later date (greater value) of EF as the ES
of the next activity. In this case, it is 60.
Rule 1: If there are more than one preceding activities,
their largest (latest) ES date becomes ES date of the following
activity.
Here we can fill out ES and EF of all the activities. Please
see Fig. 2. It tells us that System test will complete in day
75 at earliest. This is the delivery date of this work. However,
we have to go on further.
(Fig. 2 Earliest start and earliest finish dates)
Next, we calculate the LF (latest finish) and LS (latest start)
date of the final activity, System test. Its LS date is 75. Subtracting
the activity duration from EF date gives ES date (75 – 15 = 60).
This number should be LF dates for the two preceding activities,
H/W Installation and S/W development. In this manner, we can fill
in LF and LS of all the activities. It is called “Backward
Scheduling”.
Basic design activity has two following activities; H/W purchase
and Detail design. LS of H/W purchase is day 20, and LS of Detail
design is day 30. This case means H/W purchase has to start at
latest on day 20. Therefore, Basic design should finish at latest
day day 20.
Rule 2: If there are more than one following activities,
their least (earliest) LS date becomes LF date of the preceding
activity.
Now, four spaces of all the boxes are filled in. So, let’s
pick up activities whose ES equals to LS. It means its earliest
possible start date is exactly the date it should start at latest.
We call an array of such activities as “Critical
Path”. In Fig. 3, the critical path is marked in red.
(Fig. 3 Schedule dates and the critical path)
If ES is less than LS for an activity, it means that the activity
have a certain slack in starting date. For instance, Detail design
is possible to start on day 20, but it is okay to start even on
day 30. This slack is called “Float” in the scheduling theory.
Rule 3: Difference between LS and ES shows schedule float
of the activity starting date.
Critical path is a series of those activities whose float days
equal to 0. Furthermore, duration of the entire work equals
to the length of the critical path. Unless we can make the
critical path shorter, we cannot deliver work earlier. In other
words, even if we work harder to attain shorter duration of an
activity with positive float days, such effort does not contribute
to earlier delivery date at all. Therefore, managers has to recognize
there the critical path resides and concentrate his/her control
efforts to it.
The most unique characteristic of schedule control is the fact
that there is a clear distinction between “important” and “non-important”
activity. This is quite a different situation from the cost control.
Cost control is based on the logic of addition. When we can save
$1 for an activity, total cost would be saved by $1. In the schedule
control, however, making shorter duration for an activity with
positive float does not contribute to earlier delivery of the
work.
Up to this point is a basic explanation of the critical
path method (CPM). Now, we face a question about the
"important activity” – how much is it important? A metrics
called DRAG is needed to answer
this question.
DRAG is a measurement that shows how many days an activity
pushes down the entire delivery date. For instance, DRAG of
an activity is zero if that activity has float. In the above example,
DRAG = 0 for Detail design and S/W development. On the other hand,
for an activity on the critical path that has no parallel activity
(like Basic design and System test), its duration becomes DRAG
value. This is because existence of such an activity pushes down
the final delivery date by its duration. Clearly, the shorter
the activity’s duration becomes, the earlier the final delivery
date comes.
Some consideration is needed for an activity that is on the
critical path but has parallel activities running with. H/W purchase
and Installation are these kinds. There is a parallel path: Detail
design and S/W development, which has 10 days float. If we shorten
H/W purchase by 5 days, then final delivery date becomes 5 days
earlier. If we shorten by 10 days, delivery date is 10 days earlier,
respectively. However, if we shorten H/W purchase by more than
11 days, then the other path becomes now a new critical path and
no effects on final delivery date any more. 10 days are the limit.
Therefore, DRAG of H/W purchase is 10 days.
H/W installation has only 5 days duration. It is shorter than
float of the parallel path, 10 days. Thus, if we can shorten its
duration by 1 to 5 days, then delivery date becomes earlier by
the same days. DRAG = 5 days for H/W installation.
Let me summarize the rule with DRAG.
(1) For activities with float days: DRAG = 0
(2) For activities on the critical path with no parallel activities
running: DRAG = duration of the activity
(3) For activities on the critical path with parallel activities
running: DRAG = float of the parallel activity
(4) Nevetheless, in case its duration is shorter than the parallel
activity’s float: DRAG = duration of the activity
Fig. 4 shows this results.
(Fig. 4 DRAG values)
Is there any benefit if we know DRAG values? Yes, there is.
