Lee Merkhofer Consulting Priority Systems

Technical Terms Used in Project Portfolio Management (Continued)

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Term
Explanation

U

user interface

See graphic user interface (GUI).

utile

Also called util, the unit of measurement for a utility function. For example, if the utility function has been defined such that 100 utiles are assigned to the desirability of the best available alternative and zero utiles have been assigned to the least desirable alternative, 1 utile represents one percent of the total satisfaction, pleasure, or happiness gained by deciding to choose the best alternative rather than the worst available alternative.

utility

A quantitative measure of a decision maker's subjective preference for the alternatives to a decision or the outcomes of those decisions. The concept is central to utility theory; also called the theory of rational choice. Utility is a number representing the level of satisfaction, pleasure or happiness as it relates to the decisions that people make.

utility function

Also called preference function, cardinal utility function, Von Neumann utility function, and probabilistic utility function, a mathematical function that assigns numbers to attributes (also called performance measures) selected to describe the outcomes to a decision. The number assigned by the utility function indicates the decision maker's preferences for the outcome bundle as described by the specified attribute levels (the higher the number the more preferred the bundle of attribute outcomes). The number assigned is expressed in arbitrary units called "utiles," however, in many instances (when the function expresses utility on a cardinal scale), a utility function can be scaled so that the utility number is the equivalent monetary value of the outcome; that is, what obtaining those attribute outcomes is worth to the decision maker.

Utility functions are the central concern of utility theory. According to utility theory, attributes (also called performance measures) are selected to measure performance relative to each of the decision maker's objectives. For example, the decision maker might be an engineer tasked with selecting the best approach for constructing a large building. One objective might be safety, another objective might be cost, and so forth. The attribute selected to measure performance relative to the safety might be the number of injuries that occur during construction. The attribute selected for the cost objective might be the total cost of constructing the building. A utility function is then constructed to denote how much the decision maker prefers outcomes as described by the selected attributes. For example, for specified levels for cost and for the other attribute outcomes, the utility function would assign the highest utility to an outcome with zero injuries. Utility functions are typically denoted U(x), where x may represent a single attribute, in which case the utility function is referred to as a single attribute utility function or x may represent multiple attributes x1,x2,...xN, in which case the utility function is called a multi-attribute utility function. Regardless, the utility function has the important property that the most preferred alternative will be the one that produces the attribute outcomes with the highest value for U. Also, if there is uncertainty and probabilities are assigned to indicate the decision maker's beliefs about how likely the various possible attribute outcomes are, the most preferred alternative will be the one that maximizes the expected value of U.

The utility function concept was first developed in 1947 by the mathematicians John von Neumann and Oscar Morgenstern who were concerned about how one should choose among alternative gambles, which they called lotteries. Von Neumann and Morgenstern showed that a utility function exists provided that the individual (the decision maker) accepts certain assumptions or axioms meant to define "rationality." Most people find the axioms, which may be expressed in various ways, easy to accept:

  • Orderability: Two items A and B are always comparable; that is, you must be able to tell if you prefer A to B, B to A, or that you are indifferent between the them.
  • Transitivity: If you prefer item A to item B, and you prefer item B to item C, then you must prefer item A to item C.
  • Continuity: If you prefer item A to item B and item B to item C, then there must be some probability p for which you are indifferent between item B and a lottery that provides item A with probability p and item C with probability 1-p.
  • Substitutability: If you are indifferent between two items A and B, then for any lottery that contains A as a possible outcome, A may be replaced by B without affecting your preferences.
  • Monotonicity: If items A and B are the only possible outcomes for alternative lotteries, and you prefer A to B, then you must prefer lotteries with the higher probability of winning A.
  • Lottery 1
  • Decomposability: (The "no fun in gambling axiom") Suppose you are faced with the compound lottery illustrated by the event tree shown to the right: The lottery will provide either item A or a subsequent lottery that will provide either item B or item C. Suppose when you consider the second stage lottery independently, you conclude that you are Lottery 2 indifferent between it and some item D (figure to the left). Then, you must be indifferent between the original two stage lottery and the one stage lottery where item D replaces the lottery between B and C.
    Lottery 3

Decision analysts have developed assessment methods for encoding (i.e., deriving) a person's utility function.

