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Value erosion occurs when what was actually delivered by a project is lower than what was promised when the project was funded. Cost and schedule overruns are usually thought of as the main culprit of value erosion, and they do indeed make a significant contribution to lower NPV, but the largest source of value erosion for these industrial projects has nothing to do with how the project was managed. The breakdown of value erosion falls into three categories in order of importance: (1) demand for the product was lower than expected, (2) the cost and/or schedule were overrun, or (3) the facility did not operate as expected. Any single project may have done well in one or two areas but fell short in others. These are just the averages for each category (see Table 1.1).

Table 1.1 Average Value Loss by Category

Some of the reasons people gave for the lack of demand include:

● “Lost our biggest customer.”

● “Orders were lower than expected.”

● “Prices were not high enough to keep the plant running.”

Changes in economic conditions, competitor actions, and shifting customer preferences are outside executives' control, and they make demand and price forecasts inherently uncertain, especially in the short term. Yet overconfidence in the market forecast by executives is a common source of value erosion, especially for projects that destroyed all the capital invested. The project sponsors are so certain about the revenue forecast that they are willing take on the risk of a significant cost overrun to accelerate the schedule to meet a market window when demand or prices are expected to rise rapidly. The value erosion caused by the cost and schedule overruns is doubly painful when demand is lower than expected.

What executives do control is the quality of the work behind the market forecast used to justify the project. In Chapter 3, I will show you that projects based on rigorous market analyses are 30 percent less likely to face a lack of demand. In other words, the chances of building unneeded capacity are much lower if executives establish requirements for developing a reliable market forecast and check that the requirements are met.

The average project erodes 5 percent of value because the production facility built by the project cannot produce what the business needs. For example, a software application may not meet all the service-level requirements established by a business. Responsibility for asset performance shortfalls is usually shared among all the groups involved in the project. Sometimes the asset could not make the product because it was never designed for that capability. The project sponsor may not have communicated the requirements clearly to the project team. It is also true that project teams sometimes do not hear what the sponsor is saying. Other times, the shortfall is due to innovative technology not working as well as expected. The technology executive may have downplayed the technical risk of the innovation. Finally, the shortfalls may occur because of mistakes made in the design or construction of the facility, often the result of a project trying to cut corners or go faster to meet the cost and schedule targets set by executives.

The results of the study show that responsibility for value erosion is shared across the organization. They also mean that fixing the problem involves executives across the organization working to improve their own areas as well as how their group interacts with others to create a common understanding as a project is developed and executed.