DRAG indicates how many days the activity pushes down the final
delivery date. If you wish to attain earlier delivery date, then
you should tackle activities with larger DRG values. Priority
is very clear.
DRAG value also measures how the entire work is out of parallelism. If you would like to
make the entire schedule shorter, then you had better break down
your work into pieces that can be run in parallel. This parallelism
principle applies to any kinds of work, even applicable to construction
of pyramid or calculation process in the computer. DRAG clearly
shows which activity is out of parallelism.
The above example is made up of only 6 activities, so you may
easily find out which one to tackle without computation of DRAG.
However, you cannot do it easily with 60 or 600 activities. (As
to my business field, engineering projects, 600 activities are
not a big number)
Of course, there are certain limitations for the critical path
method or DRAG. You can criticize that, say, they are no more
than static analyses, or, it is difficult to estimate activity
duration precisely by one value, or no resource constraints are
considered. But here is one point to keep in our mind. The scheduling
is a practice to build approximation models based on various assumptions.
Modeling always accompanies with simplification. Still, simplification
enables us to see structure of time schedule. “Models are all
wrong, but they are useful.” Simple tools are powerful as
far as we are know its usage in a simple manner. Scheduling is
the same. What matters is how and when to use models and methods.
DRAG metrics was first developed and proposed by Steven Devaux
in his textbook “Total Project Control: A Practitioner’s Guide to
Managing Projects as Investments” (1999, 2nd Edition 2015).
It will be more useful when applied together with costs. However,
this article is already long. So, I would like to write it in
next occasion.
Drag Cost – The true cost that
takes into account delivery schedule effects (2016/03/20)
"Liquidated damages" is a legal term used in the
contracts. It represents potential compensation by the contractor
for damages caused by delays in delivery or poor product performance.
The contractor is obliged to pay penalty costs stipulated in the
liquidated damages clause, in case it fails to satisfy mandatory
contractual requirements.
Liquidated damages cost on the schedule
delay is often calculated on pay-per-day basis; delayed
days multiplied by, for example, thousand dollars or million dollars
per day. In addition, a ceiling amount for the penalty is usually
defined, say, up to 8% of the contract price. Although the liquidated
damages are a stringent term, it clarifies the formula and boundary
with schedule risks. Therefore, contractors may regard the term
better than unlimited liability. To my observation, American and
European companies will never sign agreements that requires unbounded
compensation for schedule delays.
Penalty cost for schedule delays is usally clear with the contracted
projects in this manner. Then, how about the internal projects
that are initiated by the company itself? New product development
project is an example. Consider a case that its target date of
market-in was the end of December. However, the first lot was
actually shipped in next February. Sales and marketing people
might complain, but there were no real damages — is this correct?
The answer is NO. Let’s suppose the product life length in
the market will be 5 years. Expected revenues will be 100 million
Japanese Yens per year (I use "\1 M” notation for 1 million
Yens hereinafter for simplification). Profit margin will be at
20% or \20 M. It means revenues in total will be \500 M and profits
will be \100 M in five years. This will be the expected income
up to December 2021, if shipped in December 2016. However, it
may be too optimistic to expect the same income for 5 years in
case market-in date is delayed to February 2017. The life length
of a new product is not determined by physical persistency but
by competition with others. Therefore, we should think the
duration of sales become shorter if market-in date delays. It
means profit will decrease by 20 x (2/12) = \3.3 M.
In other words, profit decreases \3,300,000/40 = \830,000 per
day if delayed (20 working days per month assumed). About \10,000
is lost per hour. \140 loss per hour, or \2 loss per second.
Saying “oh!” costs \2. If you drop a 1 Yen coin onto the ground,
you should not bend your body to pick it up. Because it may take
more than 0.5 second, and costs you more than \1. This is the
“time is money” sense for the new product development projects.
Okay. Then, suppose my project is a contracted type without
any liquidated damages terms. My time won’t be a cost? Even if
delivery delays, we just make apologies to my customer, perhaps
together with our sales guy. How about this?
A good try, but NEVER count on such ideas. Now, this is the
very important point. In the contractor’s business such as the
systems integrators, number of project managers governs the company’s
capability of work. A project manager needs to be engaged from
the very beginning to the end of the project. Missing chances
of getting new contract because no PM is available at that moment
– this often happens in real business situations. PM is the
bottleneck resource for contractors.
