This series of articles is extracted from a similar series I wrote for Projects@Work a couple of years ago. I’m posting it here in reaction to my review of Josh’s articles on Earned Value where he (in my opinion) used the term “estimate” when he should have said ”budget.” Many of the terms related to estimating are used either inconsistently or imprecisely. Future items will address some “how tos,” but first, let’s take a minute to establish some common terminology.
Estimate. An estimate is an informed assessment of an uncertain event. Informed means that you have an identified basis for the estimate. Uncertain recognizes that multiple outcomes are possible. For example, if I tell you that there are two people standing outside the door, that one is male and the other female, and that one is 6’ 6” (200 cm) tall and the other is 5’ 2” (158 cm) tall, which would you guess is the female?
Most people will predict that the tall person is male. Most people will make an informed assessment of this uncertain event based on their knowledge that men tend to be taller than women, that few women are as tall a 6’ 6”, and that few men are as short as 5’ 2”. But what if I said the woman was a professional basketball player and the man was a jockey? Most people will now predict that the tall person is female.
Guess. A guess is a special kind of estimate—one where we do not have enough information to make an informed assessment. Note that in the above examples I used predict rather than guess since you do have enough information to make an informed assessment. For example, if I asked you to predict which person outside the door was taller, the person on the right or the one on the left, you would be forced to guess. In my experience, it is rarely necessary to make a true guess when working on a project.
Effort. Effort is an expenditure of physical or mental effort on the part of a project team member. We almost always measure effort in terms of staff hours. In many application areas (IT, NPD, pharma, consulting, architecture), most project estimates will be effort estimates. If you purchase resources from outside your organization, you may not see the effort estimates that were used to develop the cost estimates, but they’re there somewhere.
Cost
Another advantage of using monetary units to express cost is that the financial people in your company understand the language of money. One disadvantage is that monetary units can distort the numbers if the hourly rates are not reasonable. For example, if you use a rate of $100 per hour for an employee making $50,000 per year, and the same rate for someone making $150,000 per year, your cost estimates will misrepresent the actual cost of any project that has a preponderance of effort from one or the other.
Price. A price is what you charge someone for something. Prices are always (well, almost always) expressed in monetary units. Prices can reflect rates (e.g., $100 per hour) or totals ($500,000 for the entire project). Pricing is a business decision. It is usually derived from the estimate, but the estimate is not the price—if we are selling products or services to someone, we can charge more or less than our estimated costs. Even if we know for certain what the costs are or will be, we can still charge a different price.
For this series of articles, I’m going to assume that most readers are either managing internal projects or developing estimates in order to support a pricing decision that will be made by someone else (as is often the case for project managers working for a consulting firm). As a result, I am not going to cover pricing past the point of defining it.
Budget. A budget is a management control or metric (I prefer the term metric since control has negative connotations to some). A budget is a type of plan. Most people use the term only with regard to monetary metrics, but you can have effort budgets or schedule budgets as well. Project budgets should be derived from the project estimates.
Project budgets are not absolutes! Or at least they shouldn’t be. If a project is budgeted for $1,000,000, all of the stakeholders should understand that that number is a target. It is what the team expects to spend based upon what it knows today. If the team can find a way to spend less and still deliver the full scope, it should do that. If it needs to spend more, that should generate a discussion with the funders to decide what to do.
The project budget is not the same as the project price, even for a project done under contract. The seller can price the work for an amount that is different from its internal management metric.
Baseline. A baseline is very nearly a synonym for budget. There are two subtle differences. First, project baselines are normally time-phased. While I might say that the budget for my project is $500,000, I wouldn’t really have a baseline unless I had also defined when I expected to spend that money—how much in week 1, week 2, and so on. Second, the term baseline implies some level of formal approval. I can prepare a budget for an activity or a project, but it isn’t really a baseline until the relevant stakeholder(s) have agreed to it.
Estimating Effort
- Estimating Effort: Part 1
- Estimating Effort: Part 2
- Estimating Effort: Part 3
- Estimating Effort: Part 4
- Estimating Effort: Part 5
No related posts.
