1. business and industrial
2. business operations
3. management
4. project management

How to Respond When
Opportunity Knocks
How to
Respond
when
Opportunity
Knocks
“Risk comes from not knowing what you are doing”
Warren Buffet
By Will Witt
Page 1 of 95
3/24/2011
How to Respond When
Opportunity Knocks
How to Respond When
Opportunity Knocks
Introduction
This book is divided into three Sections
Section 1
Section 1 provides an overview of the Shorace Process and can be read on its
own without reference to Sections 2
Section 2
Section 2 is an E-book on how to use the Software Provara in the Analysis of the
Options. It can be ignored initially when the reader is trying to absorb the
Shorace concept. There is a lot of information in Section 2 on the selection and
evaluation of the Options that will be of great value to the reader – even if the
software itself is not purchased.
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How to Respond When
Opportunity Knocks
Introduction ..............................................................................................8
Section 1 ..................................................................................................9
Introduction ..............................................................................................9
Background ............................................................................................9
Use of the E-book.................................................................................. 10
Applicability of the E-book ...................................................................... 10
Scope of the E-book .............................................................................. 11
Claims and Representations .................................................................... 11
Liability................................................................................................ 12
Section 1 .................................................................................................. 13
Chapter 1: ................................................................................................ 13
How Shorace Works ................................................................................. 13
Chapter 1 - Shorace Overview ................................................................... 14
Terminology ......................................................................................... 14
The SHORACE Process ........................................................................... 15
Definitions............................................................................................ 16
The Project Shell ................................................................................ 16
Optionology ....................................................................................... 16
Refinery ............................................................................................ 17
Accordancy ........................................................................................ 17
Execution .......................................................................................... 18
Comparison with Historic Terminology ................................................... 19
The Project Shell ................................................................................... 20
Definition .......................................................................................... 20
Why us the word “Shell”?..................................................................... 20
Why is the Shell document so important?............................................... 20
What should you call the process?......................................................... 20
What can trigger the need for a project? ................................................ 21
What does the word "success" mean in the context of the project execution
process?............................................................................................ 21
How should the whole process work?..................................................... 21
Project Bible ...................................................................................... 22
Shell changes..................................................................................... 22
The SHORACE Matrix ............................................................................. 22
What is it? ......................................................................................... 22
The project approval process................................................................ 23
Project planning ................................................................................. 23
Your own matrix name ........................................................................ 23
Chapter 2 – the Project Shell ..................................................................... 26
Work scope summary ............................................................................ 26
Shell implementation philosophy........................................................... 26
Clarify the objectives ............................................................................. 26
Briefing meeting................................................................................. 26
The first workshop / stakeholder conference ........................................... 27
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What is a stakeholder? ........................................................................ 27
What sort of issues can be considered as bone fide objectives................... 28
Workshop conclusions ......................................................................... 28
Define the criteria for strategic fit and test against the criteria ..................... 28
What is strategic fit? ........................................................................... 28
Verify the business need...................................................................... 28
Identify the core competencies available to undertake the project ............. 29
Undertake SWOT analysis .................................................................... 29
Identify any regulatory or environmental issues ...................................... 29
Identify who will operate the facility ...................................................... 29
Undertake strategic risk review............................................................. 29
Gather the existing data available............................................................ 29
Preliminary project assessment: .............................................................. 30
Define the assumptions ....................................................................... 30
Identify the uncertainties..................................................................... 30
Strategic Risk Assessment ................................................................... 30
Capex and Opex models ...................................................................... 31
Source of total project funding ............................................................. 31
Identify internal and external stakeholders and prepare outline inquiry /
communication plan............................................................................... 31
Define the option evaluation metrics ........................................................ 31
Prepare project shell document ............................................................... 32
Identify the project team, AP, cost and source of funding for Optionology ... 32
Project team for Optionology ................................................................ 32
Optionology Authorization Panel ........................................................... 32
Cost of Optionology ............................................................................ 32
Source of funding for Optionology ......................................................... 32
Summary of Optionology Work scope ....................................................... 32
Chapter 3: .............................................................................................. 33
Optionology ............................................................................................ 33
Chapter 3 – Optionology ........................................................................... 34
Work Scope.......................................................................................... 34
Summary .......................................................................................... 34
Optionology implementation philosophy ................................................. 34
Develop the option evaluation metrics ...................................................... 34
Identify the distinct options and test for strategic fit ................................... 35
The Identification process .................................................................... 35
The ground rules for the choice of options .............................................. 35
Test for strategic fit ............................................................................ 35
Identify key value drivers and their weighting ........................................... 36
Set risk criteria to ensure Risk Management consistency ............................. 37
Risk register ...................................................................................... 37
Develop each option that passes strategic fit tests ..................................... 37
Evaluation criteria............................................................................... 37
Preliminary execution plans.................................................................. 37
Stakeholder inquiry / communication plan................................................. 38
Identify stakeholders .......................................................................... 38
Deploy inquiry / communication plan..................................................... 38
Test the options via the inquiry / communication plan.............................. 38
Evaluate and select the preferred option using VM and RM techniques .......... 38
Evaluate the metric criteria .................................................................. 38
Select the preferred option .................................................................. 39
Identify the Source of Project Funds ...................................................... 39
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Identify the project team, AP, cost and source of funding for Refinery and
Accordancy........................................................................................... 39
Project team for Refinery ..................................................................... 39
AP for Refinery ................................................................................... 39
Cost of Refinery and Accordancy ........................................................... 39
Source of funding ............................................................................... 39
Summary of Optionology work scope ....................................................... 39
Chapter 4: .............................................................................................. 41
Chapter 4 – Refinery ................................................................................ 42
Work Scope.......................................................................................... 42
Follow AP instructions in finalising the definition of the selected option .......... 42
Land acquisition ................................................................................. 42
Planning authorities and consents ......................................................... 42
Detailed project scope ......................................................................... 42
Infrastructure works ........................................................................... 43
Operational parameters ....................................................................... 43
Prepare draft contracts for surveys soil investigation etc ............................. 43
Site investigation and topographical survey. ........................................... 43
Other specialist studies ....................................................................... 43
Finalise and place contracts for the Refinery surveys and studies by consultants
and supervise their execution.................................................................. 44
Contract documentation. ..................................................................... 44
What do you want? ............................................................................. 44
How do you want it done?.................................................................... 44
What are the benefits that you will gain? ............................................... 44
Can they do it?................................................................................... 45
Supervise the surveys and special studies................................................. 45
Test the preferred option using the survey and study data........................ 45
Prepare more detailed project schedule .................................................... 45
Undertake value engineering studies ........................................................ 45
Undertake risk reviews to reduce risk ....................................................... 45
Confirm project funding source................................................................ 45
Chapter 5: .............................................................................................. 46
Accordancy ............................................................................................. 46
Chapter 5 – Accordancy ............................................................................ 47
Work Scope.......................................................................................... 47
Prepare and submit planning and any other applications for consent / approval
.......................................................................................................... 47
Prepare the Project Execution Plan........................................................... 47
Undertake Value Engineering Studies ....................................................... 47
Undertake Risk Reviews ......................................................................... 47
Continue the deployment of the communication plan .................................. 48
Project Funding..................................................................................... 48
Chapter 6: .............................................................................................. 49
Value and Risk Management ...................................................................... 49
Chapter 6 - Value and Risk Management ..................................................... 50
Introduction ......................................................................................... 50
Definition of a successful project ............................................................. 50
Value management................................................................................ 50
Risk management ................................................................................. 51
Summary ............................................................................................. 51
During detailed design the absolute values become even more important and
more advanced techniques may need to be used – but the principles will
remain exactly the same. .................................................................... 51
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Chapter 7: .............................................................................................. 52
Project Execution ..................................................................................... 52
Chapter 7 – Go – Ahead and Execution ....................................................... 53
Work Scope Summary............................................................................ 53
Check that all aspects of the project comply with the Shell .......................... 53
Deploy the final stage of the communication plan....................................... 53
Prepare final ROI calculations.................................................................. 53
Undertake Design and Cost Review .......................................................... 53
Undertake Construction Review ............................................................... 53
Section 2 ................................................................................................ 54
Section 2 ................................................................................................ 55
Chapter 8 ............................................................................................... 55
Introduction to NPV .................................................................................. 55
The purpose of the E-book ................................................................... 55
About Provara .................................................................................... 55
Background .......................................................................................... 55
Economic and Financial Assessments........................................................ 56
License to use Provara ........................................................................ 57
Identification of the Options ...................................................................... 59
What is an Option? ................................................................................ 59
What are the Option differentiators? ........................................................ 59
Projects with several components ............................................................ 60
How do you actually develop the Options? ................................................ 60
In an established business ................................................................... 60
Other circumstances ........................................................................... 61
Glossary of terms..................................................................................... 62
Introduction ......................................................................................... 62
Discounting .......................................................................................... 62
Net Present Value.................................................................................. 63
What is NPV? ..................................................................................... 63
How does inflation effect NPV ............................................................... 63
How does Company taxation effect NPV ................................................. 63
How do you use the results of the Provara output? .................................. 64
Internal Rate of Return .......................................................................... 64
Chapter 9: .............................................................................................. 65
Capital Cost ............................................................................................ 65
The Assessment of Capital Cost.................................................................. 66
Introduction ......................................................................................... 66
Advanced economies........................................................................... 66
Fast developing economies .................................................................. 66
Backward economies and very remote projects ....................................... 66
The Approximate Approach to Cost Estimation ........................................ 67
Probability assessment........................................................................... 68
The input to Provara ........................................................................... 68
Worked example of probability assessment ............................................ 69
Chapter 10: ............................................................................................ 71
Project Income ........................................................................................ 71
The assessment of project income .............................................................. 72
Chapter 11: ............................................................................................ 73
Operating Costs ....................................................................................... 73
The assessment of Operating Cost.............................................................. 74
The difference between Direct Costs and Indirect Costs .............................. 74
A garage ........................................................................................... 74
A hotel.............................................................................................. 74
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Why are the differences so important?................................................... 75
Direct and indirect cost probabilities......................................................... 75
Sensitivity analysis................................................................................... 76
Just ignore the probabilities for the Capital, Income and Operating costs and
Provara will calculate the NPV for the median case as well as the Optimistic and
Pessimistic. ............................................................................................. 76
Chapter 12: ............................................................................................ 77
Value Management................................................................................... 77
Value Management................................................................................... 78
Introduction ......................................................................................... 78
Role in Construction............................................................................... 78
The benefits....................................................................................... 78
How is best value achieved? ................................................................... 78
Understanding Value.............................................................................. 78
The three value factors........................................................................ 78
Utility Value ....................................................................................... 79
Exchange Value.................................................................................. 79
Esteem Value..................................................................................... 79
Hard and Soft Values .......................................................................... 79
Value Management using Provara ......................................................... 80
Risk assessment techniques ...................................................................... 82
Introduction ......................................................................................... 82
Eliminate (Terminate) show-stoppers and biggest risks ............................ 82
Reduce (Treat) risks ........................................................................... 82
Insure or Transfer risks ....................................................................... 83
Contain (Tolerate) the risk within the contingency reserve........................ 83
Chapter 14: ............................................................................................ 84
Study and Survey Costs ............................................................................ 84
How to assess the cost of studies and surveys.............................................. 85
By the use of specialists ......................................................................... 85
What do you do if there are no local specialists.......................................... 85
Chapter 15: ............................................................................................ 86
Provara in Action ..................................................................................... 86
How to use the Provara Options Analysis Tool .............................................. 87
How and When to use Provara................................................................. 87
What are Scenarios and Sub-scenarios .................................................. 87
Concept development.......................................................................... 87
Analysis of the Options ........................................................................ 88
The Development of the Project Plan ..................................................... 88
Definition of the Options......................................................................... 89
Appendices ............................................................................................. 91
Appendix A ............................................................................................. 92
Cost Estimate accuracy and related fee costs ............................................ 92
Appendix B ............................................................................................. 93
Project Classification Tool ....................................................................... 93
Appendix C ............................................................................................. 94
Risk Assessment Tables ......................................................................... 94
Likelihood.......................................................................................... 94
Impact .............................................................................................. 94
Appendix D ............................................................................................. 95
Value benchmarking .............................................................................. 95
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Introduction
As a general rule the most successful man in
life is the man who has the best information.
Benjamin Disraeli (1804 – 1881)
By Will Witt
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Opportunity Knocks
Section 1
Introduction
Background
Will Witt is one of the most experienced and widely practiced Civil Engineers in
the World.
He was one of the very successful graduates produced by the Sheffield University
Faculty of Civil Engineering run by the famous Professor Bill Eastwood in the late
1960’s.
His rigorous and enthusiastic approach to engineering was taken up by the many
students that became very well known engineers – such as Professor Les Clark
who became the President of the Institution of Structural Engineers
Will got a good honours degree and went straight out on site to see how things
were really built. After 2 years he was put in charge of a $25.0m (current value)
project – a lot of responsibility for a 23 year old!
After 5 years in muddy boots it was time to see what design was about and he
became a Member of the Institution of Civil Engineers (MICE) and also passed the
difficult Institution of Structural Engineers Entrance Exam. He was a Chartered
Engineer twice over!
In 1978 he helped Bob West start up Robert West Consulting – a firm still in
business now.
In 1985 he set up a contracting firm called Pentacon. Projects included the
infrastructure for the new town of Chafford Hundred at West Thurrock in Essex.
Feasibility studies, master planning and construction of roads, drains, utility
services, railway station, schools and shops, were carried out to develop old
quarries into a thriving town of 12000 people.
