Pan-Europia Foods Case Study

88 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION Lubianiker, S. “Opening the Book on the Open Maturity Model.” PM Network, March 2000. Luehrman, T. A. “Investment Opportunities as Real Options: Getting Started on the Numbers.” Harvard Business Review, July–August 1998a. Luehrman, T. A. “Strategy as a Portfolio of Real Options.” Harvard Business Review, September–October 1998b. Mantel, S. J., Jr., J. R. Evans, and V. A. Tipnis. “Decision Analysis for New Process Technology,” in B. V. Dean, ed., Project Management: Methods and Studies. Amsterdam: North-Holland, 1985. Matzler, K., and H. H. Hinterhuber. “How to Make Product Development Projects More Successful by Integrating kano’s Model of Customer Satisfaction into Quality Function Deployment.” Technovation, January 1998. McIntyre, J. “The Right Fit,” PM Network, November. 2006. Meade, L. M., and A. Presley. “R & D Project Selection Using the Analytic Network Process.” IEEE Transactions on Engineering Management, February 2002. Meredith, J. “The Implementation of Computer Based Systems.” Journal of Operations Management, October 1981. Pennypacker, J. S., and K. P. Grant. “Project Management Maturity: An Industry Benchmark.” Project Management Journal, March 2003. Project Management Institute. A Guide to the Project Management Body of Knowledge, 3rd ed. Newtown Square, PA: Project Management Institute, 2004. Remy, R. “Adding Focus to Improvement Efforts with PM3 .” PM Network, July 1997. Roman, D. D. Managing Projects: A Systems Approach. New York: Elsevier, 1986. Ross, S. A., R. W. Westerfield, and B. D. Jordan. Fundamentals of Corporate Finance, 8th ed. New York: Irwin/ McGraw-Hill, 2008. Saaty, T. S. Decision for Leaders: The Analytic Hierarchy Process. Pittsburgh: University of Pittsburgh, 1990. Simon, H. The New Science of Management Decisions, rev. ed. 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Reprinted from Journal of Product Innovation Management, Vol. 16, No. 1, pp. 58–69, 1999. The following case concerns a European fi rm trying to choose between almost a dozen capital investment projects being championed by different executives in the fi rm. However, there are many more projects available for funding than there are funds available to implement them, so the set must be narrowed down to the most valuable and important to the fi rm. Financial, strategic, and other data are given concerning the projects in order to facilitate the analysis needed to make a fi nal investment recommendation to the Board of Directors. In early January 1993, the senior-management committee of Pan-Europa Foods was to meet to draw up the fi rm’s capital budget for the new year. Up for consideration were 11 major projects that totaled over :208 million (euros). Unfortunately, the board of directors had imposed a spending limit of only :80 million; even so, investment at that rate would represent a major increase in the fi rm’s asset base of :656 million. Thus the challenge for the senior managers of Pan-Europa was to allocate funds among a range of compelling projects: new-product introduction, acquisition, market expansion, 81721_Ch02.indd 88 9/16/08 11:36:05 PM CASE 89 effi ciency improvements, preventive maintenance, safety, and pollution control. The Company Pan-Europa Foods, headquartered in Brussels, Belgium, was a multinational producer of high-quality ice cream, yogurt, bottled water, and fruit juices. Its products were sold throughout Scandinavia, Britain, Belgium, the Netherlands, Luxembourg, western Germany, and northern France. (See Exhibit 1 for a map of the company’s marketing region.) The company was founded in 1924 by Theo Verdin, a Belgian farmer, as an offshoot of his dairy business. Through keen attention to product development, and shrewd marketing, the business grew steadily over the years. The company went public in 1979 and by 1993 was listed for trading on the London, Frankfurt, and Brussels exchanges. In 1992, Pan-Europa had sales of almost :1.1 billion. Ice cream accounted for 60 percent of the company’s revenues; yogurt, which was introduced in 1982, contributed about 20 percent. The remaining 20 percent of sales was divided equally between bottled water and fruit juices. Pan-Europa’s fl agship brand name was “Rolly,” which was represented by a fat, dancing bear in farmers’ clothing. Ice cream, the company’s leading product, had a loyal base of customers who sought out its high butterfat content, large chunks of chocolate, fruit, nuts, and wide range of original fl avors. Pan-Europa sales had been static since 1990 (see Exhibit 2), which management attributed to low population growth in northern Europe and market saturation in some areas. Outside observers, however, faulted recent EXHIBIT 1 Pan-Europa Foods S. A. Nations Where Pan-Europa Competed Note: The shaded area in this map reveals the principal distribution region of Pan-Europa’s products. Important facilities are indicated by the following fi gures: 1. Headquarters, Brussels, Belgium 6. Plant, Copenhagen, Denmark 2. Plant, Antwerp, Belgium 7. Plant, Svald, Sweden 3. Plant, Strasbourg, France 8. Plant, Nelly-on-Mersey, England 4. Plant, Nuremberg, Germany 9. Plant, Caen, France 5. Plant, Hamburg, Germany 10. Plant, Melun, France 81721_Ch02.indd 89 9/16/08 11:36:06 PM 90 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION failures in new-product introductions. Most members of management wanted to expand the company’s market presence and introduce more new products to boost sales. These managers hoped that increased market presence and sales would improve the company’s market value. Pan-Europa’s stock was currently at eight times earnings, just below book value. This price/earnings ratio was below the trading multiples of comparable companies, but it gave little value to the company’s brands. Resource Allocation The capital budget at Pan-Europa was prepared annually by a committee of senior managers who then presented it for approval by the board of directors. The committee consisted of fi ve managing directors, the président directeur-général (PDG), and the fi nance director. Typically, the PDG solicited investment proposals from the managing directors. The proposals included a brief project description, a fi nancial analysis, and a discussion of strategic or other qualitative considerations. As a matter of policy, investment proposals at PanEuropa were subjected to two fi nancial tests, payback and internal rate of return (IRR). The tests, or hurdles, had been established in 1991 by the management committee and varied according to the type of project: Maximum Minimum Acceptable Acceptable Payback Type of Project IRR Years 1. New product or new markets 12% 6 years 2. Product or market extension 10% 5 years 3. Effi ciency improvements 8% 4 years 4. Safety or environmental No test No test In January 1993, the estimated weighted-average cost of capital (WACC) for Pan-Europa was 10.5 percent. In describing the capital-budgeting process, the fi nance director, Trudi Lauf, said, “We use the sliding scale of IRR tests as a way of recognizing differences in risk among the various types of projects. Where the company takes more risk, we should earn more return. The payback test signals that we are not prepared to wait for long to achieve that return.” Ownership and the Sentiment of Creditors and Investors Pan-Europa’s 12-member board of directors included three members of the Verdin family, four members of management, and fi ve outside directors who were prominent managers or public fi gures in northern Europe. Members of the Verdin family combined owned 20 percent of Pan-Europa’s shares outstanding, and company executives owned 10 percent of the shares. Venus Asset Management, a mutual-fund management company in London, held 12 percent. Banque du Bruges et des Pays Bas held 9 percent and had one representative on the board of directors. The remaining 49 percent of the fi rm’s shares were widely held. The fi rm’s shares traded in London, Brussels, and Frankfurt. At a debt-to-equity ratio of 125 percent, Pan-Europa was leveraged much more highly than its peers in the European consumer-foods industry. Management had relied on debt fi nancing signifi cantly in the past few years to sustain the fi rm’s capital spending and dividends during a period of price wars initiated by Pan-Europa. Now, with the price wars fi nished, Pan-Europa’s bankers (led by Banque du Bruges) strongly urged an aggressive program of debt reduction. In any event, they were not prepared to fi nance increases in leverage beyond the current level. The president of Banque du Bruges had remarked at a recent board meeting, Restoring some strength to the right-hand side of the balance sheet should now be a fi rst priority. Any expansion of assets should be fi nanced from the cash fl ow after debt amortization until the debt ratio returns to a more prudent level. If there are crucial investments that cannot be funded this way, then we should cut the dividend! At a price-to-earnings ratio of eight times, shares of Pan-Europa common stock were priced below the average multiples of peer companies and the average multiples of all companies on the exchanges where Fiscal Year Ending December 31 Gross sales Net income Earnings per share Dividends Total assets Shareholders’ equity (book value) Shareholders’ equity 1990 1,076 51 0.75 20 477 182 453 1991 1,072 49 0.72 20 580 206 400 1992 1,074 37 0.54 20 656 235 229 (market value) EXHIBIT 2 Summary of Financial Results (all values in : millions except per-share amounts) 81721_Ch02.indd 90 9/16/08 11:36:06 PM Pan-Europa was traded. This was attributable to the recent price