MaProContingenCy andManageMent ReseRve

MaPro´s take on

Author: Gestur Valgarðsson, M.Sc.

2 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 3

MaProIntroductionMannvit has developed a suite of project management tools, collectively referred to as MaPro. the components of MaPro rest on pillars of time proven management techniques and tools combined to a module based method which is fully scalable to the size and complexity of projects or programs.

BackgroundCapital investment projects are large part of Mannvit’s daily life; we produce cost estimates and deliverables, assisting our clients in assessing the feasibility of their capital spending projects.

there seems to be some confusion among end-users outside the circle of cost engineers producing these estimates as to how to interpret the results of the estimates. Key-values such as: Contingency, estimating accuracy range, level of confidence and management reserve are not always well understood. even, in some cases, trained financial institutions demonstrate lack of connected understanding of the key terms defining the results of cost estimates. inability to correctly interpret estimate results can create misalignment between estimators and users.

Plausible explanation might be the many papers on the subject most preoccupied with how to produce the key-statistics but not how to interpret them.

this MaPro paper demonstrates the main properties of the key-values and how to use them to interpret results of cost estimates. the reader will take away a understanding of these values and understanding of the need for contingency and risk assessment in any project. the paper will demonstrate that contingency will be consumed totally with fifty per cent probability.

the nature of the Point estimate and the P50 cost will be explained and their tie-in with the statistical variables: Mode, median and mean. it will demonstrate how contingency does not cover design allowances, scope changes or major upsets to the planned project. the paper will enhance understanding of management reserve and how it is different from contingency.

Contents

introduction 3

Background 3

What constitutes a cost estimate 4

estimate Range 5

Types of distribution curves – symmetrical and skewed 5

The mode and its relationship to the Point Estimate 6

The median and its relation to the P50 cost 6

estimate accuracy 7

Cost contingency 8

Items typically covered by contingency 9

Items expressly excluded from contingency 9

aaCe view on accuracy Range 10

Management Reserve and its relation to Contingency 12

Risks 13

Conclusions 14

2 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 3

MaProIntroductionMannvit has developed a suite of project management tools, collectively referred to as MaPro. the components of MaPro rest on pillars of time proven management techniques and tools combined to a module based method which is fully scalable to the size and complexity of projects or programs.

BackgroundCapital investment projects are large part of Mannvit’s daily life; we produce cost estimates and deliverables, assisting our clients in assessing the feasibility of their capital spending projects.

there seems to be some confusion among end-users outside the circle of cost engineers producing these estimates as to how to interpret the results of the estimates. Key-values such as: Contingency, estimating accuracy range, level of confidence and management reserve are not always well understood. even, in some cases, trained financial institutions demonstrate lack of connected understanding of the key terms defining the results of cost estimates. inability to correctly interpret estimate results can create misalignment between estimators and users.

Plausible explanation might be the many papers on the subject most preoccupied with how to produce the key-statistics but not how to interpret them.

this MaPro paper demonstrates the main properties of the key-values and how to use them to interpret results of cost estimates. the reader will take away a understanding of these values and understanding of the need for contingency and risk assessment in any project. the paper will demonstrate that contingency will be consumed totally with fifty per cent probability.

the nature of the Point estimate and the P50 cost will be explained and their tie-in with the statistical variables: Mode, median and mean. it will demonstrate how contingency does not cover design allowances, scope changes or major upsets to the planned project. the paper will enhance understanding of management reserve and how it is different from contingency.

Contents

introduction 3

Background 3

What constitutes a cost estimate 4

estimate Range 5

Types of distribution curves – symmetrical and skewed 5

The mode and its relationship to the Point Estimate 6

The median and its relation to the P50 cost 6

estimate accuracy 7

Cost contingency 8

Items typically covered by contingency 9

Items expressly excluded from contingency 9

aaCe view on accuracy Range 10

Management Reserve and its relation to Contingency 12

Risks 13

Conclusions 14

4 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 5

Estimate RangeBy definition an estimate is a prediction; thus, a cost estimate is a prediction of a cost. And since it is impossible to predict future developments, any estimate must have associated with it some risk that it does not predict/estimate the future outcome correctly. it depends on the type of estimate how well the projects risks are reflected in the cost estimates. in this respect two main types of estimates will be mentioned:

● SinGLe-Point eStiMAte - The estimator assigns a single cost value to the estimate, the Point Estimate, and may proclaim that the project will cost this much – not more and not less. Single-point estimates are in common use. The method is simple but lacks usability for it does not make an attempt to address the probabilistic nature of the estimating process.

Nevertheless, it is important to connect this single cost prediction to more developed estimating techniques called Three-point estimates. Research has shown that Single-point estimators tend to pick a value which they believe represents best the final outcome – e.g. the “most likely” outcome. Thus, the terms: “most likely” cost and the Point Estimate are interchangeable.

● tHRee-Point eStiMAte - Is a more accountable approach, as it recognizes the inherent uncertainties of all estimates. Three-point estimate is an attempt to frame in the likely outcome –not specify the only outcome. Through systematic analysis of the risk register, this method produces statistical variables: Mode, median and the mean, characterizing the underlying distribution and can be connected with the more commonly used terms, the: min, “most likely” and max cost.

Research show that estimator producing a Single-point estimate tends to pick the value which is the “most likely” outcome. He does not fully account for the project risks and he does not produce any statistical interpretation of his estimate; thus, contingency in the sense explained in this paper does not enter his picture. even though the estimator adds contingency to his estimate, research shows that in his mind he is still producing the “most likely” cost – i.e. his contingency is to cover for the so called “known unknown costs, which” experience

has taught him is required to predict the most likely outcome.

By looking at the project risk register, the three-point estimator can assess the vulnerability of his project to risks. By systematically accessing the cost impact each risk has and assigning risk likelihood, he generates a probability distribution for the project. the distribution is a graphical indication of possible cost outcome for the project.

For each risk, the three-point estimate specifies a minimum, maximum and the most likely outcome and through a statistical analysis (For example; Monte Carlo analysis) is able to produce underlying cost distribution and key variables; thus, bettering the Single-point estimate.

types of distribution curves – symmetrical and skewedin general two types of distribution curves will come out of the estimator’s effort; symmetrical distribution or skewed.

the symmetrical distribution is characterized by the key-values: Mode, median and mean all being the same value. Skewed distribution, in general, have different values and right skewed distribution are characterised by the mode begin lower than then median which is lower than the mean. the mean is of no consequence to what is being detailed here and it will not be dealt with further.

For practical projects the skewed curve is more common because when evaluating the cost risks the estimator knows that the lower boundary of cost cannot be less than zero while the upper limits are less well defined. in practice this is reflected in the common assumption that the point-estimate could in all probability be somewhat lower, say 15%, but probably much higher, say 30%. this type of thinking will generate a right skewed distribution curves.

