PROJECT MANAGEMENT

MODULE I
1.1. INTRODUCTION
More specifically, what is a project? Its a temporary group activity designed to produce a
unique product, service or result. A project is temporary in that it has a defined
beginning and end in time, and therefore defined scope and resources.
And a project is unique in that it is not a routine operation, but a specific set of
operations designed to accomplish a singular goal. So a project team often includes
people who dont usually work together sometimes from different organizations and
across multiple geographies.
The development of software for an improved business process, the construction of a
building or bridge, the relief effort after a natural disaster, the expansion of sales into a
new geographic market all are projects.
Some other examples of a project are:

Developing a new product or service

Constructing a building or facility

Renovating the kitchen

Designing a new transportation vehicle

Acquiring a new or modified data system

Organizing a meeting

Implementing a new business process

And all must be expertly managed to deliver the on-time, on-budget results, learning
and integration that organizations need.
Project management, then, is the application of knowledge, skills and techniques to
execute projects effectively and efficiently. Its a strategic competency for organizations,
enabling them to tie project results to business goals and thus, better compete in
their markets.
Project management processes fall into five groups:

Initiating

Planning

Executing

Monitoring and Controlling

Closing

PROJECT MANAGEMENT

1.2. CAPITAL EXPENDITURE (CAPITAL INVESTMENT)

The basic characteristic of a capital expenditure (also referred to as a capital investment or capital
project or just project) is that it typically involves a current outlay (or current and future outlays)
of funds in the expectation of a stream of benefits extending far into the future.
A capital expenditure, from the accounting point of view, is an expenditure which is shown as an
asset in the balance sheet. This asset, except in the case of a nondepreciable asset like land, is
depreciated over its life. In accounting, the classification of an expenditure as a capital
expenditure or a revenue expenditure is governed by certain conventions, by some provisions of
law and by the managements desire to enhance or depress reported profits. Often, outlays on
research and development, major advertising campaigns, and reconditioning of plant and
machinery may be treated as revenue expenditures for accounting purposes, even though they
are expected to generate a stream of benefits in the future and, therefore, qualify for being capital
expenditures.

1.2.1.

CAPITAL INVESTMENTS: IMPORTANCE AND DIFFICULTIES

Importance Capital expenditure decisions often represent the most important decisions taken by a
firm. Their importance stems from three inter-related reasons:

Long-Term Effects The consequences of capital expenditure decisions extend far into the
future. The scope of current manufacturing activities of a firm is governed largely by
capital expenditures made in the past. Likewise, current capital expenditure decisions
provide the framework for future activities. Capital investment decisions have an enormous
bearing on the basic character of a firm.

Irreversibility The market for used capital equipment in general is ill-organised. Further, for
some types of capital equipment, custom- made to meet specific requirements, the market
may virtually be non-existent. Once such an equipment is acquired, reversal of decision
may mean scrapping the capital equipment. Thus, a wrong capital investment decision
often cannot be reversed without incurring a loss.

Substantial Outlays Capital expenditures usually involve substantial outlays. An integrated

steel plant, for example, involves an outlay of several thousand crore rupees. Capital costs
tend to increase with advanced technology.

Difficulties While capital expenditure decisions are extremely important, they also pose difficulties
which stem from three principal sources:
Measurement Problems Identifying and measuring the costs and benefits of a capital
expenditure proposal tend to be difficult. This is more so when a capital expenditure has a
bearing on some other activities of the firm (like cutting into the sales of some existing
product) or has some intangible consequences (like improving the morale of workers).

Uncertainty A capital expenditure decision involves costs and benefits that extend far into
the future. It is impossible to predict exactly what will happen in the future. Hence, there is
usually a great deal of uncertainty characterising the costs and benefits of a capital

PROJECT MANAGEMENT
expenditure decision.

1.2.2.

Temporal Spread The costs and benefits associated with a capital expenditure decision are
often spread out over a long period of time, usually 10-20 years for industrial projects and
20-50 years for infrastructural projects. Such a temporal spread creates some problems in
estimating discount rates and establishing equivalences.
TYPES OF CAPITAL INVESTMENTS

Capital investments may be classified in different ways. At the simplest level, capital investments
may be classified as physical, monetary, or intangible.
i.

Physical assets are tangible investments like land, building, plant, machinery, vehicles,
and computers.

ii.

Monetary assets are financial claims against some parties. Deposits, bonds, and equity
shares are examples of monetary assets.

iii.

Intangible assets are not in the form of physical assets or financial claims. They
represent outlays on research and development, training, market development, franchises,
and so on that are expected to generate benefits over a period of time.

Capital investments may also be classified as strategic investments and tactical investments.
iv.

A strategic investment is one that has a significant impact on the direction of the firm.
Tata Motors decision to invest in a passenger car project may be regarded as a strategic
investment.

v.

A tactical investment is meant to implement a current strategy as efficiently or as

profitably as possible. An investment by Tata Motors to replace an old machine to improve
productivity represents a tactical investment.

Capital investments are often classified by companies in different categories for planning and
control. While the system of classification may vary from one firm to another, the following
categories are found in most classifications: mandatory investments, replacement investments,
expansion investments, diversification investments, R&D investments, and miscellaneous
investments.
vi.
A mandatory investment is a capital expenditure required to comply with statutory
requirements. Examples of such investments are a pollution control equipment, a fire
fighting equipment, a medical dispensary, and a creche in the factory.
vii.
A replacement investment is meant to replace worn out equipment with new equipment
to reduce operating costs, increase the yield, and improve quality.
viii.
An expansion investment is meant to increase the capacity to cater to a growing demand.
ix.
A diversification investment is aimed at producing new products or services or entering
into new geographical areas.
x.
R&D investments are meant to develop new products and processes which would
sharpen the technological edge of the firm.
xi.
Finally, miscellaneous investments represent a catch-all category that includes items
like interior decoration, recreational facilities, and landscaped gardens.

PROJECT MANAGEMENT

1.3. PHASES OF CAPITAL BUDGETING

Capital budgeting is a complex process which may be divided into six broad phases: planning,
analysis, selection, financing, implementation, and review. Exhibit 1.1 portrays the relationship
among these phases. The solid arrows reflect the main sequence: planning precedes analysis;
analysis precedes selection; and so on. The dashed arrows indicate that the phases of capital
budgeting are not related in a simple, sequential manner. Instead, there are several feedback
loops reflecting the iterative nature of the process.

Planning
The planning phase of a firms capital budgeting process is concerned with the articulation of its
broad investment strategy and the generation and preliminary screening of project proposals. The
investment strategy of the firm delineates the broad areas or types of investments the firm plans
to undertake. This provides the framework which shapes, guides, and circumscribes the
identification of individual project opportunities.
Once a project proposal is identified, it needs to be examined. To begin with, a preliminary project
analysis is done. A prelude to the full blown feasibility study, this exercise is meant to assess (i)
whether the project is prima facie worthwhile to justify a feasibility study and (ii) what aspects of
the project are critical to its viability and hence warrant an in-depth investigation.

PROJECT MANAGEMENT
Analysis
If the preliminary screening suggests that the project is prima facie worthwhile, a detailed analysis
of the marketing, technical, financial, economic, and ecological aspects is undertaken. The
questions and issues raised in such a detailed analysis are described in the following section. The
focus of this phase of capital budgeting is on gathering, preparing, and summarising relevant
information about various project proposals which are being considered for inclusion in the capital
budget. Based on the information developed in this analysis, the stream of costs and benefits
associated with the project can be defined.
Selection
Selection follows, and often overlaps, analysis. It addresses the questionIs the project
worthwhile? A wide range of appraisal criteria have been suggested to judge the worthwhileness
of a project. They are divided into two broad categories, viz., non-discounting criteria and
discounting criteria. The principal non-discounting criteria are the payback period and the
accounting rate of return. The key discounting criteria are the net present value, the internal rate
of return, and the benefit cost ratio. The selection rules associated with these criteria are as
follows:
To apply the various appraisal criteria, suitable cut-off values (hurdle rate, target rate, and cost of
capital) have to be specified. These are essentially a function of the mix of financing and the level
of project risk. While the former can be defined with relative ease, the latter truly tests the ability
of the project evaluator. Indeed, despite a wide range of tools and techniques for risk analysis
(sensitivity analysis, scenario analysis, simulation analysis, decision tree analysis, portfolio theory,
capital asset pricing model, and so on), risk analysis remains the most intractable part of the
project evaluation exercise.

Criterion

Accept

Reject

Payback period (PBP)

Accounting rate of return (ARR)

PBP < target period

ARR > target rate

PBP > target period

ARR< target rate

Net present value (NPV)

NPV> 0

NPV< 0

Internal rate of return (IRR)

Benefit cost ratio (BCR)

IRR> cost of capital

BCR> 1

IRR< cost of capital

BCR< 1

Financing
Once a project is selected, suitable financing arrangements have to be made. The two broad
sources of finance for a project are equity and debt. Equity (referred to as shareholders funds on
balance sheets in India) consists of paid-up capital, share premium, and retained earnings. Debt
(referred to as loan funds on balance sheets in India) consists of term loans, debentures, working

PROJECT MANAGEMENT
capital advances and so on.
Flexibility, risk, income, control, and taxes (referred to by the acronym FRICT) are the key
business considerations that influence the capital structure (debt-equity ratio) decision and the
choice of specific instruments of financing.