{ 32 comments… read them below or add one }
Just a little calibration. When estimating the price of eggs five (5) years in the future, those doing the estimating use a +/- 15% variance around their median price. Eggs for gawd sake.
How can estimates be made in the absence of the underlying statistical distributions, which in turn produce the probabilty of the estimated value having a known confidence interval?
Without this information the estimates are just made up numbers, no matter how hard we try to convince ourselves otherwise.
Glen B. Alleman
Program Planning and Controls
Aerospace and Defense
Denver, Colorado
Just a little calibration. When estimating the price of eggs five (5) years in the future, those doing the estimating use a +/- 15% variance around their median price. Eggs for gawd sake.
How can estimates be made in the absence of the underlying statistical distributions, which in turn produce the probabilty of the estimated value having a known confidence interval?
Without this information the estimates are just made up numbers, no matter how hard we try to convince ourselves otherwise.
Glen B. Alleman
Program Planning and Controls
Aerospace and Defense
Denver, Colorado
Glen — you’re about 2 articles ahead of me. We’ll get there.
Glen — you’re about 2 articles ahead of me. We’ll get there.
I assume in the future articles that you will expand upon “gross estimate” vs. “pure estimate”. And does the budget contain any contingency and/or management reserve. One has to be careful with applying reserve to the budget when the estimate is grossly base on some parametric of inefficiency. I believe in a pure estimate that has contingency applied at the control account level and a management reserve applied at the project manager or top level.
I look forward to reading your next article. This is such an important topic.
I assume in the future articles that you will expand upon “gross estimate” vs. “pure estimate”. And does the budget contain any contingency and/or management reserve. One has to be careful with applying reserve to the budget when the estimate is grossly base on some parametric of inefficiency. I believe in a pure estimate that has contingency applied at the control account level and a management reserve applied at the project manager or top level.
I look forward to reading your next article. This is such an important topic.
Travis –
I don’t know what you mean by “gross” vs. “pure” estimate. Those are not terms that I have ever used personally, or ever heard used elsewhere, so I don’t know if I will address your concern or not.
I am not planning on discussing the process of budgeting as part of this series, although I will spend a few paragraphs at the end to discuss the relationship between effort estimating and effort budgeting.
Duncan
Travis –
I don’t know what you mean by “gross” vs. “pure” estimate. Those are not terms that I have ever used personally, or ever heard used elsewhere, so I don’t know if I will address your concern or not.
I am not planning on discussing the process of budgeting as part of this series, although I will spend a few paragraphs at the end to discuss the relationship between effort estimating and effort budgeting.
Duncan
Travis,
What does “gross” estimate means and how is that different from “pure” estimate?
Travis,
What does “gross” estimate means and how is that different from “pure” estimate?
Glen – a pure estimate is without pad. The estimate assumes that resources will be allocated at 100% efficiency where one FTE equals 8hrs/day for example. A gross estimate has pad. The estimate assumes that resources will be allocated at a less than 100% efficiency where one FTE equals less than 8hrs/day for example.
I always ask the person providing me the estimate to indicate if the estimate is “pure” or “gross” in the rationale substantiating the estimate along with the techniques for deriving the estimate (expert judgment, parametric, analogous, etc…). It is important to know pure vs. gross so we do not apply extra contingency reserve to the estimate before handing it off the the executives. The executives must know how contingency reserve is applied so they can properly apply management reserve on top of the whole project.
Glen – a pure estimate is without pad. The estimate assumes that resources will be allocated at 100% efficiency where one FTE equals 8hrs/day for example. A gross estimate has pad. The estimate assumes that resources will be allocated at a less than 100% efficiency where one FTE equals less than 8hrs/day for example.
I always ask the person providing me the estimate to indicate if the estimate is “pure” or “gross” in the rationale substantiating the estimate along with the techniques for deriving the estimate (expert judgment, parametric, analogous, etc…). It is important to know pure vs. gross so we do not apply extra contingency reserve to the estimate before handing it off the the executives. The executives must know how contingency reserve is applied so they can properly apply management reserve on top of the whole project.
Hi Bill,
Nicely written!!