Pentacon built offices, warehouses and factory units for developer, retailer and
manufacturing clients. It ceased trading in September 1990 during the severe
credit squeeze. Will had given personal guarantees to banks and was made
personally bankrupt in 1992.
Lack of engineering work forced Will into building house extensions by hand for
several years.
Eventually, engineering picked up again and Will became a consultant to Kellog
Brown and Root in 1995. For 12 years he was involved with some of the biggest
projects in the world like the Darwin-Alice Springs railway, Tengiz oil field,
Kashagan oil-field in the Caspian, Sahkalin Island project for Shell and many
other very large projects. He was always involved in the master planning and
feasibility study stages because of his wide experience, analytical ability,
enthusiasm and ability to think “Outside of the Box”
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In 2004 he moved to France and set up Bluepools with his oldest son Luke.
Bluepools has now built about nearly 100 swimming pools and is on course to
become one of the biggest swimming pool installers in France and the UK. He also
found the time to set up a pool building operation in Nevada and Arizona with a
US partner who is resident in Las Vegas.
He still helps companies carry out feasibility studies on major projects and has
continued to work as a hands-on engineer for particular clients but has found the
time to write this E-book so that project developers everywhere can benefit from
his experience.
So Will knows everything just about everything there is to know about
engineering and construction projects and setting up new businesses involving
construction – and has written this book for the benefit of anyone that really
wants to know how to do a Feasibility Study on a Major Project.
Use of the E-book
It is a sad fact that most new businesses fail and that many existing businesses
fail or are taken over after a project has gone sour. Most of the projects that
cause such failures are fundamentally sound and fail or do not progress because
of mistakes that are made during the early project development process.
The objective of the E-book is to help get new engineering and construction
projects that are required to solve problems or take advantage of an opportunity
up and running.
Shorace is a system and is not mandatory. I recommend that you read the entire
E-book and then consider how you might implement the principles of the process
within your own organisation.
It is possible that you will need to “tune” the process to suit the requirements of
your own business. Many firms are set up on a departmental basis and it is in
those businesses that SHORACE may prove to be most beneficial.
The most important thing is to mould the principles involved to your particular
business style and type of work and not to let the particulars get in your way.
And please remember the two fundamental facts about systems.
A system is a process of realising a specific objective based on
undertaking a series of logical actions in a logical sequence.
A system allows inexperienced people to predictably achieve a specific
objective.
Applicability of the E-book
The E-book has been written expressly to help people who are new to feasibility
studies or people with previous experience of them that want to improve their
techniques.
The E-book is mainly geared towards engineering and construction but the author
has applied exactly the same principles in business development feasibility
studies.
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The E-book has been written for large complex projects. However the principles
are very simple and can also be applied to the smaller engineering and
construction projects of any shape and size. In simple projects many of the Work
Items in each Step can just be ignored when they are obviously inappropriate.
Many people have read the book and have said that
“I do not need to follow a complicated process like this” – Well I know that are
wrong - unless you undertake each Step in sequence your project is likely to go
sour.
The methodology of the process is that there are 5 distinct steps or stages of
project development before Detailed Design even commences. At the end of
each Step there should a milestone where the real decision makers are involved.
It is very important to remember that the project development process should be
decision driven and not led by the activities involved. There are three important
underlying objectives that must be constantly born in mind;
•
•
•
The identification and optimization of the value of the project drivers
The execution of just the work required to support a defined decision
making process
Continuous alignment of all the involved parties
This E-book has been designed to help the project owner and developer and has
been written on that basis.
The project owner may be an industrial concern, a property developer, a private
individual or part of local or central government. The project owner may also be
the project developer. He is referred to as the “Project Sponsor” in this E-book.
One really important issue is that there is a steep increase in the cost of
each of the 4 steps.
So if a total show stopper emerges during any of the Steps it is important to stop
the project then and there – and perhaps reconsider the previously agreed
objectives.
Scope of the E-book
This E-book concentrates on the Shell, Optionology and Refinery but the sections
on Accordancy and Execution are included for the sake of clarity although there
are hundreds of publications available that deal with these aspects in more detail.
You are probably unfamiliar with these terms and they are explained in Chapter1.
Claims and Representations
Every effort has been made to accurately represent this informational product
and it’s potential. There is no guarantee that you will earn any money using the
techniques and ideas from this product or that your projects will be improved by
them. Examples in this product are not to be interpreted as a promise or
guarantee of success or earnings. The level of success in attaining the results
claimed in our materials depends on the time you devote to the program, ideas
and techniques mentioned your finances, knowledge and various skills. Because
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these factors differ according to each individual, Piexe cannot guarantee your
success or income level. nor that it is responsible for any of your actions.
Liability
The materials in this site are provided "as is" and without warranties of any kind
either expressed or implied. Piexe disclaims all warranties, implied or expressed,
including, but not limited to, implied warranties of merchantability for a particular
purpose. Piexe does not warrant that the functions contained in this site's
material will be error free, that errors will be corrected, or that this site or the
server that makes it available are free of viruses or other harmful things. Piexe
does not warrant or make any representations regarding the use or the results of
the use of the information and material in this E-book in terms of their
correctness, accuracy, reliability, or otherwise. You assume the entire cost of all
necessary servicing, repair or correction. Under no circumstances, including, but
not limited to, negligence, shall Piexe be liable for any special or consequential
damages that result from the use of, or the inability to use, the materials in this
E-book, even if Piexe has been advised of the possibility of such damages.
Applicable law may not allow the limitation or exclusion of liability or incidental or
consequential damages, so the above limitation or exclusion may not apply to
you. Facts and information in this E-book are believed to be accurate at the time
they were placed in it. Changes may be made at any time without prior notice. All
data provided in this E-book is to be used for informational purposes only. The
information contained in this E-book and pages within, is not intended to provide
specific legal, financial or tax advice, or any other advice, whatsoever, for any
individual or company and should not be relied upon in that regard. The services
described in this E-book are only offered in jurisdictions where they may be
legally offered.
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Section 1
Chapter 1:
How Shorace
Works
“It would be naive to think that the problems
plaguing mankind today can be solved with
means and methods which were applied or
seemed to work in the past. . .”
Mikhail Gorbachev, (1988)
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Chapter 1 - Shorace Overview
Terminology
Shorace is an acronym for the following steps that are carried out in chronological
order;
1. Shell
2. Optionology
3. Refinery
4. Accordancy
5. Execution
Shell, Optionology, Refinery and Accordancy are new terms that I use to describe
the different early steps in Project Development. I make no excuse for making up
the word “Optionology”. It is the most important part of the Project Appraisal
process and there is no English word that has the meaning that I have given to it.
This E-book concentrates on the Shell, Optionology and Refinery but the sections
on Accordancy and Execution are included for the sake of clarity.
I have used the word “Shell” to describe the first Step of the Shorace system
quite deliberately because it indicates something that is hard and unyielding –
and there is a very powerful reason for this.
In the past terms like “Project frame” and most popularly “Project Charter” have
been used to describe the initial project stage. And the normal approach has been
to guess what this document should say because “We don’t know much about the
project so it doesn’t matter if we get it wrong because we can always change it in
the future”. Consequently the document is often put in a drawer and forgotten.
THIS ATTITUDE AND APPROACH IS ONE OF THE FUNDAMENTAL REASONS
WHY PROJECTS GO WRONG!
The Shell should be written and redrafted endlessly until every “Project Sponsor”
that has any responsibility for the Project can sign off on it. Then it should
become the “Project Bible” against which every future document is measured. If
the new document does not comply then it should be changed.
If the issue is so fundamental that the project cannot continue then it should be
paused until the Shell document is revised and re-approved. If the “Project
Sponsors” cannot agree on the change the project should be cancelled.
You will probably have heard of Value Management and Risk Assessment but may
not be sure exactly what is entailed in undertaking these types of analysis. There
is a Chapter on each of these concepts and they may be ignored at this stage
during your first reading of this E-book, because the techniques can be easily
applied later when your project is underway.
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The SHORACE Process
STEP
Content
Process
SH
SHELL
Opportunity statement
Strategic fit statement
Project manager and his Gather existing data
team are impartial
Statement of assumptions
Statement of uncertainties
Define the options
Values and trade-offs
Capex and Opex
Identify stakeholders
Strategic risk review
Why are we doing
this?
What exactly are we
going to do?
Is it something we
should be doing?
O
OPTIONOLOGY
Finalise option evaluation metrics
Identify the real options
Identify value drivers
Set risk criteria
Develop each doable option
Test the options
Deploy communication plan
Select preferred option and develop scope
and outline specification documentation
What is the best
way of doing it?
Can we eliminate
every major risk?
Will it do what we
want?
Finalise the scope of the selected Option
Undertake the required surveys and
investigations
Prepare the concept design to match the
project sponsors requirements regarding
features and performance parameters.
Prepare costs estimates and schedules in
order to calculate the Return on Investment
etc
Finalise the
proposal and
develop the answers
to every query and
possible objection
Project team is
technically challenged
and intrigued.
Consultants are only
used for tasks such as
surveys, technical
reports and cost advice.
R
REFINEMENT
Project team is now the
project champion and
develops the preferred
option to meet all the
project sponsors
requirements.
Technical consultants
are now required
AC
ACCORDANCY
Preliminary engineering design
Prepare detailed project execution plan
Project team appoints
Undertake Value Engineering
the consultants and gets Undertake Risk Review
all the stakeholders
Continue with communication plan
behind the project
Submit consent applications
Get everyone
involved to agree
with and back the
project
Major input from
technical consultants
required
E
EXECUTION
Final commitment of resources
Final Go – No by the
The project is placed in the project execution
Full agreement is
Project Sponsor
process where detailed design and
confirmed and the
construction proceeds on a conventional
project sponsor commits basis
the business to the
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project
Definitions
The Project Shell
The Project Shell document should include:
1. A brief statement outlining the business opportunity or a problem that
needs to be resolved.
2. A Statement demonstrating strategic fit or business need
3. A Statement of the assumptions and uncertainties
4. A preliminary assessment of the options that might be considered (not an
exhaustive list at this stage)
5. The qualitative values and the trade-offs between capital costs (Capex)
and operating costs (Opex) that need to be taken into account
6. Strategic Risk Review
7. Preliminary Capex and Opex figures
During this stage the work is concentrated on the acquisition of background data
and the identification of “show-stoppers”,
The Shell must be coherent and its purpose is to define the objectives of the
project and demonstrate how the project is allied with the strategic business
strategy of the Project Sponsor.
It should be a short document and never cover more than 5 / 6 sheets of paper
and should include the Shorace Matrix (Outline project development plan).
Optionology
A new word that I have made up to describe this project stage that concentrates
on identifying all the possible development options or alternatives and will
include;
1. Development of quantitative option evaluation metrics
2. Identification of all the distinct options and testing for strategic fit
3. Identification of the key value drivers and their weighting
4. Setting of risk criteria to ensure RM consistency
5. Development of each option that passes the strategic fit test along with
preliminary execution plans
6. Confirmation of stakeholder identity and the deployment of an initial
inquiry / communication plan
7. Testing of the options via the inquiry / communication plan
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8. Evaluation and selection of preferred option using Value Management and
Risk Management techniques and the evaluation metrics
It is always preferable to restrict the choice to one option but in some projects it
will be found that the cost and construction schedule is so dominant that the final
choice may have to be deferred into the Refinery and occasionally into the
Accordance S
tage.
Refinery
I have given another meaning given to an old word. As the name suggests this
stage concentrates on improving and identifying more refined project details and
would include;
1. The identification of any land that needs to be acquired and the cost of
acquisition and obtaining consent for access for testing
2. The preparation of a detailed project scope
3. The identification of any infrastructure works that are required
4. Confirmation of all the operational parameters
5. The preparation and letting of contracts for surveys, soil investigation and
any special studies such as market surveys.
6. Supervision of the surveys and special studies and acceptance of the
reports and results.
7. The assessment of the results of the surveys and studies and the testing
of the preferred option including consideration of staged construction to
optimise the ROI.
8. The preparation of a detailed project schedule
9. Undertaking Value Engineering Studies
10. Undertaking Risk Management Studies
It is the Value and Risk Management in this step that reduces the likelihood of
those late changes that can cost so much during construction.
Accordancy
This is another new word that emphasizes the importance of communicating the
projects aims and objectives to all the parties that could affect the project
outcome. The title of this stage or step may be puzzling to many of you who are
more experienced in the execution of feasibility studies. Accordancy is a very
appropriate name because it is at this stage that the detailed project execution
plan is prepared and published and everyone who has any influence or interest in
the project must be brought on side to back it – or the project is fine tuned to
take account of any valid objections.
The detailed project execution plan should include;
1. The work plan and work breakdown
2. The detailed construction schedule
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3. The contracting plan
4. The tender documents
5. Detailed Capex, Opex and other costs
6. Risk assessment and mitigation plan
This stage will also include all the applications for consent to both local, regional
and national government in accordance with the local rules and regulations as
well as the project Communication Plan that deals with project Public Relations.
Execution
This will include the detailed design, construction, commissioning and operation
etc that has largely been ignored in this book because there are thousands of
book, reports and publications that deal with it in great detail.
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Comparison with Historic Terminology
Readers will find the following Table useful. It also illustrates how confusing the
old terminology is – especially as many people move about between the
construction, investment and oil and gas industries.
