UNIT 3: PROJECT IDENTIFICATION

Contents
3.0 Aims and Objectives
3.1 Introduction
3.2 Generation of Project Ideas
3.3 Monitoring the Environment
3.4 Corporate Appraisal
3.5 Profit Potential of the Industry/Industry Analysis
3.6 Scouting for Project Ideas
3.7 Preliminary Screening
3.8 Project Rating Index
3.9 Being an Entrepreneur
3.10 Managing Risks
3.11 Summary
3.12 Answers to Check Your Progress Questions

3.0 AIMS AND OBJECTIVES

After completing this unit, you will be able to:

 describe the different stages in identifying and screening investments (projects);
 understand the need for generating project ideas;
 understand how to stimulate the flow of project ideas;
 explain the importance of monitoring the environment in generating project ideas;
 list factors to be considered in environmental analysis, corporate analysis, and
industry analysis;
 explain the competitive forces that affect the profit potential of the industry;
 identify the possible sources of project ideas;
 understand the factors that are considered in projects’ preliminary screening; and
 use project-rating index to screen the project.

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3.1 INTRODUCTION

The identification of promising project ideas is the first step towards establishing a successful
venture. It is also the beginning of the mobilization of investment funds.

The identification of opportunities for project (investments) requires an understand of the

environment in which one operates, sensitive to emerging investment possibilities,
imaginative analysis of tangible and intangible factors, and also an element of luck. The task
is partly structured and partly unstructured; partly dependent on convergent thinking and
partly on divergent thinking; partly requiring objective analysis of quantifiable information,
partly requiring subjective evaluation of qualitative factors; and partly amenable to control,
partly dependent on fortuitous circumstances.

The task (objective) of identification stage is to identify investment opportunities, which are
feasible and promising and which deserve further in-depth study and appraisal. To briefly
discuss the identification stage, the following points are explored.
 Generation of ideas  Preliminary screening
 Monitoring the environment  Project rating index
 Corporate appraisal  Being an entrepreneur
 Scouting for project ideas

3.2 GENERATION OF PROJECT IDEAS

‘Necessity is the mother of invention’ sounds rhythmic with projects, as they are roots of
needs and wants. These needs may be social, political, economic, commercial, technical or
environmental that drives the actions of entrepreneurs to pursue some creative actions. That is
project ideas are generated in order to satisfy the needs and wants. These actions will impact
both the macro and micro perspective of mankind.

Stimulating the flow of ideas:

Most organizations adopt a causal and haphazard approach to the generation of ideas. To
stimulate the flow of ideas, the following are helpful:

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a. SWOT Analysis – SWOT stands for strength, weakness, opportunities and threats. SWOT
analysis represents a conscious, deliberate and systematic effort by an organization to identify
their internal strengths and weaknesses and the opportunities and threats in the environment.
This analysis helps to identify opportunities that can be profitably exploited by the
organization in light of its strength and weakness. Thus, periodic SWOT analysis facilitates
the generation of ideas.

b. Clear articulation of objectives – A clear articulation and prioritization of objectives of an

organization helps in canalizing the efforts of employees and helps them to think more
imaginatively.

The operational objectives of the firm may include

1. Cost reduction
2. Productivity improvements
3. Increase in capacity utilization
4. Improvement in contribution margin
5. Expansion into promising fields

c. Fostering a conductive climate – To tap the creativity of people and to harness their
entrepreneurial urges, a conducive organizational climate has to be fostered.

3.3 MONITORING THE ENVIRONMENT

Basically a provision investment idea enables a firm (or entrepreneur) to exploit opportunities
in the environment by drawing on its competitive strengths or to minimize the external threats
Hence, the firm must systematically monitor the environment and assess its competitive
abilities. The business environment consists of all those aspects and forces in the surroundings
of business enterprises under which business operations are to be carried out effectively and
efficiently. Business external environment can broadly be divided in to two categories,
namely:
1. Macro – external environment, and
2. Micro – external environment