PROJECT MANAGEMENT
Implementation
The implementation phase for business project that involves setting up of industrial facilities that
consists of several stages such as
1.
2.
3.
4.
5.

Project and engineering designs

Negotiations and contracting
Construction
Training, and
Plant commissioning

Translating an investment suggestion into a material is a complex, time- consuming, and risk
burdened task. Delays in implementation that are common, can lead to considerable cost
overruns. For speedy implementation at a rational cost, the below are helpful.
i)

Adequate Formulation of Projects: A major reason for the delay is inadequate formulation of
projects. Put differently, if the necessary homework in terms of preliminary studies and
comprehensive and detailed formulation of the project is not done, many surprises and
shocks are likely to spring on the way. Hence, the need for adequate formulation of the
project cannot be over-emphasised.
ii) Use of the Principle of Responsibility Accounting: Assigning specific responsibilities to project
managers for completing the project within the defined time-frame and cost limits is helpful
in expeditious execution and cost control.
iii) Use of Network Techniques: For project planning and control two basic techniques are
available - PERT (Programme Evaluation Review Technique) and CPM (Critical Path Method).
These techniques have, of late, merged and are being referred to by a common terminology
that is network techniques. With the help of these techniques, monitoring becomes easier.
Review
Once the project is commissioned, the review phase has to be set in motion. Performance review
should be done periodically to compare actual performance with projected performance. A
feedback device, it is useful in several ways: (i) It throws light on how realistic were the
assumptions underlying the project; (ii) It provides a documented log of experience that is highly
valuable in future decision making; (iii) It suggests corrective action to be taken in the light of
actual performance; (iv) It helps in uncovering judgmental biases; (v) It induces a desired caution
among project sponsors.

1.4. CHARACTERISTICS OF PROJECT

1) Objectives: A project has a set of objectives or a mission. Once the objectives are
achieved the project is treated as completed.
2) Life cycle: A project has a life cycle. The life cycle consists of five stages i.e. conception
stage, definition stage, planning & organising stage, implementation stage and
commissioning stage.
3) Uniqueness: Every project is unique and no two projects are similar. Setting up a cement
plant and construction of a highway are two different projects having unique features.

PROJECT MANAGEMENT
4) Team Work: Project is a team work and it normally consists of diverse areas. There will be
personnel specialized in their respective areas and co-ordination among the diverse areas
calls for team work.
5) Complexity: A project is a complex set of activities relating to diverse areas.
6) Risk and uncertainty: Risk and uncertainty go hand in hand with project. A risk-free, it
only means that the element is not apparently visible on the surface and it will be hidden
underneath.
7) Customer specific nature: A project is always customer specific. It is the customer who
decides upon the product to be produced or services to be offered and hence it is the
responsibility of any organization to go for projects/services that are suited to customer
needs.
8) Change: Changes occur throughout the life span of a project as a natural outcome of
many environmental factors. The changes may vary from minor changes, which may have
very little impact on the project, to major changes which may have a big impact or even
may change the very nature of the project.
9) Optimality: A project is always aimed at optimum utilization of resources for the overall
development of the economy.
10)Sub-contracting: A high level of work in a project is done through contractors. The more
the complexity of the project, the more will be the extent of contracting.
11)Unity in diversity: A project is a complex set of thousands of varieties. The varieties are
in terms of technology, equipment and materials, machinery and people, work, culture and
others.

1.5. Characteristics of Project Plans

A project plan can be considered to have five key characteristics that have to be managed:

Scope: defines what will be covered in a project.

PROJECT MANAGEMENT

Resource: what can be used to meet the scope.

Time: what tasks are to be undertaken and when.

Quality: the spread or deviation allowed from a desired standard.

Risk: defines in advance what may happen to drive the plan off course, and what will be
done to recover the situation.

Balanced Plans

The sad thing about plans is you cannot have everything immediately. Many people plan using
planning software packages, without realising the trade-offs that must be made. They assume
that if they write a plan down, reality will follow their wishes. Nothing is further from the truth.
The point of a plan is to balance:

The scope, and quality constraint against,

The time and resource constraint,

While minimising the risks.

1.6. Project: Identification, Selection & Formulation

The process of identifying a candidate idea for developing into a project is called Project
Identification. This is a systematic process and sometimes it may be a serendipitous act.
Sources of Project ideas

Observation

Trade and Professional magazines

Bulletin of Research organizations

PROJECT MANAGEMENT

Government sources

Project selection is a careful study of each project idea in detail and choosing one of them for
further consideration and development. A project idea is universal. However, a project must be
implemented in the background of factors such as

Technology

Equipment

Investment

Location

Market

Project Formulation
The process of studying a selected project further with reference to investment decisions is called
project formulation. It considers issues such as relevance and feasibility of the project.
It involves a step-by-step procedure to investigate and develop project further.

1.7. TAXONOMY OF PROJECTS

The term taxonomy refers to the science of classifying things by naming and identifying them.
Projects can be classified under different heads, some of which are explained below.
Based on the Type of Activity
Under this category, projects can be classified as industrial projects and non-industrial projects.
Industrial projects are set up for the production of some goods. Projects like health care projects,
educational projects, irrigation projects, soil conservation projects, pollution control projects,
highway projects, water supply projects etc. come under the category of non-industrial projects.
Investments in non-industrial projects are made by the Government and the benefits from such
projects are enjoyed by the entire society of people. It is difficult to quantify the benefits enjoyed
by the society out of non- industrial projects.
Based on the Location of the Project
Under the category, projects can be classified as national projects and international projects.
National projects are those set up within the national boundaries of a country, while international
projects are set up in other countries. International projects may be either projects set up by the

10

PROJECT MANAGEMENT
Government or by the private sector. The following are the major forms of international projects.
Setting up of fully owned subsidiaries abroad

Setting up of joint ventures abroad

Setting up of projects abroad by way of mergers & acquisitions

Handling of international projects needs more expertise and greater efforts in view of higher risk
proportion and procedural formalities involved.
Based on Project Completion Time
Based on the constraints on project completion time, projects can be classified into two types,
viz., normal projects and crash projects. Normal projects are those for which there is no constraint
on time. Crash projects are those which are to be completed within a stipulated lime, even at the
cost of ending up with a higher project cost. For example, construction of canal lining with the
condition that the work should be completed before the monsoon starts is a crash project.
Based on Ownership
Based on ownership, projects can be classified into private sector projects, public sector projects
and joint sector projects. A private sector project is one in which the ownership is completely in
the hands of the project promoters and investors. Profit maximization is the prime objective of
private sector projects since the investors invest their money in such projects only with the sole
idea of earning better returns.
Public sector projects are those that are owned by the state. The evolution and growth of public
sector enterprises is the natural consequences of the efforts of Governments for undertaking
developments in a country. The growth of public sector enterprises vary from country to country.
In a country that follows only the system of private enterprises (USA, for example) there is hardly
any public sector enterprise except for essential sectors like defense sectors, public utility services
etc. In socialist countries (China, for example) public enterprises dominate the economy and they
have become public property. In countries that follow a system of mixed economy (India, for
example) both private and public sector enterprises exist.
An enterprise is considered as public enterprise when the state or any other national, regional or
local authority holds at least 51% of its capital and the enterprise is under the control of the state.
In India, public sector undertakings can be owned either by the Central Government or by the
State Governments. Government undertakes investment in public sector enterprises due to many
reasons.
Both developing and under-developed countries need a planned economy for their
sustained growth. The Government announces industrial and trade policies in tune with its
plans to direct the growth of the economy in the desired direction. It becomes imperative
for the Government to invest in growth sectors.
Private sector in developing and under-developed countries are not willing to take up
investments in many planned sectors (sectors that the Government considers as thrust
areas for the development of the economy) either due to huge investments required or
due to unattractive returns from the investments in such projects. Hence it becomes the

11

PROJECT MANAGEMENT
responsibility of the Government to invest and nurture industries in such planned sectors.
Investment in strategic sectors (defense, space research, atomic research etc.) cannot be
given to the private sector for obvious reasons. Also, public utility services sectors can also
be not left fully to the private sector since the private sector by nature is oriented only
towards profit maximization and not in welfare maximization.
The natural resources of a country are the properties of the Government. The natural
resources can be exploited only by the public sector enterprises since the investment
required is huge and the ownership of the resources rests with the Government,
(example: mining, construction of dams for irrigation purposes, hydro power plants.)
Joint sector projects are those in which the ownership is shared by the Government and by private
entrepreneurs. The main consideration for the Governments investment in joint sector projects is
to make use of the managerial talents, entrepreneurial capabilities and marketing skills of the
private entrepreneurs. Joint sector offers hope to the private entrepreneurs since the Government
shares the investment required for the project.
Based on Size
Projects can be classified based on the size into three categories, viz. small projects, medium
sized projects and large projects. The size is normally expressed in terms of the amount of
investment required. The investment limit for the different categories of projects are announced
by the Government and this undergoes periodical changes keeping in view the inflation, the
decision to offer certain incentives to projects categorized as small scale projects etc. As per the
directives of the Govt. of India, projects with investment on plant and machinery up to Rs. 1 crore
are categorized as small scale projects while those with investment in plant and machinery above
Rs. 100 crores are categorized as Large scale projects. Projects with investment limit between
these two categories are Medium scale projects.
Based on Need
Projects can be classified under the following groups, based on the need for project.
1. New project.
2. Balancing project.
3. Expansion project.
4. Modernization project.
5. Replacement project.
6. Diversification project.
7. Backward integration project.
8. Forward integration project.

