3. ‘An effective evaluation system must start from the beginning of the life cycle of the investment.’ Why? Explain with reference to Project Performance Evaluation.
Project Performance Evaluation
Project investments in new enterprises, or for expansion, diversification and modernisation of the existing establishments become profit centres when completed. Their performance until production commences cannot, therefore, be measured in terms of output or profits.
On the other hand, an effective evaluation system has to start from the beginning of the life cycle of the investment. Once the initial investment, which is substantial, has been committed, it produces a heavy impact on the operating results for a long period.
It has been observed that projects often suffer from large time and cost overruns. It is true, especially of international projects, which have to pass through inter-country regulatory measures in one or both countries, and involve external factors which are not too precise.
Projects are generally evaluated in terms of capital expenditures incurred. This is an erroneous approach, since it is not related to the work accomplished. When evaluated in physical terms, the process ignores costs involved. A given quantum of work (e.g. civil construction of 10,000 cubic meters) is completed within the scheduled timeframe, but might have cost more by Rs 2 million over the budgeted cost of Rs 20 million. Both methods do not take into account the efficiency of the project management (in terms of cost. and capital inputs in relation to work done or performance).
In the pre-investment estimates of a process plant project, the budgetary allocation for civil work upto June, 1984, was Rs 184 million. The actual expenditure was of the order of Rs 173 million upto that date. Two views were taken. The first one was that the project has lagged behind schedule since capital expenditure target on civil works was short by Rs 11 million. The second view was that there was a saving of Rs 11 million. In fact, both assessments were erroneous. The savings were due only to the deferment of foundation-laying, which was expected to cost Rs 20 million but would now cost Rs 18 million. Even with the reduced cost of foundations, there was a cost overruns on civil works. There was, besides, a slippage in the time schedule (with deferment of the foundation-laying activity).
Slippages in project management occur due to a diversity of variables, which differ from project to project and from one component of a project to another. It also occurs in terms of inputs (material, manpower). A break-up is, therefore, necessary in accordance with the objectives of the project.
The alternative is the Value-based Project Monitoring (VbPM) System. VbPM seeks to establish relationships between the value of the work planned (VWP) and the value of work actually done (VWA). The value of work does not mean the monetary cost of work; it denotes the `real' quantum of work. Paradoxical as it may seem, the real quantum is sometimes measured in terms of monetary values. This becomes necessary, because the work to be measured is an aggregation of several component activities, which cannot have a uniform measure (for example, civil construction and machinery erection). The problem can be resolved by using `constant' prices. The prices at which the VWA is measured is the same as applied to VWP. This will not determine the cost overrun but slippage in work performance. To arrive at cost overruns, it will be necessary to escalate the physical slippage by price inflation.
For a better understanding of the system, it may be appropriate to identify that cost of projects increase because of the following seven basic factors:
- Price increase due to inflation,
- Changes in project design (including technological and location changes),
- Deficiencies in project design and the need for post-planning revision,
- Mistakes committed in construction and erection,
- Non-availability of resources on schedule,
- Less efficient management causing delays in implementation,
- Eternalities (factors beyond the control of project management).
It is obvious that the first step is the recording of data juxtaposed against the projected estimates. The data required are by activity and resource inputs. The values are to be recorded in physical quantities as well as values, both in current and constant prices: The extent to which the dissection of the data, in term; of activities and resource inputs, is needed would depend on the size of the project and-the critically of the inputs and management objectives.
The analysis and appraisal is first geared to the identified activity centers. It is then extended to activity groups, and then to the project as a whole. The transcription of the data takes the form as shown in Exhibit 1, called "Value-based Project Monitoring Chart". This exhibit has been designed for the total project. The curves delineated are all cumulative.
The ordinates S1, S2, S3, mark the audit or monitoring stations in the time scale. There could be as many audit stations 'as the management finds effective. These should, nonetheless, be chosen with good care. Too many of them have been found to be distracting for the project team; too little to be ineffective. The amount of overrun, at any point of time, is given by the vertical distance between the two curves VWP and VWA, and not between costs which is generally assumed.
Prerequisites and Precautions:
- The objectives of performance evaluation should be defined precisely.
- The candidate for performance evaluation - an individual, a group or a firm - should be clearly identified,
- Performance evaluation should be period-specific. Performance can and does vary from one period to another.
- Assumptions made in making the evaluation should be articulated without reservations.
- The limitations of the evaluation indicators should be spelt in clear terms.
- Each performance evaluation should be used for the specific purpose for which it is made. Any evaluation transposed for any other objective should be adjusted suitably.
- Performance evaluation should be forthright, not open to different meanings or conclusions.
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