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Managing the heightened uncertainty of capital project portfolios calls for the flexible and forward-looking approach of emergence-focused planning.
This article is based on research funded by a grant from the IMA Research Foundation.
Plenty of focus is given to earnings targets in the popular press, but the discussion around capital expenditure (capex) targets is limited at best. This lack of focus is puzzling because the practice of disclosing capex forecasts has become widespread: Annual capex forecasts have been more common than annual earnings forecasts for more than a decade (see Figure 1).
This changing trend coincides with investors' and executives' growing criticism of short-termism prompted by earnings targets (see, for example, Jamie Dimon and Warren Buffett, "Short-Termism Is Harming the Economy," The Wall Street Journal, June 6, 2018, bit.ly/3u7FJNl). But shifting from earnings myopia to a future focus has its own challenges. Capex forecasts represent a company's longer-term strategy for securing future economic benefits, but capital expenditures represent opportunities that are new and uncertain and are therefore riskier ventures than managing short-term earnings efforts. If managers don't appropriately address uncertainty in capital projects, they can derail long-term operating returns.
Learning and applying best practices for forecasting and project execution facilitates sustainable success despite known and unknown risks. Along with outlining best practices, we hope to motivate increased collaboration between project managers, the financial planning and analysis (FP&A) function, and executives and boards to achieve better future performance.
Executives are responsible for the selection and execution of risky yet profitable projects. Yet capital portfolio management is an elusive skill-even talented executives can preside over disastrous projects plagued by cost overruns and completion delays, which ultimately result in poorer returns than originally planned. A notable example involves Barrick Gold Corporation, whose capital project overruns in the early 2010s contributed to the abandonment of its Pascua-Lama project, which management had promoted as eventually becoming a world-class mine. The dysfunction in this megaproject attracted lawsuits from shareholders claiming Barrick Gold Corporation misled them since, as a builder of mines, its executives should have better known and managed the risks of their project portfolio. As challenging as FP&A is for short-term earnings, it can be even more difficult for capital project portfolios.
Capital expenditure planning analytics are difficult because...