Project Management

Project Selection and Portfolio Management

 Learning Objectives

After completing this chapter, you should be able to:

1. Explain six criteria for a useful project selection/screening
model.
2. Understand how to employ checklists and simple scoring
models to select projects.
3. Use more sophisticated scoring models, such as the
Analytical Hierarchy Process.
4. Learn how to use financial concepts, such as the efficient
frontier and risk/return models.

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 Learning Objectives

5. Employ financial analysis and options analysis to evaluate

the potential for new project investments.
6. Recognize the challenges that arise in maintaining an
optimal project portfolio for an organization.
7. Understand the three keys to successful project portfolio
management.

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 PMBOK Core Concepts

Project Management Body of Knowledge (PMBoK) covered in

this chapter includes:
• Portfolio Management (PMBoK 1.4.2)

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 Project Selection
Screening models help managers pick winners from a pool of projects. They
should have:
• Realism
• must reflect organizational objectives, should include criteria related to constraints on
resources as money and personnel, must consider both commercial risks and technical
risks, including performance, cost, and time.
• Capability
• should be robust enough to accommodate new criteria and constraints, applicable to
different project types
• Flexibility
• should be easily modified if trial applications require modifications on parameters, etc.
• Ease of use
• must be simple enough to use, clear and easily understandable, timely
• Cost effectiveness
• should be cost-effective in time and money
• Comparability
• must support general comparisons of project alternatives

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 Screening & Selection Issues
Number of factors to consider when selecting project can be enormous,
keep Pareto Principle in mind.

1. Risk – unpredictability to the firm

a. Technical
b. Financial
c. Safety
d. Quality
e. Legal exposure
2. Commercial – market potential
a. Expected return on investment
b. Payback period
c. Potential market share
d. Long-term market dominance
e. Initial cash outlay
f. Ability to generate future business/new markets
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 Screening & Selection Issues

3. Internal operating – changes in firm’s operations

a. Need to develop/train employees
b. Change in workforce size or composition
c. Change in physical environment
d. Change in manufacturing or service operations
4. Additional
a. Patent protection
b. Impact on company’s image
c. Strategic fit
All models are wrong, but some are useful.
All models only partially reflect reality and have both
objective and subjective factors embedded.

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 Approaches to Project Screening

• Checklist model
• Simplified scoring models
• Analytic Hierarchy Process
• Profile models
• Financial Models

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 Checklist Model

A checklist is a list of criteria applied to possible

projects.

• Requires agreement on criteria

• Assumes all criteria are equally important

Checklists are valuable for recording opinions and

stimulating discussion; for a preliminary
evaluation.

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 Simple Checklist Model
Project Zeus Sufficient Insufficient
Cost X
Profit Potential X
Time to Market X
Development Risks X
Proje Athena Sufficient Insufficient
Cost X
Profit Potential X
Time to Market X
Development Risks X

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 Simple Checklist Model
Performance
Proje Zeus High Medium Low
Cost X
Profit Potential X
Time to Market X
Development Risks X
Proje Athena High Medium Low
Cost X
Profit Potential X
Time to Market X
Development Risks X

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 Disadvantages of Checklist Model

• Subjective nature of high, medium and low ratings

• Failure to resolve trade-off issues; what if some
criteria are more important than others?

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 Simplified Scoring Models

Each project receives a score that is the weighted

sum of its grade on a list of criteria. Scoring models
require:
• agreement on criteria
• agreement on weights of criteria
• a score assigned for each criteria
Score =  (Weight  Score)

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 Simplified Scoring Model
Proje Zeus Importance Score (B) Weighted
Weight (A) Score (AxB)
Cost 1 3 3
Profit Potential 2 2 4
Time to Market 3 1 3
Development Risks 2 2 4
Total 14
Proje Athena Importance Score (B) Weighted
Weight (A) Score (AxB)
Cost 1 3 3
Profit Potential 2 2 4
Time to Market 3 3 9
Development Risks 2 1 2
Total 18

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 Disadvantages of Scoring Models

• From the perspective of mathematical scaling, it is

simply wrong to treat evaluations on such a scale as
real numbers that can be multiplied and summed.
• If 3 means High and 2 means Medium, we know that 3
is better than 2, but we do not know by how much.
• We cannot assume the distance between 3 and 2 is the
same as the distance between 2 and 1.
• If a project gets a score of 20 and another gets 10, it
does not mean that the first is two times better.
• Some criteria may overlap, be careful.

