Reserve analysis for Estimate Activity Duration & Estimate Cost

Reserve Analysis - for Estimate Activity duration and  Estimate cost

Although we may know how long our project activities should take, we also know that it is likely that there will be at least some minor setbacks—a key person is sick, weather delays a shipment, etc.

Similarly, although we may know how much things should cost, we can easily find ourselves dealing with unexpected costs.

By planning upfront for a little extra time and/or funds, we have a safety net when things do not go as hoped.

Adding these buffers is one of the principles of the Critical Chain Method.
There is not a set way to determine how much of a buffer to add—some may simply add a couple days to each activity or systematically add a certain percentage to the budget. The nature of the project relates to how large of a safety net to spread. A routine project should not need as much of a buffer as will a critical project in uncharted waters.

Contingency Reserve vs Management Reserve

Contingency Reserves

Contingency Reserve is the cost or time reserve that is used to manage the identified risks or “known-unknowns” (known=identified, unknowns=impacts). Contingency Reserve is not a random reserve, it is a properly estimated reserve based on the Expected Monitory Value (EMV), or the Decision Tree Method.
Contingency Reserve is controlled by the project manager. He/She has authority to use it when any identified risk occurs, or can delegate this authority to the risk owner, who will use it at an appropriate time and informs the project manager at a later stage.

The  contingency  reserve may be a percentage of the estimated activity duration or a fixed number of work periods. As more precise information about the project becomes available, the contingency reserve may be used, reduced, or eliminated. Contingency should be clearly identified in the cost & schedule documentation.

Contingency Reserve becomes a part of Schedule and Cost baseline.

Management Reserve

Management Reserve is the cost or time reserve that is used to manage unidentified risks or “unknown-unknowns” (unknown=unknown, unknowns=impacts). Management Reserve is not an estimated reserve; it is defined as per the organization’s policy. For some organizations, it is 5% of the total cost or time of the project, and for others it is 10%.
Management Reserve is controlled by someone outside the project team, usually from the management. Every time an unidentified risk occurs, the project manager has to get approval from the management to use this reserve.

Management reserve is not a part of Schedule and Cost baseline.
Depending  on  contract  terms,  use  of  management  reserves may require a change to the schedule baseline.

Here the discussion about the contingency reserve and management reserve finishes, but before we leave let’s summarize all the key points once again:

Contingency Reserve

• It used to manage identified risks
• It is estimated based on Expected Monitory Value (EMV), or decision tree method
• The project manager has authority to use this reserve
• Part of Schedule and Cost baseline.

Management Reserve

• It is used to manage unidentified risks
• It is calculated as a percentage of the cost, or time of project
• Management approval is required to use management  reserve
• Management reserve is not a part of Schedule and Cost baseline.
• Once a Management Reserve is used the baseline (Cost &/or Schedule) is changed accordingly.

Protect Your Project Against Cost Overruns

What happens when one of the activities goes over budget? How do you mitigate the cost risk associated with critical activities? Reserve Analysis holds the key to these project budget-related answers.

• Determining a Project Budget

  Reserve Analysis is one of the techniques used to determine a project budget. During Reserve Analysis, a project is analyzed from a cost overruns point of view and buffers are placed in appropriate place. These buffers are called Contingency and Management Reserves.

• Contingency and Management Reserves

  Contingency Reserves are buffers to account for risks that you know will occur. For example, you may have a Contingency Reserve for lack of the skilled human resources in a certain technology. By looking at the Risk Breakdown Structure, you'll be able to get more categories that require a contingency reserve. Management Reserves are for risks that have not been identified. Every project is hit by unidentified risks. The Management Reserve protects the project from these critters.
  Regardless of the type of reserve, the amount of buffer is proportional to the cost risk foreseen in the project or individual activities. The norms within an organization may also dictate the level of buffering applicable. There is no prescribed method to perform Reserve Analysis. However, the guiding principle is that you should buffer or pad according to the risk levels identified for the project or individual activities. In this article, we’ll use this guiding principle for Reserve Analysis.

• Example 1 – Pad Each Activity Cost Estimate

  After you’ve created the Precedence Diagram (Network Diagram) for the project and estimated the activity duration and resources, you might realize that the project is very similar to some previous projects that you successfully completed. The risks associated with the project are low and there are no critical pieces that need extra cost buffering. In such a case, you might decide to pad each activity cost estimate by 10 percent across the board. Many organizations have a set policy that will determine the degree of buffering.

• Example 2 – Pad High-Risk Activities

  Now, suppose you have identified activities on the critical path and need to give them extra protection. In this case, you would provide a higher  cost buffer to these activities than other activities that are not on the critical path. It is common for the critical path of a project to change during the course of a project. Therefore, it’s safer to pad high risk activities for cost over-run, regardless of whether they are on the critical path or not. For example, you might be developing a non-critical component for a client. If the contract specifies a fixed time, then you may want to utilize an extra cost buffer to ensure schedule crashing, if required, is possible. Alternatively, you may want to pad all activities by 10 percent and the high-risk activities by 20 percent.