When considering a request for additional funding there are three types of funds: sunk funds, the ‘money at risk’ (to be spent in the next phase) and the remaining projected cost of the project. The remaining projected costs have not yet been spent.
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?
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 $Z million
- An increase in the total cost of the project from inception — from a total of $X million to a new total of $Y million.
Using the incremental approach projects can (and do) grow from $60 million to $180 million, for example, in “only another $20 million” increments! Each decision justified on the basis of realising some value from the sunk costs to date.
Some project managers will argue that the only consideration is total cost from here on in, as the sunk costs are already gone. So, having spent, say, $50 million, you can justify another $20 million on top of the original $60 million as “we need another $30 million to finish”. This is a dangerous road to follow.
The relevant questions are:
What cost 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 your project’s benefits will support to give a neutral ROI. Be very reluctant to go beyond this cost.
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 you are still high on the uncertainty curve then you know the figures are uncertain and, therefore, likely to be exceeded in due course. Then you know that this additional cost is not likely to be the final cost. Are you prepared to spend even more?
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 the competition and your project becomes 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)?
Further complicating matters is the tax dimension that 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.
So, when do you pull the plug rather than continue to invest?
1. When the project will not deliver a (worthwhile) solution
I stopped an HR system that was so out of control that it had consumed its total budget and then some more before it had even finalised the requirements.
I 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 $82 million, was restarted and delivered for $36 million.
2. When the project’s original costs/estimates are obviously out of range
For example, a project’s original costs are seen to be, at most, half of the likely total cost.
A $5 million project should be set up as a $5 million project; a $10 million+ more complex project will be set up differently and require a different calibre of project leadership team. Just ploughing money into a project that is set up inappropriately is to invest in failure.
These types of projects need to be re-baselined, re-justified and restarted, not continued with additional funds.
3. When the project is not delivering successfully — a proven record of non-success
I 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 organisation, the project was cancelled and the implementation rolled back to the original system. The total investment ($11.7 million) 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.
I stopped a ‘low cost account’ system in bank when the projected cost of delivery and operation of the new account exceeded the current account system costs.
5. When the need for the project has disappeared/is found to be missing or can be met more cost-effectively
I stopped a project when we found an alternative solution could fix the problem for less than 4% of the original project’s projected cost.
I cancelled a project when I found that the problem it was solving would not occur for another eight to 10 years!
6. When there is a better use of the resources
I cancelled a ‘staff wardrobe stock control system’ when we couldn’t find any IT resources to bring new products to market. While few of the wardrobe IT resources could be reallocated in this case, by releasing them and hiring the appropriate resources we could deliver the organisation’s strategy (even if not its wardrobe!)
Always think of it as your money: would you continue to invest in this project? Don’t be afraid to stop projects and reallocate the funding to more worthwhile projects to generate greater value. After all, generating the maximum value is what portfolio and investment management is all about.