What constitutes a cost estimateAn estimate is, by definition, an intellectual attempt at predicting an outcome. in more precise words of the AACe:

● CoSt eStiMAte - A prediction of quantities, cost, and/or price of resources required by the scope of an asset investment option, activity, or project. As a prediction, an estimate must address risks and uncertainties. Estimates are used primarily as inputs for budgeting, cost or value analysis, decision making in business, asset and project planning, or for project cost and schedule control processes. Cost estimates are determined using experience and calculating and forecasting the future cost of resources, methods, and management within a scheduled time frame.

the process of estimating involves these activities and principles:

● tHe eStiMAtinG PRoCeSS is a predictive process used to quantify, cost, and price the resources required by the scope of an asset investment option, activity, or project. As a predictive process, estimating must address risks and uncertainties. The outputs of estimating are used primarily as inputs for budgeting, cost or value analysis, decision-making in business, asset and project planning, or for project cost and schedule control processes.

Beside the estimate itself, the estimating process produces a written document termed “Basis of the estimate,” Boe. Boe commonly includes a description of the project scope, methodologies used for estimating, list of supporting documents and supporting deliverables produced by the estimating team.

the Boe details the Base Case, a key concept in any estimate, is a description of what is being estimated. during execution the Base Case is the reference to which cost, schedule, scope and other project performance criteria are referenced. Without a clear Base Case and a written Boe, the estimate is of little worth.

estimates typically support the following activities:

● determine the economic feasibility of a project

● Choose between Project options

● Lay down the Base Case for project budget – i.e. cost and schedule.

● Compare actual results to a baseline.

4 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 5

Estimate RangeBy definition an estimate is a prediction; thus, a cost estimate is a prediction of a cost. And since it is impossible to predict future developments, any estimate must have associated with it some risk that it does not predict/estimate the future outcome correctly. it depends on the type of estimate how well the projects risks are reflected in the cost estimates. in this respect two main types of estimates will be mentioned:

● SinGLe-Point eStiMAte - The estimator assigns a single cost value to the estimate, the Point Estimate, and may proclaim that the project will cost this much – not more and not less. Single-point estimates are in common use. The method is simple but lacks usability for it does not make an attempt to address the probabilistic nature of the estimating process.

Nevertheless, it is important to connect this single cost prediction to more developed estimating techniques called Three-point estimates. Research has shown that Single-point estimators tend to pick a value which they believe represents best the final outcome – e.g. the “most likely” outcome. Thus, the terms: “most likely” cost and the Point Estimate are interchangeable.

● tHRee-Point eStiMAte - Is a more accountable approach, as it recognizes the inherent uncertainties of all estimates. Three-point estimate is an attempt to frame in the likely outcome –not specify the only outcome. Through systematic analysis of the risk register, this method produces statistical variables: Mode, median and the mean, characterizing the underlying distribution and can be connected with the more commonly used terms, the: min, “most likely” and max cost.

Research show that estimator producing a Single-point estimate tends to pick the value which is the “most likely” outcome. He does not fully account for the project risks and he does not produce any statistical interpretation of his estimate; thus, contingency in the sense explained in this paper does not enter his picture. even though the estimator adds contingency to his estimate, research shows that in his mind he is still producing the “most likely” cost – i.e. his contingency is to cover for the so called “known unknown costs, which” experience

has taught him is required to predict the most likely outcome.

By looking at the project risk register, the three-point estimator can assess the vulnerability of his project to risks. By systematically accessing the cost impact each risk has and assigning risk likelihood, he generates a probability distribution for the project. the distribution is a graphical indication of possible cost outcome for the project.

For each risk, the three-point estimate specifies a minimum, maximum and the most likely outcome and through a statistical analysis (For example; Monte Carlo analysis) is able to produce underlying cost distribution and key variables; thus, bettering the Single-point estimate.

types of distribution curves – symmetrical and skewedin general two types of distribution curves will come out of the estimator’s effort; symmetrical distribution or skewed.

the symmetrical distribution is characterized by the key-values: Mode, median and mean all being the same value. Skewed distribution, in general, have different values and right skewed distribution are characterised by the mode begin lower than then median which is lower than the mean. the mean is of no consequence to what is being detailed here and it will not be dealt with further.

For practical projects the skewed curve is more common because when evaluating the cost risks the estimator knows that the lower boundary of cost cannot be less than zero while the upper limits are less well defined. in practice this is reflected in the common assumption that the point-estimate could in all probability be somewhat lower, say 15%, but probably much higher, say 30%. this type of thinking will generate a right skewed distribution curves.

What constitutes a cost estimateAn estimate is, by definition, an intellectual attempt at predicting an outcome. in more precise words of the AACe:

● CoSt eStiMAte - A prediction of quantities, cost, and/or price of resources required by the scope of an asset investment option, activity, or project. As a prediction, an estimate must address risks and uncertainties. Estimates are used primarily as inputs for budgeting, cost or value analysis, decision making in business, asset and project planning, or for project cost and schedule control processes. Cost estimates are determined using experience and calculating and forecasting the future cost of resources, methods, and management within a scheduled time frame.

the process of estimating involves these activities and principles:

● tHe eStiMAtinG PRoCeSS is a predictive process used to quantify, cost, and price the resources required by the scope of an asset investment option, activity, or project. As a predictive process, estimating must address risks and uncertainties. The outputs of estimating are used primarily as inputs for budgeting, cost or value analysis, decision-making in business, asset and project planning, or for project cost and schedule control processes.

Beside the estimate itself, the estimating process produces a written document termed “Basis of the estimate,” Boe. Boe commonly includes a description of the project scope, methodologies used for estimating, list of supporting documents and supporting deliverables produced by the estimating team.

the Boe details the Base Case, a key concept in any estimate, is a description of what is being estimated. during execution the Base Case is the reference to which cost, schedule, scope and other project performance criteria are referenced. Without a clear Base Case and a written Boe, the estimate is of little worth.

estimates typically support the following activities:

● determine the economic feasibility of a project

● Choose between Project options

● Lay down the Base Case for project budget – i.e. cost and schedule.

● Compare actual results to a baseline.

