Integrated Risk-Based and Economic-Based (IRBEB) Methodology for Selection of Project Alternatives

Integrated Risk-Based and Economic-Based (IRBEB) Methodology for Selection of Project Alternatives

Yuri Raydugin (Risk Services & Solutions Inc., Canada)
DOI: 10.4018/978-1-5225-1790-0.ch021
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Abstract

Selection of a most optimal project alternative in early phases of project development is paramount for overall project success. A standard practice is to make the selection based on economic considerations that overlook risk exposure of a selected alternative. Standalone risk evaluation of alternatives cannot ensure that a most optimal alternative is selected either as economic considerations may be overlooked. Moreover, both economic-based and risk-based alternative's selection methodologies cannot guaranty that all viable alternatives have been considered. This chapter introduces integrated risk-based and economic-based (IRBEB) alternative's selection methodology that includes an algorithm to generate a comprehensive set of all viable project alternatives to choose from.
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Introduction

Every project that an organization undertakes is supposed to contribute to organization’s strategic goals. An alignment between business strategy and a project business case is normally established in early phases of project development. A project in its earliest phase cannot have well defined scope and other baselines. There is just a business need or concept that resembles a vague cloud of project uncertainty floating in organization’s internal and external environment. Project uncertainty may have several characteristics related to:

  • Various types and quantities of produced products,

  • Served market niches,

  • Possible project locations,

  • Suitable technologies,

  • Phasing scenarios,

  • Commercial arrangements, etc.

In other words, combination of all viable realizations of relevant uncertainty characteristics (options) should give rise to all possible project alternatives that may be considered as a potential path forward to reach strategic goals.

A traditional method of business alternative’s selection is based on technical and economic evaluations. Technically viable alternatives are assessed using agreed project economic models. This is a deterministic approach towards economic modeling as every parameter in the models is represented as an exact one-point number. Direct comparison of an agreed profitability indicator (IRR, ROI, ROC, etc.) developed for each alternative is used. Quite often such comparison is done for alternatives’ net present values of future cash flows (NPV CF). An alternative of best profitability indicator would be selected to become a basis of project scope. One additional evaluation step is usually devoted to economic sensitivity analysis. All main parameters of the model are represented as reasonable ranges (in place of one-point values) to see economic model outcomes for minimum and maximum parameter’s values. This sensitivity analysis based on parameter’s uncertainty is undertaken when parameters get varied one by one. Sensitivity analysis like this is the only representation of project uncertainties and risks in economic evaluation. Corresponding project risks attached to a selected alternative would be identified, assessed and addressed in consecutive project phases. As a result, despite a selected project alternative could be well developed and justified from the angle of economics it might bring forward multiple business and execution risks.

Another methodology of business alternative’s selection relies on identification of risks for each technically viable alternative. Standard project risk management methodology is used to consider all possible risks that could be associated with development and execution of a specific alternative. All project alternatives that are perceived risky are screened out.

Following issues pertaining to these two methods should be pointed out and resolved.

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