CHAPTER TWO

IDENTIFICATION AND FORMULATION OF PROJECTS

2.1 Definition

Project idea is the statements of how a certain problem can be overcome or a particular
policy objective can be achieved

2.1 Generation and Screening of Project Ideas

The search for promising project ideas is the first step towards establishing a successful
venture. Identification of investment opportunities requires imagination/thoughts,
sensitivity to environmental changes, and realistic assessment of what the investor can do.
The task is partly structured/planned and partly unstructured/unplanned, partly dependent
on convergent thinking, partly dependent on divergent thinking. However, there is no
well-defined theory to guide the task of identifying project opportunities.

A very common route for project formation is: Someone with specialized technical
knowledge or marketing expertise or some other competence feels that he can offers a
product or service which can cater to a presently unmet need or serve a market where
demand exceeds supply or effectively compete with similar products or services because of
certain favorable features like better quality or lower prices. This idea is endorsed by his
associates and financial institutions.

To stimulate the flow of project ideas, SWOT analysis is helpful. It analyzes strengths,
weaknesses, opportunities and threats; SWOT Analysis represents a conscious, deliberate,
and systematic effort by an organization to identify opportunities that can be profitably
exploited by it. Periodic SWOT analysis facilitates generation of idea.

2.2 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.

Project Analysis and Management Lecture note compiled by Tesfamichael F. 1

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 pave 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.

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

projects usually employs the following:

A) 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.

B) 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.

2.3 Sources of Project Ideas

The following are some suggestions for trapping the sources of good project idea.

1. Analyze the performance of existing industries: A study of existing industries in

terms of their profitability and capacity utilization is helpful. The analysis of profitability
and break even level of various industries and an examination of capacity utilization of
various industries indicate promising investment opportunities.

2. Examine the inputs and outputs of various industries: An analysis of inputs may
throw up project ideas. If inputs required are purchased from distant sources or if some
firms produce their inputs internally that can be supplied at a lower cost investment
opportunity is there. Similarly, a study of output may reveal opportunities for adding value

Project Analysis and Management Lecture note compiled by Tesfamichael F. 2

through further processing of main products, by-products, as well as waste products. ‘One
person’s trash may be another person’s treasure.’

3. Review Imports and Exports: An analysis of import statistics from period of 5 to 7

years is helpful in understanding the trend of imports and the potential for import
substitution. Local production of such goods may improve the balance of payment
situation and create employment opportunities.

4. Study Plan Outlays and Government Guidelines: The government’s proposed

outlays in different sectors, its priority areas in the development process, and its attitude
towards private investment will lead to a number of investment opportunities. Various
incentives offered by the government will also be helpful for formulating projects.

5. Look at the suggestions of Financial Institutions and Developmental Agencies :

Financial institution and development agencies offer suggestions to potential
entrepreneurs. The suggestions of these agencies are helpful in identifying promising
projects.

6. Investigate Local materials and resources: A search for local materials will lead to a
number of project opportunities. We may come across unexplored raw materials and
unexploited labor skills.

7. Analyze Economic and Social Trends: A study of economic and social trends is
helpful in projecting demand for various goods and services. Changing economic
conditions and consumer preferences provide new business opportunities. The demand for
timesaving products like fast food, ovens etc. have been increasing.

8. Study new technological development: New products or new processes and

technologies for existing products developed by researchers may offer investment
opportunities.

9. Draw Clues from consumption abroad: Products or supply of services which are
new to the country but extensively used abroad may be good ideas for investment.

10. Explore the possibility of reviving sick units: There may be a number of units, which
have been characterized as sick. A significant proportion of sick units can be nursed back
to health, by sound management, infusion of further capital, and provision of inputs.
Hence, there is a fairly good scope for investment in this area.

11. Identify unfulfilled psychological needs: Though goods are available in the market,
there may be customers who are not satisfied with the available products. The available
products may not be suitable for satisfying the particular passions and desires of certain
customers. A study on such unsatisfied needs may open doors for investment.

12. Attend Trade Fairs: National and international trade fairs provide excellent
opportunities to get to know about new products and developments.

Project Analysis and Management Lecture note compiled by Tesfamichael F. 3

13. Stimulate creativity for generating new product ideas: New product ideas may be
generated by thinking along the following lines: Modification, Rearrangement,
Magnification, Combination and Substitution.

14. Chance factors : You may come across various investment opportunities accidentally,
particularly while you are on a journey.

15. Unusual events such as drought, flood, earthquake, hostilities etc.

2.4 Preliminary Screening

Using the above mentioned guidelines, it is possible to develop a long list of project ideas.
But, all these ideas may not be promising. Therefore, a preliminary screening is required
to eliminate ideas which prima facie are not promising. In order to do a preliminary
screening the following aspects have to be taken into account.

