Pergamon
International Journal of Project Management Vol. 16, No. 4, pp. 223-233. 1998
4 1998 Elsevier Science Ltd and IPMA. All rights reserved Printed in Great Britain 0263-7863/98 $19.00 + 0.00 PIh S0263-7863(97)00055-0
Project appraisal a framework to assess non-financial aspects of projects during the project life cycle M D S Lopes? Faculdade de Engenharia da Universidade do Porto, Departamento de Engenharia Mecdnica e Gestdo Industrial, Secqdo de Gestdo Industrial, Rua dos Bragas, 4099 Porto, Codex, Portugal
R Flavell* The Management School Imperial College o f Science, Technology and Medicine, Exhibition Road, London S W 7 2PG, UK
The methodology of project appraisal should assess the overall viability of a project for an organization. However, in many cases it has concentrated on the assessment of the financial and technical feasibility of a project only. A major reason why non-financial and non-technical aspects are not considered more fully during project appraisal is probably the lack of an analytical framework that would highlight the importance of those aspects and would provide guidelines on how to incorporate them into the appraisal. This paper tries to construct such a framework by extending published guidance through interviews with a number of project oriented organizations in the UK as well as a detailed examination of one very large and complex project. The framework identifies and analyses the non-financial aspects of projects, how they can be assessed, their relative importance to the success of the project, and how they can be incorporated in the appraisal procedure. These non-financial aspects include, in particular, the managerial role, strategic and synergistic effects with the rest of the organization, social, political, environmental and technical links, and organizational issues. © 1998 Elsevier Science Ltd and I P M A . All rights reserved
1. I n t r o d u c t i o n : objectives
According to several surveys (e.g. Refs [1] and [2]) project appraisal in the private sector has systematically concentrated on establishing the financial and technical viability of a project. Occasionally, non-financial aspects such as social, environmental, political or legal factors, are also deemed to be important; but these would usually be considered to lie outside the normal appraisal process, and be assessed through some form of subjective judgment 3. The emphasis on the financial and technical aspects of projects is understandable from two points of view. First, for private sector companies, the requirement for ensuring financial viability is ultimately related to the survival of the organization; an objective which can never be subjugated. In association, a project that is not technically viable is effectively unfeasible, and in turn would lead to financial problems. Second, and *Present address: Lombard Risk Consultants Limited, 13th Floor, 21 New Fetter Lane, London EC4A IAJ, UK tAuthor for correspondence.
more pragmatically, both aspects can, to a large extent, be quantified and manipulated. This in turn, in our opinion, leads to an over-confidence in the 'numbers'. Recent literature has been criticizing the emphasis placed on the financial and quantitative side of projects, defining it as myopic and misplaced (e.g. Ref. [4]). The analysis of a project should be broadened so as to include other dimensions, such as the organizational and managerial aspects, political aspects, social acceptability, environmental problems, etc., depending on the precise nature of the project (see, for example, Ref. [5] and the subsequent World Bank publications). These are all risk dimensions which can cause the failure of a project. This view is supported by the results of an increasing number of audits, conducted by both practitioners and academics, examining the reasons for success and failure of projects 4 8. These studies have suggested that many non-financial factors such as organizational and managerial, political, social and environmental issues, can cause the failure of a project despite very favourable financial or technical com223
Assessing non-)qnancial aspects o f projects during the project life cycle: M D S Lopes and R Flavell Table 1
2.
[+1 [+] [+] 3. 4.
[ + ] 5. 6. [+]7.
[+]8.
Basic principles and overall strategies Investment programmes should be closely related to organizational planning. The evaluation must be in the light of the organizational goals and strategies. Planning and definition of strategies should therefore come in the first place and they will set the tone for the evaluation. Planning throughout the life of the project, and in relation to that project, is also fundamental; initial planning must concentrate on building viable planning bases for the following stages. Projects should be phased. The benefits include: • building on experience and adapting to uncertainty; • establishing point-decisions on project go-ahead: • greater facility of stopping the project; • avoiding phases overlapping, if work at each phase is previously defined: • avoiding cost of enthusiasm; • continuously checking initial assumptions; • money being spent in steps (start with a survey of all risks instead of immediately developing the work). Work programmes should be defined by both timing and content. Use flexibility in the evalution procedures to adapt to changes and particular situations. Manuals can be used, and indeed are important, to provide a systematic, objective and comprehensive study of the project, but should always be seen as a guide and not as a straightforward checklist. Back-up strategies and plans should be defined for the major areas of uncertainty and risk identified. Train people how to think rather then using a mechanistic dependency on the written procedures. Use pilot projects or feedback from project monitoring to learn from past experience. Keep track of what is going on in the field and interrelated fields so that new opportunities can be detected and immediately assessed. Look to organizational support for the encouragement and creation of ideas and for the training of specialists. Change the culture of the organization, if necessary, so that appraisal is taken more seriously. The appraisal should be comprehensive from the start, but done in a progressive way, in terms of the depth of analysis. All highrisk factors should be identified at the start, including the non-financial and non-technical ones.
ponents. Therefore they should be assessed along with the financial aspects when appraising projects. A review of the literature, however, showed that there is little research into the role played by the nonfinancial aspects of projects in the appraisal. In particular there is no comprehensive study of all those aspects or any published framework that a c o m p a n y might use to incorporate systematically all the various non-financial components in the appraisal process. It is the objective of this paper to provide such a framework. The framework should be seen as a tool of risk analysis and management. It identifies all likely risks for the successful accomplishment of projects, and the ways that trough the appraisal these risks can be minimized and taken into account. It examines the nonfinancial aspects of projects, how they can be assessed, their relative importance to the success of the project, and how they can be incorporated in the appraisal procedure. These non-financial aspects include, in particular, the managerial role, strategic and synergistic effects with the rest of the organization, social, political, environmental and technical links, and organizational issues. These aspects were identified during the course of the research as explained in Section 3. The current paper is organized into four sections. The present section (Section 1) sets the objectives of the work. Section 2 discusses each area of analysis in detail, and summarizes the main findings and conclusions. Section 3 describes the underlying methodology and Section 4 concludes the paper.