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 Analytic Hierarchy Process

The AHP is a four step process:

• Construct a hierarchy of criteria and subcriteria.
• Allocate weights to criteria.
• Assign numerical values to evaluation dimensions.
• Determine scores by summing the products of
numeric evaluations and weights.
Unlike the simple scoring model, these scores can
be compared!

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 AHP Example Hierarchy

(0.672) (0.182) (0.145)

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 AHP – Allocating Weights
• Pairwise comparisons of criteria
• Example (IT Project): Numerical Rating Scale
1 Equally Important
• Financial Benefit 3 Moderately More Important
• Contribution to Strategy 5 Strongly More Important
7 Very Strongly More
• Contribution to IT Infrastructure Important
9 Extremely More Important

Financial Contribution to
Benefit Strategy

Financial Contribution to
Benefit IT Infrastructure

Contribution to
Contribution
IT
to Strategy
Infrastructure

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AHP

Financial Contribution to
Benefit Strategy

Contribution to Financial
IT Infrastructure Benefit

Contribution to
Contribution
IT
to Strategy
Infrastructure

Finance Strategy IT
Finance 1 3 6
Strategy 1/3 1 1
IT 1/6 1 1

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AHP

• Calculate Column Sums

• Divide each value with the associated column sum
Finance Strategy IT
Finance 1 / 1.5 = 0.67 3/5 = 0.60 6/8 = 0.75
Strategy 1/3 / 1.5 = 0.22 1/5 = 0.20 1/8 = 0.13
IT 1/6 / 1.5 = 0.11 1/5 = 0.20 1/8 = 0.13
Total(Sum) 1.5 5 8

• Calculate Priority vector

Eigenvector
Finance (0.67+0.60+.075)/3 = 0.672
Strategy (0.22+0.20+0.13)/3 = 0.182
IT (0.11+0.20+0.13)/3 = 0.145

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Consistency Rate
• Multiply the columns of the comparison matrix
with priorities of criteria
1 3 6 2.092
0.672 1/3 + 0.182 1 + 0.145 1 = 0.552
1/6 1 1 0.440
• Divide the elements by the corresponding priorities
2.092/0.672 3.112
0.552/0.182 = 3.025
0.440/0.145 3.025
• Compute the average, this is called λmax
• λmax = (3.112+3.025+3.025)/3=3.054

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Consistency Rate
• Calculate consistency index (CI)
CI = (λmax – n) / (n – 1)
where n is the number of evaluated criteria
CI = (3.054-3)/2=0.027
• Calculate consistency rate (CR)
CR = CI / RI, CR = 0.027/0.58 = 0.047

• The matrix will usually be considered consistent if

the resulting ratio is less than 10%. (i.e. İf CR<0.1)
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AHP
• Also compare subcriteria among themselves to
assign them weights that sum to 1.
• Then multiply these with the weight of the parent
criterion to achieve the final weight.
• If Finance receives a weight of 0.672, which is to be split
between short-term benefits (30%) and long-term
benefits (70%), long-term financial benefits receives an
overall weight of (0.672 ) * (0.7) = 0.470.

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AHP
• Originally, this comparison process is repated to
compare alternatives in pairs with respect to each
criterion.
• Now the comparison scale becomes:
Numerical Rating Scale
1 Equally Preferred
3 Moderately Preferred
5 Strongly Preferred
7 Very Strongly Preferred
9 Extremely Preferred

• Difficult to apply with large number of alternatives.

• Some organizations have hundreds of projects to assess.

