Focusing on the wrong thing
TPM: traditional project management
PPA: profitably performing asset
Constraint trifecta (budget-schedule-quality)
Valunomy vs cost effectiveness. When a project is managed in accordance with the constraint trifecta discussed in a previous article (the ubiquitous cost-time-quality triangle), the necessary obsession with cost containment within the project management group will be translated into a buying decision framework built around cost effectiveness, a pure misnomer if ever there was one. The pursuit of lowest cost, at all costs, conveyed by the idea of cost effectiveness, is universal among the TPM set. The quintessence of cost efficiency is to prefer the least cost incurred now for an immediate outcome, over a higher cost designed to increase profitability later. With industrial projects with very large capital outlays, the dominance of the front-end price advantage is taken for granted. The PPA approach takes an opposite stand based on valunomy (a neologism formulated originally in the book investment-centric project management). Valunomy shifts the emphasis of a buying design toward the maximization of future investment returns, and always includes total costs of ownerships (TCO) in the analysis. The highest valunomy is the one that achieves the highest sustained profitability over an asset’s economic life. Mathematically, valunomy is given by:
V = Valunomy
D = Time interval during which the outputs “O” must be produced
Ic = Accrued costs during time interval D to produce the outputs (the aim is to minimizing Ic)
O = Number of outputs generated at the end of the D interval
ec = Additional costs required by extra work to correct / complete the outputs. The ideal case is when ec = 0.
wd = +1 if D is meant to be maximized
-1 if D is meant to be minimized
wo = +1 if O is meant to be maximized
-1 if O is meant to be minimized
The units of V will vary as a function of the outputs. In comparative analyses, it is therefore essential that the units of D, Ic and O be used uniformly.
Among several options, the best one offers the highest valunomy to the asset, because that is where the highest commercial impact is felt (and not to the budget, which always seeks to minimize costs now at all costs). Let us examine three illustrative examples, starting with the hiring of a consulting firm to produce a system specification for a power generator. The incurred costs Ic may include the direct and indirect labor costs and specialized software licenses. The duration is to be minimized (no longer than necessary). The output O is to be minimized, in the form of the estimated cost to buy the system. Thus, both wd and wo would be set at -1.
In the second instance, we seek to obtain an industrial plant design. The incurred costs Ic include the contract value of the engineering and procurement works, and the procurement costs (actuals). Duration is minimized, once again, with a corresponding wd = -1. The outputs O, on the other hand, is defined as the number of drawings, specifications and datasheets produced, thus maximized, with a wo = +1.
In the third example, we look at an entire operating asset. In this case, we may define the Ic in terms of operating, maintenance and tax costs. The duration D is set as the operating life of the asset (i.e. wd = +1). Finally, the output O is defined as the accrued profits during the operating life (wo = +1).
To be or not to be complete. The variable ec plays a crucial role when comparing options. It represents the ability of the party doing the work to produce the outputs in a competed state. A value of ec = 0 implies completeness: i.e., no additional work is required on any of the outputs to either correct or finish them. If ec > 0, more work (additional costs) will be needed to reach completion. If ec < 0, less work was required to reach completeness, which implies a greater efficiency of the party doing the work. The classic case is the comparatively abnormal low price bid received in response to a competitive request for proposal from a bidder trying to buy the job or located in a low labor cost jurisdiction. When ec corrections from past experiences are included in the evaluation of the bids, the cost advantage of the low-ball proposal will in fact vanish entirely.
Invariably, the cheapest at the outset will cost the most in the long run.
Further insights can be gleaned from chapter 2 of Investment-Centric Project Management, available on Amazon.com.