Among other things that affect preferences, a utility function may account for the decision maker's willingness to accept risk. This can be seen most clearly if the utility function is expressed in a form that relates utility to the equivalent monetary value of the decision outcome. Suppose, therefore, that V = V(x) is the maximum amount of money a decision maker would be willing to pay to obtain the decision outcome x (V(x), then, is a value function). What would the utility function look like? Since utility functions, by definition, are determined empirically, there is no obvious reason to expect that a particular mathematical relationship would emerge. However, it has been shown that an exponential equation nearly always provides a good approximation:


Exponential utility function:

An exponential utility function

This equation is often alternatively written with constants added so that U goes from zero to one when V goes from the minimum to maximum values assigned to the decision outcomes.

It can be shown that if a condition known as the delta property holds, then the utility function must have either this exponential form (or a linear form). The delta property applies if the following is true: whenever there is uncertainty over the outcome of some uncertain choice, if the value of every possible outcome were increased by the same amount (same delta), then the value of the uncertainty (its certain equivalent) would be increased by the same amount (by delta).

The exponential utility function scales the possible outcomes to a decision in a way that accounts for willingness to accept risk, and the coefficient R in the exponent determines the amount of scaling. R is termed the risk tolerance, and the lower the risk tolerance the less desirable the utility function will show outcomes that involve uncertainty to be. A method for assessing risk tolerance (and therefore, for deriving the utility function from a value function) is provided in the section of the paper chapter on risk tolerance, where there is also an example illustrating how to use a utility function to value uncertain project outcomes.

utility independence

An independence condition similar to preferential independence, except that the assessments are made with uncertainty present. Attribute Y is said to be utility independent of attribute Z if preferences over lotteries involving different levels of Y do not depend on a fixed level of Z.

Note that utility independence (in contrast to additive independence) is not symmetric: it is possible that attribute Y is utility-independent of attribute Z and not vice versa.

Utility independence is a slightly weaker independence condition than additive independence. If attributes are mutual utility independent, the multi-attribute utility function will either have an additive form:

Additive utility function

or it will have a multiplicative form:


Additive utility function

where the Ui(xi) are single attribute utility functions.

Since utility independence refers to lotteries and a deterministic outcome is a special case of a lottery, utility independence implies preferential independence. However, the converse is not necessarily true.

The two-variable case of the multiplicative equation is known as a multilinear form, and it is often useful in situations where a compromise choice is sought that would be attractive to multiple stakeholders:


U(X1,X2) = w1U1(X1) + w2U2(X2) + (1 - w1 - w2)U1(X1)U2(X2)

The w's are weighting factors and U1 and U2 are utility functions representing the preferences of stakeholder 1 and stakeholder 2 (or the preferences of two distinct stakeholder groups). The decision maker's utility function is additive with respect to these two terms and represents a desire to seek an alternative that each will desire. The third, multiplicative term, may be thought of as representing the decision maker's desire for an equitable distribution of value between the two stakeholders.

utility theory

A theory of how individuals should make decisions, related to the concept of "rationality" used in economics. Also called subjective expected utility theory, or, with reference to the primary developers of the theory, von Neumann Morgenstern utility theory.

Utility theory is an "axiomatic" theory in that it is derived from a set of axioms (hypotheses) defining how rational people behave. It has been shown that utility theory's axioms can be expressed in a number of different ways, but in all cases the axioms seem, at least to most people, to be quite reasonable. For example, one axiom (transitivity) states that if a person prefers outcome A to outcome B and outcome B to outcome C, that person should prefer outcome A to outcome C. Another axiom (substitution) states that if a person is participating in a lottery where the prize is A, and if that person is completely indifferent between receiving prize A and some alternative prize C, then that person should not care if the lottery is modified by substituting prize C for the equally desirable prize A. Other typical statements of utility theory's axioms include diminishing marginal utility and diminishing rate of substitution, which imply that as a person acquires more and more of a given good, their marginal value for another unit of that good, becomes less relative to other goods. An axiom termed non-satiation states that people do not have so much of everything they desire that they are at the point of not wanting any more.

Utility theory shows that if a decision maker accepts any one of the various ways of expressing the axioms of rationality, then it can be proven that there is a mathematical function, called a utility function, typically denoted U, with the capability of aggregating all of the different considerations that must be taken into account when deciding among alternatives. It also shows that under certain specified conditions, the function will have various simple mathematical forms, such as additive, multiplicative, or exponential forms. Most significantly, the theory proves that, provided the axioms apply, the best alternative (the one that is most preferred) will be the one that maximizes the value of U (or, if there are uncertainties, the expected value of U).

