Project Analysis and Evaluation

CHAPTER THREE: PROJECT IDENTIFICATION

Project identification is the first step of a new venture and it is the birthplace of the project.
Project ideas can arise with the entrepreneur, from business associations or planning
agencies or from special studies conducted for identifying opportunities within a country or
region. The sources of project ideas, project identification, formation and related issues will
be addressed in this chapter.
Aims and Objectives
After completing this unit successfully, you will be able to:
 Identify possible sources of project ideas;
 Describe the different stages in identifying and screening investments (projects);
 Understand how to stimulate the flow of project ideas;
 Explain tools for identifying investment opportunities
 Conduct opportunity studies for identification of projects
 Understand SWOT analysis as a tool to identify projects
 Use project-rating index to screen the project.
Theoretically, an investor has an infinitely wide choice with respect to investment
opportunities. The important dimensions of choices are; products/ services, technology,
equipment, scale of production, location, incentives and time phasing. The task of
identifying feasible and promising project is somewhat difficult. Moreover, it is interrelated
with the government policies, infrastructural developments and skill of people. Project
identification is concerned with collection, compilation and analysis of economic data for
locating possible opportunities for investment and with development of such opportunities.

3.1 Sources of Project Ideas

There are multiple sources of project idea. Project ideas will contribute to the realization of
development objectives. ‘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.
Often firms adopt a somewhat casual and haphazard approach to the generation of project
ideas. To stimulate the flow ideas the following are helpful:

 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

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exploited by the organization in light of its strength and weakness. Thus, periodic
SWOT analysis facilitates the generation of ideas.
 Clear Articulation of Objectives: The operational objectives of the firm may include

 Cost reduction
 Productivity improvements
 Increase in capacity utilization
 Improvement in contribution margin
 Expansion into promising fields
 Fostering a Conducive Climate: To tap the creativity of people and to harness their
entrepreneurial urges; a conducive organizational climate has to be fostered.

3.2 Methods of Project Identification

According to Ministry of Economic Development and cooperation, there are five methods for
identifying projects. They are the following:

1. Analyze major development problems: Development of a country depends heavily on

the way of handling the problems related to development. The development
possibilities of the country together with the problems that confront with the
development should be analyzed thoroughly. The ideas for development and problems
have to be listed down in their order of priority.
2. Analyze National Objectives: The stated objectives of the government (country) have
to be analyzed to formulate projects. The objectives of the country can be achieved
only by formulating suitable projects. The national objectives are always emerged on
the basis of the social needs. In other words, a proper analysis of the social needs is
inheritable for identifying suitable projects.
3. Economic Analysis: The nature and type of trade in a country provides a number of
opportunities for establishing projects. Information on imports, exports etc. may be
obtained from trade reports such reports may also shed light to the possible
accessibility to the trade sector of other countries and the investment opportunities in
other countries. This information may cover the way for the establishment of a
number of projects inside and outside a country.
4. Natural Resource Survey: A survey on the natural resources of a country may facilitate
for identifying a number of projects. A country may also have a lot of unidentified
natural resources. A part of the resources that have already been known to the people
might not have been properly exploited. Thus surveys on both identified resources
and unidentified resources are important sources of project opportunities.
Especially, agricultural and mineral projects depend heavily on natural resource
surveys.

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5. Socio-Spatial Approach to Project Identification: This approach for identifying projects

usually employs the following:
i. Participatory Approach: The participatory approach of formulating projects is on
the belief that the projects should be formulated with the participation of the people.
This approach emphasizes that the first step in the project planning cycle is to
consult the population about the development needs of their area. Then, a
situational analysis of major development bottlenecks will be done with the
participation of the people. As a result, many key projects, which are very essential
for the people, could be identified. Since these projects are formulated with the
participation of the people, they will have more acceptability and commitment of the
community.
ii. Area-based functional Analysis: This approach is to identify package projects or
complementary projects for a particular area, village, district, or community. These
projects usually aim at addressing problem of social and spatial inequalities. They
may be part of the overall development plan of the region or the country.

