Why Do Investment Decisions Fail? 7 Common Mistakes in Capital Allocation

Companies invest an enormous amount of time in their investment decisions.

Business cases are prepared. Projects are evaluated. ROI and NPV are calculated. Functional departments make recommendations. Finance reviews the numbers. Management and the board discuss priorities.

And yet, one crucial question often remains unanswered:

Have we really selected the best combination of investments?

The problem often isn’t the quality of individual projects.

It lies in the decision-making process.

Many companies evaluate investments individually, even though capital allocation is a portfolio problem.

This can result in good individual decisions failing to produce the best possible overall outcome when combined.

Here are seven common reasons why investment decisions may not be optimal despite good data and experienced decision-makers.

Table of Contents

• 1. Projects are evaluated individually rather than as a portfolio
• 2. Prioritization is confused with optimization
• 3. The budget is allocated rather than optimized
• 4. Investment decisions are made in silos
• 5. The number of possible combinations is underestimated
• 6. Decisions are based on static scenarios
• 7. New questions in the boardroom lead to new rounds of analysis
• How Decision Intelligence Is Transforming the Decision-Making Process

1. Projects are evaluated individually rather than as a portfolio

Most investment projects are initially considered individually.

How much is the investment?

What economic contribution do we expect?

What are the ROI or NPV?

How strategically relevant is the project?

This information is important.

However, it does not yet answer the actual portfolio question.

After all, a company doesn’t just decide whether Project A makes economic sense.

It must decide whether Project A, together with B, C, and D, represents a better use of available capital than, for example, the combination of B, E, F, and G.

A good project is not automatically part of the best portfolio.

2. Prioritization is confused with optimization

Many companies rank their investment projects.

Project A is assigned Priority 1.

Project B is given priority 2.

Project C is assigned priority 3.

Projects are then selected until the investment budget is exhausted.

That seems logical.

Mathematically, however, this is a different problem than portfolio optimization.

A ranking evaluates the projects one after another.

Optimization, on the other hand, considers the combination of projects.

Several projects with lower individual priorities can collectively generate a greater economic contribution than a single high-priority project with correspondingly high capital requirements.

Prioritization answers: What comes first?

Optimization answers: Which combination best meets our goal under the defined conditions?

3. The budget is allocated rather than optimized

Another typical effect arises from the way investment budgets are allocated.

Business units, plants, or departments receive budgets and then prioritize their respective projects.

This can lead to decisions that make sense at the local level.

However, this does not automatically mean that capital allocation at the corporate level is also optimal.

The key question is:

What would the investment portfolio look like if all available capital were considered across all eligible projects?

This shifts the perspective.

Budget allocation becomes capital allocation.

And capital allocation becomes a mathematically calculable decision-making problem.

4. Investment Decisions Are Made in Silos

Companies are organized into divisions, regions, plants, functions, and areas of responsibility.

This is necessary from an operational standpoint.

For investment decisions, however, this structure can lead to projects initially being optimized within individual silos.

Production focuses on production projects.

IT focuses on digitalization projects.

Locations focus on their respective investments.

Finance then consolidates the results.

The strategic question, however, lies one level higher:

Which combination of all available investment opportunities will have the greatest impact on the company as a whole?

A company-wide investment decision therefore requires a common decision-making level that transcends individual silos.

5. The number of possible combinations is underestimated

Investment decisions become very complex very quickly as the number of projects increases.

With N projects, there are theoretically up to:

2^N possible project combinations.

With 20 projects, that’s already more than one million combinations.

With 50 projects, there are more than a quadrillion.

Added to this are budget constraints, resources, dependencies, timeframes, strategic objectives, and other conditions.

People excel at drawing on their experience, defining strategic goals, and assessing framework conditions.

Systematically calculating an exponentially growing decision space, on the other hand, is a mathematical task.

The problem, therefore, is not a lack of management experience. The problem is the sheer size of the decision space.

6. Decisions Are Based on Static Scenarios

An investment decision is always based on assumptions.

Budget.

Costs (expenses).

Expected economic contribution (revenue).

Resources.

Time.

Dependencies.

But these assumptions change.

A CAPEX of 100 million euros becomes 90 million euros.

One project’s costs are rising.

Another is delayed.

An investment becomes strategically essential.

New projects are added.

This also changes the scope for decision-making.

A portfolio decision that made sense yesterday under certain conditions may not remain the same under changed conditions.

That is why a modern investment decision should not merely result in a static plan.

It should allow for the recalculation of changed assumptions.

7. New questions in the boardroom lead to new rounds of analysis

This point becomes particularly evident when an investment decision is discussed by management or the board of directors.

The analysis has been prepared.

The portfolio is presented.

Then a decision-maker asks a new question:

“What happens if we invest 10 percent less?”

Or:

“What additional impact would we get for another 10 million euros?”

Or:

“What changes if this project must be implemented?”

If the impact cannot be calculated immediately, a new round of analysis begins.

Finance or Controlling adjusts the assumptions.

The portfolio is recalculated.

The results are reconciled.

A new presentation is created.

And the decision is either postponed or made based on the available information.

This is exactly where Live Boardroom Simulation can transform the process.

How Decision Intelligence Transforms the Decision-Making Process

Decision Intelligence combines management decision-making with mathematical calculation.

Management defines goals, assumptions, and constraints.

The technology calculates the resulting decision options.

With StratePlan, investment projects can therefore be evaluated not only individually but also as a portfolio.

Investments, economic benefits, budgets, resources, dependencies, and other conditions form a unified mathematical decision space.

If an assumption changes, the portfolio can be recalculated under the new conditions.

This changes the role of technology.

Reporting shows what is.

Simulation shows what will happen.

Optimization calculates which permissible combination best fulfills the defined objective.

The goal here is not to hand over management decisions to an algorithm.

Quite the opposite is true.

Management retains the authority to make decisions.

But it gains the ability to mathematically compare the consequences of different options.

From:

Discuss → analyze → discuss again

becomes:

Question → Calculation → Comparison → Decision.

And for us, that is precisely the next stage in the evolution of investment decisions.

Same projects. Different combinations. Better results.

Decision Intelligence for All.

Don’t take our word for it. Calculate it.