Reserve Management

One of the most important outputs of the Plan Risk Responses process is the creation of Reserves. The term Reserve is something that we use in our day to day lingo and hence most of us must be familiar with it. If you can’t exactly recollect what a reserve means, think of it as a “Buffer”. Now, are you able to figure out what a reserve could mean?

Definition of a Reserve:

A provision within the Project Management Plan that is meant to get in front of cost and schedule risks.

In other words Reserve refers to cost or time buffers that we will utilize if we fall back in schedule or overuse the available funding.

Trivia:

Reserves is something we use in real life even without explicitly knowing that we are using it. For ex: If your boss asks you for a report that you know will definitely need 9 days and may get extended by a few hours, you don’t tell your boss that you will give him by EOD 9th day. Instead you add a little buffer for safety and tell him that it will be done in 10 days to account for the risk of delay. In case your report isn’t ready by the 9th day, you utilize the 1 day extra you added to finish the report. As per proper project management practices, we are expected to inform our management of such reserves so that they will know that, unless required the reserve will not be used and the report will be available for them at the end of the 9th day if it is ready.

Definition of Contingency Reserves:

The amount of funds, budget or time needed above the estimate to reduce the risk of overruns of project objectives to a level acceptable to the organization.

Trivia:

When we use Accept as a strategy for risks, it means that we are planning to use these contingency reserves to handle them if the risk event occurs.

Realistically, we are going to use the reserves to handle the result or impact of whatever has happened as a result of the risk instead of trying to prevent the risk from happening or minimizing its impact. Though this may not sound like a bright idea – trying to address the situation after the damage has occurred, this is usually the response we give risks that are pretty low down in the priority list or those risks that have little impact but require a huge cost to address them. Remember the example from the last chapter where a $1000 damage required us to invest $5000 to prevent it?

Calculating Contingency Reserves for Risks:

The contingency reserve is technically the sum of the EMV of all the risks that have been identified. We multiply the probability with the impact (in $ terms) to arrive at the individual risk numbers and then sum them all up to come up with the overall Contingency Reserve for the Project.

Trivia:

If your project has 100 known risks each with a varied impact of losses, after you calculate the reserve number, you may begin to wonder if the reserve will be enough. Remember that not all of those risks are going to occur. Only a few of them will occur. If we consider the reserve requirements for all the risks, then it should be practically enough to handle the few risks that eventually materialize.

On important point we need to consider while coming up with these reserve figures is the “Stakeholder Risk Tolerance”. If your stakeholder has a low tolerance for risks, you may have to come up large reserves to minimize or nullify the impact of certain risks and vice versa. Once the numbers are calculated, they are updated in the Project Cost Baseline.

Trivia:

A lot of people think that the contingency reserves are not part of the Project Budget or the Project Cost Baseline. But unfortunately they are wrong. Contingency reserves are planned in advance and factored into the overall cost of the Project.

Management Reserves

The Management Reserves are for the management as the Contingency Reserves are for the Project Manager. The PM is managing only one project and hence has crated his contingency reserves. Whereas, the Organization Management is probably executing multiple projects and hence they will keep some sort of reserve in their end for emergency requirements.

Management Reserves are:
• Used for unknown-unknown risks
• Not part of the Project cost Baseline
• Approved by the Senior Management if any project needs to use it

The project manager does not know if any management reserves are present and if so how much. So, for all practical purposes, the PM has to work with the idea that his cost budget is final. Though the Management will be willing to pitch in when required, as PM’s it is our responsibility to come up with numbers that are accurate and going to the management stating that you have overrun your allocated budget makes you look bad because you messed up the calculation of budget figures during the planning phase of the Project.

Contingency Planning

Contingency Planning is one of the tools and techniques in the Plan Risk Responses process and is part of the Contingent Response Strategy.

While developing a response to a risk, we usually determine when the risk response should be implemented. For ex: When warning signs and symptoms occur we will apply the contingency plan to try to eliminate the risk, provided we have enough time before the risk actually occurs. The warning signs can also tell us if a risk has occurred. In such cases we will use the contingency plan to try to minimize the impact of the risk.

The Contingency Plan is:

• The planned response to a risk
• Executed when the predefined risk trigger occurs
• Part of the overall risk response plan
• Documented in the Risk Register
• Meant to offset a threat or an opportunity

Example:

As per the project schedule, you can see that Activity X in your network diagram is on the critical path and if we miss its deadline, the projects schedule milestone will be missed. In this case, a response is not required unless we actually miss the deadline for Activity X. If we finish activity X as planned, then we don’t need to utilize our contingency plan at all.

