Negative Project Interactions
Negative interactions mean that the sum of the parts is worth less than the parts individually. In this case, projects have negative influences on one another, and thereby decrease one another’s value. Economists sometimes call negative externalities diseconomies of scale. Here are a few examples.
Pollution and Congestion If there is only one major road to two divisions, and the traffic of one division clogs up the traffic to the other division, it can cause a loss of cash flow in the other division. A division that wants to expand and thereby clog up more of the existing infrastructure will not want to pay for the congestion cost that its own expansion will impose on the other divisions. (Of course, it is the overall firm’s headquarters that should step in and allow the expansion only if the NPV is positive after taking into account the negative externalities imposed on other divisions.)
Cannibalization If a new Apple computer can produce $100,000 in NPV compared to the older Windows machine that only produced $70,000 in NPV, how should we credit the Apple machine? The answer is that the Apple would eliminate the positive cash flows produced by the existing Windows machine, so the cash flow of the project “replace Windows with Apple” is only the $100,000 minus the $70,000 that the now unused Windows machine had produced.
Bureaucratization and Internal Conflict If more projects are adopted, project management may find it increasingly difficult to make good decisions in a reasonable time frame. This may require more cumbersome bureaucracy and reduce cash flows for all other divisions.
Resource Exhaustion Perhaps the most common source of negative externalities—and often underestimated—is limited attention span. Management can only pay so much attention to so many different issues. An extra project distracts from the attention previously received by existing projects.
Although costs always include opportunity costs, in the case of negative project externalities, they are more obvious. If your project cannibalizes another project or requires more attention, it’s clearly an opportunity cost.