Safety in numbers
the proper contingency budget can blunt the blow of surprises -- without surpassing spending limits
Jihan Al-Sherif, PMP, David Jones, Sydney, Australia
BY KATE ROCKWOOD
PORTRAITS BY RYAN LINNEGAR
Every project has risks. Whether the cost of a building material suddenly spikes, the value of a currency nose-dives or the regulatory landscape changes mid-project, realized risks can kill a project's prospects. Contingency budgets offer a lifeline: They prevent setbacks from pushing a project off the rails and save project leaders from asking the sponsor for more funds.
But determining exactly how much should be held in reserve funds to cover specific risks and managing the back-and-forth between the risk register and the contingency fund takes finesse. Bloat the contingency budget with too much padding, and the sponsor might reject it. Trim it to the bone, and those early estimations have a choke hold on the project team's ability to problem-solve. Striking the proper balance between flexibility and frugality requires project leaders to build a strong case for the value of a safety net.
“Unfortunately, project budget planning is too often tied to the financial constraints of the organization,” says Maja Ferle, PMI-ACP, PMP, IT project manager, Tata, Ljubljana, Slovenia. “Stakeholders, including project sponsors, want to cut corners by eliminating contingencies, especially because contingencies are not well-defined at the start of the project.”
As any seasoned project leader knows, a project with scant contingency funds is a project skating on thin ice. Here are five tips for staying on safer ground.
Contingency budgets are built on a detailed understanding of the project's risks—including the likelihood they will be realized and the cost of a response plan.
“Contingency planning and risk management go hand in hand,” says Jihan Al-Sherif, PMP, transformation project manager, David Jones, Sydney, Australia.
“Contingency planning and risk management go hand in hand.”
—Jihan Al-Sherif, PMP, David Jones, Sydney, Australia
To ensure that the contingency budget is built on a solid foundation, calculate the cost of a risk response plan for high-impact risks or those that are more likely to happen. At London, England-based Network Rail, for instance, projects have a contingency budget that ranges from 20 percent to 80 percent above cost, depending on the scope and complexity of the project and the risks associated with it, says Matthew Hannaway, PMI-RMP, PMP, head of project risk and value management, Network Rail, London, England.
When Ms. Al-Sherif recently calculated a contingency budget for a business process management program she oversaw, she realized the organization didn't typically do this type of work—yet the program's successful execution was an integral part of its strategy.
When the program began to suffer during the execution phase because of resource and training issues, “the contingency budget saved the day,” she says. Those allocated funds were used to cover the cost of additional resources and much-needed training. As a result, the program finished on time, on budget and delivered its intended scope.
“Without the right contingency budget assigned and approved, the organization would have suffered.”
2 Make the Case
Setting a responsible contingency budget starts with an honest conversation about how much the sponsor is prepared to hold in reserve—and what will happen if the project encounters a major risk with no safety net in place.
“You need to understand from the sponsor what amount of contingency fund might even be available for the project,” says Travis Scruggs, PMP, senior technical project manager, Helix Education, Chicago, Illinois, USA.
Having an engaging, data-driven dialogue with the project sponsor does more than just build the case for contingencies. It can also help make the project team's response to risks during project execution faster and more effective. But getting sponsor buy-in can be as much about persuasion and education as logistics. “Break it down as a story, so it connects with the sponsor. Make sure your presentation includes more graphs and pictures than blocks of text or data,” Mr. Scruggs says. “And you need to be prepared with alternatives regarding your contingencies and risk management strategies.”
“Break it down as a story, so it connects with the sponsor. Make sure your presentation includes more graphs and pictures than blocks of text or data.”
—Travis Scruggs, PMP, Helix Education, Chicago, Illinois, USA
For instance, maybe the project sponsor can't green-light a sizable contingency but is willing to approve scope reduction if certain risks are realized, Mr. Scruggs says.
3 Follow Protocol
Project leaders should determine what level of spending authority they have over contingency funds. For instance, at Network Rail, project managers have the freedom to access the first 10 percent. If they need an amount that falls between 20 and 50 percent, they must get approval from the program management team. Any amount above 50 percent requires authorization from the portfolio management governance board.
“It's less about the size of the budgets than the behaviors around contingency reserves,” Mr. Hannaway says. “Taking a tiered approach allows us to make sure the money is there and accessible, but also make sure it's not spent inappropriately.”
