Contingency WTD Project Control Workshop June 14, 2012 Became mainstream in 2002 when used by Donald Rumsfeld in a Department of Defense news briefing most reporters/critics did not understand the point and have panned him routinely Terminology has been around in the project and risk management environment for decades Legitimate, indispensible concept in decision analysis Describe types of risk Most often refers to use of contingency or management reserves Knowns and Unknowns Generally determined during planning and predesign Identified well in advance and complete information is available Known and quantifiable Predictable Can be estimated directly Which part of a WTD project budget would be known-knowns? Known-Knowns Known issues yet not quantifiable Partial information May or may not occur risk register Which part of a WTD project budget would be known-unknowns? Known-Unknowns Cannot be identified or predicted to any degree No information about when, how and what impact Yet unrecognized Totally unexpected Which part of a WTD project budget would be unknown-unknowns? Unknown-Unknowns Contingency Reserve cost or time reserve that is used to manage identified risks or known-unknowns contingency reserve is controlled by the PM Management Reserve cost or time reserve that is used to manage unidentified risks or unknown-unknowns management reserve is controlled by someone outside the project team Contingency Reserve versus Management Reserve Risk an uncertain event or condition that, if it occurs, has a positive or negative effect on a projects objectives (PMI) Contingency an integral part of the risk management process and is a necessary part of the capital project budget provides a means to mitigate the risk of uncertainty and unforeseen events within the project scope that are inherent in capital projects generally included in most estimates, and is expected to be expended Risk and Contingency Cost contingency When estimating the cost of a project, there is always uncertainty as to the precise content of all items in the estimate, how work will be performed, what work conditions will be like when the project is executed and so on. These uncertainties are risks to the project. Some refer to these risks as "known-unknowns" because the estimator is aware of them, and based on past experience, can even estimate their probable costs. The estimated costs of the known-unknowns is referred to by cost estimators as cost contingency.risksproject AACE International, the Association for the Advancement of Cost engineering, has defined contingency as "An amount added to an estimate to allow for items, conditions, or events for which the state, occurrence, or effect is uncertain and that experience shows will likely result, in aggregate, in additional costs. Typically estimated using statistical analysis or judgment based on past asset or project experience. Contingency usually excludes: AACE InternationalCost engineering Major scope changes such as changes in end product specification, capacities, building sizes, and location of the asset or project Extraordinary events such as major strikes and natural disasters Management reserves Escalation and currency effects Some of the items, conditions, or events for which the state, occurrence, and/or effect is uncertain include, but are not limited to, planning and estimating errors and omissions, minor price fluctuations other than general escalation), design developments and changes within the scope, and variations in market and environmental conditions. Contingency is generally included in most estimates, and is expected to be expended". [1] [1] A key phrase above is that it is "expected to be expended". In other words, it is an item in an estimate like any other, and should be estimated and included in every estimate and every budget. Because management often thinks contingency money is "fat" that is not needed if a project team does its job well, it is a controversial topic. From Wikipedia, the free encyclopedia (Pauls Secret Source of Knowledge) Construction Contingency design contingency pricing or market conditions construction contract change orders all are known-unknowns Project Contingency intended to cover the costs of identified risk register items not all risks are funded, portion determined by project team only covers risks associated with chartered scope of work only used when a planned risk materializes, known-unknown Management Reserve (Flexible Spending Ordinance) encompasses issues that were unforeseen and not expected seldom used, at discretion of WTD management/finance referred to as unknown-unknowns Types of Capital Contingency Origins date back to the 2004 accomplishment rate assumed rate, 82% actual rate achieved, 66% Concern that Council would react to low performance and approve future budget requests proportionally Current WTD contingency policy went into effect in 2005 Current WTD Contingency Policy Contingency: When entering contingency, use the percentages listed below -- this means PMs will revise contingency during each phase of the project. The Portal has two places to enter contingency project and construction. In both cases, contingency will be loaded in the close-out year of each project. If your project does not have a construction component, use the project contingency only. The contingency will be based on total project costs. PMs should get approval from their Section Manager and the Finance Section for exceptions to this policy. Example: Project X is currently in predesign with all activity to be complete in Further, the total project cost is $10 million, of which $5 million is for construction. The total contingency is $2,000,000 ($10M*.20) of which $500,000 (.1* $5,000,000) is construction contingency and $1,500,000 ($2,000,000 - $500,000) is project contingency to cover the unknowns and unexpected events. These amounts would be entered in 2008 only. Estimate Classification for Process Industries