Capital Projects - Barshop Paul

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sponsors are so certain about the revenue forecast that they are willing take on the risk of a significant cost overrun to accelerate the schedule to meet a market window when demand or prices are expected to rise rapidly. The value erosion caused by the cost and schedule overruns is doubly painful when demand is lower than expected.

      What executives do control is the quality of the work behind the market forecast used to justify the project. In Chapter 3, I will show you that projects based on rigorous market analyses are 30 percent less likely to face a lack of demand. In other words, the chances of building unneeded capacity are much lower if executives establish requirements for developing a reliable market forecast and check that the requirements are met.

      The average project erodes 5 percent of value because the production facility built by the project cannot produce what the business needs. For example, a software application may not meet all the service-level requirements established by a business. Responsibility for asset performance shortfalls is usually shared among all the groups involved in the project. Sometimes the asset could not make the product because it was never designed for that capability. The project sponsor may not have communicated the requirements clearly to the project team. It is also true that project teams sometimes do not hear what the sponsor is saying. Other times, the shortfall is due to innovative technology not working as well as expected. The technology executive may have downplayed the technical risk of the innovation. Finally, the shortfalls may occur because of mistakes made in the design or construction of the facility, often the result of a project trying to cut corners or go faster to meet the cost and schedule targets set by executives.

      The results of the study show that responsibility for value erosion is shared across the organization. They also mean that fixing the problem involves executives across the organization working to improve their own areas as well as how their group interacts with others to create a common understanding as a project is developed and executed.

      How to Deliver the Value Promised

      The proven processes to create more business value from investments and prevent value erosion are well known and largely accepted, at least on the surface. Three-quarters of IPA's clients have a perfectly serviceable capital project development and delivery process. I will go into more detail in the next chapter, but the process covers the entire life cycle of the project from inception to the point when the asset is put in service. Let's say R&D is finishing up the development of a new product and a new manufacturing facility is needed to make the product. The usual process for creating an asset combines a set of defined development stages with decision gates at the end of each stage. The stage-gate process for this opportunity starts when someone is assigned to investigate ways to produce the new product. The process ends when the factory is in service. The stages sequence work in the order needed to identify and deliver value, and the gates allow executives to control the project's progress through the process. The process is managed by a project governance structure that assigns different executives specific roles and responsibilities, creating the checks and balances needed for good project decision making.

      There isn't even much debate company-to-company on what the process should look like. Although there are some differences to accommodate a particular industry, there is very little substantive difference in the fundamental approach companies take toward capital project development.

Moreover, the process works – when it is used correctly. Projects that followed a process, on average, actually added slightly more value than what was forecast when the project was funded, while projects that did not meet any of the process requirements eroded about half the expected NPV (see Table 1.2). The average 22 percent value erosion shows that most projects sort of muddle through, meeting some requirements while not meeting others.

Table 1.2 Projects That Meet the Stage-Gate Process Requirements Tend to Deliver the Expected Value

      The assets created by projects that followed the process were much less likely to face a lack of demand, have cost and schedule overruns, or have performance issues. Critically important to understand is that there are no average differences in the market risk and external project risk faced by the projects in the three categories. That is, the projects that met all the requirements were not any less complex or inherently less risky than those that did not. Rather, using the stage-gate process effectively allowed executives to navigate through the complexity, address risks, and deliver better results. Throughout the book, I am going to give specific examples, both good and bad, to illustrate how you can use the process to get better results for your projects.

Causes of Value Erosion Often Start Early

      One of the key findings of the research I have completed at IPA is that the quality of the starting point is a very strong predictor of the project's eventual business success. You can think about the sequence of activities in the stage-gate process in the following way: identify the business need, choose the preferred solution for meeting the business need, plan the project, do the project, and put the asset into service. Put more succinctly, the sequence is ready, aim, fire.

      The beginning of a project establishes a trajectory that is difficult to change once the project gains momentum. First, projects are progressively defined, meaning details are continually added to work that was done previously. Mistakes made in the technical design, project strategies, and foundational project scope tend to cascade through the entire project life cycle. Making changes later almost always leads to costly rework and mistakes from overlooked details.

      Once a project builds momentum, it is also hard to stop even if the project has a marginal value. Projects build momentum as more individuals become invested in their outcomes. The business executives sponsoring the project are usually counting on the project to improve the business's financial performance. The technology group may be keenly interested in demonstrating its research commercially. The project manager and the rest of the project professionals also have a vested interest in the project continuing and often become advocates for the project. Projects also gain financial momentum as more money is invested to complete project definition. There is a reluctance to incur the sunk costs from canceling a project just before full-funds authorization, when the full budget to complete the project is released to the project team. For example, the business may have spent a million dollars developing the project. Canceling the project means throwing away that money.

      Executives throughout a company have a huge influence on how well the initial work on a project is done. My research shows that the early stages of the capital project life cycle tend to be done with less rigor and discipline than the later stages. Executives just do not pay enough attention to the formative stages of the project. The problem is a little like diet and exercise. We all know that a balanced diet and exercise are key ingredients to good health. Yet – as most of us know from personal experience – we do not always do what we know is right. To make the effort easier, I will provide practical guidance on what executives can do to improve results without overburdening them with work that adds no business value.

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      WHY THE STAGE-GATE PROCESS IS THE BEST TOOL EXECUTIVES CAN USE TO GET THE MOST VALUE FROM THEIR CAPITAL PROJECTS

      I was once presenting to the CEO of a medium-sized manufacturing company and his executive team on how they could improve the results of their capital projects. Some of their recent projects had not gone so well. About five minutes into the briefing, one of his lieutenants muttered, “Oh no – not another presentation about the stage-gate process!” “Well, yes,” I said, “that is a big part of what I am going to talk about.” He rolled his eyes and spent most of the time checking his e-mail on his phone while I talked. Yes, the stage-gate process is old hat, but the fact is it is the only approach that has ever been shown to work long term.

A more complete name is the stage-gate project development and delivery process (see Figure 2.1). The process contains five distinct stages with gates between the first three stages, which are referred to as the front end of the process. Each stage has a set of requirements for the work to be completed in that stage. That work is used by executives at each stage-gate to decide whether the potential

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