Suppose PM is 5 times valuable than normal engineers in your
company. It does not mean PM wages are 5 times higher, but PM
is a scarce resource from the company’s viewpoint. Let’s assume
annual wage of average engineers is \5 M per year. Then, value
of PM availability is \25 M per year. A year has roughly 250 working
days. So, its value is \100,000 per day or \3.5 per second. Loss
of PM availability caused by delays will cost more than the previous
new product development project case.
Time is money in any projects. Based on this principle,
I would like to remind the readers of DRAG.
It is the metrics I explained in the previous
English article. It evaluates impact of an activity duration
to the entire project duration. An activity having DRAG of 10
days can be regarded that it pushes final project delivery date
by 10 days. Basically, DRAG = 0 for an activity which is not on
the critical path. DRAG of a critical path activity normally has
plus value, depending on its duration and existence of parallel
activity paths.
DRAG Cost is defined as
DRAG days multiplied by the penalty cost per day for project delivery
delays. It is a monetary value. For instance, DRAG Cost of an
activity having DRAG of 8 days equals to \1.6 M when penalty cost
is \200,000 per day of delay. DRAG Cost represents cost effects
of each activity’s duration in the project.
Each activity, of course, needs cost to execute itself. Suppose
execution costs are given in the below table for the Fig. 1, then
summation of execution costs and DRAG Costs are as shown in the
right end column.
| WBS No. | Activity | Duration (days) | Execution cost | DRAG (days) | DRAG cost | Overall cost |
1 | Basic design | 20 | \1.0 M | 20 | \4.0 M | \5.0 M |
2.1 | Hardware | 35 | \4.0 M | 10 | \2.0 M | \6.0 M |
2.2 | Installation | 5 | \0.3 M | 5 | \1.0 M | \1.3 M |
3.1 | Detail design | 10 | \1.2 M | 0 | \0 M | \1.2 M |
3.2 | Software | 20 | \6.0 M | 0 | \0 M | \6.0 M |
4 | System test | 15 | \2.5 M | 15 | \3.0 M | \5.5 M |
When we compare execution costs only, "3.2 software"
seems to be the most costly activity. However, calculation result
shows "2.1 Hardware" and "3.2 software" both
have the highest costs of \6 M and next is "4. System test"
of \5.5 M, when we take into the DRAG Cost. It means we should
tackle activities in this order when maximizing the project profit.
Business trends nowadays make many people simply think "tackling
for profit means trying cost down". However, the DRAG Cost
provides us another approach. Duration of "2.1 Hardware"
may not be easy to shorten, as it relies on vendors. Case of "3.2
software", DRAG=0. It has no effects on the project delivery
even if we can shorten it.
Therefore, we should tackle "4. System test" activity.
Can we make it shorter with assigning double number of people?
Of course, double resources does not reduce duration by half.
There will be learning curve with people, and more communication
time may be required as members increase. Let’s say duration will
be cut off by about 30%. Then, its dration becomes 10 days instead
of 15 days. Execution cost will increase, because double resources
are assigned for 2/3 duration. Hence, execution cost will be 4/3
times larger, which is \3.33 M in total. Meanwhile, delivery date
becomes 5 days earlier. DRAG Cost will decrease by \1.0 M. In
total, we will gain \0.17 M. If this is not sufficient,
then the next target may be "1. Basic design".
This approach is also applicable to cases with multiple sources
for hardware procurement with different conditions. For example,
A company: delivery = 35 days, price = \4.0 M
B company: delivery = 25 days, price = \5.0 M
We can calculate total costs as: A company = \6.0 M, and B company
= \5.0 M. In this case, we should buy from B company although
its price is a bit higher.
Concepts of DRAG and DRAG Cost were proposed by Steven
Devaux, an US-based project management consultant in
late 90’s. He calls summation of the execution cost and DRAG Cost
as "True cost" of the activity. Traditional project
management theory could not resolve trade-off between time and
cost. Time is time, and cost is cost. They have been two separate
worlds, until the day he established his new methodology. Hence,
DRAG concepts are very valuable.
We have to elaborate this method more in order to apply to
real problems. Creating an appropriate tool is very important
contribution to the management. It will bring out a big diffenrence,
it is like going out to the sea with having GPS equipment. I believe
more people should learn the DRAG Cost approach.
[Website of Mr. Steven Devaux]
"Total Project
Control"
Sunk cost principle and DIPP
criteria for project portfolio management (2016-05-05)
Among various concepts and principles for the management theory,
“sunk cost” principle looks
easy to learn, but is the most difficult to apply in practices.
