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Putting Lipstick on a Pig

Business cases, project economics and accountability in investment decisions

We live in a world of investment-driven and project-oriented companies that require us to make decisions every day in a risky and uncertain environment. Companies use numerous approaches to deal with the problem of decision-making under risky conditions, including standardised processes and planning methods. At specific milestones within the phases of a project, management decides whether a project should proceed or stop based on the progress achieved, the results to date and the project's plans.

The central deliverable at these gates, particularly for the final investment decision, is the forecast economic viability of the project. This document is intended to provide an objective statement about the project's benefits, supported by figures.

The project manager is invited to the gate to give what is effectively a sales presentation. Well prepared, the project manager uses an impressive presentation to provide an overview of all planning work and results achieved to date. The presentation explains the project's purpose and sets out the plans for the execution phase, including the resources and budgets required. The finale of the presentation is the business case, showing product-life-cycle costs and revenues based on supposedly objective assumptions and allegedly taking into account every uncertainty and risk that could potentially arise. At the end, the project is reduced to a small number of KPIs, such as IRR and NPV, on the basis of which management decides to provide the required budget, while the project manager promises to deliver the financial benefit to the company.

The project manager may be aware that the case is being exaggerated slightly and that the economic figures may even be fictitious. The project manager may also know that the promise made to senior management cannot be kept—perhaps even realising that lipstick has been put on a pig.

Why the Lipstick?

In larger companies, projects are not viewed in isolation. Projects are brought together in a project portfolio and compared using different criteria. The portfolio is also continuously supplied with new business ideas and opportunities. In addition, companies generally have a medium- to long-term planning process in which limited resources—people and funding—are allocated among numerous projects. Ultimately, this creates competition between projects and between project managers and sponsors, which can turn the economic evaluation into the weapon of choice.

This situation leads to increasingly subjective assumptions in the economic evaluation: objective criteria may be deliberately omitted; only a desired part of the picture may be presented; the most important value drivers may be embellished; and risks, uncertainties and their effects may be assessed unrealistically. The defined processes and methods continue to be followed, but business-case decision-makers effectively cherry-pick the assumptions in order to emphasise the project's benefits and make the project appear even more attractive to management.

Will the Pig Be Discovered?

Investment projects are long term. This is precisely why the question above is not the real problem. Yes, the pig will eventually be discovered; it is only a matter of time. Long term also implies that the people who make a decision today will not necessarily be the same people who identify the pig at a later stage. It further means that, when this happens, there will most likely be no individual or team that can still be held accountable.

Removing the Lipstick

Holding project sponsors and project managers accountable for the results of their projects appears to be the obvious solution. However, the stakeholders and influences affecting sponsors and project managers must also be understood. Senior and middle managers in multinational companies are usually guided by management-by-objectives systems and KPIs that, in most cases, are intended to generate company growth. This growth comes from projects with good—or at least promised—results.

Ultimately, this means that managers encourage project protagonists to submit promising projects for approval. Managers may even benefit personally from a higher number of growth- and value-enhancing projects passing through the project funnel and may therefore welcome the lipstick on the pig. This can only work where there is no clear accountability. Project benefits and project justification consequently become unclear and more difficult to verify.

Companies must therefore review their KPIs and assess whether they encourage questionable business models and economic evaluations. KPIs should motivate managers to identify pigs early and remove them from the project portfolio. Accountability and pig-spotting require continuous monitoring of the economic evaluation, its assumptions and the associated KPIs, as well as careful planning and continuous identification of assumptions, risks and uncertainties throughout the different project phases. This must be performed consistently, centrally, transparently and accurately.

Tracking the business case across the project phases can also reveal the credibility of project managers. For example, a major change in a project's economic performance may be a sign of increased maturity, but it may also reveal instability in the underlying assumptions.

It is widely recognised that many different individuals contribute to corporate decisions in a variety of ways, not only through formal channels. It can therefore be difficult to identify who should be responsible for particular outcomes. The problem intensifies when so many factors and individuals influence a project's result.

Thompson identifies this situation as the 'problem of many hands'. The accountability dilemma means that responsible individuals who could not have prevented particular outcomes may either be punished unfairly or held accountable only symbolically, without suffering any consequences. When an organisation is held accountable, all individuals within the organisation either share the blame equally or are collectively acquitted.

One possible solution is to broaden individual responsibility. Individuals would then be held accountable for failing to take organisational dysfunctions into consideration. Project sponsors and project managers would therefore assume responsibility for aspects of the business case that they might otherwise define as external to their project. Whatever a company decides to do, accountability must be defined and clearly assigned to individuals. Accountability will only be taken seriously when it is part of the corporate culture, when it is monitored and when it has consequences.