Lopes 9. We have tried to separate, where deemed important, guidelines discussed in the literature and subsequently verified by the interviewed companies, and new guidelines which have not to the best of our knowledge been previously identified or sufficiently analysed. These latter are indicated by a [+] sign.
Table 2
•
strategy synergy - - r i s k of project vs risk of company
•
224
The risks are:
- - f r a g m e n t a t i o n of the business not using company's best capacities duplication of work [ + ] --inconsistency too much risk in one area
• [ +]
[+]
[+ ]
[+ ]
•
2. The f r a m e w o r k - - d i s c u s s i o n and summary of findings The main conclusions and findings concerning each area of analysis are discussed in the following subsections and are summarized in Tables 1-8 at the end of each subsection. Table 1 refers to the overall methodology of project appraisal, Tables 2-7 to each of the non-financial areas as defined in Section 1, and Table 8 to the problems of integration. For further details on each of the conclusions and its supporting evidence see
Strategic analysis
Key issues in the analysis:
Ways of minimizing the risks: strategy O predefine it clearly and comprehensively; O review it throughout the appraisal. --synergy O check consistency in all units; O make sure project has some synergy, to benefit from current experience; keep innovation in small steps. --risk O see how much company can afford; O diversification; be clear as to the type of risk company wants to take (usually spread risks by geography, politics, etc.) but also be clear what kind of projects the company is capable of doing; O the aim is to get a good balance of risk and doing things at which the company is good.
Assessment:
--when O at the preliminary analysis; --who 0 senior personnel, to have a clear idea about strategy and experience in assessing risk; 0 all units represented, to ensure coordination; how 0 all areas interdependently; [+] 0 use a strategy panel (ICL); [+ ] 0 use a list of items (Shell), or ensure knowledge of those items (senior personnel will have it); 0 use of a Directional Policy Matrix (Shell).
Assessing non-financial aspects o f projects during the project life cycle: M D S Lopes and R Flavell Table 3
Technical analysis
• Risks are normally associated with: --risky technologies; new technologies; - - b a d l y established technology; underestimation of the complexity of the task and frequent changes in the technical specifications. • The risks are: cost overrunnings; - - t i m e delays; - - p o o r quality of performance. • Ways o f minimizing the risks: understand the technology before the project starts; do not rush the design phase; - - g e t personnel trained; - - u s e standards of technology compatible with skills of staff; - - a v o i d changes as project proceeds; [ + ] --trace the impact, in all disciplines, of any change; use prototypes; avoid overoptimism in the assessment of the risks; - - g e t other opinions; use good personnel in the assessment of the risks; increase technology in small steps; - - g o for safer technologies rather than cheaper ones; [ + ] - - u s e of good review milestones, to allow the review and confirmation of assumptions, including demonstration of capabilities; - - u s e of joint ventures to transfer knowledge of technology; - - s h a r e the project, if this is too risky for the company alone to take it. • Assessment: --when - - a s early as possible in the life of the project; --reviewed throughtout; --who --technical personnel; [ + ] --double-checked.
[+]
how - - k e p t in mind the effects of that assessment being incorrect to allow for contingencies.
Basic principles and overall strategies for project appraisal This section discusses the overall principles and strategies that we believe should support any appraisal system. It is based upon perceived good practices; not incorporating them have been highlighted by some companies as a leading cause for project failure and was the subject of revision in their updated methodologies (Aquascutum, ICL, Delta). Many of the guidelines provided in the literature were recognized by the interviewed companies as important aspects to consider in their appraisal systems and some were emphasized. These were, the need to coordinate evaluation and planning, the need to plan throughout the life of the project, the importance of phasing the project, being flexible in the appraisal process, and learning from the auditing of past projects. Some new suggestions emerged from the companies. In particular, the cultural need to ensure that all aspects of appraisal were actually taken seriously; and making sure that the project appraisal process had a number of 'stopping' points, so that the money was spent in steps and effectively agreement was required at each stopping point before proceeding further. The latter slowed down the appraisal process as excessive enthusiasm for a project frequently caused premature approval before all the details had been determined.
All literature guidelines that were confirmed in the interviews as fundamental strategies and the new ones that came out from the companies are summarized in
Table 1. Strategic analysis The need to take synergistic and strategic aspects into account has been emphasized by recent literature 4"1°. Without this analysis, it is difficult to define a project as good or bad; what may be appropriate for one company may not be for another.
