Technical Terms Used in Project Portfolio Management (Continued)

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dependency matrix

Also called a dependency structure matrix (DSM), a method for documenting and analyzing the interdependencies between programs, projects, or project tasks. The capability for constructing a dependency matrix is provided by some project management tools and some project portfolio management (PPM) tools. A few PPM tools take into account the interdependencies expressed in a dependency matrix when computing optimal project portfolios.

The rows and columns in a dependency matrix are labeled with projects and/or programs and the cells represent dependencies. A number placed in a cell indicates an estimated degree of dependency between the project represented by the column and the project represented by the row.

Dependency matrix

The precise meaning of the numbers entered into the cells is not standardized and differs depending on the application and the nature of the dependencies. For example, in some versions, a zero or one is written into each cell—zero indicates there is no connection between the projects, one indicates that the project corresponding to the column cannot be conducted unless the project corresponding to the row is completed. In a version of the tool for projects to create new products, users indicate in the diagonal cells the amount of revenue produced if the corresponding projects are conducted alone; the numbers in the other cells in the column indicate the amount of revenue produced if the column project and the corresponding row projects are jointly conducted. In another version, users indicate in the cell corresponding to a column and row the "impact," expressed as a percent, that the row project has on the column project, where impact could relate to impact on benefit, cost, schedule, or risk.

Some PPM tools use a dependency matrix for portfolio monitoring. For example, "traffic light" icons may be associated with projects. A red light may indicate that a problem is forecast for a project because a problem has occurred for one of the projects on which it is dependent. A green light may indicate that a project is dependent on other projects, but that so far no problems have been encountered by those projects.

derivative project

A project with objectives or deliverables that are only slightly or incrementally different from those provided by the organization's other projects. The term is typically used for projects intended to modify existing products or services, or that create new products that derive naturally from the firms other product offerings. Projects that provide an add-ons, new packaging, or manufacturing efficiencies are typically viewed as derivative projects.

deterministic

Non random. Typically applied to describe a model or method of analysis whose outputs are fully determined by its inputs, with no uncertainty or possibility of an alternative outcome. Compare with stochastic.

discounted cash flow (DCF)

See net present value (NPV).

discount rate

A rate, expressed as a percentage, used to compare the value of obtaining future versus present outcomes. The discount rate appears in the formula for net present value, where it is denoted r. The discount rate indicates time preference in that it specifies the return that would be required to make a decision maker indifferent to delaying an outcome (e.g., If you could earn a 10% return, would you be willing to postpone receiving your paycheck for a year?). In effect, the discount rate expresses the opportunity cost of committing current funds—If I can earn a return r per year from investing, then I won't be willing to accept less than r if my current investment delays my cash flow by a year. Discount rates are important to project portfolio management because they provide a means for comparing projects that produce delayed costs and benefits.

discrete risk

An event, circumstance or condition that may or may not occur, which would adversely and predictably impact a project or its outcomes (e.g., technology failure, strike, discovery of unexpected hazardous conditions, labor strike). A discrete risk may be characterized by the probability of occurrence and the estimated consequences should the event occur. For comparison, see continuous risk.

discrete scale

A measurement scale that allows for the assignment of only a finite number of possible values, for example, a one-to-ten scale that does not allow assigning non-integer values. For comparison, see continuous scale.

diversification

The inclusion of different types of investments within a portfolio. Diversification is commonly used in financial investing to reduce risk. Similarly, diversification tends to reduce uncertainty over the total return generated by a portfolio of risky projects. Thus, project diversification is often good for project portfolios. However, diversification is not as effective when uncertain project returns are highly correlated. For example, if many projects would be similarly and significantly affected by the same uncertainty (e.g., an economic recession or a change in currency exchange rates), diversification will not be as effective at reducing portfolio risk.

downside risk

The maximum amount of possible loss in a given decision or situation

drill down

A term used to describe the action of moving from summary level information to the more detailed information on which the summary is based. Tools for project portfolio management (PPM) are often advertised as providing dashboards with drill down capability—clicking on summary information on the dashboard causes the user to navigate to a more detailed level or record. Drill down capability is made possible by arranging data in hierarchies that start with general information and encompass increasing levels of detail.

due diligence

Refers to the level of care and analysis that should be reasonably conducted prior to making business investment decisions. The term is most often applied in the context of venture capital investment and business mergers and acquisitions, where due diligence is regarded as the essential means for preventing avoidable harm to the investing parties. However, the concept applies to any important decision. Before investing scarce resources to conduct a major project, a deliberate, documented process should be undertaken to uncover and understand all of the information relevant to the choice.

