A New Method of Cost Contingency Management

Transcription

1 A New Method of Cost Contingency Management Mohammed Wajdi Hammad, Alireza Abbasi, Michael J. Ryan School of Engineering and Information Technology, University of New South Wales (UNSW Australia), Canberra Abstract - Controlling the progress and performance of a project is pivotal to achieve its planned goals. Schedule and cost are often used to make a baseline for managing projects progress, but there are always uncertainties in planning and estimating the schedule and cost of projects. Therefore, a contingency reserve is needed to manage uncertainties and risks. In this paper, we present a new cost contingency management method. To show the benefit of our new proposed method, it is applied to a real-life bridge maintenance project, and then it is compared with an existing cost contingency management method. The comparison shows that our new method can help the project manager obtain more detailed information about the financial status of the project. Keywords - Contingency Allocation, Contingency Management, Cost Contingency, Project Management. I. INTRODUCTION AND BACKGROUND There are many uncertainties and risks involved in all phases of construction projects [1]. These uncertainties can be classified as predictable (known unknowns) and unpredictable (unknown unknowns). Contingency reserve is a managerial tool to control such identifiable (and unidentifiable) uncertainties/risks. Contingency reserve is more precisely defined as the amount of funds, budget, or time needed above the estimate to reduce the risk of overruns of project objectives to a level acceptable to the organisation [2]. Construction participants including owners, contractors, and designers add cost contingency reserve to cover unpredicted costs from changes in the base cost estimate. Research has shown that one of the main factors that contribute to the projects success is the improvements in the cost estimation techniques including cost contingency estimation [3]. The contingency budget is not established to cover changes in scope; rather, its purpose is to cope with cost increases resulting from the uncertain nature of some construction activities. So, for example, if in a bridge construction project the asset manager decides to add a new ladder or paint a new pier, this constitutes a change of scope and its cost or duration impact cannot be absorbed by contingency reserve. Allocation of low amounts of contingency for projects with high risks may result in significant losses. On the other hand, high amounts of contingency may decrease the chances of being awarded a contract. Expert judgment is generally used to determine the bidding contingency reserve. Expert decision is mainly based on the previous experiences with similar projects. Subjectivity is the main disadvantage of this technique as the skill, knowledge, and motivation of the experts may vary widely or the nature of the project might be very different from the ones the expert has experienced [4]. The research topic of project cost contingency consists of contingency estimation, contingency allocation and contingency management. Cost contingency estimation is about calculating the estimated amount of total cost contingency for a project. Contingency allocation involves assigning the total cost contingency to individual activities based on the activity s contribution to the overall variance of the project. Contingency management is a list of processes to monitor and track the status of the contingency for each activity and the entire project. Most of the papers found in the literature were about estimating cost contingency ([5], [6], [7]), and very few about managing and controlling estimated contingency. Among the very few works on cost contingency management, Eldosouky [8] presented a method to manage contingency on a project which requires data collection from previous projects (e.g., interviews with project managers and collecting data about cost and duration of the project) and also the use of some subjective opinion. More recently, Barraza and Bueno [9] presented a methodology for using Monte Carlo Simulation (MCS) for cost contingency estimation, which also includes heuristics for contingency assignment allocation among project activities. They stated that if independent performance is assumed among the project activities and a probability distribution is assigned to each activity, all possible project costs will be normally distributed with a mean cost similar in value to the one that is calculated by the addition of the activities mean costs, and the variance of the possible project cost results to be equal to the accumulation of all activities cost variances [9]. Their proposed methodology provided performance status classification which can be used as a practical guide for management decision making. This research, extending their approach, presents a new cost contingency management method by developing new metrics to calculate the current remaining contingency on a project and compare it with the expected remaining contingency. The new proposed method also updates the contingency for each activity at the end of each reporting period, giving the project manager an early warning sign. A comparison among the two methods is provided by applying both to a real-life bridge maintenance project. The similarities and differences between the two cost contingency management methods are also discussed in detail. The aim of this paper is to introduce an improved cost contingency tracking method that would allow the project