Table 4
Political analysis
•
The risks are: For national projects, political interference: O through funding, permissions, decisionmaking, political policies etc.; O they need Government support for major projects to succeed. For overseas projects political risk include: [+] O size of the project in comparison with the size of the economy (problems of financing it, pressure on the inflation rate, etc.); O inexperience (technical, managerial, etc.); O lack of resources; O nationalistic feelings; [+] O imposition of partners; [+] O bureaucracy and unclear rules of decisionmaking; [+] O different expectations of the project. • Ways o f minimizing the risks: [ + ] - - A comprehensive assessment of the economic and political situation of the country should be done as early as possible. Steps to be taken in case of conflict should be established in advance. --Nationalistc feelings should be constrained. This can be done by: O negotiating the basic deal in a manner perceived to be fair from the start; O developing good relations with the country's officials and with the inhabitants (obtain their trust, make them feel a counterpart; take their views into account); O recognizing the reasonable requirements and aspirations of the host Government; [+] O involving the nationals in management at all levels; [+] O participation of nationals in the profits; [+] O participation of nationals on the Board. [+ ] - - W h e n selecting an overseas partner, it is best to check their political relations with their Government. [+] International institutions can be involved for credibility. [ + ] - - I n v o l v e other countries and diversify the countries of investment. - - O n a day-to-day basis, be aware of all political implications of the different issues, and take them into account in making decisions. • Assessment: [+ ] --when O To be effective, it should be done at a time prior to the initial commitment. [ + ] --who 0 Use experts, internal and external people, on the analysis
[+]--how 0 talks with the Government and governmental bodies to assess stability and intentions as to the project; 0 visits to the country by the analysts to assess the economy and politics; 0 talks with previous companies operating in the area to gain knowledge of their experience within the political and economic situation of the country; 0 use previous economic and political reports on the country. [+ ] ~ontents 0 It should include, in particular, the economic structure of the country, political stability and past experience of foreign companies
225
Assessing non-fi'nancial aspects o f projects during the project life cycle: M D S Lopes and R Flavell Table 5
Social analysis
• The risks are: Possible delays on account of: --social opposition --public inquiries • Ways o f minimizing the risks: take social characteristics into account when designing a project; make the project compatible with local values; build up internal flexibility to allow for changes in relation to socio-cultural information; eliminate or modify aspects if they make the project socially unfeasible; learn about the country and the people; compensate fairly for damages, taking into account local values and traditions; --listen to what people say, establish Liaison Committees where all social partners can meet to discuss and receive information on the project; listen to people's proposals and views: do it early in the appraisal; [+] persuade people of the project' s benefits by: O giving them priority on the benefits of the project (employment, good housing conditions cash injections into the local community, etc.); O using sites where people will most benefit from the project, such as areas of high unemployment; and O using local resources; [ + ] --align the company's objectives with the objectives of the country; [ + ] --train managers to be aware of the outside world and deal with social problems; [+] develop good links with the local communities throughout the whole life of the project through general support of local activities, etc.; seek a good public image; if appraisal determines the project to be a high risk socially, it is advisable to postpone it or start with a pilot project. • Assessment: when The work should be one in parallel with the technical evolution of the project, so that it can affect decisions, and in coordination with the environmental work. who it is better to rely on experts, inhouse or external consultants; [+] --site management should be involved with the organization of the social work, as for any other activities. --contents the analysis should cover O assessment of project impact on society, in particular the local people; O identification of all social groups affected; O collection of baseline data, for future comparison and assessment of project impact, on all aspects affected by the project; cultural acceptability; O establishment of standards for the most critical aspects of [+l the social impact; O social strategy to elicit commitment.
The interaction between the project and the comp a n y c a n b e e x a m i n e d a t t h r e e levels: s t r a t e g i c ; s y n e r gistic; a n d risky. S t r a t e g y l o o k s a t t h e c o m p a t i b i l i t y o f the project with the objectives of the company at both c o r p o r a t e a n d f u n c t i o n a l levels. S y n e r g y l o o k s a t t h e compatibility of the project with the existing activities of the company, and the benefits from their combin a t i o n . M a n y c o m p a n i e s , s u c h as I C L , G l a x o a n d Consolidated Goldfields, would seldom consider a project with no synergy irrespective of the perceived financial b e n e f i t s . I f a p r o j e c t h a d l o w s y n e r g y , t h e n t o reduce risk the degree of innovation should also be l o w a n d m a d e in s m a l l i n c r e m e n t s . T h e t h i r d level, r i s k , m a y b e v i e w e d a t t w o a n g l e s . F i r s t , t h e i n h e r e n t r i s k w i t h i n a n y specific p r o j e c t . 226
S e c o n d , t h e effect o f t h e p r o j e c t o n t h e o v e r a l l r i s k i n e s s o f t h e c o m p a n y . T h e l a t t e r is i m p o r t a n t f o r m a j o r p r o j e c t s c a p a b l e o f i n f l u e n c i n g t h i s o v e r a l l risk signific a n t l y . T h e s m a l l e r t h e p r o j e c t , t h e m o r e it c a n b e v i e w e d o n i s o l a t i o n as l o n g as t h e c o m p a n y is d o i n g lots of small projects. W i t h o u t c o n s i d e r i n g t h e s e t h r e e levels o f a n a l y s i s t h e c o m p a n y is a c t i n g w i t h o u t a n i n t e g r a t e d v i s i o n o f t h e b u s i n e s s , a n d p o s s i b l y c r e a t i n g p r o b l e m s s u c h as h a v i n g t o o m u c h risk in a n a r e a , n o t u s i n g t h e c o m p a n y strengths, duplicating work, etc., w h i c h will b e r e f l e c t e d in its p e r f o r m a n c e . S o m e o f t h e i n t e r v i e w e d c o m p a n i e s h a d f o u n d it n e c e s s a r y t o t a k e specific c o r r e c t i v e a c t i o n s in t h e s e a r e a s ; f o r e x a m p l e , I C L f o u n d it n e c e s s a r y t o c l a r i f y t h e p r i o r i t i e s o f its b u s i n e s s a n d t o i n v o l v e all d e p a r t m e n t s in t h e a s s e s s m e n t o f p r o j e c t s to prevent restrictive views; Aquascutum created an i n t e g r a t e d v i s i o n o f t h e c o m p a n y in o r d e r t o a v o i d fragmentation of the business.
Table 6
Environmental analysis
• The ri~ks are: --possible delays on account of: 0 social opposition to the environmental impact; 0 public inquiries; @ legal demands on the environmental standards (if not met). • Ways o f minimizing the risks: --use a consultative approach for cooperation and support from a wide range of people; a liaison company/other parties should be established, to inform all interested and affected people: compensate for the damage; [+] pay attention to the benefits to be gained from local knowledge (it may be a vital part of background environmental assessment): do not trade off minimum standards by cheaper costs: [+] use of most practicable means taken into account: O best proved relevant technologies available; O nature and gravity of the situation; O operating and capital cost; give high priority to safety of workers and people living nearby; have first class operations from top to bottom; do not try to get away from the environmental effects of the project, even though the law in the country is not well established (Bhopal situations should not occur as the consequences would be too high, apart from complete loss of company image in that situation). • Assessment: when - - I n the early stages to be effective, in order to provide trade-offs to design selection, site selection or other alternative selections; --strictly in parallel with the technical side; [+] phased with the project development so that the conclusions reached at one stage can be taken into account to define the next set of work. --who [+] - - A n environmental officer should be appointed, at the early stages, to coordinate all aspects (internal and external); [+ ] it is advised the use of local skills (experts, local universities, etc.) for a better knowledge of specific problems in the area; - - t h e use of external experts - local and international - can provide independent judgement on the assessment, which may be needed to satisfy all parties; --reporting should be done to the project manager, on site, to coordinate with all other areas. --contents - - T h e analysis should cover: O the collection of baseline data for future comparisons; O experimental work; O assessment of project impact on the environment; O health and safety considerations.