wars, which had suppressed the company’s profi tability, and to the well-known recent failure of the company to seize signifi cant market share with a new product line of fl avored mineral water. Since January 1992, all of the major securities houses had been issuing “sell” recommendations to investors in PanEuropa shares. Venus Asset Management in London had quietly accumulated shares during this period, however, in the expectation of a turnaround in the fi rm’s performance. At the most recent board meeting, the senior managing director of Venus gave a presentation in which he said, Cutting the dividend is unthinkable, as it would signal a lack of faith in your own future. Selling new shares of stock at this depressed price level is also unthinkable, as it would impose unacceptable dilution on your current shareholders. Your equity investors expect an improvement in performance. If that improvement is not forthcoming, or worse, if investors’ hopes are dashed, your shares might fall into the hands of raiders like Carlo de Benedetti or the Flick brothers.1 At the conclusion of the most recent meeting of the directors, the board voted unanimously to limit capital spending in 1993 to : 80 million. Members of the Senior Management Committee The capital budget would be prepared by seven senior managers of Pan-Europa. For consideration, each project had to be sponsored by one of the managers present. Usually the decision process included a period of discussion followed by a vote on two to four alternative capital budgets. The various executives were well known to each other: Wilhelmina Verdin (Belgian), PDG, age 57. Granddaughter of the founder and spokesperson on the board of directors for the Verdin family’s interests. Worked for the company her entire career, with significant experience in brand management. Elected “European Marketer of the Year” in 1982 for successfully introducing low-fat yogurt and ice cream, the first major roll-out of this type of product. Eager to position the company for longterm growth but cautious in the wake of recent difficulties. Trudi Lauf (Swiss), fi nance director, age 51. Hired from Nestlé in 1982 to modernize fi nancial controls and systems. Had been a vocal proponent of reducing leverage on the balance sheet. Also had voiced the concerns and frustrations of stockholders. Heinz Klink (German), managing director for Distribution, age 49. Oversaw the transportation, warehousing, and order-fulfi llment activities in the company. Spoilage, transport costs, stock-outs, and control systems were perennial challenges. Maarten Leyden (Dutch), managing director for Production and Purchasing, age 59. Managed production operations at the company’s 14 plants. Engineer by training. Tough negotiator, especially with unions and suppliers. A fanatic about production-cost control. Had voiced doubts about the sincerity of creditors’ and investors’ commitment to the fi rm. Marco Ponti (Italian), managing director for Sales, age 45. Oversaw the fi eld sales force of 250 representatives and planned changes in geographical sales coverage. The most vocal proponent of rapid expansion on the senior-management committee. Saw several opportunities for ways to improve geographical positioning. Hired from Unilever in 1985 to revitalize the sales organization, which he successfully accomplished. Fabienne Morin (French), managing director for Marketing, age 41. Responsible for marketing research, new-product development, advertising, and, in general, brand management. The primary advocate of the recent price war, which, although fi nancially diffi cult, realized solid gains in market share. Perceived a “window of opportunity” for product and market expansion and tended to support growth-oriented projects. Nigel Humbolt (British), managing director for Strategic Planning, age 47. Hired two years previously from a well-known consulting fi rm to set up a strategicplanning staff for Pan-Europa. Known for asking dif- fi cult and challenging questions about Pan-Europa’s core business, its maturity, and profi tability. Supported initiatives aimed at growth and market share. Had presented the most aggressive proposals in 1992, none of which were accepted. Becoming frustrated with what he perceived to be his lack of infl uence in the organization. 1 De Benedetti of Milan and the Flick brothers of Munich were leaders of prominent hostile-takeover attempts in recents years. CASE 91 81721_Ch02.indd 91 9/16/08 11:36:07 PM 92 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION The Expenditure Proposals The forthcoming meeting would entertain the following proposals: 1. Replacement and expansion of the truck fl eet. Heinz Klink proposed to purchase 100 new refrigerated tractortrailer trucks, 50 each in 1993 and 1994. By doing so, the company could sell 60 old, fully depreciated trucks over the two years for a total of :1.2 million. The purchase would expand the fl eet by 40 trucks within two years. Each of the new trailers would be larger than the old trailers and afford a 15 percent increase in cubic meters of goods hauled on each trip. The new tractors would also be more fuel and maintenance effi cient. The increase in number of trucks would permit more fl exible scheduling and more effi cient routing and servicing of the fl eet than at present and would cut delivery times and, therefore, possibly inventories. It would also allow more frequent deliveries to the company’s major markets, which would reduce the loss of sales caused by stock-outs. Finally, expanding the fl eet would support geographical expansion over the long term. As shown in Exhibit 3, the total net investment in trucks of :20 million and the increase in working capital to support added maintenance, fuel, payroll, and inventories of :2 million was expected to yield total cost savings and added sales potential of :7.7 million over the next seven years. The resulting IRR was estimated to be 7.8 percent, marginally below the minimum 8 percent required return on effi ciency projects. Some of the managers wondered if this project would be more properly classifi ed as “effi ciency” than “expansion.” 2. A new plant. Maarten Leyden noted that PanEuropa’s yogurt and ice-cream sales in the southeastern Expenditure Project (€ millions) Sponsoring Manager 1. Replacement and expansion of the truck fl eet 22 Klink, Distribution 2. A new plant 30 Leyden, Production 3. Expansion of a plant 10 Leyden, Production 4. Development and introduction of new 15 Morin, Marketing artifi cially sweetened yogurt and ice cream 5. Plant automation and conveyor systems 14 Leyden, Production 6. Effl uent water treatment at four plants 4 Leyden, Production 7. Market expansion eastward 20 Ponti, Sales 8. Market expansion southward 20 Ponti, Sales 9. Development and roll-out of snack foods 18 Morin, Marketing 10. Networked, computer-based inventory-control 15 Klink, Distribution system for warehouses and fi eld representatives 11. Acquisition of a leading schnapps brand and 40 Humbolt, Strategic associated facilities Planning effi cient facility, located in Strasbourg, France. Shipping costs over that distance were high, however, and some sales were undoubtedly being lost when the marketing effort could not be supported by delivery. Leyden proposed that a new manufacturing and packaging plant be built in Dijon, France, just at the current southern edge of Pan-Europa’s marketing region, to take the burden off the Melun and Strasbourg plants. The cost of this plant would be :25 million and would entail :5 million for working capital. The :14 million worth of equipment would be amortized over seven years, and the plant over ten years. Through an increase in sales and depreciation, and the decrease in delivery costs, the plant was expected to yield after-tax cash fl ows totaling :23.75 million and an IRR of 11.3 percent over the next ten years. This project would be classifi ed as a market extension. 3. Expansion of a plant. In addition to the need for greater production capacity in Pan-Europa’s southeastern region, its Nuremberg, Germany, plant had reached full capacity. This situation made the scheduling of routine equipment maintenance diffi cult, which, in turn, created production-scheduling and deadline problems. This plant was one of two highly automated facilities that produced Pan-Europa’s entire line of bottled water, mineral water, and fruit juices. The Nuremberg plant supplied central and western Europe. (The other plant, near Copenhagen, Denmark, supplied Pan-Europa’s northern European markets.) region of the company’s market were about to exceed the capacity of its Melun, France, manufacturing and packaging plant. At present, some of the demand was being met by shipments from the company’s newest, most 81721_Ch02.indd 92 9/16/08 11:36:07 PM 1 The effl uent treatment program is not included in this exhibit. 2 The equivalent annuity of a project is that level annual payment over 10 years that yields a net present value equal to the NPV at the minimum required rate of return for that project. Annuity corrects for differences in duration among various projects. For instance, project 5 lasts only 7 years and has an NPV of 0.32 million; a 10-year stream of annual cash fl ows of 0.05 million, discounted at 8.0 percent (the required rate of return) also yields an NPV of 0.32 million. In ranking projects on the basis of equivalent annuity, bigger annuities create more investor wealth than smaller annuities. 3 This refl ects :11 million spent both initially and at the end of year 1. 4 Free cash fl ow incremental profi t or cost savings after taxes depreciation  investment in fi xed assets and working capital. 