The sunk cost means the money we have already spent for a subject
matter. Because it was already spent, our decision making should
not be affected by it. The principle of sunk cost tells us to
decide based on future prospectives of the matter. However, our
way of thinking often reflects past history, and it is hard to
make right decisions.
Let’s take an example. Suppose a woman bought ticket for a
concert at \8,000 (roughly $70). It is a good price. However,
she cannot find her ticket in her handbag when she arrives the
concert theater. She might have lost it or just left it home.
She confirms with the box office that seats are still available
at the same price. She has money to buy it. The concert is held
only that night. Then, what should she do? She should buy another
ticket to enter, or just return home?
If she believes the concert is worth \8,000, then she should
buy another ticket. She might have lost or forgot her original
ticket. Whichever it was, the money she paid for the ticket never
comes back. It is the “sunk cost”. The question is, now, simply
to compare the concert value and price of \8,000, as seats are
available and she can pay that amount. And for her, concert value
would be greater (that’s why she bought one ticket before).
Nevertheless, people often wonder on this problem because they
transform the question into “is this concert worth \16,000?”.
This example problem was originally raised by the Nobel Prize
Economist Daniel Kahneman (2012). He explains: “if the lady’s
income this month is just \8,000 less that the normal month, then
does she buy the ticket? Most people may answer “yes”. However,
if the same problem is presented in a different fashion of “lost
ticket she once bought”, then many reply wrong answer. This is
because they put the lost \8,000 on the cost accounts. (D. Kahneman:
“Thinking,
Fast and Slow” chapter 34)
Similar problems arise during the course of much larger projects.
I dare not mention its proper name, but a huge national dam construction
project in northern part of Kanto region has been a political
issue for several years. The underlying cause of this dispute
is a fact that the central bureaucracy does not have any criteria
or mechanism to terminate projects once they were commenced. One
more complicating factor is a way of thinking “we’ve already spend
so much amount of money, so we cannot stop the project to make
it in vain”. Oh yeah, it’s natural to consider that way, unless
we learn the principle of sunk cost. According to the economics,
it is not relevant to our decisions no matter how much money has
been spent. We have to make up our mind, just based on comparison
between “amount of money to spend till the end" and “value
of the dam when completed”.
It is very difficult to decide whether to continue or stop
projects regardless of their sizes. Reality is that efforts and
faces of project members are at stake.
“Amount of money to spend till the end” of a project is called
cost ETC (estimate to complete) in the PM theory. “How many days
till the end” is called time ETC. Cost ETC refers to the cost
from now till completion regardless of the amount already spent.
Total cost of a project when completed is called “cost EAC (Estimate
at Completion)”.
Decisions about project commencement, continuation and termination
are the problems in the project portfolio management domain. The
most important factor is normally the economic evaluation, except
for non-profit projects such as academic researches. There are
various criteria for economic evaluation like NPV/IRR of DCF method,
or payout period. However, there is a common limitation with them:
they are all comparison between the total investment cost
and the total profits. They are applicable for planning
phase decisions, but not appropriate for judgement of ongoing
projects because they do not take into account of the sunk cost
principle.
In order to conquer these limitations, DIPP
was proposed as a metric for portfolio management. DIPP stands
for Devaux’s Index of Project Performance, originally conceived
by Mr. Stephen Devaux as well as DRAG and drag cost which I explained
in previous articles.
Definition of DIPP is quite simple:
DIPP = EMV / Cost ETC
Where, EMV represents Expected Monetary Value which is anticipated
profits of the project. Its division by Cost ETC gives DIPP calculation.
For example, suppose there are four projects ongoing. Some of
them are in planning phase and some in execution phase, as shown
in the below table.
Very simple. Now, there comes another new proposal for Project
E.
It seems to be a good idea to include Project E into our portfolio
because it has higher profitability – unless it has any impacts
to others. However, there is often a limitation of available man-power
resources. Pursuit of Project E may affect other project schedule.
If we have proper scheduling tools, we can evaluate it. The simulation
result shows following impacts to the other projects.
Please be aware that EMV of each project decreases due to delay
of the finish date. If we are too greedy and put priority to Project
E, it will end up with depleted DIPP of the overall portfolio
from 2.9 to 2.2. It may not be a good decision.
Of course, this is just a desktop calculation. We all know
that other factors, such as gut feelings, prides or customer relations,
etc. coming into the equation. However, it would bring out a significant
difference for corporate performance in the long run, whether
the management makes decisions with knowing this equation or without
knowing it. Please also be aware that normal DCF method cannot
evaluate such portfolio impact problems due to lacking of the
sunk cost calculation.