Assessing non-financial aspects o f projects during the project life cycle." M D S Lopes and R Flavell Table 7
Organizational and managerial analysis
• Choice of organizational structure: - - I t should be flexible enough to attend to size and complexity of the project and to move with the project' s life cycle (careful design and dynamic adjustmetns over time are essential). It should establish a good flow of information between all relevant parties and define clearly responsibility and authority, especially in the later stages. - - I t should adapt to the project" s needs in terms of: O areas to implement; [+] O special groups needed; O formal vs informal communications; and O overall structure (matrix versus projectized); --Either a matrix or a project form should be used for most projects. • Partnerships: Partners should be selected paying attention to: O past performance; O skills and experience; [+] O political relations; O capability of holding together; - - t h e minimum number of participants is adivsable with only one operator; responsibilities of each partner should be carefully defined in advance. [+ ] --Commitment of both parties to the project, and a sound relationship between them is essential to solve problems and reach solutions. [+ ] - - W h e n a partner is imposed by a country's law and this partner lacks expertise, it is advised to negotiate for some key positions to be filled by the company's own staff (at least at an initial stage). • Communications: Dotted line relationships are as important as formal ones, in particular at the early stages, which might be the best way to have immediate and updated information. [ + ] - - I n international projects it is best to avoid spreading activities through too many locations for a tighter control and to improve communications. [+] In partnerships joint teams improve communications between the partners and can lead to mutual trust. • The human element: - - G o o d selection of all personnel is important. --All project senior management, including the project manager, should have experience and multid, sciplinary skills to be able to coordinate all areas of the project, and to have a good judgement ability to identify the risks soon enough. --Teams should be selected according to: O how people will perform the job (expertise); [+] O how well they will get on together (for communication to flow); --Team spirit is particularly important in international projects; senior management have a key role to establish it and to create a good atmosphere for the project. --Ensuring that every person is well motivated raises productivity, creates stability and lowers absenteeism; non-economic ways of motivation are as important as economic ones. --some non-economic motivators include: O variety of work; O working on a prestigious project; O working with new technologies in leader areas; O providing opportunities for people moving into other areas. [ + ] - - T h e role of project manager and teams is very important, in particular when time is critical; if there is not a good relationship, time will be spent in solving human problems and opportunities will be missed.
I n o u r o p i n i o n , t h i s a n a l y s i s s h o u l d b e p e r f o r m e d as e a r l y a s p o s s i b l e , a n d b y s e n i o r p e r s o n n e l f r o m all areas to prevent a parochial attitude. Some companies try to f o r m a l i z e this process. F o r e x a m p l e , I C L c r e a t e d a strategy panel, while Shell used a ' d i r e c t i o n a l policy matrix'. T h e r i s k s i n v o l v e d w h e n t h i s a n a l y s i s is n o t d o n e , the best practices of assessment, and the best ways of m i n i m i z i n g t h e risks, a r e s u m m a r i z e d in T a b l e 2.
Technical analysis T e c h n i c a l f a c t o r s h a v e b e e n w i d e l y i d e n t i f i e d in t h e lite r a t u r e as o n e o f t h e c o m m o n c a u s e s f o r c o s t a n d t i m e o v e r r u n s (e.g. R e f . [7]). M a n y c o m p a n i e s , e s p e c i a l l y t h o s e o p e r a t i n g in h i g h l y t e c h n i c a l a r e a s s u c h as a e r o s p a c e , d e f e n c e a n d e l e c t r o n i c s , a l s o c o n f i r m e d this. S u c h difficulties a r e n o t i n e v i t a b l e a n d w a y s t o r e d u c i n g t h e r i s k s h a v e b o t h b e e n p r o p o s e d in t h e l i t e r a t u r e a n d a l s o i d e n t i f i e d in t h e w o r k i n g p r a c t i c e s o f s o m e companies. O n e o f t h e c o m m o n e s t p r o b l e m s is t o u n d e r e s t i m a t e the technical complexities, particularly where the techn o l o g y m a y be newly (or even badly) f o u n d e d . Overoptimism by technical staff has been identified by
Table 8 Analysis and incorporation of all non-financial aspects in decisionmaking • Type of assessment: [+ ]--Past experience is the key to assessing the risks, as referred to by all companies. It is therefore important to have a track record of past managerial expertise to check the credibility of their judgements (and use consultants if needed). [ + ] - - T o minimize the risk of managerial judgement, the assessment should always keep in mind what the effect of it being incorrect is and take it into account (for back-up strategies and for weighting the risks). [ + ] - - O n e of the deficiencies with the present systems is that they are very dependent on people, personal experience and judgement as to what needs to be done. A few companies are trying to establish a standard format for the qualitative assessment (non-financial aspects) so as to provide a checklist for both assessors and decision-makers. --With or without a checklist as a guide, the analysis should be systematic and thorough for all projects, calling on many people covering all disciplines. • Weighting and decisionmaking: Analysis and judgement are complementary. [+] The analysis is needed to provide the necessary background for decisions. Sound judgement is needed to assess the likelihood and effects of risks. Decisions are mostly taken by discussion and balancing out arguments. [+] All aspects are to be brought into a panel and seen in coordination. [ +] --Weighting indices and scores are not well received in practice, as the balance of what is important changes in the project. [+] Anything that damages the project (risks) has to be a yes factor. The success of these processes depends on: [+] the experience of people; [ + ] - - t h e ability to feedback from past projects; [ + ] - - a good background analysis, systematic and thorough; [+]--having experts and other relevant people assessing the Board or decisionmakers. Risks of which to be aware: [ + ] - - n o t letting emotional reasons rule (provide a wide and rational debate); [ +] - - n o t letting a strong character, not necessarily with the right ideas, dominate the discussions. • Trade-offpolicy: --all risks will have to be balanced; in the end it is a matter of how much the company can afford. [ + ] - - A l l major aspects in social environmental, political, or other areas would have to be yes factors; minimum standards should be established which should not be traded off by cheaper costs; the aim is to maximize the whole package of factors and not just a particular one (such as finance, in many cases). [+]--Attention should also be drawn to the different levels at which trade-offs can occur. [+]--Trade-offs can start at decisions taken by project teams, and people are not always aware of the consequences when they decide, on their own initiative, which things to do or to rub out. 227
Assessing non-financial aspects of projects during the project life o,cle. M D S Lopes and R Flavell m a n y companies. This has led to conservative procedures such as the use of independent and multiple appraisal, frequent review milestones and the use of prototypes where feasible. These procedures may seem wasteful and excessive, but an insufficient check on the technology is one of the surest ways to failure. An associated problem is that, in projects that involve rapidly changing technology, the project may be outmoded before completion. In this case, as part of the appraisal process, it is recommended that contingency plans should be drawn up. Both literature guidelines and new findings are summarized in Table 3.
