Contingency Reserve and Management Reserve are different kinds of reserves that serve the same purpose: managing the risks; therefore, a lot of professionals mix up these two different concepts. From my personal experience, I can say that more than 50% of project professionals (not the PMPs) I met were not aware of the correct meaning of it. They understand it as 5% or 10% of the cost or time of the project. They think that Contingency Reserve and Management Reserve is same thing; though, they are not the same.
Anyway, let’s discuss them one by one.
Contingency Reserves: Contingency Reserve is the cost or time reserve that is used to manage the identified risks or “known-unknowns” (known=identified, unknowns=risks). 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 has authority to use it when any identified risk occurs, or he 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.
Management Reserve: Management Reserve is the cost or time reserve that is used to manage unidentified risks or “unknown-unknowns” (unknown=unknown, unknowns=risks). 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.
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:
- used to manage identified risks
- estimated based on Expected Monitory Value (EMV), or decision tree method
- project manager has authority to use this reserve
Management Reserve:
- used to manage unidentified risks
- calculated as a percentage of the cost, or time of project
- require management approval to use this reserve
This was all about Contingency and Management Reserve. Feel free to write in the comment box if you require any further clarification – I am ready to discuss it with you to reach a mutually agreed conclusion.
Please prepare for this topic well as you may see one or two questions from this topic in your PMP Test.
I have undersrtood the following:
1. Neither the CR or the MR are included in the cost baseline.
2. The CR is included in the project's budget (i.e., required funding)
3. The MR is not incliuded in the project's budget (i.e., required funding)The exposure draft of the 5th Edition of the PMBOK Guide espouses the following
1. The CR is included in the cost baselne
2. The MR is not included in the cost baseline, but is included in project's budget (i.e., required funding)
What are your thoughts?
As per the PMBOK Guide 4th Edition,
Cost base line is the sum of project cost estimate and contingency reserve; i.e.
Cost Baseline = Project Cost Estimate + Contingency Reserve
And, project budget is the sum of project cost base line and the management reserve; i.e.
Project Budget = Cost Baseline + Management Reserve
Therefore, Management Reserve is not a part of the cost baseline but it is a part of the project budget and Contingency Reserve is a part of cost baseline as well as project budget.
Hope it answers your query.
Since, I’ve not reviewed the exposure draft of the PMBOK Guide 5th edition thoroughly, I would not comment on it. However, the information provided by you here in comment section is agreeing with the current version of the PMBOK Guide; i.e. 4th edition.
I respectfully disagree with your assessment of the current PMBOK Guide (4th Edition) position regarding Management Reserves and Contingency Reserves. I would ask you to review the following article on Max Wideman's (PMI Fellow) http://www.maxwideman.com/guests/unraveling/4th_ed.htm
PMBOK Guide 4th Edition, Page-174, Second Para from bottom:
"This baseline includes all authorized budgets, but excludes Management Reserves"
Please note here: here PMBOK does not exclude the Contingency from the cost baseline, it excludes only Management reserve from it.
PMBOK Guide 4th Edition, Page-177, Point. 7.2.2.2
"Budget reserve analysis can establish both Contingency Reserve and Management Reserves for the Project"
PMBOK Guide 4th Edition, Page-177, Point. 7.2.2.2
"Management Reserves are not a part of project cost baseline, but may be included in the total budget for the project"
As per my understanding, the PMBOK is trying to say that cost baseline includes the Contingency Reserves but not the Management Reserves.
An additional follow-up question:
If a negative risk (theat) is actively accepted, good practice would require that we develop a contingent plan of action (response) that woulf be executed should thwe risk be realized. The implementation of that response would require that we use established formal change control procedures to modify the scope, schedule and/or cost baselines as necessary. If a modification of the cost baseline is needed.and we have estiblished both a Contingency Reserve and a Management Reserve of money, where would the funds to cover the contingent response come from?
If any identified risk occurs then fund from the Contingency Reserves will be used, otherwise Management Reserved will be used but only after taking the required approval from the management.
It is a fact that the cost baseline is the sum of the cost estimates of each work package. Every dollar of the cost baseline must be linked to a component of the projects scope. If, as you replied earlier, the Contingency Reserve (CR) funds are included in the baseline, what element of scope are they tied to before possibly being moved to funding a contingent response for an actively accepted risk?.
The PMBOK Guide 4th Edition, Page 173, Article 7.1.2.6 says,
"Cost estimates may include contingency reserves (sometimes called contingency allowances) to
account for cost uncertainty."
This is a separate reserve, known as a CR and this reserve is not tied with anything. Just a calculated reserve for identified risks.
I have one Question regarding Secondary Risk , is it covered by Contingency Or Management reserve ?
Thank you
Since it is a known or identified risk, it is covered under contingency reserve.