1. Compatibility with the promoter

In choosing from the project ideas, it has to be borne in mind that the ideas must be
compatible with the interest, personality, and resources of the entrepreneur. A real project
opportunity has three characteristics;
i. It fits the personality-ability and training-of the entrepreneur
ii. It is accessible to him and
iii. It offers him the prospect of rapid growth and high return on invested
capital.
2. Consistency with Government Priorities
The project idea under consideration must be capable of meeting the national goals and be
within the framework of the regulation of the government. Some of these regulations are:
environmental regulations, foreign exchange restrictions, and the procedure for giving
licenses. The project must be within the environmental impacts regulations and should
never be contrary to such regulations. The foreign exchange requirement of the project
must be within the foreign exchange regulations of the country. It should also be checked
whether the project is able to obtain license from the government or it falls under business
areas that are restricted by the government.

3. Availability of Inputs
The resources and inputs required for the project must be reasonably assured. A number of
projects in some of the developing countries face with shortages of inputs like power,
foreign exchange, and important raw materials. Therefore, the project under consideration
should make sure that:
i. The capital requirements of the project are within the manageable limits.
ii. The technical know how can be obtained.
iii. Raw materials are available and
iv. The power supply and infrastructural facilities are adequate.

4. Adequacy of the Market

Project Analysis and Management Lecture note compiled by Tesfamichael F. 4

The size of the market offers the prospect of adequate sales volume. There should be a
potential for growth and a reasonable return on investment. Therefore, the overall situation
of the market should be paid attention in the secretion of a project idea. The total present
domestic market, export market, competitors and their market shares, sales and distribution
system, and projected increase in consumption are some of the factors that influence the
marketing aspect of the project. In other words, the project under consideration must make
sure that adequate market will be available for the product of the project.

5. Reasonableness of Cost
Availability of inputs at exorbitant rates will never help the project to be successful.
Therefore, the proposed project must see that it can get the necessary inputs at reasonable
costs. The costs of materials, labor costs, factory overheads, administrative and selling
costs, and service costs must be affordable and within the limits of the project cost
structure. Thus, it is better to select a project for which the inputs are available at
reasonable cost and drop a project for which materials and other inputs are available only
at a high cost.

6. Acceptability of Risk Level

The desirability of a project is critically dependent on the risk characterizing it. A project
that is exposed to low risk is always advisable. In the assessment of risk, the factors to be
considered are;
(1) Technological changes
(2) Competition from substitutes
(3) Competition from imports and
(4) Governmental control over price and distribution
3.1 Project Identification Studies

Search for promising project ideas aimed at identifying feasible and promising
investment opportunities that merit further examination and appraisal.
 Finding project ideas contributing towards achievement of specified objectives –
for development projects, national and sub-national plans serve as a frame of
reference.
 Tell what is possible in particular area or field of investment.
 Sketchy, based more on rough aggregate estimates that detailed analysis.
 Intended primarily to highlight the principal investment aspects of a possible
industrial proposition.
 Their purpose is to arrive at a quick and inexpensive determination of the salient
facts of an investment opportunity, thus, their preparation should not involve any
substantial costs.
 Enable projects to be conceived and identified.
 General or specific.

3.3.2 Things to be considered in Project Identification Studies

Project Analysis and Management Lecture note compiled by Tesfamichael F. 5

For a preliminary analysis to ascertain the viability of the idea conceived and alternative
investment opportunities identified the following should be considered.
a) Related natural resources base with the potential for exploitation.
b) Relevant agricultural pattern that can motivate agriculture based activities.
c) Potential demand for products in reaction to population increase, national
income increase (hence personal income) or due to the novelty of the product.
d) Imports and possible import substitution.
e) Experience of other countries with similar development, resource and economic
background.
f) Possible interlink-age with domestic/foreign industries.
g) Possible product line extension through integration with other existing set-ups:
i. Horizontal integration – combination of organizations producing essentially
similar products or existing at the same stage of production, marketing or
distribution. The most common approach is to buy out competitors.
ii. Vertical integration – combination of different types of organizations along
the supply chain:
 Backward: when an organization starts to produce materials or components
needed to produce a finish product it currently produces e.g. when a bakery
starts to process flour
 Forward: when an organization engaged in supply of inputs (materials or
components) starts to produce finished goods/services based on the inputs it
supplies e.g. when a flour mill starts baking bread
h) Possible diversification:
i. Conglomerate diversification – widening product range by adding products
unrelated to existing ones e.g. when a college is engaged in
transportation/bottling affairs.
ii. Concentric diversification – widening product range by adding products
related to existing ones in terms of processing, input or other requirements e.g.
when a college diversifies to distance education or when a food processing
plant enters into processing drinking items
i) Expansion of current capacity to attain economies of scale
j) General investment climate
k) Industrial policies
l) Availability of production factors
m) Export possibilities

3.3.3 General Project Identification Studies

√ Descriptive providing highlights only.
 Usually conducted by :
 Federal, regional or local government units such as investment bureaus.
 National or international chamber of commerce.
 A national or international investment promotion agency.
 A national or international financing agency.
 Free from detailed cost or other quantitative analysis.
 Divided into area, sub-sector and resource-based studies.