AACEProjectWTDTotal Project Construction ClassDefinitionAnalogContingencyContingencyContingency Class %Planning30%20%10% Class %Pre-Design20%10%10% Class %Design15%5%10% Class %Construction10%0%10% Please keep in mind when putting your budget together that there is $10 million in program contingency available for projects if the need arises during the year. This authority can be transferred to a project up to 15% of total project costs without exceptional reporting requirements. WTD 2005 Contingency Policy PRISM Contingency Module Intended Effects reduced best case, padding, etc. contained within annual budgets contingency in last or out year since 2005, accomplishment rate averaging over 90% Unintended Effect effectively reduced amount of project contingency 2005 Policy Effects Several years ago Christie asked Project Control to verify or debunk the notion that WTD projects take twice as long and cost twice as much to complete as anticipated As funds get tighter and backlog grows, must portray projects and program more accurately BFO hired to study in depth WTDs historical performance Findings initiation - WTD projects take 120% longer and cost 71% more than budgeted baseline - WTD projects take 61% longer and cost 32% more than budgeted Why Does Any of This Matter? Average WTD capital project takes 10.5 years to complete, first two years are idle Cost or schedule widely thought to be project driver, analysis hints scope/quality Inadequate project management processes PMI process improvements now in place but due to length of projects, results are slow to be seen since as m0del percentages reflect only completed projects initial indicators show 22% cost and 28% schedule improvements Study indicated hand built, bottom-up & modeled allied cost percentages too low Inadequate funding of contingency and improper contingency drawdown Why Is This? Authorized contingency less than industry or AACE Elements not easily estimated often defaulted to contingency 25% uncertainty flow factor ancillary structures 4 siphon inlet and outlet structures mitigation Contingency used faster than policy suggests Faster contingency usage masks increasing costs and scope Schedule has no such contingency (not as important?) Contingency Problems Contingency Reporting Green/Yellow/Red Reporting Cos t Schedule Time Contingency Cost Contingency Depleted / Budget Increase Contingency Variance versus Recommended Practice Joe and Lisa assign Paul to update WTD Capital Project Estimating Manual by end of 2011 Project & Management Services, Inc. (P&M) hired under work order to assist with estimating manual P&M points out three insightful (yet obvious) deficiencies budgeted construction costs not reflective of actual bid amount contingencies do not appear to follow industry norms cannot compare estimates and budgets easily BFO Data + P&M = Better Way Budgeted construction costs not reflective of actual bid amount final construction costs significantly higher than budgeted construction costs (misleading) significant known-unknown construction costs defaulted to project contingency allied costs, sales tax, construction change and other modeled costs all calculated as a percent of construction budget and therefore all are underfunded CONCLUSION: Projects effectively start with no project contingency Actual Construction Costs not Reflected in Budgeted Costs Design contingency not mandated allowance for scope and design uncertainty Pricing or market conditions not mandated market factors associated with future estimates (not escalation which is the future cost of money) Construction contract change orders assumed to be 10% per CON Project contingency significantly less (especially at early stages) than industry Contingencies Do Not Follow Industry Approach New contingency method trialed with Gate 3 Baselining of the four CSO Beach projects (South Magnolia, Murray, North Beach and Barton) at CST on May 8, Still a work in progress Feeling is that more realistic contingency amounts will afford a project a reasonable chance of meeting budget Recommended contingency policy effectively splits the difference between initial budget and actual cost and baseline budget and actual cost PRISM not yet updated Revised Contingency Policy Takes Shape WTD Matrix Combines: WTD Phases WTD Deliverables WTD Gates AACE Estimate Classifications AACE Degree of Project Definition AACE Accuracy Ranges WTD Contingency Categories and Recommended Amounts design, pricing, change order and project Draft WTD Contingency Matrix 18-97R (2011 update) Handout Cost Estimate Classification Matrix (page 2) Estimate Input Checklist and Maturity Matrix (page 9/10) Accuracy Range versus Range Estimating accuracy range is +/- a percentage based upon design definition range estimating determines the probability of a cost overrun and determines the required contingency needed in an estimate to achieve a desired level of confidence uses statistical modeling such as Monte Carlo simulation AACE Recommended Practice 18-97R WTD Draft Contingency Matrix Project Budget/Contingency Example Planning Level Budget Estimate Example WARNING!!!! WARNING!!!! WARNING!!!! WARNING!!!! WARNING!!!!! Reaction likely to be that suggested costs are too high Revised method splits the difference between budgets and actuals historical data suggests the added $s will be spent (and then some) If scope increases are not deflected/avoided, costs will be higher Project expansion through scope changes/increases or business decisions must be accompanied by a rebaseline event Change Can be Difficult Formatted into two chapters: Chapter 1 For internal use. Describes the what, why and how of WTDs project budgeting process(es) Chapter 2 For internal and/or external estimating staff concentrates on capital construction estimating describes required level of detail, order and formats introduces requirement to present estimates in WBS format Estimating Guidelines ? Conclusion / Questions