About the only suggestion I can add is under “price” I think you should state that it includes or should include:
1) Direct costs of producing/procuring the goods or services;
2) Indirect or Overhead costs associated with producing/procuring the goods or services;
3) Any contingency to cover potential variations to the underlying estimate;
4) Profit margin.
As strange as it may seem, one of the biggest misunderstandings I find in clients is the definition of cost vs price. Once explained, it becomes obvious, but especially when using the “old” EVM terms “Actual Cost of Work Performed”, I hate to say how many contractors believe that to use EV, they need to tell the owner the COST of their products of services and not the contractor’s selling price. (The owner’s cost, not the contractor’s cost)
BR,
Dr. PDG, Jakarta
Hi Bill,
Nicely written!!
About the only suggestion I can add is under “price” I think you should state that it includes or should include:
1) Direct costs of producing/procuring the goods or services;
2) Indirect or Overhead costs associated with producing/procuring the goods or services;
3) Any contingency to cover potential variations to the underlying estimate;
4) Profit margin.
As strange as it may seem, one of the biggest misunderstandings I find in clients is the definition of cost vs price. Once explained, it becomes obvious, but especially when using the “old” EVM terms “Actual Cost of Work Performed”, I hate to say how many contractors believe that to use EV, they need to tell the owner the COST of their products of services and not the contractor’s selling price. (The owner’s cost, not the contractor’s cost)
BR,
Dr. PDG, Jakarta
Hi Again…..
Just for fun, I went to the Association for the Advancement of Cost Engineering website to see what THEIR definitions are for these terms. My reason for doing this is not to start a major debate over the terminology Bill is using, but to reflect on another thread started by J. LeRoy Ward, http://pmstudent.com/common-language-is-the-key-to-project-management
For those new to this level of discussion, the subject of definitions is beyond frustrating, because it seems NO ONE is willing to change
Here is what I found from AACE: http://www.aacei.org/technical/rps/10s-90.pdf
ESTIMATE –
(1) A prediction or forecast of the resources (i.e., time, cost, materials, etc) required to achieve or obtain
an agreed upon scope (i.e., for an investment, activity, project, etc.).
(2) In cost estimating, a compilation of all the probable costs of the elements of a project or effort included
within an agreed upon scope.
COST ESTIMATE – A prediction of quantities, cost, and/or price of resources required by the scope of an
asset investment option, activity, or project. As a prediction, an estimate must address risks and
uncertainties. Estimates are used primarily as inputs for budgeting, cost or value analysis, decision
making in business, asset and project planning, or for project cost and schedule control processes. Cost
estimates are determined using experience and calculating and forecasting the future cost of resources,
methods, and management within a scheduled time frame.
GUESS – No definition
EFFORT – The number of labor units necessary to complete work. Effort is usually expressed in staff
hours, staff days or staff weeks and should not be confused with duration.
COST – In project control and accounting, it is the amount measured in money, cash expended or liability
incurred, in consideration of goods and/or services received. From a total cost management perspective,
cost may include any investment of resources in strategic assets including time, monetary, human, and
physical resources.
PRICE – The amount of money asked or given for a product (e.g., exchange value). The chief function of
price is rationing the existing supply among prospective buyers.
BUDGET – A planned allocation of resources. The planned cost of needed materials is usually
subdivided into quantity required and unit cost. The planned cost of labor is usually subdivided into the
workhours required and the wage rate (plus fringe benefits and taxes)
BASELINE –
(1) In project control, the reference plans in which cost, schedule, scope and other project performance
criteria are documented and against which performance measures are assessed and changes noted.
(2) The budget and schedule that represent approved scope of work and work plan. Identifiable plans,
defined by data bases approved by project management and client management, to achieve selected
project objectives. It becomes basis for measuring progress and performance and is baseline for
identifying cost and schedule deviations.
And to make it even more interesting, here is what Max Wideman has to recommend from his glossary: http://www.maxwideman.com/pmglossary/ (NOTE- I chose only Max’s recommended definitions, ignoring all the others)
Estimate – The prediction of a quantitative result. It is usually applied to project costs, resources and durations.
Cost Estimate – The expected costs to perform a task or to acquire an item. Costestimates may be a single value or a range of values.
