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I'm a risk enthusiast who likes to discuss techniques, tools and models—and use risk as a practical means to make better decisions in project environments. Join me on the ride!

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(mis)Understanding Contingency

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(mis)Understanding Contingency

Early this month I posted a poll here asking how you determine contingency and how much is generally considered.

In my venues, I usually map the risks and uncertainties as good as possible and run a simulation to understand variation regarding my goal, being it cost or schedule. I then determine a level of contingency for the project and add extra days or dollars to arrive at the percentile level.

Reading some references on risk analysis, people usually choose some references for safety. David Hulett, in his "Schedule Risk Analysis" (Gower, 2004) generally highlights P80. So I started wondering: how safe should your schedule be? How safe should your budget be?

My answer for that is that it depends. Depends on whether this project is another one in a set of 40 or 50, or if it is the only project of your firm, or the first project you are undertaking.

If you have a single project, you may be quite worried and stablish a high level of contingency, not to be caught off guard. I did some numerical experiments assuming a project would have an estimated P50 cost of 100 thousand dollars with a standard deviation of 20 thousand dollars, normally distributed.

If you want a safety level of 50%, you would always be prepared for spending the 100 thousand dollars for each project. However, as you add more projects to your portfolio, considering the results are statistically independent.

The question is how much should you add to each project in order to secure a safety level for the whole portfolio. If you have a single project, you need to add an extra US$ 32,900 to reach a 95% safety level. That's an increase in almost 33% of your budget! In the other ned, if you have 30 projects in your portfolio, adding US$ 6,000 in each project will get you to the same level of safety. 6% extra increase for a good night's sleep! If you want to see the detail, there is a graph and a table in the end of this entry with the data.

We should consider portfolio size in our decisions regarding contingency. That is why some references tell you to aim for the P50 or the average value in the simulation. If you have plenty of projects, the overall value will converge to the average in most of the cases.

Please let me know your opinion on this one. Do you run Monte Carlo to determine contingency or safety levels? Do you impose those values directly into each project? Do you have a line in your budget for the whole portfolio?

Looking forward to hear from you!

A graphical depiction of the example.

 

A table with the values calculated for the example

  Level of Safey required      
# of projects 50% 60% 70% 80% 90% 95%
1 100,0 105,1 110,5 116,8 125,6 132,9
2 100,0 103,6 107,5 111,9 118,1 123,3
3 100,0 102,9 106,0 109,7 114,8 119,0
4 100,0 102,5 105,2 108,4 112,8 116,5
5 100,0 102,2 104,7 107,6 111,5 114,7
6 100,0 102,0 104,3 106,9 110,5 113,4
7 100,0 101,9 104,0 106,4 109,7 112,4
8 100,0 101,8 103,7 106,0 109,0 111,6
9 100,0 101,7 103,5 105,6 108,5 111,0
10 100,0 101,6 103,3 105,3 108,1 110,4
11 100,0 101,5 103,2 105,1 107,7 109,9
12 100,0 101,5 103,0 104,9 107,4 109,4
13 100,0 101,4 102,9 104,7 107,1 109,1
14 100,0 101,4 102,8 104,5 106,9 108,8
15 100,0 101,3 102,7 104,4 106,6 108,5
16 100,0 101,3 102,6 104,2 106,4 108,2
17 100,0 101,2 102,5 104,1 106,2 108,0
18 100,0 101,2 102,5 104,0 106,0 107,8
19 100,0 101,2 102,4 103,9 105,9 107,6
20 100,0 101,1 102,3 103,8 105,7 107,4
21 100,0 101,1 102,3 103,7 105,6 107,2
22 100,0 101,1 102,2 103,6 105,5 107,0
23 100,0 101,1 102,2 103,5 105,4 106,9
24 100,0 101,0 102,1 103,4 105,2 106,7
25 100,0 101,0 102,1 103,4 105,2 106,6
26 100,0 101,0 102,0 103,3 105,0 106,5
27 100,0 101,0 102,0 103,2 105,0 106,4
28 100,0 100,9 102,0 103,2 104,9 106,3
29 100,0 100,9 101,9 103,1 104,8 106,1
30 100,0 100,9 101,9 103,1 104,7 106,0
31 100,0 100,9 101,9 103,0 104,6 105,9
32 100,0 100,9 101,9 103,0 104,6 105,8
33 100,0 100,9 101,8 102,9 104,5 105,7
34 100,0 100,9 101,8 102,9 104,4 105,6
35 100,0 100,9 101,8 102,8 104,3 105,6
36 100,0 100,9 101,8 102,8 104,3 105,5
37 100,0 100,8 101,7 102,8 104,2 105,4
38 100,0 100,8 101,7 102,7 104,2 105,4
39 100,0 100,8 101,7 102,7 104,1 105,3
40 100,0 100,8 101,7 102,7 104,1 105,2
Posted on: February 08, 2019 11:26 AM | Permalink | Comments (9)
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