The conventional approach to project prioritization is to specify the cash flows provided by a project (out to some arbitrary time in the future, assuming that cash flows are projected), discount those cash flows by the hurdle rate, do the same thing with the costs (assuming that costs are projected), and compute the benefit-to-cost ratio. Projects are selected in order of benefit/cost ratio until the budget is exhausted.

This approach is flawed in at least five fundamental ways:

• Projects provide benefits other than cash flows and projects should be selected based on all the benefits.
• Project benefits should be stated over the foreseeable future, not just to some arbitrary time. End effects of projects are important because the service for which the company exists will be provided after the useful life of the project is over. Implicit in project choice is the decision about what to do when the project ends.
• Uncertainty is almost always ignored in the conventional analysis, but it is risk that is a fundamental consideration in project choice.
• The issue is not just which projects to select, but which projects can be safely deferred. The conventional approach ignores important intertemporal considerations.
• Projects are combined into a portfolio. The combined effects of projects are important, and the conventional approach ignores any such effects. The need for a new method is based on the persistence of these flaws in business decision making.
  
  

Our project prioritization methodology begins by specifying the various dimensions of value provided by projects. We specify these dimensions analytically, such that the benefit to the company that results from a change in any dimension of value can be measured. This measurement provides a company-specific value representation. The value representation is a mathematical model of what is important to the client company. With such a mathematical, analytic structure, we recognize that a project provides value based on the changes it causes: companies undertake projects because the company wants to improve performance in one or more dimensions of value. The value representation permits the effects of projects to be reported analytically.

Thus, the next critical element in our methodology is project reporting. After all projects are reported and all budgets specified, the methodology optimizes project selection with respect to timing. All projects cannot be done immediately because of budget constraints. Which projects should be done immediately and which can be safely deferred is based on the analysis of the value stream provided by each project.

We have proprietary optimization algorithms that specify project timing. Thus, project portfolios are assembled optimally. Further, we treat uncertainty in project value directly, as part of the project reporting. Uncertainty considerations permit us to provide a complete risk analysis, and we characterize the timed project portfolio by its expected value and its risk. Finally, because the entire structure is analytic, we are able to provide a complete sensitivity analysis so that the user can review the consequences of various assumptions made about projects and other parameters.

The prioritization methodology has been applied at various organizations, including businesses and government agencies, for more than twenty years. VMN Group’s methodology has been applied in the electric utility sector over the past five years.