Your best project could destroy value

The highest ROI from a single project is not automatically the best allocation of capital.

BOARDROOM QUESTIONS
The questions your portfolio should be able to answer.

25 per cent ROI.

The best project in the entire investment portfolio.

The business case is convincing.

The presentation is ready.

Finance has done the maths.

The business unit recommends the investment.

In the Investment Committee, the decision seems obvious:

We have to go ahead with this project.

But this is precisely where one of the most dangerous oversimplifications in capital allocation begins.

Because the relevant question is not:

“Which project has the highest ROI?”

But

rather:

“Which combination of our projects generates the highest defined total value with the available capital?”

And suddenly, the supposedly best project can become a problem.

The best project is not automatically part of the best portfolio

Let’s take a simple example.

Project A requires 50 million euros in CAPEX and achieves an expected ROI of 25 per cent.

It is the project with the highest single-project ROI.

There are also several smaller projects.

Project B: 20 million euros in CAPEX.

Project C: 15 million euros in CAPEX.

Project D: 15 million euros in CAPEX.

Taken individually, each of these projects has a lower ROI than Project A.

A traditional prioritisation approach might therefore lead to a clear conclusion:

Project A comes out on top.

But what happens if B, C and D, taken together, generate a higher absolute value contribution with the same 50 million euros?

In that case, Project A is indeed the best individual project.

But it may not be the best use of the 50 million euros.

ROI evaluates a project. The board allocates capital.

That is the crucial difference.

ROI is a ratio.

It helps to assess the expected return on capital employed.

But the board does not have unlimited capital.

It must decide which combination of the many possible investments will actually be funded.

This shifts the level at which the decision is made.

From the project to capital allocation.

A single project may look excellent.

Nevertheless, the decision to proceed with this project may prevent a more economically attractive combination of other projects from being realised.

The problem is known as opportunity cost

If Project A requires 50 million euros, Project A does not just cost 50 million euros.

It may also cost the opportunity to implement Projects B, C and D.

This alternative is not usually included in the business case for Project A.

And yet it is crucial to the capital allocation decision.

The actual costs of an investment also include the best alternative, which cannot therefore be implemented.

This is precisely why the question:

‘Is this project profitable?’

is

not sufficient.

The second question must be:

‘What

else could we achieve with this capital?’

A simple example

Let’s assume a company still has 50 million euros of available CAPEX.

There are two possibilities.

Option 1: The top project

Project A requires the entire 50 million euros.

It has the highest ROI of all available projects.

All the remaining capital is channelled into this single project.

Option 2: The project combination

Instead, projects B, C and D are implemented together.

None of these projects achieves the ROI of project A.

But together, they can generate a higher absolute expected value contribution.

In addition, they may be able to fulfil different strategic objectives, spread risks or utilise existing resources more efficiently.

Project A wins the project comparison.

B + C + D may still win the portfolio comparison.

The problem becomes more complex as soon as resources are

added

Capital is often not the only constraint.

Project A may require:

engineering

capacity.

IT

resources.

production

downtime.

specialists.

Management Attention.

Space.

Machinery capacity.

Or other scarce resources.

Consequently, a project can do more than just tie up capital.

It can simultaneously prevent other projects from being implemented.

A high ROI says nothing about which opportunities are being squeezed out by scarce resources.

And then there are the dependencies

Perhaps Project B absolutely requires Project C.

Perhaps Project D may only be implemented if a specific infrastructure investment is also made.

Perhaps Project A and Project E are mutually exclusive due to the same production resource.

Perhaps Project F is a regulatory requirement.

Perhaps Project G cannot begin until the second year.

This means that a simple ranking is no longer sufficient.

Because the question is no longer:

‘Which project is better?’

But

rather:

‘Which permissible combination is better under all conditions?’

Ranking and optimisation are two different things

A ranking orders projects.

For example:

1

. Project A – 25% ROI

2. Project B – 22% ROI

3. Project C – 19% ROI

4

. Project D – 17% ROI

Funding is then often allocated from top to bottom until the budget is exhausted.

That seems logical.

But mathematically

,

it answers a different question.

It answers:

‘What is the order of our projects?’

Portfolio optimisation, on the other hand, asks

:

‘Which combination of these projects produces the best result given our constraints?’

That is a fundamental difference.