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AHP
• For practical purposes, alternatives can be
evaluated on criterion-specific scales that assign
numerical values to verbal assignments, e.g.
• Poor, Fair, Good, Very Good, Excellent -> 0.00, 0.10, 0.30,
0.60, 1.00
• High Risk, Moderate Risk, Low Risk -> 0.00, 0.40, 1.00

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 Disadvantages of AHP

• Does not adequately account for negative utility of

some alternatives in certain criteria
• Requires that all criteria be fully exposed and
accounted for at the beginning of the selection
process; some powerful members may resist such
an open selection process.
• If new criteria or alternatives become available,
may need to do the whole process again.
• Criteria have to be independent; cannot consider
the effects of criteria on others.
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 Other Simple Weight Generation Methods

1. Simple Ranking
• Among n criteria, decision maker (DM) gives 1 to the
least important criterion, 2 to the next, …, n to the most
important one. They are all divided by the sum to
normalize.
• If there are ties, tied criteria are given the average of
values they would have obtained if there were no ties.
• Advantage: Simple
• Disadvantage: Weights are not allowed to take all values
between 0-1, not realistic.

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Simple Ranking Example
• Let ci denote criterion i
Criterion c1 c2 c3 c4 c5
Rank from least important 4 5 1 2.5 2.5
to most important
• c4 and c5 have equal importance
• Divide all ranks by the total, 15, to obtain the weights
Criterion c1 c2 c3 c4 c5
Weight 0.26 0.33 0.07 0.17 0.17

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2. Simple Cardinal Evaluation Method
• DM evaluates each criterion according to a scale of
measurement (0-5, 0-100, etc).
• All evaluations are divided by their sum to normalize.
• Advantage: It does not restrict the values of the interval.
• Disadvantage: DM answers vary considerably with different
scales used, the DM cannot foresee the effect of dividing
with the sum.

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Simple Cardinal Evaluation Example
• Let ci denote criterion i
Criterion c1 c2 c3 c4 c5
Score on a scale of 10 10 4 8 8
1-10
• Divide all scores by the total, 40, to obtain the
weights
Criterion c1 c2 c3 c4 c5
Weight 0.25 0.25 0.1 0.2 0.2

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3. Ranking-Based Methods
•DM ranks N criteria, wj is the weight of the jth ranked criterion, rj is the rank order
•Rank Sum (RS):
Assumes equal distance between weights of consecutive ranks
𝑁 − 𝑟𝑗 + 1
𝑤𝑗 (𝑅𝑆) = 𝑁
σ𝑘=1 𝑁 − 𝑟𝑘 + 1
•Rank Reciprocal (RR): Rank RS Weight RR Weight ROC Weight
1 0.333 0.438 0.457
Higher differences between consecutive weights
1Τ𝑟𝑗 2 0.267 0.219 0.257
𝑤𝑗 (𝑅𝑅) = 𝑁 3 0.200 0.146 0.157
σ𝑘=1 1Τ𝑟𝑘
•Rank Order Centroid (ROC): 4 0.133 0.109 0.090
5 0.067 0.088 0.040
Higher differences between consecutive weights
𝑁
1 1
𝑤𝑗 (𝑅𝑂𝐶) = ෍
𝑁 𝑟𝑘
𝑘=𝑗

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 Profile Models
(figure 3.4)

X7
X6
Maximum
Desired Risk

X2 Criteria
selection as
Risk

X4 X5 axes

Efficient Frontier
X3 Rating each
X1 project on
criteria
Minimum Return
Desired Return
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 Disadvantages of Profile Models

• They limit decision criteria to just two—risk and

return
• Can increase the number of criteria, but then it would
not be easy to compare alternatives with each other and
would most likely need weights for criteria again.
• To be evaluated in terms of an efficient frontier,
some value must be attached to risk, which may
not be readily quantified

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 Financial Models

• Payback period

• Net present value

• Discounted payback period

• Internal rate of return

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 Payback Period

Determines how long it takes for a project to

reach the breakeven point

Investment
Payback Period =
Annual Cash Savings

Cash flows should be discounted, but the basic version

does not.
Lower numbers are better (faster payback).
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 Payback Period Example
(table 3.5)

