Many projects will have some type of variance that may impact total project cost. These variances could be expected seasonal bad weather delaying a team from flying to a job site, an organization lacking well documented business processes, a very complex technical plan, many interfaces with a new system, unmaintained data, a team with limited experience or any other potential risk. Often these risks occur and become change orders and add cost to a project. When planning a project these risks should be considered and communicated in economin impact terms.
The cost allocation or estimate for some probability based combination of these risks or changes is typically expressed as project risk contingency.
There are many ways to calculate risk contingency. In its most basic form it should follow these steps:
Identify the estimated cost of the risk neutral scope of a project.
Identify the potential project risks.
Assign probabilities to each potential risk.
Quantify the potential risks*.
Determine the range of the additional potential cost based upon the probability of these risks (lowest, highest and most likely).
The "most likely" value is probably an accurate contingency value although any number within the project range is a possibility.
The contingency value can then be expressed as a dollar figure, percentage of neutral scope or both.
* While not part of this discussion if you are following these steps you are actually risk planning and determining ways to potentially mitigate the identified risks would be recommended.
Some very complex tools and calculations that can help to very accurately predict project costs utilize concepts like Probability Analysis, Monte Carlo Analysis, Pert Distribution and Triangle Distribution.
Industry averages or experience averages can also be used to help validate or plan for contingency. For example, if a project manager has implemented an ERP system 20 times with the same basic functionality and has learned that most projects are about 12% over estimated costs due to specific risks, this provides some high level insight for future project contingency. However, it is very lazy, and identifying, analyzing, quantifying and communicating the probability of the key risks or changes and their potential project impact is recommended as every project has its own uniqueness.
So in the real world, how is a contingency percentage or number often calculated? The hope is that most project managers leverage a tool or follow a process, like the one illustrated here. Unfortunately, it is all too common that a project manager will assign an arbitrary number pulled out of thin air, for example 5-10% of total estimated costs. This haphazard approach can have some serious consequences, as it is based on only the wishful hope of being accurate. Don't be lazy, do the work and go have a successful project!
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