Based on project post mortem experiences and project finance participant discussions, in the sections that follow we identify failures factors using the Fishbone diagram shown in Figure 3.2 and discuss root causes of failures by key areas of project finance. These root cause factors, in turn, provide motivation for developing better alternatives, processes,
and approaches that can minimize these failures. The analysis is focused on 12 main categories of problem areas that lead to project failures; namely: strategy and project objectives, screening and preparation, bidding and procurements, skills and
competencies, processes and practices, project economics, technical issues, risk management, project management, contracts and agreements, financing, and organizational and operational factors.
Figure 3.2 Project Finance Failures Root Cause Analysis.
The fishbone diagram is also known as a cause and effect diagram that gets its name from its design, which looks like fish bones. It is a tool to visualize and categorize the potential reasons of a problem and identify its root causes. The purpose of root cause analysis is to identify, examine closely, and help eliminate the factors causing
failures.
The purpose of project failure root cause analysis is identify, break down, and eliminate the root causes that contribute to project finance challenges and failures. The process used is shown at the bottom of Figure 3.2 and it starts with first defining the effect or problem and selecting key categories to examine. Then major causes are identified using the 5 whys technique and further investigation is conducted to provide enough evidence and evaluation to draw conclusions. In the subsections that follow each problem category is examined and the predominant factors identified. The analysis is by no means
exhaustive, but it covers the majority of reasons that contribute to project failures and while individual factors may not be sufficient to derail a project, in most cases there is a confluence of factors that cause project failure.
5 Whys technique: It is a method used in Six Sigma used to identify the root cause of a problem by asking repeatedly five times why to get beyond symptoms and to
determine relationships between different root causes.
3.2.1 Strategy and Project Objectives
One of the first reasons for large capital expenditure project failures is an apparent disconnect between undertaking projects and corporate strategy and project objectives.
That is, projects do not have the benefit of a sound rationale justification and thorough strategic and portfolio fit assessment. Because of that, and in the absence of a well
thought out project strategy, project objectives are vague, confusing, and unsupported by facts. In such a context, project objectives are influenced by excessive optimism and the problem is compounded by wishful thinking begetting unrealistic expectations. This is true of some project sponsor or developer and other project stakeholders' objectives, including those of the host government ceding authorities.
In the absence of a clear project strategy that is consistent with the overall project stakeholder strategy, conflicting participant interests and objectives can create
cooperation problems and result in longer negotiations of contracts and project delays.
This kind of environment is characterized by impeded communication, coordination, cooperation, and collaboration all of which result in mistrust and indecision. What comes out of that context is a set of different and unreconciled individual project stakeholder objectives which drive project forecasts and financials everywhere. This is not a correct, consensus, reality checking, and validating assumptions environment. Another factor contributing to project failures is that project objectives do not align with project requirements. That is, a gap exists between project specifications and performance
requirements and unrealistic sponsor expectations and objectives which results in wrong cost estimates and different perceptions of project financeability.
A different failure factor related to project sponsor strategy and project objectives has to do with project portfolio management, or more precisely, with little consideration and analysis given to the project impacts on the portfolio allocation and risk composition in current project finance practices. So, why is that a problem? It is because it results in unbalanced portfolios in terms of risk exposure, blurred strategic intent and clarity of purpose, and suboptimal allocation of capital investments. It is also because successful project portfolios require correspondingly appropriate allocation of scarce financial and human scarce resources possessing the right skills and competencies. This is true of all types of project stakeholders, but particularly true of project sponsors or developers initiating large projects.
3.2.2 Screening and Preparation
Projects starting with unclear strategy and project objectives are followed by inadequate preparation and project screening, which are then complicated by a series of other project
failure factors. Screening is usually limited to technical achievability and financial viability while ignoring other tests, such as the ability to execute successfully,
compatibility of technical platforms, and alternative project investment prospects. Poor sponsor team preparation for a large project begins with reliance on the initiating
organization to move the project forward and not creating early on a dedicated project team with experienced personnel supported by external advisors and consultants. But, even in cases of early project team formation, failures occur when teams are inadequately resourced or not fully dedicated to project screening, preparation, and development. Also, when little attention is paid to processes and required financial and human resource
systems to ensure proper screening and preparation, disappointing project evaluation and performance follow. Other project failures related to screening and preparation are due to inadequate host government preparation, systems, resources, and project development plans and processes.