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Macro – external environment
The macro environment (which include the economic, political and legal, social and cultural,
and technological forces) and its important aspects studied in monitoring consists of the
following:
Economic sector - State of the economy
- Overall rate of growth
- The growth rate of primary, secondary and tertiary sectors.
- Projected national income trends, GNP trends
- Projected industry output, projected price movements
- Trends in fiscal, credit and monetary policies
- Cyclical fluctuation of the economy
- Corporate taxation and incentives
- Provisions of infrastructure
- Inflation rate, interest rate, exchange rate
- Unemployment level
- Linkage with the world economy
- Balance of payment (trade surplus/deficit)
- Budget deficit/surplus
Governmental (political - Manifestoes of party in power and the opposition
and legal) sector - Attitude towards investors
- Restrictions on areas of investment by private sector
- Restrictions on imports
- Industry policy
- Import and export policies
- International trade regulation
- Government programs and projects
- Tax framework
- Subsidies, incentives
- Financing norms
- Lending conditions of financial institutions and commercial banks
- Environmental protection laws
- Control over prices and distribution of goods
Technological sector - Emergence of new technologies
- Access to technical know-how, foreign as well as indigenous
- Transport
- Product processing
- Use of computers and other automations
- Receptiveness on the part of the industry
Social and cultural sector - Population trends, shift in population among regions
- Age shifts in population
- Educational profile
- Employment of women
- Attitude towards consumption and investment
- Changes in ethnic composition
- Customs, beliefs and values

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Micro – External environment
The micro external environment is also known as Task environment. The micro – external
environment is mainly concerned with industry, market, competitors, etc. and the major
factors to be studied consists of:
Competition sector (analysis of the - Number of firms in the industry and the market
industry and the market) share of the top few
- Degree of homogeneity and differentiation among
products
- Exit and Entry barriers
- Comparisons with substitutes in terms of quality,
price and functional performance
- Marketing policies and practices
- Capacity utilization
- Product life cycle
- Foreign opportunities

Supplier sector - Availability and cost of raw materials and sub-

assemblies
- Availability and cost of energy
- Availability and cost of money
- Exit and entry of suppliers
- Power of suppliers

Check Your Progress 3.1

1. Project ideas are generated in order to satisfy the needs and wants. (True/False)
2. What should entrepreneurs do to generate ideas?
3. Mention the major macro-environmental factors that may provide opportunities or
threats.
4. Indicate the major micro-external factors that may provide opportunities or threats
5. Mention at least three operational objectives of the firm that guide project ideas.

3.4 CORPORATE APPRAISAL

A realistic appraisal of corporate strengths and weakness is essential for identifying

investment opportunities, which can be profitably exploited. The broad areas of corporate
appraisal and the important aspects to be considered under them are as follows:

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Market and distribution:
Corporate resource and personnel:
 Market image
 Corporate image
 Product line
 Clout with governmental and regulatory
 Market share
agencies
 Distribution network
 Dynamism of top management
 Customer loyalty
 Competence and commitment of employees
 Marketing and distribution costs
 State of industrial relations
Production and operations:
Finance and accounting:
 Conditions and capacity of plant and
 Financial leverage and
machinery
borrowing capacity
 Availability of raw materials,
 Cost of capital
sub-assemblies and power
 Tax situation
 Degree of vertical integration
 Relations with shareholders and
 Locational advantages
creditors
 Cost structure
 Accounting and control system
Research and development:
 Cash flow and liquidity
 Research capability of the firm
 Track record of new product development
 Laboratories and testing facilities
 Coordination between research and operation

3.5 PROFIT POTENTIAL OF THE INDUSTRY/INDUSTRY ANALYSIS

Michael porter has argued that the profit potential of an industry depends on the combined
strength of the following five basic competitive forces:
1. Threat of new entrants
2. Rivalry among existing firms
3. Pressure from substitute products
4. Bargaining power of buyers
5. Bargaining power of sellers/suppliers

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These five forces are depicted in the following diagram.