DIPP increase as a project proceeds. This is because the Cost
ETC, denominator of the equation, becomes smaller as the project
reaches to its goal. When we have to prioritize budgets or resources
among projects having different progresses or phases, it is rational
to select the one which has the largest DIPP (normally the closest
to the goal).
I have explained methods developed by Mr. S. Devaux in three
article series. They were proposed in the US and have put in practices
in military industries to some extent. I first learned them at
the conference Project World in Boston in 2003. In that conference,
many other new ideas or techniques were presented. I could feel
enthusiasm by the people gathering in the PM field in the States.
12 years have passed since then. DRAG, DIPP or any other new
idea has not been introduced to Japan. Discussions about PM in
our country are still bound within PMBOK Guide(R) knowledge areas
or just reports of in-house trial & errors. I believe we should
have more sensible antenna for new evolution in PM theories in
the world.
Calculating real values of activities
– an introduction to the risk-based project value (2016-06-12)
“A Guide to the Project Management Body of Knowledge” (PMBOK
Guide)(R) by Project Management Institute (PMI) has been introduced
to Japan and widely accepted by the IT industry in recent 10 years.
As it became well known, technique of Earned
Value Management System (EVMS) has also been widely
tried put in practice. EVMS is a very useful tool that can monitor
and control cost and progress of a project at the same time. In
Japan, the concept of “Earned Value” (EV) has corresponding word
“Dekidata” (出来高). This word and concept can be tracked back even
to 18c Edo-era in Japanese construction industry. However, we
could not develop any management system using EV, which is a bit
pity for us.
By the way, introduction of the EVMS seems to have made many
practitioners to hold a misperception that it is applicable and
powerful to control any types or situations of project. No, it
is not. The EVMS should be used carefully with appropriate premises
and methods. It is not an omnipotent tool.
The weak point of the EVMS may be clearly understood when
we try putting it to the research and development (R&D) type
of projects for new products. Let us consider very simple example:
suppose there are two people starting a garage company. 
One is an engineer and the other
is a salesman. The engineer has made a brilliant new idea. With
this idea, he thinks he can make a very unique product having
new features from parts and materials costing only $2,000 amount.
The salesman says to the engineer that he can easily find a customer
to buy the product at a price of $10,000 if it is really manufactured
and be functional.
However, the engineer thinks success probability of making
the product would be fifty-fifty, as it is the first attempt for
his new invention. On the other hand, the salesman is 90% confident
that he could find a customer. It is a very simple new product
development project with only two activities: development activity
and sale activity. Initial cost of the development activity requires
$2,000. Sales activity would cost only some phone calls and transportation,
therefore negligible small.
Now, here is a question. Suppose their project have just successfully
completed the first activity, development. The engineer has fabricated
the new product and it’s functional. Then, what is the current
project progress in percentages? How do you think?
Conventional EVMS tells us that the project progress percentage
should be measured by current EV divided by total EV (which equals
to the total budget of the project). In this case, current EV
is $2,000, and the total budget is also $2,000. Therefore, progress
becomes 100% even though they have completed the first activity!
Do you concur to this calculation?
Clearly, this calculation does not match perceptions by practitioners.
You cannot manage projects properly, with measurements which is
not acceptable to people. Some may argue that a cause of this
problem is in the assumption of zero cost in the second activity
for sales. Then, let’s assume sales may cost $10. Progress calculation
now becomes 2,000 / 2,010 = 99.5%. When we round up after the
decimal point, it is still 100%. It does not resolve this issue.
You can see challenges when we apply the EVMS progress calculation
automatically to new product development projects.
What is the root cause of this issue? It comes from the assumption
widely used in EVMS that “budgeted cost of an activity is regarded
as its value”. It means that low cost activities are low value
activities, in other words. In general, costs of intellectual
activities such as design or concept development are relatively
small because it just human salaries. To the contrary, manufacturing
or implementation activities normally cost higher as they require
material and outsourcing expenses. Physical labors are high value
than intellectual world. EVMS has evolved in procurement projects
in the US DoD. Cost-based progress measurement seems to have been
base of their way of thinking.
If the cost-based progress calculation is not acceptable, then
how about this? “This is a collaborative project with two persons,
so, we say 50% progress at the completion of the first half.”
However, this is not a theoretical resolution, rather a political
compromise. What do we say if development needs 2 persons or sales
takes 5 guys? Progress measurement system depending on political
voice power may not be useful in the fair management. Then, what
should we do?