Effort – The number of labor units necessary to complete the work. Effort is usually expressed in staff hours, staff days or staff weeks and should not be confused with duration.
Cost – The cash value of project activity.
Price – The amount paid for a supply or service.
Pricing – The setting of, or finding out about, prices for goods, services,contract work, etc.
Budget – When unqualified, usually refers to an estimate of funds planned to cover a fiscal period. (See project budget.) Also a plannedallocation of resources.
Baseline – The value or condition against which all future measurements will be compared.
I think this will give everyone a good sense of the problems being faced in project management regarding the definitions. This becomes important on many levels, but ESPECIALLY important as this is one of the major stumbling blocks to project management evolving as a profession.
BR,
Dr. PDG, Jakarta
Hi Again…..
Just for fun, I went to the Association for the Advancement of Cost Engineering website to see what THEIR definitions are for these terms. My reason for doing this is not to start a major debate over the terminology Bill is using, but to reflect on another thread started by J. LeRoy Ward, http://pmstudent.com/common-language-is-the-key-to-project-management
For those new to this level of discussion, the subject of definitions is beyond frustrating, because it seems NO ONE is willing to change
Here is what I found from AACE: http://www.aacei.org/technical/rps/10s-90.pdf
ESTIMATE –
(1) A prediction or forecast of the resources (i.e., time, cost, materials, etc) required to achieve or obtain
an agreed upon scope (i.e., for an investment, activity, project, etc.).
(2) In cost estimating, a compilation of all the probable costs of the elements of a project or effort included
within an agreed upon scope.
COST ESTIMATE – A prediction of quantities, cost, and/or price of resources required by the scope of an
asset investment option, activity, or project. As a prediction, an estimate must address risks and
uncertainties. Estimates are used primarily as inputs for budgeting, cost or value analysis, decision
making in business, asset and project planning, or for project cost and schedule control processes. Cost
estimates are determined using experience and calculating and forecasting the future cost of resources,
methods, and management within a scheduled time frame.
GUESS – No definition
EFFORT – The number of labor units necessary to complete work. Effort is usually expressed in staff
hours, staff days or staff weeks and should not be confused with duration.
COST – In project control and accounting, it is the amount measured in money, cash expended or liability
incurred, in consideration of goods and/or services received. From a total cost management perspective,
cost may include any investment of resources in strategic assets including time, monetary, human, and
physical resources.
PRICE – The amount of money asked or given for a product (e.g., exchange value). The chief function of
price is rationing the existing supply among prospective buyers.
BUDGET – A planned allocation of resources. The planned cost of needed materials is usually
subdivided into quantity required and unit cost. The planned cost of labor is usually subdivided into the
workhours required and the wage rate (plus fringe benefits and taxes)
BASELINE –
(1) In project control, the reference plans in which cost, schedule, scope and other project performance
criteria are documented and against which performance measures are assessed and changes noted.
(2) The budget and schedule that represent approved scope of work and work plan. Identifiable plans,
defined by data bases approved by project management and client management, to achieve selected
project objectives. It becomes basis for measuring progress and performance and is baseline for
identifying cost and schedule deviations.
And to make it even more interesting, here is what Max Wideman has to recommend from his glossary: http://www.maxwideman.com/pmglossary/ (NOTE- I chose only Max’s recommended definitions, ignoring all the others)
Estimate – The prediction of a quantitative result. It is usually applied to project costs, resources and durations.
Cost Estimate – The expected costs to perform a task or to acquire an item. Costestimates may be a single value or a range of values.
Effort – The number of labor units necessary to complete the work. Effort is usually expressed in staff hours, staff days or staff weeks and should not be confused with duration.
Cost – The cash value of project activity.
Price – The amount paid for a supply or service.
Pricing – The setting of, or finding out about, prices for goods, services,contract work, etc.
Budget – When unqualified, usually refers to an estimate of funds planned to cover a fiscal period. (See project budget.) Also a plannedallocation of resources.
Baseline – The value or condition against which all future measurements will be compared.
I think this will give everyone a good sense of the problems being faced in project management regarding the definitions. This becomes important on many levels, but ESPECIALLY important as this is one of the major stumbling blocks to project management evolving as a profession.
