Cost Contingency

Using information from the S curve, management can determine the contingency needed to reach a specified level of confidence. The difference between the point estimate and the cost estimate at the desired percentile determines the required contingency.

Decision-makers choose the level of confidence at which to set the budget. Because each program is different, there are no set rules as to what level of contingency is sufficient for program success. The amount of contingency that should be allotted to a program above the point estimate depends on the level of risk the agency is willing to accept for that program. While no specific confidence level is considered a best practice, budgeting to the mean of the S curve is a common practice. The amount of contingency should be based on the level of confidence with which management chooses to fund a program, based on the values reported in the S curve.37

For a high risk program, adopting a higher confidence level estimate (70 or 80 percent) can be used to (1) increase the organization’s confidence in success within the program’s budget, (2) make some provision for risks unknown at the time but likely to appear as the program progresses, and (3) reduce the likelihood that the organization will have to re-baseline the program because the program’s contingency is expended before program completion. However, budgeting to a higher confidence level for multiple projects within a portfolio can result in an unaffordable portfolio budget and limit the number of programs that can be funded within that portfolio.38

Using an S curve, decision-makers can understand what the likelihoods of different funding alternatives imply about program success. Another benefit of using an S curve is that management can proactively monitor a program’s costs because they know the likelihood of incurring overruns. Early knowledge of potential risks enables management to prepare contingency plans to monitor and respond to risks once the program is under contract. In addition, having adequate funding is essential for optimal program execution because it can take many months to obtain necessary funding to address an emergent program issue. Such delays in obtaining funding can also create cost growth. Also, additional funding may have to come from other programs, which affects those programs’ ability to execute.

A program may entail much uncertainty, and the amount of contingency funding identified may exceed available funding levels. Management may gain insight from the risk analysis by acting to reduce risk to make the program affordable. Management may also examine different levels of contingency to understand what level of confidence the program can obtain.

  1. Because cost distributions tend to be right skewed, the mean of the distribution tends to fall somewhere between the 55 and 65 percentiles. Therefore, a program funded at the 50th percentile still has a greater chance of a large overrun than a large underrun.↩︎

  2. Research has shown that budgeting each program in a portfolio at its 80th percentile can result in budgeting the portfolio above the 95th percentile. The total portfolio budget will be larger than needed to successfully execute the programs. Anderson, Timothy P., “The Trouble with Budgeting to the 80th Percentile,” Aerospace Corporation, (Washington, D.C.: Nov 15, 2006).↩︎