I have talked about the contingency plan and fallback plan, and now it is time to discuss the contingency reserve and management reserve.
These are two kinds of reserve that serve the same purpose: managing risks. Since their purpose is the same, many people mix these concepts together. Some of them think that these two terms are synonyms to each other. Others think that they are calculated as a percentage (5% or 10%) of the cost or time of the project.
Contingency reserve and management reserve are not the same; they are different and calculated with different techniques. Although they do serve the same purpose, i.e. managing risks, they manage different kinds of risks.
Okay, let’s discuss them in detail.
Contingency reserve is the cost or time reserve that is used to manage identified risks or “known-unknown” (known=identified, unknown=risks). Contingency reserve is not a random reserve, it is an estimated reserve based on various risk management techniques, such as Expected Monetary Value (EMV) and the Decision Tree Method.
This reserve is controlled by the project manager. The project manager has full authority to use it whenever any identified risk occurs. He can also delegate this authority to the risk owner who will use this reserve at the time of risks occurring. The project manager can be updated on later stages.
Management reserve is the cost or time reserve that is used to manage the unidentified risks or “unknown-unknown” (unknown=unidentified, unknown=risks). Management reserve is not an estimated reserve; it is a random figure, which is defined according to 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%. Usually the management reserve is guessed based on the overall uncertainty of the project.
For example, if you are doing a project in which your organization has expertise, the management reserve will be less, because in this case there will be less uncertainty. However, if you’re doing a new kind of project where your organization has less or no expertise, the management reserve will be high because in this case the uncertainty will be more.
Management reserve is not controlled by the project manager; it is managed by someone outside the project team, usually someone from management. Whenever any unidentified risk occurs, the project manager has to get approval from management to use the management reserve.
Management reserve is used in emergencies. It is basically used to avoid a situation where you need some urgent money and the organization says that they don’t have additional money available for your project.
Many organizations try to avoid using this kind of reserve because they think that if the project manager has to come to them every time to get approval, then why keep it separate? According to them, the project manager can come any time if he needs extra money, so there is no need for a management reserve.
Cost Estimate, Cost Baseline, and Project Budget
You will be wondering why I have brought up these cost management concepts here. They are important and you must understand their relation with contingency and management reserve.
Without the contingency and management reserve, the cost baseline and project budget cannot be estimated.
Let’s discuss it in detail.
The cost estimate is the cost of all work packages and is “rolled up” to the top level. This is the total cost of your project.
When you add the contingency reserve to the cost estimate , you get the cost baseline.
Cost Baseline = Cost Estimate + Contingency Reserve
Please note that the cost baseline is your performance baseline against which you will measure your project’s performance.
If you add the management reserve to the cost baseline, you will get the project budget.
Project Budget = Cost Baseline + Management Reserve
The difference between the Contingency Reserve and Management Reserve
The following are a few differences between the contingency reserve and management reserve:
- Contingency reserve is used to manage identified risks, while management reserve is used to manage unidentified risks.
- Contingency reserve is an estimated figure based on Expected Monetary Value (EMV), or the decision tree method. Management reserve is calculated as some percentage of the cost or duration of the project.
Contingency reserve and management reserve are kept to manage the risks. Contingency reserve is used to manage identified risks, while management reserve is used to manage unidentified risks. A project manager has the authority to use the contingency reserve, while for management reserve, he needs management’s permission.
Contingency reserve is a calculated reserve based on the various techniques such as Expected Monetary Value (EMV) or Decision Tree Method, while management reserve is a percentage of the cost estimate; for example 10% of the estimated cost of the project.
Here is where the discussion about the contingency reserve and management reserve ends. If you have any comments, you are free to post them in the comment section.
This topic is important from a PMP and PMI-RMP exam point of view. You may see a few questions on this topic in your PMP and PMI-RMP Test.