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Owner’s Perception of Contingency

Contingency Owners Point of View by Rick Geren Prepared for AACE Panel Discussion Montreal October 28. 2003. Contingency - Owner’s Point of View. Owner’s Perception of Contingency There is suspicion Contingency is "slush fund" to offset errors resulting from poor engineering or estimating.

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Owner’s Perception of Contingency

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  1. Contingency Owners Point of Viewby Rick GerenPrepared for AACEPanel DiscussionMontreal October 28. 2003

  2. Contingency - Owner’s Point of View Owner’s Perception of Contingency There is suspicion Contingency is "slush fund" to offset errors resulting from poor engineering or estimating. The larger the contingency, the larger the suspicion.

  3. Contingency - Owner’s Point of View An Owner’s Wishful Contingency Definition A small, all-encompassing allowance to absorb all unforeseen project costs, including estimating errors, design development, scope changes, cost over-runs and other project risks. Implicitly this means: “When the money is gone don’t ask for more”

  4. Contingency - Owner’s Point of View An Engineer-Estimator Definition of Contingency Estimate contingency is an allowance for undefined items of work which will have to be performed, or elements of costs which will have to be incurred, within the defined “scope of work” covered by the estimate, and that could not be explicitly foreseen or described at the time the estimate was made because of lack of complete, accurate and detailed information. Therefore the contingency is an integral part of the estimate. Implicitly this means: “The contingency will be spent and there is always risk the project will need more”

  5. Contingency - Owner’s Point of View Differences in understanding of Contingency can lead to arbitrary reduction (by Owner) of the contingency allowance with unfortunate consequences, such as over-runs and unexpected lower project financial returns. It is vital the Owner clearly understands contingency and estimate risk

  6. Contingency - Owner’s Point of View Contingency - How Much is Enough? Classical approach based on amount of engineering A very approximate estimate - no engineering. Conceptual flow sheet. List of major equipment. Functional specifications of equipment. Budget prices obtained for major equipment Detailed equipment list and bills of material. Sketches of concept Drawings Finalized Budget Prices for majority of Items GA Drawings Completed and Approved Bids received for major Equipment Size and Field Verifications Completed Approval by Concerned Departments Specifications Complete Engineering Detail,Drawings Completed Completed Bills of Material Prices and Delivery of Equipment Confimed

  7. Contingency - Owner’s Point of View Contingency - How Much is Enough? • Advantage of Conventional Approach • Easy to understand and apply • Disadvantage of Conventional Approach: • Inflexible “blind” application of percentages • No appreciation of risk or sensitivity

  8. Contingency - Owner’s Point of View • Need to Reconcile • Owner’s Perception • Engineers Definition • Contingency Amount • Risk and Sensitivity The accepted solution is: application of Statistical Risk Analysis to Contingency determination

  9. Contingency - Owner’s Point of View - Example

  10. Contingency - Owner’s Point of View 100% Confidence Range $39,271 to $54,293 Estimate = 47,200 Suggested Contingency = $7,542 (15%)

  11. Contingency - Owner’s Point of View 85% Confidence Range $42,530 to $50,731 Estimate = 47,200 Suggested Contingency = $ (7.5%)

  12. Contingency - Owner’s Point of View • Advantages of Statistical Approach to Contingency Evaluation • Owner sees how the risk is impacted by adjusting the contingency. • Owner can choose his appropriate risk level • Owner sees sensitivity (spread) of estimate components

  13. Contingency - Owner’s Point of View Sensitivity Chart Electrical installation Mechanical installation Steel Concrete Automation Site Prep

  14. Contingency - Owner’s Point of View • Application of Contingency • Two Schools of Thought • Pessimistic • Assumes contingency will be spent. Includes remaining contingency in forecast Cost at Completion. Over-runs are flagged when forecast exceeds base estimate plus the contingency allowance.

  15. Contingency - Owner’s Point of View Application of Contingency 2. Optimistic … Assumes contingency is not to be spent. Remaining contingency is not included in forecast “Cost at Completion.” Over-runs are flagged in relation to base estimate. In both Cases, contingency is depleted to balance Budget and Costs

  16. Contingency - Owner’s Point of View The Missing Piece - Scope Changes Should Contingency include for Scope Change? or Should Owner have a reserve fund?

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