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 Payback Period Example
(table 3.6)

Divide the
cumulative amount
by the cash flow
amount in the third
year and subtract
from 3 to find out
3 - 50,000 = 2.857 the moment the
350,000 project breaks even.
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 Payback Period Example
(table 3.6)

Divide the
cumulative amount
by the cash flow
amount in the third
year and subtract
from 3 to find out
5 – 875,000 = 4.028 the moment the
900,000 project breaks even.
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 Net Present Value

Projects the change in the firm’s stock value if a

project is undertaken.
Ft
NPV = I o + 
(1 + r + pt )t
where Higher NPV values
Ft = net cash flow for period t are better!
R = required rate of return
I = initial cash investment
Pt = inflation rate during period t

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 Net Present Value Example

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 Net Present Value Example

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 Net Present Value Example
(Table 3.8)

The NPV
column total
is positive,
so invest!

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 Discounted Payback Period

• Initial investment of $30,000

• Promised return of $10,000 per year
• 12.5% required rate of return per year
• What is the undiscounted payback period?
• What is the discounted payback period?

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 Discounted Payback Period
(table 3.9)

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 Internal Rate of Return

A project must meet a minimum rate of return before

it is worthy of consideration.
Higher IRR
values are
better!

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 Internal Rate of Return

• You can calculate it by trial and error

1. Pick an arbitrary discount rate and determine the net
present value of the stream of cash flows
2. Compare the present value of inflows with the initial
investment, if they are equal, you have found the IRR
3. If the present value is larger (or smaller) than the
initial investment select a higher (or lower) discount
rate for computation
4. Determine the present value of the inflows and
compare with the initial investment. Continue to
repeat steps 2 – 4 until you have determined the IRR.

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 Example

• Initial cash investment: $5000

• Year 1 inflow: $2500
• Year 2 inflow: $2000
• Year 3 inflow: $2000
• Required rate of return 10%
• Find the IRR
• Is this project worth funding?

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 Example: Solved by trial and error. Try 12%
first

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 Example: second trial with 15%

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 Internal Rate of Return Example

This table
has been
calculated
using a
discount rate
of 15%.

The project does meet our 10% requirement and

should be considered further.
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 Project Portfolio Management

The systematic process of selecting, supporting, and

managing the firm’s collection of projects.

Project portfolio management should have four goals:

• maximizing the value of the portfolio
• achieving the right balance of projects in the portfolio
• achieving a strategically-aligned portfolio
• resource balancing

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 Project Portfolio Management

Portfolio management objectives and initiatives require:

• decision making
• prioritization
• cost
• opportunity
• top management pressure
• risk
• strategic fit
• portfolio balance
• review
• realignment
• reprioritization of a firm’s projects
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 Proactive Portfolio Matrix
(figure 3.8)

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 Keys to Successful
Project Portfolio Management

• Flexible structure and freedom of communication

• not constrained by restrictive layers of bureaucracy, narrow
communication channels, and rigid development processes
• Low-cost environmental scanning
• not relying on a single or few projects, constantly building
and testing new projects prior to full-scale development
• Time-paced transition
• plan ahead in order to make the smoothest possible
transition from one product to another

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 Problems in Implementing
Portfolio Management
• Conservative technical communities
• unwillingness to give up project ideas that are too risky,
too costly, or out of sync with strategic goals.
• Out-of-sync projects and portfolios
• strategy and portfolio management must accurately
reflect a similar outlook
• Unpromising projects
• Scarce resources
• create complementary projects and create synergies
within project portfolio
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 Summary

1. Explain six criteria for a useful project selection/

screening model.
2. Understand how to employ checklists and simple
scoring models to select projects.
3. Use more sophisticated scoring models, such as
the Analytical Hierarchy Process.
4. Learn how to use financial concepts, such as the
efficient frontier and risk/return models.

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 Summary

5. Employ financial analyses and options analysis to

evaluate the potential for new project
investments.
6. Recognize the challenges that arise in maintaining
an optimal project portfolio for an organization.
7. Understand the three keys to successful project
portfolio management.

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