Capital Projects

What Every Executive Needs to Know to Avoid Costly Mistakes and Make Major Investments Pay Off

Paul Barshop

• Publisher: Wiley
• Year: 2016
• Print ISBN: 9781119119210
• eBook ISBN: 9781119119241
• Edition: 1
• Topic: Business
• Subtopic: Project Management
• Index: Business

A real-world framework for driving capital project success

Capital Projects provides an empirically-based framework for capital project strategy and implementation, based on the histories of over 20, 000 capital projects ranging from $50, 000 to $40 billion. Derived from the detailed, carefully normalized database at preeminent project consultancy IPA, this solid framework is applicable to all types of capital investment projects large and small, in any sector, including technology, life sciences, petroleum, consumer products, and more. Although grounded in empirical research and rigorous data analysis, this book is not an academic discussion or a conceptual dissertation; it's a practical, actionable, on-the-ground guide to making your project succeed. Clear discussion tackles the challenges that cause capital projects to fail or underperform, and lays out exactly what it takes to successfully manage a project using real-world methods that apply at any level.

Businesses report that 60 percent of their projects fail to meet all business objectives, and IPA's database shows that projects' final average net present value undershoots initial estimates by 28 percent. This book provides concrete, actionable solutions to help you avoid the pitfalls and lead the way toward a more positive outcome.

• Avoid the missteps that make capital projects fail
• Learn the specific practices that drive project success
• Understand what effective capital project management entails
• Discover real-world best practices that generate more value from capital

When capital projects fail, it is almost always preventable. Inefficiency, underestimated timelines, and unforeseen costs are the primary weights that drag a project down—and they are all avoidable with good management. Capital Projects gives you the insight and practical tools you need to drive a successful project.

1
Falling Short of Expectations
How Executives Struggle to Deliver the Value from Their Capital Projects

Executives often start out with high hopes for their capital projects, only to have them fall short of expectations. Capital projects are investments of substantial company resources to develop, to improve, or to refurbish an asset that is expected to generate cash flows for more than one year. Only 60 percent of finished projects actually meet all objectives after the project is complete and the asset was put into service.¹ The success rate is not much better than a coin flip. The complaints about projects range from business cases ruined by cost overruns, to market windows missed because the project was late, to assets that did not perform as expected and that are expensive to operate.

As an executive responsible for capital, you do not have to accept these results. Success or failure is not random. I will show you what you can do to increase the probability of a successful project, make your project portfolio pay off as expected, and, critically, reduce the chances of the disaster project that loses all the capital investment and gets executives fired. The road to success starts with you. Success will require your active leadership and participation in the projects that you are sponsoring or that your organization has a major role in.

How do executives cause projects to fail? Here is a real example. A company initiated a small project to boost operating margins by consolidating production at one factory. The plan was to relocate some equipment from an older factory to a newer one before shutting down and selling the old factory. The project had a very strong business case and was expected to pay back its investment in less than a year. A critical success factor for the project was to have the consolidated facility up and running in time for a three-month production period when the factory would be run at full capacity. The factory was used to process an agricultural product, and the new factory had to be ready for the harvest. The project was a failure because the consolidated factory was only able to run at half capacity during the production window. The business needed three supplemental projects to finally bring the facility up to full capacity.

So, what happened? How did this project turn out to be a failure—and why were the executives in charge responsible? Many mistakes were made, but the most important one was that the executives delayed the start of the project so that the older facility could finish a production run. Another bad decision was not allowing the project team to get input from the operators of the old factory because of the sensitivities of shutting down the old factory where people were about to lose their jobs. The late start caused mistakes in the technical design because of the rush to get the work done. And because the team could not work with the factory operators, they had to make assumptions about how the equipment would be reused—and those assumptions turned out to be wrong.

The root cause of the failure was that the executives never reconciled the conflict in their objectives. On one hand, they wanted to keep the old factory running and delay the announcement of the closing for as long as possible. On the other hand, they wanted the consolidated factory up and running in time for an important seasonal window. The desire to achieve both objectives is understandable. Executives face tremendous pressure to deliver value from capital. Delivering that value often requires meeting targets that are hard to achieve. In this case, the executives should have acknowledged the risk in the objectives and developed a strategy to reduce the risk. The mitigation would have lengthened the payback period but would have still allowed for a profitable project. Instead, the business lost money on the investment.