5 Franchisees would gradually take over the burden of carrying receivables and inventory. 6 :15 million would be spent in the fi rst year, 20 million in the second, and 5 million in the third. EXHIBIT 3 Free Cash Flows and Analysis of Proposed Projects 1 (all values in : millions) CASE 93 1 2 3 4 5 7 8 9 10 11 Expand Automation Truck and Eastward Southward Inventory- Strategic Fleet New Expanded Artificial Conveyer Expansion Expansion Snack Control Acquisition Project (note 3) Plant Plant Sweetener Systems (note 5) (note 5) Foods System (note 6) Investment Property 20.00 25.00 10.00 15.00 14.00 15.00 15.00 30.00 Working Capital 2.00 5.00 20.00 20.00 3.00 10.00 Year EXPECTED FREE CASH FLOWS (note 4) 0 (11.40) (30.00) (10.00) (5.00) (14.00) (20.00) (20.00) (18.00) (12.00) (15.00) 1 (7.90) 2.00 1.25 (5.00) 2.75 3.50 3.00 3.00 5.50 (20.00) 2 3.00 5.00 1.50 (5.00) 2.75 4.00 3.50 4.00 5.50 5.00 3 3.50 5.50 1.75 3.00 2.75 4.50 4.00 4.50 5.00 9.00 4 4.00 6.00 2.00 3.00 2.75 5.00 4.50 5.00 11.00 5 4.50 6.25 2.25 4.00 2.75 5.50 5.00 5.00 13.00 6 5.00 6.50 2.50 4.50 2.75 6.00 5.50 5.00 15.00 7 7.00 6.75 1.50 5.00 2.75 6.50 6.00 5.00 17.00 8 5.00 1.50 5.50 7.00 6.50 5.00 19.00 9 5.25 1.50 6.00 7.50 7.00 5.00 21.00 10 5.50 1.50 6.50 8.00 7.50 5.00 59.00 Undiscounted Sum 7.70 23.75 7.25 22.50 5.25 37.50 32.50 28.50 4.00 134.00 Payback (years) 66 6 7 6 5 6 5 3 5 Maximum Payback Accepted 45 5 6 4 6 6 6 4 6 IRR 7.8% 11.3% 11.2% 17.3% 8.7% 21.4% 18.8% 20.5% 16.2% 28.7% Minimum Accepted ROR 8.0% 10.0% 10.0% 12.0% 8.0% 12.0% 12.0% 12.0% 8.0% 12.0% Spread 0.2% 1.3% 1.2% 5.3% 0.7% 9.4% 6.8% 8.5% 8.2% 16.7% NPV at Corp. WACC (10.5%) 1.92 0.99 0.28 5.21 0.87 11.99 9.00 8.95 1.16 47.97 NPV at Minimum ROR 0.13 1.87 0.55 3.88 0.32 9.90 7.08 7.31 1.78 41.43 Equivalent Annuity (note 2) 0.02 0.30 0.09 0.69 0.06 1.75 1.25 1.29 0.69 7.33 81721_Ch02.indd 93 9/16/08 11:36:08 PM 94 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION The Nuremberg plant’s capacity could be expanded by 20 percent for :10 million. The equipment (:7 million) would be depreciated over seven years, and the plant over ten years. The increased capacity was expected to result in additional production of up to :1.5 million per year, yielding an IRR of 11.2 percent. This project would be classifi ed as a market extension. 4. Development and introduction of new artifi cially sweetened yogurt and ice cream. Fabienne Morin noted that recent developments in the synthesis of artifi cial sweeteners were showing promise of signifi cant cost savings to food and beverage producers as well as stimulating growing demand for low-calorie products. The challenge was to create the right fl avor to complement or enhance the other ingredients. For ice-cream manufacturers, the diffi culty lay in creating a balance that would result in the same fl avor as was obtained when using natural sweeteners; artifi cial sweeteners might, of course, create a superior taste. :15 million would be needed to commercialize a yogurt line that had received promising results in laboratory tests. This cost included acquiring specialized production facilities, working capital, and the cost of the initial product introduction. The overall IRR was estimated to be 17.3 percent. Morin stressed that the proposal, although highly uncertain in terms of actual results, could be viewed as a means of protecting present market share, because other high-quality ice-cream producers carrying out the same research might introduce these products; if the Rolly brand did not carry an artifi cially sweetened line and its competitors did, the Rolly brand might suffer. Morin also noted the parallels between innovating with artifi cial sweeteners and the company’s past success in introducing low-fat products. This project would be classed in the new-product category of investments. 5. Plant automation and conveyor systems. Maarten Leyden also requested :14 million to increase automation of the production lines at six of the company’s older plants. The result would be improved throughout speed and reduced accidents, spillage, and production tie-ups. The last two plants the company had built included conveyer systems that eliminated the need for any heavy lifting by employees. The systems reduced the chance of injury to employees; at the six older plants, the company had sustained an average of 75 missed worker-days per year per plant in the last two years because of muscle injuries sustained in heavy lifting. At an average hourly wage of :14.00 per hour, over :150,000 per year was thus lost, and the possibility always existed of more serious injuries and lawsuits. Overall cost savings and depreciation totaling :2.75 million per year for the project were expected to yield an IRR of 8.7 percent. This project would be classed in the effi ciency category. 6. Effl uent water treatment at four plants. Pan-Europa preprocessed a variety of fresh fruits at its Melun and Strasbourg plants. One of the fi rst stages of processing involved cleaning the fruit to remove dirt and pesticides. The dirty water was simply sent down the drain and into the Seine or Rhine rivers. Recent European Community directives called for any waste water containing even slight traces of poisonous chemicals to be treated at the sources and gave companies four years to comply. As an environmentally oriented project, this proposal fell outside the normal fi nancial tests of project attractiveness. Leyden noted, however, that the water-treatment equipment could be purchased today for :4 million; he speculated that the same equipment would cost :10 million in four years when immediate conversion became mandatory. In the intervening time, the company would run the risks that European Community regulators would shorten the compliance time or that the company’s pollution record would become public and impair the image of the company in the eyes of the consumer. This project would be classed in the environmental category. 7. and 8. Market expansions eastward and southward. Marco Ponti recommended that the company expand its market eastward to include eastern Germany, Poland, Czechoslovakia, and Austria and/or southward to include southern France, Switzerland, Italy, and Spain. He believed the time was right to expand sales of ice cream, and perhaps yogurt, geographically. In theory, the company could sustain expansions in both directions simultaneously, but practically, Ponti doubted that the sales and distribution organizations could sustain both expansions at once. Each alternative geographical expansion had its benefi ts and risks. If the company expanded eastward, it could reach a large population with a great appetite for frozen dairy products, but it would also face more competition from local and regional ice cream manufacturers. Moreover, consumers in eastern Germany, Poland, and Czechoslovakia did not have the purchasing power that consumers did to the south. The eastward expansion would have to be supplied from plants in Nuremberg, Strasbourg, and Hamburg. Looking southward, the tables were turned: more purchasing power and less competition but also a smaller consumer appetite for ice cream and yogurt. A southward expansion would require building consumer demand for 81721_Ch02.indd 94 9/16/08 11:36:09 PM premium-quality yogurt and ice cream. If neither of the plant proposals (i.e., proposals 2 and 3) were accepted, then the southward expansion would need to be supplied from plants in Melun, Strasbourg, and Rouen. The initial cost of either proposal was :20 million of working capital. The bulk of this project’s costs was expected to involve the fi nancing of distributorships, but over the ten-year forecast period, the distributors would gradually take over the burden of carrying receivables and inventory. Both expansion proposals assumed the rental of suitable warehouse and distribution facilities. The after-tax cash fl ows were expected to total :37.5 million for eastward expansion and :32.5 million for southward expansion. Marco Ponti pointed out that eastward expansion meant a higher possible IRR but that moving southward was a less risky proposition. The projected IRRs were 21.4 percent and 18.8 percent for eastern and southern expansion, respectively. These projects would be classed in the new market category. 9. Development and roll-out of snack foods. Fabienne Morin suggested that the company use the excess capacity at its Antwerp spice- and nut-processing facility to produce a line of dried fruits to be test-marketed in Belgium, Britain, and the Netherlands. She noted the strength of the Rolly brand in those countries and the success of other food and beverage companies that had expanded into snack-food production. She argued that Pan-Europa’s reputation for wholesome, quality products would be enhanced by a line of dried fruits and that name association with the new product would probably even lead to increased sales of the company’s other products among health-conscious consumers. Equipment and working-capital investments were expected to total :15 million and :3 million, respectively, for this project. The equipment would be depreciated over seven years. Assuming the test market was successful, cash fl ows from the project would be able to support further plant expansions in other strategic locations. The IRR was expected to be 20.5 percent, well above the required return of 12 percent for new-product projects. 