6 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 7

the point to remember is that independent of the form of the curves each has two key-values, mode and median, which characterise them; it is imperative that readers of estimates know the meaning of these values and how they tie with the more common names given to them by cost estimators.

the mode and its relationship to the Point estimateit suffices to remember that the mode will be termed the Point estimate in this paper and that it equals the “most likely” outcome of any probability distribution. By definition the mode represents the outcome which is to be expected to be the most frequent outcome. For example, for the following collection of numbers: 3, 8, 3, 4, 3, 6, 4, 3, 11, the mode value is 3, because the number 3 appears most often in the collection.

the median and its relation to the P50 costthe median of any probability distribution is the outcome where 50% of the numbers are equal or lower and 50% are higher – i.e. there is equal probability of the outcome being higher and lower than this value. in statistical terms this value is the median of the distribution and it plays a major role in all discussions on estimates. in this paper the median will be referred to as the P50 cost.

Using the same collection of numbers, as in Chapter 4, but ordered: 3, 3, 3, 3, 4, 4, 6, 8, 11, the median value is 4.

Estimate AccuracyAccuracy is a measurement of how close to the actual value or the outcome of the project our estimate is. in another words, the estimate accuracy is an indication of the degree to which the final cost outcome of a cost estimate may vary from the single point value used as reference point. two of the most obvious reference points are the Point estimate and P50.

estimate accuracy is represented as percentage range around the selected reference points and it depends on the reference point; weather the range is symmetric or asymmetric.

As the estimate accuracy is a probabilistic assessment, there must be a separate evaluation of confidence which the estimator has in his estimate accuracy. this evaluation is termed the confidence level and is based on statistical analysis of the underlying distribution. it reflects the estimator’s confidence that the final value being within the boundaries of the low and high estimate. thus the estimator must not only put forward his estimated accuracy, but also a statement as to his confidence level.

the following statements are examples of coherent estimate conclusions:

● The estimated P50 cost of the project is 110 USD, based on November 2011 USD to the Icelandic krona (ISK) exchange rate. Implying 80% confidence level, it is expected that the estimate accuracy is 80 USD to 140 USD. The most likely cost is estimated at 100 USD. The cost estimate is based in project definition and estimating effort which corresponds to an AACE Class III.

Comparing this coherent presentation, to a familiar presentation of a Single-point estimator:

● The estimated cost of the project is 100 USD with +/- 10%

the last presentation is put forward with seemingly narrower estimate accuracy; thus, might be construed as a more elaborate and more accurate estimate. Without more information, it is impossible to assess if this is so; even more difficult is to assess the confidence level the estimator puts into his estimate. then, the level of project definition and the effort level which was budgeted for the making the estimate is not reported. in conclusion, the best conclusion to be drawn from this presentation is that the estimators “most likely” cost prediction is 100 USd.

P50=

50/5

0 es

timat

e

P90/

P10

out

com

e

Pe=P

oint

est

imat

e

(median)

(mode)

Figure 1b. Depicts the interrelationship between the key-values: mode, median and mean, for a right skewed distribution

P50=

Poin

t est

imat

e

(mode) (median)

Figure 1a. Depicts the interrelationship between the key-values: mode, median and mean, for a symetric distribution

6 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 7

the point to remember is that independent of the form of the curves each has two key-values, mode and median, which characterise them; it is imperative that readers of estimates know the meaning of these values and how they tie with the more common names given to them by cost estimators.

the mode and its relationship to the Point estimateit suffices to remember that the mode will be termed the Point estimate in this paper and that it equals the “most likely” outcome of any probability distribution. By definition the mode represents the outcome which is to be expected to be the most frequent outcome. For example, for the following collection of numbers: 3, 8, 3, 4, 3, 6, 4, 3, 11, the mode value is 3, because the number 3 appears most often in the collection.

the median and its relation to the P50 costthe median of any probability distribution is the outcome where 50% of the numbers are equal or lower and 50% are higher – i.e. there is equal probability of the outcome being higher and lower than this value. in statistical terms this value is the median of the distribution and it plays a major role in all discussions on estimates. in this paper the median will be referred to as the P50 cost.

Using the same collection of numbers, as in Chapter 4, but ordered: 3, 3, 3, 3, 4, 4, 6, 8, 11, the median value is 4.

Estimate AccuracyAccuracy is a measurement of how close to the actual value or the outcome of the project our estimate is. in another words, the estimate accuracy is an indication of the degree to which the final cost outcome of a cost estimate may vary from the single point value used as reference point. two of the most obvious reference points are the Point estimate and P50.

estimate accuracy is represented as percentage range around the selected reference points and it depends on the reference point; weather the range is symmetric or asymmetric.

As the estimate accuracy is a probabilistic assessment, there must be a separate evaluation of confidence which the estimator has in his estimate accuracy. this evaluation is termed the confidence level and is based on statistical analysis of the underlying distribution. it reflects the estimator’s confidence that the final value being within the boundaries of the low and high estimate. thus the estimator must not only put forward his estimated accuracy, but also a statement as to his confidence level.

the following statements are examples of coherent estimate conclusions:

● The estimated P50 cost of the project is 110 USD, based on November 2011 USD to the Icelandic krona (ISK) exchange rate. Implying 80% confidence level, it is expected that the estimate accuracy is 80 USD to 140 USD. The most likely cost is estimated at 100 USD. The cost estimate is based in project definition and estimating effort which corresponds to an AACE Class III.

Comparing this coherent presentation, to a familiar presentation of a Single-point estimator:

● The estimated cost of the project is 100 USD with +/- 10%

the last presentation is put forward with seemingly narrower estimate accuracy; thus, might be construed as a more elaborate and more accurate estimate. Without more information, it is impossible to assess if this is so; even more difficult is to assess the confidence level the estimator puts into his estimate. then, the level of project definition and the effort level which was budgeted for the making the estimate is not reported. in conclusion, the best conclusion to be drawn from this presentation is that the estimators “most likely” cost prediction is 100 USd.

P50=

50/5

0 es

timat

e

P90/

P10

out

com

e

Pe=P

oint

est

imat

e

(median)

(mode)

Figure 1b. Depicts the interrelationship between the key-values: mode, median and mean, for a right skewed distribution

P50=

Poin

t est

imat

e

(mode) (median)

Figure 1a. Depicts the interrelationship between the key-values: mode, median and mean, for a symetric distribution

8 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 9

items typically covered by contingencynow that it has been established that the contingency is the numerical difference between the P50 and the Point estimate, it helps to increase understanding of the nature of contingency to investigate which cost items are typically covered by contingency. the following costs are typically covered by contingency:

● errors and omissions in the estimating process

– Quantity variations during preparation of the estimate

– owners instructions affecting scope

– design and technological selection may impact material take-offs.

– Some item my defy precise quantification at the time of estimation; will only become known during execution

– the estimating methodology; for example, factored methods are by design never precise.

● Variability of Productivity

– Actual labour productivity may differ from that assumed.

– estimate based on execution during the summer months, but actually executed during the winter months may impact labour productivity

– only the average tradesman can perform at his best all the time. Mere mortals have good and bad days – i.e. there no such team as the average installation team.

