What is the Answer When You Don't Know the Question?
(aka Fiscal Budgeting for Project Portfolios)
The other day, one of my clients posed an interesting dilemma relating to fiscal budget management. The situation is as follows, one that must be common to many companies these days. The company has a certain capacity to undertake projects during the year, projects intended to improve their performance and increase their competitive advantage. In this case the projects are generally of an administrative or information technology nature, but I would imagine that the issue could apply to a variety of project types and on different scales.
Prior to the start of each financial year, the organization goes through a financial budgeting process in which a potential
stream of projects are identified and prioritized as a project portfolio for the year. This can be done on the basis of availability
of people resources and projected revenue and/or capital set aside for the purpose. Within this framework, individual projects
are approved and money "earmarked" (i.e. set aside in the books) for the conduct of each project.
The problem is, how much should be earmarked for each project, especially at the beginning of the year when a new set of projects are selected from the standing list of desirable projects? Setting aside the projects that are "carry-overs" from the previous fiscal year, the projects in question are typically at the "idea" stage and may or may not even have a business case. However, it is fair to say that sufficient is at least known about each proposed project to determine the cost of undertaking the assembly of a business case, if in fact it has not already been done.
In rather typical "firm-number" accounting, "single numbers" are assigned to each project using the classic "wet-thumb"[1] approach.
True, you have to start somewhere, but the problem is that this number tends to get handed down to the project manager as the budget
for the project, even before the stakeholder requirements have been established or finalized. The consequence of all of this
is that projects end up being wildly off the budget target, either over or under, but mostly over. The current solution
tends to be simply stopping the project when the money runs out – or at least postponing the outstanding work until the following
year when more money is available.
Has anyone else encountered this situation? There's got to be a better way!
Of course there is! The concept of project cost control is well established and
we wrote a paper detailing the process some time ago. The paper was called Project
Cost Control: The Way it Works and you will find it here:
http://www.maxwideman.com/papers/cost_control/intro.htm.
As we said then:
- Every project starts with someone identifying an opportunity or need. That is usually someone of importance or influence, if the project is to proceed, and that person often becomes the project's sponsor.
- To determine the suitability of the potential project, most organizations call for the preparation of a "Business Case" and its "Order of Magnitude" cost to justify the value of the project so that it can be compared with all the other competing projects. This effort is conducted in the Concept Phase of the project and is done to satisfy the organization's management of the entire project portfolio.
Most project managers are familiar with the idea of an "Order of Magnitude" estimate at the concept stage for the work of producing the project's product. Since at this point we don't know the exact extent of the project's scope, or quality grade, we can only guess at the estimated cost of the work. An Order of Magnitude estimate is typically taken as being in a range of minus 25% to plus 75% or even higher. In other words it is very much an inexact figure! Nevertheless, it is necessary to use this figure in some consistent way for assessing whether, given this cost, the expected benefits justify the project being listed in the portfolio of projects for the coming fiscal year. In practice, the amount of money actually released for the project at this initiation point should only be sufficient to undertake the proper definition and planning of the project. This planning work for execution should be documented in the more elaborate document known as the Project Charter or Project Brief.
Delivery of this document for management approval represents the crucial Executive Control Point, or "gate", at which management can decide to continue with the execution (i.e. product production phases) of the project. Or, they can use the opportunity as the "exit ramp" to disengage from the project altogether and divert their resources to more beneficial projects. In terms of the simplified standard project life span (PLS), the project management methodology can be displayed as shown in Figure 1. Note the importance and placing of the two documents, Business Case and Project Charter, in this progressive PLS sequence.
Figure 1: The PLS phase deliverables and executive control points or gates[2]Only with executive management's acceptance and approval of the Project Charter, should the project proceed to execution (phase 3 in the diagram), and this time on a firm budget as a commitment between the project sponsor and the project manager.
But what of the projects in the portfolio that may not have even reached the Business Case stage? Or perhaps they are between the Business Case and Project Charter points at the time of establishing the fiscal budget for the project portfolio framework? This is where some creative estimating is needed. We have already discussed the idea of Order of Magnitude estimates as a basis for budgeting. Now we can take that a step further.
Let us assume that a track record of past projects has been kept, that standard Business Case templates have been established and used and that the cost of working up Business Cases have also been kept. True, these are big "ifs" but we have to start somewhere. Very broadly, we can say that large project ideas warrant more attention and consequently more thorough Business Cases, while lesser project ideas can be reflected in less detail, and hence less expensive Business Cases. Thus we have an early indication of the cost of the project, well, at least as an Order of Magnitude!
The question is: what can we deduce from this? Here, we will go out on a limb and based on some of our experience and that of others here are some ideas and figures to play with. The following table arrives at multipliers based simply on the costs of, or allocated for, the Business Case, or for small projects, the Business Case and the Project Charter together.
|
Phase
|
Principal Activity
|
Percent Effort in Phase
|
|
Trad %
|
IS/IT %
|
|
1
|
C
|
Concept: Business Case
|
2.5
|
5
|
|
2
|
D
|
Definition: Proj. Charter
|
12.5
|
20
|
|
3
|
E
|
Execution: Production
|
70
|
65
|
|
4
|
F
|
Finish: Product Transfer
|
15
|
10
|
|
|
|
Totals:
|
100
|
100
|
|
|
Ratio:
|
D+E+F
C
|
19
|
39
|
|
|
Ratio:
|
E+F
C+D
|
3
|
6
|
Figure 2: Table showing range of multipliers from planning to production phases
According to the table, the cost of the Business Case multiplied up to represent the rest of the project might range between 19 and 39 times as much. On much smaller projects it might make more sense for the initial project funding to cover both Business Case and Project Charter together. In this case, since the project is further along, the rest of the project might range between 3 and 6 times that cost. It seems that "25" and "5" could be useful multipliers to use for each case until such time as better data are available. In the real world, each organization has to establish its own track record, its types of projects and the diligence with which they conduct their Concept and Definition phases to arrive at satisfactory multipliers.
The next step to consider is how can this information be used? In our view, this represents valuable financial planning information, a basis for setting aside project funding for the entire portfolio, and/or for determining cash flow requirements during the financial year. However, no funding is committed to the execution phase of any given project until it has an approved Project Charter, complete with a working project budget. From the project portfolio perspective, the idea is that through the year there will be "swings and roundabouts" in which some projects prove to be more elaborate and hence more costly while others turn out to be less so.
This way, senior management has control over its fiscal investment finances and its project portfolio. At the same time, project managers do not get "stuck" with unrealistic budgets that compromise their products or find they get put on hold until the next financial year. Either way, the resulting products tend to get compromised. Alternatively, money does not get quietly diverted to other things when there happens to be some "leftovers".
It all boils down to the proper application of project management and the intelligent use of project management metrics in running a business.
Comments and thoughts on this project portfolio management approach will be welcomed.
1. "Wet-thumb"
approach – a way of arriving at a dollar amount by licking one's thumb and sticking
it in the air and writing down the most likely number you can think of.
2. Reproduced from Figure 5-1: The PLS phase deliverables and executive gates in A
Management Framework for Project, Program and Portfolio Integration, 2004, p49, by R. Max Wideman.
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