What is the difference between contingency reserve and management reserve ? How are these calculated? and Who has the authority to use them.
The Contingency Reserve and the Management Reserve are calculated during the risk management planning process and after the risks have been identified and qualified. These reserves are necessary to estimate the actual budget and cost of a project, and the reserves are against both unknown and known risks. The contingency and management reserves are different and are calculated using different techniques. They are also meant to serve different purposes.
Contingency Reserve
The contingency reserve is for overcoming the known or identified risks and the unknown risks. The reserve can be measured in terms of time or cost.
Calculation of contingency reserve- There are multiple techniques for calculating the contingency reserve. These may include:
Percentage of the project cost- The technique is used by medium and small-sized businesses where the complexity of operations is less. The contingency reserve here is usually between 3% to 10% of the total cost of the project and is based primarily on the perceived risks that a given project may face.
Expected monetary value (EMV)- The technique is used in cases where project failure cannot be risked as the stakes are too high. EMV is used widely in both high and medium-cost projects that require ample of resources. The impact and probability of each event are calculated. These two data figures are then multiplied with each other and the value generated is the expected monetary value (EMV) of each of the risks.
EMV= Impact*Probability
The calculated EMVs of all the identified risks are then added to know the contingency reserve value.
Decision tree analysis- It is a quantitative technique for analyzing risk, which helps project managers know the best choice from the various options. Because a graphical representation is obtained, the technique is called decision tree analysis. The risk analyzer will determine the probability of each of the risky events occurring and their impact and will determine the multiple choices. The expected monetary value of all the events is also calculated (probaility*impact) and the most suitable/profitable choice is made. For instance, if EMV of choice A is 312 USD, Choice B is 355 USD and Choice C is 240 USD, the project manager will choose the choice B, which has the highest EMV value and consequently highest profit. In cases where all the underlying risks are negative, the least negative option needs to be chosen.
Monte Carlo simulation- The technique was given by a nuclear scientist by the name Stanislaw Ulam in the year 1940. It provides the various probabilities of outcomes and also gives the probabilities for each choice of action. The project managers can evaluate risks on the basis of normal and worst-case scenarios and make the right choice.
Authority to use contingency reserve: The project manager of a given project has the authority to use the contingency reserve in cases when the identified or unknown risks occur. The authority can also be delegated to some other risk owner, who updates the project manager on the same at some later stage.
Management Reserve
Management reserve is the time or cost reserve that is used for managing the unknown and unidentified risks. The value of management reserve is in accordance with the policy of the organization and is not an estimated reserve (i.e. it is not part of the cost baseline). In most cases, it is around 5% of the total project cost or project duration. In other cases, it may be as high as 10%. The uncertainty is related to a given project may affect the management reserve and its value. For instance, if an organization is already experienced in a given kind of project, the management reserve for the project will be low and vice-a-versa.
Authority to use management reserve: The management reserve can be used by the management of the organization and not by the project manager. A project manager will require the permission of the senior management to use the reserve.
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