10. Networked, computer-based inventory-control system for warehouses and fi eld representatives. Heinz Klink had pressed for three years unsuccessfully for a state-of-the-art computer-based inventory-control system that would link fi eld sales representatives, distributors, drivers, warehouses, and even possibly retailers. The benefi ts of such a system would be shortening delays in ordering and order processing, better control of inventory, reduction of spoilage, and faster recognition of changes in demand at the customer level. Klink was reluctant to quantify these benefi ts, because they could range between modest and quite large amounts. This year, for the fi rst time, he presented a cash-fl ow forecast, however, that refl ected an initial outlay of :12 million for the system, followed by :3 million in the next year for ancillary equipment. The infl ows refl ected depreciation tax shields, tax credits, cost reductions in warehousing, and reduced inventory. He forecasted these benefi ts to last for only three years. Even so, the project’s IRR was estimated to be 16.2 percent. This project would be classed in the effi ciency category of proposals. 11. Acquisition of a leading schnapps brand and associated facilities. Nigel Humbolt had advocated making diversifying acquisitions in an effort to move beyond the company’s mature core business but doing so in a way that exploited the company’s skills in brand management. He had explored six possible related industries, in the general fi eld of consumer packaged goods, and determined that cordials and liqueurs offered unusual opportunities for real growth and, at the same time, market protection through branding. He had identifi ed four small producers of well-established brands of liqueurs as acquisition candidates. Following exploratory talks with each, he had determined that only one company could be purchased in the near future, namely, the leading private European manufacturer of schnapps, located in Munich. The proposal was expensive: :15 million to buy the company and :25 million to renovate the company’s facilities completely while simultaneously expanding distribution to new geographical markets.2 The expected returns were high: after-tax cash fl ows were projected to be :134 million, yielding an IRR of 28.7 percent. This project would be classed in the new-product category of proposals. Conclusion Each member of the management committee was expected to come to the meeting prepared to present and defend a proposal for the allocation of Pan-Europa’s capital budget of :80 million. Exhibit 3 summarizes the various projects in terms of their free cash fl ows and the investment-performance criteria. Reprinted from Journal of Product Innovation Management, Vol. 16, No. 1, pp. 58–69, 1999. Copyright ©1999 with permission from Elsevier Science Publishers. 2 Exhibit 3 shows negative cash fl ows amounting to only :35 million. The difference between this amount and the :40 million requested is a positive operating cash fl ow of :5 million in year 1 expected from the normal course of business. CASE 95 81721_Ch02.indd 95 9/16/08 11:36:10 PM 96 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION Growth in organizations typically results from successful projects that generate new products, services, or procedures. Managers are increasingly concerned about getting better results from the projects under way in their organizations and in getting better cross-organizational cooperation. One of the most vocal complaints of project managers is that projects appear almost randomly. The projects seem unlinked to a coherent strategy, and people are unaware of the total number and scope of projects. As a result, people feel they are working at cross-purposes, on too many unneeded projects, and on too many projects generally. Selecting projects for their strategic emphasis helps resolve such feelings and is a corner anchor in putting together the pieces of a puzzle that create an environment for successful projects [6]. This article covers a series of steps for linking projects to strategy. These steps constitute a process that can be applied to any endeavor. Included throughout are suggestions for action as well as guidelines to navigate many pitfalls along the path. Process tools help illustrate ways to prioritize projects. The lessons learned are from consulting with many fi rms over a long time period and from personal experiences in applying the lessons within Hewlett- Packard DIRECTED READING FROM EXPERIENCE: LINKING PROJECTS TO STRATEGY R. L. Englund and R. J. Graham QUESTIONS 1. Strategically, what must Pan-Europa do to keep from becoming the victim of a hostile takeover? What rows/ categories in Exhibit 2 will thus become critically important in 1993? What should Pan-Europa do now that they have won the price war? Who should lead the way for Pan-Europa? 2. Using NPV, conduct a straight fi nancial analysis of the investment alternatives and rank the projects. Which NPV of the three should be used? Why? Suggest a way to evaluate the effl uent project. 3. What aspects of the projects might invalidate the ranking you just derived? How should we correct for each investment’s time value of money, unequal lifetimes, riskiness, and size? 4. Reconsider the projects in terms of: • are any “must do” projects of the nonnumeric type? • what elements of the projects might imply greater or lesser riskiness? • might there be any synergies or confl icts between the projects? • do any of the projects have nonquantitative benefi ts or costs that should be considered in an evaluation? 5. Considering all the above, what screens/factors might you suggest to narrow down the set of most desirable projects? What criteria would you use to evaluate the projects on these various factors? Do any of the projects fail to pass these screens due to their extreme values on some of the factors? 6. Divide the projects into the four Project Profi le Process categories of incremental, platform, breakthrough, and R&D. Draw an aggregate project plan and array the projects on the chart. 7. Based on all the above, which projects should the management committee recommend to the Board of Directors? The following reading describes the approach Hewlett-Packard uses to select and monitor its projects for relevance to the fi rm’s strategic goals. The article describes the behavioral aspects of the process as well as many of the technical tools, such as the aggregate project plan, the plan of record, and the software aids they employed. In addition, the authors give tips and identify pitfalls in the process so anyone else implementing their approach will know what problems to watch out for. 81721_Ch02.indd 96 9/16/08 11:36:11 PM Company (HP), a $40 billion plus company where two thirds of its revenue derives from products introduced within the past 2 years. The Importance of Upper Management Teamwork Developing cooperation across an organization requires that upper managers take a systems approach to projects. That means they look at projects as a system of interrelated activities that combine to achieve a common goal. The common goal is to fulfi ll the overall strategy of the organization. Usually all projects draw from one resource pool, so they interrelate as they share the same resources. Thus, the system of projects is itself a project, with the smaller projects being the activities that lead to the larger project (organizational) goal. Any lack of upper management teamwork reverberates throughout the organization. If upper managers do not model desired behaviors, there is little hope that the rest of the organization can do it for them. Any lack of upper management cooperation will surely be refl ected in the behavior of project teams, and there is little chance that project managers alone can resolve the problems that arise. A council concept is one mechanism used at HP to establish a strategic direction for projects spanning organizational boundaries. A council may be permanent or temporary, assembled to solve strategic issues. As a result, a council typically will involve upper managers. Usually its role is to set directions, manage multiple projects or a set of projects, and aid in cross-organizational issue resolution. Several of these council-like activities become evident through the examples in this article. Employing a comprehensive and systematic approach illustrates the vast and important infl uence of upper management teamwork on project success. Increasingly evident are companies who initiate portfolio selection committees. We suggest that organizations begin by developing councils to work with project managers and to implement strategy. These councils exercise leadership by articulating a vision, discussing it with the project managers, asking them their concerns about and needs for implementing the strategy, listening carefully to them, and showing them respect so they become engaged in the process. In this way, upper managers and project managers develop the joint vision that is so necessary for implementation of strategy. Process for Project Selection and Prioritization Once the upper management team is established, they can follow a process to select sets of projects that achieve organizational goals. They are then ideally positioned to implement consistent priorities across all departments. Figure 1 represents a mental model of a way to structure this process. Outputs from the four steps interrelate in a true systems approach. This model comes from experience in researching and applying a thorough approach to all the issues encountered in a complex organization. It is both simple in concept and complex in richness. The authors use the model both as an educational tool and to facilitate management teams through the process. What the Organization Should Do and How to Know When You Are Doing It. First, identify who is leading the process and who should be on the management team. More time spent here putting together a “mission impossible” team pays dividends later by getting up-front involvement of the people who will be affected by the decisions that will be made. Take care not to overlook any key-but-not-so-visible players who later may speak up and jeopardize the plan. This team may consist solely of upper managers or may include project managers, a general manager, and possibly a customer. Include representation of those who can best address the key opportunities and risks facing the organization. Ideally they control the resources and are empowered to make decisions on all projects. The leader needs to get DIRECTED READING 97 Figure 1 A systematic approach to selecting projects. 