Friday, August 25, 2006

The High Cost of Optimism

The Standish Group, which analyzes IT projects, reported that in 2004 only 29% of IT projects succeeded, down from 34% in 2002. Cost over-runs from original budgets averaged 56%, and projects on average took 84% more time than originally anticipated.

Put another way, 71% of projects did not succeed, 44% came in on budget, and only 16% came in on time. Wow!

Another study examined 210 rail and road projects and found that traffic estimates used to justify the projects (i.e. passenger or car traffic) were overly aggressive by an average of 106%.

Today's papers are rife with horror stories of projects failing - from the FBI's abandoned $170m internal IT project, to EDS' failing Navy contract, to incredible cost overruns and delays in the Pentagon's weapons development programs.

What does all this mean for venture capital and for executive teams?

Venture capitalists fund companies to value creating milestones. The theory is that if objective value milestones are met, the company and insiders will be able to raise a new round of funding at a stepped-up valuation. All too often, however, the cost, time, and effort associated with such milestones is underestimated. Instead of hitting plan, the company runs out of money a quarter or two prior to realizing its objectives. The insiders and management are then faced with the dreaded prospect of a down round or a bridge financing to tide the company through to meeting its original plan.

Why do such smart people, across so many industries, fail to adequately account for two crucial variables in planning - cost and time?

Max Bazerman, an HBS professor and former professor of mine at Kellogg, blames "self-serving bias," overly optimistic projects that help win the business and advance careers and agendas.

Think about the LBO business. Most deals are auctions, and the winning bid is often simply the highest bid. In some sense, the only way to win is to forecast the rosiest outlook and forecasts.

Along those lines, I once sat through a McKinsey pitch on private equity firm performance in which McKinsey found that the winning bidder/firm overestimated the target company's first year EBITDA 66% of the time. By overestimating profit performance, the winner bidder justified a very aggressive bid.

This is not good for investors, nor for companies who set overly aggressive goal, fail to realize them, and then have to retrench, rationalize, and regroup.

Project management gurus think of five key stages of project management: initiation, planning, execution, control, and closure.

If we think of start-ups as projects (a popular VC description of young companies) and if start-ups suffer the statistics of the IT industry at large, then 71% will go under, 84% will take longer than anyone thought, and 56% will run out of money before they get to value creating events.

Another cliche in venture is that execution separates great start-ups from losers. These numbers illustrate why that is the case. If you are great at the initiation phase - idea articulation and business plan creation - and suffer the ability to execute and control the project...then not good.

These numbers suggest that VC firms that help their portfolio companies optimize execution - operating plan development, sales forecasting and management, engineering project planning, marketing plans, etc - will add tremendous value.

Helping young companies develop the best practices associated not just with coming up with great ideas or products, but also on executing on a budgeted plan that ensures the company comes in on time and on budget with the deliverables in hand will be of immense value.

Start-ups should look for VCs who add value in this very concrete manner. Ask VCs how they provide the tools, systems, and practices that contribute to project success and avoid the long history of project disasters.


  1. First of all, I think your concerns are very valid and your advice prudent, but I would beware of the Standish group numbers if you are planning to use them in any kind of predictive economic analysis. Industry leading figures are beginning to question Standish since their results are not consistent with other research.

    as quoted by erp4it

    "...the Standish Chaos Report could be considered fundamental to most claims of crisis. What do we really know of that study?

    "The question is of increasing concern to the field. Several researchers, interested in pursuing the origins of this key data, have contacted Standish and asked for a description of their research process, a summary of their latest findings, and in general a scholarly discussion of the validity of those findings. They raise those issues because most research studies conducted by academic and industry researchers arrive at data largely inconsistent with the Standish findings.

    "Let me say that again. Objective research study findings do not, in general, support the Standish conclusions. "

    Robert L. Glass, "The Standish Report: Does It Really Describe a Software Crisis?," Communications of the ACM 49:8 (August 2006).

  2. Of course, asking a prospective investor about tools, systems, and practices is sage advice for any entrepreneur to follow. However, project failure often occurs despite the presence of so-called best practices.

    Unfortunately, hubris, denial, and poor judgement often trumps good practice -- this is so in both investing and projects. My blog describes many failed projects run by smart, experienced people, in both the public and private sectors.

    Obviously, there is no simple solution, but we can define certain anti-project-failure personality characteristics. Chief among these is the ability for a person to remain impartial and objective, especially when their own self-interest is at stake. Denial is an element common to almost every project meltdown. Show me a team that does not easily sink into denial, and I will show you success.

    Michael Krigsman

  3. Erp4it (who also writes a great blog) is certainly right in questioning the validity of the Standish Group study.

    However, many other studies have also suggested a high rate of software and implementation project failures. It sure doesn't take a rocket scientist to quickly find examples of troubled projects and screwed-up investments.

    At the end of the day, I trust my own eyes and ears before placing confidence in so-called experts and their studies.

    Michael Krigsman