Potential
Entrants

Threats of
new entrants

Bargaining Bargaining
power of The Industry: power of
Suppliers Rivalry among Buyers
Buyers
Suppliers existing firms

Threats of
substitute
products

Substitutes

Each of the above forces will be explained in the section that follows:

1. Threat of New Entrants

If an industry faces the threat of new entrants, its profit potential would be limited. New
entrants have the following effects on the industry:
- Add (increase) capacity
- Inflate costs
- Push prices down
- Reduce profitability
The entry barriers may limit the number of new entrants and the effect as well. If it is not
easier to entry an industry, the threat from new entrants is low. Entry barriers are high when:
a) Entrance requires substantial resources to invest
b) Economies of scale are enjoyed by the industry
c) Control of the distribution channels by existing firms
d) Product differentiation by existing firms in the form of brand image and
customer loyalty
e) High switching costs

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 f) The government policy may limit or even prevent new entrants.

2. Rivalry between Existing Firms

There could be stiff competition among existing firms in terms of price, quality, promotion,
service, warranties, and so on. This is the case when one firm attempts to improve its
competitive position, other firm may take counter action. Strong completion in the industry
reduces the average profitability of the industry. The intensity of rivalry in an industry tends
to be high when:
 The number of competitors in the industry is large
 The level of fixed costs is high
 There is chronic over capacity in the industry
 The industry’s product is regarded as a commodity or near – commodity
 The industry confronts high exist barriers.

3. Pressure from substitute products

Substitute products are those products that perform the same function as the original products.
Substitute products may limit the profit potential of the industry by imposing a ceiling on the
prices that can be charged by the firms in the industry. The threat from substitute products is
high when:
- the price-performance trade-off offered by the substitute products is attractive
- the switching costs for prospective buyers are minimal
- the substitute products are being produced by industries earning superior profits

4. Bargaining power of buyers

Buyers, the competitive force, can bargain for price reduction, ask for superior quality and
better service, and induce rivalry among competitors. Buyers have high bargaining power
when:
- the purchase is large
- switching costs are low
- it poses a strong threat of backward integration.

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 5. Bargaining power of suppliers
Like buyers, suppliers can exert a competitive force in an industry because they can increase
material prices, lower quality and reduce the range of services that they provide. Powerful
suppliers can reduce the profitability of the buyer’s industry. Suppliers have strong bargaining
power when:
- few suppliers dominate
- the supplier group is more concentrated than the buyer group
- there are hardly any viable substitutes for the products supplied
- the switching costs for the buyers are high
- their strong threat for forward integration

Check Your Progress 3.2

1. What is the role of SWOT analysis in project idea generation?
2. What important aspects of the firm are appraised in order to identify internal strengths
and weaknesses?
3. What are the five basic competitive forces in the industry according to Porter?
4. The higher the threat of new entrants in to the industry, the greater the possibility that
industry’s profit margin increases. (True/False)
5. How new entrants affect the industry?

3.6 SCOUTING FOR PROJECT IDEAS

Good project ideas – the key to success – are elusive. So a wide variety of sources should be
tapped to identify them. Here are some suggestions in this regard.
 Analyze the performance of existing industries
 Examine the inputs and outputs of various industries
 Analyze possible extension of existing lines of manufacture by backward or forward
integration linking
 Analyze inter-linkage with other industries, indigenous or transnational
 Review import and exports
 Study plan outlays and governmental guidelines
 Look at the suggestions of financial institutions and developmental agencies

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  Investigate local materials and resources
 Analyze economic and social trends
 Study new technological developments
 Draw clues from consumption abroad
 Analyze sectors successful in other countries with similar economic background and
levels of development, capital, labour and natural resources.
 Study new technological developments
 Explore the possibility of reviving sick units
 Identify unfulfilled psychological needs
 Attend trade fairs
 Hope that the chance factor will favor you
 Brain storming

3.7 PRELIMINARY SCREENING

By using the suggestions made in the preceding sections, it is possible to develop a long list of
project ideas. Some kind of preliminary screening is required to eliminate ideas which are not
promising. For this purpose, the following aspects may be looked in to:
 Compatibility with the promoter’s objectives
 Consistency with governmental priorities
 Availability of inputs
 Adequacy of market
 Reasonableness of cost
 Acceptability of risk level

Project preliminary screening is like pouring all the ideas into a filtering funnel. In the first
instance, all possible project ideas are listed (identified). Then some of them are eliminated
and few projects are screened for further analysis. After detailed study of few limited projects,
one project will be selected at the end.