Step /
Stage
SHORACE
Terminology
Construction
Terminology
Investment
Terminology
Oil and Gas
Terminology
1
Shell
Charter
Appraisal
Feasibility
2
Optionology
Pre-feasibility
Appraisal
Concept
3
Refinery
Feasibility
Investment
Planning
Front End
Engineering
Development
(FEED)
4
Accordancy
Project Plan
Asset Creation
Detailed Design
5
Execution
Detailed design
and
construction
Asset Creation
and Operation
Construction and
Operation
You will find that no two engineers actually agree on the names in the table, let
alone what should be undertaken during each stage. The main differences
between SHORACE and the traditional approaches are as follows
•
The SHORACE process is decision driven whereas the traditional
approaches are activity driven
•
The SHORACE process covers different ground during each stage whereas
the traditional approach does the same thing but in ever increasing detail
•
The SHORACE process requires a clear go – no go decision at the end each
stage, whereas traditionally the go – no go decision is made at the end of
Refinery
•
The SHORACE terminology is clear and unambiguous whereas the
vagueness of the old terminology leads to constant debate and confusion
as to what should be included in each stage
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The Project Shell
Definition
For ease of reference I have copied the definition of the Shell here again and it is;
1. A brief statement outlining the business opportunity or a problem that
needs to be resolved.
2. A Statement demonstrating strategic fit or business need
3. A Statement of the assumptions and uncertainties
4. A preliminary assessment of the options that might be considered (not an
exhaustive list at this stage)
5. The qualitative values and the trade-offs between capital costs (Capex)
and operating costs (Opex) that need to be taken into account
6. Strategic Risk Review
7. Preliminary Capex and Opex figures
Why us the word “Shell”?
The word "Shell" is the name that I give to the primary document that will govern
the whole feasibility study process. It has also been called the "Frame" or the
"Project Charter".
I prefer the word Shell because it implies that it is hard and unyielding - and this
is exactly what the document should be - a hard and unchangeable "Bible" that
the project must comply with. If it becomes a soft changeable document subject
to the whims of senior management the project will quickly become
unmanageable.
Why is the Shell document so important?
The Shell is particularly important because it is the lack of a document of this
stature that is most commonly neglected and where the seeds of dramatic project
failure are sown.
The Golden Rule of the Shorace Process is that the following Step cannot be
commenced until the Project Sponsor (or his delegate) has signed off on the
previous step and sanctioned the expenditure on the next one. In practice the
Shell should never be signed off lightly as in good practice it immediately
becomes the Project Bible to which all future decisions will be referred.
What should you call the process?
It is important that you give the process a name so that in the course of time it
becomes "branded" as your firms approach to project inception and execution.
Your consultants will learn to live with it over time and they may even eventually
acknowledge that it is effective.
They will never like it because it reduces their control over the end product and
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their ability to pad the documents out with "boiler plate" text.
For the uninitiated "boiler plate" text is standard text that is just inserted from old
documents and not expressly written for the project.
I call the process SHORACE but I expect that others will develop their own
terminology.
What can trigger the need for a project?
These might include:●
A change in the regulations that govern business operations
●
A new product or service or market or business opportunity
●
Capacity change
●
Operational change
●
Accident or environmental disaster
●
Human resource problems
What does the word "success" mean in the context of the project
execution process?
Before we go any further let's look at what I believe the word success means in
this context - it is quite simple and there are two options:
●
If the project is viable the best value option and method of
execution are chosen to ensure a maximum Return on the
Investment
●
If the project is not viable the project is terminated as early as
possible in the project initiation and execution process
You will all know that there are many projects that were executed when they
should not have been and many more that should have been more successful
than they were.
One of the objectives of this E-book is to help project developers ensure that
their projects fall firmly into one of the above two categories.
How should the whole process work?
At the end of every Step the project team will undertake a presentation to an
Authorization Panel (AP) based on the deliverables specified in the SHORACE
Matrix (described below).
One common arrangement is for the Authorization Panel to consist of Senior
Management and for the Project Work to be undertaken by Line Managers
assisted by Consultants or just by Consultants. The Authorization Panel Chairman
may either be directly responsible for the budget required for the project or be
responsible for reporting on the budget to the Directors or to higher
management.
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Most defective projects will be abandoned during the Shell Authorization Panel
presentation.
However some will make it through to the Optionology Authorization Panel. Such
projects are always the ones that cause the most difficult go – no/go decisions.
Don't forget that one of the main purposes of the process is to weed out the
projects that do not work.
The most important thing about the Shell is that it must have a clear purpose
that is easy to understand.
"If the concept is difficult to explain then you
don't understand what the real problem or
opportunity is".
The early project assessment process and the drafting of the Shell document can
be a highly iterative process in complex projects.
When you start to draft the Shell you will realise that there are gaping holes in
the early project assessment work that needs to be looked at again. When you
have plugged these holes more appear as you redraft the Shell over and over
again.
I have personally spent weeks trying to forge a single shell document of a few
pages into a simple coherent document – but it was a very complex project!
Project Bible
Once the Shell has been approved by the Authorization Panel (AP) it will become
the "Project Bible" throughout the life of the project and every project decision
must be made in accordance with its stipulations and provisions.
Shell changes
The Shell must be written with great care at a time when all the overriding
project issues are fresh in the minds of the project team and so ideally the Shell:“Should never need to be changed”
A change requirement will indicate that the Shell project team - “Got it wrong”
So if the project is in trouble unless the Shell is changed, any revision must be
considered with great care to ensure that coherency is maintained.
It should then be taken back to and approved by the AP from the previous Step.
The SHORACE Matrix
What is it?
The term project planning can be very confusing because there are two different
aspects of it that are very frequently confused. I have seen plenty of instances
when activities from each aspect have even been put into the same schedule!
I call them the project approval process and project planning – they are both
interdependent but they must be kept as two separate processes.
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The project approval process
This is the process whereby a project is approved by the organisation that is the
ultimate benefactor of the project and will in most circumstances provide the
personnel and chairperson of the Authorization Panel (where approval means
project go-ahead)
The SHORACE Matrix maps out the project approval process that is
prepared during the Shell step, and is updated in subsequent steps as
described below.
The Matrix maps out the whole project and gives reasonable time frames for each
step. The detailed schedules for the subsequent steps are part of the deliverable
from each previous step.
On the following page I have provided the basic format of the SHORACE Matrix in
a simple tabular basis. It can be set up in MS Word in a few minutes and so you
do not need to buy expensive templates.
My format and the explanatory notes in this E-book will allow you to populate and
tailor the table to meet the requirements of every project that you undertake.
During the Shell step the matrix is populated with:
●
The work scope for the Shell and Optionology Stages
●
The deliverables for the Shell and Optionology Stages
●
The Project team for the Shell and Optionology Stage
●
Authorization Panel personnel for the Shell and Optionology Stages
●
The dates for the Shell and Optionology Stage Authorization Panel
meetings.
During Optionology the original matrix is updated and the rest of the matrix is
populated for Refinery, Accordancy and Execution.
During Refinery the matrix is updated for Accordancy and Execution and so on.
Project planning
Do not confuse the SHORACE Matrix with detailed project planning tools like
Microsoft Project and other software tools that are used. These should incorporate
milestone dates from the SHORACE Matrix but these tools are used to schedule
the design, consent and construction process (where consent refers to local /
regional / central government approval).
Your own matrix name
I am sure that you as you improve and develop your own procedures you will
choose your own name for it as part of the branding and consolidation of the
process into your own organisation.
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The SHORACE Matrix
Step
Step work
scope
summary
Shell
Optionology
Refinery
Accordance
Shell
(Desk study)
Optionology
(Desk study)
Refinery and
surveys
Accordancy
Go – no go and
and project
Execution
execution plan
Follow the AP instructions
in finalising the scope of
the selected option
including:-
Prepare and submit
planning and any other
applications for consent /
approval
Clarify the project objectives Develop the option
evaluation metrics
Define the criteria for
Identify all the distinct
strategic fit and test
options and test for strategic
fit
Gather the existing data
Preliminary project
assessment
Identify the key value drivers
and their weighting
• Land acquisition
• Detailed project scope
• Infrastructure works
• Operational
parameters
• Define the assumptions Set risk criteria to ensure RM
• Identify the uncertainties consistency
Prepare draft contracts for
• Strategic risk
assessment
Develop each option that
• Capex - Opex models passes the strategic fit test
• Possible funding sources along with preliminary
execution plans
Identify internal and external
stakeholders and prepare Confirm stakeholder identity
and deploy completed inquiry
draft inquiry /
/ communication plan
communication plan
surveys, soil investigation,
etc.
Finalise and place
contracts for the Refinery
surveys and special
studies.
Supervise the surveys and
special studies.
Define the option evaluation Test the options via the
inquiry / communication plan
metrics
Take the results of the
surveys and studies and
Evaluate and select
Prepare project shell
test the preferred option
preferred option using VM
document
and RM techniques and the including consideration of
staged construction to
evaluation metrics
Identify the project team,
optimise the ROI.
review board, cost and
Identify source of funding
schedule for Optionology
Confirm source of funding
Identify the project team,
Prepare more detailed
review board, cost and
schedule for Refinery and project schedule based on
the preferred option
Accordancy
Step
deliverables
Undertake value
engineering studies
Execution
Check that all aspects of the
project comply with the
Shell.
Deploy the final stage of the
communication plan.
Prepare final ROI
calculations including
estimates of the figures
required to demonstrate
Prepare detailed execution that corporate investment
plan including:
objectives are being met.
Undertake risk reviews to
reduce risk
• The work plan and
Undertake Value and Risk
Management Review
work breakdown
• The detailed
construction schedule
• The contracting plan
• The tender documents
• Detailed Capex, Opex
and other costs
• Risk assessment and
mitigation plan
Finalise funding contracts
Continue the deployment
of the communication plan
1). Project shell
2). Project planning matrix
3). Presentation of all
relevant date to the AP
1). Responses to inquiry /
communication plan
2). Report on the options and
recommendations
2). Presentation of all
relevant date to the AP
1). Updated planning
matrix inc detailed
Accordance schedule
2). Presentation of all
relevant date to the AP
including surveys and
special study reports
1) The detailed project
execution plan
2). Report on the
engagement with the
stakeholders
Final Report on project
viability and
recommendations on project
go - no/go.
AP has 3 choices:
Proceed to Optionology
Re-do Step1
Abandon the project
AP has 3 choices:
Proceed to Refinery
Re-do Optionology
Abandon the project
AP has 3 choices:
Proceed to Accordance
Re-do Refinery
Abandon the project
AP has 2 choices:
Proceed to Execution
Re-do Accordance
The final go or no-go
decision
Project team
Authorization
Panel
(By name and inc.
ext. consultants)
Review date
Study cost
Notes
In most circumstances consultants will not be involved with Shell. The matrix then provides both power and
flexibility. For instance at the end of Shell the Shell document can be used to get funding and then be issued
to consultants as the Terms of Reference for Optionology and the deliverables from Optionology can be the
basis of the Terms of Reference for Refinery.
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Chapter 2:
The Project
Shell
“We must avoid here two complementary errors:
on the one hand that the world has a unique,
intrinsic, pre-existing structure awaiting our grasp;
and on the other hand that the world is in utter
chaos. The first error is that of the student who
marvelled at how the astronomers could find out
the true names of distant constellations. The
second error is that of the Lewis Carroll's Walrus
who grouped shoes with ships and sealing wax,
and cabbages with kings...”
R. Abel, Man is the Measure, New York: Free Press, 1976
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Chapter 2 – the Project Shell
Work scope summary
1. Clarify the objectives – the opportunity statement
2. Define the criteria for business fit and test against the criteria:
●
What is strategic fit?
●
Verify the business need
●
Identify the core competencies available to undertake the project
●
Undertake SWOT analysis
●
Identify any regulatory or environmental issues
●
Identify who will operate the facility
●
Undertake strategic risk study
3. Gather the existing data available
4. Preliminary assessment:
●
Define the assumptions
●
Identify the uncertainties
●
Preliminary Risk
●
Assessment
●
Capex and Opex spreadsheets
5. Identify internal and external stakeholders and prepare outline inquiry /
communication plan
6. Define the option evaluation metrics
7. Prepare the Shell document
8. Identify the project team, AP, cost and source of funding for Optionology
Shell implementation philosophy
The timescale for Shell should be kept as short as is possible consistent with the
requirement that sufficient work is done to allow the Shell AP to sanction the
implementation of Optionology.
Clarify the objectives
Briefing meeting
At the outset the project will probably be quite vague in concept and structure.
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The first thing to do is to clarify what the project objectives are at a strategic
briefing meeting involving client representatives and key stakeholders.
The agenda could include:●
Clarification of the underlying business need
●
The options that have been considered and the initial views on these
●
Identification of the strategic risks
●
The assumptions and uncertainties
●
Sources of finance and order of cost envisaged
●
Preliminary identification of the stakeholders
●
Format for the first workshop
The first workshop / stakeholder conference
After the briefing meeting the project team should prepare a workshop brief that
should at least include:●
An agenda
●
A list of participants and their interest
●
The minutes of the briefing meeting
●
The scope of the issues to be examined and the desired output
●
Briefing documentation and background data
There are all kinds of ways of running workshops that will depend on the culture
of the organisation.
In my experience this kind of workshop is likely to involve senior managers who
intensely dislike debating trivial issues. In this case a great deal of analysis and
preparation needs to be in place before the workshop so that the gathering can
concentrate on processing it.
Whatever format the workshop takes it should generate a large volume of data
that will take time to process and summarise into a clear set of project
objectives.
What is a stakeholder?
A stakeholder is anyone who has or may have a direct or indirect interest in the
project for whatever reason.
The identity of the internal stakeholders will be obvious to anyone who has been
in the promoting firm for any length of time – if they are not obvious then the
project promoter should seek the opinion of his immediate superior.