Failure factors caused by host governments originate with inadequate ceding agency preparation, issuance of bids with unclear project requirements, and underestimating the financial support needed for the project. On the sponsor side, inadequate understanding of the host country macroeconomic and operating environment; partial knowledge of industry structure, capacity, and dynamics; and little appreciation of the effects of
megatrends and subtrends are factors causing false assessments of project viability and subsequent project failure. Also, poor assessment of host country social and living
conditions for skilled project company expatriates result in difficulties recruiting talent needed to manage the project company. The combined effect of these factors leads to poor risk assessment and inadequate risk allocation and mitigation.
The main factors resulting in project failures from the screening and operational fit assessment side are inadequate understanding of project equipment requirements and design specifications, and ambiguity of performance specifications that result in flawed cost estimates and financing requirements. While the absence of standardized project screening and evaluation templates is sometimes blamed for project finance failures, the reality is that projects are unique and require the tailoring of processes and assessments throughout the project stages. However, there is cursory, if any, sponsor company
strengths, weakness, opportunities, threats (SWOT) analysis, which impedes the project team's ability to execute a project successfully. The absence of early and comprehensive political, economic, social, technical, legal, educational, and demographic assessments produces erroneous project feasibility studies. Time after time, weak industry, market, and competitor assessments and a lack of benchmarking data result in the creation of faulty assumption sets and skewed economic evaluations. These factors complicate the due diligence process and result in incomplete risk assessments and weak due diligence reports that weaken the major cornerstones of project finance.
The failure factors mentioned above are project preparation causes, but factors related directly to raising financing failures have to do with poor PFO and project team
preparation and planning with respect to ensuring clear and complete processes,
integrated planning and budgeting, sound financial models development, and correct data
and assumption inputs. Just as damaging a factor is the inability of sponsor PFOs to educate, prepare, and help the host government ceding agency understand all project finance requirements and what it takes to complete a project successfully. Also, a failure to cultivate good working relationships with funding sources globally, and to know well their processes and requirements for different types of projects, is another factor leading to project finance complications and delays.
3.2.3 Bidding and Procurement
Many of the bidding and procurement related reasons for project failures stem from confusion among project stakeholders, misunderstandings of requirements, protracted fact finding, and back and forth clarification seeking discussions. More often than not, a lack of host government bidding process transparency and clear selection criteria throws projects off track. This is a prime factor for frictions, delays, and project failure. Also, the difficulties of inexperienced sponsor teams working with different cultures and host
government bureaucracies add to mistakes, delays, and inefficiencies, as does the absence of rigorous bidding and procurement processes, which lead to wrong assessments of
project development costs.
Ambiguous bid requirements and project specifications even in the presence of good
intentions result in project changes, delays, technical difficulties, longer negotiations, and cost overruns. But, the effect of low ball bids by competitors not bound by laws such as the US Foreign Corruption Practices Act, causes sponsors going back to the drawing board, making costly technical changes and price adjustments in order to prepare more competitive bids to win a project and in the process end up with a losing proposition.
More factors responsible for failures, however, have to do with rigged bid processes and procurement practices and, sometimes, with host government officials' corruption and fraud. And, one cannot ignore the effect of loss of proprietary information contained in bids which are assessed by independent agents hired by the ceding authority and leaks to competitors on the current and future project chances of structuring profitable deals.
3.2.4 Skills and Competencies
It is widely recognized that an all around project finance knowledge deficit is a leading cause of project finance failures. Just as important, however, is the point that because the knowledge, skills, and experience required in project finance are so broad that, by
necessity, they are rare. To work around that constraint, they are compartmentalized and highly specialized. Engineers know project design and technology; project finance
associates know accounting and tax, financial modeling, and instruments; legal teams know law, contract development, and negotiation of agreements; but they do not know each other's area. Therefore, all the responsibility of integrating the vast amount of
diverse knowledge, analyses, and evaluations rests with the project manager supported by the PFO. In large capital investment projects, if the set of required project finance and project management skills and competencies is weak and not outsourced, it is a common and major cause of project failures. This is primarily because the inability to direct and
integrate effectively results and deliverables of varied and specialized assessments into a unified evaluation that results in erroneous conclusions and project failures.