2 manager to manage the project more efficiently, as well as presenting a practical method without the use of complex mathematical equations. II. REVIEWING THE PROPOSED COST CONTINGENCY MANAGEMENT METHOD In the approach proposed in this paper, a probabilistic method is adopted to determine the cost contingency of the project. This involves assigning a probability distribution function to each activity in the project, and through a summative process, developing a probability distribution function for the overall project cost. Subsequently, Monte Carlo Simulation (MCS) is applied which essentially represents repeating construction of the project through a very large number of trials (e.g., 10,000 trials). For any given trial, all of the chosen values for the individual cost components can be mathematically combined to get a (total) project cost. The process is then repeated for the remaining trials and a probability distribution based upon the overall project cost is generated. The cost contingency is then allocated to each activity and are managed with the proposed method in this paper. The remaining contingency for each activity (and for the total project) calculated at the end of each reporting period allows comparison between the actual remaining contingency and the expected (planned) remaining contingency. The proposed method controls the actual costs for a project, as well as the individual activity, to be under the target cost value. If an activity is completed, any remaining contingency reserve will be used as a cushion for future risks. The similar indices between the proposed cost contingency management and the original cost contingency method presented by Barraza and Bueno [9] are: Approved Budget (AB), is the maximum amount of money assigned to each activity without contingency. Work Performed (WP), is the percentage complete for each activity. Planned Value (PV), otherwise known as budgeted cost of work performed (BCWP), is calculated by multiplying AB with WP. PV = AB * WP (1) Cost Variance (CV), which is the difference between PV and actual cost (AC), also known as actual cost of work performed (ACWP). CV = PV AC (2) Cost Contingency of Work Performed (CCWP), which is calculated by multiplying the cost contingency (CC) by WP. CCWP = CC * WP (3) Cost Underrun (CU), which is calculated by subtracting AC from PV and then added to CCWP. CU = PV AC + CCWP (4) Status, which classifies each activity as well as the total project into either A, B or C. Status A shows that the CV is nonnegative and the project has not used any of the contingency assigned to it, status B shows that the CV is negative but below the CCWP, and status C shows that the CV is negative and above (in absolute value) the CCWP and is presenting a cost overrun. The following new parameters are introduced in our proposed method providing more information about future remaining contingencies: Expected Remaining Contingency (ERC), which shows the amount of cost contingency that is expected (planned) to remain at the end of the reporting period. It is calculated by subtracting CCWP from CC. ERC = CC CCWP (5) Actual Remaining Contingency (ARC), which shows the amount of contingency that is actually remaining at the end of the reporting period. This is calculated by dividing the ERPV of each activity over the ERPV of the total project, multiplied by the project s CU and then added to ERC. ARC = (ERPV / ERPV) * CU + ERC (6) When an activity is 100% complete, then the ARC is assumed to be zero. This is because when the activity is complete, it is expected to spend the entire contingency allocated to it. The difference between the ERC and ARC shows the amount of contingency saved/spent. Expected Remaining Planned Value (ERPV), this shows only the remaining PV for each activity and for the total project at the end of the reporting period. ERPV = (1 - WP) * PV (7) Remaining Contingency (RC), informs the project manager about the remaining cost contingency of each activity in real terms. This means that the contingency is not restricted to the percentage complete of an activity, i.e. if an activity is 60% complete then it does not necessarily need to use up to 60 % of the contingency, the activity can use as much of the allocated contingency as needed. This time a negative RC means that the entire contingency allocated to the activity is consumed, and the project manager should take immediate action to stop this. RC is calculated by adding CC to CV. RC = CC + CV (8)