Political analysis This dimension may be viewed from two perspectives, according to the type of project, national or international one. First, most national projects in their home country will face some degree of political interference, for example through the need for permission, through funding, through legislation, through public inquiries, and so on. These interferences are naturally greatest in the case of public or social projects, where ultimate decisionmaking lies with the politicians. Second, overseas projects, especially if located in a country which may be considered to be politically unstable, are considerably susceptible to interference both during the appraisal and also the operational processes. Many political risks for a project in a home developed country manifest themselves in other guises such as social or environmental, as will be discussed in those sections. An overseas project is susceptible to political risk either if the size of the project is significant compared to that of the national economy, or if the product is deemed to be strategic in some sense. Many projects in developing countries fall into the latter category because they tend to be generators of scarce hard currency. In addition, local political parties tend to use nationalistic or similar arguments to generate popular support, which in turn can put overseas projects at risk. Examples of the expression of risk range from an excessively cautious bureaucracy, to the forced imposition of a local partner. Political risks may be mitigated by trying to develop good working relations and understandings with the government officials and the local inhabitants in general, trying to make them feel part of the decisionmaking process. This would need a recognition of the local requirements and aspirations. External experts are often a good way of presenting a less-biased profile. Direct local involvement at various levels would also reduce the risks. F o r example, providing sources of employment, capital expenditure within the local community, profit participation, even representation on the local Board. Obviously a c o m m o n sense approach of trying to be aware of the various political issues and implications is also extremely important. To evaluate the risks in this area, other overseas companies already operating in the area are an invaluable source of information. Unfortunately there are no secure ways of eliminating political risks during the lifetime of a project. Some companies have specific policies about not operating in countries of political instability, but political systems can change very 228
rapidly. An alternative is to spread the risk by joint ventures. In either event, national or international projects, the political factors may well be sufficient to cause project failure if they are not carefully considered. In our opinion, the relevance of these factors, at the appraisal stage, has not been adequately researched. The guidelines concerning the assessment of political risks and the ways of minimizing it are summarized in Table 4.
Social analysis Almost any type of major project will have some degree of social impact on the local community. This may include an impact in terms of creation of jobs; financial benefits, for example local spending by the workforce; health, if a project is dealing with harmful substances, such as nuclear projects, or if it is polluting the environment; housing, for the work force; resettlement, if the project installations are on currently inhabited land; construction of infrastructures that may open a route to the destruction of a culture; and so on. Overseas projects face even greater challenges brought about by the problems of understanding the cultural framework. If the negative aspects are not recognized and properly dealt with early on, they may lead to significant social opposition, causing delays and changes to the project, or even ultimately forcing it to cease. Risk may be reduced by trying to make the project compatible with local social values, and creating internal flexibility Io make changes as additional social information is required during the appraisal. Social impact studies (SIS) should be carried out, either by in-house specia!ists or external consultants, to collect base-line data and to try to predict the reaction of the local communipy to the project. In addition, all representatives of the project, especially site management, should receive some training into the local culture and on how to present the project in the best light. Liaison committees, where all social partners are represented, should be established early as part of the SIS. This demonstrates that a mechanism exists to take all views seriously and formally. They also permit the discussion of standards for the most critical components of the SIS. The local community may also be persuaded by the benefits of the project if it is located in areas of high social need, if local resources are being fully utilized, and if fair compensation is offered, when damage is created. A degree of personal ownership has to be felt by the community, else the project may come to be regarded as some form of exploitation. This process does not cease on completion of the appraisal process, or even on completion of the construction of the project, but must continue throughout the operating life. If the SIS does deem the project to carry an high social risk, it is advisable to postpone it until a solution to the problems can be found. At least, spending should be kept to the minimum in other areas, such as the technical ones, so that money will not be wasted in a project that might be terminated. With the exception of the work published by the World Bank, little has been written concerning the assessment of these aspects. Yet, problems with the
Assessing non-financial aspects of projects during the project life cycle." M D S Lopes and R Flavell social dimension of projects are increasingly recognized by companies as potential reasons for delays or nonacceptance of projects (Shell, RTZ, National Power, Smiths Industries and BNFL). The relevance of the social issues was also a lesson from the Cerro Colorado, a major mining project that was examined as a case study during the course of this work. The best ways of dealing with these problems, according to companies' past experience are summarized in Table 5. Environmental analysis The purpose of the environmental analysis is to minimize, as far as is practical, all damage caused by a project to the landscape, air, water or any other element. Environmental impact is particularly important when major construction is involved, and in the processing, mining and energy sectors. In the public sector, ca 10% of the programmes in the transport department are built on environmental grounds. Safety and health aspects are normally associated with environmental studies. The need for the analysis is, in most developed countries, determined by the need to comply with the existing regulations on levels of pollution, noise, etc. It is also in developed countries where the social opposition is strongest, since there is a greater awareness of the importance of preserving the environment. Developing countries possess greater dilemmas. In many countries legislation does not exist for a number of reasons. It may be that the government simply has not got around to it, or recognizes the difficulty and cost of enforcing the legislation, or recognizes the economic hardship such legislation might cause, with concomitant political difficulties. One argument that is difficult to combat is that developed countries, during the process of creating their wealth, caused enormous environmental damage, so why cannot developing countries go through the same stage? International groups such as Greenpeace, Friends of the Earth, etc., tend to intervene and draw the attention of the local people to the consequences of not protecting the environment. Because of this, most large companies have developed their own minimum environmental standards, even when the country's law does not rule on environmental matters. In recent years environmental factors have become increasingly important in decisionmaking due to the greater awareness of global problems such as depletion of the ozone layer, or the deforestation of the planet. This in turn has led to a stricter consideration of possible environmental damages by both companies and governments. Consequently the literature in this area is quite substantial (e.g. Refs [11]-[13]). There are two basic ways of reducing the impact of environmental risks. In the first place, not try to ignore them. In the second place, adopting an open and consultative approach working towards an environmental impact study (similar to that discussed above on the social analysis). The environmental study should be phased with the appraisal process so that the conclusions reached at the end of one stage can be taken into account during the definition of the work to be done in the next stage. It is important to give a senior person responsibility for the environmental issues and
