As Donald Rumsfeld once said:

There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know
It is a confusing opening line, but what he was trying to say was quite profound in the context of risk management. Over numerous projects we have seen project teams try to justify their contingency levels and provide a basis for how they derived their budgets and in the process of doing so, fail to correctly evaluate the risks that may apply to their projects.
 
This is no surprise given the level of mis-information and misguidance in the field of risk management caused by several factors:
  1. Organisations do not understand how a budget is structured in the Project Control context
  2. There are numerous standards that define risk management and contingency practices. Most use differing terminologies which confuse the reader. These standards are also quite contradictory against each other which doesnt help
  3. Organisations are culturally immature when it comes to implementing risk management
  4. Project teams use the term P10, P50 and P90 very loosely without understanding what those terms actually mean
  5. Humans are by nature incapable of removing bias from estimating which results in questionable quantification of risk
It's pretty clear therefore that we need to go back to basics and understand what contingencny is and how it is correctly derived.
 

Standards

The first problem we face is that of the actual definition of contingency in the context of Project Risk Management. If you look at the PMBOK (5th Edition) it defines what Management Reserve is:
An amount of the project budget withheld for management control purposes. These are budgets reserved for unforeseen work that is within scope of the project. The management reserve is not included in the performance measurement baseline (PMB)
 To understand what the PMBOK means by this, you really need to examine Figure 7-8 from the PMBOK:
 
 
Because Management Reserve does not feature within the PMB it cannot be earnt which becomes a point of confusion for some organisations because they mistakenly apply it to planned activities within the project schedule. This is typically due to the inherant nature of program wide corporate budgeting. Project teams will rarely show a project total budget that does not match the agreed funding for fear of losing the difference. 
 
So we then need to examine Figure 7-9 of the PMBOK to help in understanding how to correctly represent a project's financial forecasts: 
 
 
The PMBOK provides this diagram to clearly identify the difference between Funding and the PMB. Funding is linearly spread by financial years where as the PMB is representative of the work planned - which may span numerous reporting periods. Imagine now applying this diagram to a control account and renaming "Management Reserve" to "Contingency Reserve"; a better explaination on how to show contingency at the control account level.
 
Often, organisations who are more culturally advanced in Project Controls will adopt a configured cost performance management system which ensures alignment to the PMBOK and AS4817-2006 standards, producing similar charts. They also will define a Management Reserve which can only be accessed through proper change management practices.
 
Now, when it comes to contingency planning and the implementation of earned value, there are multiple standards that are available including:
  • AS 4817-2006 - Project Performance using Earned Value (Australian)
  • ANSI/EIA Standard 748-A (American)
  • The PMI Practice Standard for EVM (Global)

So with this in mind, how does your organisation treat management reserve and project contingency? Does it adopt a best practice and actually implement it correctly? 

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