The rational model is, in effect, a conceptualization wherein decision making is regarded as simply a matter of choosing from among sets of alternatives. Alternatives are viewed as leading to outcomes that can be evaluated by applying the decision maker's preferences. The theory recognizes that the outcomes that follow the selection of alternatives are not generally precisely known, due to uncertainties. However, in the face of uncertainties, rational decision makers judgmentally evaluate possible decision outcomes in terms of their preferences and assess probabilities to indicate their beliefs about uncertainties. This, as shown by the theory, maximnize their expected preference satisfaction.

Numerous doubts have been raised about utility theory's descriptive validiaty. In otherwords, it is clear that peole do not always (maybe event often) behave according to the rational model. Much has been writing critizing utility theory based on showing that the rational model does not reflect how people typically make decisions. The proposnents of utility theory, however, see the fact that real world decision makers fail to follow the prescriptions of utility theory as the main arguement for its applicaton. In otherwords, the fact that utility theory leads to recommendations for actions that differ from what people typically do means that following utility theory is likely to produce significant improvements in the degree to which outcomes desired by decision makers are obtained.

The collection of techniques and methods for applying utility theory to real-world decisions is known as decision analysis. Those techniques that apply in the special case of decisions involving multiple decision objectives is called multi-attribute utility analysis (MUA), or multi-objective decision analysis (MODA).

V

valuation

The process of determining the value of something, such as a project or asset. In a business context, valuations typically seek to determine monetary worth, and that is the meaning ascribed to the term throughout this website. However, in much of the literature on project portfolio management, valuation means assigning a number representing some concept of attractiveness. Regardless, various theories and techniques are available for conducting valuations, and the methods typically involve both objective and subjective components.

value

As used on this website, value means monetary worth. The value of something to someone is the maximum amount that individual would be willing to pay to acquire it. Thus, the value of an asset to an organization is the maximum amount that the organization's decision makers would be willing to pay for that asset. Likewise, the value of a project is the maximum amount the organization's decision makers would be willing to pay for the opportunity to conduct that project; that is, what they would be willing to pay to obtain the consequences of doing the project. If the consequences of doing the project are uncertain, the value of the project is the maximum the organization would spend for the gamble over project consequences. The net value of a project is the difference between the value of the project and its cost.

Although my definition of value is intuitive, it is usually not practical to ask decision makers to estimate the maximum amount they would pay for things, including projects. Fortunately, there are well-established methods for quantifying project value. In particular, decision theory and its subfield multi-attribute utility analysis (MUA) provide methods for building models for estimating project value based on consideration of business objectives, the impacts of projects on those objectives. and the willingness of the organization's decision makers to make tradeoffs.

Be aware that word value appears often in project portfolio management (PPM) literature and that many authors either don't define the term or define it in a way that is unrelated to the concept of worth. Many PPM tools, for example, allow users to define criteria, score projects against those criteria, and then rank projects by the weighted, summed scores. Since weighted summed scores do not measure value, such tools are unable to find value-maximizing project portfolios.

Compared to other definitions, defining the value of a project as its monetary worth to the organization has two significant advantages. First, since project value may be expressed in monetary units, project value can be directly compared to project cost. Second, value defined as worth exactly maps to organizational preferences—given two projects competing for the same resources, we know that the organization will prefer Project A to Project B if and only if it views the worth of Project A's consequences to be greater than the worth of Project B's consequences. This critical mapping does not hold for most other definitions of project value.

Despite the arguments for expressing project value in monetary units, there are situations where doing so could create problems. If expressing value in dollar units isn't possible, then, at minimum, project value should be expressed as a cardinal utility; that is, a number that not only correctly measures the relative preferences of a decision maker for candidate projects, but also correctly measures the increment in preference obtained from of a change from a decision to not conduct a project to a decision to conduct the project.

value at risk (VaR)

A metric that describes the potential for loss, typically the potential for loss from a portfolio of financial investments. The term is sometimes similarly applied in the context of project portfolio management to describe the risk associated with a portfolio of projects. Typically, VaR is defined as the amount or percentage of available portfolio value such that there is a 95% (or 99%) probability of the portfolio losing less than that amount over a specified time horizon.