– Labour skill levels may be different from what was assumed

● Variability in Wages

– Labour agreements may expire during execution

– Labour availability may inflate labour cost or even delay project completion

● Variability in Prices

– Material prices may differ from what was assumed

– Assumed material for a particular structure may be substituted

– Changes in material take-offs may change. As a consequence assumed quantity discount may not be realized

– Procurement strategy may be different from what was assumed

● Logistics

– equipment might be lost at sea – greatly impacting cost and schedule

items expressly excluded from contingencyitem expressly excluded form contingency:

● Significant changes in project scope

● Major, unexpected work stoppages

● disasters

● excessive or out of the ordinary escalations or currency fluctuations

● design allowances

● Management reserve

Cost contingencySingle-point estimator thinks of contingency as an amount used to cover the uncertainties inherent in the estimating process – i.e. to cover the cost of the known unknowns. experiences have taught the estimator that this is necessary to arrive at an estimate which will come close to the project outcome. Sometimes the estimator uses recognized standards for guidelines and selects prescribed contingency values. these standards, base their prescription on real data correlated to the project definition and the effort level put into the estimate. depending on the estimators understanding of the project definition, he will add different contingencies to each line item or one number to the sum of line items. Research has shown that this process produces the “most likely” outcome. in statistical terms the mode of the underlying probability distribution.

in order to increase the quality of the estimate, the three-point estimator uses the project’s Risk Register to quantify the impact each risk has on the project cost outcome. By systematically going through the register he assigns a minimum and maximum cost impact to each risk and then through statistical analysis produces the underlying cost probability distribution.

Figure 2 depicts a typical estimate probability distribution. the Point estimate is 100 USd. the probability distribution is right skewed and thus there is higher than 50% probability that the final cost will exceed the Point estimate. in order to arrive at a cost estimate which has 50% probability of being exceeded by the actual cost, contingency would be added to the Point estimate. in this example contingency of 10 USd would produce the P50 estimate.

For this particular example an accuracy range of 80% confidence level is bound between 80 and 140 USd. in probabilistic terms, 80% of the probability distribution is bound by the low and the high values. if these low and high values were referenced against the Point estimate (100 USd), the estimate range would be -20% and +40% - i.e. not symmetrical. However, if the reference point was the P50 value (110 USd) as in Figure 3, the estimate range would be specified as -27% and 27% and now it is symmetrical. thus, it is important to specify the reference point used when the range is defined. Unfortunately this important piece of information is missing from many estimates.

the lesson to remember is that the difference between the Point estimate and the P50 is the contingency which need to be added to the Point estimate to arrive at the P50 cost.

Figure 2. Estimate Accuracy Range specified around the Point Estimate.

-20% +40%

80% Confidence Estim accuracy range

140 USd(+40%)

80 USd(-20%)

Poin

t est

imat

e

P50

Cont

inge

ncy

100 USdPe

Freq

uenc

y of

par

ticul

ar c

ost v

alue

Figure 3. Estimate Accuracy Range specified around the P50 value. Notice: The low and high are the same as in Figure 2).

-27% +27%

80% Confidence Estim accuracy range

140 USd(+40%)

80 USd(-20%)

Poin

t est

imat

e

P50

Freq

uenc

y of

par

ticul

ar c

ost v

alue

110 USdP50

8 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 9

items typically covered by contingencynow that it has been established that the contingency is the numerical difference between the P50 and the Point estimate, it helps to increase understanding of the nature of contingency to investigate which cost items are typically covered by contingency. the following costs are typically covered by contingency:

● errors and omissions in the estimating process

– Quantity variations during preparation of the estimate

– owners instructions affecting scope

– design and technological selection may impact material take-offs.

– Some item my defy precise quantification at the time of estimation; will only become known during execution

– the estimating methodology; for example, factored methods are by design never precise.

● Variability of Productivity

– Actual labour productivity may differ from that assumed.

– estimate based on execution during the summer months, but actually executed during the winter months may impact labour productivity

– only the average tradesman can perform at his best all the time. Mere mortals have good and bad days – i.e. there no such team as the average installation team.

– Labour skill levels may be different from what was assumed

● Variability in Wages

– Labour agreements may expire during execution

– Labour availability may inflate labour cost or even delay project completion

● Variability in Prices

– Material prices may differ from what was assumed

– Assumed material for a particular structure may be substituted

– Changes in material take-offs may change. As a consequence assumed quantity discount may not be realized

– Procurement strategy may be different from what was assumed

● Logistics

– equipment might be lost at sea – greatly impacting cost and schedule

items expressly excluded from contingencyitem expressly excluded form contingency:

● Significant changes in project scope

● Major, unexpected work stoppages

● disasters

● excessive or out of the ordinary escalations or currency fluctuations

● design allowances

● Management reserve

Cost contingencySingle-point estimator thinks of contingency as an amount used to cover the uncertainties inherent in the estimating process – i.e. to cover the cost of the known unknowns. experiences have taught the estimator that this is necessary to arrive at an estimate which will come close to the project outcome. Sometimes the estimator uses recognized standards for guidelines and selects prescribed contingency values. these standards, base their prescription on real data correlated to the project definition and the effort level put into the estimate. depending on the estimators understanding of the project definition, he will add different contingencies to each line item or one number to the sum of line items. Research has shown that this process produces the “most likely” outcome. in statistical terms the mode of the underlying probability distribution.

in order to increase the quality of the estimate, the three-point estimator uses the project’s Risk Register to quantify the impact each risk has on the project cost outcome. By systematically going through the register he assigns a minimum and maximum cost impact to each risk and then through statistical analysis produces the underlying cost probability distribution.

Figure 2 depicts a typical estimate probability distribution. the Point estimate is 100 USd. the probability distribution is right skewed and thus there is higher than 50% probability that the final cost will exceed the Point estimate. in order to arrive at a cost estimate which has 50% probability of being exceeded by the actual cost, contingency would be added to the Point estimate. in this example contingency of 10 USd would produce the P50 estimate.

For this particular example an accuracy range of 80% confidence level is bound between 80 and 140 USd. in probabilistic terms, 80% of the probability distribution is bound by the low and the high values. if these low and high values were referenced against the Point estimate (100 USd), the estimate range would be -20% and +40% - i.e. not symmetrical. However, if the reference point was the P50 value (110 USd) as in Figure 3, the estimate range would be specified as -27% and 27% and now it is symmetrical. thus, it is important to specify the reference point used when the range is defined. Unfortunately this important piece of information is missing from many estimates.

the lesson to remember is that the difference between the Point estimate and the P50 is the contingency which need to be added to the Point estimate to arrive at the P50 cost.