A sponsor project team's lack of international business experience and its inability to work with different cultures and government bureaucracies to gain political support and negotiate contracts effectively is another failure factor. This manifests itself in long negotiations and contract revisions and an inability to implement the project company's business plan successfully. Similarly, weak and ineffective PFOs are responsible for project failures in three ways: The lack of project finance skills and experience, the inability to screen and select qualified external advisors and consultants, and failure to create processes that are best suited for each project and assign roles and responsibilities appropriately.
A lack of adequate PFO skills and competencies extends to unfamiliarity with specific duties in the different project stages, and failure to lead and manage project finance processes and create sound project company business plans. This is partly due to lack of critical mass of project finance transactions for a sponsor company and excessive reliance on the skill set and guidance of external advisors, who may not have a thorough
understanding of the sponsor company's needs, strategy, and objectives, nor the
customers' needs and requirements. A more common factor, however, is the limited set of established, good working relationships with associates in funding sources and partial knowledge of financial instruments and their proper application in different projects.
Lack of innovation added to each of these factors individually can lead to project failures, but when combined they undoubtedly lead to unsuccessful project structuring and
financing.
3.2.5 Project Processes
Processes in project finance are important because (1) they serve as clear maps and
blueprints that guide the project team through the maze of activities to be performed and do it consistently well, and (2) of the necessary integration of each process' analyses and evaluations into other processes with minimal frictions and adjustments. Sound
processes are complete, efficient, parsimonious, and effective procedures that have been executed successfully a number of times and lead to the least time to completion and lowest costs of doing a project. Such processes are not a common occurrence in many project finance deals in the current paradigm. In fact, the opposite is true; that is, project failures result from flawed or incomplete processes that are developed with an
orientation towards expediency and weak organizational cultures, or when dictated by wrong or misguided project objectives.
The creation of effective project finance processes involves skilled associates, good
preparation and planning, and the right financial and contract management systems, lack of which leads to wrong evaluations, schedule slippages, and errors. Even when there are sound processes in place, a lack of adherence to tested processes and procedures, and difficulty managing the integration of the various processes, leads to failures to meet
project financing requirements as well as compliance with lender, ECA, and multilateral institution guidelines and requirements. Project failures due to process defects are
usually related and traced to the following causes:
1. Compartmentalized sponsor company processes of sales, engineering, finance, legal, and external affairs organizations with individual needs, processes, and objectives 2. Difficulties in dovetailing internal sponsor company processes to create a seamless,
consistent, and complete end to end project finance process and winning proposals 3. Incomplete, inconsistent, faulty host government processes that are challenging to
reconcile with sponsor and funding source processes and requirements
4. Impeded all around communication, coordination, cooperation, and collaboration within the sponsor entity and between project participants leading to inability to manage processes effectively and to project delays, errors, and omissions
5. An unwarranted, single focus on engineering, finance, or legal processes at the expense of others, and selecting project managers from the project initiating organization who may not the most qualified managers
6. The exclusion of valuable skills and expertise due to the internal, competing interests and politics of the project sponsor company
7. Unreasonable timelines, misguided objectives, wrong assumptions driving project finance processes, and duplication of work trying to reconcile different process outputs
3.2.6 Project Economics
A major part of project finance failures is due to insufficient and unsatisfactory economic evaluations; that is, inadequate project cost/benefit analyses. Deficient or faulty project economic evaluations are the direct result of poor environmental assessment, lack of megatrend and subtrend evaluations, and scanty market, industry, and competitor
analysis; underestimated creeping project costs, and overestimated revenues. Inadequate economic evaluations can be due to erroneous data and information which, in turn, cause wrong assumptions, the effect of which is to contaminate the results of forecasting and financial models. However, it is not only deficient or unreasonable assumptions that cause the failure of projects; it is also the casual use of assumptions without reality checks and an absence of reasonableness checks of the resulting analyses and
assessments.
Deterministic project cost modeling may be appropriate under conditions of certainty of project specifications and requirements and stability of economic and market conditions of the host government and the sponsor countries. In the absence of those conditions, miscalculations and underestimation of cost overruns become common and significant.
Also, limited consideration to possible specification, technology, design revisions, and cost changes, and their inclusion in cost analyses along with lack of provisions to handle
cost escalations, lead to wrong cost projections. More important, however, are project finance failures related to deterministic project revenue modeling using overly optimistic operating scenarios and optimistic pricing and project output demand that yields
unjustifiably high revenue projections.