VaR is popular because it addresses the concept of "maximum potential loss." A major weakness is that it is not additive; that is, the VaR for a set of portfolios is not the sum of the VaR's of the individual portfolios.

value function

Also called worth function, measurable value function or value model, a function similar to utility function but applicable to situations of certainty rather than uncertainty. A value function is a mathematical representation of preferences; it maps the criterion/attribute specific measurement scale onto numerical scale of value. Value functions are used in multi-attribute utility analysis (MUA) to quantify value.

The independent variables for value functions are called attributes. A value function that has only a single attribute is called a single attribute value function If the value function has multiple attributes, it is called a multi-attribute value function.

When used to value projects, a multi-attribute value function, denoted V(x1,x2,...xN), assigns a number V to a project based on attributes of the project, denoted x1,x2,...xN, typically chosen so as to describe the outcomes that would result if the project were to be conducted. The number V indicates the relative value of the indicated outcomes. V is often expressed in dollar units, so as to indicate equivalent monetary value, or it may scaled between zero and one so that higher values indicate more preferred outcomes. Regardless, V is interval scaled, so that differences in the value of V indicate differences in the levels of preference (a definition of interval scale is provided under scale).

Some authors use the term ordinal value function to denote a different type of value function, one that assigns values on an ordinal scale rather than on a cardinal scale. An ordinal value function is capable of correctly ranking attribute combinations in terms of preference, but the differences in values so assigned may not correctly indicate the differences in preference. A monotonic transformation can be applied to any ordinal value function and the result will continue to be an ordinal value function that ranks attribute combinations in exactly the same way. The term measurable value function is sometimes used to distinguish a value function that measures value on a cardinal scale, and so, unless otherwise specified, the discussion of value function in the papers on this website refer to measurable value functions.

Because the goal of project selection is to choose projects that create maximum value, creating value/utility functions is the key step for designing formal methods to prioritize projects. See additive utility function for a brief description of a popular method for constructing a value function.

value of information (VoI)

A term used in decision analysis to describe the maximum amount a decision maker should logically be willing to pay for information prior to making a decision. The VoI is defined as the monetary amount that makes the value of the existing decision situation equal to the value of the decision situation with information and with the added cost of paying VoI for the information. Decision trees are often used to compute VoI.

value judgment

Also referred to as a value-based judgment, personal, subjective judgment of how desirable or undesirable, good or bad, better or worse, useful or not useful something is.

value model

A model for expressing in monetary units, or units that can be converted to monetary units, the worth of an alternative, outcome, project, or uncertainty.

value tree

Another name for an objectives hierarchy. Sometimes the term is used to describe an objectives hierarchy with the performance measures arrayed below the corresponding lowest-level objectives in the diagram.

vaporware

An upcoming software product that has been announced but is not yet available. Software developers sometimes provide information about future products or upgrades months or even years in advance. They may do so as a marketing ploy—if current customers believe the supplier will release a breakthrough product soon, those customers may be willing to stick with the supplier's aging software products longer. Also, announcing a phantom product may cause potential customers to perceive the products currently offered by competitors to be less attractive. The vaporware may or may not exist, and may not ever be available with the indicated capabilities and features. Regardless, spreading information about possible future products helps the software provider.

variance

A discrepancy or deviation, as in schedule variance. Also, a measure of variability that indicates how much spread there is in a set of numbers. The variance is the square of the standard deviation. It represents the average squared deviation of each number from its mean.

vision statement

A formal statement developed by an organization to define what it wants to achieve over time. For example, this is the vision statement of the Alzheimer Association: "Our Vision is a world without Alzheimer's disease." The vision statement is typically written succinctly and in an inspirational manner to make it easy for employees to remember and repeat to others. Like an organizational mission statement, the vision statement, if it has been developed, can be found on the organization's website.

virtual machine

A software program that mimics the behavior of computer hardware. A virtual machine is capable of performing tasks such as running applications and programs like a separate computer. The end user has the same experience on a virtual machine as they would have on dedicated hardware.

virtual market

Also called predictive market, a mechanism that allows people to make real or simulated decisions related to the purchase or sale of items or events. The results, such as the market prices that are produced, are used to infer collective preferences or beliefs, or to make predictions. Though a relatively new concept, numerous companies are reportedly using virtual markets to generate information to guide decision making. Virtual markets are can be attractive because participating in a virtual market is simple and the collective information produced by participants can be quite useful. One application area for a virtual market is prioritizing projects (explained here).