12

PROJECT MANAGEMENT

1.8. THE 7-S OF PROJECT MANAGEMENT

In the modern age of cutting-edge technology and continuous innovation, product life
cycle is ever shortening. There is constant pressure on companies to differentiate from
competition and earn customer satisfaction. In such a business environment, it is
essential that internal organization network is strong and efficient to deal with any kind
of changes.
The 7S framework introduced by McKinsey is one of the ways through which
analysis can be done to determine the efficiency of organization in meeting
strategic objective.
The 7-S framework provides a comprehensive set of issues that need to be considered.
It also allows classification of tasks within the remit of the project manager, which
reduces the complexity of the role. In addition, classifying issues in this manner ensures
that the project manager will know where to look to find sources of help if novel situation
arises. Knowing that interpersonal problem in a team are aggravated by the style
/culture that a project manager promotes provides a means for finding solutions to the
problem
The Seven Elements
The McKinsey 7S model involves seven interdependent factors which are categorized as
either "hard" or "soft" elements:

Hard Elements

Soft Elements

Strategy

Shared Values

Structure

Skills

Systems

Style
Staff

"Hard" elements are easier to define or identify and management can directly influence
them: These are strategy statements; organization charts and reporting lines; and
formal processes and IT systems.
"Soft" elements, on the other hand, can be more difficult to describe, and are less
tangible and more influenced by culture. However, these soft elements are as important
as the hard elements if the organization is going to be successful.
The way the model is presented in the figure below depicts the interdependency of the
elements and indicates how a change in one affects all the others.

13

PROJECT MANAGEMENT

Let's look at each of the elements specifically:

Strategy: the plan devised to maintain and build competitive advantage over
the competition.

Structure: the way the organization is structured and who reports to whom.

Systems: the daily activities and procedures that staff members engage in to
get the job done.

Shared Values: called "superordinate goals" when the model was first
developed, these are the core values of the company that are evidenced in the
corporate culture and the general work ethic.

Style: the style of leadership adopted.

Staff: the employees and their general capabilities.

Skills: the actual skills and competencies of the employees working for the
company.

1.8.1.

7 S Work Sheet

14

PROJECT MANAGEMENT

1.9.

FACETS OF PROJECT ANALYSIS

The important facets of project analysis are:

Market analysis

Technical analysis

Financial analysis

Economic analysis

Ecological analysis

Market Analysis:
Market analysis is concerned primarily with two questions:

What would be the aggregate demand for the proposed product/service in the
future?

What would be the market share of the project under appraisal?

To answer the above questions, the market analyst requires a wide variety of information
and appropriate forecasting methods. The kinds of information required are:

15

PROJECT MANAGEMENT

Consumption trends in the past and the present consumption level

Past and present supply position

Production possibilities and constraints

Imports and exports

Structure of competition

Cost structure

Elasticity of demand

Consumer
requirements

behaviour,

intentions,

motivations,

Distribution channels and marketing policies in use

Administrative, technical, and legal constraints

attitudes,

preferences,

and

Technical Analysis:
Analysis of the technical and engineering aspects of a project needs to be done
continually when a project is formulated. Technical analysis seeks to determine whether
the prerequisites for the successful commissioning of the project have been considered
and reasonably good choices have been made with respect to location, size, process, etc.
The important questions raised in technical analysis are:

Whether the preliminary tests and studies have been done or provided for?

Whether the availability of raw materials, power, and other inputs has been
established?

Whether the selected scale of operation is optimal?

Whether the production process chosen is suitable?

Whether the equipment and machines chosen are appropriate?

Whether the auxiliary equipments and supplementary engineering works have

been provided for?

Whether provision has been made for the treatment of effluents?

Whether the proposed layout of the site, buildings, and plant is sound?

Whether work schedules have been realistically drawn up?

Whether the technology proposed to be employed is appropriate from the social

point of view?
Financial Analysis:
Financial analysis seeks to ascertain whether the proposed project will be financially
viable in the sense of being able to meet the burden of servicing debt and whether the
proposed project will satisfy the return expectations of those who provide the capital.
The aspects which have to be looked into while conducting financial analysis are:

Investment outlay and cost of project

16

PROJECT MANAGEMENT

Means of financing

Cost of capital

Projected profitability

Break-even point

Cash flows of the project

Investment worthwhileness judged in terms of various criteria of merit

Projected financial position

Level of risk

Economic Analysis:
Economic analysis, also referred to as social cost benefit analysis, is concerned with
judging a project from the larger social point of view. In such an evaluation the focus is
on the social costs and benefits of a project which may often be different from its
monetary costs and benefits. The questions sought to be answered in social cost benefit
analysis are:

What are the direct economic benefits and costs of the project measured in terms
of shadow (efficiency) prices and not in terms of market prices?

What would be the impact of the project on the distribution of income in the
society?

What would be the impact of the project on the level of savings and investment in
the society?

What would be the contribution of the project towards the fulfillment of certain
merit wants like self-sufficiency, employment, and social order?
Ecological Analysis:
In recent years, environmental concerns have assumed a great deal of significance
and rightly so. Ecological analysis should be done particularly for major projects which
have significant ecological implications (like power plants and irrigation schemes) and
environment-polluting industries (like bulk drugs, chemicals, and leather processing).
The key questions raised in ecological analysis are:

What is the likely damage caused by the project to the environment?

What is the cost of restoration measures required to ensure that the damage to
the environment is contained within acceptable limits?

1.10. FEASIBILITY STUDY

17

PROJECT MANAGEMENT
The feasibility study is concerned with the first four phases of capital budgeting, viz.,
planning, analysis, selection (evaluation), and financing, and involves market, technical,
financial, economic, and ecological analysis. The schematic diagram of the feasibility
study is shown below

1.10.1. Market & Demand Analysis

In most cases, the first step in project analysis is to estimate the potential size of the
market for the product proposed to be manufactured and get an idea about the market
share that is likely to be captured. Given the importance of market and demand analysis,
it should be carried out in an orderly and systematic manner.
The key steps involved in market and demand analysis are as follows:

Situational analysis and specification of objectives

Collection of secondary information
Conduct of market survey
Characterization of the Market
Demand forecasting
Formulation of the Market Plan

18

PROJECT MANAGEMENT

Key steps in Market and Demand analysis

What Is Market Demand Analysis?

Companies use market demand analysis to understand how much consumer demand
exists for a product or service. This analysis helps management determine if they can
successfully enter a market and generate enough profits to advance their business
operations. While several methods of demand analysis may be used, they usually contain
a review of the basic components of an economic market which are:
1. Market identification
2. Business cycle
3. product niche
4. growth potential
5. competition
Market Identification
The first step of market analysis is to define and identify the specific market to target
with new products or services. Companies will use market surveys or consumer feedback
to determine their satisfaction with current products and services. Comments indicating
dissatisfaction will lead businesses to develop new products or services to meet this
consumer demand. While companies will usually identify markets close to their current
product line, new industries may be tested for business expansion possibilities.
Business Cycle
Once a potential market is identified, companies will assess what stage of the business
cycle the market is in. Three stages exist in the business cycle: emerging, plateau and
declining. Markets in the emerging stage indicate higher consumer demand and low
supply of current products or services. The plateau stage is the break-even level of the

19

PROJECT MANAGEMENT
market, where the supply of goods meets current market demand. Declining stages
indicate lagging consumer demand for the goods or services supplied by businesses.
Product Niche
Once markets and business cycles are reviewed, companies will develop a product that
meets a specific niche in the market. Products must be differentiated from others in the
market so they meet a specific need of consumer demand, creating higher demand for
their product or service. Many companies will conduct tests in sample markets to
determine which of their potential product styles is most preferred by consumers.
Companies will also develop their goods so that competitors cannot easily duplicate their
product.
Growth Potential
While every market has an initial level of consumer demand, specialized products or
goods can create a sense of usefulness, which will increase demand. Examples of
specialized products are iPods or iPhones, which entered the personal electronics market
and increased demand through their perceived usefulness by consumers. This type of
demand quickly increases the demand for current markets, allowing companies to
increase profits through new consumer demand.
Competition
An important factor of market analysis is determining the number of competitors and
their current market share. Markets in the emerging stage of the business cycle tend to
have fewer competitors, meaning a higher profit margin may be earned by companies.
Once a market becomes saturated with competing companies and products, fewer profits
are achieved and companies will begin to lose money. As markets enter the declining
business cycle, companies will conduct a new market analysis to find more profitable
markets.

