How to focus only on good projects?
In a world of scarce resources, portfolio management is key to maintaining a balance between the project’s risks and returns. But this is much more complex than simply applying some methodologies. It requires implementing a management culture that banishes some false beliefs from the minds of many managers…
“I understand the concept of a strategic portfolio very well”, an oil company CEO once told me. “I know that we will have to take risks, and that some drilling projects will be successful, and others will not. That’s clear to me. All I ask is that we drill the successful wells first and save the unsuccessful ones for last.”
In previous articles, we have presented various methodologies, structures, and processes for effective portfolio management within an organization. Here, we will focus on the management of a type of portfolio that has great impact on the success of a business, the portfolio of the company’s strategic projects.
In general, technical aspects can be implemented quickly. But they will be of little use if we fail to manage cultural change, banishing some deeply rooted but false beliefs.
Some may seem obvious. But, in years of experience working in this area, I have learned not to take anything for granted.
We cannot choose the successful projects
If we could know in advance which projects will be successful and which will not, as that oil manager intended, what would be the point of managing portfolios? We would only need to invest in the successful ones and dismiss the rest.
Of course, we don’t know which projects will work. But many times, we act as if we had this knowledge. Therefore, the first step is to recognize that not all projects will be successful. This is easy. The hard part comes in steps two, three and four: accept it, accept it, and accept it.
The good portfolio manager is not the one who guesses which projects will be successful, but rather the one who understands the risks of each one and what levers can be moved in the process, to increase the probability of success of the most profitable ones.
If we are going to pursue long-term projects, let them be many
“A long-term project is a short-term project that didn’t go well.” This is one of the best definitions I’ve heard.
Many times, long-term projects began as short-term projects whose horizon was gradually extended, to wait for them to bear fruit. In other cases, they are really projects with higher risks (and potential) that seek success on a distant horizon.
If we have a conservative and short-term portfolio, we will likely not capture the most lucrative opportunities in our market. Therefore, a good portfolio should include some projects with higher risk and potential return on a distant horizon.
Continually betting on low-risk projects might be good for the manager, but it’s definitely bad for the organization’s long-term sustainability.
But how many projects should be high risk? By definition, the higher the risk, the lower the probability of success. Therefore, to succeed with at least one, we will have to nurture our portfolio with several high-risk projects. If we only have a couple of such initiatives, it is likely that none of them will bear fruit and we will end up wasting valuable resources.
In general, this is easier said than done. The truth is that company incentive systems generally reward only projects that turned out to be successful. As a result, managers often “play it safe” and worry about guaranteeing a certain number of these low-risk projects. The manager who takes risks and fails is punished.
Let’s fail fast and move on
Sustaining projects that don’t get off the ground for a long time consumes resources that could be used for more valuable purposes. Therefore, if a project is going to fail, let it be fast. If you are going to have moments of truth or tests where you can see the potential success or failure of the project, try to anticipate these tests to fail as soon as possible and reallocate resources.
The problem is that killing projects is hard. Rather than annihilate them with a decisive decision, many managers prefer to let them die slowly during the development stages. Above all, when it comes to “our project”. Many times, we think that if we give it a few more months, the results will begin to be seen.
The self-confidence bias clouds our ability to judge the potential of a project in which we have invested so much time and effort. We are usually optimistic when we shouldn’t be.
To avoid this bias, it is important that the evaluation is carried out by someone who has not participated in the project and who preferably has an overview of the rest of the organization’s initiatives. Every business unit has an insatiable desire for capital. An outside look can better judge where to direct scarce resources.
Capturing the value of the real option
When we evaluate a project, it is essential to incorporate the additional value provided by its future management. A good project team has a value that is manifested in the decisions that will be made in the future. And this value must be quantified and incorporated into the risk measurement.
A project with less adaptability or less flexibility has less value than a similar one in that, at some point in its life, the decision can be made to change course if things don’t go as expected. If we omit the value of this real and future option, we are likely undervaluing the projects, and taking each decision as if there were no later moments to change course.
In short, in a world of scarce resources, we will never be able to fund all the projects that we would like to. And, with all due respect to that CEO of the oil company, we don’t know “a priori” which ones will work, and which ones won’t. To have a balanced portfolio of projects that builds the company’s vision requires a decision-making capacity that allows us to assess uncertainty, understand our limitations, quickly clean up the portfolio, and above all, understand the value of our management capacity. Project portfolio management is not a mere set of methodologies, but a management culture that must integrate these points among all areas of the organization.
Partner at Tandem.