3.3 Monitoring the Environment

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:

 Macro – external environment, and

 Micro – external environment

Macro External Environment

Macro level sources refer to the source of project idea, which is reflected from national,
regional and sectoral level sources. At macro level project ideas can be obtained from various
sources as mentioned below:
 Lack of foreign exchange (trade deficit) requires export oriented projects or import
substitution oriented projects
 Natural disaster such as drought, earthquake or flood requires resettlement projects
and flood control projects like dam
 Multilateral or bilateral development agencies,
 Regional or international agreements in which a country participates, etc.
 National policies, strategies and priorities as may be enunciated by government from
time to time;
 National, sectoral, sub – sectoral or regional plans and strategies supplemented by
special studies, sometimes called opportunity studies, conducted with the explicit

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aim of translation national and sectoral, sub– sectoral and regional programs into
specific projects;
The macro environment (which include the economic, political and legal, social and
cultural, and technological forces) and its important aspects studied in monitoring consist
of the following:

Macro External Environment

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  Population trends, shift in population among regions
sector  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

Micro source refers to the source of project idea, which is reflected from community or
individual level sources. They are concerned with industry, market, competitors, etc. The
micro external environment is also known as Task environment . At micro level project ideas
can be generated from various sources. Some of these are discussed below:
Micro External Environment
Competition sector  Number of firms in the industry and the market share of the top few
 Degree of homogeneity and differentiation among products
(Analysis of the industry  Exit and Entry barriers
and the market)  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

The following are some suggestions for trapping the sources of good project idea.
1. Analysis of the performance of existing industries: A study of existing industries in
terms of their profitability utilization can indicate promoting investment opportunities
which are profitable and relatively risk free. An examination of capacity utilization of
various industries provides information about the potential for further investments.
Such study is more useful if it is done region wise. Particularly for products which have
high demand for consumption and wide scope for production.
2. Examination of the input-outputs of various industries: The analysis of inputs required
for various industries may throw some project ideas. Opportunities exist when {1]
Materials, purchased parts, or supplies are presently procured from distance sources
with considerable time lag and transportation cost and [2] Several firms produce
internally some components parts which can be supplied at lower cost by a single
producer who can enjoy economics of scale. Similarly, a study of the output of the
existing industries may reveal opportunities for adding value through further processing
of the main outputs, by produce, by products as well as waste products .

3. Review of Imports and Exports: Analysis of import statistics for a period of five to seven
years is helpful in understanding the trend of imports of various goods and the
potential for import substitution. Indigenous manufacture of goods currently imported
is advantageous for several reasons. [1] It improves the balance of payments situation.
[2] It generates employment, and [3] it provides market for the supporting industries
and services. Likewise an examination of export statistics is useful in learning about the
export possibilities of various products.

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4. Investigation of local materials and resources: A search for project ideas may begin an
investigation into local resources and skills. Various ways of adding value to locally
available materials may be examined. Similarly, the skills of local artisans may suggest
products that might be profitably produced and marketed.
5. Study of new technological developments: New products are the new process and
technologies for existing products developed by the research laboratories may be
examined for profitable communication.
6. Exploring the possibility of reviving sick units: Industrials sickness is spread in many
countries. There are innumerable business units which have been characterized as
sick. These units either closed are have reached the prospect of closure. A significant
proportion of sick units however can be nursed back to health by sound management,
fusion of further capital and provision of complementary inputs. Hence, there is a
fairly good scope investment in this area.
7. Identification of unfulfilled psychological needs: For well-established multi brand
product groups like bathing soaps, detergents, cosmetics and tooth paste, the
questions to be asked is not whether there is an opportunity to manufacture them for
satisfying an actual physical need, but whether there are certain psychological needs of
the consumers which are presently unfulfilled.
8. Attending trade fairs: National and international trade fairs provide an excellent
opportunity to know about new product and developments.

3.4 Project Ideas and Opportunity Studies

Opportunity Studies: The identification of investment opportunities is the starting – point
in a series of investment – related activities, when potential investors (private or public) are
interested in obtaining information on newly identified viable investment opportunities.

The main instrument used to quantify the parameter information and data required to
develop a project idea into a proposal is the opportunity study, which should analyze:

 Natural resources
 The existing agriculture (basis for agro- industry)
 Future demand for consumer goods
 Imports substitution and export possibilities
 Environmental impact
 Expansions of existing capacity
 Manufacturing sectors (successful in other countries)
 Diversification

Opportunity studies are rather sketch in nature and rely more on aggregate estimates than
on detailed analysis. Opportunity studies could be general or specific.

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 General opportunity studies (sector approach) could be area studies designed to

identify opportunities on a given area (Administrative province, backward region),
industry studies to identify opportunities in delimited industrial branch and
resource – based studies to reveal opportunities based on the utilization of natural,
agricultural or industrial.
 Specific project opportunity studies (enterprise approach) are seen in the form of
products with potential for domestic manufacture. A specific project opportunity
study maybe defined as the transformation of a project idea into a broad investment
proposition.

A project opportunity study should not involve any substantial cost in its preparation, as it
is intended primarily to highlight the principal investment aspect of a possible industrial
proposition. The purpose of opportunity study is to arrive at a quick and inexpensive
determination of salient facts of an investment possibility.