Situational analysis & specification of objectives

In order to get a feel of the relationship between the product and its market, the project
analyst may informally talk to customers competitors, middlemen and other in the
industry.
Where and how to market the new product/service the objectives of the market and
demand analysis in this case may be to answer the questions.
1. Who are buyers of the new product/service?
2. What is the current demand for the new product/service?
3. How is demand distributed temporally and geographically?
4. What is the breakup of demand for the new product/service of different sizes?
5. What price and warranty will ensure its acceptance?
6. What channels distribution is most suited for the new product/service?
7. What trade margins will induce distributors to carry it?
8. What are prospects of immediate sales?

20

PROJECT MANAGEMENT
Collection of secondary information
Information may be obtained from secondary and primary sources. Secondary
information is information that has been gathered in some other context and is already
available. Primary information on the other hand represents information that is collected
for the first time to meet the specific purpose on hand secondary information provides
the base and starting point market and demand analysis.
General sources of secondary information: The important sources of secondary
information useful market and demand analysis in the country are mentioned below:
1. National Census
2. National sample survey reports
3. Plan reports
4. statistical abstract of national union
5. Statistical year book
6. Economic survey
7. Guidelines to industries
8. Annual survey of industries
9. Annual reports of the Department of commerce and industry.
10. The exchange directory
11. Monthly bulletin of reserve bank.
12. Publications of advertising agencies

Evaluation of secondary information

While secondary information is available economically and readily. Its reliability, accuracy
and relevance for the purpose under consideration must be carefully examined. The
market analyst should seek to know:
1. Who gathered the information?
2. What was the objective?
3. When was the information gathered?
4. When was it published?
5. Have the terms in the study been carefully and unambiguously defined?
6. What was the target population?
7. How was the sample chosen?
8. How representative was the sample?
9. How satisfactory was the process of information gathering?

21

PROJECT MANAGEMENT
10. What was the degree of sampling bias and non-response in the information
gathered?
11. What was the degree of misrepresentation by respondents?

Conduct of market survey

The information sought in a market survey may relate to one or more of the following.
1. Total demand and rate of growth of demand
2. Demand in different segments of market
3. Income and price elasticitys of demand
4. Motives for buying
5. Purchasing plans and intentions
6. Socioeconomic characteristics of buyers
7. Unsatisfied needs
8. Attitudes toward various products
9. Distributive trade practices and preferences
10. Satisfaction with existing products
Steps in a sample survey:
1. Define the target population
2. Select the sampling scheme and sample size
3. Develop the questionnaire
4. Recruit and train the field investigators
5. Obtain information as per the questionnaire from the sample of respondents
6. Scrutinise, analyse & interpret information.

Characterization of the Market

Based on the information gathered from secondary sources and through the market
survey, the market for the product or service to be offered may be described in terms of
the following:
1. Effective demand on the past and present
2. Breakdown of demand
3. Price
4. Methods of distribution and sales promotion

22

PROJECT MANAGEMENT
5. Consumers
6. Supply of competition
7. Government Policy

Demand forecasting
After gathering information about various aspects of the market and demand from
primary and secondary sources. An attempt may be made to estimate future demand.
These may classified in three categories as shown
1. Qualitative Methods
2. Time series projection Methods
3. Causal Methods

Methods of Demand Forecasting

Qualitative Forecasting Methods

Your company may wish to try any of the qualitative forecasting methods below if you do
not have historical data on your products' sales.
Qualitative Method

Description

Jury of executive
opinion

The opinions of a small group of high-level managers are

pooled and together they estimate demand. The group
uses their managerial experience, and in some cases,

23

PROJECT MANAGEMENT
combines the results of statistical models.
Sales force composite Each salesperson (for example for a territorial coverage)
is asked to project their sales. Since the salesperson is
the one closest to the marketplace, he has the capacity to
know what the customer wants. These projections are
then combined at the municipal, provincial and regional
levels.
Delphi method

A panel of experts is identified where an expert could be

a decision maker, an ordinary employee, or an industry
expert. Each of them will be asked individually for their
estimate of the demand. An iterative process is conducted
until the experts have reached a consensus.

Consumer market
survey

The customers are asked about their purchasing plans

and their projected buying behaviour. A large number of
respondents is needed here to be able to generalize
certain results.

Quantitative Forecasting Methods

There are two forecasting models here (1) the time series model and (2) the causal
model. A time series is a set of evenly spaced numerical data and is obtained by
observing responses at regular time periods. In the time series model, the forecast is
based only on past values and assumes that factors that influence the past, the present
and the future sales of your products will continue.
On the other hand, the causal model uses a mathematical technique known as the
regression analysis that relates a dependent variable (for example, demand) to an
independent variable (for example, price, advertisement, etc.) in the form of a linear
equation. The time series forecasting methods are described below:
Time Series
Forecasting
Method

Nave Approach

Description

Assumes that demand in the next period is the same as demand

in most recent period; demand pattern may not always be that
stable
For example:
If July sales were 50, then Augusts sales will also be 50

24

PROJECT MANAGEMENT
Time Series
Forecasting
Method
Moving
Averages (MA)

Description
MA is a series of arithmetic means and is used if little or no trend is
present in the data; provides an overall impression of data over time
A simple moving average uses average demand for a fixed
sequence of periods and is good for stable demand with no
pronounced behavioral patterns.
Equation:
F 4 = [D 1 + D2 + D3] / 4
F forecast, D Demand, No. Period
A weighted moving average adjusts the moving average method
to reflect fluctuations more closely by assigning weights to the most
recent data, meaning, that the older data is usually less important.
The weights are based on intuition and lie between 0 and 1 for a
total of 1.0
Equation:
WMA 4 = (W) (D3) + (W) (D2) + (W) (D1)
WMA Weighted moving average, W Weight, D Demand, No.
Period

Exponential
Smoothing

The exponential smoothing is an averaging method that reacts

more strongly to recent changes in demand by assigning a
smoothing constant to the most recent data more strongly; useful if
recent changes in data are the results of actual change (e.g.,
seasonal pattern) instead of just random fluctuations
F t + 1 = a D t + (1 - a ) F t
Where
F t + 1 = the forecast for the next period
D t = actual demand in the present period
F t = the previously determined forecast for the present period
= a weighting factor referred to as the smoothing constant

Trend
Projection
Method

This time-series forecasting method fits a trend line to a series of

historical data points and then projects the line into the future for
medium- to long range forecasts. There are several mathematical
trend equations that can be developed viz. linear, exponential,
quadratic etc. Here we will concentrate only on the linear trends. Of
the components of a time series, secular trend represents the longterm direction of the series. One way to describe the trend
component is to fit a line visually to a set of points on a graph. Any
given graph, however, is subject to slightly different interpretations
by different individuals. We can also fit a trend line by the method of
least squares

25

PROJECT MANAGEMENT
Uncertainties in demand forecasting
Demand forecasts are subject to error and uncertainty which from three principal source.
1. Data about past and present market. The analysis of past and present markets,
which serve as the springboard for the projection exercise, may be vitiated by the
following inadequacies of data:
o

Lack of Standardization: Data pertaining to market features like

product, price, quantity, cost, income, etc. may not reflect uniform
concepts and measures.

Few observations: observations available to conduct meaningful analysis

may not be enough.

Influence of abnormal factors: Some of the observations may be

influenced by abnormal factors like war or natural calamity.

Method of forecasting. Methods used for

characterized by the following limitations:

Inability to handle unquantifiable factors: most of the forecasting

methods, being quantitative in nature, cannot handle unquantifiable
factors which sometimes can be of immense significance.

Unrealistic assumptions: Each forecasting method is based on certain

assumptions. For example, the trend projection method is based on the
mutually compensating affects premise and the end use method is based
on the constancy of technical coefficients. Uncertainty arises when the
assumptions underline the chosen method tend to be realistic and
erroneous.

Exercise data requirement: In general, the more advanced a method,

the greater the data requirement. For example, to use an econometric
model one has to forecast the future values of explanatory variables in
order to project the explained variable.

Environmental Change. The environment in which a business functions is

characterized by numerous uncertainties. The important sources of
uncertainty are mentioned below:

Technological Change: This is a very important and very hard-to-predict

factor which influences business prospects. A technological advancement
may create a new product which performs the same function more
efficiently and economically, thereby cutting into the market for the
existing product. For example, electronic watches are encroaching on the
market for mechanical watches.

Shift in Government Policy: Government resolution of business may be

extensive. Changes in government policy, which may be difficult to
anticipate, could have a telling effect on the business environment.

Development on the International Scene: Development

International Scene may have a profound effect on industries.

demand

forecasting

on

are

the

26

PROJECT MANAGEMENT
o

Discovery of New Sources of Raw Material: Discovery of new sources of

raw materials, particularly hydrocarbons, can have a significant effect on
the market situation of several products.

Vagaries of the Weather: Weather plays an important role in the economy

of a country, is somewhat unpredictable. Extreme weather influences,
directly or indirectly, the demand for a wide range of products.

Coping with Uncertainties:

Given the uncertainties in demand forecasting, adequate efforts, along the following
lines, may be made to cope with uncertainties.
1. Conduct analysis with data based on uniform and standard definitions.
2. In identifying trends, coefficients, and relationships, ignore the abnormal and outof-the-ordinary observations.
3. Critically evaluate the assumptions of the forecasting methods and choose a
method which is appropriate to situation.
4. Adjust the projections derived from quantitative analysis in the light of
unquantifiable, but significant, influences.
5. Monitor the environment imaginatively to identify important changes.
6. Consider likely alternative scenarios and their impact on market and competition.
7. Conduct sensitivity analysis to access the impact on the size of demand for
unfavourable and favourable variations of the determining factors from their most
likely levels.

