There can be no project that is immune to risks. There is no question that whether a project faces risks or not, it is only about how risks are managed as they occur. Proper risk management is the responsibility of every Project Manager. There are two types of risks, 1) Known Risks and 2) Unknown Risks. They are also called Identified Risks and Unidentified risks. In order to tackle these risks, a certain amount of funds, called Reserves, are allocated. Contingency reserve and Management Reserve are the different types of reserves based on the type of risk. Lets see these in detail.
As part of Risk Management, Reserves are created in every project to accommodate risks. Now, What is a Reserve?
What is a Reserve in Project Management?
PMBOK defines a “Reserve” as a provision in the project management plan to mitigate the cost and/or schedule risk. So, one has to understand that, there will be different reserves for Schedule and Cost i.e… Schedule Reserve and Cost reserve.
During the initial phases of a project, an Initial Reserve is created with whatever the limited amount of information is available. Later, after risks are identified and risk responses are planned, a Revised Reserve is created.
2 Types of Reserves in Project Management
Based on the type of risks that a reserve intends to accommodate or manage, there are two types of reserves
- Contingency Reserve or Buffer Reserve
- Management Reserve
Contingency Reserve in Project Management
- Contingency Reserve in project management is also called Buffer Reserve.
- Contingency Reserve is used to manage Known-UnKnowns (known= identified, Unknowns=risks) or Identified risks that have active risk response strategies available.
- PMBOK defines Contingency Reserve as Time or Money allocated in the schedule or cost baseline for known risks with active response strategies.
- Contingency reserves are part of the Performance Measurement Baseline (PMB). Here it is important to understand that, Contingency Reserves for Schedule risks are part of Schedule Baseline, while Contingency Reserves for Cost risks are part of Cost Baseline.
- Project Manager has full authority over the contingency reserves, however, he can delegate this power to the risk owner if he wishes.
- Contingency reserves can be allocated at the Activity level.
How to Calculate Contingency Reserve
Contingency Reserves are not fixed randomly but are properly calculated with various techniques.
Below are some of the popular techniques used to calculate contingency reserve.
- Decision Tree analysis
- Monte Carlo simulation
- Expected Monetary value (EMV)
- A percentage of Project Cost
Management Reserve in Project Management
- Management reserves are used to manage Unknown-Unknowns (Unknown=Unidentified, Unknowns=risks) or Unidentified Risks (Active risk response strategies are not available for this type of risk.)
- PMBOK defines a Management reserve as an amount of project budget or project schedule held outside the Performance Measurement Baseline (PMB) for management control purposes, that is reserved for unforeseen work that is within the scope of the project.
- Management reserves are not part of the Performance Measurement Baseline.
- These reserves are not estimated using a technique but are allocated based on organizational norms.
- Management reserves are under the control of the higher management, and the project manager does not have authority over these reserves. Use of these reserves, cannot be done at the Project manager’s discretion. A formal request should be raised and it should be approved for using these reserves.
- Management Reserves are allocated at the Project level only.
Contingency reserve = sum of all activity contingency reserves
Work Package Cost Estimates = sum of all activity cost estimates
Cost Baseline = Contingency Reserve + Work Package Cost Estimates
Project Budget = Cost Baseline + Management Reserve.
It is important to understand the relationship between Estimating and Risk Management. Estimating and Risk management are interlinked. While proper estimating will help identify more risks, proper risk management will reduce the range of schedule and cost estimates by making them more accurate.