If you think a big projects executed well cost a lot of money, just wait until you have one that goes poorly.
The implication is that that good project management increases project value by removing risk to those initial cash flows.
Here is how we think about the sources of value of good project management (PM).
Back to Basics: Evaluating Project Business Cases
Most large projects have a business case attached to them. That is, the project sponsor or company defines the conditions under which the project will succeed. This often includes project objectives and financial impact models. The financial models include projection of future cash flows with and without the project. The discounted cash flows include the capital costs of the project, the operating expenses, and the projected cash benefits over time.
The benefits may be complex and extend across the company. For example, think about a new distribution or returns center. The financial modeling could include freight savings from the new distribution center, new sales enabled by the new site’s better service levels in a new market, in-sourcing current outsourced distribution, changes in inventory levels across the company’s network, improved efficiency of processing returns, labor savings from an automated site, or other relevant items.
But let’s consider a simple example. Imagine a 3PL starting up a large, automated warehouse for a 10-year customer contract. Consider the budget as $100,000,000 and minimal staffing onsite. It’s not a megaproject (defined as ~$1 Billion or greater), but it is still a substantial and complex project.
Here is a discounted cash flow model. It shows a 10-year evaluation horizon, $100M investment (figures in ‘000s), and has a 15% IRR to meet the company hurdle rate. Clearly there are many simplifying assumptions in putting such a model together, like the time horizon, costs, benefits, terminal value, and discount rate, but it will help us understand project business impacts.
If the sum of the discounted cash flows is positive and meets some rate of return hurdle, then the project is much more likely to be approved. Here, the project above shows a 15% Internal Rate of Return, a positive Net Present Value (NPV), and pays back in year 6. Looks great!
So, to be successful, the project must meet the conditions specified in the business case. And this is where project management makes its money. We’ll come back to this in a moment, but first we’ll see what can go wrong.
Where Projects Go Wrong
The bigger the project, the higher the risk of failure. With large projects like complex warehouse startups, which integrate aspects of large construction projects, software projects, automation/industrial machinery, and organizational change, there are many possible avenues to failure for the projects.
Failure effects of projects can include:
- Delays in implementation
- Budget or cost overruns
- Not delivering promised functionality (operationality problems)
- Impacts to company reputation or public-relations
- Lack of adoption by target audience
These are each very costly. And no one likes costly failures.
Frequency of Failure
How often do failures happen?
Ed Merrow shares some figures in his book Industrial Megaprojects. He notes that large capital projects, depending on industry, can have up to 70-80% failure rates, defined as 25% or more cost overrun, 50% over average time for implementation, or severe technical problems into the 2nd year after startup. He also notes that slips in schedule, cost, and operability tend to be correlated.
And in software project literature, project failure rates of 50-75% are commonly cited.
The takeaway is that project failure is common.
So what do you think can happen with a project that combines construction, software, and organizational change? The chances of failure go up when the critical project component work is already risky. The more complex the project, the higher the risk and the larger the consequences of failure.
Schedule delays
Schedule delays are the most common type of failure people recognize. “It’s late!” But why are they a problem? Let’s explore why.
In the financial model we showed earlier, benefits start accruing to the project in Year 1. Let’s see what happens when the project is delayed for different periods of time. We model this by reducing the benefit cash flow in Y1 by 8% to show a 1-month delay, 50% for a 6-month delay, and then 100% for a full 1-year delay:
The value of the project is front-loaded due to the time discounting. We see a 1-month impact of $1.4M representing 4% of the overall project NPV. A 6-month delay has impact of $9M, or roughly 25% of the total NPV value of the project. A 1-yr delay takes almost 50% of the value of the project.
This type of math is very visible. While you can’t eat NPV, it is what determines if a project is profitable. Then the lack of planned revenue or savings can have large effects on a company’s cash flows. This can be dangerous to the company, since it was probably financing the project from the resulting benefit cash flows.
And the impact understated because it doesn’t include increased project costs from the extended implementation. It also assumes there are no other interrelated costs from the delay; that is, it assumes all impacts are captured from the project benefits number. There may be other company-wide, systemic effects of the delays. This would make the financial impact even greater.
But while schedule slip is highly visible and impacts returns, Merrow also points out that schedule is actually not the biggest driver of rate-of-return. For that, we look to other areas, such as…
Budget & Cost Overruns
Costs are the second biggest driver of rate of return on a project. The total cost on a project will drive its returns. This is a highly risky area on a project. Failing to properly understand and manage costs on a large project will have large effects.
In our example above, let’s assume a 10% overrun and then 25% cost overrun.
A 10% cost overrun destroyed 27% of the NPV benefits and reduced the IRR to 13%. And a 25% overrun reduced NPV by 66%. That type of slip is enough to invalidate many project business cases.
Also note that a 10% cost overrun is more-or-less equivalent to a 6-month delay.
“That type of overrun could never happen on a project of that size.” Oh, but it does.
A 25% cost increase on a warehouse project of this size seems incredible but the nature of estimating, planning, construction, software, and scope creep means that it is not out of the question. Poorly defined scope, for example, can cause expensive rework. Failure to manage procurements and contracting can mean both increased cost and delays.
