Project Risk Costs: Estimation Overruns Caused When Using Only Expected Value for Contingency Calculations
Publication: Journal of Management in Engineering
Volume 38, Issue 5
Abstract
Real project experiences show that project actual risk cost is usually higher than expected. A significant reason for that overrun could be that the overall expected risk cost () is often calculated using only the deterministic expected value method (EV), i.e., the sum of the products of probability times the cost for each risk event. This article analyzes the reliability of the so-calculated value by comparing the to results obtained with the Monte Carlo simulation, using thousands of random analytical models and models from 271 real projects. This article addresses the theoretical basis of the EV method and the influence of the number of risk events, their correlation, and their statistical distribution. It proves that common project risk models do not meet the premises required to use the EV method and that this method, when used alone, often results in an underestimation of the ; project risk cost could actually be up to three times higher. This article proposes the application of an enlargement factor to the deterministic to improve its level of certainty, and provides a formula obtained with multivariate regression analysis to calculate it.
Practical Applications
Project cost overrun is a fact in project management and a risk assessment is usually conducted to prevent it. The total expected cost of the risk events identified is used as a contingency sum to cover for risks that occur, and many companies calculate it as the sum of the products of probability times the cost for each risk event. This contingency sum affects project profitability and, if it is wrongly calculated, the related decision-making process could also be wrong. This article proves that this calculation method increases the chances of an unacceptable overrun in common projects and risk scenarios because it yields just an average that will overrun 50% of the time, and real values could easily be even three times higher. This simplified method should not be used for this purpose in common projects and risk scenarios. A more sophisticated method, such as the Monte Carlo simulation, could be used instead, but many companies do not have the knowledge and skills they require. For that reason, this article proposes the application of an enlargement factor to that sum to improve its level of certainty and provides a formula to calculate it.
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Data Availability Statement
Real project data used in this study (a blind list of risk events with an estimation of their costs and likelihoods) are proprietary and confidential in nature and cannot be provided. The Excel files used to generate random simulation scenarios to apply the Monte Carlo simulation are available from the corresponding author upon reasonable request.
Acknowledgments
The author sincerely thanks the library of Escuela Técnica Superior de Ingenieros de Caminos, Canales y Puertos (Universidad Politécnica de Madrid) for its help; Palisade Corporation, for granting the use of @Risk for this article; and Mrs. Katherine Reddington for her continuous encouragement and her unlimited help. The author would also like to thank the reviewers of this paper for their incredible help to make this article better and their constructive comments.
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Information & Authors
Information
Published In
Journal of Management in Engineering
Volume 38 • Issue 5 • September 2022
Copyright
© 2022 American Society of Civil Engineers.
History
Received: Aug 31, 2021
Accepted: Mar 22, 2022
Published online: Jun 17, 2022
Published in print: Sep 1, 2022
Discussion open until: Nov 17, 2022
ASCE Technical Topics:
- Analysis (by type)
- Benefit cost ratios
- Business management
- Construction costs
- Construction engineering
- Construction industry
- Construction management
- Engineering fundamentals
- Financial management
- Mathematics
- Methodology (by type)
- Models (by type)
- Monte Carlo method
- Numerical methods
- Practice and Profession
- Probability
- Project management
- Regression analysis
- Simulation models
- Statistical analysis (by type)
- Value engineering
Authors
Metrics & Citations
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- Yu Qiao, Abdullah Nafakh, Majed Alinizzi, Jon D. Fricker, Samuel Labi, Sensitivity of Cost Overrun Propensity and Severity to Highway Project Bundling, Journal of Management in Engineering, 10.1061/JMENEA.MEENG-5425, 40, 2, (2024).