The actual response (from the contingency plan) may not be viable until the trigger event actually occurs. Think this way - Why would you want to apply a contingency plan when activity X is on track and will be completed on time? Responding to risks involves utilization of time and resources. So, the logic here is – why waste them when not required.

Prev: Strategies to Handle Positive Risks

Next: Important Terms - Plan Risk Responses

Probabilistic Analysis of the Project

In the previous section we took a detailed look at the Quantitative Risk Analysis process, its inputs and tools. As we saw in the previous chapter, the output of the process is a series of updates to the Risk Register and the first update in the list is “Probabilistic Analysis of the Project” which is the topic of our discussion in this chapter. 

The focus or purpose of this update is to identify the Probabilities relating to the Project as a whole. 

How probable are we to achieve our Project Schedule? How probable are we to complete the project within budget? These are some of the probabilities that we aim at identifying and updating the Risk Register during this step. Once our quantitative analysis is complete, we should be in a position to show possible completion dates and costs that are associated with our Project, along with the confidence levels with which we predict the aforementioned information. 

In all practical situations, by the time you start your quantitative analysis, your projects schedule would already be ready or would in its final stages of finalization. So, based on the risks that could affect our project, we will try to figure out if our schedule is realistic. We try to figure out if it takes into account the cost limitations as well as any other risk that could affect it. 

The biggest problem in most failed project is either Unrealistic Schedule or Unrealistic Budget. Many PMs miss out this part and pay a dear price towards the end of the project, where they are forced to see their project sink. The whole purpose of risk management is to minimize this kind of a scenario. 

The PMBOK guide says that, the result of this kind of analysis is typically displayed as a Cumulative Distribution. These distributions are then used along with Stakeholder Risk Tolerances to allow for the quantification of Cost and Contingency Reserves. As with any value that is calculated by us, these reserves must be appropriate and realistic. 

Trivia: 

Do you remember where these Contingency Reserves are developed??? 

If you haven’t done your PMP Certification already you may not know the answer. But, nonetheless, if you are already PMP Certified, do you remember??? 

Plan Risk Responses is the process where we calculate these contingency reserves.

Contingency Reserves are extremely important for any project because, whenever a project overruns its budget or schedule, the Project Manager may need to take corrective action and this would involve some additional unplanned expenses (both time and effort) which may not be possible if appropriate reserves aren’t available. The presence of proper contingency reserves can help both the Project and the Project Manager try to achieve the project goals in case of an unfortunate event that threw the whole project off-track. 

In General – After Quantitative Analysis, we must remember that: 

• Experts are an important source of Risk Related information 
• Expert Judgment is important in quantifying risks 
• Often information from experts is expressed as a probability distribution and it forms the basis to the whole risk analysis process 
• It is always a good idea to document all the information obtained from experts because, everyone must know how the estimates and values were derived. This adds a lot of credibility to the information
• Three Point Estimates are frequently used to arrive at overall project estimates
• Remember three point estimates? We use the Optimistic, Most Likely and Pessimistic values to arrive at an estimate. Here these 3 numbers are given to us by experts 
• Majority of the output information is displayed using probability distributions
• Based on the distribution we intend on using, we must determine and prepare the information that is required to come up with that report.
• All information we used/considered must be properly documented in the Risk Register 

Probability of Achieving Cost and Time Objectives

In this process, we are going to quantify the probability of achieving the cost and time objectives of our project.

This comes about by using all of the tools and techniques that are used by the Quantitative Analysis process. It requires a thorough understanding of the current project’s objectives as well as a thorough knowledge/understanding of all the risks. Our focus here is to find out the probability of achieving our project’s objectives under the existing plan – for both the Cost and the Schedule

The results of this activity too are displayed as a probability distribution. It is simply a representation of the probability of meeting the project’s cost and time objectives.

Ex: let us say the current project budget is USD 5 million and based on quantitative risk analysis, it is determined that there is a 65% probability that our project will be within budget. If the budget were USD 7.5 million then, there will be a 80% probability that our project will be within budget and if the budget were USD 10 million, then there will be a 100% probability that our project will be within budget.

In all practical scenarios, project managers don’t have the luxury of determining the best possible budget (10 million here) and give 100% accuracy on cost estimates. They are probably given a number that would result in a very low probability of meeting the budget and are asked to work around it. So, in real life, don’t expect your sponsor to say, ok buddy, I need 100% probability of meeting the budget, so here you take this 10 mil and work with it. Most probably he will say “5 million is the max you will get and if you finish within 4.5 you will get a small incentive and if you exceed 5.5 million start uploading your resume in job sites!!!”

Prev: Introduction - Updates to Risk Register after Quantitative Analysis

Next: Prioritized List of Quantified Risks