“Taking a tiered approach allows us to make sure the money is there and accessible, but also make sure it's not spent inappropriately.”
—Matthew Hannaway, PMI-RMP, PMP, Network Rail, London, England
Project leaders may also want to determine whether the organization is willing to offer access to management reserves. Because these funds aren't tied to a specific project's risk register and are intended to cover emergencies across the portfolio, project sponsors could offer fewer contingency funds by tapping these reserves in case of an emergency—as long it wouldn't expose other projects to unacceptable levels of risk.
There's little margin for error when creating and managing right-sized contingency budgets. We asked project professionals: What are the most common missteps?
|“Some project practitioners consider contingencies another line item of money that they can spend however they like, rather than remembering it's there to deal with risk and uncertainty. Contingencies should be available to be drawn down—but only when you can demonstrate that the risk has happened.”||“Newer project managers may perceive uncertainty on a project as their own weakness and a sign they are not fully in control. Consequently, they don't consider planning contingencies. But there's always a certain level of risk on any project, and the contingency budget is one way to start mitigating those risks.”||“The biggest mistake some project managers make is diving into the calculations before they've identified the risks upfront. Only by identifying the risks can you really identify what the potential additional costs may be—and work to avoid them with proper planning.”||“If you are new to project management, it's okay to start contingency planning by applying simple methods to avoid complicating things. But it's a mistake to stop there. Continue educating yourself on risk management, whether by reading articles and books or going for the PMI-RMP® certification.”|
|—Matthew Hannaway, PMI-RMP, PMP, head of project risk and value management, Network Rail, London, England||—Maja Ferle, PMI-ACP, PMP, IT project manager, Tata, Ljubljana, Slovenia||—Travis Scruggs, PMP, senior technical project manager, Helix Education, Chicago, Illinois, USA||—Jihan Al-Sherif, PMP, transformation project manager, David Jones, Sydney, Australia|
4 Learn From the Past
No two projects are exactly alike. So it's impossible to use the same risk formula for each initiative's contingency budget.
“Every project has a unique nature, requirements and context, so it doesn't make much sense to use a standard percentage, like 5 percent or 10 percent, to calculate contingency budgets,” Ms. Al-Sherif says. “You have to understand the project's unique risks, prioritize them and work on the cost of your risk mitigation actions.”
Looking closely at past projects can help point project practitioners in the right direction, Ms. Ferle says. Having a historical perspective on the size of the contingency fund and how much of it was tapped during the project can inform future estimates.
“You have to understand the project's unique risks, prioritize them and work on the cost of your risk mitigation actions.”
—Jihan Al-Sherif, PMP
“In well-established project teams that develop software using known technology, applying lessons learned from previous projects can be a great resource for estimating contingency budgets,” she says. “But in projects where a new technology is used or a new approach is introduced, there's more uncertainty with respect to contingency planning.”
When a project has a long R&D phase, untested technical aspects or is making a foray into a new area, it can be harder to calculate contingencies because there are fewer (or no) precedents to draw from. These projects are inherently riskier, which makes it all the more important that key stakeholders, such as executives and the project sponsor, weigh in on the risk register and how that will inform contingency planning.
5 Be Ready to Act
Tracking spending against contingencies as a project progresses can help project managers raise the red flag when too many risks have been realized. For instance, if 30 percent of the project is complete but 75 percent of the contingency budget has been used up, it's time to discuss the possibility of a budget increase or scope reduction with the project sponsor.
“From my perspective, the most effective strategy for structuring the contingency budget is at the phase level,” says Mr. Scruggs. With a software development project, for instance, project execution might be broken into design, development and testing. Each phase would be assigned its own contingency budget, so if the design phase proved riskier—and more costly—than estimated, the project leader would be prepared to react at that time.
If the team is using an agile approach, the project manager and sponsor could incorporate contingency analysis into each iteration review. “That allows them to pivot as needed, depending on how the project is coming along,” Mr. Scruggs says. “It's so important to have a sponsor who's not just committed to the project but also understands that there may be a scenario where the scope needs to be decreased in order to stay within budget.” PM
PM NETWORK JUNE 2016 WWW.PMI.ORG
JUNE 2016 PM NETWORK
The Practice Standard for Project Estimating – Second Edition focuses on providing models for the project management profession in both plan-driven and change-driven adaptive (agile) life cycles.