Tuesday, December 4, 2012

Back to Basics

By Ann L. Lovejoy
Creative Intermedia LLC

Every decade or so, some group brings up how the schools need to get “back to basics – you know – reading, writing, and arithmetic.” Apparently, spelling is not one of these “three R’s.”

This post is about the nuts and bolts of figuring out what projects to invest in. There are some real R activities that happen before big projects kick off: these are Results, Resources, Requirements, and Risk.

Results: We get actual results at the end of a project. But we need to understand our expected results first. Thinking about goals must come first because if you don’t know where you are going – there is no way to know when you’ve arrived. Goals are tangible. They can be measured. Examples include profit, quicker time to deliver, lower inventory expense, better cash flow, lower error rates. Goals are specific, measureable, actionable, and time-bounded. Measurements include such categories as quantity, quality, time, cost, and trend or velocity.

At the end of the project, if the actual results meet the goals, then the project was successful. These results are facts because they can be checked – you’ve set up measurements before you start. If your project’s results do not meet the goals; then the project wasn’t successful. We invest money to do a project. That money is wasted if the investment didn’t give us good results.

Requirements: Requirements describe what needs to happen to meet a goal. We define requirements to make sure we know how big the project or investment will be. A requirement is specific, and lists one concrete thing that must be done. A typical large project has thousands of requirements, each stands alone. When a high-priority requirement conflicts with another, then we have to decide which one to do. Typically there is a hierarchy and business rules for which ones are more important.

Resources: People, equipment, and money are resources. We also have to describe what kind of people – usually we want people who are experienced, educated, an expert. The resource is their knowledge. The project can only meet requirements if we have resources to do the work.

Risk: We think about what can go wrong, that’s a risk. We also think about how likely that risk will happen. This is the frequency of the risk.

Most of the time we know pretty well how frequently a bad thing might happen, and we write down assumptions that must be met for success. For example: “We assume experienced people are available and can be hired since 8% of the population has these skills, and 5% are currently unemployed in this market.”

A risk, on the other hand, may or may not happen: “Turnover of key personnel is a risk; the typical turnover in these roles is 10%. If we backfill staff to build back-up knowledge, we reduce the risk.”

Risks can be a catastrophe: Fires are fairly frequent. “A plane will hit the building.” The frequency is low. So in that case, we document it, and we take actions to store information somewhere else. I once worked in a place where war zone military supply planes came in low over our building every day. That plane crash risk was more likely than flood damage from a river 1000 feet below us.

So, how do these R’s help us decide on what projects to invest in?

We use another R – we rank the possibilities based on the results expected, resources, requirements, and risks. We may look at net present value (NPV) at the end of the project. This is cash flows and discounted interest rates from the project. We want the results to be more valuable than what we paid to do the project. Suppose one project returns twice as much as it cost – this is better than a project that gave us just a few dollars more than it cost.

We look at resources and risks. If one project is harder to do – it needs more resources. If the risks are higher, then we want a higher return to make the risk worthwhile. Often, a lower-risk project is better. A low-risk project is much more likely to be successful. Cash flow matters. A failed, high risk project means no results, no cash, lost investment, wasted resources. If this happens a lot – the whole company fails.

Decision-making is a kind of balancing act. We weight the rules to help decide. A bunch of project proposals together is called a portfolio. We may say something like, “Only a small percentage of our portfolio can have a high risk factor. Most of our projects must have a lower risk score with guaranteed cash flow.”

When projects are ranked, the next step is to set the priorities for 1, 3, 5 or more years. Any organization cannot do every single proposed project – there’s not enough time, money, or people to manage them. The rejected projects may be reconsidered when the top priority projects are finished and generating results.

So, what’s the bottom line for Alaskans thinking about oil and gas project investments? Knowing how project investments are made helps us to ask better questions. And we will have a better expectation of what results are possible and probable.

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Ann L. Lovejoy is a consultant who helps organizations be better to do better.