Inadequate economic evaluations are frequently traced back to deficient screening in feasibility studies, weak due diligence reports, and erroneous risk assessment
assumptions and ineffective risk allocation. These factors lead to project failures in the presence of incomplete, and inaccurate financial models and evaluations that are usually coupled with inadequate or optimistic project company business plans. In many projects, little attention is paid to performing sensitivity analysis of financial results to changes in controllable factors. This is a problem because good project forecast realization plans cannot be developed for simulated scenarios that do not capture the effects of the
sensitivity of revenue drivers under less optimistic views. The end result is untested and unreasonably high estimates of project value creation that cannot materialize.
Repeatedly, the point has been made that inadequate reasonableness checks of
assumptions and evaluations result in project failures. This is a crucial requirement in the project economic evaluation and financial model development well ahead of the due
diligence report, prior to the start of operations, and also in the operating stage. Checking the reasonableness of assumptions in the operating stage presumes development of a sound business plan and an early warning system to alert the project company's
management team of risks appearing on the horizon so that measures are taken to course correct and avoid invalidation of the economic evaluation which was the basis of
decisions to implement the project. Lastly, an obsession with project risk management and security arrangements and insufficient attention paid to sound project economic evaluation also causes project finance failures.
3.2.7 Technical Issues
Technical factors contributing to project failures begin with unclear, conflicting, wrongly stated, unreasonable, misinterpreted, or misunderstood project requirements and
specifications. In this case, sponsors and the host government ceding authority share responsibility equally, but lack of host government project team technical know how and an unwillingness to invest in getting technical knowledge accentuates the likelihood of technical issues causing project failures. Faulty project design and engineering are factors that lead to project failures when cost considerations create rigid designs that require subsequent modifications, expensive changes, and protracted negotiations.
Project scope creep and associated changes of requirements are failure factors because of capital cost overruns and schedule delays well beyond planned levels. Overlooked
physical project asset security needs and cyberspace security protection end up increasing costs when projects are retrofitted and cause operational disruptions, which mean
revenue losses. Additionally, new and untested technologies intended to increase productivity and project efficiency can lead to project failures because they require
changes, schedule slippages, and cost overruns. At other times, the poor reliability of technology components used causes construction delays and cost increases beyond
insured levels, as does the problem of technology, equipment, and systems integration in large, complex projects.
Conflict between technology suppliers and noncooperation or sabotage during construction lead to project completion delays and, often, to price increases in the operations stage of the project. Another factor related to technology is the inability to attract qualified talent to manage technology update issues in the operations stage and this leads to higher operating costs and revenue loss. As importantly, underestimating technology transfer costs and long training periods of local personnel cause large
adjustments to the project company business plan projections which alter the project's profit profile. Finally, inadequate monitoring and management of technology issues throughout a project's lifetime, the absence of reserves to cover cost increases, and provisions to handle schedule delays throw projects off the planned track and into eventual failure.
3.2.8 Risk Management
Project risks are events, developments, or changes whose occurrence adversely affects a project's ability to achieve expected objectives. Risk management is the process of
identifying those factors, assessing their impact, analyzing and prioritizing, mitigating, and monitoring them to control chances of occurrence and manage their impact. One of the risk management factors is the reality that not all project risks are knowable before agreements are negotiated and signed in order to subject them to the risk management process. Also, the inability to identify sources of new risks in the operations stage has the same effect and sometimes projects fail because there is no ongoing, proactive risk
management for the duration of the project and only reactive and inadequate risk management. In other projects, risk management processes and activities are poorly carried out and end up in construction delays and the project risk management in the operations stage relying entirely on signed contracts and insurance, which causes friction among project stakeholders and further delays.
Disconnects between corporate risk tolerance and project risk levels lead to internal sponsor organization frictions, project changes, and delays. This happens partly because of incomplete risk identification and assessment or due to a lack of skills and experiences across the management structure, both of which are project failure factors. Frequently, inadequate risk management happens because it is based on shaky assumptions and erroneous feasibility studies and due diligence reports. While these are the main reasons that risk assessments are inadequate, in some instances it is the inability to quantify
correctly the likelihood and impact of risks that result in inadequate risk mitigation. Also, incorrect risk identification and assessment are sometimes due to incomplete or flawed external environment and project analyses and evaluations.
Project failures can also be due to inadequate risk allocation; that is, imbalanced,