3 Cost Balance (CB), which shows the total remaining cost for each activity including contingency. This shows the project manager if the remaining budget is enough to complete the activity (or the project). CB can be compared against ERPV to determine whether the project has enough funds to be completed. CB is calculated by subtracting PV from AB and then added to RC. CB = RC + (AB PV) (9) III. APPLICATION OF THE PROPOSED COST CONTINGENCY MANAGEMENT METHOD In order to demonstrate the use of our proposed method and compare it with the existing cost contingency management method, both methodologies have been applied to a real life bridge maintenance project. The project is a recently completed Roads & Maritime Services (RMS) maintenance project in the Australian state of New South Wales. To preserve the identity of the project, all activities have been replaced with WBS numbers. The bridge project lasted for 110 days (22 weeks) with a budget of $156,850 and the reporting period is chosen to be every 30 working days (every six weeks). The cost contingency management method proposed by Barraza and Bueno [9] ends at giving the project manager a status about the project while our method continues to provide more information to the project manager about the project using the following five indices (also discussed above) to reinforce the results about the status of the project (ERPV, ERC, ARC, RC and CB). Table I shows the assigned budget and contingency for each activity. The CC is the amount of money used to cover the unforeseeable cost, also known as known unknown. The method used to obtain CC and allocate them to each activity is outside the scope of this paper. TABLE I. Project information Task Name AB CC 1 $151,500 $5, $4,500 $ $68,000 $2, $60,000 $2, $1,000 $ $7,000 $ $79,000 $2, $21,000 $ $15,000 $ $21,000 $ $15,000 $ $7,000 $201 Table II shows all the indices used in both methods for the first reporting period, after 30 days. As seen, the Cost Variance (CV) of the project is $-2,700. This means that the actual costs of the project exceeded the planned cost. The Status of the project is C which means that the project has made use of more than the allowed contingency for the work performed and is therefore presenting a cost overrun. The Expected Remaining Contingency (ERC) of the project is $2,897 and the Actual Updated Remaining Contingency (ARC) is $2,650, this means that the total remaining cost contingency for the project is expected to be $2,897 out of the total $5,350 but in fact the project had $2,650 remaining. The Remaining Contingency (RC) for ongoing and completed activities is $99. The Cost Balance (CB) of project is $97,450 (remaining PV and remaining CC). To know more about ongoing activities, the next level in WBS (1.1, 1.2 and 1.3) should be examined. For instance, the CV of task 1.2 is $-2,700 and the status is C showing that sub-activities under 1.2 used more than the allowed contingency for the work performed. The RC is -$35, while ERC and ARC are $585 and $544 respectively. This shows that the activity is doing worse than expected. The CB for activities under 1.2 is $16,003. For the second reporting period (Table III), after 60 days, the result of the project are as follows- the CV is $- 4,400 which means that the project is still spending more money than planned. The status of the project is B which is an improvement from the previous reporting period, this shows that the entire contingency have not been consumed, the RC is $252. The ERC is $709 while the ARC is $950 showing that the entire project has more cost contingency remaining; the CB is $25,350. For the third reporting period (Table IV), after 90 days, the CV of the project is $-4,450 while the status of the project is B that is the same as the previous reporting period, the RC of the project is $815. The project s ERC is $150 and the ARC is $900 showing that the project is doing better financially than the previous reporting period, while the CB of the project is $6,150. For the fourth and last reporting period (Table V), after 110 days, the CV of the project is $-5,100 and the remaining contingency is $250 as seen on the RC and CB. The ERC and ARC are both zero because the project is expected to consume the entire cost contingency at the end of the project.

4 TABLE II. Results for first reporting period (after 30 days) 1 $56,700 33% $59,400 $2,453 $-2,700 $-247 C $2,897 $2,650 $94,800 $99 $97, $52,200 69% $54,900 $2,318 $-2,700 $-382 C $585 $544 $15,800 $-35 $16, $52,200 87% $54,900 $2,318 $-2,700 $-382 C $346 $326 $7,800 $-35 $7, % $29 $26 $1,000 - $1, % $210 $192 $7,000 - $7, % $2,312 $2,106 $79,000 - $81, % $612 $557 $21,000 - $21, % $438 $399 $15,000 - $15, % $621 $566 $21,000 - $21, % $440 $400 $15,000 - $15, % $201 $183 $7,000 - $7,201 TABLE III. Results for the second reporting period (after 60 days) 1 $127,100 $118,100 $4,641 $-4,400 $241 B $709 $950 $24,400 $252 $25, $54,600 55% $42,200 $1,603 $-1,000 $603 B $709 $950 $24,400 $615 $25, $18,600 83% $18,100 $552 $500 $1,052 A $69 $93 $2,400 $1,064 $3, % $440 $587 $15,000 - $15, % $201 $270 $7,000 - $7,201 TABLE IV. Results from the third reporting period (after 90 days) 1 $146,250 91% $137,300 $5,200 $-4,450 $750 B $150 $900 $5,250 $815 $6, $73,750 85% $61,400 $2,162 $-1,050 $1,112 B $150 $900 $5,250 $1,177 $6, $21, % $19,900 $621 $1,100 $1,721 A $1,721 $1, $13,800 90% $13,800 $405 - $405 A $34 $206 $1,200 $440 $1, $2,950 40% $3,600 $85 $-650 $-565 C $116 $694 $4,050 $-534 $3,601 TABLE V. Results from the third reporting period (after 110 days) 1 $151, % $143,200 $5,350 $-5,100 $250 B $250 $ $79, % $67,300 $2,312 $-1,700 $612 B $612 $ $21, % $19,900 $621 $1,100 $1,721 A $1,721 $1, $15, % $14,800 $440 $200 $640 A $640 $ $7, % $8,500 $201 $ -1,500 $-1,299 C $-1,299 $-1,299

