Labor shortages, material cost increases and a wet winter have wreaked havoc on construction budgets and schedules recently. As the change orders roll in, the project managers must determine where to code these costs. “Let’s code that to contingency… if there’s any left”. Enter the conundrum… What does contingency mean to you – and how is it determined?
What goes in a Contingency Budget?
Most construction budget contingencies range from 5-10%. The percentage of contingency tends to be a “rule of thumb” and as a result not much emphasis gets put on whether the contingency is appropriate.
Think about what components make up your contingency budget:
- Risks (inclement weather, labor shortage, etc.)
- Cost Increases
- Design Changes / Owner Upgrades
- Unknowns
Once you identify these components, evaluate their probability and the potential impact to the project. The overall scale and schedule of your project must be considered when assigning the value of the contingency. For example, if you have a project with a 12 month build time and can only lock material pricing for 6 months, a material cost increase allowance should be factored into your contingency. Likewise, if your schedule is very aggressive or have milestones with absolute deadlines, you are more likely to pay extra to expedite the schedule or make repairs due to weather damage. Sometimes the scope of work changes; for example, an Owner may decide to upgrade the project to boost sales or the local municipality may adopt a building code change that adds cost. Sometimes these changes are unforeseen, however in many cases they should be expected. For example, if the Project Owner is known for changing the design (even during construction) then this can be anticipated and accounted for as part of the contingency budget. Regarding building code changes, most municipalities advertise proposed changes months in advance, and if a proposed change is announced, it is best to quantify the potential impact to the budget and allocate contingency funds accordingly. And of course, there are the unknowns, which warrant some baseline level of contingency regardless of these other factors.
This best practice of intentionally calculating each major component of the contingency budget doesn’t always happen, despite the best of intentions. All too often, contingency is based on a percentage of the total budget and can become a line item to reduce if the project feasibility is marginal.
Be Intentional
In order to avoid the contingency conundrum, I recommend these best practices:
1) Assign a target % range for contingency (usually 5-10%). This should be a guideline, not set in stone.
2) Quantify the components that make up your contingency budget. These should vary from project to project depending on scope, design stage, schedule, location, etc. I recommend itemizing these components and if acceptable, allocate them to the applicable cost-codes to which they apply. (Example: if concrete is expected to increase by 8% over the life of the project, add this line item to concrete).
3) Once you’ve calculated the components of the contingency budget and allocated them accordingly, don’t reduce contingency before the project starts. If the feasibility of the project is marginal, then cutting the contingency is wishful thinking and may leave you in a bind before the project is completed. We recommend evaluating the design, assess the spec level and re-negotiating terms as a priority.
Uncertain vs. Unknown
Most of the line items of the contingency budget are known and quantifiable, however their probability and impact to the project budget is uncertain. If one is disciplined and follows these best management practices, then there should be appropriate line-item amounts in the contingency budget for the “uncertain” items that may occur and a prudent allowance for the “unknown” (can anyone say COVID-19)