We’re seeing a trend in megaproject planning toward overreliance on estimate classification systems as the sole characterization of the overall state of project definition, readiness and risk.
As a result, project teams, executives and boards are approving multibillion-dollar projects on a general, subjective assignment of Class 5, Class 4, Class 3, etc., without a clear picture of the risk and uncertainty associated with these broad definitions.
These projects are using an industry-standard method: AACEi’s Cost Estimate Classification System. So what’s the issue?
Not all classified estimates are created equal
Often excluded from the planning-based discussions on AACEi estimate classification for project organizations is the fact that you are required (per Recommended Practice 18R-97, Note [a]) to ensure that a P50 contingency figure has been assessed and included in the estimate before the class — and its associated +/- ranges — can be assigned. This is the figure that half of the simulated project costs fall below and half exceed, based on the risk and uncertainty profile of the project at the time the estimate is prepared.
This means that, before you declare the estimate class, a contingency quantitative risk analysis (QRA) exercise should be completed. The QRA uses ranges of potential project cost, schedule and risk data and performs a statistical analysis to come up with the probability of different cost and schedule outcomes — including the confidence levels of those outcomes. This provides a more accurate and precise assessment of the reliability of the base estimate defined for the project.
This element — the need to augment the estimate with a QRA — is frequently overlooked, and the contingency funds are “bolted on” to the classified estimate afterwards. Project sanctioning boards and executives should not take the defined estimate class at face value without interrogating the process and products developed to establish it.
You have to look behind the curtain to ensure the process is complete and robust, and a comprehensive QRA process provides the assurance needed to obtain that validation. Augmenting your estimate with a robust QRA is:
- The most powerful way to characterize the reliability of the project estimate, and
- Indeed, a requirement to be able to assign an estimate class and use those associated classification ranges in the first place.
- A strong basis to establish a risk and uncertainty baseline to monitor as the project matures, risks retire or emerge, and the assumptions driving uncertainties are proven valid or invalid.
One of the “drawbacks” we hear from clients is that this takes time and money to do properly. True, you do need to workshop this with many internal and external project resources who have a lot on the go and, yes, it takes time, money and commitment and focus for a brief time.
But the juice — the resulting confidence in your scope, estimate, and schedule — is truly worth the squeeze.
Developing realistic contingency budgets
One of the primary benefits of the QRA for project team members, executives and boards is the ability to make more informed, evidence-based decisions for contingency and reserve funds. If leaders are relying on an estimate with a classification that states the range is +50%/-30% to sanction a project, they expect that the -30% is actually a possible outcome when the project is completed.
We know based on experience that optimism bias can be a prevailing force early in projects. Without a robust QRA effort and a detailed ranging exercise that represents truly possible outcomes (i.e. +50% is possible, but the actual cost or schedule reduction potential is -5%), the project may be approved on false budget pretenses and the contingency allocation will be inadequate.
Maybe the most painful element of this approach is that everyone from senior execs to boards of directors will be “surprised” and disappointed in the planning “failure” when the project exceeds its approved budget. Not a great outcome.
QRA uses Monte Carlo simulations to assess a wide range of possible outcomes based on varying risk inputs. The resulting range of possible cost outcomes gives executives a more realistic picture of potential project costs and timelines, rather than relying on an arbitrary buffer that might be too high or too low.
This level of clarity helps boards approve more realistic budgets and ensures that executives are equipped with the information they need to sanction capital projects with confidence. It removes emotionality and brings an objective, repeatable, defendable process to what has historically been a very subjective, gut feel-based effort.
By providing a data-driven approach to contingency estimation, QRA empowers executives and boards with a clearer understanding of actual project outcomes.
Early identification of top risks and uncertainties
Using a robust, bottom-up basis for assigning a contingency budget is critically important. But even more important is the effort to produce a robust QRA to help align the entire project team — including vendor partners, executives, board members and other stakeholders — by providing a unified view of the project’s top risks and most impactful uncertainties.
This creates a tactical and strategic roadmap for the project team to most effectively go about containing costs through targeted risk mitigation. It also validates the key assumptions and key undefined scope items that drive the biggest uncertainties.
The ability to highlight gaps and areas of concern early in the project planning process is a compelling benefit of QRA for executives and boards of directors. By identifying potential issues early on, project teams can develop more effective strategies to mitigate or resolve risks before they escalate.
This early identification is particularly valuable for large capital projects, where the cost of addressing issues during execution can be substantial, when compared to addressing during pre-construction planning.
And, it is particularly beneficial when it comes to gaining approval for large capital projects. By involving key stakeholders in the risk identification and analysis process, executives can ensure that no risks are overlooked and that the project budget has been evaluated from multiple perspectives.
Furthermore, when boards of directors understand that the budget was developed using a systematic, data-driven stochastic methodology, they can feel more secure in their decision to approve the project.
Creating a collaborative foundation for project success
The collaborative process of developing range estimates and involving key stakeholders in the QRA process also fosters a culture of shared accountability and proactive problem-solving. This shared understanding fosters better communication and collaboration between teams, creating a solid foundation for project success.
Executives and boards benefit from knowing that they are not just approving a budget, but that they are supporting a project plan that has been thoughtfully developed with input from all relevant departments.
By having all key parties aligned on the project’s potential challenges, executives and boards can confidently approve budgets knowing that no major stones remain unturned and “surprises” — the single most detrimental factor on any project — are minimized.
Driving confident, informed decisions
QRA offers significant advantages for estimating capital project contingency, especially for executives and boards of directors tasked with approving and sanctioning large projects.
By providing a comprehensive and data-driven analysis of risks and uncertainties, QRA enhances decision-making, improves transparency, and fosters a collaborative environment. Executives and boards can rest assured that the contingency estimates they approve are based on a realistic and thorough assessment of potential outcomes, enabling them to make more confident and informed decisions that ultimately drive successful project execution.
At its core, QRA is a comprehensive effort that helps executives and boards understand the key uncertainties and risk that could affect the project’s financial viability and the true reliability of the classified estimate, giving them confidence that the project has been evaluated from all angles.