to recruit local experts where feasible. These experts have specific knowledge of the local environment, and will create an atmosphere of independence of the analysis. One of the difficulties when dealing with environmental counterparts is that they tend, by and large, to concentrate on environmental issues to the exclusion of everything else. However, it is important to present the project as a whole. Whilst a project wishes to use the most economic means to meet its objectives, trading off environmental standards for cheaper costs may not lead to the maximization of long-term returns as either very expensive accidents may occur or legislation may be retrospective. A balance will have to be found that takes into account the best proven technology available, the perceived level of environmental risk, and the cost. Table 6 summarizes the literature guidelines deemed to be relevant by this research and adds some new ones. Organizational and managerial analysis Strictly speaking, one might argue that project management plays little role within the appraisal process, but we would disagree for two reasons. First it is not u n c o m m o n for organizations to appoint a project manager at an early stage of the appraisal process. For major projects, appraisal is not a single decision point but a whole series of formalized decisions which blend into a general project acceptance. The management of that process can itself be extremely complex. Second, the appraisal process should be concerned with an assessment of project risk in its broadest sense, and various studies have concluded that managerial and organizational issues have caused the failure of a large number of projects 7A4. Therefore, these aspects are germane to this discussion. Organizational structure, partnership relations, communications and report system, role of project manager, selection of key personnel, and work atmosphere and motivation, are all factors that can lead to a good or bad project performance. All these factors interact. It is from their integration and adaptation to the project' s needs that a good level of performance can be achieved. The project manager, is a key person in any project. He or she needs to create a good team spirit, motivating all project members. If members of the project team have been allocated from functional areas, it is necessary to convert them into a broader project outlook. The other members of the project team are also critical to the project. They should be selected ensuring that there is a sufficient mix of expertize within the team and that they are individually capable of functioning as team members. Communications within the project team are vital, and one of the important tasks of the project manager is to decide upon the balance of formal and informal reporting relationships as the appraisal process progresses. Dissemination of information is equally important, especially to maintain motivation. Two of the lessons drawn from the Cerro Colorado project were that a tighter geographical spread would have made the flow of information better, and that joint teams 229
Assessing non-financial aspects of projects during the project life cycle: M D S Lopes and R Flavell would have caused far fewer communication difficulties that the actual separate R T Z and Panamanian teams, the two partners in the project. Another dimension of managerial problems arises when a project is a joint venture. The partner(s) should have been selected on the basis of some expertize, such as in the specific topic of the project, financial diversification, or for political reasons. It is also important to ensure that all partners have a strong commitment to the success of the project, and that there exists a sound basis for resolving problems and reaching workable solutions. Some people recommended that partners should be of roughly equal size; this may be achievable for true joint ventures, but for overseas projects involving a multinational c o m p a n y and a local partner it is impracticable. In any event, it is important to define responsibilities and reporting lines for all partners in advance, and to ensure that these responsibilities are feasible; this was a major lesson of the Cerro Colorado. Many people in practice stress that the organizational structure of the project may be crucial to its success or failure. Yet there is no optimal way of organizing the team; each involves some trade-offs. Some organizations employ a project structure, whereby a project manager is appointed effectively as having total responsibility for the project and members of the team are task-oriented. Many other organizations use a matrix structure whereby team members possess a dual allegiance to both the project and their original function. During the interviews, it was repeatedly stressed that neither the right organization without the right people nor the right people in a badly setup organization would be efficient. This is an area reasonably covered in the literature but usually from a general project management angle. Most factors in Table 7 are therefore c o m m o n to the literature guidelines. The framework made some contribution to the existing knowledge by analysing the relevance, at the appraisal stage, of some of the aspects.
Including the non-financial aspects in decisionmaking We have already discussed the necessity for companies to consider a range of non-financial aspects during the formal project appraisal process. Such an inclusion does bring some difficulties. When financial criteria is the only aspect to be considered, the decisionmaking is relatively straightforward, and there are a large number of texts that would provide guidance. There are still problems about trading off short-term against long-term, and risk against return, but these may be addressed within a financial framework. When one wishes to include the non-financial aspects, which may not be easily reduced to a monetary scale, the difficulties of incorporating them within a formal framework are many. Proposals in the literature recommending the use of scoring techniques and weighting indices l0 are not well received in practice by the companies trying to incorporate these aspects formally. In this section, we therefore try to offer some guidelines as to how the non-financial aspects may be incorporated in practice. These guidelines are summarized in Table 8. 230
A key factor to a successful assessment and balancing of risks is, ultimately, relevant past experience. Unfortunately such experience, by its very nature, tends to be scarce and in high demand. It is therefore important for organizations to establish a standardized format within which projects may be qualitatively described. This format should act as both a checklist for the assessors and as an indicator of the scale of risks to the decisonmakers. The scale may be presented on an absolute basis or on a basis relative to other projects undertaken by the company. The former requires considerable expertize and judgement in the risks being assessed, and we would recommend the latter as being simpler to conceive and to implement. This format however should not attempt to assign weights, scores or any other form of trade-offs. Throughout all our discussions with organizations trying to incorporate non-financial aspects, the consensus view has been that each major project tends to be sufficiently different as to warrant individual consideration. Trade-offs obviously need to occur, but they should be on the basis of judgment as to when a particular aspect is a constraint and when it can be traded-off. The format should also provide information about alternatives, and how particular risks may be reduced by taking particular actions. One of the deficiencies of the present systems is that they are very dependent on people and personal judgement. Judgement, based on relevant past experience, is important but decisionmaking should be done mostly through analysis, that can be supported by a framework. The use of a framework demands a systematic and thorough collection and analysis of information in all areas; it also permits the identification of missing information. The presence of a framework also reduces the likelihood of individuals swaying the decisionmaking for their own ends. 3.