I give the answer first. We can calculate progress with "risk-based value” of the project activity.
In this case, it tells us the current progress = 81.8%.
New product development projects are collaborative endeavors undertaken
to attain unique outcome, which are always associated with risks
of failure. In fact, any project is associate with risks. In such
cases, theory of the risk-based value analysis of projects are
applicable and useful. Let me describe it in the below sections.
The above contradiction with the EVMS comes from assumption
that value of an activity is its budgeted cost. It gives us 100%
completion in the middle of a project. In order to avoid this,
we have to weigh the real value of an activity in the project.
Then, what is the “real value”?
Let us simplify this project. How about making it into a single
activity project of “make-and-sales”? It requires initial cost
of $2,000. Risk probability of failure of this project equals
to 55%, because 100% – 50%×90% = 100% – 45%＝55%. If this project
successfully completes, then it will bring out monetary value
of $8,000 as a profit.
However, at the beginning of the project, revenue of $10,000
is not assured. Its expected value is calculated as just $4,500,
because 10,000 x 45% = 4,500. On the other hand, it is sure they
have to expend $2,000 as an initial cost for parts and materials.
Therefore, the expected monetary value of the project
is just $4,500 – $2,000 = $2,500 at the starting point. Success
of “make-and-sales” activity will increase and realizes their
project value from $2,500 to $8,000. It will contribute value
to the project by $5,500 (= $8,000 – $2,500).
Let me put this in other way. Value contribution of an activity
can be expressed as an increase of the expected monetary value
of the project; the difference of values before the activity’s
starting point and after its successful completion. Expected monetary
value of a project is determined by costs and incomes (cash flows)
of its consisting activities, and risk probability of failure
associated with the activities.
Then, what would be with the project with two activities:
development and sales as in the original example. Let us calculate.
Expected monetary value of the project (we call it “risk-based
project value", or RPV
in short, hereinafter) is as follows:
After completion of “sales” activity: $10,000 – $2,000 = $8,000.
After completion of “development” activity: $10,000 x 90% – $2,000
= $7,000.
Before starting of “development” activity: $10,000 x 90% x 50%
– $2,000 = $4,500 – $2,000 = $4,500.
Therefore,
Value contribution of “sales” activity = $8,000 – $7,000 =
$1,000.
Value contribution of “development” activity = $7,000 – $2,500
= $4,500.
Total contributions of the two activities are $5,500 in total,
which corresponds to the value contribution of the “make-and-sales”
activity in the simplified case.
Now, we are ready to measure the progress. They have just
completed the development and are about to start the sales. Progress
can be obtained as attained (“earned") contributed value
divided by total value contributions, like the EVMS tells us.
It is,
$4,500 / $5,500 = 81.8%.
OK? Real value of an activity is represented by an increase
of the project’s expected value before and after of the activity
execution. The value depends on risk probabilities of failure
with project activities. Please see the above example.
Value contribution of development is greater than that of sales.
This difference comes from the fact that the development has higher
risks, or in other words, more difficult. The more the work difficult,
the more it brings value when successfully completed. The theory
of risk-based project value proves why our common-sense insights
are true.
What if the risk probability of sale in the above case is
zero? You can immediately see the value contribution by the sales
equals to zero. Activities with no risks are zero values to contribute
to the project, even if they are necessary to complete.
Practical projects have activities far more than two, and
there are parallels projects. Even with these cases, calculation
of the RPV and value contribution of activities are possible.
Please see my academic papers in the references.
And, please see the above case once more. Conventional management
theory has usually treated as development as the “cost center”
activity and regarded the sale as “profit center”
one. This is one background of the phenomenon that sales sections
have more influential power in companies. However, if we compare
real value contributions of the two activities in the above case,
development has greater value. It is clear which is more important
in the viewpoint of management.
The theory of risk-based project value enables evaluation
of components in value-chain in a enterprise or calculation of
added-values in a supply chain. This was made possible because
we included concept of “risk probability” into cash flow analysis.
I hope the readers understand how this theory can be a powerful
tool for us.
References:
(1) Sato, T. (2014): “Risk-based project value ? the definition
and applications to decision making”, Procedia – Social and
Behavioral Sciences. Vol. 119, pp.152-161.
(2) Sato, T. (2009): “Risk-based Project Value Analysis: General
Definition and Application to Progress Control”, Journal of
Japan Industrial Management Association Vol. 60, No. 3E.
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