Article - Do You Consider Company’s Internal Resource Costs When Prioritizing Projects?

 

Whenever I either teach my “Project Portfolio Management Masterclass” or consult on project portfolio management initiatives I like to surprise the senior executives with a seemingly innocent question:

Oh, by the way, do you consider your internal company resources to be free?

After the angry noise in the audience finally subsides, one of the executives – usually in a voice full of emotion – replies to me:

Of course not! Our employees are the main and the most valued asset at this organization!

Knowing that the trap is set and the victims are completely unaware as to what really awaits them, I ask the next innocuous question:

So, in that case, do you include the cost of internal resources when assessing the feasibility of your projects?

As a rule, about 90% of the time my question is greeted by a complete silence. The executives exchange glances attempting to comprehend the meaning of my question and finally answer something to the effect of,

“Uhm, no, not really … They are considered to be a fixed rather than a variable cost”

In order to analyze this problem, let us consider two scenarios. In the first one we have to choose between projects A and B. For simplicity let us assume that the only factor of importance in this case is the return on investment (ROI), one of the most uncomplicated financial formulas.

Project A should generate revenue of $1,000,000. The external (direct) cost of this project is $500,000 (e.g. purchase of materials and equipment).  In addition the company should expect to “invest” about 200 man-months of their internal resources, but since we are not considering the internal employee costs, the overall impact of this factor on the total project budget is zero (see Figure 1).

Project B is also expected to generate $1,000,000 in revenues, but the external cost is expected to be $750,000. Also, the human investment is estimated to be 5 man-months. But again, since the “internal employee” costs are ignored, the overall impact of this factor is also zero.

Figure 1

Under these conditions, which project is preferable? A simple calculation will tell us that project A is way more attractive than project B:

ROI_A = ($1,000,000 - $500,000)/$500,000 = 100%

ROI_B = ($1,000,000 - $750,000)/$750,000 = 33%

But what happens if we decide to incorporate the employee cost into the equation? My personal experience, based on numerous interactions with companies’ CFOs, suggest that in the developed countries the average blended monthly employee cost is around $10,000 (7,300 Euros). This (surprisingly high to some people) number includes: salary, benefits, employment taxes as well as hiring, equipment and space costs.

Let us recalculate the financial feasibility numbers for our candidate projects once more, but this time we will consider internal human resources costs (see Figure 2).

Figure 2

ROI_A = ($1,000,000 - $2,500,000)/$2,500,000 = -60%

ROI_B = ($1,000,000 - $800,000)/$800,000 = 25%

So, what conclusions can we make from these two mini case studies?

• Internal employee efforts on your projects should never be viewed as “free resources”
• Companies should make an effort to calculate at least an approximate blended monthly (daily, weekly) employee costs
• The employee costs should always be include in the project feasibility calculations