Market planning
A marketing plan usually has the following components
1. Current marketing situation
o

Where is your organisation now?

Who are your customer groups? What are their needs and requirements?
How large and diverse are they?

What kinds of products and services do you currently provide?

How do you reach your customer groupings?

Do you have any competition?

What factor/s in your environment has an effect on your organisation?

Opportunity and issue analysis (S.W.O.T. analysis). This identifies key

issues and opportunities for your organisation and it comprises an analysis
of your internal operations

Strengths

27

PROJECT MANAGEMENT
o

Weaknesses

Also those external factors, which affect your organisation

o

Opportunities

Threats

Objectives. Having identified the key issues affecting your organisation

you can make some decisions about future objectives. These guide the
development of strategies and action plans.

Objectives should meet certain criteria e.g. financial, and marketing which
will be customer focused.

They should be clearly stated, measurable and listed in order of

importance

They should be attainable and consistent with your organisation's culture.

Marketing strategy. This is the game plan that needs to be implemented

to achieve the objectives. It addresses the following:

Whom are you now targeting?

What do you want your position to be in terms of new product/service

delivery?

Do you want to change your organisation profile and will you need to
rebrand your organisation?

Will you change the way you promote and advertise yourself?

Will there be any changes in how you reach your customer groupings?

Any changes in staff?

Is there a need for more research?

Action program. This describes:

What will be done

When will it be done?

Who will do it?

How much will it cost?

Budget and controls.

The Budget is essentially a cash flow statement and profit/loss statement

to support the marketing plan

Control mechanisms and procedures should be established to monitor the

progress of the plan to determine if anything needs changing. It would
include a contingency plan in case something adverse should happen.

28

PROJECT MANAGEMENT

1.10.2.

TECHNICAL ANALYSIS

Analysis of technical and engineering aspects is done continually when a project is being
examined and formulated. Other types of analyses are dependent and closely
intertwined with technical analysis. Technical analysis is concerned primarily with:
Materials and inputs
An important aspect of technical appraisal is concerned with defining the materials and
inputs required, specifying their properties in some detail, and setting up their supply
programme. There is an intimate relationship between the study of materials and inputs
and other aspects of project formulation, particularly those concerned with location,
technology, and equipment
Materials and inputs may be classified into four broad categories: (i) raw materials, (ii)
processed industrial materials and components, (iii) auxiliary materials and factory
supplies, and (iv) utilities.
(i) Raw materials Raw materials (processed and / or semi- processed) may be
classified into four types: (i) agricultural products, (ii) mineral products, (iii)
livestock and forest products, and (iv) marine products.
(ii)Processed industrial materials and components Processed industrial
materials and components (base metals, semi-processed materials, manufactured
parts, components, and sub-assembly represent an important input for a number
of industries. In studying them the following questions need to be answered: In
the case of industrial materials, what are their properties? What is the total
requirement of the project? What quantity would be available from domestic
source? What quantity would be available from foreign sources? How dependable
are the supplies? What has been the past trend in prices? What is the likely future
behaviour of prices?
(iii)
Auxiliary materials and factory supplies In addition to the basic raw
materials and processed industrial materials and components, a manufacturing
project requires various auxiliary materials and factory supplies, like chemicals,
additives, packaging materials, paints, varnishes, oils, grease, cleaning materials,
etc. The requirements of such auxiliary materials and supplies should be taken
into account in the feasibility study.
(iv)
Utilities A broad assessment of utilizes (power, water, steam, fuel, etc.)
may be made at the time of input study though a detailed assessment can be
made only after formulating the project with respect to location, technology, and
plant selection. Since the successful operation of a project critically depends on
adequate availability of utilities the following points should be raised while
conducting the input study: What quantities are required? What are the sources

29

PROJECT MANAGEMENT
of supply? What would be the potential availability? What are the likely
shortages/bottlenecks? What measures may be taken to augment supplies.

Production technology
For manufacturing a product/service often two or more alternative
technologies are available. For example:

Steel can be made either by the Bessemer process or the open hearth process.
Cement can be made either by the dry process or the wet process.
Soda can be made by the electrolysis method or the chemical method.
Paper, using bagasse as the raw material, can be manufactured by the kraft
process or the soda process.
Vinyl chloride can be manufactured by using one of the following reactions:
acetylene on hydrochloric acid or ethylene or chlorine.

Choice of technology
The choice of technology is influenced by a variety of considerations:
(i) Principal inputs The choice of technology depends on the principal inputs
available for the project. In some cases, the raw materials available influences the
technology chosen. For example, the quality of limestones determines whether
the wet or dry process should be used for a cement plant. It may be emphasized
that a technology based on indigenous inputs may be preferable to one based on
imported inputs because of uncertainties characterizing imports, particularly in a
country like India.
(ii)Investment outlay and production cost The effect of alternative
technologies of investment outlay and production cost over a period of time
should be carefully assessed.
(iii)
Use by other units The technology adopted must be proven by
successful use by other units, preferably in India.
(iv)
Product mix The technology chosen must be judged in terms of the
total product-mix generated by it, including saleable by-products.
(v)Latest developments The technology adopted must be based on latest
development in order to ensure that the likelihood of technological obsolescence
in the near future, at least, is minimized.
(vi)
Ease of absorption The ease with which a particular technology can be
absorbed can influence the choice of technology. Sometimes a high-level
technology may be beyond the absorptive capacity of a developing country which
may lack trained personnel to handle that technology.
Product Mix
The choice of product mix is guided primarily by market requirements. In the production
of most of the items variations in size and quality are aimed the production of most of

30

PROJECT MANAGEMENT
the items, variations in size and quality are aimed at satisfying a broad range of
customers. For example, production of shoes to different customers. It may be noted
that sometimes slight variations in quality can enable a company to expand its market
and enjoy higher profitability. For example, a toilet soap manufacturing unit may by
minor variation in raw material, packaging, and sales promotion offer a high profit
margin soap to consumers in upper-income brackets.
While planning the production facilities of the firm, some flexibility with respect to the
product mix must be sought. Such flexibility enables the firm to alter its product mix in
response to changing market conditions and enhances the power of the firm to survive
and grow under different situations. The degree of flexibility chosen may be based on a
careful analysis of the additional investment requirements for different degrees of
flexibility.
Plant capacity
Plant capacity (also referred to as production as capacity) refers to the volume or
number of units that can be manufactured during a given period. Several factors have a
bearing on the capacity decision.
(i) Technological requirement For many industrial projects, particularly in process
type industries, there is a certain minimum economic size determined by the
technological factor. For example, a cement plant should have a capacity of at least 300
tonnes per day in order to use the rotary kiln method; otherwise, it has to employ the
vertical shaft method which is suitable for lower capacity.
(ii)Input constraints In a developing country like India, there may be constraints
on the availability of certain inputs. Power supply may be limited; basic raw
materials may be scarce; foreign exchange available for imports may be
inadequate. Constraints of these kinds should be borne in mind while choosing
the plant capacity.
(iii)
Investment cost When serious input constraints do not obtain, the
relationship between capacity and investment cost is an important consideration.
Typically, the investment cost per unit of capacity decreases as the plant capacity
increases. This relationship may be expressed as follows:

Where C1 = derived cost for Q1 units of capacity

C2 = known cost for Q2 units of capacity a = a factor reflecting capacity-cost
relationship. This is
usually between 0.2 and 0.9.
(iv) Market conditions The anticipated market for the
product/service has an important bearing on plant capacity. If the market for the product
is likely to be very strong, a plant of higher capacity is preferable. If the market is likely
to be uncertain, it might be advantageous to start with a smaller capacity. If the market,
starting from a small base, is expected to grow rapidly, the initial capacity may be higher

31

PROJECT MANAGEMENT
than the initial level of demand- further additions to capacity may be affected with the
growth of market.
(v)Resources of the firm The resources, both managerial and financial, available
to a firm define a limit on its capacity decision. Obviously, a firm cannot choose a
scale of operations beyond its financial resources and managerial capability.
(vi)
Governmental policy The capacity level may be constrained by
governmental policy. Given the level of additional capacity to be created in an
industry, within the licensing framework of the government the government may
decide to distribute the additional capacity among several firms.
Location and site
The choice of location and site follows an assessment of demand, size, and input
requirement. Though often used synonymously, the terms 'location' and 'site' should be
distinguished. Location refers to a fairly broad area like a city, an industrial zone, or a
coastal area; site refers to a specific piece of land where the project would be set up.
The choice of location is influenced by a variety of considerations: proximity to raw
materials and markets, availability of infrastructure, governmental policies, and other
factors.
(i) Proximity to raw materials and markets An important consideration for
location is the proximity to sources of raw materials and nearness to the market
for final products. In terms of a basic locational model, the optimal location is one
where the total cost (raw material transportation cost plus production cost plus
distribution cost for final product) is minimized. This generally implies that: (i) a
resource-based project like a cement plant or a steel mill should be located close
the source of basic material (for example, limestone in the case of a cement plant
and iron-ore in the case of a steel plant); (ii) a project based on imported
material may be located near a port; and (iii) a project manufacturing a
perishable product should be close to the center of consumption.
However, for many industrial products proximity to the source of raw material or the
center of consumption may not be very important. Petro-chemical units or refineries, for
example, may be located close to the source of raw material, or close to the center of
consumption, or at some intermediate point.
(ii) Availability of infrastructure

