Most project managers will include some contingency reserves within their budget to offset the negative financial impacts of realized risks. Determining how much to put aside for a rainy day might be done from a top-down method such as using a flat percentage derived from past projects (e.g. low complexity projects will have 10% contingency whereas higher complexity ones will have 25% contingency) or a bottom-up approach based on assessing and aggregating the expected monetary value of the financial impacts from key risks.
But, how is the contingency allocated over time and released back to the funding organization if unused?
There are four common approaches which I’ve encountered:
- Allocated as a single lump sum (i.e. not time sequenced) and held for the life of the project. In other words, contingency reserves are not released back till the project is completed.
- Allocated to specific milestones or project phases and held for the life of the project.
- Allocated as a single lump sum, but returned back at a gradual pace based on the actual realization of risks over the project’s life.
- Allocated to specific milestones or project phases with unused amounts being returned as each milestone is accomplished or phase completed.
#1 and #4 are the two which I’d most frequently witnessed, but as usual, I wanted to compare my experience with that of the broader project management community.
I ran a one week poll in both PMI’s LinkedIn Project, Program and Portfolio Management discussion group as well as in the ProjectManagement.com community. I received 56 responses with the following distribution:
- 45% voted for the single lump sum with no returns till the project’s end
- 35% voted for the time sequenced sums with returns based on milestone or phase completion
- 13% voted for the single lump sum with gradual returns
- 7% voted for the time sequenced sums with no returns till the project’s end
This matches my experience, but I was pleasantly surprised to see the fourth option receiving over a third of the votes as it does indicate a higher level of capability than I’d expected. Of course, this might also be the result of a bias in the polling sample towards more knowledgeable practitioners.
I did receive two insightful comments on the poll.
The first was that it depends on what consequences exist for budgetary over and under runs. The greater the penalty, the more likely that contingency reserves will be retained and fully utilized over the life of a project.
The other comment indicated that as reserves are tied to risks, some risks may not have a single expected realization time and hence it might become difficult to purely allocate contingency reserve amounts at the milestone or phase level and the bulk might end up tied to the final completion of the project.
While it is much easier to calculate a single lump sum for contingency reserves, this does not provide financial authorities with a forecast of when those reserves might be utilized and at what pace. And while risk-averse project managers might be reluctant to give back reserves until the project is done, they need to understand that reserving those funds for longer than is needed will represent a significant opportunity cost to the organization.
One of the rules in Jerry Madden from NASA’s one hundred rules for project managers reads “All problems are solvable in time, so make sure you have enough schedule contingency—if you don’t, the next project manager that takes your place will.”
While in some cases you will have a project which absolutely can’t end a day late (think Bruce Willis and Ben Affleck trying to prevent that planet-killer asteroid from hitting Earth in Armageddon), schedule delays will rarely mean the end of the world. However, go materially over budget and you’ll wish that asteroid was about to hit the planet to save you from the dressing down you’ll receive from your funding authorities!
(If you liked this article, why not read my book Easy in Theory, Difficult in Practice which contains 100 other lessons on project leadership? It’s available on Amazon.com and on Amazon.ca as well as a number of other online book stores).