5 IV. DISCUSSION AND CONCLUSION There are several types of uncertainties in the construction industry, the most important being the uncertainty in the estimated cost of project activities. No budget estimate can be correct in every detail. Also, it is very difficult to decide on the appropriate level of detail to include in a cost estimate. Therefore, cost contingency not only should be properly calculated but also wisely controlled during project execution. The main aim of this article is to provide a simple heuristic approach to cost contingency management that provides the project manager with different depth of information. The cost contingency management approach allows controlling the actual cost of each activity, by keeping it below the target cost. The new cost contingency management method proposed in this paper is an improvement to the method presented by Barraza and Bueno [9]. They classify each activity in the project based on the contingency expenditure: status A is when no contingency is used; status B is when some but not the entire contingency is used; and status C is when the entire contingency is used. This is a simple and effective approach and as stated by Barraza and Bueno [9] complex models would not be the solution either for a contingency management approach, as if a model is found conceptually too complex, or if it takes a lot of time for decision maker to analyse the information obtained from it, such a model will have no value for practice. We extended the management method to provide more information to the project manager, while at the same time preserving the method s simplicity. After showing the status of each activity, as well as for the total project, we provide the decision maker with the actual remaining contingency at the end of the reporting period to compare it with the expected remaining contingency. The expected remaining contingency is calculated by assuming that the amount of contingency spent is directly proportional to the percentage complete of each activity, for example if an activity is 60% complete then we assume the activity has 40% contingency remaining. In summary, we extend the management method after showing the status of each activity and the total project. We then show a comparison between the expected remaining contingency and the actual remaining contingency. In addition, we compare between the contingency remaining (with respect to the percentage complete) and the actual contingency remaining, this is only for ongoing and completed activities. This paper has proved that cost contingency can be managed when placed to individual activities and not placed at the end of the project. We have also found that the proposed method provides a warning system and clearly identifies the activity(s) that is causing the cost overrun. This means the project manager can always find the activities that are causing problems in the project. It is very difficult to claim that this is the best and the only method for managing contingency available, and there is no one manual to manage cost contingency during project execution. But what we need to have in the construction industry is a simple to understand, clear and easy to use method that allows the decision maker to select the level of information required to be known. The proposed method works at different levels within the WBS. A couple of assumptions have been used in this paper including, that the PV (BCWP) of the activity can never increase unless there is an increase in scope, therefore, any increase in actual cost that is not associated with an increase in scope results in spending contingency. Another assumption is that the rate at which the cost contingency is used is directly proportional to the percentage complete in an activity, for example if an activity is 60% complete then the assumption is that 60% of the cost contingency is spent. We recommend for future research, that the method incorporates schedule contingency as well. We also suggest applying the proposed cost contingency management method to different types of projects (i.e. software projects). REFERENCES [1] Lhee, S.C., Flood, I. & Issa, R. 2014, "Development of a two-step neural network-based model to predict construction cost contingency", Journal of Information Technology in Construction, vol. 19, pp J. U. Duncombe, Infrared navigation Part I: An assessment of feasibility, IEEE Trans. Electron Devices, vol. ED-11, pp , Jan [2] Project Management Institute 2013, A Guide to the Project Management Body of Knowledge (PMBOK Guide). Project Management Institute, Incorporated.. 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Construction Research Congress 2014, American Society of Civil Engineers (ASCE), Atlanta, Georgia, USA, pp J. Williams, Narrow-band analyzer, Ph.D. dissertation, Dept. Elect. Eng., Harvard Univ., Cambridge, MA, [8] Eldosouky, I.A., Ibrahim, A.H. & Mohammed, H.E. 2014, "Management of construction cost contingency covering upside and downside risks", Alexandria Engineering Journal, vol. 53, no. 4, pp [9] Barraza, G.A. & Bueno, R.A. 2007, "Cost contingency management", Journal of Management in Engineering, vol. 23, no. 3, pp