BR,
Dr. PDG, Jakarta
Paul — I didn’t include much on price intentionally. Maybe in a future article or series.
Travis — I just submitted the second article. What you call gross vs. pure will be addressed in the third article. But for the most part, I am going to ignore what you call a pure estimate because I find them pretty much useless. I would also NEVER NEVER NEVER use the term “pad.” Padding is wrong and evil.
Duncan
Paul — I didn’t include much on price intentionally. Maybe in a future article or series.
Travis — I just submitted the second article. What you call gross vs. pure will be addressed in the third article. But for the most part, I am going to ignore what you call a pure estimate because I find them pretty much useless. I would also NEVER NEVER NEVER use the term “pad.” Padding is wrong and evil.
Duncan
Hi Bill,
I suggested you include clarification only because (somewhat surprisingly) I find so many people not really understanding the difference clearly. I consider most of my clients to be fairly sophisticated users of project management as a delivery system and still they get confused over pricing and costs.
BR,
Dr. PDG (packing and ready to leave for Boston tomorrow AM)
Hi Bill,
I suggested you include clarification only because (somewhat surprisingly) I find so many people not really understanding the difference clearly. I consider most of my clients to be fairly sophisticated users of project management as a delivery system and still they get confused over pricing and costs.
BR,
Dr. PDG (packing and ready to leave for Boston tomorrow AM)
Travis,
Is “pad” margin? No estimate can be correct in the absence of the variability associated with that estimate. As such the “margin” produced by that variability at some confidence level is also mandatory.
The challenge is where to put this margin.
In the absence of the “margin” discussion, there is also the absence of the variance on the estimate. The of the variance on the estimate produces a point estimate – and this is what Bill should speaking “evil” about.
So ignoring the “pad as evil” suggestion for the moment, ALL etimates MUST include the variance and by direct inference the needed margin to assess the estimate to some level of confidence.
Formally this is required in all federal procurements. The standard acceptance for scehdule estimates is an 80% confidence level when the defined “margin” is put in line. The Cost confidence level varies accourding to the procurement agency. NASA Cost Estimating Handbook, has many suggestion. Paul’s suggestion for AACE provides many others.
NASA Cost Estimating Hanbook is a detailed overview of estimating costs. Estimating scehdules have similar resources in many domains.
Travis,
Is “pad” margin? No estimate can be correct in the absence of the variability associated with that estimate. As such the “margin” produced by that variability at some confidence level is also mandatory.
The challenge is where to put this margin.
In the absence of the “margin” discussion, there is also the absence of the variance on the estimate. The of the variance on the estimate produces a point estimate – and this is what Bill should speaking “evil” about.
So ignoring the “pad as evil” suggestion for the moment, ALL etimates MUST include the variance and by direct inference the needed margin to assess the estimate to some level of confidence.
Formally this is required in all federal procurements. The standard acceptance for scehdule estimates is an 80% confidence level when the defined “margin” is put in line. The Cost confidence level varies accourding to the procurement agency. NASA Cost Estimating Handbook, has many suggestion. Paul’s suggestion for AACE provides many others.
NASA Cost Estimating Hanbook is a detailed overview of estimating costs. Estimating scehdules have similar resources in many domains.
Paul,
Great link to AACE. I’ve put the NASA link in the previous post. At the end of the day cost and scehdule along with the techncial performance measures are inseperable. Some when speaking of scehduling estimating, cost and the resulting techncial performance comes along for the ride – whether acknowledged or not.
There are many books and sites around that provide guidance for schedule estimating. We use tow tools in our daily practice. SEER and PRICE-S. As well Estimate Pro is another tool popular in our domain. These can produce probabilstic and statistically sound estimates for cost, scehdule, resoruce demands. Finally COCOMO is the foundation of all these approaches.
Paul,
Great link to AACE. I’ve put the NASA link in the previous post. At the end of the day cost and scehdule along with the techncial performance measures are inseperable. Some when speaking of scehduling estimating, cost and the resulting techncial performance comes along for the ride – whether acknowledged or not.