81721_Ch02.indd 97 9/16/08 11:36:12 PM 98 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION explicit commitment from all these people to participate actively in the process and to use the resulting plan when making related decisions. Be aware that behavioral issues become super urgent. This process hits close to home and may have a severe impact on projects that people care personally about. Uncertainty and doubt are created if management does not tread carefully and pay attention to people concerns. The team begins by listing all projects proposed and under way in the organization. Many times this step is a revelation in itself. A usual reaction is, “I didn’t realize we had so many projects going on.” The intent is to survey the fi eld of work and begin the organizing effort, so avoid going into detailed discussion about specifi c projects at this point. The team clarifi es or develops the goals expected from projects. Be careful not to get constrained through considering only current capabilities. Many teams get sidetracked by statements such as “We don’t know how to do that,” effectively curtailing discussion on whether the organization ought to pursue the goal and develop or acquire the capability. Rather, the discussions at this stage center around organizational purpose, vision, and mission. This is a crucial step that determines if the rest of the project selection process can be successful. In the authors’ experience, those organizations with clear, convincing, and compelling visions about what they should be doing move ahead rapidly. Any lack of understanding or commitment to the vision by a member of the team leads to frustration, wheel spinning, and eventual disintegration of the whole process. This pattern is so prevalent that clarity of the goal or strategy is applied as a fi lter before agreeing to facilitate teams through the process. Organize the projects into categories that will later make it easier to facilitate a decision-making process. Wheelwright and Clark [14] suggest using grids where the axes are the extent of product change and the extent of process change. Some organizations use market segments. The benefi t to this effort is that seeing all projects and possible projects on a continuum allows checking for completeness, gaps, opportunities, and compliance with strategy. This might also be a good time to encourage “out-of-the-box” thinking about new ways to organize the work. Use creative discussion sessions to capture ideas about core competences, competitive advantage, and the like to determine a set of categories most effective for the organization. For example, the categories might be: Evolutionary or derivative—sustaining, incremental, enhancing. Platform—next generation, highly leveraged; and Revolutionary or breakthrough—new core product, process, or business. The actual products in Figure 2 were introduced to the market over time in alphabetical order and positioning shown. Although the fi gure represents a retrospective view, it illustrates a successful strategy of sequencing projects and products. There is a balanced mix of breakthrough products, such as A, followed by enhancements, B through E, before moving on to new platforms, F through H, and eventually developing a new architecture and product family with L. At the time, this strategy was improvisational [1]; it now represents a learning opportunity for planning new portfolios. No one area of the grid is overpopulated, and where large projects exist there are not too many of them. Another reason to organize projects into these “strategic buckets” is to better realize what business(es) the organization is in. Almost every group the authors work with get caught in the “tyranny of the OR” instead of embracing the “genius of the AND” [2]. In trying to do too many projects and facing the need to make tradeoffs among them, the decision becomes this OR that. In reality, most organizations need a balanced portfolio that creates complete solutions for their customers. They need to do this AND that. The way to achieve this goal is to set limits on the size of each category and then focus efforts on selecting the best set of Figure 2 Bubble diagram of a product grid for one HP division. Size of bubble size of project. 81721_Ch02.indd 98 9/16/08 11:36:12 PM projects within each category. The collective set of categories becomes the desired mix, a way of framing the work of the organization. The ideal percentage that constitutes the size of each category can be determined from the collective wisdom of the team or perhaps through experimentation. The organization can learn the right mix over time but only if it makes a concerted effort to do so. Within each category, determine criteria that can assess the “goodness”—quality or best fi t—of choices for the plan. A criterion is a standard on which a comparative judgment or decision may be based. Because the types of projects and the objectives within categories may be quite different, develop unique criteria for each category or have a core set of criteria that can be modifi ed. Many teams never get to the point of developing or clarifying criteria, and they usually want to discuss projects before agreeing on criteria; reversing the order is much more effective. Several works on research and development project selection [8, 9, 12] provide a robust set of criteria for consideration. Examples include strategic positioning, probability of success, market size, and availability of staff. Most important is to identify the criteria that are of greatest signifi - cance to the organization; fewer are better. However, teams usually need to brainstorm many criteria before focusing on the few. The role of each criterion is to help compare projects, not specify them. Select criteria that can measurably compare how projects support the organizational strategy. For example, one criterion may be degree of impact on HP business as interpreted by a general manager. On a scaling model from 1 to 10, small impact scores a 2, strong a 6, critical to the success of one business an 8, and critical to the success of multiple businesses a 10. Most likely all proposed projects meet meaningful specifi cations and provide value to the organization. The task is to develop tough criteria to select the best of the best. Some organizations use narratives to describe how each project contributes to the vision; others use numerical scores on whether one project is equal, moderate, or strongly better than another. It is also helpful to set thresholds or limits for projects that will be considered for the plan. These help to screen out projects so that later prioritization efforts can focus on fewer projects. Writing a thorough description of each criterion helps ensure understanding of the intent and expectations of data that must be supplied to fulfi ll it. One team of three or four people at HP spent 5 days working only on the criteria they were to use for decision-making. And this was only the beginning; they next involved customers in the same discussion before reaching consensus and beginning to evaluate choices. An “Aha” occurred when people found they were wrong to assume that everyone meant the same thing by terms such as packaging; some used wider defi nitions than others did, and the misunderstanding only surfaced through group discussion. Asked if the selection process ever failed the team, its leader replied, “If the results didn’t make sense, it was usually because the criteria weren’t well defi ned.” Unfortunately, most teams do not exhibit the same patience and discipline that allowed this team to be successful. Before moving to the next step, the team should establish relative importance among criteria. Assign a weighting factor for each criterion. All criteria are important but some more so than others. The example in Figure 3 is the result of one team’s brainstorming session that ultimately Customer Satisfaction (28%) Employee Satisfaction (7%) • Improves service levels • Improves employee knowledge • Results in more consistent and accurate • Increases employee efficiency or information/transactions effectiveness • Helps ensure services are delivered as • Improves work/life balance promised expected • Positive impact to employee survey • Helps balance workload Business Value (46%) Process Effectiveness (19%) • Achieves results that are critical for a • Enables employees to do things right specific window of opportunity the first time • Minimizes risk for implementation and • Increases the use of technology for ongoing sustainability service delivery • Improves integration and relationships • Reduces manual work and non-value with partners added activities • Provides a positive ROI in  2 yrs • Increases employee self-sufficiency • Aligns with business goals Figure 3 Sample criteria and weighting, plus subcriteria, developed by one HP team. DIRECTED READING 99 81721_Ch02.indd 99 9/16/08 11:36:12 PM 100 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION led to selecting four criteria. Breakout groups subsequently defi ned each criterion with subcriteria. They also devised scoring methods to apply the criteria. Collectively they then determined the respective weighting or importance of each criterion (see the Process Tools section for how they did this). Unlike threshold criteria that “gate” whether a project is go or no-go, all projects have to satisfy selection criteria to some extent. Weighting of criteria is the technique that can optimize and determine the best of the best. Another “Aha” that helped teams get through the hurdle to develop effective criteria is when they realized the task at this point is “weighting, not gating.” It is the authors’ experience that criteria, while universally desired, are usually lacking or not formalized. One benefi t of effective criteria is the shaping effect it has on behavior in the organization. When people know how projects will be scored, they tend to shape proposals in positive ways to meet the criteria better. A pitfall is when people play games to establish criteria that support personal agendas. Then it is up to the leader to identify and question these tactics. Remind people to support the greater good of the organization. Signifi cant effort could be devoted to the behavioral aspects that become relevant when deciding upon criteria; suffi ce to say, be warned that this is a touchy area to approach with sensitivity and persuasiveness. What the Organization Can Do. The next step for the team is to gather data on all projects. Use similar factors when describing each project in order to ease the evaluation process. Engage people in extensive analysis and debate to get agreement on the major characteristics for each project. This is a time to ask basic questions about product and project types and how they contribute to a diversifi ed set of projects. Reexamine customer needs, future trends, commercial opportunities, and new markets. The person consolidating the data should challenge assertions about benefi ts and costs instead of accepting assumptions that may have been put together casually. It is important for each member of the team to assess the quality of the data, looking closely at sources and the techniques for gathering the data. When putting cost fi gures together, consider using activity-based costing models instead of traditional models based on parts, direct labor, and overhead. Activity-based costing includes the communications, relationship building, and indirect labor costs that usually are required to make a project successful. The team needs to constantly apply screening criteria to reduce the number of projects that will be analyzed in detail. Identify existing projects that can be canceled, downscaled, or reconceived because their resource consumption exceeds initial expectations, costs of materials are higher than expected, or a competitive entry to the market changed the rules of the game. The screening process helps eliminate projects that require extensive resources but are not justifi ed by current business strategies; maybe the projects were conceived based on old paradigms about the business. The team can save discussion time by identifying must-do projects or ones that require simple go/no-go decisions, such as legal, personnel, or environmental projects. These fall right through the screens and into the allocation process. Determine if some projects can be postponed until others are complete or until new resources or funding become available. Can project deliverables be obtained from a supplier or subcontractor rather than internally? Involve customers in discussions. The team constantly tests project proposals for alignment with organizational goals. It is not necessary to constrain the process by using the same criteria across all categories of projects. In fact, some teams found that different criteria for each category of projects was more effective. Also, consider adjusting the weighting of criteria as projects move through their life cycles. Kumar et al. [7] documented research showing that the most signifi cant variable for initial screening of projects is the extent to which “project objectives fi t the organization’s global corporate philosophy and strategy.” Other factors, such as available science and technology, become signifi cant later during the commercial evaluation stage. A big “Aha” experienced by some teams when confronted with this data is that they usually did it the other way around. That explains why they got into trouble—by focusing on technology or fi nancial factors before determining the link to strategic goals. Cooper (and others before him) report that top-performing companies do not use fi nancial methods for portfolio planning. Rather, they use strategic portfolio management methods where strategy decides project selection [3]. This lesson is still a hotly debated one, especially for those who cling to net present value as the single most important criterion. The diffi - culty lies in relying upon forecast numbers that are inherently fi ctitious. The authors’ experience is that teams get much better results tapping their collective wisdom about the merits of each project based upon tangible assessments against strategic goals. Using computed fi nancial numbers more often leads to arguments about computation methods and reliability of the data, resulting in unproductive team dynamics. The next part of gathering data is to estimate the time and resources required for each potential and existing project. Get the data from past projects, statistical projections, or simulations. The HP Project Management Initiative particularly stresses in its organizational initiatives to get accurate bottom-up project data from work breakdown structures and schedules. Reconcile this data with top-down project goals. Document assumptions so that resource requirements can be revisited if there are changes to the basis for an assumption. For new or unknown projects, make a best estimate, focusing fi rst on the investigation phase with the intent to fund only enough work to determine feasibility. The team can revisit the estimates when more infor- 81721_Ch02.indd 100 9/16/08 11:36:13 PM mation becomes available. Constantly improve estimation accuracy over time by tracking actuals with estimated task durations. Next, the team identifi es the resource capacity both within and outside the organization that will be available to do projects. Balance project with nonproject work by using realistic numbers for resource availability, taking into account other projects, vacations, meetings, personal appointments, and other interruptions. Tip: a wise planner consumes no more than about 50% of a person’s available time. One assessment about the quality of projects in a portfolio is to look at the rejects. In a story attributed to HP founder Bill Hewlett, he once established a single metric for how he would evaluate a portfolio manager’s performance. He asked to see only the rejects. He reasoned that if the rejects looked good, then the projects that were accepted must be excellent. All the actions in this step of the process are intended to screen many possible projects to fi nd the critical few. The team may take a path through multiple screens or take multiple passes through screens with different criteria to come up with a short list of viable projects. Figure 4 represents one scenario where Screen 1 is a coarse screen that checks for impact on the strategic goal. Subsequent screens apply other criteria when more data are available. Any number of screens may be applied, up to the number n, until the team is satisfi ed that the remaining projects relate to compelling business needs. These steps actually save time because the next section on analysis can get quite extensive if all possible projects go through it. It usually is necessary to go through several validation cycles before fi nishing the next step: the upper management team proposes project objectives, project teams provide preliminary estimates based on scope, schedule, and resources back to management, management is not happy with this response and makes adjustments, and so on. This exercise in due diligence is a healthy negotiation process that results in more realistic projects getting through the funnel. Analyze and Decide on Projects. The next step is to compare estimated resource requirements with available resources. A spreadsheet is useful to depict allocation of resources according to project priority. Part of the analysis is qualitative: Consider the opportunity costs of committing to short-term, opportunistic, or poorly conceived projects that take resources away from future prospects that may be a better fi t strategically. Also, avoid selecting “glamorous” new ideas over addressing the tough issues from ongoing projects. Some people lack the stamina to deal with the details of implementation and so are ready to jump to a new solution at the slightest glimmer of hope from the latest technology. This is a recipe for disaster. Also, be careful to balance the important projects rather than giving in to urgent, but not so important, demands. Documenting all the fi ndings and supportive data using a common set of descriptive factors makes it easier to compare similar factors across projects. Use a “project charter” form or a template where all information about each project, its sponsors, and key characteristics is recorded. The team can now prioritize the remaining projects. Focus on project benefi ts before costs; that way the merits of each project get full consideration. Later include costs to determine the greatest value