Project Analysis and Management Lecture note compiled by Tesfamichael F. 6

1. Area Study – concerned with a given geographic area such as an administrative
province, region or locality
a) Basic features of the area – size, physical features and maps.
b) Population – occupational pattern, per capita income, socio-economic
background.
c) Main exports from and imports to the area.
d) Basic production factors – exploited or exploitable.
e) Existing industries utilizing local resources.
f) Infrastructure facilities (conducive for investment) – communication and
power.
g) List of possible industries that can be developed based on the available
resources and infrastructure facilities.
h) Revised list of industries identified above excluding those:
 With too small local demand.
 Involving too high transportation costs.
 Facing too severe competition from adjoining areas.
 Which can be more favorably located in other areas.
 With unacceptable environmental impacts.
 Requiring feeder industries not available nearby.
 For which markets are distantly located.
 Which do not merit priorities as per national plans, allocation, etc.
i) Estimate present demand for industries listed above.
j) Identify approximate capacity.
k) Estimate capital costs taking into account land, technology, equipment, civil
engineering works, project implementation, pre-investment capital
expenditure and working capital requirement.
l) Approximate estimation of major input requirements such as raw materials,
components, supplies, utilities and labor including sources (local vs.
imported).
m) Estimate production costs.
n) Estimate annual sales revenue.
o) Organizational and management aspects typical for the industry.
p) An indicative time schedule for project implementation.
q) Total contemplated investments in project and peripheral activities.
r) Projected and recommended source of finance.
s) Estimated foreign exchange requirements and earnings.
t) Financial evaluation – approximate payoff, RR, possible advantages and
potentiality of enlarged product-mix, diversification, etc.
u) Tentative analysis of overall economic benefits:
 Those related to national economic objectives.
 Balanced dispersal of economic activities.
 Foreign exchange savings.
 Generation of employment opportunities.
 Economic diversification.
2. Sub-sectoral Study – concerned with a certain industrial branch such as food processing,
leather or electronics:

Project Analysis and Management Lecture note compiled by Tesfamichael F. 7

 a) Place and role of the sub-sector in industry.
b) Size, structure, growth rate of the sub-sector.
c) Present size and rate of growth of demand of items that are not imported
and of those wholly or partially imported.
d) Rough projection of demand for each item.
e) Identification of the items in short supply that have growth and/or export
potential.
f) A broad survey of the raw materials indigenously available.
g) Identification of investment opportunities based on items ii, v & vi and
other important factors such as transport cost, available and potential
infrastructure.
h) Continue with items "k" to "u" of area study - once the investment
opportunities are identified, the structural requirements of both the area and
sub-sect oral studies are the same.

3). Resource-based Study – dealing with utilization or exploitation of certain resources

such as forestry and minerals
a) Characteristics of the resource, prospective and proven reserves, past rate of
growth and potential for future growth.
b) Role of the resources in the national economy, its utilization, demand in the
country and exports.
c) Industries currently based on the resources, their structure and growth,
capital employed and labour engaged, productivity and performance
criteria, future plans and growth prospects.
d) major constraints and conditions in growth of industries based on the
resources
e) Estimated growth in demand and prospects of export of items that could
utilize the resources.
f) Identification of investment opportunities based on items iii, iv and v.
g) Continue with items xi to xxi of area study - once the investment
opportunities are identified, the structural requirements of both the area and
resource-based studies are the same.
3.3.4 Specific Project Identification Studies
√ More common than a general opportunity studies.
 Follow the general opportunity studies.
 May be defined as the transformation of a project idea into a broad investment
proposition.
 In developing countries, this is done by a governmental investment promotion
agency or chamber of commerce.
 May be undertaken by the prospective investor or an entrepreneurial group.
 As the objective is to stimulate investor responses, the mere listing of products
(based on general economic indicators such as past imports, growing consumer
demand or from one of the general opportunity studies relating to areas, sectors or
resources) that may have potential for domestic manufacture is not sufficient, it,
however, may serve as a starting point.
 Should include certain basic information:

Project Analysis and Management Lecture note compiled by Tesfamichael F. 8

  Be selective as to the products identified.
 Incorporate data (e.g. demand and resource requirement) relating to
each product so that potential investors will be able to consider
whether the possibilities are attractive enough to proceed to the next
stage of project preparation.
 Such data can be supplemented with information on basic
governmental policies and procedures that may be relevant to the
production of the particular product.

Project Analysis and Management Lecture note compiled by Tesfamichael F. 9