Methodology
The work described in this paper has deliberately concentrated on major projects as, by their nature involving size, complexity and frequently novelty, these are the projects that present the greatest risks for companies. They typically also present a more complex variety of aspects to analyse. The work was conducted in three stages. First a literature review was undertaken. This identified some elements of non-financial analysis, and also some major gaps. Based on this, an initial framework of analysis was constructed. Second this framework was applied to the appraisal process of a large project, with great impact in m a n y of the non-financial areas under investigation. This permitted an analysis in a real situation of how all aspects interact, and the trade-offs involved at the difference levels of decisions. As a result a number of deficiencies in the framework were corrected. Finally the modified framework was sent to some 20 organizations, followed up in each case by a detailed interview discussing their practices and the applicability of the framework. The need for a framework was confirmed during the course of the interviews. Several companies were found to be in the process, or have recently been in the process, of revising their appraisal methodologies and the trend was to include a more systematic appraisal of non-financial factors
Assessing non-[inancial aspects ~f pr~/ects during the pr~lect l(['e cycle. M D S Lopes and R Flavell (e.g. Logica, ICL, British Rail). The resulting framework was presented in Tables 1 ~ and was discussed in Section 2. Stage 1: literature review There is a considerable literature on m a n y aspects of project appraisal. This section has been deliberately summarized to keep the paper to a reasonable length. The published literature was reviewed, concentrating on three major areas. First, the question of whether there was any consensus on the most important nonfinancial areas of appraisal was considered. Based upon the literature, in particular taking the methodology of appraisal produced by the World Bank as a basis 5 together with the contributions of the authors reviewed, the following separate dimensions were identified: • • • • • •
strategic analysis; technical analysis; political analysis; social analysis; environmental analysis; managerial and organizational analysis.
The above framework differs from the one produced by the World Bank in the following ways. The finance-related areas (financial, commercial and economic) included in the World Bank framework were dropped, as they are of no direct concern to this paper. Technical analysis has been retained as problems in this area have lain behind many project failures, and a number of subcomponents have been identified. The sociological area was also retained, but we extracted from it the two additional areas of environmental and political, as we feel that these are substantive topics in their own right and also are assessed by different specialist groups. A further dimension, not included in the World Bank framework, is the broad strategic importance of the project to the organization. Projects, especially in the private sector, usually relate to the existing business of the organization, and thus contain strategic and synergistic components that need to be assessed 4,10. Most of what has been written in relation to these areas does not specifically concern the appraisal stage, although it is pointed out that all problems should be taken into account as early as possible in the life of the project. An associated issue that was seldom mentioned in the literature, and hence one addressed by this paper, is by whom these non-financial dimensions should be considered. The second major area reviewed was the requirement for a successful appraisal system. The aim was to examine the overall strategies and methodological aspects in the appraisal. A number of important suggestions has been made, such as the need to maintain flexibility during the appraisal process 8, to learn as much as possible from experience~ 1"5 , to phase the project 1'IS, etc. Taking as a basis the literature propositions, the research aimed to check their relevance in the light of the companies' experience and to add some new suggestions. JPMA 164
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Finally, the third area reviewed was how the non-financial aspects should be integrated into the decisionmaking process. The literature is remarkably reticent on this point. Some authors have proposed weighting indices or scores 1°, but we felt this to be mechanistic and unsatisfactory. The indices were also not favoured by the people interviewed. One objective of the subsequent work, discussed in Section 2, was to try to identify how this integration was achieved in practice.
Stage 2." the Cerro Colorado project The Cerro Colorado was a large open-cast copper mining project in Panama. The deposit had been discovered in the 1930s, and R T Z acquired 49% of a specific development company in the mid-1980s; the remaining 51% was held by a Panamanian government agency called Codemin. Two years of extensive appraisal then incurred, but the project was mothballed in 1982 and never re-opened. This particular project was chosen because of the significant non-financial difficulties that arose. In fact although the immediate reason for stopping the project was a very sharp decline in the world price of copper, there were an increasing number of nonfinancial problems that were delaying the project. The project was never subsequently re-opened, despite a rise in the copper prices, principally because of these non-financial problems. R T Z went on to open new copper mines, but in countries where social, political and environmental problems were far easier to solve. The Cerro Colorado study permitted an examination of all aspects of the project appraisal framework in detail over a 5 month period. The authors interviewed many of the R T Z personnel involved with the project, and were granted open access to the projects' files. This permitted all the events to be traced, with their underlying rationale, during the development of the project, so that a changing picture of the appraisal process was built up. This method was a better way at the beginning of research, given the depth of analysis permitted, of gaining an insight into m a n y of the implications of the issues raised by the initial framework hypothesis in a real situation. The Cerro Colorado findings were also important to identify some of the gaps in the initial framework, especially on social and political aspects where few guidelines were found in the literature. The project enabled R T Z and the authors to draw a number of conclusions as to how the problems due to the non-financial aspects might be reduced in the future. These conclusions have been included in Section 2. They were also discussed, albeit anonymously, during the company interviews described in the next stage.