External stakeholders might be the land owner, riparian owners, planning
authority, local newspaper etc
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What sort of issues can be considered as bone fide objectives
The removal of a problem, bottom line profit, greater efficiency, reduction of
business risk, removal of long term obligations, capital growth, reduction in rental
outgoings, accommodation for increased staffing levels, etc etc
Workshop conclusions
The conclusions from the first workshop / stakeholder conference should be
boiled down into minutes with the following headings:● The primary objective(s)
● Any secondary objectives
● Nice to haves
● Preliminary assumptions
● Preliminary uncertainties
● Any other special or unusual project characteristics
Define the criteria for strategic fit and test against the criteria
After the objectives have been clarified they need to be tested against the
strategy of the sponsoring business or organisation.
What is strategic fit?
Answer - “The extent to which the activities of an organisation are complemented
by a new activity in such a way as to contribute to competitive advantage”.
Many organisations will already have internal ground rules that govern the type of
new activity or business that the organisation can undertake and these will
obviously have a primary role in decisions regarding strategic fit.
Environmental concerns, national and local political considerations, ethical
considerations are all areas where strategic fit may influence whether the
proposed project is viable.
Beware - if you do not do this testing your whole project may be shot down by a
senior executive or a stakeholder after you have invested a lot of time and
resources into the project.
Verify the business need
When someone has realised that there is a need for some kind of change the first
thing to do is to verify that a building or construction project is the best way to
deliver the benefit. This will involve considering all the other options that are
available and testing them against the overall strategy.
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Identify the core competencies available to undertake the project
This may not be easy because of the conflicting demands of senior managers.
They will want their own line managers involved but at the same time will not
release them from any day to day responsibilities to help with the project. Make
no mistake you must maximise the input from everyone in the organisation that
has core experience or knowledge that will enhance the body of knowledge that
the project must develop if it is to be successful.
The following approach will probably make the most productive use of line
manager’s time:●
Co-opt them as part-time team members
●
Have a series of meetings with each line manager that are basically
question and answer sessions
●
Prepare a draft Project Shell and circulate it to the managers involved
asking them to indicate how they can help
This process will probably help you to set up the Project Team for Steps 1,2 and
3.
Undertake SWOT analysis
The acronym for Strengths, Weaknesses, Opportunities and Threats and normally
undertaken in brain-storming sessions that will help get the internal stakeholders
behind the project.
Identify any regulatory or environmental issues
Data on this may be available from internal line management.
Identify who will operate the facility
This may be a political can of worms that may need to be parked at an early
stage of a project. However if there are stakeholder issues involved they will have
to be dealt with.
Undertake strategic risk review
At this stage the project team needs to examine the risks that could affect the
business in the long term particularly the project effect on growth, continuation
and even survival as well as the actual risk involved in the project itself dealt with
in the Preliminary Project Assessment.
Gather the existing data available
This can be delegated - instruct someone to gather together every piece of
information from every source available and then file and index it. This is the
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start of the project body of knowledge.
Preliminary project assessment:
Define the assumptions
Sometimes these are called “Givens” - I prefer the term “Assumptions” but the
terms are totally interchangeable. They will form the bedrock scope requirements
of the project and should be continuously challenged throughout the entire Shell
process.
They might include:●
The operational capacity of the proposed facility
●
The location and / or site availability
●
The project schedule requirements
●
Local Infrastructure capacity
●
Environmental standards
●
Local / regional / national planning requirements
●
Operational criteria
●
Etc
The project team must satisfy themselves that the assumptions are a rock solid
basis on which to proceed. If they are not certain then the Assumptions must be
classed as Uncertainties – see below
In many organizations these requirements are set in place by senior management
and not challenged – does this sound familiar to you?
It is of fundamental importance that during Shell they can be challenged
by any member of the project team, internal stakeholders or the AP
After the Shell is approved by the Shell AP it should only be challenged in rare
circumstances – probably after some fundamental change in the economic or
environmental conditions.
Identify the uncertainties
The uncertainties may be items that cannot be made assumptions by the project
team during Shell but can be verified as facts during further study in Optionology.
Many of the uncertainties will also feature in the Risk Management process as the
project proceeds.
Strategic Risk Assessment
This part of the Risk Assessment study should also identify a project strategy for
managing the project risks.
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Capex and Opex models
These will be preliminary spreadsheets that test whether the project looks
reasonably viable or not.
Remember that you only need to fix an order of cost at this stage and that in
badly managed projects “scope creep” is the major cause of cost overruns - So
place all the emphasis on the scope and do not worry too much about schedule
and cost. It is very important to make sure that the scope differentiates between
the essentials and the “nice to haves” as this reduces the potential for scope
creep.
Normally reference to the Shell will quickly show whether an item is “In scope” or
not.
Source of total project funding
This may be known or unknown – especially if the purpose of the study is to
secure funding.
Identify internal and external stakeholders and prepare outline
inquiry / communication plan
The internal stakeholders should not be difficult to identify.
The external stakeholders will be more difficult but their identity will be exposed
by others as the project moves through the planning application and
environmental impact stages.
The outline inquiry / communication plan should take account of the requirement
to continuously identify new stakeholders throughout the project process and the
measures to be put in place to bring them on board
Define the option evaluation metrics
This is where things can start to get difficult. First of all you need to think about
the nature of the project.
If the project is designed to solve a business problem it may be appropriate to
use a "just get over the bar" approach. In other words if you can put ticks in the
box for each measurement criteria then the option that provides the best value or
trade-off as measured by NPV will be the option to select.
The problem with this is that it can allow the executives on the AP to prevaricate
if they have personal hobby horses to ride or other prejudices.
If the project is mainly designed to increase bottom line profits then another
approach may be needed whereby the metrics are heavily weighted towards
profit and risk.
In general it will always be preferable to use a quantitative approach to all the
metrics by the assignation of a scale of numerical values of say 1 to 10 to
qualitative items as is commonly done in risk analysis. But the metrics should be
weighted. Please refer to the Value Benchmarking tool in the Appendix of this E-
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book.
Prepare project shell document
This is described above in our introduction to the Shorace process
Identify the project team, AP, cost and source of funding for
Optionology
This will all be part of the presentation to the Shell Authorization Panel
Project team for Optionology
The maintenance of continuity is always preferable.
Optionology Authorization Panel
This should consist of a Chairman and several others depending on the size and
importance of the project. It may often be preferable to choose the Senior Line
Manager that will be responsible for the operation of the project. However there
may be many reasons why this is not appropriate in your particular project.
Remember that the Project Manager may need to sound out the Chairman from
time to time and so he must be reasonably accessible.
Cost of Optionology
This can be set out in a simple spreadsheet.
Source of funding for Optionology
This may be left for the AP to decide
Summary of Optionology Work scope
The essence of the Optionology work scope is that the project is fleshed out in
enough depth to know whether to proceed to Optionology or not.
You will note that all the important elements of the project are brought forward to
the same level of detail and that this level should be sufficient to either abandon
the project or move to Optionology.
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Chapter 3:
Optionology
“We must dare to think "unthinkable"
thoughts. We must learn to explore all the
options and possibilities that confront us in a
complex and rapidly changing world. We
must learn to welcome and not to fear the
voices of dissent. We must dare to think
about "unthinkable things" because when
things become unthinkable, thinking stops
and action becomes mindless”
J. William Fulbright (1905 - ), March 27, 1964
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Chapter 3 – Optionology
Work Scope
Summary
1. Develop the option evaluation metrics
2. Identify all the distinct options and test for strategic fit
3. Identify the key value drivers and their weighting
4. Set risk criteria to ensure RM consistency
5. Develop each option that passes the strategic fit test along with preliminary
execution plans
6. Confirm stakeholder identity and deploy completed inquiry / communication
plan
7. Test the options via the inquiry / communication plan
8. Evaluate and select preferred option using VM and RM techniques and the
evaluation metrics
9. Identify the project team, review board, cost and schedule for Refinery and
Accordancy
Optionology implementation philosophy
This is the step where the most important project decisions are made and so it is
unwise to impose a time scale that may reduce the quality of the study work.
If the project is for manufacturing or production it is better if the work is carried
out by an in-house project manager because a large proportion of it will involve
internal communication. If consultants have to be used hire them for the
Optionology period and sit them down at a desk within your organization’s office.
Develop the option evaluation metrics
This will be an iterative process that goes instep with the identification of the
options as described below. You will probably not be able to finalise the metric
criteria until all the options have been identified and tested against them.
Typical metrics might include Capex, Cost per Unit, Capacity etc
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Identify the distinct options and test for strategic fit
The Identification process
It is a highly iterative process in that every time an option is identified it is
possible that further research will be required by:●
Acquiring advice from internal experts
●
Hiring consultants for specific tasks
●
Electronic and library searches for papers etc
Don't forget you must archive and index all the data for both audit purposes and
for reference in later project stages.
Make no mistake this is a core feature of the Value Management process
and you must leave no stone unturned in the identification of all
practicable options and the elimination of every one that you can on the
basis of solid coherent logic.
The ground rules for the choice of options
These are:1) They must be practicable and so expert advice may be needed to ensure
viability
2) Internal stakeholders must be involved in their identification
3) Out of the box thinking processes should be used to maximise creativity
4) They must fit the Shell requirements
5) Each option must provide real benefit(s) to the business or its customers
6) Potential options that require more research should not be ignored
7) Each option must be significantly different and not variations on a theme
8) Consider hybrid options based on the best features of identified options
The key to successful identification of options is too make sure that you have
researched every aspect of the project and have identified all the areas where
data is lacking or where you are uncertain as to what significance the data has.
This will lead you into the areas of research where further reading may bring out
new ideas.
In complex projects it is quite likely that further research or investigation is
required before the options can be finalised.
Test for strategic fit
After option selection you must test for strategic fit by reference back to the Shell
and reconsideration of the criteria for business fit in the light of the options that
are now on the table. They may still be applicable or they may seem to
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unnecessarily rule out a viable option and need revision but remember that a
revision of the Shell is a major issue showing that the Shell work was faulty.
The actual test for strategic fit is probably best carried out on a tabular basis with
values between 1 and 10 assigned to each of the variables. The tests might
include consideration of:●
Use of proven or unproven technology
●
Branding and Marketing
●
Method of finance and taxation
●
Legal issues
●
Environmental issues
●
Local and national political issues
●
Labour and union issues
●
etc
Identify key value drivers and their weighting
This might include such functions as:●
Cost per square metre of the facility
●
Construction period
●
Production capacity
●
Cost per unit produced
●
Maintenance costs
●
Useful life
●
Employee comfort and satisfaction
●
External image
●
Environmental impact
●
Third party constraints
●
Health and Safety during construction and operation
When the important drivers are identified they can be weighted on a percentage
basis so that the total of the weights = 100.
Benchmark figures for best in class performance can then be applied to each
value driver so that a Maximum Value Index (MVI) figure is identified. Benchmark
figures can be obtained from published data from industry associations, Internet
forums, trade magazines, financial analysts etc.
The value drivers for each option can then be assessed by the project team and
the score compared with the MVI. Each option can then be considered for
improvement by focusing on the value drivers where the deficit between
performance and the MVI is greatest.
There is a worked example in the free Value Benchmarking E-book that came free
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with this E-book.
Set risk criteria to ensure Risk Management consistency
If the options that have passed the strategic risk test are considered at a
workshop of the project team and selected stakeholders it will be quite easy to
develop a list of the risks for each option and then add them together to form a
master list of risks together with a joint opinion of the likelihood and impact using
the tables provided in the risk tables that came as a free offer with this E-book.
Further desk study may well throw up other risks that need to be added to the
register.
The risk register might then look something like this:-
Risk register
Risk
Likelihood
Impact
Planning consent denied
Low
Very high
Capital cost overrun
high
low
Lack of skilled operators
high
medium
Raw material shortages
low
high
Power cuts
very low
very high
New competitor in market
medium
low
Legislation change
low
medium
Each option should then be assessed against the register of risks.
Develop each option that passes strategic fit tests
Evaluation criteria
Each option now needs to be developed in sufficient detail to enable the
preparation of the date required for evaluation.
This will probably may require some engineering design, preparation of sketch
plans and cost estimating that may require additional expertise to be brought into
the project.
Preliminary execution plans
A preliminary execution plan will also need to be drawn up for each option and
this should include:●
Scope of the option identifying the primary elements
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●
Land acquisition and local / regional / central government planning
application strategy
●
Sketch plans showing all the primary characteristics
●
Outline work plan and work breakdown
●
Design and construction schedule
●
Contract strategy
●
Capex, Opex and IRR (or NPV)
Stakeholder inquiry / communication plan
Identify stakeholders
The project now should be sufficiently advanced for the identity of all the most
important stakeholders to be confirmed.
The most important external stakeholders will be the authorities in control of the
consent processes. This element of Optionology should include the acquisition of
all the application documentation and knowledge of how the entire application
and consent process works.
Deploy inquiry / communication plan
The inquiry / communication plan documents should now be completed
incorporating the scope definition and sketch plans of all the options and sent out
to all the stakeholders.
Formal applications for consent should not be submitted and so the
communication plan during Optionology will just include an informal notice of the
project planning that is being carried out.
Test the options via the inquiry / communication plan
Tabulate the responses to the communication plan documents and then
summarise them under the headings:●
Comprehension – did the stakeholders understand the proposals?
●
Attitude – warm, hostile, apathetic?
●
Changes – were there any useful ideas for improvement
●
Effect - on the choice of option
Evaluate and select the preferred option using VM and RM
techniques
Evaluate the metric criteria
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Tabulate the metric VM and RM criteria for each option and summarise the
implications for each. These studies at this stage will help the project team
differentiate between the options and help to select the one that has the potential
to provide the greatest value at least risk.
