We can divide risks into following three broad category based on their identification & response planning:
1. Known – Responded (with avoidance, mitigation, transference)
2. Known – Not responded (or accepted)
3. Unknown (here also default strategy is acceptance)
Eliminating maximum number of risks is the main objective. But not all can be eliminated or responses would be too costly or time consuming and hence the risks are accepted.
In case of transference – project cost need to include the insurance amount
In case of mitigation – project cost and schedule need to consider the extra effort to execute contingency plan and subsequent fallback plan in case of contingency failure.
So even implementing planned responses increases cost and schedule of the project to execute the activities. These are not extra. They are inherent to the project based on the risk responses and it should not omitted during planning phase. These added cost and schedule due to risks are called ‘Reserve‘.
There are two types of reserves.
Contingency reserve is needed to tackle residual risks or “Known – Unknowns”. Risks that are identified but they are accepted.
Management reserve handles the “Unknown” risks. Those risks that are not identified as part of risk management process are “Unknown” risks. We don’t know what the risk is and we don’t have any response plan for them. They falls under ‘accepted’ risks.
Project manager has to take these into consideration in project schedule & budget plans. General representation of the project total budget & total schedule is:
Project’s Total Budget = Sum(Project’s Activity Cost) + Contingency Reserve + Management Reserve
Project’s Total Schedule = Critical path duration + Contingency Reserve + Management Reserve