Availability of power,

transportation, water, and communications should be carefully assessed before a location

decision is made.
Adequate supply of power is a very important condition for location insufficient power
can be a major constraint, particularly in the case of an electricity-intensive project like
an aluminium plant. In evaluating power supply the following should be looked into: the
quantum of power available, the stability of power supply, the structure of power tariff,
and the investment required by the project for a tie-up in the network of the power
supplying agency.
For transporting the inputs of the project and distributing the outputs of the project,
adequate transport connectionswhether by rail, road, sea, inland water, or air are

32

PROJECT MANAGEMENT
reqired. The availability, reliability and cost of transportation for various alternative
locations should be assessed.
Given the plant capacity and the type of technology, the water requirement for the
project can be assessed. Once the required quantity is estimated, the amount to be
drawn from the public utility system and the amount to be provided by the project from
surface or sub-surface sources may be determined. For doing this the following factors
may be examined: relative costs, relative dependabilities, and relative qualities.
In addition to power, transport, and water, the project should have adequate
communication facilities like telephone and fax etc.
(iii)
Governmental policies Governmental policies have a bearing on
location. In the case of public sector projects, location is directly decided by the
government. It may be based on a wider policy for regional dispersion of
industries.
In the case of private sector projects, location is influenced by certain governmental
restrictions and inducements. The government may prohibit the setting up of industrial
projects in certain areas which suffer from urban congestion. More positively, the
government offers inducements for establishing industries in backward areas. These
inducements consist of outright subsidies, concessional finance, tax relief, and other
benefits.
(iv)
Other factors Several other factors have to be assessed before
reaching a location decision: ease in coping with environmental pollution, labour
situation, climatic conditions, and general living conditions.
A project may cause environmental pollution in various ways: it may throw gaseous
emission; it may produce liquid and solid discharges; it may cause noise, heat, and
vibrations. The location study should analyse the costs of mitigating environmental
pollution to tolerable levels at alternative locations.
The labour situation at alternative locations may be assessed in terms of: (i) the
availability of labour, skilled, semi-skilled, and unskilled; (ii) the past trends in labour
rates, the prevailing labour rates, and the projected labour rates; and (iii) the state of
industrial relations judged in terms of the frequency and severity of strikes and lockouts
and the attitudes of labour and management.
The climatic conditions (like temperature, humidity, wind, sunshine, rainfall, snowfall,
dust and fumes, flooding, and earthquakes) have an important influence on location.
They have a bearing on cost as they determine the extent of air-conditioning, dehumidification, refrigeration, special drainage, etc., required for the project.
General living conditions, judged in terms of cost of living, housing situation, and
facilities for education, recreation, transport, and medical care, need to be assessed at
alternative locations.
Machinery and equipment
The requirement of machinery and equipment is dependent on production technology
and plant capacity. It is also influenced by the type of project. For a process-oriented
industry, like a petrochemical unit, machinery and equipment required should be such
that the various stages have to be matched well. The choice of machinery and

33

PROJECT MANAGEMENT
equipment for a manufacturing industry is somewhat wider as various machines can
perform the same function with varying degrees of accuracy. For example, the
configuration of machines required for the manufacture of refrigerators could take
various forms. To determine the kinds of machinery and equipment requirement for a
manufacturing industry, the following procedure may be followed: (i) Estimate the likely
levels of production over time. (ii) Define the various machining and other operations.
(iii) Calculate the machine hours required for each type of operation. (iv) Select
machinery and equipment required for each function.
The equipment required for the project may be classified into the following types: (i)
plant (process) equipment, (ii) mechanical equipment, (iii) electrical equipment, (iv)
instruments, (v) controls, (vi) internal transportation system, and (vii) other machinery
and equipment.
In addition to the machinery and equipment, a list should be prepared of spare parts and
tools required. This may be divided into: (i) spare parts and tools to be purchased with
original equipment, and (ii) spare parts and tools required for operational wear and tear.
Constraints in selecting machinery and equipment In selecting the machinery and
equipment, certain constraints should be borne in mind:
(i) there may be a limited availability of power to set up an electricity intensive plant
like, for example, a large electric furnace; (ii) there may be difficulty in
transporting a heavy equipment to a remote location; (iii) workers may not be
able to operate, at least in the initial periods, certain sophisticated equipment
such as numerically controlled machines; (iv) the import policy of the government
may preclude the import of certain types of machinery and equipment.
Structures and civil works
Structures and civil works may be divided into three categories: (i) site preparation and
development, (ii) buildings and structures, and (iii) outdoor works.
(i) Site preparation and development This covers the following: (i) grading and
leveling of the site, (ii) demolition and removal of existing structures, (iii)
relocation of existing pipelines cables, roads, powerlines, etc., (iv) reclamation of
swamps, draining and removal of standing water, (v) connections for the following
utilities from the site to the public network: electric power (high tension and low
tension), water (use water and drinking water), communications (telephone, fax,
etc.), roads, railway sidings, and (vi) other site preparation and developmental
work.
(ii)Buildings Buildings and structures may be divided into: (i) factory or process
buildings; (ii) ancillary buildings required for stores, warehouses, laboratories, utility
supply centers, maintenance services, and others; (iii) administrative buildings; (iv) staff
welfare buildings, cafetaria, and medical service buildings; and (v) residential buildings.
(iii)
Outdoor works Outdoor works cover (i) supply and distribution of
utilities (water, electric power, communication, steam and gas); (ii) handling and
treatment of emissions, wastages, and effluents; (iii) transportation and traffic
arrangements (roads, railway tracks, paths, parking areas, sheds, garages, traffic
signals, etc.): (iv) outdoor lighting; (v) landscaping; and (vi) enclosure and
supervision (boundary wall, fencing, barriers, gates, doors, security posts, etc.).

34

PROJECT MANAGEMENT
Project charts and layouts
Once data is available on the principal dimension of the project market size, plant
capacity, required technology, equipment and civil works, conditions obtaining at plant
site, and supply of inputs to the project project charts and layouts may be prepared.
These define the scope of the project and provide the basis for detailed project
engineering and estimation of investment and production costs.
Work Schedule
The work schedule, as its name suggests, reflects the plan of work concerning
installation as well as initial operation. The purpose of the work schedule is:

To anticipate problems likely to arise during the installation phase and suggest
possible means for coping with them.
To establish the phasing of investments taking into account availability of
finances.
To develop a plant of operations covering the initial period (the running in period).

Often, it is found that the required inputs like raw material and power are not available
in adequate quantity when the plant is ready for commissioning, or the plant is not ready
when the raw material arrives.

1.10.3. FINANCIAL ANALYSIS

Financial analysis is defined as the process of discovering economic facts about an
enterprise and/or a project on the basis of an interpretation of financial data. Financial
analysis also seeks to look at the capital cost, operations cost and operating revenue.
The analysis decisively establishes a relationship between the various factors of a project
and helps in maneuvering the project's activities. It also serves as a common measure of
value for obtaining a clear-cut understanding about the project from the financial point of
view.
An analysis of several financial tools provide an important basis for valuing securities and
appraising managerial programmes. Financial analysis is vital in the interpretation of
financial statements. It can provide an insight into two important areas of management
return on investment and soundness of the company's financial position.
Internal management accounts provide information which is valuable for the purpose of
control. The information is made available in the form of accounting data, which may be
manifested as financial and accounting statements. A financial analysis reveals where the
company stands with respect to profitability, liquidity, leverage and an efficient use of its
assets. Financial reports provide the framework within which business planning takes
place. They are the key through which an effective control of a business enterprise is
exercised. It is the process of determining the significant financial characteristics of a
firm. It may be external or internal. The external analysis is performed by creditors,

35

PROJECT MANAGEMENT
stockholders and investment analysis. The internal analysis is performed by various
departments of a firm.
Significance of financial analysis
Financial analysis primarily deals with the interpretation of the data incorporated in the
proforma financial statements of a project and the presentation of the data in a form in
which it can be utilized for a comparative appraisal of the projects. It is, in effect,
concerned with the development of the financial profile of the project. Its purpose is to
find out whether the project is attractive enough to secure funds needed for its various
constituent activities and once having secured the funds, whether the project will be able
to generate enough economic values to achieve the objectives for which it is sought to
be implemented. It deals not only with the financial aspects of a project but also with its
operational aspects. As such, it is necessary to undertake such an analysis not only in
the case of industrial projects but also in the case of non-industrial projects.
Analysis of financial statements has become very significant due to the widespread
interest of various parties in the financial results of a company. In recent years, the
ownership of capital of most public companies has become broad-based. A number of
parties and bodies, including creditors, potential suppliers, debenture-holders, credit
institutions like banks, industrial finance corporations, potential investors, employees,
trade unions, important customers, economists, investment analysts, taxation authorities
and government have a stake in the financial results of a company. Various people look
at the financial statements from various angles. A number of techniques have been
developed to undertake analysis of financial statements in order to reach conclusions
about the financial health, profitability and efficiency of an enterprise and also to
compare an enterprise with other similar undertakings. The technique of ratio analysis is
the most important tool of financial analysis. It helps in comparing the performance of
various companies and judge their financial soundness.
Utility of financial and accounting statements