Figure 2. Estimate Accuracy Range specified around the Point Estimate.

-20% +40%

80% Confidence Estim accuracy range

140 USd(+40%)

80 USd(-20%)

Poin

t est

imat

e

P50

Cont

inge

ncy

100 USdPe

Freq

uenc

y of

par

ticul

ar c

ost v

alue

Figure 3. Estimate Accuracy Range specified around the P50 value. Notice: The low and high are the same as in Figure 2).

-27% +27%

80% Confidence Estim accuracy range

140 USd(+40%)

80 USd(-20%)

Poin

t est

imat

e

P50

Freq

uenc

y of

par

ticul

ar c

ost v

alue

110 USdP50

10 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 11

examples of inputs defining project definition include:

● Facility descriptions (technically the owners instructions)

● Process information: PFds, P&id diagrams, equipment lists and general technical specifications.

● drawings and calculations

● Lessons Learned from past similar projects

● Reconnaissance data and other information developed to define the project

Common misunderstanding is that any given estimate can be produced with a preferred accuracy. this is not true. At any given point in time finite knowledge is available for only fraction of the project, while the other fractions will be subject to modifications, improvements, alterations or even cancelations. As the set of defining documents become more refined, the level of project definition increases; thus, justifying the upgrade between estimate classes. only by systematic project engineering and expert inputs will the project definition increase. this implies that the estimating process is iterative in nature and that more than one estimate will be issued for any given project.

Figure 5. depicts the interrelationships between estimating classes and expected accuracy classes.

the percent indication for the accuracy range should be interpreted only as indicator. the actual accuracy

range can only be determined by association with the underlying probability distributions for the estimate.

Although the level of project definition is the primary variable deciding the accuracy range, there are other factors which also can influence the class level. Some of these other factors are:

● Quality of cost reference data

● the quality of the assumptions laid down as basis for the estimate

● the stage of technology – i.e. is it time tested or is it new technology

● experiences, skills and commitment of the estimator

● the estimating techniques employed.

● the intended end use of the estimate

● the level of budget allocated for estimating resources

● outside boundary conditions, such as escalating markets or climate conditions

thus, it is possible to have a Class 3 estimate with as narrow accuracy range as Class 2 estimates. For example, technological transfer projects; project which are simple in terms of technology and when the estimate is supported by resent actual data, the narrower accuracy range will emerge from the statistical analysis of the underlying probability distribution. of the same token, Class 3 estimate can have as wide an accuracy range as Class 4, if the

technological know-how is based on new technology or such projects have not been built in a long time.

often, better accuracy can be gained by concentrating on the design base and improving the level of definition of the project rather than overemphasizing more accurate estimating technique.

AACE view on Accuracy RangeAACe has issued a cost estimate classification system. the system facilitates selection of estimate class; allows macroscopic comparison between different estimates and enhances communication between project owners and estimators.

the following table 1 is an excerpt from AACe, Cost Estimate Classification System – As Applied in Engineering, Procurement , and Construction for The Process Industries, 18R-97 (See also AACE, Recommended Practices on Estimate Classification, 17R-97).

the estimate class designations are labelled Class 1, 2, 3, 4 and 5. A class 5 estimate is based upon the lowest level of project definition, while Class 1 estimate is closest to a full project definition and maturity.

While only intended as an illustration of the general relationship between estimate accuracy and the level of engineering definition, it guides owners

and estimator in selecting the appropriate accuracy range and approving the required budget to achieve such estimates.

it should be pointed out that according to AACe, the following characteristics should be considered at the front end of the work in order to categorize the estimates according to the AACe guidelines:

● degree of project definition

● end usage of the estimate

● Methodology

● expected Accuracy Range

the last column, effort to Prepare estimate, is an relative indication of the needs for resources, money, and man hours to produce an estimate with the required accuracy.

of these, the project definition is the most influential (termed by AACe, the primary characteristic), while the others are of second order. there is a strong correlation between the quality of the information available to estimating effort and the level of project definition.

Primary Characteristic Secondary Characteristic

Estimate Class

Level of Project Definition

expressed as % of complete

definition

End Usagetypical purpose of

estimate

Methodologytypical estimate

method

Expected Accuracy Rangetypical variation in low and high

ranges

Preparation Effort

typical degree of effort relative to least cost index

of 1

CLASS 5 0% to 2% Concept Screening

Capacity Factored, Parametric Model,

Judgement, or Analogy

L: -20% to -50%H: +30% to +100% 1

CLASS 4 1% to 15% Study or Feasibilityequipment Factored or

Parametric Models

L. -15% to -30%H: +20% to +50% 2 to 4

CLASS 3 10% to 40%Budget

Authorization, or Control

Semi-detailed Unit Costs with Assembly Level

Line items

L: -10% to -20%H: +10% to +30% 2 to 10

CLASS 2 30% to 70% Control or Bid/tender

detailed Unit Cost with Forced detailed take-off

L: -5% to -15%H: +5% to +20% 4 to 20

CLASS 1 50% to 100% Check estimate Bid/tender

detailed Unit Cost with detailed

take-off

L: -3% to -10%H: +3% to +15% 5 to 100

Table 1. Estimate Accuracy as a Function of Estimate Class.

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Acc

urac

y Ra

nge

(%)

Class 1

Class 2

Class 3

Class 4

5

10 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 11

examples of inputs defining project definition include:

● Facility descriptions (technically the owners instructions)

● Process information: PFds, P&id diagrams, equipment lists and general technical specifications.

● drawings and calculations

● Lessons Learned from past similar projects

● Reconnaissance data and other information developed to define the project

Common misunderstanding is that any given estimate can be produced with a preferred accuracy. this is not true. At any given point in time finite knowledge is available for only fraction of the project, while the other fractions will be subject to modifications, improvements, alterations or even cancelations. As the set of defining documents become more refined, the level of project definition increases; thus, justifying the upgrade between estimate classes. only by systematic project engineering and expert inputs will the project definition increase. this implies that the estimating process is iterative in nature and that more than one estimate will be issued for any given project.

Figure 5. depicts the interrelationships between estimating classes and expected accuracy classes.

the percent indication for the accuracy range should be interpreted only as indicator. the actual accuracy

range can only be determined by association with the underlying probability distributions for the estimate.

Although the level of project definition is the primary variable deciding the accuracy range, there are other factors which also can influence the class level. Some of these other factors are:

● Quality of cost reference data

● the quality of the assumptions laid down as basis for the estimate

● the stage of technology – i.e. is it time tested or is it new technology

● experiences, skills and commitment of the estimator

● the estimating techniques employed.

