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PHARMACEUTICAL ENGINEERING®
The Official Magazine of ISPE Cost Estimate Contingency
September/October 2007, Vol. 27 No. 5
This article
presents the Use and Misuse of Capital Cost Estimate
general
principles of Contingency – Why Deleting it Makes
what
contingency and Projects More Expensive, Not Less
estimate
accuracy are in
order to remove by Gordon R. Lawrence
common
misconceptions
about their
composition and
use.
I
Introduction agement conference. One possible reason for
nvestment of capital in new production or this confusion and lack of understanding is the
research facilities is a regular part of daily fact that although there are many published
life for all major pharmaceutical firms. articles discussing in great detail how to calcu-
Before a decision to invest is made, an late contingency and estimate accuracy,2 these
estimate of the costs to design, engineer, and articles (of necessity) contain a considerable
construct the new facility must be made. Any amount of statistical terminology. This termi-
estimate, by definition is imprecise and carries nology can be off-putting to the layman. An-
financial risks. The cost implications of that other reason may be due to the fact that many
imprecision and those risks are reflected in the people conflate design allowance and manage-
application of contingency to an estimate and ment reserve with project contingency.
in assigning an accuracy range to that esti- There also is a tendency among finance and
mate. business groups to view contingency as evi-
There is a great deal of confusion among dence that the project team is inflating or “pad-
business sponsors, end-users, and finance man- ding” the estimate to give itself an easy life. In
agers outside of the project/engineering group an effort to remove this padding and ensure the
as to exactly what contingency is, what it is for, project is built for a competitive cost, these
and how it differs from an estimate accuracy groups very often decree that the contingency
range. This lack of common understanding was should be limited to a specific percentage of the
exposed in an article by Baccarini,1 in which he estimate cost or even in extreme cases deleted
described the results of a brief vox populi on the from the estimate altogether.
subject of contingency, held at a project man- This article presents the general principles
Figure 1. “Normal” of what contingency and estimate
distribution curve of accuracy are in order to remove com-
possible cost outcomes. mon misconceptions about their com-
position and use. It uses simple
graphical descriptions in order to
assist the reader in visualizing the
concepts. It avoids as much statisti-
cal detail as possible, sticking to
simple statistical terms that should
be familiar to all (i.e., median and
mode). The article also differenti-
ates between design allowance, con-
tingency, and management reserve.
The article then goes on to show
that contingency is not the same as
estimate accuracy, that it is an es-
sential part of any estimate, that it
What is Contingency?
Written Definitions of Contingency
Baccarini noted a lack of understanding of contingency;
however, although there is a lack of common understanding
on the detail of what contingency means, Baccarini also noted
that there is general agreement that contingency is a sum of
money added to a capital cost estimate to cover certain
uncertainties and risks in a capital cost estimate. Taking this
point further, consider the de-facto industry standard for
project management in the USA (and to some extent glo-
bally); the Project Management Body of Knowledge.7 This
reference book describes contingency as: “A provision in the
project management plan to mitigate cost risk.” The Associa-
tion for the Advancement of Cost Engineering International
(AACE-I) performs a similar role for cost engineering in that
Figure 4. “Right Skewed” distribution, showing how mean,
its recommended practices also are de-facto USA (and global) median, and mode no longer align.