Due diligence is not just important for making good decisions; it is also important for the defense of those decisions. In legal disputes involving situations where projects have gone badly or created significant health, environmental, or economic losses, due diligence has been established as a legal obligation, and demonstrating due diligence represents an important legal defense. Courts, however, have held that due diligence requires not merely showing that the standard of care for the decision was normal for the industry, but proving that what was done is what a "reasonable and prudent" professional within the area would do. Failure to meet this standard can give rise to civil and criminal liability

In the context of project portfolio management, due diligence means that organizations should institute a deliberate, documented, quality process for making major project investment decisions. The process should include and ultimately be based on an evaluation of the consequences of doing versus not doing the project and the risks involved. Due diligence for project selection doesn't just improve decision quality, it ensures that tough choices can be defended in hindsight. Even if a simplistic project evaluation technique, such as strategic alignment, could be shown to be the "normal approach," organizations (especially those that depend on projects for success or that operate assets or sell products that produce public risks) would be well advised to utilize better and more defensible project evaluation methods.

dynamic programming

A type of mathematical solution technique wherein a complex problem is broken into a series of interconnected and similarly-structured sub-problems in such a way that the sequential solution of the sub-problems results in the solution to the complex problem. Dynamic programming is used as a solution technique in some project portfolio management tools, especially tools designed for projects requiring a series of decisions, such as new product development projects. When applicable, dynamic programming is a divide-and-conquer approach that can efficiently generate solutions to complex problems.

E

earned value management (EVM)

An acronym-rich method for measuring progress on projects and indicating any variances in planned accomplishments, schedule, and cost expenditures. EVM, also called earned value analysis (EVA, not to be confused with economic value added) is primarily used as a way of reporting project progress to stakeholders, and government regulations often require that contractors providing services to government agencies comply with standards for using EVM. In the context of project portfolio management (PPM), EVM may be incorporated as a means for reporting progress on individual projects and for demonstrating compliance with government requirements for EVM.

The basic concept with EVM is that project work be planned, budgeted, and scheduled in time-phased, "planned value" increments. Typically, these work increments are defined in a hierarchical fashion as a work breakdown structure, but for a smaller project the work elements might simply be individual project tasks. The work elements define a schedule and cost/value baseline for the project. As project work is conducted, project value is "earned." Various indices are computed to summarize project status based on comparing earned value with planned and actual costs.

With EVM, the value that is assigned to each work element is termed its planned value (PV). The PV is meant to be a quantity or weighting factor that indicates the portion of the project value that, according to the plan, will be contributed by that work element at a specified time. Usually, the PV for a work element is set equal to its cost, however, the PV might alternatively be defined as the number of labor hours required or as a subjectively assigned number of "points."

The value of the work element is earned as the work is completed. For example, the earning rule might be that 25% of the value is earned when the task is started, and the remaining 75% is earned upon completion.

Progress against the plan is reported on a regular basis (e.g., weekly or monthly) by accumulating earned value (EV) based on the earning rules. By subtracting the value of the work planned (PV) from the value of the work performed (EV), a schedule variance (SV) may be computed at any point in time during the project:

(Some EVM documents alternatively define SV = PV - EV. With the definition given above, negative numbers are "unfavorable," and positive numbers are "favorable.")

Similarly, a schedule performance index (SPI) may be computed by dividing the EV by the PV:

If the SV is greater than zero (SPI is greater than 1), the work is ahead of schedule. If the SV is less than zero (SPI is less than 1), the work is behind schedule. Schedule variances can be rolled up to any level in the work breakdown schedule to provide higher-level indicators of schedule compliance.

Since a work element's PV is traditionally chosen to be the scheduled cost of the work, the traditional term for a work element's planned value is the budgeted cost for work scheduled (BCWS). The traditional term for earned value is the budgeted cost for work performed (BCWP). The actual cost of conducting each work element is termed the actual cost of work performed (ACWP). In this context, where value and cost are both measured in dollars, a cost variance (CV) can be computed by subtracting the actual cost of work performed (ACWP) from the budgeted cost of work performed (BCWP):

EVM defines many additional indicators of technical, schedule, and cost performance that can also be calculated, and guidance is available for interpreting and addressing the various discrepancies that the indicators may reveal. As you can no doubt appreciate, EVM can be confusing because of the many acronyms that are used.

