What’s the Price of Contingency?
Contingency budgets are a common and necessary aspect of construction project budgets. These are not “slush funds” that should be, or generally are, arbitrarily created by overly cautious project managers. On the contrary, a well thought out contingency budget is the direct result of a risk assessment by the project manager and team, to cover those known and unknown risks that are thought to be likely to occur, during the course of the construction project. Nonetheless, this direct correlation between existence and size of contingency budgets to project risks, are not always well understood, nor articulated clearly to either clients or company management. This article begins the discussion of how to use established Risk Management techniques, to both define and defend a project contingency.
Contingency budgets are widely used within construction projects, both in the US and worldwide. The most common percentage of the base costs reserved for Contingency is between 5 and 10%, but can range from 0% to upwards of 20%. (See the graph to the right.) Nonetheless, questions will continue to arise on how, you, as Project Manager, have chosen the Contingency Budget for your particular project:
- Clients may push back on the extra costs in your budget; OR
- Your management may question whether you have budgeted enough contingency, to be sure your project delivers on time, and on budget.
Ultimately, you want to have confidence that your choice of Contingency Budget is sufficient to reasonably assure your project is successful — on-time and on-budget! But reserving too much, can cause real problems for your client, in that money just sitting unused, could have been used to fund other vital business objectives for them. So, just pulling a number “out of the hat”, say 10%, may end up not being the best option.
Wouldn’t it be great to have a real basis for your estimate of contingency, rather than just “what everybody else does”? Luckily, there are many proven methods for coming up with Contingency Budgets, ranging from very simple to very complex. I’ve outlined one simple approach in this article.
Risk Management and Contingency Budget
Contingency Planning (and contingency budgets) is just one facet of the general Project Management discipline of Risk Management. There are many great sources of detailed thinking on this discipline, e.g. the Project Management Institute web pages (PMI.org.) (I actually feel like Risk Analysis & Management is the most important planning tool for project managers, but that is the topic of another blog.)
But, you don’t necessarily have to spend a huge amount of time, in order to ground your Contingency Budget, and provide yourself, and your clients, with some reassurance, that these reserve funds are both sufficient and reasonable.
Level 0 Contingency Budgeting:
For many smaller or more straightforward construction projects, it is frankly, just not worth spending days or weeks, in risk assessment meetings, or running Monte Carlo simulations of possible scenarios, etc., to achieve a “95% Confidence Level contingency budget.” It is just overkill! But, you can likely justify spending an hour or maybe two, doing what I call a Level 0 Contingency Budget. It is as simple as choosing a Base Contingency Rate, and then adjusting this based upon a quick Risk Analysis:
- Choose a Base Rate, based upon the type of project, and you and your company’s past experience. (There is a great discussion of this in this video.)
- Identify the main Risk Types for your project, say Regulatory Challenges, Shortage of qualified labor, Weather, Lack of sufficient detail in the designs, etc.
- Assign a factor to each risk area, which moves the Contingency Rate up or down, depending upon the assessed risk.
Now, for an example….
Here’s an example of Level 0 Contingency Budgeting:
- Start with a Base Contingency Rate of 5% (for new build.) (The video link above presents a good discussion of some standard contingency rates for various types of construction projects.)
- To the right are the results of a quick Risk Assessment, ranking 5 risks from 0.5 (low risk) to 1.5 (high risk).
- Now, just multiply all the Risk Factors together, and then times the Base Rate, and you come up, in this case, with 5% X ( 1.2 X 0.8 X 0.9 X 1.5 X 1.2 ) = 7.8%
If you couple this quick analysis, with a few statements for each Risk Area justifying your Risk Factor, then not only do you have much better confidence in your Contingency Budget, but you also have a great one-page Risk Managed Contingency Budget deliverable that you can show to your client (and to your boss!)
I hope that you found this article of interest, and of value. There is a lot of value in performing, even a relatively quick and easy risk analysis, in order to define your construction project’s contingency budget. You can provide yourself and your team some assurance that it is adequate and sufficient, to make your project a success. And, you can provide great documentation to your clients and company management, that your contingency funds are well thought through. In the next article, I will looking at the next level of complexity of this Risk Analysis for Construction Project Budgets.