Select the preferred option
Just remember that this is the selection of the Project Team.
The AP will have the same access to all the data and may easily make a different
choice.
At this stage it will be prudent for the Project Manager to seek the advice of the
AP Chairman before plowing ahead with total emphasis on one option and it may
even be appropriate to go to the Optionology AP with no preferred option.
Identify the Source of Project Funds
At this stage the potential sources need to be known so that any special
requirements can be built into the Refinery work.
Identify the project team, AP, cost and source of funding for
Refinery and Accordancy
This will all be part of the presentation to the Optionology AP.
Project team for Refinery
The work undertaken in Optionology will have indicated the size of the team and
the required level of experience of the team members.
Generally the Refinery project stage may not need to be much longer but the
work content is greater and so more man-hours will need to be allowed.
AP for Refinery
As indicated before, this should preferably the same AP as for Shell and
Optionology.
Cost of Refinery and Accordancy
This will should be set out in a spreadsheet based on a work breakdown
structured approach and must include the cost of the surveys and special studies.
Source of funding
Recommendations should be made to the AP following receipt of AP guidance
during the Shell presentation.
Summary of Optionology work scope
I hope that you are now beginning to realise just how effective the Shorace
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process is!
All the essential elements are again brought forward to the same level of detail,
to the point where you have a preferred option that the process has indicated is
the best way to proceed with the project.
If the IRR is not good enough or the negative NPV too high the project can be
abandoned before all the expensive surveys required for Refinery are carried out.
But this is decision crunch time because quite big money is about to be
committed and spent on the surveys etc.
Furthermore if the Optionology work is done properly there should be no
major issues that evolve during Refinery that might halt the project at
the end of Refinery.
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Chapter 4:
Refinery
“The whole of science is nothing more than a
refinement of everyday thinking”
Albert Einstein (1879 - 1955), Physics and Reality [1936]
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Chapter 4 – Refinery
Work Scope
1. Follow the AP instructions in finalizing the scope of the selected option
including:•
Land acquisition
•
Detailed project scope
•
Infrastructure works
•
Operational parameters
2. Prepare draft contracts for surveys, soil investigation, etc.
3. Finalise and place contracts for the Refinery surveys and special studies.
4. Supervise the surveys and special studies.
5. Take the results of the surveys and studies and test the preferred option
including consideration of staged construction to optimise the ROI.
6. Prepare more detailed project schedule based on the preferred option
7. Undertake Value Engineering Studies
8. Undertake Risk Management Studies
Follow AP instructions in finalising the definition of the
selected option
Land acquisition
The land required should be defined on a map. Cost and availability should have
been determined by the inquiry / communication plan.
Planning authorities and consents
The project should be presented to the involved planning and regulatory
authorities with the objective of getting feedback on their probable response
when the actual application is delivered in Accordance.
Detailed project scope
The definition should be comprehensive and accurate enough to get the capital
cost estimates prepared to an accuracy in the +5% (simple projects) or +10%
(complex or larger projects).
If the estimators cannot achieve this then more definition is required.
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Infrastructure works
Local infrastructure works may be required by the planning authority or to meet
the additional demand on local utilities and other services. These should always
be identified and costed separately as the cost may not all need to be allocated
to the project in hand and it is the only way that bench-mark comparisons can be
validated.
Operational parameters
What is the required output or capacity?
What are the personnel requirements?
etc.
Prepare draft contracts for surveys soil investigation etc
Site investigation and topographical survey.
It is likely that specialist advice will be required from the potential contractors
involved. You will probably get some useful specification drafts from interested
potential bidders and in my experience you will also be able to obtain very
reliable cost estimates.
Other specialist studies
These might include:●
Traffic surveys
●
Noise surveys
●
Preliminary environmental impact studies
●
Unexploded ordinance surveys
●
Seismic studies
●
Market research
●
Operational method studies
●
etc, etc
You will need to get information on specification, scope and cost from potential
bidders in the same way recommended above for the site investigation and
topographical surveys.
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Finalise and place contracts for the Refinery surveys and
studies by consultants and supervise their execution
Contract documentation.
I am now going to be very presumptuous and tell you how to write Invitations to
Tender (ITT) or Request for Proposal (RFP) documentation. The implementation
of this advice may well upset your contracts department – but what the hell - you
have already upset the planning department so why not go the whole hog!
Most of the ITT's and RFP's are extremely bad written in that they do not tell the
potential contractor what you really want or ask for the information that you need
to make a rational choice of consultant or supplier.
What do you want?
Give a list in a table and weight each of the elements from 1 to 5 on the following
basis:1. Not essential but possible useful
2. Not essential but would improve your view of the tenderer
3. Essential on a qualitative basis
4. Essential on a quantitative basis without detail or accuracy
5. Essential on a highly detailed basis
You can develop your own system but you have got to tell the bidder what you
want and the accuracy of the information required.
For instance you might tell the site investigation contractor that you want a site
investigation that will allow the construction contractor to price the works on a
lump sum where he takes on all the risks associated with ground conditions.
You might pay a lot of money for the site investigation but will get it back in
spades during the course of the main works!!
How do you want it done?
You may not care but this is not a wise approach. Get some advice from the
bidders and select the best combination.
It is always better to get bids on a standard basis and tell the bidder that he can
suggest other approaches as an option. This allows you to make a valid
comparison between each bid.
What are the benefits that you will gain?
You need a reason to select a particular consultant or investigation contractor –
ask them why you should choose them rather then someone else.
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Can they do it?
Ask them to prove that they can do the job by the provision of:1. References
2. Case histories of similar jobs that they have done
3. The names and CV's of the personnel that will be involved
4. A presentation to you involving all the key personnel from the project
Supervise the surveys and special studies
Never ever economise on this - if you are not 100% sure that the data is correct
it is not worth having.
Fact - I have seen a $1.5m offshore site survey that was useless because
it was not benchmarked against a fixed level onshore.
Test the preferred option using the survey and study data.
Take the results of the surveys and studies and test the preferred option
including consideration of staged construction to optimise the ROI.
Prepare more detailed project schedule
The schedule for the preferred option, at this stage, is still a forecast and can be
prepared using MS Project.
Undertake value engineering studies
During the design development the project team should undertake the value
engineering studies to optimise the chosen design solution in terms of time cost
and quality. These studies should then be developed and validated to improve the
design.
Undertake risk reviews to reduce risk
When the preferred design has been developed to a sufficient degree, successive
risk reviews can be used to monitor the effectiveness of the risk management to
reduce exposure to acceptable levels.
Confirm project funding source
By this time the preferred source of funding should have been identified.
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Chapter 5:
Accordancy
“If a man is offered a fact which goes against
his instincts, he will scrutinize it closely, and
unless the evidence is overwhelming, he will
refuse to believe it. If, on the other hand, he
is offered something which affords a reason
for acting in accordance to his instincts, he
will accept it even on the slightest evidence.
The origin of myths is explained in this way”
Bertrand Russell (1872 – 1970)
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Chapter 5 – Accordancy
Work Scope
1. Prepare and submit consent applications
2. Preparation of Project Execution Plan
3. Value Engineering Studies
4. Risk Reviews
5. Deployment of Communication Plan
6. Finalise project funding
Prepare and submit planning and any other applications for
consent / approval
The initial requirements should have been identified under the Stakeholder
communication plan in Optionology. and feedback received on their response in
Refinery. Now the actual applications have to be made.
Prepare the Project Execution Plan
Most of the following items are self-explanatory.
• The work plan and work breakdown
• The detailed construction schedule
• The contracting plan
• The tender documents
• Detailed Capex, Opex and other costs
• Risk assessment and mitigation plan
A consultant may be needed to carry out this work.
Undertake Value Engineering Studies
The VM studies can now be focused on the selected option in order to optimise
the actual value rather than a comparison of values as was undertaken in
Optionology.
Undertake Risk Reviews
As with VM the RM studies can now be focused on the selected option in order to
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manage, mitigate or transfer all the risks.
Continue the deployment of the communication plan
The planning applications will have been lodged by now.
Further communication will be based on circulars, meetings, news bulletins etc on
the project progress to keep all the stakeholders informed and on-side.
Project Funding
The documentation should be prepared and in place but requiring signatures as
soon as the final project go-ahead is given during the Execution Authorization
Panel.
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Chapter 6:
Value and
Risk
Management
“The wise man is he who knows the relative
value of things”
William Ralph Inge (1860 - 1954)
“Great deeds are usually wrought at great
risks”
Herodotus (484 BC - 430 BC), The Histories of Herodotus
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Chapter 6 - Value and Risk Management
Introduction
Value and risk management (VM and RM) are both quite complex processes that
get more complex as project complexity increases. But as with all effective
processes they are based on quite simple principles
Both processes are integrated into the Shell, Optionology and Refinery sections of
this E-book and it gives clear guidance on how to undertake VM and RM in Shell
and Optionology. You may need to use more sophisticated VM and RM techniques
in Refinery. There are plenty of textbooks that deal with both topics.
Earned Value Management is also very useful during construction but should not
be confused with Value Management as they are entirely different techniques.
Definition of a successful project
A successful project will have the following characteristics:1. The business gets the benefit it needs at a level of quality that meets its
expectation
2. It is delivered at the expected price at the time the business needs it
The first of these is provided by Value Management and the second by Risk
Management.
It is axiomatic that the SHORACE process should identify projects that will not
meet the above criteria - as soon as possible and that they are abandoned preferably at the end of Shell.
Value management
There are three distinct phases in value management as shown in the following
table:Steps
Value management components
Feasibility Stages Definition of the benefits and their quality
Execution
Optimisation of benefits and cost
Project
Operations
Lessons learned and performance optimisation
All the Value Management techniques that you need to worry about are built into
Shell and Optionology of this E-book.
More advanced techniques can be used in Refinery and where use of these is
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appropriate they are mentioned in the text but are not dealt with in detail in this
E-book.
Risk management
Project risks can be grouped under three headings:
●
Business risks
●
Project delivery risks
●
Operational risks
Unlike the three components of value management shown in the table above the
three primary categories of risk are not time related.
For instance:●
Operational problems can arise as a result of decisions from project
inception to commissioning
●
Business problems can arise from similar causes from inception right
through into operations
All the Risk Management techniques that you need to worry about are built into
Shell and Optionology of this E-book.
More advanced techniques can be used in Refinery and where use of these is
appropriate they are mentioned in the text but are not dealt with in detail in this
E-book.
Summary
Both Value Management (VM) and Risk Management (RM) as outlined above
should be used on every significant construction project.
The process described in this E book for Steps 1, 2 and 3 follows the principles of
both Value and Risk Management but it is beyond the scope of this E-book to
describe the various techniques in the detail that might be required in Steps 4
and 5 where actual quantification of the risk may be necessary.
This is primarily because we are predominantly interested in identifying and
making a choice between options in Steps 1, 2 and 3. Hence the absolute values
of the VM and RM criteria are not so important as the difference in value that will
help us differentiate between the options.
During detailed design the absolute values become even more
important and more advanced techniques may need to be used –
but the principles will remain exactly the same.
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Chapter 7:
Project
Execution
Quality is never an accident; it is always the
result of high intention, sincere effort,
intelligent direction and skilful execution; it
represents the wise choice of many
alternatives.
William A. Foster
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Chapter 7 – Go – Ahead and Execution
Work Scope Summary
Check that all aspects of the project comply with the Shell
Deploy the final stage of the communication plan
Prepare final ROI calculations
Undertake Design and Cost Review
Undertake Construction Review
Check that all aspects of the project comply with the Shell
This is where you may find that the Shell needs to be changed - but only with the
consent of the Execution Authorization Panel.
Deploy the final stage of the communication plan
Tell everyone what the project looks like and the construction schedule.
Prepare final ROI calculations
These will need to demonstrate that the required corporate investment objectives
are being met. If not then a Design and Cost Review will be necessary.
Undertake Design and Cost Review
If the estimate Capex and Opex are resulting in an ROI that is inadequate then
the D & C review will explore each of the functional areas of the project from the
point of view of reducing cost and improving buildability. The line management of
the client must be involved in this process.
Undertake Construction Review
During the construction stage much of the risk will be passed to the contractor(s).
However there will be a number of residual risks including consequential
construction risks as well as those allocated to the client during the early contract
stages.
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Section 2
Chapter 8:
Introduction
to NPV
(Net present value)
Price is what you pay. Value is what you get.
Warren Buffett (1930 - )
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Section 2
Chapter 8
Introduction to NPV
The purpose of the E-book
Feasibility studies always include a lot of text on the many issues that can and do
affect the project outcome. These must be meticulously prepared and cover just
about every technical and commercial aspect of the project.
But the reality is that unless the Economic Assessment shows that the project is
viable it will be abandoned.
The purpose of this E-book is to show how to undertake the Economic
Assessment and make sure that your project is viable and at the same time
optimise Value and reduce Risk. It has been written to help understand and
obtain maximum benefit from “Provara”.
About Provara
“Provara” is an Excel spreadsheet based tool that allows very rapid and
comprehensive Economic Assessment of the Project Alternatives and facilitates
the use of Value Management and Risk Analysis in the identification of the best
Option for development.
Provara was written on Microsoft Excel 1997 and so it will run on all copies of
Excel from 1997 onwards.
The input and results sheet has been set up so that it will print out onto 4 A4
sheets of paper. This sheet and the working sheets behind are password
protected so that you cannot inadvertently put errors into the software.