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3.8 PROJECT RATING INDEX

When a firm evaluates a large number of project ideas regularly, it may be helpful to
streamline the process of preliminary screening. For this purpose, a preliminary evaluation
may be translated into a project rating index. The steps involved in determining the project
rating index are as follows:
1. Identify factors relevant for the project rating
2. Assign weights to these factors (the weights are supposed to reflect their relative
importance)
3. Rate the project proposal on various factors, using a suitable rating scale. (Typically a
5-point or a 7-point scale is used for this purpose.
4. For each factor, multiply the factor rating with the factor weight to get the factor score.
5. Add all the factor scores to get the overall project rating index.
Example of project rating index
Assume that the following factors are identified to be relevant for project rating
Factors Factor weight
- Technical know-how 0.20
- Input availability 0.15
- Reasonableness of cost 0.20
- Adequacy of market 0.05
- Stability 0.10
- Dependence of firm’s strength 0.20
- Consistency with government priorities 0.10

If the firm uses five rating scale, determine the rating index for the project
Factor Factor Rating Factor
weight 5 4 3 2 1 Score
Technical know-how 0.20  0.80
Input Availability 0.15  0.45
Reasonableness of costs 0.20  1.00
Adequacy of market 0.05  0.20
Stability 0.10  0.50
Dependence of firm’s strength 0.20  0.40
Consistency with gov’t priorities 0.10  0.50
Rating index 3.85

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What is the purpose of rating index? Project rating index enables to identify (from the list) the
project(s) that can be studied further in detail. If the policy of the firm is to further study the
projects whose rating index is 3.50 and above, the above project will enter the next phase of
the project.

3.9 BEING AN ENTREPRENEUR

What qualities and traits are required to be a successful entrepreneur? While it is difficult to
answer this question definitively, it appears that a successful entrepreneur has the following
qualities and traits:
 Willingness to make scarifies
 Leadership
 Decisiveness
 Confidence in the project
 Marketing orientation
 Strong ego

Check Your Progress 3.3

1. What major factors are considered in preliminary screening of project ideas?
2. What are the qualities of successful entrepreneurs?
3. Describe the procedures in project rating index?

3.10 MANAGING RISK

Risk is an inherent property of any change activity and is considered exclusively as a future
phenomenon. Risks may happen in project work but it is very difficult to write down any
specific universal rules for managing all risks. Risk management, however, is important
because it enables to minimize or even avoid the ‘show-stoppers’ that can cost huge money to
correct. Besides, risk management is important for the following:
 Predict the serious threats to the project before they happen
 Enable mitigation actions to be implemented immediately
 Enable contingency plans to be derived in advance
 Improve decision making in managing the project portfolio

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  Help to create a ‘no surprise’ environment for the project

Risk management of a project is not a utility; it is a vital and fundamental part of the project
management process that impacts the probability of success.

3.10.1 Project Constraints and Risk

Constraints are those things that are imposed on the project knowingly or unknowingly. The
project has three major constraints; namely,
1. Cost. It refers to the overall cost of the work
2. Schedule. It refers to the time the project will take
3. Scope. It refers to the project deliverables or outputs and the quality of the work.

Project constraints and project risks are not the same. Constraints exist throughout the project
life. The project will be operated under these constraints.

3.10.2. The Risk Management Process

The identification and management of risk involves several phases. These phases are
described below:
1. Identifying Risk. Risk identification is the first step in risk management process. The
approaches to risk identification process include:
 Brainstorming session
 Checklists developed from data generated from past projects
2. Assessing the Risks. All projects have risks at the outset because of the many
unknown factors. Risks may disappear and new risks appear as the project progresses.
Risk assessment requires answers to the following questions:
o What exactly is the risk?
o How serious it is as a threat to the project?
o What could be done to minimize its impact on projects success?
For each risk an attempt should be made to establish the following two characteristics:
a. What is the probability of it happening? The probability of occurrence is on a scale
of 1 to 9. 1 is low which means most unlikely to happen whereas 9 is high which
means very high probability it will happen.

