March 3, 2019

Optimism Bias and Strategic Misrepresentation

.... an issue of Corporate Governance and the negative impact on realisation of benefits...

Detailed investigations into project delivery confirm that without appropriate levels of scope definition and relevant information at Business Case preparation and investment appraisal stages, the undertaking will likely carry inherent, often substantial, technical and commercial risk.  Furthermore, investigation into failing large scale strategic projects identified a common thread, with the presence of two clear strategic approaches and internal political influences, notably:-

  • Strategic Misrepresentation
  • Optimism Bias

Previously, in a buoyant Oil and Gas industry, where high oil price almost guaranteed investment returns, lack of scope definition, poor risk identification and lack of risk mitigation planning combined with strategic influences and physiological desires.

In the recent market, [$30 down from $140 bbl] – the pain of inaccuracies, misplaced assumptions, poor scope definition and blind optimism in the Business Case is severe. Poor definition or understanding of real scope alongside investment decisions influenced by strategic misrepresentation and optimism bias, results in major scope growth and cost increase during fabrication and construction. Such quantum in cost and schedule increases brings negative impact to corporate value, intended benefits, share price, Partner and Investor relations and forecast profitability. Typically, where project sanction to execution can be measured in years, projects in the execute phase, with a market price at $30 USD per barrel were likely conceived and approved with a price at circa +$100 USD per barrel. In simple terms a 70% reduction of income streams, set against substantial capital cost increases brings into question the validity and credibility of the proposals within the Business Case.

Research has identified a fundamental need at Executive and Board level, to ensure robust, detailed and verified data is used in any major strategic investment decision. This approach is supported by the APM and the recognised obligations of the Executive at a Corporate and Project Governance level.

Information is of high value, and the quality and quantity of information available at the earliest stages of an endeavour, particularly for large scale strategic investments, has a defining influence over the core principals and assumptions embedded within the Business Case. An evolving scope is open to growth, cost increase and schedule delay. Whilst such a situation is by no means unique, specific examples in both the Oil and Gas industry and in the wider infra-structure project  environment shows that a lack of due diligence and governance in the creation of the endeavour can set the scene for potential failure.

There is often an implied acceptance of the issues of poor performance raised by large scale high capital value projects as many Clients / Operators commission specific bench-marking comparisons for their projects. A recent commission with the Independent Project Analysis group - IPA 3rd June 2015, led to an investigation into fabrication costs:-

"A major petroleum exploration and production company sought market intelligence on the fabrication costs for large offshore processing facilities. …….  We looked at fabrication yard cost trends in terms of cost and capability for six different regions. This study not only helped our client to gauge whether they were getting competitive bids from fabrication yards but also improved the company’s understanding of IPA benchmarks." [3rd June 2015]

However, whilst such investigation is of undoubted value, the decisions that frame the costs at the fabrication or construction yard are set at the earliest investment sanction stages. Variations in fabrication yard costs do not drive final cost increases that can be directly linked back to poor scope definition in the Business Case. Strategic Misrepresentation and Optimism Bias are far more influential in the preparation of scope definition, estimates and schedules as submitted for approval. Whilst strategic benefits may ultimately be realised, the premise of the Business Case at investment approval is often fundamentally flawed.

Extensive statistical work was conducted by Flyvberg, et al (Flyvberg, 2002) on the issues of cost growth in large scale public works transportation infra-structure projects. The work made allowance for four types of underestimation in cost estimates, these being, Technical, Economic, Psychological and Political. The work supports a position that poor cost estimation cannot be explained by error but is best explained by "Strategic Misrepresentation". This further suggests that cost estimates for strategic projects prepared by project promoters and their analysts should not be trusted.

Where external stakeholders, shareholders, investors and partners have commercial interests, based on funding decisions grounded in flawed information provided by those promoting the venture, this conclusion raises many questions.  This work by Flyvberg et al is stated as being the largest of its kind and their analysis supports the premise that "Strategic Misrepresentation" and "Appraisal Optimism" both play a key role, as a common thread, when preparing large scale, strategic projects.