There are many books and sites around that provide guidance for schedule estimating. We use tow tools in our daily practice. SEER and PRICE-S. As well Estimate Pro is another tool popular in our domain. These can produce probabilstic and statistically sound estimates for cost, scehdule, resoruce demands. Finally COCOMO is the foundation of all these approaches.
Glen – When I speak of pad, I do mean margin. If the estimator indicates that the estimate type is a gross estimate, then the amount of margin is important to know. I do not want to apply the same contingency reserve to the gross estimates as are applied to the pure estimates. Typically, I have seen 80% to 88% as a factor to account for inefficiencies in the work estimates.
Glen – When I speak of pad, I do mean margin. If the estimator indicates that the estimate type is a gross estimate, then the amount of margin is important to know. I do not want to apply the same contingency reserve to the gross estimates as are applied to the pure estimates. Typically, I have seen 80% to 88% as a factor to account for inefficiencies in the work estimates.
Travis,
Thanks for the clarification. One approach used in the domains we work in is to build the schedule in the following way:
1. Define the individual work packages that produce the deliverables. The duration of the Work Packages is made of the durations of the Tasks. These duration have 3-point estimates. But these are not PERT estimates, but values used for a Monte Carlo Simulaiton.
2. The “non-slack” schedule is sequenced on the “most likely” value. This is the Deterministic Schedule.
3. The upper and lower values of the 3-point estimates are used to drive the Monte Carlo simulation. The result is a model of the schedule. The 80% confidence date is used for the Probabilistic Schedule.
4. The difference in the completion date between the Deterministic Schedule and the Probabilistic Schedule is the needed “margin” for the overall schedule. Allocating this total to critical points within the schedule comes next.
This is how NASA and DoD do it.
Travis,
Thanks for the clarification. One approach used in the domains we work in is to build the schedule in the following way:
1. Define the individual work packages that produce the deliverables. The duration of the Work Packages is made of the durations of the Tasks. These duration have 3-point estimates. But these are not PERT estimates, but values used for a Monte Carlo Simulaiton.
2. The “non-slack” schedule is sequenced on the “most likely” value. This is the Deterministic Schedule.
3. The upper and lower values of the 3-point estimates are used to drive the Monte Carlo simulation. The result is a model of the schedule. The 80% confidence date is used for the Probabilistic Schedule.
4. The difference in the completion date between the Deterministic Schedule and the Probabilistic Schedule is the needed “margin” for the overall schedule. Allocating this total to critical points within the schedule comes next.
This is how NASA and DoD do it.
Hi Travis,
You seem to be digging yourself into a verbal hole. Your use of “pad” was bad but now to use the term “margin” while better, still tells us only part of the story.
First, there are three types of contingency.
“Management Reserve.”
Covers “Unknown Unknowns”
Owned and Controlled by MANAGEMENT
“Estimating Contingency.”
Covers “Known Unknowns”
Used by either Owners or Contractors to cover the probability of underestimating time or costs. Owned and Controlled by the person establishing it.
“Risk Events Contingency.”
Covers “Known Unknowns”
Used by either Owners or Contractors to cover any known risks which have been ACCEPTED by the Owner or Contractor. For the contractor, this is his/her profit. For the owner, this is a set aside to cover uninsurable or business risks
Peter W. Ripley, Contingency! Who Owns and Manages It?, Professional Practice Guide to Contingency (AACE International CD-ROM, 2d ed.), page CSC.08.1.
Your use of the term “margin” refers only to a contractor and while it can and does apply to any of the three categories, it more traditionally applies to “Risk Events”. That is, risks that the contractor, because of his/her experience in this field or specialty, is willing to accept risks in exchange for a margin, simply because he/she believes they are better capable at managing those risks.
Owners, because they do not MAKE money DOING the project, (a project for them is a net cash outflow or investment)would never have a “margin” (more appropriate stated profit margin) What owners have are contingencies (if they are allocated) and management reserves (if they are not allocated)
While I like the use of the terms “knowns” and “unknowns” to describe the various types of risk, unless you further refine them as to the type of risk they are designed to cover, it becomes very easy to generate false or misleading S curves. (FWIW, UNALLOCATED reserves should never be part of the Performance Measurement Baseline from the OWNERS perspective, but PROFIT MARGIN (which may very well be unallocated reserve from the contractors perspective) would ALWAYS be included in the Baseline Budget, spread or allocated over time.
