49 Contingency Funding
In addition to creating the project plan, you need to create a contingency plan, which is a plan for addressing key possible obstacles to project success. A contingency plan defines alternate paths for the project in case various risks are realized. A contingency plan typically includes a contingency fund, which is an amount of resources set aside to cover unanticipated costs. Contingency plans and funds are necessary because even the most seasoned project planner sometimes succumbs to excessive optimism, assuming everything will go well and that all resources will be available when needed. Also, no matter how thoroughly you plan a project, you will inevitably miss at least a few small issues.
Examples of issues that might necessitate the use of a contingency fund:
- Inadequate initial estimates
- Small items not covered in planning
- Errors in initial estimates
- Small deviations due to inevitable delays
Note that a contingency fund is not designed to manage major deviations or scope changes.
A simple and effective form of contingency planning is setting aside a contingency fund consisting of a fixed percentage of all resources (time, money, people) in addition to the amounts spelled out in the final budget. Ten percent is a typical amount, but that can vary depending on the size and type of project, as well as the type of industry.
One of the chief difficulties of contingency planning is getting people to agree on exactly what is and is not covered by a contingency fund, and how it applies in specific circumstances. A considerable amount of research has been done on this topic, but there is still no clear consensus. For that reason, before launching a major project, you would be wise to investigate the ins and outs of contingency planning at your organization in particular, and in your industry in general.
Contingency planning is closely related to risk management, which is discussed in chapter 9. When you are working on small projects of limited complexity, you can probably assume that a fixed percentage contingency plan will cover most risks. However, for highly complex, technically challenging projects, it’s important to distinguish between generic budget planning contingencies (using a fixed percentage) and the more sophisticated modeling of risk for uncertainty.
If money is not available from other sources, then cost overruns typically result in a change in the project’s scope or a reduction in overall quality. To prevent this, organizations build contingency funds into their budgets. Technically, a contingency fund is a financial reserve that is allocated for identified risks that are accepted and for which contingent or mitigating responses are developed. The exact amount of a contingency is typically 10% to 15% of the total budget.
Contingency funds are often available to pay for an agreed-upon scope change. However, some project managers make a practice of treating a contingency fund as a “Get Out of Jail Free” card that they can use to escape any cost limitations. Some, as a practical matter, will artificially inflate a contingency fund to ensure that they have plenty of resources to draw to manage any unforeseen future risks. But that is never a good idea because if you wind up with a large contingency fund that you ultimately don’t spend, you have essentially held that money hostage (i.e., lost opportunity costs) from the rest of the enterprise. That can be as damaging to your organization’s mission as a cost overrun that prevents you from finishing a project.
As explained, contingency funds are a form of risk management. They are a necessary tool for dealing with uncertainty. Unfortunately, as necessary as they are, it’s not always possible to build them into your approved budget. For example, if you are competitively bidding on a contract that will be awarded on the lowest cost, then including a contingency fund in your estimate will almost certainly guarantee that your company won’t win the contract. It is simply not practical to include a contingency fund in a lump sum contract.
In the living order approach to this problem, the owner maintains a shared contingency fund instead and makes it available, upon justification, for all project stakeholders. This approach helps ensure that project participants will work collaboratively with the project sponsor to solve any problems they might notice, confident that there is money available to address problems that threaten project value or to leverage opportunities that will provide greater project value. For example, in a lecture on Lean and integrated project delivery, David Thomack, a long-time veteran of the construction industry, explained how the Boldt Company and other stakeholders involved in a $2 billion healthcare project protected millions of dollars in contingency funding, which was then ultimately shared among all stakeholders (Thomack, 2018). Such shared contingency funds are typically spelled out in the project contract and are an effective tool to manage risk and uncertainty. Although some organizations only manage out-of-pocket project costs, the best practice is to manage total cost, including costs associated with staff (engineering, purchasing, testing, etc.) working on the project.
Text Attributions
This chapter of Project Management is a derivative the following texts:
Essentials of Project Management by Adam Farag is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.
