Contingency Reserve vs Management Reserve

contingency-reserve-vs-management-reserve

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

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

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.

Cost Estimate

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.

Cost Baseline

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.

Project Budget

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.

Summary

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.

Comments

  1. Scott Freauf says

    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?

    • says

      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.

        • says

          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.

      • Scott Freauf says

        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?

        • says

          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.

          • Scott Freauf says

            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?.

            • says

              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.

  2. Arturo says

    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

    • Arturo says

      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

      • Fahad Usmani says

        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.

        • Arturo says

          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

          • Fahad Usmani says

            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.

  3. Nora says

    Nice post, but if i have risks and probabilities of their occurance, how can i calculate both Contingency and management reserve ?!

    • Fahad Usmani says

      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%.

  4. Anmol says

    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.

    • Fahad Usmani says

      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.

  5. Eoin C says

    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

    • Fahad Usmani says

      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.

      • Eoin C says

        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?

        • Fahad Usmani says

          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

  6. Sumeet Gupta says

    Hello Fahad,

    I have a question on CR. CR, as we all know, are the reserves used to cover the costs of known-unknowns. It is said that CR is calculated using EVM, which is a part of Perform Quantitative Analysis process of Risk Management. Now, we also know that this process is optional – if the cost of doing Perform Quantitative Analysis is high, it can be skipped altogether. Does it mean that calculating CR without doing a quantitative analysis a guesswork?

    Sumeet

    • Fahad Usmani says

      The process for establishing Contingency Reserve is established in the Risk Management Plan. It can be set using EMV, but that’s not required. Some organizations set the contingency as a fixed rate (e.g. 10%). Others set it using a risk model (generally a high-level questionnaire to determine the relative level of risk compared to other projects). And yes, some set it using expected value.

      The key is to know which process you’re going to apply. If you are ONLY going to use EMV, then you need to set down Quantitative Analysis as a process step that shall not be skipped. If you’re going to use some other metric to set it, you’re free to include or exclude the Quantitative Analysis.

      Hope it helps.

  7. says

    Fahad –
    I am having trouble deciphering the following from PMP book. Any help would be appreciated.

    1. On Pg. 173, it states that activity cost estimates may include contingency reserves…and then says contingency reserves are part of funding requirements. Then on Pg. 177 it mentions that reserves are not included in the project cost baseline but can be included in the total project budge? Leaving aside the issue of management reserves, are contingency reserves included in cost baseline or not? How do we reconcile these two different conflicting passages in PMBOK 4?

    2. Are contingency reserves layered? In other words, do we have contingency reserves at the activity level and then also contingency reserves at the work package / control account level?

    3. (optional question if you can answer): If time spent on the project = cost incurred, then we have activity duration estimation reserves as well as activity cost reserves (both of these amount to additional cost from pure economic perspective)? Isn’t this double dipping or both of these reserves are reconciled at some point in the project?

    4. Lastly, in the practical world, do project managers maintain 2 different cost buckets for each work package: original cost & contingency reserve or both of them are merged into one cost number for a package?

    Thanks

    • Fahad Usmani says

      1. On page-173, the PMBOK is talking about the contingency reserve that cost estimate may include the contingency reserve. On page-177, the PMBOK Guide is talking about the management reserve that it is not included in the cost baseline but in the total budget. Contingency reserve is included in the cost baseline while management reserve is not.

      budget = cost baseline + management reserve

      2. Contingency reserve is a pool of amount which is utilized when any identified risk occurs. Contingency reserve is calculated for whole project considering positive risk and negative risks.

      3. The way you have calculated the contingency reserve for cost, you also have to calculate the contingency reserve for schedule, here they are called time reserve of buffers. Please see page-151 PMBOK 4th edition.

      4. Answer for this point is melted in above explanation.

      Hope it helps.

  8. M Ehsan Saeed says

    Nicely explained. One query. In the top-down/bottom-up budget estimation, where are the CR placed..under ‘distributed budgets’ or ‘undistributed budgets’? Thanks and regards

    • Fahad Usmani says

      These terms (distributed and undistributed budgets) are not mentioned in the PMBOK guide.

      However, contingency reserves are calculated based on probabilities and impacts of many activities, we can say that it should be placed under distributed budget.

  9. Mohamad Esmail Samim says

    There can be two kinds of reserves for time and cost: contingency reserves and management reserves.
    Contingency reserves account for “known unknowns”; these are items you identified in risk management.
    Management reserves account for “unknown unknowns” (or simply “unknowns”); these are times you did not or could not identify in risk management. Projects can have both kinds of reserves.

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