● the intended end use of the estimate

● the level of budget allocated for estimating resources

● outside boundary conditions, such as escalating markets or climate conditions

thus, it is possible to have a Class 3 estimate with as narrow accuracy range as Class 2 estimates. For example, technological transfer projects; project which are simple in terms of technology and when the estimate is supported by resent actual data, the narrower accuracy range will emerge from the statistical analysis of the underlying probability distribution. of the same token, Class 3 estimate can have as wide an accuracy range as Class 4, if the

technological know-how is based on new technology or such projects have not been built in a long time.

often, better accuracy can be gained by concentrating on the design base and improving the level of definition of the project rather than overemphasizing more accurate estimating technique.

AACE view on Accuracy RangeAACe has issued a cost estimate classification system. the system facilitates selection of estimate class; allows macroscopic comparison between different estimates and enhances communication between project owners and estimators.

the following table 1 is an excerpt from AACe, Cost Estimate Classification System – As Applied in Engineering, Procurement , and Construction for The Process Industries, 18R-97 (See also AACE, Recommended Practices on Estimate Classification, 17R-97).

the estimate class designations are labelled Class 1, 2, 3, 4 and 5. A class 5 estimate is based upon the lowest level of project definition, while Class 1 estimate is closest to a full project definition and maturity.

While only intended as an illustration of the general relationship between estimate accuracy and the level of engineering definition, it guides owners

and estimator in selecting the appropriate accuracy range and approving the required budget to achieve such estimates.

it should be pointed out that according to AACe, the following characteristics should be considered at the front end of the work in order to categorize the estimates according to the AACe guidelines:

● degree of project definition

● end usage of the estimate

● Methodology

● expected Accuracy Range

the last column, effort to Prepare estimate, is an relative indication of the needs for resources, money, and man hours to produce an estimate with the required accuracy.

of these, the project definition is the most influential (termed by AACe, the primary characteristic), while the others are of second order. there is a strong correlation between the quality of the information available to estimating effort and the level of project definition.

Primary Characteristic Secondary Characteristic

Estimate Class

Level of Project Definition

expressed as % of complete

definition

End Usagetypical purpose of

estimate

Methodologytypical estimate

method

Expected Accuracy Rangetypical variation in low and high

ranges

Preparation Effort

typical degree of effort relative to least cost index

of 1

CLASS 5 0% to 2% Concept Screening

Capacity Factored, Parametric Model,

Judgement, or Analogy

L: -20% to -50%H: +30% to +100% 1

CLASS 4 1% to 15% Study or Feasibilityequipment Factored or

Parametric Models

L. -15% to -30%H: +20% to +50% 2 to 4

CLASS 3 10% to 40%Budget

Authorization, or Control

Semi-detailed Unit Costs with Assembly Level

Line items

L: -10% to -20%H: +10% to +30% 2 to 10

CLASS 2 30% to 70% Control or Bid/tender

detailed Unit Cost with Forced detailed take-off

L: -5% to -15%H: +5% to +20% 4 to 20

CLASS 1 50% to 100% Check estimate Bid/tender

detailed Unit Cost with detailed

take-off

L: -3% to -10%H: +3% to +15% 5 to 100

Table 1. Estimate Accuracy as a Function of Estimate Class.

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Acc

urac

y Ra

nge

(%)

Class 1

Class 2

Class 3

Class 4

5

12 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 13

RisksRisk management is the process used to gain understanding of the probability of overrunning or underrunning each line item in the estimate and it follows that any attempts to control project risks will influence the key variable in a favourable way. once the risks have been registered; their impact and likelihood quantified the underlying probability distribution can be produced.

the MaPro system has catalogued categories of systemic risks which to a degree all projects are subjected. Systemic risks imply risks to the project which might bring it to the stage of failure. the first column indicates the risk categories; the second column indicates the leverage to influence the risks and when the leverage should be levelled against the risks.

For the estimator, the most important risks to look at are those that relate to level of completeness and which can be influenced at the front end of the project and the risks that relate to project type.

the Base Case reflects the scope of work supplied to the estimator by the owner and other stakeholders. therefore, any gaps in the scope associated with the project size, complexity and assumptions & constraints could become a potential risk to the project outcome. Similarly ill-defined, shifting or unclear owner’s requirements are a classical source of risks to projects.

Project type is another category which the estimator needs to understand thoroughly. Projects using new technology or technology extrapolated beyond current equipment sizes carry greater risk than simple project or technological transfer projects. these projects will require greater level of contingency.

Category InfluenceLeverage

Project Size and Complexity FeL

owner’s Requirements dC/FeL

Change impact idC

organization dC

Sponsorship idC

Stakeholder idC

Schedule FeL

Funding idC

Facilities idC

team dC

technology dC/FeL

Vendor & Supplies idC

external Factors idC

Business Factors idC

Assumptions & Constraints dC/FeL

Project Management dC

dC: direct control of the project teamidC: only indirect control of the project teamFeL: Predominantly related to Front end decisions

Management Reserve and its relation to Contingencynow we will look at management reserve and its relationship to contingency. to recap, adding contingency to the Point estimate created the P50 cost. in another words, adding funds to the Point estimate is an effort to ensure specific predictability, in this case 50%.

P50 = Point estimate + Contingency

if the estimator wants to know, not just the P50 cost and the associated probability but the estimate value which has a greater than 50% probability of being underrun, the estimator adds management reserve to the P50 estimate. Specifically, the P90 cost is a common reference point. the numerical difference between the P90 and P50 is the management reserve associated with the 90/10 accuracy range. By adding this difference to the P50 value the estimator can now specify with 80% probability that the project will be underrun with reference to P90. Figure 6 depicts this graphically.

Just like the contingency, the management reserve is based on a particular project definition, project scope and estimating effort. thus once the project becomes better defined the P90 management reserve shrinks toward the P50 because the P90 and P10 will move toward the P50 which remains nearly constant.

it is stressed here that management reserve is never to cover scope changes, only to ensure predictability.

even though contingency and the management reserve both serve to define predictability, they should be treated differently.

Contingency has also useful properties not shared by the management reserve. Let us assume that the owner is running a portfolio of projects. Under such circumstances it makes sense for the owner to control each project to the P50 cost and prearrange financial strength to back it up. Some of the time individual projects will come in at a lower than P50 cost and sometimes higher. on the average the portfolio will come in at the budgeted cost. Should the owner decide to use different level of predictability, the portfolio would either tie up to much money or it would in emergency cases need more money, which might not be available on short notice.

thus, the conclusion is that if the capital spending owner systematically turns down or deletes contingency from project budgets, misalignment will soon arise between the asset owner and the project team performing the work, as probability predicts that funds will systematically be needed to close the gap between the budget and the outcome of projects.