Utility of financial analysis

36

PROJECT MANAGEMENT
Financial statements play a vital role in the internal financial control of an enterprise.
These should, therefore, the properly constructed, analysed and interpreted by
executives, bankers, creditors and investors.
The entire future of a company hinges on the manager's ability to decide relevant
financial data with a view to planning profit ability moves. Learning to read financial
statements is the first essential element in any businessman's attempt to acquire
financial management skills. The change in the elitism of stock ownership to broad public
ownership has necessitated a concomitant change in the entire process of reporting
corporate financial results. The role of management in the matter of preparation of
financial statements is to add understanding to these statements, the fairness of which is
to be viewed through the eye of the user, while that of the accountant is to close the
communication gap and of the auditor to add credibility to them. For evolving a good
economic information system, accounting innovations are of great economic information
system. Without these, communication with the financial community would be difficult,
the interest of present and future potential investors would not be served, the ability of
the company to raise additional capital would be impaired and the government's
regulatory measures and policies would not serve the best interest of society. Though a
financial statement reveals less than it conceals, it provides the indicators of the
enterprise's performance during the year.
Financial analysis seeks to spotlight the significant facts and relationships concerning
managerial performance, viz., corporate efficiency, financial strengths and weaknesses
and creditworthiness of the enterprise.

1.10.4. SOCIAL COST BENEFIT ANALYSIS

The economic evaluation of any investment proposal involves an analysis of social
profitability arising out of the investment. Apart from the direct financial benefits as a
result of revenue which will flow in the national exchequer from duties and taxes levied,
there are various indirect benefits which will accrue such as opening up of employment
opportunities in downstream/ancillary industries, transport and other secondary and
tertiary sectors of commercial activity. This analysis which basically determines whether
an investment is worthwhile from the point of view of the society as a whole, involves
adjustment on cost and return to the enterprise taking into account the direct and
indirect benefits leading to revalued inputs and outputs. Thus,

Social cost benefit analysis (SCBA) is a methodology for evaluating project from social
point of view. It is also referred as economic analysis and is developed for evaluating

37

PROJECT MANAGEMENT
investment project from the point of view of the society. In recent years particularly in
the developing countries where GOVT is playing significant role in economic development
(SCBA) is playing a very important role. It is concerned with tactical decision making
within the framework of broad strategic choice defined by planning at the macro level.

Rationale for SCBA

In SCBA the focus is on social cost and benefits of a project. These often tend to differ
from the cost incurred in monetary terms and benefits earned in monetary terms by the
project.
The principle reasons for discrepancies are -:
Market imperfections -:

The common market imperfections found in

developing countries are

Rationing -: rationing means control over the prices and distribution of a

commodity. The price paid by the consumer in case of rationing is much less than
the price prevailing in the competitive market.

Prescription of minimum wage rates -: in case of minimum wage rates the

wages paid to the labourers are more than what the wages would be in a
competitive labour market free from such wage legislation.

Foreign exchange regulations -: the official rate of foreign exchange in most

of the developing countries which exercise close regulation over foreign exchange
is typically less than the rate that would prevail in the absence of foreign
regulation.

Externalities: - a project may have beneficial external effects, for e.g. a

project may create certain infrastructure facilities like roads which benefit the
neighbouring areas, or a may have harmful external effects like it may create
environmental pollution. Such benefits/losses are ignored in assessing the monetary
benefits to the project sponsors but such externalities are relevant in SCBA because
in such analysis all cost and benefits, irrespective to whom they accrue and whether
they are paid for or not, are relevant.

Taxes and subsidies -: in case of monetary cost and benefit of a project

taxes and subsidies are to be considered because they are definite monetary gains,
however, taxes and subsidies are ignored in case of SCBA because they are
considered as transfer payments.

Concern for savings -: in case of monetary cost benefit analysis a

private firm is least concerned as to how its benefits are divided between
consumption and savings, but from social point of view, however, the division of
benefit between saving and consumption is relevant because while doing SCBA it is

38

PROJECT MANAGEMENT
assumed that a rupee of benefit saved is more valuable than a rupee of benefit
consumed. Thus a higher concern of society for saving and investment is duly
reflected in SCBA where higher valuation is put on saving than on consumption.
Concern for redistribution -: while doing monetary cost and benefit

analysis a private firm is least concerned about as to how its benefits are being
distributed among various groups of the society, but while doing SCBA this factor is
kept in mind because it is assumed that a rupee of benefit going to the poor section
is considered more valuable than a rupee of benefit going to an affluent section.
Merit wants -: while merit wants are not relevant from the private point

of view, they are important from the social point of view. E.g. GOVT may prefer to
promote an adult education programme even though they are of no benefit to the
consumers in market, but from the point of view of the society they are important.

APPROACHES to SCBA
1. UNIDO Approach
2. L & M Approach
3. Approach Adopted By Financial Institutions

A. UNIDO Approach -: the UNIDO approach was first articulated in the guidelines
of project evaluation. It involves five stages :

Calculation of financial profitability of the project, measured at the market prices

of resources and output.

Calculation of the net benefit of project measured in terms of economic prices.

Some resources are priced at international prices and for others shadow prices
are considered.

Adjustment for the impact of the project on saving and investment.

Adjustment for the impact of project on income distribution.

Adjustment for the impact of project on merit goods and demerit goods whose
social value differ from their economic values.

i.

Financial Analysis -: to judge a project from the financial angle, we need

following information.

Cost of the project

Means of financing

Estimates of sales and production

Cost of production

Working capital requirement and its financing

39

PROJECT MANAGEMENT

Estimates of working results (profitability projections)

Break even point

Projected cash flow statements

Projected balance sheets

with a project, which are supported by long term funds. It is the sum total of following:
Land and site development
Building and civil work
Plant and machinery
Technical know-how and engineering fees
Expenses on foreign technicians abroad
Miscellaneous fixed asset
Preliminary and capital issue expenses
Pre-operative expenses
Provisions of contingencies
Margin money of working capital
Initial cash losses

rces of finances may be available -:

Share capital (equity and preference share capital)
Term loan (rupee term loan and foreign currency loans)
Debenture capital
Deferred credit
Incentive sources (seed capital, capital subsidy etc )
Tax deferment
Miscellaneous sources (unsecured loans, public deposits)

ility projection is the forecast of sales revenues. In estimating sales it is reasonable to assume that
capacity utilisation will be somewhat low in the first year and rise thereafter
gradually to reach the maximum level in the third and fourth year of operation.

Material cost

Labour cost

Factory overhead cost

rking capital requirement and planning for its financing, the following points must be borne in mind -:

40

PROJECT MANAGEMENT
The built of current assets till the rated level of capacity utilisation is
reached.
The maximum permissible bank finance.
Margin requirement against various current assets.

e following lines :

Cost of production

Total administrative expenses

Total sales expenses

Royalty and know-how payable

Total cost of production

Expected sales

Gross profit

Other incomes

Preliminary expenses written off

P & L before tax

Provision for taxation

PAT

Dividend

Retained profits

Net cash accrual

t nor incur losses it is calculated as follow

e firm and its net impact on the cash balances of the firm.
accounts, reflects the financial condition of the firm.

ii.

Net benefit in terms of economic prices

Stage two is concerned with determination of economic prices also referred as
shadow prices. A key issue in shadow pricing is that in what unit the input or
output is expressed i.e. in what unit of currency should benefit or cost be
expressed, whether the cost and benefit should be valued at current or constant

41

PROJECT MANAGEMENT
prices. Shadow price is also known as hidden price, a price that is hidden under
monetary cost and benefits.

For a traded good the shadow price is the border price translated in the domestic currency at market
exchange rate. The shadow price in case of non-tradable good is consumer
willingness to pay or cost of production depending on the impact of the project on
the rest of the economy.

ersion of non- traded input from the producer or addition of non-traded input, taxes should be included.
If a project augment domestic production by other producers, taxes should be
excluded and for fully traded goods taxes should be ignored.

s in demand or supply affect just the level of import or export. For a good being tradable the following
condition should be met-:

The import quota, if any should not be restrictive.

The import supply should be perfectly elastic.

There is no surplus capacity in the domestic industry.

If, additional demand exist inland, the imported goods even after taking
into account the cost of transport from port to the point of inland demand
should be less than the marginal cost of local production.

The imported input cost should be less than the domestic marginal cost of
purchase.

Non tradable inputs and outputs -: a good is non-tradable if following conditions

are satisfied -:

If its CIF prices is greater than its domestic cost of production.

Its FOB price is less than its domestic cost of production.

ncy, at market exchange rate.

llingness to pay or cost of production, depending on the impact of project on the rest of the economy.

msoever they may accrue external effects should also be taken into account. The valuation of external
effects is rather difficult because they are often intangible in nature and there is no
market price, which can be used as a starting point.