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 b. What is the likely impact on the project if it happens? The impact on the project
could be high, medium or low. High impact means the risk has significant effect
on the schedule and project costs. If the impact is medium, the risk has less serious
effect on the schedule and some effect on costs. If the impact is low, the risk has
some effect on schedule and little effect on costs.
3. Ranking of Risks. The ranking of risk is based on the impact and probability of
occurrence. Risks can be ranked using either a qualitative or quantitative approach.
The approach used should rank the risk as high risk, medium risk, and low risk.
4. Record the ranking on project risk log and derive action plan. All the risks must
be recorded in the project risk log. To derive action plan, the following should be
recorded:
 A Short description of the risk;
 When t is expected to occur;
 The probability assessed;
 What consequences are expected;
 What actions will be taken if it happens
 Who will take the actions
 Who is responsible for monitoring the risk

5. Monitoring Risks. Once risks to the project have been identified and action plans
derived, then these must be monitored to make sure that prompt action is taken when
appropriate. Risks change with time so careful monitoring is essential as the project
proceeds, achieving success is dependent on effective risk monitoring.

3.11 SUMMARY

The identification of promising project ideas is the first step towards establishing a successful
project. In order to generate ideas, the following are important. (1) Conduct SWOT analysis
(2) clear articulation of objectives (3) fostering a conducive environment.

SWOT analysis involves the study of internal strengths and weaknesses, on one hand, and the
study of external threats and opportunities. The internal analysis, also called corporate
appraisal, involves the study of the firm’s market and distribution, resources, production and

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operations, research and developments, and accounting and finance. SWOT analysis is also
concerned with industry analysis, which is studied in terms of the threats of new entrants,
rivalry among existing firms, pressure from substitute products, bargaining power of buyers,
and bargaining power of sellers. SWOT analysis also deals with monitoring of other external
environments in terms of economic, legal and political, social, cultural, and technological
forces. The purpose of conducting SWOT analysis is to generate new project ideas.

At first glance, all project ideas are listed down. Since all of them cannot be pursued,
preliminary screening should be performed to eliminate project ideas that are not promising.
Aspects that can be considered in preliminary screening are compatibility with the promoter’s
objectives, consistency with government priorities, availability of inputs, adequacy of market,
reasonableness of costs, and acceptability of risk level. In preliminary screening of project
ideas, project-rating index may be used.

3.12 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS

CYP 3.1
1. True
2. Conduct SWOT analysis, clearly articulate the objectives, and foster a conducive
climate for people
3. Economic factors, political factors, legal factors, social and cultural factors,
technological factors etc.
4. Industry, market, competitors, suppliers etc.
5. Cost reduction, productivity improvements, increase in capacity utilization, improve
contribution margin, or expansion

CYP 3.2
1. SWOT analysis deals with identifying internal strengths and weaknesses and external
threats and opportunities. The strength, weaknesses, threats or opportunities may be
the sources of new project ideas
2. Market and distribution, production, research and development, resources and
personnel, and finance and accounting.

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 3. Rivalry among existing firms, threat of new entrants, bargaining power of buyers,
bargaining power of suppliers, and threat of substitute products.
4. False
5. By increasing capacity, inflate costs, decrease prices, and reduce profitability.

CYP 3.3
1. - Compatibility with the promoter
- Consistency with governmental priorities
- Availability of inputs
- Adequacy of market
- Reasonableness of costs
- Acceptability of risk level
2. - Willingness to make sacrifices
- Leadership
- Decisiveness
- Confidence in the project
- Marketing orientation
- Strong ego
3. - Identify factors that are most relevant
- Assign weight to each factor (Factor weight)
- Rate the project on factors identified earlier using the rating scale
- Multiply the factor weight by factor rating
- Determine the rating index by adding the product of factor weight and rating scale.

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