Project Planning - Project Identification

PROJECT IDENTIFICATION

    Project identification is the first step of a new venture.  A right direction may enable an entrepreneur to scale new heights.  Otherwise, he has to undergo a number of hurdles in his way.  It is therefore, very crucial to entrepreneur to identify projects.
    Theoretically, an entrepreneur has an infinitively wide choice with respect to his project.  The important dimensions of choice are: product/service, market, technology, equipment, scale of production, location, incentives and time phasing.  The task of identifying a feasible and promising project is somewhat difficult.  Moreover it is interrelated with the government policies, infrastructural development and skills of people.

MEANING AND DEFINITION OF PROJECT

    A project or a capital investment involves allocation and consumption of resources in the expected stream of benefits extending far in the future.
The following are the some of the definitions of project.
“An investment project is carried out according to a plan in order to achieve a definite objective within a certain time and which will cease when the objective is achieved” – Dictionary of Management.
“Project is an approval for a capital investment to develop facilities to provide goods and services” – World Bank.
“Any scheme or a part of scheme for investing resources which can be reasonably analysed and evaluated as an independent unit.  It may be any item of investment activity which can separately evaluated” – Little and Mirless
                Thus, a project may be defined as a scientifically evolved work plan devised to achieve a specific objective with a specified period of time.  The three basic attributes are: a course of action, specific objectives and definite time perspective.

CLASSIFICATION OF PROJECTS
    Projects have been classified in various ways by different authorities.  A classification of project helps to highlight its essential characteristics and feasibility evaluation.
1.  Quantifiable project and Non-quantifiable project
    Quantifiable projects are those in which a quantifiable assessment of benefit can be made.  Non-quantifiable projects are those where such an assessment is not possible.  Projects concerned with industrial development, power generation, mineral development fall in the first category while projects involving health, education and defense fall in the second category.

2.  Sectoral Projects
    The planning commission India accepted sectoral base as the criterion for classification of projects.  A project may, under this classification fall in to any one of the following sectors
a)Agriculture and allied sector
b)Irrigation and power sector
c)Industry and mining sector
d)Transport and communication sector
e)Social service sector
f)Miscellaneous
This system of classification has been found useful in resource allocation at macro level

3.  Techno-economic Projects
Projects are sometimes classified on the basis of their techno economic characteristics.  Three main group of classification can be identified here:
a)Factor intensity-oriented classification:  On the basis of this classification, projects may be classified as capital intensive or labour intensive depending upon whether large scale investment in plant and machinery of human resource is involved.
b)Causation – oriented classification: Here projects are classified as demand based or raw materials based projects-depending on the no availability of certain goods or services and consequent demand for such goods and services or the availability of certain raw material, skills or other inputs as the dominant reason for starting the project.
c)Magnitude oriented classification:  In this the size of investment forms the basis of classification.  Projects may thus be classified as large scale. Medium-scale or small scale projects depending upon the total project investment.

4.  Financial Institutions classification
           All India and state financial institutions classify the projects according to the purpose for which the project is being taken up.  They are:
a)New projects
b)Expansion projects
c)Modernization projects
d)Diversification projects
5.  Service projects
           The service oriented projects are classified as under:
a)Welfare projects
b)Service projects
c)R & D projects
d)Educational projects.

IMPORTANCE AND DIFFICULTIES OF CAPITAL INVESTMENT
Importance
    Capital expenditure decisions often represent the most important decisions taken by a firm.  Their importance comes 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 expenditure in the past.  Likewise, current capital expenditure decisions provide the framework for future activities.

Irreversibility- the market for used capital equipment in general is ill-organised.  Further, some type of custom-made equipments, the market may virtually non-existent.  Thus, a wrong capital investment decision often cannot be reversed without incurring a substantial loss.

Substantial outlays- Capital expenditures usually involve substantial outlays.  Capital costs tend to increase with advanced technology.


Difficulties
    While capital expenditure decisions are extremely important, they also pose difficulties which come from three principal sources.
Measurement problems: Identifying and measuring the costs and benefits of a capital expenditure proposal tends to be difficult.  This is more so when a capital expenditure has a bearing on some other activities of the firm or has some intangible consequences.
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 characterizing the costs and benefits of a capital expenditure decision.
Temporal spread:  The costs and benefits associated with a capital expenditure decision are 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.


PROJECT LIFE CYCLE
    A project has to pass through different phases, from beginning to its completion.  Following are the different phases in the life cycle of a project.

1. Conception: In this phase project idea is conceived.  The project ideas come from different sources.  These ideas should be shaped to suit for consideration and comparison.  The ideas have to be examined in the light of objectives and constraints.  The acceptable idea will form the basis of a future project.  Conception is an important phase in the life cycle of a project.

2. Development phase:  In this phase, the idea generated during the conception phase is developed.  This stage comprises of the production of document describing the project in sufficient details covering all the aspects necessary to catch the mind of the customers and/or financial institutions.

3. Planning: Once project proposal is identified, a preliminary analysis should be done.  It helps to know whether the project justify a feasibility study. Planning provides the frame work which shapes, guides and confines the identification of individual project opportunities.

