Quantifying Contingency; a Bonus Outcome of Risk Management

You have likely experienced this at least once in your project management career – your team has thoroughly planned a complex project and has decided to add contingency reserves to hedge against “known unknowns.”  Even in the halcyon days preceding the current global financial crisis, it was common practice for sponsors or other governance bodies to challenge or strip out such perceived buffers.

While not the only cause, one of the primary contributors towards this rejection of contingency reserves is the subjective approach used for their definition.  Risk perception is susceptible to bias – customers tend to be optimistic about expected project outcomes so it can be challenging to convince them of project risk severity.  The more a team can do to quantify the level of risk on a project and to educate sponsors or customers on the use of contingency reserves, the greater the likelihood that decision makers will support the need for these reserves.

Quantification begins with SMART (see http://en.wikipedia.org/wiki/SMART_criteria ) risk identification to improve credibility in project risk management practices (see http://www.projecttimes.com/kiron-bondale/capturing-the-hearts-and-minds-of-project-risk-stakeholders.html for more insights on engaging stakeholders through risk management).  If your project sponsor or customer is involved in the risk identification process, he or she should already be aware of the specific risks that requested reserves will cover.

Once the risk register has been populated, project teams can use techniques such as the Delphi method to come up with reasonable estimates for probability and impact of occurrence (even if historical data is not available).  Probabilities of occurrence can be estimated as low (25%), medium (50%) or high (75%).  Estimated impacts should not assume the worst case scenario as that will negatively impact credibility in the evaluation.  Once this evaluation is done, expected impact values for risk events can be calculated by multiplying the probability percentages by the estimated impacts.  By summing the expected impacts for all schedule-impacting risks and all cost-impacting risks your project team will have a “maximum” value for contingency reserves.  Obviously you should not present these figures, but you are in a better position to justify the rationale for suggesting that a reasonable percentage of these be allocated as reserves.

Beyond risk quantification, it is important that sponsors understand how contingency reserves are used – a common misconception is that these are “slush funds” that will be misused by project teams.  Educating them on (and following!) a consistent process for the use of contingency reserves (e.g. critical chain project schedule buffers) can help to ease these concerns.

 In spite of these recommendations, you might still encounter the occasional holdout who rejects your request for contingency reserves.  In these cases you consider stating (as diplomatically as possible!): “I understand that you do not feel that contingency reserves are necessary for this project.  As such, would you be willing to sign a decision record reflecting that you are guaranteeing that none of these risks will be realized?”