One worksheet called Cost Calculations is provided so that you can keep all your
calculations on one spreadsheet and link the results into Provara so that they
ripple through Provara as you change them. Please look at this spreadsheet for
further instructions.
Background
Section 1 of this E-book concentrates on best practice in the process of
developing a Feasibility Study. It deals with the principles underlying the process
and how these are put into practice but does not examine how the Economic
Assessment of a project should be carried out.
Feasibility Studies are undertaken when an opportunity or a business requirement
occurs that is large enough to justify the cost of such studies. In other words the
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investment required is so large that the sponsor will incur substantial risk if the
project is implemented.
The risk involved can be reduced by techniques that have developed over the
past 30 years by the major corporations and lending institutions like the World
Bank.
The most important element of the risk reduction process involves the selection
of alternative ways of achieving the project objective. The alternatives or
“Options” as they are referred to in this E-book are then fine-tuned to maximise
value and reduce risk.
In most circumstances the Option with the highest NPV value will be selected for
development. However in some projects there may be other Qualitative aspects
of the Options that are more important then raw value. In such circumstances the
most attractive project may be chosen from any of those that get over a bar of a
certain minimum NPV value.
In this book the term Project Alternatives means all the mutually exclusive
development Options that could be developed. The term “Mutually Exclusive” is
considered in more detail later in this E-book.
Economic and Financial Assessments
I suspect that many readers are already wondering about the difference between
an Economic Assessment and other types such as a Financial Assessment.
It is important to understand the difference because they are based on the same
type of data but are required at different stages of project development for
different purposes.
The “Economic Assessment” is used to select the best Option and primarily
depends on the discounting of Project Cash Flows as described in detail later in
this E-book.
The “Financial Assessment” is an accountancy based process that would be part
of the Project Plan in Accordance and would include Profit and Loss Forecasts,
Balance Sheet Projections and Cash Flow Forecasts taking into account such
elements as Taxation and Depreciation without discounting.
Banks and investors will require this type of analysis before lending on a project
and it should be carried out by someone with an accountancy background.
The need to compare mutually exclusive options to obtain the best solution for
the project is the principle reason for the application of a “Provara” type Economic
Assessment during early project stages.
Section 2 of this E-book describes the Optionology process involving the
identification and selection of the best Option for development by Economic
Assessment.
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License to use Provara
Provara is distributed under this license:
Copyright (c) 2007 Piexe Limited
Redistribution and use in source and binary forms, with or without
modification, are not permitted.
The names of the copyright owner nor the names of its
contributors may be used to endorse or promote projects and plans derived from
the Provara software tool without specific prior written permission.
THE Provara SOFTWARE and this E-book are PROVIDED BY THE COPYRIGHT
HOLDER AND CONTRIBUTORS "AS IS" AND ANY EXPRESS OR IMPLIED
WARRANTIES, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF
MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE ARE
DISCLAIMED. IN NO EVENT SHALL THE COPYRIGHT OWNER OR CONTRIBUTORS
BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, EXEMPLARY, OR
CONSEQUENTIAL DAMAGES (INCLUDING, BUT NOT LIMITED TO, PROCUREMENT
OF SUBSTITUTE GOODS OR SERVICES; LOSS OF USE, DATA, OR PROFITS; OR
BUSINESS INTERRUPTION) HOWEVER CAUSED AND ON ANY THEORY OF
LIABILITY, WHETHER IN CONTRACT, STRICT LIABILITY, OR TORT (INCLUDING
NEGLIGENCE OR OTHERWISE) ARISING IN ANY WAY OUT OF THE USE OF THIS
SOFTWARE, EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGE.
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FINALLY - Please keep this in your mind constantly
as you use Provara to go through your Economic
Assessment.
is an easy to use tool that forces you to go through a mental process that will
give you such a deep and fundamental understanding of your project that you
cannot fail to choose the best project option
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Identification of the Options
What is an Option?
From Section 1 you will know how much importance I place on the Identification
and Selection of the best development Option because it is the foundation that
underpins the Value Management process.
I am going to explore the issue in more depth here because it is also fundamental
to the Economic Assessment process.
In the section “Background” above I use the Term “mutually exclusive”.
In other words – “None of the Options can be implemented concurrently because
they all have common elements”
The simple way of looking at it is that if three Options are mutually exclusive than
only one of the Options can be carried out for whatever reason.
For example if there are three different designs for a building on one site then
only one of the designs can be built – they are mutually exclusive.
If a new river crossing is required and a tunnel, a bridge and a ferry are the
options then whilst in theory two Options could be installed the economics would
be nonsensical and so they are mutually exclusive.
In the current political climate where global warming and caAPon emissions are
getting more important every day it would be appropriate for every major
construction project to consider a conventional approach complying with current
national regulations. This would be Option 1 and the second Option would be a
“Green” approach where energy efficiency reduced Environmental Impact and
Sustainability are the project drivers.
What are the Option differentiators?
During the early stages of a project many important choices are made when
Options are rejected or retained for further study.
Many problems will have optimal technical solutions that are not optimal
from the economics – you must constantly keep in mind that a Feasibility
Study optimises the Economics and NOT TECHNOLOGY!
The identification of the Options should therefore consider such as aspects as;
•
•
•
•
•
•
The scale of the project
Types of outputs and services
Production technology
Location
Implementation schedule
Sequencing of components
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And of course the Option of not doing it all!
Projects with several components
Many projects will involve components that are interrelated but independent.
In this case each independent component must be assessed as if it were a
separate project. Every component should contribute to the economic viability of
the Option unless there are other non-economic benefits that cannot be assessed
quantitatively.
First of all each component should be assessed independently using the most
appropriate technology for the stand-alone situation.
Then each component needs to be combined with one other component at a time
using the appropriate technology for the combination.
Then all the components would need to be combined together using the most
appropriate technology for the combined project. So if there are three
components there will be 7 Options i.e.
•
•
•
3 x stand-alone options
3 x combinations of two components
1 x combination of three components.
There may also be Options within each component and each of these will need to
be assessed as part of the 3 x stand-alone assessment.
In this instance Provara would need to be run 3 times giving the result for the 7
Options.
How do you actually develop the Options?
In an established business
In an established business with experienced people it is easy. You get the movers
and shakers of the business into a workshop and hammer them out. This must
include all the primary internal stakeholders.
Do not forget that the Agenda for the workshop should include all the background
data as well as a copy of this E-book so that the participants understand the
Workshop objective.
After the workshop you minute the results – choose the Options and circulate the
results. This gives people time for reflection. Get their comments and feedback –
and finalise your list of Options.
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Other circumstances
In other circumstances it is not so easy – but always remember that relevant
experience is of paramount importance. One real expert is always worth 100
amateurs!
If you are relatively inexperienced you may have to bite the bullet and pay for
real expertise!
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Glossary of terms
Introduction
Many of you will be aware of what the following terms mean – but I have dealt
with the topic in detail because I know that there are a lot of people that are very
confused about the techniques that are so important in the Economic Assessment
of the Options.
Discounting
The Economic acceptability of a project always hinges on whether the benefits
exceed the costs. If all benefits and costs occurred in the same year, the decision
would be a simple one of comparing benefits and costs.
Usually, however, benefits and costs occur at different times, with many costs
preceding benefits and, during the first years of the project, usually exceeding
them.
The method that is used to compare costs and benefits that occur in different
years is called “discounting”.
Discounting is essentially a technique that enables us to compare the value of
dollars in different time periods. A dollar received today is worth more than a
dollar received tomorrow because the dollar received today enables us to spend it
today, whereas the dollar received in the future can increase only future
expenditure.
The fact that we have to postpone spending makes tomorrow’s dollar less
valuable than today’s, even if tomorrow’s dollar has as much purchasing power as
today’s dollar. The declining value of money over time has nothing to do
with inflation, only with the postponement of its use.
The declining value of money over time explains in large measure why we require
interest whenever we lend money. Lending money out entails postponing the use
of it. To compensate for postponing the use of it, we demand for every dollar that
we lend an amount that enables us to increase our expenditure in the future.
Thus, whenever we open a savings account and place our money at, say, 5
percent interest per year, we are implicitly stating that for us $1.05 one year
from today is worth at least as much as $1.00 today. If we buy a five-year
certificate of deposit that pays 5 percent per year, for every dollar we give up
today, we will receive $1.28 in five years (assuming that interest is compounded
annually). We are implicitly stating that $1.28 in five years time is worth the
same as $1.00 today.
Discounting involves the reverse procedure; it answers the question, how much is
$1.28, received in five years, worth today? The answer depends on the interest
rate we are willing to accept. If we are willing to accept an interest rate of 5
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percent per year, then $1.28 in five years is worth $1.00 today. Equivalently, we
are saying that $0.78 today is worth $1.00 in the future.
Net Present Value
What is NPV?
The present value of the net benefits of a project is the basic economic criterion
that is universally used for the Economic Assessment of a project. It is used by all
the major corporations involved in investment projects as well as the World Bank
and the European Bank for Reconstruction and Development (EBRD).
In principle it is a very simple calculation whereby the sums spent or received in
each year of the projects life are discounted back to the current date. Normally
sums to be spent in the first year of the project have a discount rate of zero.
In the following year the discount rate is 1 / (1 + r) and in the third year 1/(1+r)2
where r is the discount rate as a decimal (r=0.1 is equivalent to a discount rate of
10%)
When all the discounted sums from every year of the project life are added
together the answer = the NPV
Whilst the basis of the calculation is simple, the iterative nature of the project
development process and the necessity to include Value and Risk Assessment in
the process results in a complicated process that is simplified and managed by
Provara.
How does inflation effect NPV
Inflation only affects NPV when there are different inflation rates for different
elements of the project costs and incomes. For instance if transport costs go up
much more quickly than construction costs because of the increase in the price of
crude oil then the NPV would vary because of this differential inflation. In practice
whilst short-term inflation rates can differ significantly they tend not to over the
longer term and hence are normally ignored when project Options are being
compared and the preferred Option selected.
It is possible that the Economics of the Project might be affected by cost inflation
of an important element of the project (for instance a feedstock that is certain to
increase in price the future). This differential inflation effect would be examined in
the Financial Assessment that is carried out in Accordance. Inflation will only
rarely affect a project to the extent that it loses viability. It should never
fundamentally affect the choice of the selected Option.
How does Company taxation effect NPV
The project must fit into the strategy of the Project Sponsor. The strategy of
company development in the country concerned should have dealt with taxation.
Hence company taxation should be ignored during the comparison and selection
of alternatives.
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It will need to be taken into account during the Financial Assessment that is
carried out in Accordance. This is because it may affect the ability of the Project
Sponsor to borrow the capital required. This may require phasing of the project to
reduce the amount that needs to be borrowed at any one time.
How do you use the results of the Provara output?
If Provara shows that you have two Options with roughly similar NPV’s then use
qualitative issues to select the preferred Option.
In some instances every Option will have a negative NPV. For instance if a
company has to provide facilities for its staff where it is difficult to measure the
benefit gained from the project the assessment might be based on the least
negative NPV.
In practice most private projects will require a very positive NPV before they are
acceptable to shareholders. In fact if the NPV is divided by the project life used in
the Economic Assessment the resulting number will always be a crude
conservative estimate of the annual increase in net profit arising from the Project
(before taxation and depreciation are taken into account).
The estimate is crude because accounting rules are not followed and it is
conservative because the Annual Profit and Loss calculations are not discounted
as NPV is.
Internal Rate of Return
NPV is the best criterion to use but many banks may also ask the internal rate of
return (IRR) calculations. The IRR is the discount rate that results in a zero NPV
for the project. It is also the yield to maturity of a bond and so banks are familiar
with this concept. If the IRR equals or exceeds the appropriate discount rate then
the project's NPV will be not be negative.
Often the IRR approach will provide the same answers as NPV but there are
situations where this is not the case and these include;
1. Situations where the cash flow is positive from the start – An IRR cannot be
calculated.
2. Situations where the cash flow fluctuates from negative to positive and then
back to negative following further investment – This is very common in large
developments and the IRR will vary over the life of the project.
3. Situations where the cash flow is negative from the start – for instance when
the least negative NPV is being used as the Options metric.
4. A situation where components are being added together and it is the
incremental increase in NPV that is being considered. Sometimes a small
increase in Investment can lead to a large increase in NPV and a small change
in IRR.
So the comparison and selection of the preferred Option from the mutually
exclusive Options should always be undertaken using NPV. When the
Financial Assessment is undertaken it will be useful to provide the IRR for funding
purposes – but never use it in the selection of Options.
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Chapter 9:
Capital Cost
“You'd be surprised how much it costs to look
this cheap”
Dolly Parton
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The Assessment of Capital Cost
Introduction
Advanced economies
In the highly developed Western economies and places like Japan, China, Korea,
Taiwan, Philippines etc construction standards are uniformly consistent in quality
and cost information is freely available from Indices, Annually issued Price Ebooks, Government Departments, Consultants and Contractors.
The secret of getting the estimate right in these economies is to cross check the
data from a many sources as is practicable and do a check yourself using the
Approximate Approach to Cost Estimation in the section below.
Fast developing economies
In fast developing economies where there is a stable and growing construction
industry standards can improve very rapidly and completely close the gap with
Western economies. This applies in such places as the oil-based economies
including the Middle East, Nigeria, and Venezuela etc. Construction standards
vary from being pretty good to excellent and it is easy to get cost information
from many sources – not least the contractors themselves.
Get data from as many sources as possible and crosscheck using the Approximate
Approach to Cost Estimation in the section below.