Usmani, broad explantion of Cost Baseline and Project Budjet and Contingency vs Management Reserve scopes; extremily clear.
Nevertheless, I haven’t founded, reviewing the PMBOK 4th edition, the definition of the EMV and the Decission Tree Method techniques to estimate CR. Are they techniques aplicable only from estimations referred to Risk Management Reserves or are they applicable in general Project Cost Estimates?. Could you please explain rougly theirs fundamentals and give an hands-on example.
Additionally, if a positive risk has been achieved will be automaticly traduced as an increment of the CR? Is it a Project Maneger decission?
Many thanks,
Arturo
Sorry Usmani.
Reviewing more in detatil the PMBOK 4th edition I have found EVM and its use within Descision Tree Method; I think I understand rougly their fundamentals, but style I’m lost in their application to estimate CR: I still need an example, if possible.
Thanks
It is in my wish list. Sure you’re going to see few blog posts on decision tree methods in coming days… just stay tuned.
EVM and EMV are very useful concepts. I have already covered the EVM now aim is at EMV.
Hullo again Fahad,
I will stay tuned and exited, looking for EMV on desission tree method examples.
Regarding CR, I have something to clarify:
if a positive risk has been achieved, it will be automaticly traduced as an increment of the CR? Is it a Project Maneger decission?
Many thanks,
Arturo
If any identified risk occurs then its effect will reflect on the contingency reserve, regardless of whether it is positive or negative.
This decision is already factored in the the project management plan.
Nice post, but if i have risks and probabilities of their occurance, how can i calculate both Contingency and management reserve ?!
Hello Nora,
To calculate Contingency Reserve, you must have probability of each risk and its impact. Once you get it, multiply probability to its impact. Repeat this procedure for all risks and then add it. Result will be your contingency reserve.
Management reserve is a some percentage of the cost of the project. It may vary between 5 to 10%.
First of all thanks for a nice post. My doubt is:
Assuming there is a contingency plan exisitng for an identified risk, and subsequently the risk does occur, in this case my schedule will be changed taking into account the contingency. So do we have to perform integrated change control, take it to the advisory board, get an approval and then change the baselines? – because there is an identified risk
occurence..
In this case are we using management reserves or contingency reserves? If it’s contingency reserves then what is the use of it when my baselines are still changing?
Thanks in advance.
Hello Anmol,
If any identified risk occurs, you implement the approved contingency plan. In this case you will not go for schedule change because risk was already identified and it was already factored in your schedule.
For identified risks, Contingency Reserve is used. Management Reserve is for unidentified risks.
There is no change in the baseline unless you spend all contingency reserve.
Thank you Fahad for a clear explanation!!
You are welcome Anmol!
Hi Fahad,
I’m new to this area of project management, so apologies if this seems like a silly question! Since the Contingency Reserve is calculated as a percentage of the impact of the risk occurring, the reserves are never actually going to cover the impact if the risk does actually occur, correct?
So if the risk does occur, the effort to resolve the risk means your contingency will be used AND you will also have a deviation from your cost baseline? While I appreciate that you can’t factor in the complete cost of every risk, I’m having difficulty in seeing the logic of this method of estimating contingency reserves when it seems like they will never completely cover the cost of ANY risk?
Is it possibly the assumption that, if the risk was to occur, that the contingency plan for a risk factors in additional activities to reduce the cost of the impact, meaning that when combined with the contingency plan, the contingency reserves do actually cover the cost of the risk?
Kind Regards,
Eoin
Hello Eoin,
First of all you should understand that risk can be managed as an aggregate for the large population of events (macro), or it can be managed on an event-by-event (micro) basis.
In project management, Risk Management is managed by considering a large population of events.
Now, come to your point:
Let’s say that you have identified a hundred numbers of risks and then calculated the impact of these risks if they happen to occur. Then you multiply the impact by their respective likelihood and add them all to get the contingency reserve.
Now, do you really think that these all hundred identified risks are going to occur on your project? No, there is very less chance for this to happen.
Point is, some of them will occur and rest will not occur. In case of any risk occurs, you take money from the contingency reserve.
There will not be any deviation from the cost baseline unless you spend all of your contingency reserve.
Hi Fahad,
Thanks for the reply on this, what got me about the examples I saw on this section is that there was never enough contingency to cover if even a single risk occurred.
Take a simple scenario where you have identified 6 risks, all with a €10,000 impact and 10% chance of occurrence, if just one of these risks occurred, all your contingency is used up and you still have not covered the cost of the risk!
I take the point that in a larger project the number of risks is much larger, therefore your contingency reserve will be more likely to cover the cost of risks occurring, perhaps the examples involving smaller numbers of risks are just not realistic?
Hello Eoin,
As I said earlier that Project Risk Management is managed by considering a large population of events.
As the population grows, better the Risk Management Plan.
Hope it helps.
Fahad