Although EVM is a well-established and effective means for managing the completion of complex projects, it's major limitation from the standpoint of PPM is that it does not provide indicators for tracking the anticipated ability of the project to deliver benefits to the organization. Because EVM is unconcerned with project changes that might impact the ultimate value derived from a project, it provides no signals that might suggest that the project plan should be reconsidered. EVM might, for example, indicate that a project is under budget, ahead of schedule, and within scope, but that project could nevertheless be in trouble with regard to achieving the benefits that motivated the decision to fund it.

economic value added (EVA®)

A financial project valuation metric and related management framework developed by consulting company Stern Steward founders Joel Stern and G. Bennett Steward III (EVA® is a registered trademark of Stern Steward). The EVA® of a project is calculated by taking net operating profit and subtracting a charge for the capital or assets deployed. The deducted amount is the "cost of capital"—what shareholders and lenders could obtain by investing in securities of comparable risk.

EVA®, also sometimes termed earned value added, provides a useful input for prioritizing projects because it quantifies the direct financial component of project value. However, other techniques are needed to account for the indirect or non-financial components of project value. Also, depending on the characteristics of projects, it may be more convenient to account for the cost of capital using the more traditional calculation of net present value (NPV).

While there are other financial metrics that likewise account for the cost of capital, the appeal of EVA® is that it does so in a conceptually simple and intuitive way that is easy for non-financial managers to understand. Since EVA® starts with familiar operating profits and then deducts a charge for the capital employed, it can be interpreted simply as "net profit minus the rent."

EVA® has become popular because it highlights the importance of the cost of capital when financially evaluating projects. EVA® may show, for example, that despite increasing earnings, a project is destroying shareholder value because the cost of capital associated with the required investment is too high. By assessing a charge for using capital, EVA® forces managers to think about managing assets as well as income.

As indicated above, a major weakness of EVA® is that it fails to account for non-financial project impacts (such as improved employee knowledge) that are difficult to express in terms of incremental cash flows. Also, accounting for opportunity costs by subtracting a capital charge is conceptually simple only if project start times, durations, and spending rates aren't very important (if they are, then the NPV approach of discounting cash flows using hurdle rates is computationally and conceptually simpler). Like classic NPV, EVA® does not explicitly address cash flow uncertainties, and it can be very difficult to determine the appropriate charge for the capital used by a project.

efficient frontier

In the context of modern portfolio theory, the efficient frontier is the bounding curve obtained when portfolios of possible investments are plotted based on risk and expected return. The efficient frontier shows the investment combinations that produce the highest return for the lowest possible risk. A portfolio that is not on the efficient frontier is said to be "inefficient" because another portfolio exists that has lower risk for the same return.

Efficient frontier as defined by modern portfolio theory

In the context of project portfolio management, the efficient frontier typically refers to the bounding curve that is obtained when portfolios of projects (or sometimes individual projects) are plotted based on cost and some quantity that is intended to represent portfolio (or project) attractiveness (ideally, the y-axis should represent the value or worth of the portfolio to the organization). In this context, a portfolio that is not on the efficient frontier is inefficient because another portfolio exists with greater value for the same cost. For more explanation see the paper chapter on the finding the efficient frontier.

Efficient frontier as defined by project portfolio management

ELECTRE

A decision aid that involves comparing pairs of potential actions based on multiple criteria. ELECTRE, like PROMETHEE, is a so-called outranking method, representative of what has been referred to as the "European school" of multi-criteria methods. Unlike multi-criteria analysis methods such as multi-attribute utility analysis (MUA) and the analytic hierarchy process (AHP) (the so-called "American school"), outranking methods do not involve developing or assessing from decision makers a utility function (see decision theory) for quantifying decision-maker preferences. Instead, with ELECTRE and other outranking methods, preferences are determined indirectly by having decision makers express relative preferences between pairs of options.

The results of the comparisons are organized into a matrix of values that show the "concordance" and/or the "discordance" between the candidate actions. The matrix is analyzed to produce various results and to choose, rank, or sort the alternatives.

The ELECTRE method was developed in France in the late 1960s and the term is an acronym for ELEmination et Choix Traduisent la Realite—elimination and choice reflecting reality. Like PROMETHEE, ELECTRE comes in various "versions" that indicate refinements and whether the version is meant for selecting or classifying options. ELECTRE has been used to prioritize projects and some project portfolio management tools are advertised as supporting the method.