project prioritization

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.

How to Prioritize Projects? – Part 1

One of the most popular questions that frequently comes up in the conversations with senior and executive management of various companies is the one that appears in the title line of this article.

NOTE: This question, by the way, usually implies that the company has already taken a great leap forward and realized that it was impossible to accomplish all of their desired projects in a given period of time.

There are many different approaches to this task, but the most popular ones are the financial methods and the scoring models. Let us look first at the financial methodology. In a nutshell, it implies choosing some kind of a financial criterion – be it a return on investment, a net present value, an internal rate of return or some other formula – and calculating a value for each project. Once the ROI (or any other financial measure) for each project has been calculated, the projects are ranked according to their ROIs in the descending order.

Let us look at an example of how it may happen. We have a company that wants to implement 10 projects and has 200 man-months in their resource pool (roughly speaking 20 people working together for one year including the adjustments for the vacation time, sick days, etc.)

The list of projects together with their expected ROIs is presented in Table 1:

Table 1

Project

Estimated ROI

Project A

21%

Project B

5%

Project C

12%

Project D

3%

Project E