42

PROJECT MANAGEMENT
Labour inputs -: the principle of shadow pricing may be applied to labour as well,
though labour is considered to be services. When a project takes away labour
from other employment, the shadow pricing of labour is equal to what other
user of labour are willing to pay.
The shadow prices associated with inducing additional production of workers
consist of the marginal product of labour in previous employment plus certain
other costs.

The social cost of associated with import of foreign labour is the wage they
command. However, a premium should added on account of foreign exchange
remitted abroad by these workers from their savings.
Capital input -: the shadow pricing in case of capital investment involves -:
What is the value of physical assets?
What is the opportunity cost of capital?

The value of physical assets is determined the way values of other resources are
calculated.
The opportunity cost of capital depends on how the capital required for the project is
generated. To the extent that it comes from additional savings its opportunity cost is
measured by the consumption rate of interest.
To the extent that it comes from the denial of capital from the alternative project, its
opportunity cost is the rate of return that would be earned from those alternative
projects. This is also called as investment rate of interest.
Foreign exchange -: the UNIDO method uses domestic currency as the numeraire. So
the foreign exchange impact of the project must be identified and valued. The UNIDO
method determines the shadow price of foreign exchange on the basis of marginal social
value as revealed by the consumer willingness to pay for the goods that are allowed to
be imported at the margin.

iii.

Measurement of the impact on distribution -: stage three of the UNIDO

method is concerned with that given the income distribution impact of the project
what would be its impact on saving.

or lost by individual groups within the society.

43

PROJECT MANAGEMENT
Groups

owing.

Project

Other private business

Government

Workers

Consumers

External sectors

Measure of gain and loss -: the gain or loss to an individual group within the
society as a result of the project.
In case of physical resources is the difference between the shadow price and the
market price of each input or output.
In case of financial transaction it is the difference between the price paid and
value received.

iv.

Impact on saving -: most of the developing countries face scarcity of capital.

Hence, GOVT of these countries are concerned about the impact of a project on
saving and its value thereof. It is concerned with the following aspects -:

Given the income distribution impact of the project what would be the
effect on savings which is equal to-:

propensity to save of the group.

What is the value of such savings to the society -: The value of a rupee of
saving is the present value of additional consumption stream produced
when that rupee of saving is invested in the margin.

at the rate of ar forever. Its present value when discounted at the social discount rate k is:

--

1- (1+ar)/(1+k)

_________
k ar

44

PROJECT MANAGEMENT
where

I = social value of a rupee saving

r = marginal productivity of capital
a = reinvestment rate on additional income arising from investment
k = social discount rate

v.

Adjustment for merit and demerit goods -: merit good is one for which the
social value exceeds the economic value. For e.g. a country may place a higher
social value than economic value on production of oil because it reduce
dependence on foreign supplies. In case of demerit good the social value is less
than the economic value. For e.g. alcoholic products.
The method of adjusting for the difference between social value and economic
value is as follow -:

Estimate the economic value

Calculate the adjustment factor as the difference between the ratio of

social value to economic value and unity.

Multiply the economic value with the adjustment factor to obtain the
adjustment

Add the adjustment to net present value of the project.

The stream of social costs and benefits is obtained after the five steps described above.
The discount rate at which the present value of social costs=social benefits, is called as
social rate of return (SRR). SRR is then compared with the required rate of return. The
SRR of a project forgone may be taken as the desired rate of return. In absence of the
opportunity return, the consumption rate of interest can be taken as the cut-off rate.

LITTLE- MIRRLEES APPROACH

There is a considerable similarity between the UNIDO approach and the L-M approach as
both the approach call for -:

Calculating shadow pricing

Considering the factor of equity

Use of DCF analysis

But despite of these similarities there are some differences also -:

45

PROJECT MANAGEMENT

The UNIDO approach measures cost and benefits in term of domestic rupees
price whereas the L-M approach measures cost and benefit in terms of international
prices.

The UNIDO approach measures cost and benefit in terms of consumption

whereas the L-M approach in terms of uncommitted social income.

The stage by stage approach of UNIDO focus on efficiency, saving, and

redistribution consideration in different stages. The L-M approach, however, take
these consideration together.

SHADOW PRICING

Traded goods and services -: the shadow prices of traded goods and
services are the border price. If a good is exported its shadow price is the FOB price
and if a good is imported its border price is the CIF price. If foreign demand is not
perfectly elastic the marginal export revenue is substituted for the FOB and if foreign
supply is not perfectly elastic, the marginal import cost is substituted for CIF prices.

Non traded goods and services : accounting prices for non-traded good are
defined in terms of marginal social cost and benefit. The marginal social benefit is the
value of an extra unit of good from social point of view and the marginal social cost
of a good is the value in terms of accounting prices of the resources required to
produce an extra unit of the good. To determine the accounting price of a non traded
input the following formula is to be used -:

Labour -: the L-M approach suggest the following formula for calculating the
shadow wage rate-:
SWR = c 1/s (c-m)
Where SWR = shadow wage rate

marginal product of wage earner

SCBA BY FINANCIAL INSTITUTIONS

46

PROJECT MANAGEMENT
The all India term leading financial institutions---IDBI, IFCI, & ICICI-- scrutinise projects
from larger social point of view. ICICI was perhaps the first financial institution to
introduce a system of economic analysis as distinct from financial profitability analysis.
IFCI adopted a system of economic appraisal in 1979. Finally, IDBI also introduced a
system for economic appraisal of project financed by them. Though there are some
minor variations, the three institutions follow essentially a similar approach, which is
simplified version of the L-M approach.
IDBI, in its economic appraisal of industrial projects, consider three aspects:
Economic rate of return
Effective rate of protection
Domestic resource cost
Economic rate of return
The economic rate of return is the internal rate of return of the stream of social cost &
benefit. The method followed by IDBI to calculate the economic rate of return id a similar
approach, which is a simplified version of L-M approach & is described as follows:
International prices are regarded as economic prices so market price is
substituted with international prices for all non-labour input and output.
For tradable items where international prices are already given CIF prices are
used for inputs & fob prices are used for output.
For tradable items where international prices are not directly available and for
non-tradable items social conversion factors are used to convert actual rupee cost
into social cost.
Generally, the social cost of tradable component is obtained by multiplying it by a factor
of 1/1.5.
Social cost of labour cost is obtained by multiplying it by a factor of 0.5.
Social cost of the residual component is obtained by multiplying it by a factor of 0.5.
Social conversion factors (SCB) or proportion of three components, tradable
(T), labour (L), and residual (R)

Item

SCF or proportions

Land

SCF= 1/1.5

Building and construction

Proportions: t=0.5, l=0.25, r=0.25

47

PROJECT MANAGEMENT
Indigenous equipment

SCF = 0.70

Transportation

proportions: t=0.65, l=0.25, r=0.10

Engineering and know how fees

SCF = 1.50

Bank charges

SCF = 0.20

Preoperative expenses

SCF = 1.00

Labour

SCF = 0.50

Salaries

SCF = 0.80

Repairs and maintenance

SCF = 1/1.5

Water, fuel, etc.

Proportions: t=0.50, l=0.25, r=0.25

Electricity

Proportions: t=0.71, l=0.13, r=0.16

Domestic stores

SCF = 8.0

Other overheads

SCF = 1/1.5

Effective rate of protection

The extent to which a project is sheltered is measured by the effective rate of protection
(ERP). It is calculated as follows:
Value added at domestic prices value added at world prices
____________________________________________________________
Value added at world prices

The ratio is multiplied by 100 to express the ERP in percentage terms.

The data required for calculating the ERP may be arranged as follows:
At domestic prices At world prices

A. Selling price
B. Input cost

48

PROJECT MANAGEMENT

Non-traded
C. Value added

The domestic selling price is net of taxes and excise duties but inclusive
of a reasonable selling commission. The selling price at world price is the CIF price for
import and fob for exports.

The input cost consist of the cost of the following inputs:

Raw material and stores
Power, fuel and water
Repairs and maintenance
Part of administrative overheads and expenses
Selling expenses

It may be emphasised that when the value added at domestic prices is same as the
value added at world prices, the ERP is zero. In such a case it implies that a project does
not enjoy any protection from international competition. When the value added at
domestic price is higher than the value added at world price, as is often the case, the
ERP takes a positive value. Clearly the higher the value of ERP, the higher the implied
protection enjoyed by the project. It is generally agreed that the extent of protection
given to a project should not exceed 30 per cent.
Domestic resource cost
The domestic resource cost is calculated as follow -:

Value added at domestic price

___________________________________ * Exchange rate
Value added at world prices

Domestic

Imported

49

PROJECT MANAGEMENT
Selling price
Operating costs
Raw materials (net of duties & taxes)

Capital costs
Charge on capital employed
Depreciation
The capital employed consists of fixed assets plus working capital. It is broken down into
indigenous and imported components. After deducting taxes and duties from both the
components, the charge on capital employed is imputed as 10 %.
In case of depreciation capital equipment are split into indigenous and imported
components. After deducting taxes and duties depreciation is taken as 6%.
The relationship between ERP & DRC is -:
DRC = (ERP+1) Exchange rate

50