AACE has done a lot of solid research on this, and while they tend to have a bias towards owners, it is not hard to find applications of the same principles for contractors as well. http://www.aacei.org/technical/rp.shtml#40R-08
Hope this helps clarify and refine the use of terminilogy…..
BR,
Dr. PDG, still in the dark west of Boston……
Hi Travis,
You seem to be digging yourself into a verbal hole. Your use of “pad” was bad but now to use the term “margin” while better, still tells us only part of the story.
First, there are three types of contingency.
“Management Reserve.”
Covers “Unknown Unknowns”
Owned and Controlled by MANAGEMENT
“Estimating Contingency.”
Covers “Known Unknowns”
Used by either Owners or Contractors to cover the probability of underestimating time or costs. Owned and Controlled by the person establishing it.
“Risk Events Contingency.”
Covers “Known Unknowns”
Used by either Owners or Contractors to cover any known risks which have been ACCEPTED by the Owner or Contractor. For the contractor, this is his/her profit. For the owner, this is a set aside to cover uninsurable or business risks
Peter W. Ripley, Contingency! Who Owns and Manages It?, Professional Practice Guide to Contingency (AACE International CD-ROM, 2d ed.), page CSC.08.1.
Your use of the term “margin” refers only to a contractor and while it can and does apply to any of the three categories, it more traditionally applies to “Risk Events”. That is, risks that the contractor, because of his/her experience in this field or specialty, is willing to accept risks in exchange for a margin, simply because he/she believes they are better capable at managing those risks.
Owners, because they do not MAKE money DOING the project, (a project for them is a net cash outflow or investment)would never have a “margin” (more appropriate stated profit margin) What owners have are contingencies (if they are allocated) and management reserves (if they are not allocated)
While I like the use of the terms “knowns” and “unknowns” to describe the various types of risk, unless you further refine them as to the type of risk they are designed to cover, it becomes very easy to generate false or misleading S curves. (FWIW, UNALLOCATED reserves should never be part of the Performance Measurement Baseline from the OWNERS perspective, but PROFIT MARGIN (which may very well be unallocated reserve from the contractors perspective) would ALWAYS be included in the Baseline Budget, spread or allocated over time.
AACE has done a lot of solid research on this, and while they tend to have a bias towards owners, it is not hard to find applications of the same principles for contractors as well. http://www.aacei.org/technical/rp.shtml#40R-08
Hope this helps clarify and refine the use of terminilogy…..
BR,
Dr. PDG, still in the dark west of Boston……
Hi Glenn,
What do you do about the “near critical” Work Packages and/or the alternate critical paths generated through MC simulation?
While I think the DOE/NASA approach certainly is a sound one, am I safe in assuming that eventually, a “bottom up” schedule is developed to test what I believe you have described as being a “top down” approach?
We recently completed a bottom schedule and activity based cost estimate using PERT and applying the 85% P level (mean plus 1 sigma) and the results were shocking to the client. We never got to the point where we actually ran the simulation using Pertmaster. (The cost loaded schedule was done in Primavera v 6)
As a follow up to my posting to Travis, we really should be very specific and selective in our use of the term “margin”.
BR,
Dr. PDG, hoping for electricity shortly!!! (Dial up!!!)
Hi Glenn,
What do you do about the “near critical” Work Packages and/or the alternate critical paths generated through MC simulation?
While I think the DOE/NASA approach certainly is a sound one, am I safe in assuming that eventually, a “bottom up” schedule is developed to test what I believe you have described as being a “top down” approach?
We recently completed a bottom schedule and activity based cost estimate using PERT and applying the 85% P level (mean plus 1 sigma) and the results were shocking to the client. We never got to the point where we actually ran the simulation using Pertmaster. (The cost loaded schedule was done in Primavera v 6)
As a follow up to my posting to Travis, we really should be very specific and selective in our use of the term “margin”.
BR,
Dr. PDG, hoping for electricity shortly!!! (Dial up!!!)