Expected Utility Theory as a Guide to Contingency (Allowance or Management Reserve) Allocation

Abstract

In this paper, I view a project from the perspective of utility theory. I suggest that, by determining an optimal percent contingency (relative to remaining work) and identifying and enforcing a required change in behavior, from one that is risk-seeking to one that is risk-averse, a project's contingency can be managed more effectively. I argue that early on in a project, risk-seeking behavior dominates. During this period, requests for contingency are less rigorously scrutinized. As the design evolves, more accurate information becomes available. Once the designs have been finalized, the project team must transition from a free-thinking, exploratory mode to an execution mode. If projects do not transition fast enough from a risk-seeking to a risk-averse organization, an inappropriate allocation of project contingency could occur (too much too early in the project). I show that the behavioral patterns used to characterize utility theory are those that exist in the project environment. I define a project's utility and thus, provide project managers with a metric against which all gambles (requests for contingency) can be evaluated. I discuss other research as it relates to utility and project management. From empirical data analysis, I demonstrate that there is a direct correlation between progress on a project's design activities and the rate at which project contingency is allocated and recommend a transition time frame during which the rate of allocation should decrease and the project should transition from risk-seeking to risk-averse. I show that these data are already available from a project's earned value management system and thus, inclusion of this information in the standard monthly reporting suite can enhance a project manager's decision making capability.