The top-ranked

project can worsen the overall result

That is precisely why a project with excellent individual metrics can lead to a poorer overall solution.

Not because the project itself is bad.

But because selecting it prevents other combinations.

The project does not necessarily destroy operational value.

However

,

it can destroy opportunity value compared to a better available portfolio alternative.

This distinction is important.

Because a profitable project can remain profitable.

Capital allocation may nevertheless be sub-optimal.

The board should therefore consider two levels

Level 1: Project Economics

How attractive is the project when viewed in isolation?

ROI.

NPV.

Cash

flow.

Payback.

Risk.

Level 2: Portfolio Economics

What role does the project play within the overall portfolio?

How much capital does it tie up?

What resources does it require?

Which projects does it displace?

What dependencies arise?

How does it contribute to the strategic objectives?

And how does the total value of the portfolio change with and without this project?

Only when both levels are considered together can a capital allocation decision be made.

What happens if we remove our best project?

That’s an excellent boardroom question.

The current portfolio is shown here.

Project A has the highest ROI.

The CEO asks:

“Calculate the portfolio without Project A.”

What happens?

Which projects move up the list?

How is the freed-up capital deployed?

How does the total expected portfolio value change?

How do resources change?

Which strategic objectives are being met to a greater or lesser extent?

What new combinations become possible?

The result may confirm that Project A is indeed indispensable.

Or it may reveal something surprising:

The portfolio without the supposedly best project is better.

And then comes the most important counter-question

The CFO asks:

“By how much would the assumptions for Project A need to improve for it to become part of the optimal portfolio again?”

Now the analysis gets even more interesting.

Perhaps the capital requirement needs to be reduced.

Perhaps the expected value contribution needs to increase.

Perhaps a resource constraint needs to be resolved.

Perhaps a dependent project needs to be modified.

This means that portfolio optimisation is not merely a selection mechanism.

It can highlight which conditions would need to be changed to make an investment more attractive for the overall portfolio.

This changes investment discussions

A business unit then no longer needs merely to prove:

“Our project has a good ROI.”

The more challenging question is:

“Why is our project a better use of scarce corporate resources than the available alternatives?”

This takes the discussion to a different level.

It shifts the perspective from a business unit’s local optimum to the organisation as a whole.

Local optimum vs. portfolio optimum

For the head of a business unit, Project A may be the best decision.

For the production department, Project B may be the top priority.

For IT, Project C may be crucial.

For sustainability, Project D may seem indispensable.

Each department can act rationally within its own logic.

And yet the overall result may still be sub-optimal.

Local optimisation does not automatically result in a globally optimised portfolio.

This is

precisely why capital allocation is a management task that transcends individual silos.

CAPEX Live Boardroom Simulation

Let’s imagine there are 200 investment projects on the table.

The portfolio has been calculated.

The CEO clicks on the project with the highest ROI.

“What happens without this project?”

New calculation.

The CFO changes the budget.

New calculation.

The COO changes a resource constraint.

New calculation.

Strategy increases the weighting of a strategic criterion.

New calculation.

Management can compare different assumptions and scenarios.

Question. Calculate. Compare. Decide.

It is not the project that decides.

It is not the algorithm that decides.

The board makes decisions based on a calculated decision space.

StratePlan: From the best project to the best portfolio

StratePlan treats investment projects as part of a shared mathematical decision space.

The model can take into account defined budgets, economic targets, resources, dependencies and other quantifiable conditions.

This makes it possible to investigate which combination of projects, under the specified assumptions and constraints, produces the model’s optimal outcome.

A project with a high ROI may form part of this solution.

However, it does not necessarily have to be the case.

And it is precisely this information that may be more valuable to the board than the next project ranking.

Your Best Project May Be Destroying Value.

Perhaps your best project has a 25 per cent ROI.

Perhaps the business case is excellent.

Perhaps no one on the investment committee would reject the project in isolation.

But the crucial question is:

What could your company achieve instead with the same capital and resources?

Because the best project is not automatically the best investment decision.

Profitability evaluates the project.

Capital allocation evaluates the alternative.

Portfolio optimisation evaluates the combination.

Management defines objectives and constraints.

Mathematics calculates the possible combinations.

The board makes the decision.

DON’T TRUST US. CALCULATE IT.