The work provides a basis for a number of conclusions:-

  1. If cost estimating was prone to error, as a random or arbitrary event, the spread of over-estimate and under-estimates should follow a relatively equal spread, i.e. there should be as many under-estimates as over-estimates, thereby delivering as many projects under-budget as over-budget.
  2. If the preparation of estimates factored in lessons learned, then the accuracy of the initial estimates should improve over time.
  3. For the period analysed, given the fairly recent capability to analysis and process huge data sets following the growth in computer based programmes and processing capability, probabilistic estimates should converge to final out-turn estimates, thus improving the accuracy of the Business Case proposal.

This work identified a fundamental flaw in how major projects are presented and approved. Historic data is available that covers cost increase and schedule delay. The period of the statistical data below pre-dates the IT revolution, computer capability and highly developed cost estimating and planning software programmes. Trending this data clearly shows little or no improvement in the ability of large scale strategic projects to more accurately estimate and predict the final cost and schedule outcomes.  Whilst scope increase and variations are core elements of project delivery, the gap between initial cost estimate prediction – as submitted for investment decision – and final out-turn costs are not improving.

Despite massive computing power, Monte Carlo analysis, sensitivity analysis and industry databases of lessons learned it appears that industry is either not learning lessons or is incapable of using computing power and software programmes to improve estimating and planning forecasts. A more realistic conclusion is that there are other influences at work when preparing the Business Case.

There are also questions around moral obligations and corporate due diligence associated with the political approach of Strategic Misrepresentation and Appraisal Optimism. Robust Corporate and PPM Governance is required. The presence of Strategic Misrepresentation and Appraisal Optimism not only influence the Business, the outcome also has potentially significant impacts on Investors, Partners, Shareholders and Stakeholders. If such approaches were established to be intentionally misleading, the corporate function may be open to questionable ethics, lacking due diligence, failing competency, poor governance and potential negligence.

The overarching recommendation has to be set around appropriate funding, resource allocation and early research and concept development to define a strong, robust, valid Business Case. Stage Gate review and assurance processes are well developed. Those involved in strategic planning need to be capable of delivering bad news and highlight identified technical or project execution issues. Seeking personal praise for achieving sanction and turning a blind eye to obvious concerns may help achieve investment approval, yet moving these issues into the next –and critically - more expensive project stages, is at odds with the corporate responsibility, individual accountability and integrity.

If issues are highlighted in the creation and definition of large scale strategic projects then Don’t kill the Messenger. These issues and concerns are raised to protect the business, ensure that Business Case and investment appraisal is robust and investments deliver intended values and benefits.

Finally, whilst accurate information at the onset of an endeavour in the decision processes for New Business Developments is fundamental, work by Berends etc al, (Hans Berends, 2007) Knowledge Management Challenges - offers that Radical Uncertainty is present "when Organizations aiming at New Business Development lack knowledge about what they need to know".

Whilst good project management can contribute to project success, it cannot prevent project failure and those responsible for delivering the project cannot rectify the flaws that are embedded into the very fabric of the endeavour. Piecing these elements together, decision makers that do not know what they need to know, apply strategic misrepresentation and optimism bias, before approving scopes, schedules and budgets. Failure is probably inevitable.

Works Cited

Flyvberg, H. a. B., 2002. Cost Underestimation in Public Works Projects : Error or Lie?. Journal of the American Planning, vol. 68(No. 3), pp. 279-295.

Hans Berends, W. V. a. K., 2007. Management Challenges in New Business Development: Case Study Observations. Journal of Engineering and Technology Management , Vol 24(No7), p. 314–28.

Michael Mallaby

I’m Michael Mallaby and I’ve worked in FTSE 250 companies, set-up a number of businesses, currently work with specialist Mergers and Acquisitions networks and Investor groups and have supported businesses, successfully securing +£millions in either working capital or equity backed support. Formal certification as a Risk Management Professional, an Association of Chartered Certified Accountants – ACCA Business Valuations practitioner and completed the Effective Angel Investor programme. Recognised as a subject matter expert in the field of Project Management, supported by MSc in the subject, with published articles in the global APM Project Journal magazine.

Mick Mallaby

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