And looking at it another way, maybe the cost was constant, but the initial approved budget estimate was 25% low: what do you do then?
Operability & Throughput
Operability is another major failure mode. Operability means: does the project deliver what it is supposed to deliver. In warehouses, this might be processing throughput with a target accuracy over a given time. Or in other words, achieving the ramp plan.
After all, a project can start up on time and on budget, but if it does not do what it is supposed to, then it is a failure.
We can think about an operability failure as not meeting planned production targets. This type of design issue could be from missed initial requirements, layout problems, type of machinery selected, a poor systems implementation, lack of staffing, or some combination of the above.
So then it can be put in the model as a reduction in benefits plus an increase in operating cost over a period of time. Fixing the site will take money, especially while it continues to operate.
The larger the project, the more fixed the errors tend to be and the harder they are to fix. But even a 6-month issue resulting in 50% of planned production results in a big drop to the project value (not to mention a lot of heartburn for the project and operations teams).
In Large Projects, When It Rains, It Pours
Last, let’s consider all of these things happening at once: A 6-month schedule delay, 10% cost overrun, and 25% impacted operability for the remainder of the year. Remember, Merrow pointed out that these things tend to be correlated on large projects. For example, a missed scope element may cause operability issues, which causes delays and cost overruns to fix.
What happens?
That is a lot – $20.8M – of project value destroyed. More than 50% of the project value can vanish due to interrelated problems, even if the project team reacts correctly.
Other failure modes such as public-relations issues or audience adoption can be extremely costly. I can’t model a PR problem here, but the large loss of audience trust can be much bigger than an individual project budget. Likewise, internal or external audience adoption can make or break a project as well.
Why These Failures Happen
Specific causes of project failures are many and varied. But they can come back to some key causes:
- Lack of basic data & requirements
- Poor risk management
- Not resource-loading schedules and analyzing schedule risk
- Doing the project without an integrated team
- Deploying incorrect or cutting-edge (high risk) technologies
- Failure to align the management team on objectives
- Failure to manage cost
- Failure to manage scope
Each of these drivers of project failure can cost the company a lot of money. But, happily, they can be mitigated with thorough project management processes.
Where PMs Make You Money
The way to avoid these problems is to identify them and address them early in the project. “Forewarned is forearmed” is very true in large projects. Robust, thorough processes and some basic tools applied at the right scale can avoid many of these issues.
And this is where project management becomes an investment. To receive the planned benefits of the project, you need to execute the project to the plan and control it.
This means resourcing the project team, the project start-up, and having a defined plan of how to proceed.
For example, having *a* deliberate risk management process in place will take substantial risks off the project. This means saving huge amounts of money. Likewise, having an integrated schedule and periodic schedule and status reviews will give management teams much more visibility to project progress and likely issues months or years before the dollars
In our model examples above, imagine if the “all-at-once” scenario company had invested an additional $500k in an analyst and project management support at the beginning of the project. In our scenario, the project manager ensured team integration, and the analyst captured all requirements. This would have removed the root cause of the problems, and the schedule and cost overruns would have been negligible.
That’s a majority of project value and several careers saved by having a properly resourced team at the beginning of the project.
Even if the PM effort does not address all of the risks, and manage the schedule down to the day, and there are some missed requirements with subsequent change orders, the Pareto principle applies. Most of negative project effects can be mitigated through a few basic, correctly applied project approach.
If the PM teams address 90% of the possible mishaps on the project, then the money has been very well spent. If they pull 98% or 99% of the risk out of a project, then the company has received tremendous value.
We also found that Project management costs tend to decrease as a total percentage of the total installed cost as the project size gets larger. Large projects may have project managers, coordinators, and project controls specialists. But with the degree of complexity on these large projects, having the (correctly) sized larger teams means greater leverage over the project outcome. “Saving money on PM” for those projects means taking on a high level of risk.
Can’t Remove All Risk…
… but you can plan to deal with the impacts when they happen.
Unfortunately, there is no way to completely de-risk a project. There are too many possible macro influences and event relationships in the world.
A good risk management approach will help identify root causes of probable risk events. The company can then plan for impacts, whether that include accepting, mitigating, or avoiding the risks. And sometimes there are opportunities to improve project performance that the PM team can help identify and execute with the project team.
Recognizing this, it’s also important to identify, react to, and execute against adverse circumstances. The ability to deal with issues is critical to success.
A PM team, with a good project management plan, resourced and executed with an integrated project team, and with front-end preparation completed, dramatically reduces risk to the project.
The plan should be complemented by an experienced team who knows how to execute against it. Subject-matter and functional expertise can be critical to helping warehousing and distribution projects succeed. “Seeing around corners” will prevent operations teams from being surprised in the different stages of implementation.
This is another reason to invest in proper project management resourcing. A solid PMO is bureaucracy, but it is also insurance against project failure and loss of value.
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Reach out to PL Programs to learn more about helping your team deliver critical project value.