Poin

t est

imat

e

Management Reserve

P50

out

com

e

Cont

inge

ncy

P0,0

/P10

out

com

e

P10/

P90

out

com

e

Figure 6. The relation between contingency and Management reserve

12 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 13

RisksRisk management is the process used to gain understanding of the probability of overrunning or underrunning each line item in the estimate and it follows that any attempts to control project risks will influence the key variable in a favourable way. once the risks have been registered; their impact and likelihood quantified the underlying probability distribution can be produced.

the MaPro system has catalogued categories of systemic risks which to a degree all projects are subjected. Systemic risks imply risks to the project which might bring it to the stage of failure. the first column indicates the risk categories; the second column indicates the leverage to influence the risks and when the leverage should be levelled against the risks.

For the estimator, the most important risks to look at are those that relate to level of completeness and which can be influenced at the front end of the project and the risks that relate to project type.

the Base Case reflects the scope of work supplied to the estimator by the owner and other stakeholders. therefore, any gaps in the scope associated with the project size, complexity and assumptions & constraints could become a potential risk to the project outcome. Similarly ill-defined, shifting or unclear owner’s requirements are a classical source of risks to projects.

Project type is another category which the estimator needs to understand thoroughly. Projects using new technology or technology extrapolated beyond current equipment sizes carry greater risk than simple project or technological transfer projects. these projects will require greater level of contingency.

Category InfluenceLeverage

Project Size and Complexity FeL

owner’s Requirements dC/FeL

Change impact idC

organization dC

Sponsorship idC

Stakeholder idC

Schedule FeL

Funding idC

Facilities idC

team dC

technology dC/FeL

Vendor & Supplies idC

external Factors idC

Business Factors idC

Assumptions & Constraints dC/FeL

Project Management dC

dC: direct control of the project teamidC: only indirect control of the project teamFeL: Predominantly related to Front end decisions

Management Reserve and its relation to Contingencynow we will look at management reserve and its relationship to contingency. to recap, adding contingency to the Point estimate created the P50 cost. in another words, adding funds to the Point estimate is an effort to ensure specific predictability, in this case 50%.

P50 = Point estimate + Contingency

if the estimator wants to know, not just the P50 cost and the associated probability but the estimate value which has a greater than 50% probability of being underrun, the estimator adds management reserve to the P50 estimate. Specifically, the P90 cost is a common reference point. the numerical difference between the P90 and P50 is the management reserve associated with the 90/10 accuracy range. By adding this difference to the P50 value the estimator can now specify with 80% probability that the project will be underrun with reference to P90. Figure 6 depicts this graphically.

Just like the contingency, the management reserve is based on a particular project definition, project scope and estimating effort. thus once the project becomes better defined the P90 management reserve shrinks toward the P50 because the P90 and P10 will move toward the P50 which remains nearly constant.

it is stressed here that management reserve is never to cover scope changes, only to ensure predictability.

even though contingency and the management reserve both serve to define predictability, they should be treated differently.

Contingency has also useful properties not shared by the management reserve. Let us assume that the owner is running a portfolio of projects. Under such circumstances it makes sense for the owner to control each project to the P50 cost and prearrange financial strength to back it up. Some of the time individual projects will come in at a lower than P50 cost and sometimes higher. on the average the portfolio will come in at the budgeted cost. Should the owner decide to use different level of predictability, the portfolio would either tie up to much money or it would in emergency cases need more money, which might not be available on short notice.

thus, the conclusion is that if the capital spending owner systematically turns down or deletes contingency from project budgets, misalignment will soon arise between the asset owner and the project team performing the work, as probability predicts that funds will systematically be needed to close the gap between the budget and the outcome of projects.

Poin

t est

imat

e

Management Reserve

P50

out

com

e

Cont

inge

ncy

P0,0

/P10

out

com

e

P10/

P90

out

com

e

Figure 6. The relation between contingency and Management reserve

14 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 15

estimate, but which based on historical evidence is seen to be required “in aggregate” over the entire estimate. Consequently, adding contingency to the estimate is a sign of professional approach – an attempt to predict the actual outcome of the project with a specific probability.

there are those that believe that the contingency should be allocated to the estimate, but that it should not be consumed. there is a truth to that statement; however, it can be made more specific, because there is 50% probability that the contingency will be consumed totally and 50% that only some of it will be consumed.

the paper demonstrates how the management responds to the need to increase further the predictability of the estimate outcome. For example, should it be desired to increase the probability of the outcome being lower than P90, the management reserve would be defined as the numerical difference between P90 and P50 and added on top of the contingency. other reference values, suchas P80/P20 can also be selected. the management reserve, just as the contingency is based on a specific project scope and definition.

Finally, there is always less than 50% probability that the management reserve will be consumed. For that very reason the paper argues that the management reserve should not be put under control of the project team, but that the owner’s sponsor should only release it to the team on an as required basis.

ConclusionsAn estimate is by definition an intellectual attempt at predicting an outcome. two major approaches were explained: Single-point and three-point estimates. the single-point estimate is not accountable with respect to the probabilistic nature of estimates. three-point estimates do take account of the probabilistic nature of the estimating process and when correctly produced reflects the potential impacts project risks may have on the project outcome.

the estimating process produces two closely related written documents: the estimate and the basis of the estimate, Boe. the Boe describes how the estimate was produced, describes the level of project definition, methodology employed during the estimating process, the project schedule and finally detailed description of the Base Case laid down as basis for the estimate. Without the Boe, the estimate is of little worth.

the estimating range is explained as an attempt to frame in the likely outcome of a project between the low and the high outcome. However, in order for the estimating range to be meaningful, level of confidence (or the confidence level) has to be assigned to the range. Common estimating range selection is the P90/P10 range, which implies that 90% of the time the outcome will be less than P90 and 90% of the time the outcome will be higher than P10. other ranges can also be used, For a given probability distribution of the possible outcomes, the P90/P10 range has a level of confidence of 80%, implying that the estimator predicts that there is 80% probability that the outcome will lie between the P10 (the low cost) and the P90 (the high cost). Without a confidence level the range has diminished use; thus, users of estimates should ask for the confidence level should it be missing from the estimate report.

the paper explains the roles and information tied with the statistical variables: Mode, median and mean. the mean is of no consequence for the estimating activity and is not dealt with in the paper. in terms of estimating effort, the mode equals the “most likely” cost or the term Point estimate used in this paper. the “most likely” cost is effectively the cost which the Single-point estimator predicts.

