Back in 2015, a long-term client came to me with a problem.
While they were familiar with the data-based speed, accuracy and ease of the parametric tool I created for them, they knew it only worked on large projects (see the difference between large and small projects). The issue is that for every large project, they had hundreds of small projects that had a meaningful impact on the health and profitability of the company. Too all these small projects they simply added 10% contingency to.
In many cases, the project didn’t need 10% and in most they didn’t need any at all! Was there a reason for this….?
In a few cases, the project was high-risk and 10% contingency was insufficient. This resulted in somewhere around 1/3rd of their small projects requiring a supplemental AFE. All Project Managers loathed putting in for a supplemental – it culturally was viewed as an admission of incompetency – or worse, supplementalS! No PM wanted that come performance review time! What this was teaching PMs to do was to
lie, er be overly pessimistic, in their cost estimates. This was likely the root cause most of their projects coming in under. Management started thinking they should start cutting project estimates to compensate… and I think we all know what the PM’s response would be to that….
In short a vicious cycle was in the making. How could we get off of it?
The answer was a small project contingency tool!
Using the company’s in-house results we created a data-based tool that accurately predicted a project’s cost out come, and the required contingency.
This was the first step in getting out of the vicious cycle. Data-based numbers that were beyond arbitrary inclusion or reduction. This allowed for increased trust between Project Managers and Management. Like the rest of the project’s cost estimate, the contingency value became not only defendable but scale according to the underlying risk of the project.
Industry best practices! Data-based risk-adjusted contingency. Gone were the days of simply adding 10%.
But some other things occurred too…
With the prevalence of supplemental AFEs dropping by up to 80%, the tool reduced superfluous PM paper work – allowing them to focus on advancing projects forward – and redundant Management reviews of projects that were in statistical control – allowing them to focus on projects that were in true difficulty.
The net result? A 3-year return on investment on eliminated paper work alone!
But the most important thing was, with correctly allocated contingency – more to risky projects and less to safe projects – the company freed up 2-3%, or up to $17MM of their annual capital budget. This could allow dozens of much-needed more project to be sanctioned, or reduced borrowing to finance these projects.
What would you do with an extra 2-3% of your capital budget?