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This is the third part of a six-part paper explaining the reasons organizations tend to make poor project choices. Part 1 described the common errors and biases in human judgment that distort decision-making. Part 2 described the error of failing to see the forest for the trees, and provided recommendations for establishing a project portfolio management function. This part offers Reason 3 why organizations choose the wrong projects and describes the need to develop proper metrics for evaluating and selecting projects.
Reason 3: Lack of the Right Metrics
The metrics that an organization uses have a big impact not only on the projects that get chosen but also on the projects that get proposed. "Tell me how you will measure me, and I will tell you how I will behave".[1] Even if the metrics aren't used to create incentives, managers interpret them as indicating what the organization regards as important. Lack of the right metrics is the third reason organizations choose the wrong projects.
Inadequacy of Financial Metrics
Most organizations use financial metrics, for example, return on investment (ROI), return on assets (ROA), internal rate of return (IRR), net present value (NPV), pay-back period, etc. Using these metrics to evaluate candidate projects requires forecasting all of the ways that a project can impact cash flows, which is often difficult to do. The biggest limitation of using such metrics for project prioritization, however, is that they provide, at best, only a partial representation of what is relevant.
Financial metrics, quite simply, don't capture all of the organization's true objectives. For public-sector organizations, this limitation is obvious. Public-sector organizations have non-financial objectives such as protecting public health and the environment, as well as mission-specific objectives. For example, a water utility has a mission that includes serving community water needs. A public school has a mission that includes educating its students. Financial metrics fail to measure the full value of projects that achieve non-financial objectives.
Likewise, the standard financial metrics do not represent the true objectives of private-sector organizations. Management scientists and U.S. business leaders are nearly unanimous in the opinion that the fundamental objective of investor-owned organizations is to maximize shareholder value. With this view, the appropriate metrics for evaluating projects in the private sector are those relevant to forecasting impacts on the market value of the business.
1. Eliyahu Goldratt, The Haystack Syndrome, North River Press, 1991.
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PART II