P50 equals the median and predicts that there is 50% probability that the outcome will either be higher or lower. P50 has great use for those contemplating capital spending projects. the paper demonstrates that for large project portfolios, individual projects should be controlled against the P50 estimate, since otherwise either too much funds are tied up in the project or too little.

two different types of distributions are mentioned: the symmetrical distribution and the skewed distribution. While there are real projects which are represented by symmetrical distributions, the right skewed distribution is more common. it reflects that each line item in the estimate cannot be lower than zero, while at the same time the upper limits is less well-defined. Symmetrical distribution are characterized with mode, median and mean, all being the same value, while right skewed distributions are characterized with the mode begin lower than the median which is lower than the mean.

the paper explains how the internationally recognized AACe guidelines tie in with the estimating effort and how the guidelines serve as standard by which estimate quality (Class) can be measured. the paper stresses that the project definition is the primary characteristics determining the estimating class, but methodology, preparation effort and end usage are second order.

no subject in the field of estimation is more subject to interpretations as contingency, yet none should be better understood by all stakeholders. in the minds of many contingency covers the known unknowns cost; the Project Management Book of Knowledge describes contingency as:

“A provision in the project management plan to mitigate cost risk” and AACe Recommended Practice defines contingency as “An amount added to an estimate to allow for items, conditions, or events for which the state, occurrence and /or effect is uncertain and that experience show will likely result, in aggregate, in additions costs.”

in this paper contingency is, in conclusion, the amount of money added to the point estimate to arrive at the P50 cost estimate which ensures equal predictability that the actual cost will be either over or under that value. Contingency so defined and calculated, covers additions that cannot be systematically assigned to any one line item in the

OUTCOME

ESTIMATE CONTINGENCY

ContingenC

14 | MaPro´s take on... ...ContinGenCy And MAnAGeMent ReSeRVe | 15

estimate, but which based on historical evidence is seen to be required “in aggregate” over the entire estimate. Consequently, adding contingency to the estimate is a sign of professional approach – an attempt to predict the actual outcome of the project with a specific probability.

there are those that believe that the contingency should be allocated to the estimate, but that it should not be consumed. there is a truth to that statement; however, it can be made more specific, because there is 50% probability that the contingency will be consumed totally and 50% that only some of it will be consumed.

the paper demonstrates how the management responds to the need to increase further the predictability of the estimate outcome. For example, should it be desired to increase the probability of the outcome being lower than P90, the management reserve would be defined as the numerical difference between P90 and P50 and added on top of the contingency. other reference values, suchas P80/P20 can also be selected. the management reserve, just as the contingency is based on a specific project scope and definition.

Finally, there is always less than 50% probability that the management reserve will be consumed. For that very reason the paper argues that the management reserve should not be put under control of the project team, but that the owner’s sponsor should only release it to the team on an as required basis.

ConclusionsAn estimate is by definition an intellectual attempt at predicting an outcome. two major approaches were explained: Single-point and three-point estimates. the single-point estimate is not accountable with respect to the probabilistic nature of estimates. three-point estimates do take account of the probabilistic nature of the estimating process and when correctly produced reflects the potential impacts project risks may have on the project outcome.

the estimating process produces two closely related written documents: the estimate and the basis of the estimate, Boe. the Boe describes how the estimate was produced, describes the level of project definition, methodology employed during the estimating process, the project schedule and finally detailed description of the Base Case laid down as basis for the estimate. Without the Boe, the estimate is of little worth.

the estimating range is explained as an attempt to frame in the likely outcome of a project between the low and the high outcome. However, in order for the estimating range to be meaningful, level of confidence (or the confidence level) has to be assigned to the range. Common estimating range selection is the P90/P10 range, which implies that 90% of the time the outcome will be less than P90 and 90% of the time the outcome will be higher than P10. other ranges can also be used, For a given probability distribution of the possible outcomes, the P90/P10 range has a level of confidence of 80%, implying that the estimator predicts that there is 80% probability that the outcome will lie between the P10 (the low cost) and the P90 (the high cost). Without a confidence level the range has diminished use; thus, users of estimates should ask for the confidence level should it be missing from the estimate report.

the paper explains the roles and information tied with the statistical variables: Mode, median and mean. the mean is of no consequence for the estimating activity and is not dealt with in the paper. in terms of estimating effort, the mode equals the “most likely” cost or the term Point estimate used in this paper. the “most likely” cost is effectively the cost which the Single-point estimator predicts.

P50 equals the median and predicts that there is 50% probability that the outcome will either be higher or lower. P50 has great use for those contemplating capital spending projects. the paper demonstrates that for large project portfolios, individual projects should be controlled against the P50 estimate, since otherwise either too much funds are tied up in the project or too little.

two different types of distributions are mentioned: the symmetrical distribution and the skewed distribution. While there are real projects which are represented by symmetrical distributions, the right skewed distribution is more common. it reflects that each line item in the estimate cannot be lower than zero, while at the same time the upper limits is less well-defined. Symmetrical distribution are characterized with mode, median and mean, all being the same value, while right skewed distributions are characterized with the mode begin lower than the median which is lower than the mean.

the paper explains how the internationally recognized AACe guidelines tie in with the estimating effort and how the guidelines serve as standard by which estimate quality (Class) can be measured. the paper stresses that the project definition is the primary characteristics determining the estimating class, but methodology, preparation effort and end usage are second order.

no subject in the field of estimation is more subject to interpretations as contingency, yet none should be better understood by all stakeholders. in the minds of many contingency covers the known unknowns cost; the Project Management Book of Knowledge describes contingency as:

“A provision in the project management plan to mitigate cost risk” and AACe Recommended Practice defines contingency as “An amount added to an estimate to allow for items, conditions, or events for which the state, occurrence and /or effect is uncertain and that experience show will likely result, in aggregate, in additions costs.”

in this paper contingency is, in conclusion, the amount of money added to the point estimate to arrive at the P50 cost estimate which ensures equal predictability that the actual cost will be either over or under that value. Contingency so defined and calculated, covers additions that cannot be systematically assigned to any one line item in the

OUTCOME

ESTIMATE CONTINGENCY

ContingenC

Mannvit hf I Grensásvegi 1 I 108 Reykjavík I Iceland I mannvit@mannvit is I www mannvit com I t: +354 422 3000 I f: +354 422 3001

Additional information:

www.mannvit.com

Haukur Óskarsson i e-mail: haukuro@mannvit.is

Mannvit is an international consultancy firm providing services in the fields

of engineering, consulting, management, operations and ePCm project

delivery. Since 1963, the company has provided engineering, technical

and project management services for a wide range of public and private

projects including; industry, processing, infrastructure and transport,

buildings, environmental and renewable energy, power transmission, it

and telecommunications.

All Mannvit’s operations are certified under international quality,

environmental and safety management standards: iSo 9001:2008, iSo

14001:2004 and oHSAS 18001:2007.

August 2012

FS 551557 EMS 567779 OHSS 567778