Please Sir, Can I Have Some More?
When considering a request for additional project funding there are three types of funds:
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sunk funds,
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the ‘money at risk’ (to be spent in the next phase)
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and the remaining projected cost to complete the project.
The remaining projected costs have not yet been spent even if they have been approved.
Money already spent is ‘sunk’ and cannot be recovered. Money not yet spent is controllable. So, when do you continue or stop investing in a project? When are you pouring good money after bad?
Alternative Perspectives
When a project asks for more funds there are two ways of looking at the additional investment
- The incremental cost over and above the ‘sunk funds’ invested to date — "only another $Zm"
- An increase in the total cost of the project from inception — from a total of $Xm to a new grand total of $Ym.
Using the incremental approach projects can (and do) grow from $60m to $180m, for example, in “only another $20m” increments! Each decision justified on the basis of investing some more to realize some value from the sunk costs to date.
Some project managers will argue that the only consideration is the total cost from here on in, as the sunk costs are already gone. So, having spent, say, $50m, you can justify another $20m on top of the originally approved $60m as “we just need another $30m to finish”.
This is a very dangerous road to follow.
The relevant questions are:
“What total cost of delivery will the value proposition sustain?”
At some point the financial return on the investment (ROI) will turn negative. From this point onwards you are destroying capital in your business.You need to know the maximum delivery cost that your project’s benefits will support to give you at least a neutral ROI. Be very reluctant to go beyond this cost.
“What has caused the need for a re-estimation of the total costs?”
The seeds of project failure are often sown early in a project but manifest themselves much later. Projects that go wildly over budget are often trying to cope with inherent problems that they’ll never really solve.You need to explore the root causes of the overrun – Poor productivity? or Poor workload management? or Inadequate requirements? or Inappropriate software? The latter two examples indicate a project that should be stopped and re-evaluated to determine if it can be made viable and whether it should be restarted or shelved.
“How certain is this ‘final’ figure?”
Most projects that have gone way over budget have done so in several small increments. This is partly because small increments are easier to get approved, and partly because the bases on which these revised estimates were calculated were not reliable.
You need to know how certain the estimates behind the revised figures are. If your project is still high on the “uncertainty curve” (ie there are many uncertain elements) then you know the figures you are receiving are uncertain and, therefore, likely to be exceeded again in due course. In this case you know that this request for additional funds is not likely to be the final cost. So, are you prepared to spend even more on top of this amount? If not, stop the project now.
“What is the business cost of not completing this project?”
Taking a purely project-financial perspective and stopping a project because it is no longer financially viable can destroy other business value. For example, if you’re trying to catch up with the competition and your project becomes financially unviable; if you stop the project you’ll remain uncompetitive in the market with consequent downstream impacts.
You need to understand the full business impact of the project (usually covered in the business case’s project rationale and ‘do nothing’ options) when making a decision. Are the downstream impacts acceptable (either way)?
The Tax Dimension
Further complicating matters is the tax dimension that often requires cancelled projects’ costs to be expensed this year whereas delivered projects’ costs can be depreciated over several years. This tax policy encourages pouring good money after bad to deliver ‘something’ and enable depreciation. (This is why it is important to design projects to deliver progressive value – a topic of other articles.)
So, when do you pull the plug rather than continue to invest?
1. When the project will not deliver a (worthwhile) solution.
We stopped a HR system that was so out of control that it had consumed its total budget and then some more before it had even finalized defining the requirements.
We stopped another project in the planning phase when it had re-planned three times in three months but was unable to articulate what it was going to deliver. This project, originally costed at $82m, was restarted and delivered for $35m.
2. When the project’s original costs/estimates are obviously way out of range
Where, for example, a project’s original cost estimates are seen to be, at best, half of the likely total cost.
A $5m project should be set up as a $5m project; a $10+m more complex project will be set up differently and require a different calibre of project leadership team. Just ploughing money into a project that was set up inappropriately is to invest in failure.
Badly mis-estimated projects need to be re-baselined, re-justified and restarted — not just continued with additional funds.
3. When the project is not delivering successfully — a proven record of non-success
We stopped a project that had delivered phase 1 but it was not working well and the estimated cost of rolling out the other five phases had increased by 50%. Rather than impose the same or similar pain on the rest of the organization, the project was cancelled and the implementation rolled back to the original system. The total investment ($11.7m) was written off.
4. When the value has been lost
Where the project’s value is based on uniqueness, being first to market or lowest cost, for example, but this opportunity has been lost.
We stopped a ‘low cost account’ system in a bank when the projected cost of delivery and operation of the new account exceeded the current account's system costs.
5. When the need for the project has disappeared/is found to be missing or can be met more cost-effectively
We stopped a project when we found an alternative solution could fix the problem for less than 4% of the original project’s projected cost.
We cancelled a project when we found that the problem it was solving would not occur for another eight to ten years!
6. When there is a better use of the resources
We cancelled a “Staff wardrobe stock control system” when we couldn’t find any IT resources to develop the systems to bring new products to market. While few of the wardrobe system staff resources could be reallocated to the new projects in this case, by releasing them and hiring the appropriate resources we could deliver the organization’s strategy (even if not its wardrobe!).
In Conclusion
Always think of it as your money — would you personally continue to invest in this project? Don’t be afraid to stop projects and reallocate the funding to more worthwhile projects that will generate greater value. After all, generating the optimum value is what portfolio and investment management is all about.
Read about the diliemmas involved in capital management in our entertaining ebook, "The Capital Crime".