for the money. Compute overall return from the set of projects, not from individual projects, because some projects may have greater strategic than monetary value. Requiring each and every project to promise a high fi nancial return actually diminishes cooperation across an organization. Also, optimize return over time and continuity or uniformity of revenue from the projects. Some future projects must be funded early to ensure a revenue stream when current projects taper off. Using previously agreed-upon criteria and weighting factors, the team compares each project with every other one within a category. Repeat the process for each criterion. See the discussion and example later in this article about using an analytical hierarchy process (AHP) to facilitate this step. Consider using software to compute results—an ordered list of projects within each category. A pitfall to avoid that engenders fear among the team is showing one list that prioritizes all projects from top to bottom. People get concerned when their project is on the line. It is not fair to compare internal development projects with high grossing products; keep them separated and within their respective categories. Figure 4 Application of criteria screens during a funneling process eliminates the trivial many projects from the critical few that the organization can realistically complete. DIRECTED READING 101 81721_Ch02.indd 101 9/16/08 11:36:13 PM 102 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION Finally, the team is ready to decide which projects to pursue. Be prepared to do fewer projects and to commit complete resources required by projects that are selected. Decide on a mix of projects consistent with business strategy, such as 50% platform projects, 20% derivative projects, 10% breakthrough projects, and 10% partnerships. Note that these total only 90%; taking some lessons from financial portfolio management, diversify the set of projects by investing in some speculative projects. The team may not be sure which markets or technologies will grow, so buy an “option” and make a small investment to investigate the possibilities. Include experimental projects. It is also important to leave a small percent of development capacity uncommitted to take advantage of unexpected opportunities and to deal with crises when they arise. Wheelwright and Clark [14] cite an organization that reduced the number of its development projects from 30 to 11: “The changes led to some impressive gains . . . as commercial development productivity improved by a factor of three. Fewer products meant more actual work got done, and more work meant more products.” Addressing an internal project management conference, an HP Executive Vice President emphasized the need to focus on doing fewer projects, especially those that are large and complex: “We have to be very selective. You can manage cross-organizational complex programs if you don’t have very many. If you have a lot of them with our culture, it just won’t work. First of all, we need to pick those opportunities very, very selectively. We need to then manage them aggressively across the company. That means have joint teams work together, strong project management and leadership, constant reviews, a framework, a vision, a strong owner—all those things that make a program and project successful.” Subsequently, a number of organizations sought help from the HP Project Management Initiative to systematically reduce 120 projects down to 30. Another organization went from 50 projects down to 17. It appears counter-intuitive, but by prioritizing and more carefully selecting projects, organizations actually get more projects completed. Figure 5 illustrates a document that captures the output of this process. Record projects that are fully funded in an aggregate project plan (in-plan). In a separate section or another document, list projects for future consideration (out-plan); also capture and communicate reasons for delaying or not funding projects. The plan of record (POR) is both a process and a tool used by some organizations at HP to keep track of the total list of projects. It lists all projects under way or under consideration by the entity. If a project is funded and has resources assigned, it has achieved inplan status. Projects below the cutoff line of available resources or that have not yet achieved priority status are on the out-plan. The fi gure also categorizes the projects and specifi es the desired mix. Project managers at HP describe one benefi t of the POR process as identifying gaps between required and actual resources. For fl exible changes, the process gets all people into the communications loop. If people want to add something, the management team has to decide what should be deleted. The process helps two divisions that work together agree on one prioritized list instead of two. They utilize direct electronic connections for bottom-up entry of projects and resources by all project managers into a centralized administration point. Implement the Plan. No job is complete until it is acted upon. The team needs to “evangelize” all others in the organization to use the aggregate project plan or POR to guide people who plan work, make decisions, and execute projects. Although it may be countercultural to do so, do not starve committed projects of the resources they need. The team or the responsible upper managers need to enforce the plan by fully staffi ng committed projects; that now becomes possible because fewer projects are happening simultaneously. Also, use the plan to identify opportunities for leverage across projects or for process reengineering. Match people skills to project categories to tap their strengths and areas for contribution. The team or a program management offi ce needs to maintain the plan in a central place, such as a project offi ce or online. Make it known to, and accessible by, all people in the organization doing projects, subject to confi dentiality requirements. All the work to this point may go for naught if the process, the steps, and the results are not widely communicated. The same people who develop the plan are also the ones who can best update it periodically, perhaps quarterly or as changes occur. Use tools such as an online shared database to gather data directly from project managers about resources needed for each project. This system can be used both to gather data when developing the plan and to update it. View the plan as a “living document” that accurately re- fl ects current realities. The challenge for HP and many companies is to “master both adaptive innovation and consistent execution . . . again and again and again . . . in the context of relentless change. . . . Staying on top means remaining poised on the edges of chaos and time . . . These edges are places of adaptive behavior. They are also unstable. This instability means that managers have to work at staying on the edge” [1]. The advice is clear: the plan is indispensable as a strategic guideline, but don’t fall in love with it! Be prepared to adapt it and to communicate the changes. Process Tools One tool that can assist in the decision-making process is the AHP [10]. Because of the interactions among many factors affecting a complex decision, it is essential to identify the important factors and the degree that they affect 81721_Ch02.indd 102 9/16/08 11:36:13 PM Figure 5 An example plan of record showing the mix of projects in priority order and the time line for each project. DIRECTED READING 103 81721_Ch02.indd 103 9/16/08 11:36:14 PM 104 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION each other before a clear decision can be made. The AHP helps structure a complex situation, identify its criteria and other intangible or concrete factors, measure the interactions among them in a simple way, and synthesize all the information to obtain priorities. The priorities then can be used in a benefi t-to-cost determination to decide which projects to select. The AHP organizes feelings and intuition alongside logic in a structured approach to decisionmaking—helpful in complex situations where it is diffi cult to comprehend multiple variables together. An individual or team focuses on one criterion at a time and applies it step by step across alternatives. A number of sites across HP fi nd value in using AHP. In another example, a team got together to choose among a set of services they will offer to customers. More choices were available than the organization had capacity to support. After defi ning organizational strategy or product goals, the fi rst task was to identify which criteria to enter into the decision-making process. After give-and-take discussion, they decided that the criteria were customer satisfaction, business value, process effectiveness, and employee satisfaction. Next, the criteria were ranked according to priority by making pairwise comparisons between them. Which is the more desirable criterion and by how much, customer satisfaction or business value? Process effectiveness or employee satisfaction? Business value or process effectiveness? These questions were asked about all possible pairs. Each potential project or service then was scored underneath each criterion, and decisions were made about which projects to include in the portfolio, based upon existing resources. This team went on to create a POR similar to Figure 5. A detailed explanation for computing the priority scores and the fi nal rank ordering list can be quite complex, involving eigenvalues and eigenvectors, so it is much easier to get a software package (Expert Choice [4]) that does the computations. As an alternative, a