Thoughts on 'Understanding risk contingency and management reserve'
Posted by APM on 1st May 2013
The APM Risk SIG conference was hosted by Fujitsu at their Baker Street, London, headquarters on Thursday 11th April 2013. The SIG committee decided to run a conference on this topic because they believed that ‘best practice’ was still unclear, indeed it was a bit of a black art! And so the conference proved.
Peter Campbell (Risk Advantage) covered “Contingency terminology and the risk and earned value approach”
Peter started by saying that the definitions aren’t clear or agreed. Peter used the term Management Reserve to cover specific and non-specific risks. He said that non-specific risk threat reserve is typically a percentage of cost and is to cover unknown risks and actions.
One item that would be debated later was that he said that PMs shouldn’t be allowed to control usage (utilisation) of the project contingency as that doesn’t incentivise them to actively manage their risks.
Another which was part of the pre-conference survey, was that his view is risk opportunities should not contribute towards contingency/management reserve though he believed that realising opportunities would add to the specific threat reserve.
He stated that the existing change management process would be used to control draw down/usage/utilisation.
Dave Scarbrough (Fujitsu) gave his company’s view
He explained how Fujitsu manage risk and contingency and explained Fujitsu’s views of the various terms/definitions.
The term Contingency is used (not ‘management reserve’) and it is very much a management decision/judgement using the calculations provided by their in-house risk tool. They do not use ‘Monte Carlo’.
The APM ‘Portfolio’ term corresponds in Fujitsu to a business area (Account, service line) and contingency is held at the Account level for lower level activities (projects and portfolios).
Because Fujitsu have the policy that whichever area of the business holds the risk then their P&L will pay out (utilise) for any risk occurring, then the overall contingency needs to be sub-divided amongst all the business areas participating in a project or programme.
Mary Robinson and Dominic Wells (AWE - The Atomic Weapons Establishment) gave their organisation’s view
AWE use quantitative analysis ‘Monte Carlo’ to determine the level of project ‘reserve’. They allocate the P50 value to projects, give the P70 – P50 value to the Programme and the customer holds the P90 – P70 amount.
AWE do also use the change process to control contingency variations and draw downs.
Risk opportunities do not contribute towards the reserve.
Sadly none of their long timeframe projects have completed yet so they had no lessons learnt.
Val Jonas (Risk Decisions Ltd) explained “How risk tools can help you”
Because risk tools are applications, their rules have been clearly defined but that doesn’t mean their definitions/rules are correct or consistent!
Firstly Val looked at tools to help calculate cost and schedule contingency and all tools Val considered used some form of quantitative analysis (‘Monte Carlo’). She neatly reminded/explained the difference between the P80 means that there is a 80% chance of being within that stated amount and not that the project will use less that 80% of the worst case spend (total exposure)!
She explained how a 'new to me' tool, Deltek’s Cobra, can assist to manage the contingency when rolled right up to the portfolio level.
Finally she covered a few ideas on how tools can help the management of that contingency pot/management reserve.
Val threw into the ring her view that project managers should be able to draw down management reserve from their project level but only against known risks and within rules.
Survey, Discussion, Q&As
All the presenters and the SIG committee members congregated at the front for a very lively discussion and debate started off from reviewing the results of the pre-conference survey.
Should opportunities be in the contingency Provision?
There were arguments for and against including opportunities in the contingency pot.
It was argued that if the ‘best’, most cost effective solution was being undertaken then most opportunities were already included in the project baseline and including them in the contingency would ‘doubly’ reduce the available money.
Also culturally PM’s like the comfort of having a contingency they could call on, so would not want to reduce it.
The question then arose on How do we incentivise opportunity finding at the start of a project if all that it does is reduce the PMs risk pot?
Dave Hillson (on the panel) argued that as opportunities are the flip side of threats then they should be included.
Val Jonas (on the panel) stated that it was not sensible tool-wise as negative finances are not real. Also she did not believe that Threats and Opportunities are the flip side because Opportunities do not occur if you do not actively do something, whereas Threats occur if you do not actively do something.
If Opportunities are in the baseline then you need a threat that the Opportunity will not occur, which increases the contingency pot.
It was stated that from a practical standpoint that if positive risk (opportunities) reduces the contingency pot, then it would drive the wrong behaviour in PMs.
It was stated that Opportunity Management is the same as Value Management –you get the biggest effect at the start- to get the bid correct/initial design right and its effectiveness diminishes the further through the project you get.
Contingency is factored amount against a defined set of threats. Including Opportunities reduces available money but threats remain the same.
Survey Q6 In your Organisation what types of risks are covered by PPP contingency?
All risks Threat and Opps should contribute to overall contingency for PPP
T/O should be managed in same process
Against - PM not working most efficiently i.e. not most efficient baseline
Put ‘mitigation’ in baseline for both Threats/Opportunities, for Opportunities worth doing/can be afforded.
It was stated that if Risks do not happen then money still available in MR. However if Opportunties do not happen then the money is already lost.
The question arose of who owns the Opportunities and how much of the saving should be returned to the client – scope change?
Survey Q7 What proportion of programmes in your organisation have formal contingency budgets
Majority of projects have some sort of contingency
About 6 people said that they had Nonspecific contingency.
Monte Carlo was used in Public Sector but not that much in Private Sector. Why?
Reasons – expensive to do and requires specialist expertise
Undertaken because Government expects /requires it.
Why is Monte Carlo Best practice?
Get better estimates. More confidence in the answers.
Due to economic climate started to move into construction as margins get tighter need to get better estimates.
However accuracy all depends on the base data.
The discussion was very lively and it all emphasised that best practice is not yet clear in this subject of contingency and management reserve.
Right at the end Alex Davis, of the APM PMC SIG, gave a short presentation about our topic from the project management control viewpoint.
Dave Scarbrough, Fujitsu
Thanks to Keith Harrison for capturing notes during the Discussion.
The presentations can be seen below: