MaterialsGuru

A global surevey of 2500 executives from around the world provides an interesting perspective on how investment decisions are made in companies and how these decisions often go wrong despite the best efforts of a lot of smart people. The good news is that most companies follow a rigorous review process with senior executives, including the CEOs, who pay close attention to all the right criteria such as past performance of the business units and value creation potential of the proposed projects. Still, it is quite shocking to note the following statistics:

• Funding the wrong projects: Overall, those who responded, admitted that nearly 20% of their capital investments over the last 3 years were a mistake which should not have been approved. 23% of those who responded believed that more than 25% of their approved capital had gone to underperforming projects that should now be discontinued
• Not funding the right projects: Corporate level executives, who responded, believed that it was a mistake not to approve 21% of the rejected investments over the last 3 years

It appears that roughly 1 in every 4 or 5 capital investment decision is often incorrect. Clearly, this causes a lower return on investment - and even more importantly - results in lost opportunity on projects that could provide a better return. Surely, no one has the perfect crystal ball that could help them make the right decisions all the time. Still, just consider the following observations that seem to be responsible for this low investment efficiency, and it is hard not to feel that there is a lot of room for improvement:

• 40% of the frontline managers do not know their company’s rate of return on recent investments
• Overly optimistic estimates of timing and sales projections on new projects
• Generally risk averse, most companies tend to view a similar level of risk in projects of varying sizes - clearly, either the risks are not well understood, or the risk assessments are not very rigorous
• Projects are evaluated independent of each other. A portfolio-based approach is often missing, which results in a very poor understanding of the overall corporate risk
• 36% of the respondents say that managers hide, restrict or misrepresent information when submitting projects for funding decisions
• Funding decisions made as a result of intense lobbying and politicking.

Although not explicitly outlined in the study, I think the following observations may also have a significant contribution to these results:

• Frontline managers - and to some extent - even the unit-level managers, are usually reluctant to “kill” their projects even though the risks are high and probability of success is low. No one gets promoted by doing that!
• Charisma of the project champion is often more important in getting funding than the detailed analysis of risks/return on the project
• Only select projects are reviewed with senior executives while a lot of other projects continue to drain resources in the background
• Internal rivalries within various business units often result in several overlapping projects that cause duplication of effort

Certainly, there are companies that deliver a much higher return on investment than the average. It would be interesting to learn more about the factors responsible for their success.