spreadsheet could be constructed to normalize the numbers. This process appears complex and analytical but is easy when the software handles the computations, and the management team concentrates on the comparisons. It is thorough in guiding the team to consider all criteria, both emotional and logical, and to apply them to all projects. One team rejected the process as too analytical, so be aware that it does not work for everyone. The key benefi t in doing this process is the improved quality of dialogue that occurs among the management team members. In facilitating a number of teams at HP through this process, each one achieved far more progress than they thought possible. People admit that they become addicted to the AHP process. They immediately buy the software. The systematic approach is feasible whether selecting products for a product line, projects that comprise a portfolio, or the best supplier or candidate for a job. In reality, the discussions are more valuable than the analysis. The process in this case provides the discipline that makes the dialogue happen. Frame [5] offers an alternative “poor man’s hierarchy.” He puts selection criteria along the side as well as across the top of a grid. If the criterion on the side is preferred to the one on the top, put a 1 in the cell. If the criterion on top is preferred, put a 0 in the cell. Diagonals are blanked out where criteria would be compared to themselves. Below the diagonal, put the opposite value from corresponding cells above the diagonal. Then add up the numbers across the rows to get total scores, which provide a rank order. One team at HP modifi ed this process to replace the 1s and 0s with an actual count of how 18 people voted in each pairwise comparison of alternatives. Again, they added up the rows and normalized the results for a priority order and weighted ranking (Figure 6). This simplifi ed hierarchy is especially helpful for weighting criteria. It can be used for prioritizing projects Total Business Customer Technology Employee Votes % Business *** 16 16 18 50 46 Customer 2 *** 13 15 30 28 Technology 2 5 *** 14 21 19 Employee 03 4 *** 7 7 Figure 6 A simplifi ed hierarchy used by one HP team to weight criteria. 81721_Ch02.indd 104 9/16/08 11:36:14 PM when applied to one criterion at a time. It becomes bulky and less useful when applied to multiple projects over multiple criteria. Barriers to Implementation Now for a reality check. The model depicted in this article is thorough, and it integrates objective and subjective data. When all is said and done, however, people may throw out the results and make a different decision. Sometimes the reason is a hunch, an instinct, or simply a desire to try something different. Sometimes people have a pet project and use the process to justify its existence, or a hidden agenda may be at play—perhaps the need to maneuver among colleagues, trading projects for favors. Politics at this stage cannot be ignored, nor are they likely to disappear. It is imperative for leaders to become skilled in the political process. Any attempt at leading change in how an organization links projects to strategy is bound to meet resistance. The concept receives almost unanimous intellectual support. Implementing it into the heart and soul of all people in the organization is another story. It goes against the cultural norms in many organizations and conjures up all kinds of resistance if the values it espouses are not the norm in that organization. The path is full of pitfalls, especially if information is presented carelessly or perceived as fi nal when it is work in process. Some people resist because the process is too analytical. Some want decision-making to be purely interactive, intuitive, or the purview of a few people. A complete process cannot be forced upon people if the organization has more immediate concerns or unresolved issues. Resistance occurs when there is no strategy, the strategy is unclear, or people are uncomfortable with the strategy. Work on the process may come to a standstill when people realize how much work is involved to fully link projects to strategy. If the pain is not great enough with the status quo, people are not going to be ready to change. And if people sense that the leader does not authentically believe in the elements, such as the goals, the process, or the tools, they are hesitant to follow with any enthusiasm. When the leader lacks integrity and exhibits incongruity between words and actions, people may go through the motions but do not exert an effort that achieves meaningful results. Enablers for Effective Implementation It is possible to lead people through this change process if the leader asks many questions, listens to the concerns of all people involved, and seeks to build support so that people feel they have an active role in developing the process [9]. A fl exible process works better than a rigid one. Cultivate “champions” who have the credibility and fortitude to carry the process across the organization. Believe that change is possible. When the effort appears too massive, one approach is to go after the low-hanging fruit. Start with one of the more pressing issues and use the general concepts of this model to address it. Still have a vision for what the organization ultimately can achieve but understand that patience and pacing are necessary to get there. Consider also that this process is hierarchical—it can be applied singularly or collectively, up or down the organization. For people who get frustrated when all linkages are not present, the authors urge teams and individuals to “just do it.” Small changes in initial conditions have enormous consequences. Eventually successes or small wins are noticed. The practices start to permeate an organization. This can happen in the middle, move up, and then over to other organizations. Incidentally, a corporate group like HP’s Project Management Initiative helps facilitate this transformation. We do this by acting as a conduit for success stories and best practices. Over the long run, we believe that organizations that follow a process similar to the one described increase their odds for greater success. This happens because teams of people following a systematic process and using convincing data to support their arguments more often produce better results than individuals. Their projects have more visibility, and the quality of dialogue and decision-making improve. The power of using criteria that are tightly linked with strategy and known by everyone in the organization is the mitigating effect it has to guide behavior in constructive ways. Having a process means it can be replicated and improved over time until it is optimized. It also means other people can learn the process and coach others, thereby creating a learning organization. References 1. Brown, S. L., and K. M. Eisenhardt. Competing on the Edge: Strategy as Structured Chaos. Boston: Harvard Business School Press, 1998. 2. Collins, J. C. and J. I. Porras. Built to Last: Successful Habits of Visionary Companies. New York: HarperCollins, 1994. 3. Cooper, R. G., S. J. Edgett, and E. J. Kleinschmidt. Portfolio Management for New Products. Reading, MA: Addison-Wesley, 1998. 4. “Expert Choice,” Pittsburgh, PA: Expert Choice Inc. (see www.expertchoice.com). 5. Frame, J. D. The New Project Management: Tools for an Age of Rapid Change, Corporate Reengineering, and Other Business Realities. San Francisco: JosseyBass Publishers, 1994. 6. Graham, Robert J. and Randall L. Englund. Creating an Environment for Successful Projects: The DIRECTED READING 105 81721_Ch02.indd 105 9/16/08 11:36:14 PM Quest to Manage Project Management. San Francisco: Jossey-Bass Publishers, 1997. 7. Kumar, V., et al. “To Terminate or Not an Ongoing R&D Project: A Managerial Dilemma.” IEEE Transactions on Engineering Management 279 (1996). 8. Martino, J. R & D Project Selection. New York: Wiley, 1995. 9. O’Toole, J. Leading Change: Overcoming the Ideology of Comfort and the Tyranny of Custom. San Francisco: Jossey-Bass Publishers, 1995. 10. Saaty, T. L. Decision Making for Leaders. Pittsburgh, PA: RWS, 1990. 11. Stacey, R. D. Managing the Unknowable: Strategic Boundaries Between Order and Chaos in Organizations. San Francisco: Jossey-Bass Publishers, 1992, p. 62. 12. Turtle, Q. C. Implementing Concurrent Project Management. Englewood Cliffs, NJ: Prentice Hall, 1994. 13. Westney, R. E. Computerized Management of Multiple Small Projects. New York: Dekker, 1992. 14. Wheelwright, Stephen and Kim Clark. “Creating Project Plans to Focus Product Development.” Harvard Business Review, March–April (1992). Questions 1. Why are successful projects so important to HewlettPackard? 2. How far should an evaluation team go in trying to quantify project contributions to the fi rm’s mission or goals? What is the role of fi nancial selection criteria in HP’s project selection process? 3. Considerable attention is paid to the measures HP uses to evaluate its projects. Is the aim of carefully defi ning these measures to simplify the project selection process or something else? 4. What do the aggregate project plan and the plan of record illustrate to upper management? 5. When should out-plan projects be reconsidered for inclusion? 6. What was your impression of the impact that HP’s project selection process had on the number of projects underway? How do you expect HP would score on project management maturity? 7. How did the new project selection process handle nonnumeric type projects? Risk? How did this new process alter new project proposals at HP? 106 CHAPTER 2 / STRATEGIC MANAGEMENT AND PROJECT SELECTION 81721_Ch02.indd 106 9/16/08 11:36:15 PM