Managing Project Contingency Funds (Part 1): Avoiding Risk without Overcomitting

A “safety valve” is how California Polytechnic State University’s Associate Director of Facilities Planning & Capital Projects, Joel Neel described contingency funding on construction projects performed at the school’s San Luis Obispo, CA campus in January 2011.

Most owners would agree with Neel. After all, contingency is budgeting for the unknown and unexpected. Planning for it, hope fully, means that project costs won’t exceed the budget. But what about when they still do? Have you ever wondered why no one shut off the safety valve before the money ran dry?

We recently conducted a webinar on Contingency Management Best Practices with one of our clients, the University of California San Diego. In preparing for the webinar, we spoke with several of our facility owner clients and industry contacts to learn more about the challenges they face in managing contingency. We found that the current economic climate has put significant pressure on facility managers to do more with less capital and as a result, contingency budgets are being cut. We learned of cases where the project contingency was reduced from 10% to 7% - a 30% reduction, causing many owners to take a hard look at how they manage contingency funds.

We learned from our clients that they cannot meet the tighter contingency requirements unless they have a good process for (1) correctly estimating the project contingency, and then (2) controlling the contingency spent. Without having both processes in place, there is high risk of missing the project budget.

Which best describes your construction projects?
A. The project team goes through a rigorous formal process to develop the contingency budget based on industry benchmarks, past project data, team experience, unique project risks, etc.
B. There isn’t a formal process. Once the project budget is developed, you tack on a percentage – 10, 15 or even 20% of the project cost for contingency.

What we have found, in talking with our customers, is that the days of developing contingency budgets using option B above are over. Consequently, the people who worked that way are no longer employed.

You don’t need a crystal ball to set your contingency budget. Acknowledging the project’s risks, examining data from past projects, gaining insight from industry organizations and peers, and using the right tools will help you properly define your contingency budget.

The percentage of the project allocated for contingency can vary greatly – anywhere from a few percent to 20 percent or more. Even a one or two-percent swing represents significant dollars if you’re building a multimillion-dollar project. Allocating an insufficient amount ensures the project will exceed budget. Appropriating too large an amount provides an opportunity for wasteful spending and ties up capital that could be utilized elsewhere.

Making informed decisions about the amount to allocate toward contingency is vital if you want to plan appropriately and control project costs. In our next post I’ll share the link to the webinar, as well as some tips on how to make the most of your contingency budget.