4. Analysis: A detailed analysis of the idea is to be done in this phase.  Marketing, technical, financial, economic and ecological aspects should be analyzed in detail.  The information developed in this analysis will form the basis of designing the cost and benefits associated with the project.

5. Selection: In this phase the worthiness of the project is examined using one or more of the appraisal criteria.  These criteria includes pay back period, accounting rate of return, net present value,  internal rate of return and cost-benefit ratio.  Suitable cutoff values have to be specified to apply the various appraisal criteria.

6. Financing: Once the project is selected the next phase involves making suitable financial arrangements.  Equity and debt are the two major source of finance for a project.  To decide a suitable financial mix, factors like flexibility, risk, income, control and taxes should be considered.

7. Implementation: This is the phase of setting up manufacturing activities.  This includes drawing engineering designs, negotiations and contracting, construction, training and commissioning of plant.  Various techniques of project management like CPM, PERT etc can be applied in this phase.

8. Review: Performance review has to be done periodically to compare the actual performance with projected performance.  The review is useful in the following ways:
(i) It helps to judge how realistic the assumptions underlying the project are.
(ii) It provides the basis of future decision making.
(iii) It helps in taking corrective action.

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 primarily concerned with assessment of aggregate demand of proposed product and market share of the proposed project. For this a wide variety of information such as consumption trends, supply position, imports and exports, structure of competition, cost structure, demand elasticity, consumer behavior, distribution channels etc should be required.

Technical analysis: Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonable good choices have been made with respect to location, size, process, etc.

Financial analysis: Financial analysis seeks to ascertain whether the proposed project will be financially viable in the sense that whether it is able service the debt and meet the return expectations of providers of capital.  Cost of project, means of finance, cost of capital, profitability, level of risk, break-even point, etc are the important aspect in this analysis.

Economic analysis: Economic analysis, also known 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.  Here the direct economic benefits and costs of the project measured in terms of shadow prices not in terms of market prices.  It also analyse the impact of proposed project in income distribution, level of savings and investment in the society.

Ecological analysis:  This analysis concerned with environmental impact of the proposed project.  This analysis is very crucial in the case of environment-polluting industries.  The key areas in this analysis are likely environmental damage caused by the project and proposed restoration measures in the project.

GENERATION AND SCREENING OF PROJECT IDEAS
    The search of project ideas is the first step towards establishing a successful venture.  The key to success lies in getting into the right business at the right time. Identification of good business opportunities requires imagination, sensitivity to environmental changes, and realistic assessment of what the firm can do.
    Project identification is concerned with the collection, compilation, and analysis of economic data for eventual purpose of locating possible opportunities for investment and with the development of the characteristics of such opportunities.
    The objective of project identification is to find out investment opportunities which are feasible and promising and which merit further examination and appraisal.
    The following are the different aspects to be considered for the generation and screening of project ideas.

Generation of Ideas
    An entrepreneur or a firm needs to generate a few ideas about the project they can undertake in order to select a most promising one.  The project ideas can be discovered from various sources.  They include:
a)Knowledge about unmet customer needs.
b)A study of existing industries in terms of their profitability and capacity utilization.
c)Examination of inputs and outputs of various industries.
d)Review of imports and exports.
e)Study of plan outlays and Governmental guidelines.
f)Suggestions of financial institutions and developmental agencies.
g)Investigation of local materials and resources.
h)Analysis of economic and social trends.
i)Study of technological developments.
j)Exploring possibility of reviving sick units.
k)Attending trade fairs.
l)Stimulating creativity for generating new project ideas.
Stimulating the flow of ideas
    To stimulate the flow of ideas, the following are helpful:
SWOT Analysis: SWOT analysis represents a conscious, deliberate, and systematic effort by an organization to identify opportunities that can be profitably exploited by it.  Periodic SWOT analysis facilitates the generation of idea.
Clear articulation of objectives: The operations objectives of the firm may be one or more of the following:
Cost reduction
Productivity improvement
Increase in capacity utilization
Improvement in contribution margin
Expansion into promising fields.
A clear articulation and prioritization of objectives helps in channelising the efforts of employees and probes them to think imaginatively.
Fostering a conducive climate: To tap the creativity of people and to harness their entrepreneurial urges, a conducive organizational climate has to be fostered.  Many organizations successfully used suggestion schemes to motivate employees to think more creatively.