Stage 3." company survey The company survey, done through 1989 and 1990, was used both to test the applicability of the findings from the Cerro Colorado, and also to modify aspects of the framework. In particular, how different empha231
Assessing non-financial aspects o f projects during the project l(]'e cycle." M D S Lopes and R Flavell
sizes should be placed on its varying areas of analysis depending upon the type of project. The initial selection of companies was made using two criteria: 1. companies belonging to different sectors, in order to cover as m a n y types of projects as possible so that the framework would have general applicability; and 2. companies where there was to some degree a formal appraisal of the non-financial aspects. This implies large companies as earlier surveys 2 have indicated that formalization of the analysis increases with the size of the company. A number of companies were identified, and subsequently some 20 organizations agreed to take part in the survey (see the Appendix). First a semistructured questionnaire was sent to the companies, covering three main areas. One area on general methodology. A second on non-financial areas, trying to identify which non-financial components of risk the company regularly assessed, when and by whom, and their importance according to past experience. And the third area on how to integrate all information in decisionmaking. Subsequent to sending the questionnaires, interviews were then held with senior executives in each company. Each interview lasted not less than half a day, and frequently involved a number of company representatives. After each interview, the current framework was modified in the light of the discussions and used as a basis for discussion in subsequent interviews. The final framework, as discussed in Section 2, was therefore derived from the cumulative experience of all companies.
4. Conclusion The research underlying this paper is based upon two premises. Firstly, companies are starting to place a greater emphasis on non-financial aspects during the appraisal process. Secondly, there is little guidance that has been published to aid the process. The purpose of this paper was to present a framework to help companies in bringing the non-financial aspects into their project appraisal processes in a systematic and thorough way. The framework identified and analysed the non-financial aspects of projects, how they can be assessed, their relative importance to the success of the project, and how they can be incorporated in the appraisal procedure. These non-financial aspects include the managerial role, strategic and synergistic issues, social, political, environmental and technical links, and organizational factors. These aspects are risk dimensions which can cause the failure of a project, and the proposed framework should be seen as a tool to analyse and manage those risks since the earliest stages of the project life cycle.
Acknowledgements The following people were helpful in m a n y ways and the authors want to express their gratitude to all of them. To Dr P. Morris (Templeton College), for his suggestions, criticism, and generous help. To 232
R T Z for making available all the files and reports on the Cerro Colorado project and in particular to Mr Terry Lewis for his assistance and generous help. To all people, and their companies, interviewed during the research. To the Gulbenkian Foundation, for providing a research grant for this work.
References 1. Hellings, J., Capital budgeting in the real world. Management Accounting, 1985, 3841. 2. Pike, R., Capital budgeting in the 80's. In Occasional Paper ICMA, Institute of Cost and Management Accountants, London, 1982. 3. Petty, W. J. and Scott, D. F., Capital budgeting practices in large US firms a retrospective analysis and update. In Readings in Strategy for Corporate Investments, London, Pitman, 1981. 4. Pinches, G. E., Myopia, capital budgeting and decisionmaking. Financial Management, 1982, Autumn, 6 18. 5. Baum, W. C. and Tolbert, M. S., Investing in Development Lessons o[" World Bank Experience. Oxford University Press, Oxford, 1985. 6. Hayfield, F., Project success and failures. In Proceedings of the 8th World Congress on Pr~?ject Management, Internet, Rotterdam, 1985. 7. Morris, P. W. G. and Hough, G. H., Preconditions of success and failure in major projects. Technical Report, Major Projects Association, Templeton College, O~,~['ord, 1986. 8. Paul, S., Managing Development Programs: The Lessons o[" Suecess. Westview Press, Boulder, CO, 1982. 9. Lopes, M. D. S., Non-financial aspects of project appraisal. PhD thesis, University of London, London, 1990. 10. Wissema, J. G., An Introduction to Capital Investment Selection. Frances Printer Laboratory, London, 1985. 11. Bowonder, B., Prasad, S. S. R. and Reddy, R., Project siting and environmental impact assessment in developing countries. Project Appraisal, 1987, 2(1), 11 20. 12. World Bank Staff Environment, growth and development. Project Appraisal, 1987, 2(2), 75 87. 13. Kobus, D. and Lee, N., The role of environmental assessment in the planning and authorization of extractive industry projects. Project Appraisal, 1993, 8(3), 147 156. 14. Baker, B. N., Murphy, D. C. and Fisher, D., Factors affecting project success. In Project Mangement Handbook, eds Cleland, D. I. and King, W.. Van Nostrand Reinhold, New York, 1983. 15. Camillus, J. C., Designing a capital budgeting system that works. Long Range Planning, 1984, 17(2), 103 110.
Dulce Lopes graduated in Economics from Faculty of Economics of University of Porto in 1982. Her Master (1985) and Ph.D. (1990) degrees were both in the Management School of the Imperial College of Scienee Technology and Medicine, University of London. She is an Assistant Professor at the Faculty o[" Engineering of the University of Porto, where she has been since 1982. Her main areas of research, lecturing and consultancy work are project appraisal and .financial management.
Assessing non-financial aspects o f projects during the project life cycle: M D S Lopes and R Flavell
Richard Flavell, Managing Director o f LRC, was until early 1994 a senior academic and Head of the Finance and Accounting Group at Imperial College, which is part o f the University o f London. He has specialized in derivatives, and has published numerous books and articles. He gained practical derivtive experience when he set up and ran a financial engineering activity at A N Z Merchant Bank in London. This involved not only structuring and risk management but also the marketing o f derivatives to corporate customers. He has also undertaken extensive consultancy and research .['or a variety o f other organizations, and has directed and taught a variety o[" public and in-house professional courses throughout the world. Dr Flavell is also a Director o f the parent company Lombard Risk Systems, a highly succes,sful software cornpan)' specializing in financial derivative systems. Its best known system is Oberon TM. Dr Flavell has re.q)onsibility for the mathematical development o f all the sytems produced by LRS. This means that he has to be at the JbreJ?ont of the latest financial and theoretical developments.
Appendix List of companies interviewed Sector Public sector Transport Mining Aerospace and Defence Oil and Gas Energy Construction Retail Pharmaceutical Electronic Mechanical Engineering Bankers Consultants
Company Ministry of Defence, Transport Department, Health Department British Rail RTZ, Consolidated Goldfields British Aerospace, Smiths Industries Shell National Power, British Nuclear Fuels Bechtel, Foster Wheeler, Humphreys and Glasgow Aquascutum Glaxo ICL Delta County Bank W.S. Atkins, Logica
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