Background and Basis for the Book

At Independent Project Analysis, Inc. (IPA), we have been studying the problem of how businesses can maximize the value created by their capital projects for nearly 30 years. That is our mission. Our quantitative benchmarking services are used by the world's largest industrial companies as the core of their continuous improvement programs to derive more value from their projects. IPA's empirical research has led to the widespread adoption of project management concepts such as Front-End Loading (FEL) and Value Improving Practices (VIPs). The work of IPA's founder, Edward W. Merrow, has become the de facto handbook for the development and execution of megaprojects.²

For the past 22 years, I have worked directly with IPA clients all over the world evaluating projects and providing guidance on how to improve both individual projects and project systems. About eight years ago, I started a series of studies on the initial stages of capital project development. A capital project starts with an idea that a business need exists. Unfortunately, fully developed, viable projects do not fall from trees. There is hard work to be done to shape and define opportunities into projects that deliver sufficient benefits to justify the cost and risk. I have always been fascinated with these activities and, in particular, how a business and project organization should work together to translate a set of objectives for growth and profit into a doable project. Throughout this book, I will describe the executive's crucial role in capital project development as well as the steps necessary to ensure that the project organization listens carefully and fully to what the business needs.

Capital Projects Create Value

Capital projects are high-risk, high-reward activities for both the company and the executives involved with the project. Project success is critical to the long-term financial success of a company. Projects can be a business's main engine for profitable organic growth by introducing new products or services or by increasing the production capacity of existing products and services. For example, a financial services company may have invented a new algorithm for web-based investment advice but still needs to design the application and deploy the IT infrastructure to handle the expected growth in customers. A specialty chemical company may have struck an advantageous marketing deal with a foreign partner but now needs to build a plant to make the product. A manufacturing company may have spent years developing a new technology that will cut production costs in half, allowing it to undercut its competition and take market share, but needs to build a factory to deploy the technology. Projects can also make a business more efficient or solve nagging problems. For example, a project might purchase and deploy new software systems that make the company's sales force better. Even seemingly mundane projects to upgrade or refurbish existing assets represent significant commitments of capital that need to pay off to keep the company competitive.

Capital projects actually create value when the benefits from the asset created or modified by the project exceed the project cost. The most common method for measuring the added value of a project is the net present value (NPV) generated by the investment. The formal definition of NPV is the present value of future cash flows discounted at the appropriate cost of capital, minus the initial net cash outlay. More simply, NPV is the amount of shareholder wealth created from a capital investment after accounting for the total cost of the investment and the time value of money. For example, a $10 million capital project that generates $1 million in NPV has enriched the company owners by $1 million. Positive NPV from a capital investment is a good thing. Unfortunately, it is entirely possible for a capital project to make shareholders worse off than when they started. About one in seven projects will lose all of that $10 million capital investment.

Most Projects Create Less Value than Expected

Executives approve or reject capital projects based on the project's expected value. The financial gap between what was expected from a capital project when it was approved and what was actually achieved can be measured. The average project delivers 22 percent less NPV than what was forecasted when the project was funded. That is what we at IPA found in a study of 431 completed industrial sector capital projects. The business goal for each project was to increase profits by adding new production or manufacturing capacity.³ The 22 percent NPV erosion means a project targeting profit of $1 million would come out only $780,000 ahead on average.

The good news is that the average project is profitable; otherwise, everyone would be bankrupt! The bad news is that the promised profitability is often missed by a large and highly unpredictable margin.

Results Apply to All Types of Projects

The results of this study of industrial projects are important to you even if you are not an executive involved in a multimillion-dollar project to build a new factory. The conclusion that capital projects often fall short of delivering the expected business value applies to any type of project. It does not matter whether the project is to construct a new office building or to develop new software. In fact, the performance of capital projects done by companies with less experience and less infrastructure for doing projects is probably a lot worse. The industrial companies in my study are capital intensive, spen...

Table of contents

• Cover
• Title Page
• Copyright
• Acknowledgments
• Chapter 1: Falling Short of Expectations: How Executives Struggle to Deliver the Value from Their Capital Projects
• Chapter 2: Why the Stage-Gate Process Is the Best Tool Executives Can Use to Get the Most Value from Their Capital Projects
• Chapter 3: The Project Frame: Understand the Opportunity before Starting a Project
• Chapter 4: The Critical Project Sponsor Role
• Chapter 5: The Single Most Important Thing an Executive Can Do to Make Any Capital Project Succeed: Define Clear Objectives
• Chapter 6: The Executive's Role in Building and Supporting High-Performing Project Teams
• Chapter 7: Project Definition: The Fundamental Capital Project Concept Every Executive Must Understand
• Chapter 8: It's Going to Cost How Much!?! A Guide to Help Executives Avoid Capital Cost Surprises
• Chapter 9: Using a Project Steering Committee to Improve Executive Decision Making
• Chapter 10: Risk Management: A Mechanism to Understand Project Risk and Decide What to Do
• Chapter 11: Approve, Recycle, Cancel, or Hold: Making Good Stage-Gate Decisions
• Chapter 12: Executive Role, Executive Control: 12 Essential Rules
• Glossary
• Index
• End User License Agreement