Defining a Pig

Project sponsors and project managers generally calculate the economic viability of their projects independently of other projects. All planning inputs and assumptions are therefore generated within the project. The accuracy of the project evaluation primarily depends on the quality of these assumptions. The future is uncertain. Exogenous assumptions concerning markets and prices are therefore used to describe a project's economic future. Projects attempt to reduce technical uncertainty through studies and research, allowing assumptions about endogenous factors—such as production volumes and required resources—to be compiled.

For management to decide as objectively as possible between different projects—that is, whether one project performs better than another—it must recognise the need for a common basis for decision-making: a shared foundation of business-model assumptions, methods and evaluation techniques applicable to all corporate projects.

For exogenous project factors, managers must provide a common set of planning assumptions concerning markets, the economy, prices, and global economic and political scenarios. These assumptions must be applied consistently and without exception across the entire company.

Assumptions relating to project-endogenous factors must follow the same rules and procedures, whether these involve design standards or cost-estimation rules. Finally, the economic calculation methods must be appropriate and must take all assumptions, risks and uncertainties into account. Suitable methods should be selected according to the specific uncertainty of each project. These may range from basic discounted cash flow and decision-tree analysis to real-options valuation and Monte Carlo simulations.

Responsibility for establishing, continuously administering and developing this framework lies with the company's management. In other words, the same management level establishes the rules and also carries out the pig-spotting at every gate.

The Pig-Spotters

The business case and the economic calculations are prepared within the project. This activity may become a central focus only a few times during the project lifecycle and may therefore not be a core competence of those responsible for economic calculations within the project team. Furthermore, business models are not necessarily compared or benchmarked against those of other projects. Project managers do not necessarily seek best-practice examples in their environment either.

Within large, project-oriented companies, it therefore makes sense to provide central support for developing business models across the project portfolio. This organisational unit not only ensures the application of the company's defined common basis, but also serves as a centre of competence that can make a valuable contribution to individual projects through experience, benchmarks and methods.

A central service provider is responsible for the business-modelling process. It collects all necessary inputs, assesses and calculates the models, and ensures the quality of business models and economic evaluations. This also creates clear accountability to management for all results based on the common framework. Using external service providers can further increase objectivity by incorporating experience gained across different companies and industries.

Spotting Pigs, Not Piglets

Competition between projects begins as early as the project-initiation phase. Even at this stage, a project requires a positive economic evaluation before the opportunity can be comprehensively assessed or the project's strategy, content and concept have been sufficiently identified and defined. Projects must demonstrate positive portfolio results regardless of their stage of development. This already creates inaccurate and misleading information for decision-making.

More fully defined projects with comparatively realistic economic evaluations compete against newly identified opportunities promising extraordinary results. Conversely, new opportunities that may not yet be fully understood can be removed from the project portfolio even though they might ultimately prove extremely beneficial.

Opportunities should first be identified and assessed at a high level to determine whether they are worth pursuing before they are required to compete against other projects in the portfolio. A complete assessment of the underlying factors, conditions, solution approaches and concepts should take place before detailed project planning begins. Only once the key parameters of a project have been established can meaningful economic evaluations be produced, projects become comparable and decision-making become value-oriented.

This means that companies must examine their value chain to identify processes and opportunities that enable the organisation to generate enough opportunities and allow them to mature sufficiently before pig-spotting begins. This requires a larger budget for developing opportunities. However, this additional investment is offset by the efficiency gains created through relevant processes designed to optimise and accelerate projects at an early stage.

No More Lipstick

Business modelling and economic evaluation should not be used to put lipstick on a pig: we should be able to look at the pig without make-up. Economic evaluations are the most important means of determining which projects are profitable and beneficial and which will support a company's long-term survival and growth. Management must therefore ensure that its decisions are based on reliable foundations.

For some companies, this may require a fundamental change in thinking. Business cases and economic viability must no longer be used as arguments in a sales pitch. Business-model documentation and the associated economic evaluations are important project deliverables and therefore essential components of both medium- and long-term corporate planning. They are the primary basis for decision-making.

We must take business modelling in projects and all related processes seriously rather than treating them as project-marketing tools. Greater accountability for the people involved, central organisational units supporting the relevant processes, and shared, consistent planning assumptions, methods and rules can improve the situation and at least reduce the use of lipstick.

P.S. I personally think pigs are beautiful—I do not intend this article to suggest that pigs need make-up.