Monitoring Environment
    Basically a promising investment idea enables a firm to exploit opportunities in the environment by drawing on its competitive strengths.  Hence, the firm must systematically monitor the environment and assess its competitive abilities.  The important aspects to be studied in monitoring the key sectors of the environment are as follows:
Economic Sector
State of the economy
Overall rate of growth
Growth rate of primary, secondary and tertiary sectors.
Cyclical fluctuations
Linkage with the world economy
Trade surplus/deficits
Balance of payment situation
Governmental Sector
Industrial policy
Government programmes and policies
Tax framework
Subsidies, incentives, and concessions.
Import and export policies.
Financing norms
Lending conditions of FIs and Banks
Technological Sector
Emergence of new technologies
Access to technical know-how
Receptiveness on the part of industry
Socio-demographic Sector
Population trends
Age shifts in population
Income distribution
Educational profile
Employment of women
Attitude toward consumption and investment
Competition sector
Number of firms in the industry and market share of top few.
Degree of homogeneity and differentiation among products
Entry barriers
Comparison with substitutes in terms of quality, price, appeal and functional performance.
Marketing policies and practices
Supplier Sector
Availability and cost of raw materials and sub-assemblies
Availability and cost of energy

Corporate Appraisal
    A realistic appraisal of corporate strengths and weaknesses is essential for identifying investment opportunities which can be profitably exploited.  The broad areas of corporate appraisal and the important aspects to be considered under them are as follows:
Marketing and Distribution
Market image
Product line
Market share
Distribution network
Customer loyalty
Marketing and distributions costs
Production and Operations
Condition and capacity of plant and machinery
Availability of raw material, sub-assemblies, and power
Degree of vertical integration
Locational advantage
Cost structure
Research and Development
Research capabilities of the firm
Track record of new products developments
Laboratories and testing facilities
Coordination between research and operations
Corporate Resources and Personnel
Corporate image
Relation  with governmental and regulatory agencies
Dynamism of top management
Competence and commitment of employees
State of industrial relations
Finance and Accounting
Financial leverage and borrowing capacity
Cost of capital
Tax situation
Relations with shareholders and creditors
Accounting and control system
Cash flows and liquidity.


TOOLS FOR IDENTIFYING INVESTMENT OPPORTUNITIES  
    There are several useful tools or frameworks that are helpful in identifying promising investment opportunities. The most popular one is Porter model, which is discussed below.
Porter Model: Profit Potential for Industries
    Michael Porter has argued that the profit potential of an industry depends on the combined strength of the following five basic competitive forces:

a)Threat of new entrants
b)Rivalry among existing firms
c)Pressure from substitute products
d)Bargaining power of buyers
e)Bargaining power of sellers
Threat of new entrants: New entrants add capacity, inflate costs, push prices down, and reduce profitability.  Hence, if an industry faces the threat of new entrants, its profit potential is limited.  The threat from new entrants is low if the entry barriers confer an advantage on existing firms and deter new entrants.

Rivalry between existing firms: Firms in an industry compete on the basis of price, quality, promotion, service, warranties, and so on.  Generally, a firm’s attempts to improve its competitive position provoke retaliatory action from others.  If the rivalry between the firms in an industry is strong, competitive moves and countermoves dampen the average profitability of the industry.

Pressure from substitute products: All firms in industry face competition from industries producing substitute products.  Performing the same function as the original product, substitute products may limit the profit potential of the industry by imposing a ceiling on the prices that can be charged by the firms in the industry.

Bargaining power of Buyers: Buyers are a competitive force.  They can bargain for price cut, ask for superior quality and better service, and induce rivalry among competitors.  If they are powerful, they can depress profitability of the supplier industry.

Bargaining power of suppliers: suppliers, like buyers, can exert a competitive force in an industry, as they can raise prices, lower quality, and curtail the range of free services that they provide.  Powerful suppliers can hurt the profitability of the buyer industry.

PRELIMINARY SCREENING
    By environment scanning and corporate appraisal it is possible to develop a long list of project ideas.  Before going for detailed analysis some kind of preliminary screening is required to eliminate ideas which are not promising. For this purpose, the following aspects may be looked into:
Compatibility with the promoter
Consistency with governmental priorities
Availability of inputs
Adequacy of market
Reasonableness of cost
Acceptability of risk level

Compatibility with the promoter:  The idea must be compatible with the interest, personality, and resources of the entrepreneur.  A real opportunity has three characteristics (i) it fits the personality of the entrepreneur, (ii) it is accessible to him and (iii) it offers good prospect on the invested capital.

Consistency with governmental priorities: The project idea must be feasible given the national goals and governmental regulatory framework.  There should not be any difficulty in obtaining the license for the project.

Availability of inputs: the resources and inputs required for the project must be reasonably assured.  Capital requirements of the project should be in manageable limit.  It is ensured that there is no difficulty in obtaining technical know-how.  Adequate supply of raw materials and other inputs should also be ensured.

Adequacy of the market: The size of the present market must offer the prospect of adequate sales volume.  Further, there should be a potential for growth and a reasonable return on investment.  To judge the adequacy of the market the factors like market size, competitors and their market share, export market, distribution system, patent protection etc should be considered.

Reasonableness of cost: The cost structure of the proposed project must enable it to realize an acceptable profit with a price.  In this regard the factors such as cost of material inputs, labour costs, factory overheads, administration overheads, selling and distribution costs, service costs, economies of scale etc should be considered.

Acceptability of risk level: The desirability of a project is critically dependent on the risk characterizing it.  In the assessment of risk of a project the factors such as business cycles, technological changes, competition from substitutes and imports and governmental control over price and distribution should be analysed.