Backward economies and very remote projects
Estimating construction costs under these conditions can be difficult for just about
everyone including Contractors, Consultants, Engineers and Architects – but to be
truthful it is not as difficult as many people assume.
You will find that you can get something built to local standards at a much
cheaper going rate than in the advanced economies. However if you want
something built to American or European standards it will be more expensive in a
backward economy simply because expensive materials and expensive expatriate
labour will be needed to build to these standards.
This applies particularly to projects in undeveloped countries with a small
construction capacity and particularly where the project is very remote from
existing construction infrastructure.
The following is fairly typical in such circumstances;
1. Local materials such as stone, aggregates are often very cheap – can be a
third or quarter of typical western cost.
2. Imported materials – expensive – Find out the cost in the nearest developed
economy and add the cost of transport to the location concerned.
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3. Labour – very cheap – equivalent in the West can be 50 times more costly per
hour but the skill productivity ratios can reduce this by a factor of 5 or even
10
4. Construction plant – very expensive because of import and maintenance costs
and scarcity. Most substantial projects would justify the purchase and import
of new plant. The onward sale at the end of the project will probably recoup
most of the costs.
5. Supervision and management – very costly if restricted to Expatriate Labour.
Most economies like this rely on foreman and supervisors from places like
Turkey, Lebanon, and Pakistan etc. with a core group of highly trained
specialists.
The Approximate Approach to Cost Estimation
If reliable data is not available how do you go about getting a reasonable feel for
the Capital Cost of a Construction Project?
I have used the following method in many different circumstances and have
rarely been that far out. You may need an experienced construction guy to help
you through this process – it does not matter greatly if he does not have direct
experience of the type of project or the country involved – it is his basic
experience that you need. If he does have in country experience that is even
better.
The approach is based heavily on the 80:20 principles - I have found this very
reliable for construction projects. This principle state that 80% of the time taken
on a project involves the primary activities and that 80% of the cost of a project
relates to these same primary activities.
Shell – Develop a Construction Schedule for the primary activities and put in on
an Excel Spreadsheet using columns for weeks. (Most people have a much better
feel for how long activities should take than they think)
Optionology – Calculate the weekly cost of the labour involved in undertaking the
activities – even if you are not an expert you will have a reasonable idea of how
many men will be involved. Add the cost of expatriate supervision where it is
necessary. To calculate expat costs take the average take home salary in the
West and multiply by 5 – yes 5!
Refinery – Calculate the cost of the construction plant required – be very
generous in your quota by doubling your initial estimate for the plant hours.
Either use local plant hire rates or find out the prices of new plant in the nearest
western country and allow $50 per tonne for transport costs – and add back the
resale value at the end of the project (use 60% of the purchase cost if you cannot
ascertain what this is)
Accordance – Calculate the cost of the materials required using local rates
wherever you can – particularly for heavy, bulky low cost materials like cement,
aggregates and reinforcing steel (Remember it takes 0.5 tonnes of cement and 2
tonnes of aggregate to make a cubic metre of concrete)
Execution – Calculate the cost of Construction Supervision using the same factor
of 5 as in Optionology – 1 supervisor to 10 workers is a reasonable ratio.
When you have got all this information in the spreadsheet add them all up and
increase the cost by 20% using the 80:20 principles.
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You then add Risk Allowance between 10 and 20 % depending on your confidence
in the figures.
This figure is the basic construction cost
You then add 5% for Design and then another 5 to 10% for Project Management
and you have your Project Cost – without any allowance for Special Studies and
Surveys – but more of that later.
You may feel that this process is entirely beyond you – but even if you are wildly
out you will still have gained insight into the difficulties that the eventual builder
might face.
Probability assessment
We now have some numbers for the capital cost and we now need to bring
probability into consideration. If you have gone through the Approximate
Approach to Cost Estimation you will be in a much better position to consider the
probabilities because of your feel for the likely difficulties that might arise from
any of the following;
•
•
•
•
•
•
•
•
•
•
•
Logistical failure to get resources onto the site at the required time
Weather issues such as heat in summer and wind/ice/rain/snow in
winter
Labour availability, labour unrest and labour poaching
Plant breakdown / lack of spare parts
Diesel fuel quality / shortage
Electricity supply power cuts
Material supply reliability from local sources
Political instability
Contractor reliability
Contractors experience
Etc
The issues should be construction management related as design failure issues
such as unexpected ground conditions are dealt with in the Risk Assessment
Section.
The outcome cost that I refer to below is the final cost of the project construction
work after completion when you have added up all the invoices.
The input to Provara
By definition your cost estimate should be the mean of the range of the outcome
costs. This is because at the moment you have a cost estimate and there is a
50% probability that the outcome cost will be either higher or lower than your
estimate
You should now consider the probability of your cost estimate increasing by 10%
and then by 20%.
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By definition there is a 50% chance that your estimate will be exceeded. So it
would be reasonable to allocate a 30% probability that the capital cost will be
10% higher and a 20 % probability that the capital cost will be 20% higher. The
sum of these percentages must be 100 for Provara to calculate the overall
probability accurately (50 + 30 + 20 = 100)
If you are very confident in your costs then you might increase the chance that
your estimate will not be exceeded to 80%. In that instance you might allocate a
14% probability to a 10% increase and 6% for a 20% increase. (80 + 14 + 6 =
100)
Worked example of probability assessment
You are doing a study on a 200 square metre skating area for the local teenagers.
You have got some costs from a local builder who has no skating area experience
and this is $25,000. You have also had a quote by a skating area expert and this
is $50,000. There is some information on the Internet that suggests that the cost
should be about $200 per square metre – or $40,000 for your skating rink.
What should your probabilities be for input into Provara?
Your local builder is obviously out of his depth on this – but at the same time he
will be able to do a good job if you can get a design for him to work to and that
you can rely on.
But even then 25,000 is not going to get your skating area built so you are 100%
sure that the cost will exceed 25,000 but 30,000 does not seem silly – ok select
that as your lowest likely figure.
What about the upper probability limit. The 40,000 figure is based on outcome
costs over the past 5 years, but the quote from the skating area expert is at
current cost but you think he might be trying to put one over on you! – You are
certain that it will not cost as much as 50,000 but it seems quite unlikely that it
will exceed 40,000 – so use that as your upper limit.
Here is the result;
Lower limit
$30,000
Cost mean
$35,000
Upper Limit
$40,000
I hope you are not too confused but it is important that you thoroughly
understand the concept. We have a saying in the construction industry – an
estimate is an estimate is an estimate! It is extraordinarily difficult to get this
concept across to clients but unless you fully understand the risk involved in
construction you cannot manage the process.
So now you have your cost mean or average. By definition your outcome costs
are 50% likely to exceed this figure and so this might be the number to put into
the base cost of Provara. The Provara input requires you to assess the probability
of the cost increasing by 10% and 20%. In this case that amounts to 38,500 and
42,000. On the basis of the cost information that you have you might increase
the base case to 65%, the 10% increase probability to 25% and the 20%
increase probability to 10% (65 + 25 + 10 = 100)
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This might sound very complicated but the power of this whole process is that it
really makes the project team think about the project design and all the potential
construction difficulties. It also hammers home that capital cost estimates are by
definition wrong. Your project must be able to absoAP such errors and this
process and the Provara output teaches you how to ensure that it can.
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Chapter 10:
Project
Income
Solvency is entirely a matter of temperament
and not of income.
Logan Pearsall Smith (1865 - 1946
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The assessment of project income
This will normally be a question of multiplying the number of sales that are
expected by the cost per sale. It is unlikely that you will reach the Economic
Assessment stage without a pretty good idea of the sales volume and sale price.
Provara provides the facility to use the projected volume, 10% less and 10%
more. You can also assess a probability to each of these so that Provara can
calculate the probability of each Scenario as described below in the instructions
on how to operate Provara.
You can allocate the percentage likelihood of any of these three probabilities as in
the allocation of the capital cost probabilities. The only proviso is that the three
probabilities must add to 100%
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Chapter 11:
Operating
Costs
Quality in a product or service is not what the
supplier puts in. It is what the customer gets
out and is willing to pay for. A product is not
quality because it is hard to make and costs a
lot of money, as manufacturers typically
believe. This is incompetence. Customers pay
only for what is of use to them and gives
them value. Nothing else constitutes quality.
Peter Drucker (1909 - 2005
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The assessment of Operating Cost
The difference between Direct Costs and Indirect Costs
Operating costs should always be split between the Direct Costs and Indirect
Costs.
What is the difference between Direct Costs and Indirect Costs and why are they
so important?
Direct costs are those that are specifically related to the volume of output or
production.
Indirect costs are those that do not fluctuate directly in response to the volume of
output or production. They may change in response to production level change
over a period of time.
Let’s look at some examples;
A garage
Direct Costs would include;
•
•
•
Mechanics
Spares
Grease, filters, lubricating oil etc
Indirect Costs would include;
•
•
•
•
•
•
Building rent or mortgage
Office staff
Heat
Light
Stationery
Telephone
A hotel
Direct Costs would include;
•
•
•
•
Chamber maids
Bed Linen
Food for restaurant
Bar stock
Indirect Costs would include;
•
Building rent or mortgage
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•
•
•
•
•
Kitchen and reception staff
Heat
Light
Stationery
Telephone
Why are the differences so important?
The main reason that the difference is so important is that the Indirect Costs can
be identified pretty accurately and in most projects once a budget is identified for
them, the budget can be complied with by the use of various management
techniques.
The Direct costs are much harder to assess and so the risk of your estimate being
wrong is quite high.
It is also important to differentiate between them because they directly affect the
risk that the project carries. If there is a high overhead that cannot be reduced in
times of low demand the chance of project failure is higher.
A good example of this is a toll bridge project with tollbooths on a bridge with
highly cyclical flows that vary from hour to hour, day to day and month to month.
The number of tollbooths would need to be able to cope with peak bridge
capacity. Their cost is very low compared with the bridge capital cost and so they
could be provided without affecting the project viability.
But the number and cost of the staff in the booths will be critical in determining
the viability of the toll bridge itself.
The answer would be to split the booth operators into two types.
The core tollbooth operators would be permanently assigned to the staff and
would be an indirect cost.
Temporary staff would be used for the peaks and these would be a direct cost.
Direct and indirect cost probabilities
The direct and indirect costs that need to considered and calculated are set in the
work sheet in Provara. Provara calculates the impact of Direct Costs being 25%
lower than estimated and 25% higher.
You can allocate the percentage likelihood of any of these three probabilities as
in the allocation of the capital cost probabilities. The only proviso is that the three
probabilities must add to 100%
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Sensitivity analysis
The Sensitivity Analysis carried out by Provara allows you to input optimistic
values through increasing revenue, decreasing operating costs and reducing
capital costs as well as pessimistic values.
Provara will then calculate the NPV for the optimistic and pessimistic cases and
these can be compared with the most likely values to see how sensitive the
project is to changes in revenue, operating cost and capital cost.
This calculation will nearly always show that revenue and operating costs
dominate the Economic model and that the capital cost is not that important –
much to the surprise of everyone!
The figures that are most commonly used in investment presentations are as
follows and these are used in Provara;
Revenue
Operating Cost
Capital Cost
Optimistic
+10%
-25%
-10%
Pessimistic
-10%
+25%
+10%
The Sensitivity Analysis can be carried out on a stand-alone basis during
Shell when you are selecting the Options that need to be carried forward
into Optionology.
Just ignore the probabilities for the Capital, Income
and Operating costs and Provara will calculate the
NPV for the median case as well as the Optimistic and
Pessimistic.
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Chapter 12:
Value
Management
Good management is the art of making
problems so interesting and their solutions so
constructive that everyone wants to get to
work and deal with them.
Paul Hawken, Growing a Business
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Value Management
Introduction
Value management and Risk assessment are the two most important techniques
used in the feasibility study process.
This E-book just demonstrates the techniques that can be used in Provara.
Role in Construction
Value Management plays a key role in the modern construction industry and is
leading to continuous improvement and innovation. It is applied both to the
strategic planning of the business and improvement in performance in addition to
delivering Best Value.
The benefits
Value management programmes have assisted in achieving value improvement
for major organisations in the UK such as BP, Retail, British Airways, BAA, Pfizer,
Stanhope, and water and rail companies. Substantial improvements have been
achieved in the return on investment of capital projects and up to a 50%
improvement in capital productivity.
How is best value achieved?
The key to delivering Best Value projects for clients in the construction industry is
to closely control the entire project process all as described in Section 1 with
senior management supervision and clear direction.
In other words if you implement the Shorace process you will automatically be
managing your project on a Best Value basis.
Understanding Value
Value is one of those things that everyone understands but which no two people
will describe in the same way – much like feasibility studies in fact!
You cannot touch it or measure it and yet it is one of the most powerful concepts
in the market place. What is “value for money”? You will get a different answer
every time you ask someone this question.
The reason is that value is both intangible and subjective and cannot be
measured – so how can it be managed?
The three value factors
There are three fundamental value factors that never change and they are;
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•
•
•
The Utility Value – what should it do and does it work?
The Exchange Value – What can it be sold for?
The Esteem Value – Will it improve status?
Utility Value
Most buildings and structures are erected in order to accommodate and support
specific activities. They will be judged to be failures it they do not carry out this
function effectively. Therefore maximisation of productivity is a key component of
the value that the building or structure adds to a project.
Exchange Value
The property or real estate market is driven by the concept of exchange value.
Developers have but one goal – to maximise the value of their development
through a sale or rental income. Both rely on exchange – ownership or tenancy in
exchange for money.
The concept of exchange value relies on the fact that the parties involved in the
exchange have different values.