3.5 Screening Potentially Promising Project Ideas

Preliminary screening should be performed to eliminate project ideas that are not
promising. Once a list of project ideas has been put forward, the first step is to select one or
more of them as potentially promising. This, calls for a quick preliminary screening by
experienced professionals who could also modify some of the proposals. At this stage, the
screening criteria are vague and rough, that becomes specific and refined as project
planning advances.

During the preliminary screening to eliminate ideas, which prima facie are not promising, it
is required to look into the aspects such as:

 Compatibility with the promoter: The idea must be compatible with the interest,
personality, and resources of the entrepreneur. A real opportunity may fulfill the
following three characteristics
 Consistency with government priorities: The project idea must be feasible given the
national goals and governmental regulatory framework. You may need to ask
yourself: Is the project consistent with national goals and priorities? Is there any
environmental effect contrary to governmental regulations? Can the foreign
exchange requirement of the project be easily accommodated? and the like
 Availability of inputs: The resources and inputs required for the project must be
reasonably assured. To assess this, the following questions need to be answered:
 Are the capital requirements of the project within manageable limits?
 Can the technical know - how required for the project be obtained?
 Are the raw materials required for the project available domestically at a
reasonable cost?

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 Adequacy of market: The size of the present market must fit the prospect of
adequate sales volume. Further, there should be a potential for growth and a
reasonable return on investment. To judge the adequacy of the market, the following
factors have to be examined:
 Total present domestic market
 Competitors and their market shares
 Export markets.
 Analyze price profile of the product such as competitive product.
 Sales and distribution system
 Projected increase in consumption
 Barriers to the entry of new units
 Economic, social and demographic trends favorable to increased
consumption
 Patent protection
 Reasonableness of costs: The cost structure of the proposed project must enable to
realize an acceptable profit with a price. The following points should be reminded in
this regard:
 Cost of material inputs  Selling and distribution costs
 Labor costs  Service costs
 Factory overheads  Economies of scale
 General administration costs
 Acceptability of risk level: The desirability of a project is critically dependent on the
risk characterizing it. Whether the risk elements of the project is taken into
consideration while designing the new profitable projects. In the assessment of risk,
the factors to be considered are; technological changes, competition from
substitutes, competition from imports and governmental control over price and
distribution During preliminary selection, the promoter should eliminate project
proposals that:
 Are technically unsound and risky;
 Have no market for the output;
 Have inadequate supply of inputs;
 Are very costly in relation to benefits;
 Assume over – ambitious sales and profitability

3.6 Tools for identifying Investment Opportunities

Important tools for identifying promising investment opportunities are available. The
popular ones are:
 Porter Model – Profit potential of industries
 Life Cycle Approach and
 The Experience Curve

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The Porter Model

Michael porter has argued that the profit potential of an industry depends on the combined
strength of the following five basic competitive forces:

Potential Entrants

Threat of new Entrants

Bargaining power of suppliers

THE INDUSTRY
Suppliers Buyers
Rivalry among Existing Firms

Bargaining power of buyers

Threat of substitute products

Substitutes

The Life Cycle Approach

This approach classifies product life cycle into four stages. Each stage presents investment
opportunities that exhibit different characteristics.
 Pioneering stage-have low return & negative NPV yet give opportunity to go to next
stage
 Rapid growth stage – Earns high returns and generate positive NPV
 Maturity & stabilization stage-earn average & generate neutral NPV
 Declining stage – Earn meager return & negative NPV
The Experience Curve
The systematic reduction in production costs that occurs over the life of a product. E.g. first
observed in aircraft industry where unit costs reduced by 80% each time output was
doubled. Forces behind the experience curve are:
 Learning effect: - Increased labor efficiency
 Process innovations and methods improvements: - Technological improvements
 Substitution effects
 Product redesign
 Standardization
 Economies of scale
 Shared experience

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3.7 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

Factors Factor Rating Factor

weight Score
5 4 3 2 1

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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Purpose of Project Rating Index

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.

Exercises:
Instruction: Read & analyze the following questions carefully and answer them
correctly.
1. What is the project identification? What are sources for project ideas?
2. Mention the major macro-environmental factors that may provide
opportunities or threats.
3. Indicate the major micro-external factors that may provide opportunities or
threats.
4. What is the SWOT analysis? What is the role of SWOT analysis in project idea
generation?
5. Explain how to screen potentially promising project ideas.
6. What are the five basic competitive forces in the industry according to Porter?
How it would be source of project idea?
7. What are the opportunity studies and distinguish between sector approach and
enterprise approach to conduct opportunity studies.
8. List down and describe tools for identifying investment opportunities.
9. What is life cycle approach in identifying investment opportunities?
10. What is the project rating index? Describe the procedures in project rating
index?

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