The value drivers are identified early on in the Shell stage of the Project and
invariably are a compromise between various stakeholders that involve trade-offs
or exchanges between them to obtain the optimum balance between their values.
Esteem Value
Esteem is a primary value for buildings that need to portray an image of the
occupier.
Company head offices must demonstrate that the owner is successful, that it
cares about detail and by inference its customers.
This is all part of the corporate branding / marketing strategy of the business.
Hard and Soft Values
Utility values are normally hard in that the building or structure will either meet
its purpose or not.
Exchange values are normally soft because they involve the opinions of different
people and so there is often no single right answer.
When a project lacks definition – as they all do in the early stages – the decision
making tends to rely on reaching a consensus with different stakeholders and so
soft value management skills are required.
As project definition increases the harder the values become.
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Value Management using Provara
This is a two stage process – first of all the Utility, Exchange and Esteem value
drivers must be considered and identified by the stakeholders during the Project
Shell preparation.
When they have been identified in the Shell the Option analysis in Provara can be
used to evaluate the effect on NPV (or trade-off effect) by using the different
capital and operating costs that arise using different operational concepts. This is
the VA part of Provara.
In its simplest from you could evaluate the construction of a dam using men and
wheelbarrows or evaluate the construction using modern plant and equipment.
Or a high capital cost, high sustainability building with very high levels of
insulation and sophisticated air conditioning and low running costs can be
compared with a standard building specification with much higher running costs.
Or the company-marketing department can be shown just what the effect of a
very high quality building providing maximum esteem has on the NPV of the
project and indirectly the reduction in annual profit.
Only the imagination and energy of its user
limit the possibilities of using Provara to
increase value!
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Chapter
13:
Risk
Assessment
“Our lives improve only when we take
chances - and the first and most difficult risk
we can take is to be honest with ourselves”
Walter Anderson
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Risk assessment techniques
Introduction
There are four major project strategies for dealing with risk commonly known as
ERIC (Eliminate, Reduce, Insure, and Contain) or TTTT (Terminate, Treat,
Transfer, Tolerate).
Let’s look at each in turn.
Eliminate (Terminate) show-stoppers and biggest risks
We are dealing here with major strategic risks that could cause complete project
failure or even Project Sponsor bankruptcy.
This type of problem can generate one of those rare occasions when the
Objective defined in the Project Shell may need to be changed – because the only
other course of action is abandonment.
Or removal or conversion must deal with such risks so that one of the other three
strategies can be applied.
In such circumstances Provara cannot help. The Project Sponsor may have to bite
the bullet and change the project significantly or cancel it!
Reduce (Treat) risks
This is where Provara comes into play!
Risks can be treated by;
•
•
•
•
Undertaking surveys (Site investigation, Traffic, Marketing, Raw material
costs, Earthquakes, Tsunami, Typhoons/Cyclones/Hurricanes, Drought, etc.
etc.
Redesign to eliminate or reduce the risk
Changes in the methods, materials, logistics, sources, etc. etc.
Changes in the method of procurement or contract strategy.
The key difference between this process and the Elimination process is that the
project team – not the Project Sponsor, undertakes the necessary actions.
I expect you are wondering how Provara fits into this?
Well all the treatments referred to above are almost certain to involve extra
costs. The costs of all the different ways of dealing with the risks are simply put
into each Option and Provara will calculate the effect on NPV.
However the advantage of dealing with the risk in the manner described above
may allow a reduction in the contingency reserve that should be built into every
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project – and so the effect on NPV may be negligible but Provara will provide the
answer.
Insure or Transfer risks
Some risks can be insured or transferred to other parties such as the construction
contractor. This transfer of risk normally involves the payment of a premium that
can be incorporated into Provara to identify the effect on NPV.
Operational risks can also be insured. Future insurance premiums for operational
risk will have an increasingly reduced effect on the NPV because of the
discounting of future payments. In this case Provara can demonstrate that it may
be better to insure against an operational risk rather than by Reduction or
Treatment of the risk by redesign etc.
The transfer of risk is not an absolute process because the party to whom the risk
is transferred may themselves be unable to sustain the consequences of a risk
event. In these circumstances the risk comes straight back to the Project
Sponsor.
Contain (Tolerate) the risk within the contingency reserve
There is no active management of small risks because there are hundreds of
them in every project and the cost of eliminating them would be higher than the
cost of tolerating them.
Not all of them will be borne by the Project Sponsor because risk will be allocated
during the procurement process.
Some contingency reserve may need to be maintained throughout the life of the
project as well as for any termination costs.
Provara will calculate the effect of these on NPV
By Will Witt
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Chapter 14:
Study and
Survey Costs
“If we knew what it was we were doing, it
would not be called research, would it?”
Albert Einstein (1879 - 1955)
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How to assess the cost of studies and surveys
By the use of specialists
In most countries (and adjacent countries) there are specialists that undertake
studies and surveys in just about every field that you can think of.
In most circumstances they will all give you a very realistic budget for your
survey or study provided that you stick to the following E-booklines;
1. You must be truthful – do not under any circumstances tell them that you are
about to award a contract for a study when all you want is a price. These
specialists know their business – they will know even as you are talking to
them that you are just fishing for information!
2. You must prepare a short written brief describing exactly what you want –
they are going to do some work for you for nothing – so do not make things
worse by making them chase about for nothing!
3. Tell them that if they do provide information that they will definitely be asked
to quote if and when you do undertake the study – and then do as you say. If
you mess one Specialist about the others will all know about it – and hike
their prices up because they do not trust you.
4. Do not reject what they are saying just because it seems very expensive – I
have frequently commissioned studies that have cost over 1US$m. You need
to balance the cost of the study or survey against the risk that you are
reducing. This is particularly important when it comes to site investigation.
Even now many projects get into trouble because the site investigation has
not been thorough enough.
What do you do if there are no local specialists
The advantage of a local specialist is that they know local conditions and hence
know what they have to do to cope with these conditions.
So if there are no local specialists you must do the research on the local
conditions, writes this up into a short paper and then go and discuss your
problems with an expert in another country. This will nearly always give you a
realistic feel for what the surveys will cost.
By Will Witt
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Chapter 15:
Provara in
Action
“An ounce of action is worth a ton of theory”
Friedrich Engels (1820 - 1895
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How to use the Provara Options Analysis Tool
How and When to use Provara
There are 3 occasions during the Feasibility Study process that you can use
Provara.
These are identified below.
Before we go on I would like to highlight one of the biggest benefits that Provara
provides. It gives you the power to select the best Options. When these are
identified you can vary the Incomes and Operating Costs to see just how low and
high they need to be for your project still to have a positive NPV. In other words
if you can reduce the income by 50% and increase the Operating Costs by 50%
and still see a positive NPV you have a very solid project. If variations of 10%
cause a negative NPV then you need to do something to reduce the Risk.
It may well be that one of your Options is much better than the others when you
carry out this process - pointing you in the direction of that Option.
What are Scenarios and Sub-scenarios
These are used to identify the combination of probabilities from the three Capital
Cost probabilities C1, C2 and C3, the Income probabilities I1, I2 and I3 and the
Operating cost probabilities O1, O2 and O3.
The combination of these 9 probabilities gives 27 combinations of the Subscenarios.
If you have allocated the % probabilities sensibly the most likely Scenario will
have a mid-range NPV.
The more unlikely Scenarios will low probability and very high or very low NPV.
Concept development
The first occasion during the Feasibility Study process when Provara can be used
is during the initial development of the project concept when ideas are being
thrown around and some rough numbers are available. Just input the data into
the following lines:
1
28
2
29
7
30
8
31
9
32
10
35
11
36
12
37
14
38
15
39
16
40
17
41
18
42
19
49
27
Provide will provide the NPV on the base case, the optimistic case and the
pessimistic using the following criteria.
Capital Cost
Income
Operating Cost
By Will Witt
Base case
As estimate
As estimate
As estimate
Optimistic Case
-10%
+10%
-25%
Page 87 of 95
Pessimistic Case
+10%
-10%
+25%
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Analysis of the Options
This is the core task for Provara. Let’s look at the data input line by line.
Data
Insert Discount
rate as a %
Capital Cost
% Probability
that Capital
Cost will
increase.
% of Capital
Cost to be
spent in each
year
Income
% Probability
that income
will change
Direct Costs
Indirect Costs
% Probability
that Direct
Costs will
change
Termination
Costs
Data Source
Use the normal rate for the cost of capital in the business. It can be the rate
at which capital is borrowed or the required rate of return on the money that
is invested by the shareholders.
Calculated as described on page 13
Normally the % for the base estimate will be 50% because it is just as likely
to be exceeded as not. If you are very confident in your estimate this can be
increased. But in most circumstances 50:30:20 will give realistic results.
This is self explanatory – if all the spend is in the first 2 years leave lines 9
to 12 blank, if 3 years leave 10 to 12 blank and so on.
Provara is set up so that you can exert a great deal of control over how the
income from the project develops. This facility will allow you to gauge just
how risky your project by reducing the early income. In many projects initial
income is 50% of what is expected – so cut your projects initial income by
50% to see if you still have a positive NPV. If you do not you may have to
spend a lot on advertising or phase construction. So put this into Provara to
see if you can get the NPV positive.
These figures are not that important during your analysis because you will
vary the income on lines 14 to 19. So use these for your printout for
presentation purposes. I would generally set them at 30:50:20
Calculate these as accurately as you can because the effect on NPV can be
dramatic
Make sure that these figures are realistic. Bankers understand what it takes
to run a business and they will soon pick holes in these figures if they are
wrong
Generally set these at 20:50:30 because it is more likely that your Direct
Costs will be higher rather then lower.
Because these are discounted over 25 years they will only be important if
there are major clean-up costs or perhaps because your discount rate is
very low. Governments sometimes use very low discount rates based on the
rate of inflation to make very long-term projects viable. Termination costs
can be very influential in such circumstances.
The Development of the Project Plan
Provara can also be used as part of the Project Plan documentation in the
Accordancy stage of the Feasibility Study.
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Definition of the Options
When you have fine-tuned your Options using Provara what other document
should be produced?
The Optionology documentation is generally described in Section 1 , ut you will
need further documents to site alongside the Provara output.
These should include:
•
•
•
•
•
Clear precise descriptions of each Option
Reasoning behind the Economic Assessment of each Option justifying
the input data in Provara
The Value added by each Option – both Quantitative and Qualitative
The Risks involved in each Option and how they have been
Terminated, Treated, Transferred or Tolerated (indicate contingency
reserve)
Identification of the preferred Option – use tabular methods to
illustrate the advantages and disadvantages of each Option.
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Well there you have it – a very complex process boiled down into about 100
pages.
I know that implementation of the process is not easy so if you want to contact
me to discuss any aspect please Email me and I will try and answer your query as
best I can.
I am sure that you will find that Provara is a tool that will:
•
•
•
•
Vastly increase your understanding of your project
Save vast amounts of time in the preparation of your project
documentation
Give you a high degree of confidence that your project works
Give you the satisfaction of knowing that investors / bankers will be
impressed by your professionalism
Please, Please keep my Email address confidential – it is so inconvenient having
to change it when the spammers get hold of it.
I will look forward to hearing from you.
Kind Regards
PS
Don't forget it's the process that counts – just break your study down into the
Shoraces and have a real review at the end of each step and you will end up with
a pretty good study
As the French say “Bon Chance”
Email - [email protected]
By Will Witt
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How to Respond When
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Appendices
By Will Witt
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How to Respond When
Opportunity Knocks
Appendix A
Cost Estimate accuracy and related fee costs
By Will Witt
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Opportunity Knocks
Appendix B
Project Classification Tool
A
Size –
Estimate will
be very
approximate
at this early
stage in the
project. If
your guess is
$2 - $6 then
select 3
B
Complexity –
This might be
technical but
it is most
likely to be
because many
issues need to
be considered
– especially
where they
are interdependent.
C
Novelty – it
might be
routine in the
US and other
Western
States and
rare in your
locality. In this
instance select
1
D
Score out of
Strategic
20
importance –
this is a
measure of
how important
it is to get the
study right.
Most studies
will be
average and
so 3 should be
selected.
1.
2.
3.
4.
5.
1. Simple
2. Average
3. > Average
4. Complex
5. Very
complex
1.
2.
3.
4.
5.
1.
2.
3.
4.
5.
up to $2m
$2 - $4m
$4 - $6m
$8 - $20m
over $20m
By Will Witt
Routine
Common
Unusual
Rare
One-off
Page 93 of 95
None
Low
Average
High
Essential
E-booklines
>15 = major
7 – 15 =
medium,
<7 = minor
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How to Respond When
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Appendix C
Risk Assessment Tables
Likelihood
Description
Scenario
Highly likely
Very frequent
Likely
More than a 50/50 chance
Fairly likely
Quite often
Unlikely
Small chance but could happen
Very unlikely
Not expected to happen
Extremely unlikely
Just possible
Impact
Description
Scenario
Disastrous
Business failure or bankruptcy
Severe
Serious threat to survival
Substantial
Significant profit reduction
Marginal
Small profit reduction
Negligible
Trivial effect on profit
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Appendix D
Value benchmarking
Typical sample
Weighting Benchmar Target
k
Value
performan
ce
Driver
Value
performan score
ce
Cost per square
metre
25
7
175
5
125
Production capacity
15
8
120
4
60
Operating costs
30
7
210
4
120
Employee comfort
10
6
60
3
30
External image
15
8
120
6
90
Third party
constraints
5
8
40
6
30
Value index
100
725
455
The biggest deficit is in operating costs followed by production capacity and so
these ought to be examined to see what improvements can be made.
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