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2_Stutzke Estimating Project Risk Reserves



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Richard Stutzke Estimating Project Risk Reserves v7 Estimating Project Risk Reserves Richard D Stutzke Science Applications International Corp 6725 Odyssey Drive Huntsville AL 35806 256 971 6624 ofc 256 971 6550 fax 256 971 7330 asst 23 October 2002 Presented at the International Forum on COCOMO and Software Cost Modeling 22 25 October 2003 Los Angeles CA ABSTRACT All projects have risks To provide resources needed to avert or mitigate these risks planners must estimate a risk roserve Setting a reasonable reserve is important A large reserve may cause the project s bid price to be noncompetitive A small reserve may be inadequate to handle the problems that will inevitably occur This paper describes a method to estimate an optimal reserve for a list of identified risks For each risk the estimator provides the probability and consequences cost of occurrence before mitigation the cost of actions that could be performed to mitigate the risk and the probability and consequences that would remain after performing these actions The Risk Reduction Leverage RRL is the difference in the expected losses before and after mitigation divided by the cost o f mitigation RRL is similar to a Return On Investment except it uses expected costs instead o f total estimated costs The method ranks the risks based on their Risk Reduction Leverage and applies criteria to decide which risks should be mitigated and which should be accepted The method also gives criteria for deciding which risks should be mitigated immediately preventative and which can be deferred contingent The paper suggests ways to handle overlapped risks and mitigation actions coupled risks and compounded consequences This paper describes a spreadsheet that implements the method and provides an example showing how the reserve is calculated This is a hard reserve because it is based on documented calculations that are tied to specific risks It explains how to use the data for planning and for tracking the identified risks during a project This paper is based on Chapter 17 Estimating the Impacts of Risks in Software and System Estimation Project Products and Process by R D Stutzke to appear in 2003 02002 by Richard D Stutzke 1 9 30 2002 10 43 AM Richard Stutzke Estimating Project Risk Reserves v7 1 0 Introduction Risks are inevitable for any complicated project due to imperfect knowledge about the product s requirements and operating conditions the technology and tools being used and staff capabilities experience and continuity Ignorance of various factors compounds the problem In addition systems are developed in an environment that constantly changes making these factors difficult to predict A risk is an uncertain condition or event that if it occurs could have a negative effect on the project s cost and schedule or on the products it produces Risks have a probability of occurrence and an associated cost of occurrence Uncertain events that occur and provide benefits to the project are called opportunities The product of the probability of occurrence and the cost of occurrence is called the impact Some authors call this quantity the risk exposure Project planners assisted by engineers managers and other experts identify risks that could jeopardize project success These individuals also identi possible mitigation actions that can be performed to reduce the impact of each identified risk A typical mitigation action for hardware is over engineering the item to provide a large safety factor This is calculated based on the known strength of materials and the configuration of the component parts The engineers design a structure that will support some multiple of the maximum expected load The multiple is the safety factor Safety factors are commonly used in constructing bridges and buildings Hardware engineers can also mitig te the risk of system failure by designing secondary backup systems that can contain or limit the damage or can perform essential functions if the primary system fails For example elevators have brakes that prevent the elevator from falling if the cable breaks For software systems there is no analogy to the strength of materials nor are there easy ways to provide backup systems One approach that has been discussed in the literature is multi version programming Leveson 19951 Unfortunately adding backup functions and the logic needed to invoke them switchover logic actually increases the amount of software and its associated complexity Increasing software size and complexity is known to ncrease the total number of latent defects in the software and so increases the probability of system failure Another way of addressing many kinds of risk is to define Terms and Conditions in the contract or in the product s written warranty The provider of the product or service states in the contract the provider is not liable for certain types of failures that may occur It is not my fault In some cases the producer may purchase insurance to cover the occurrence of losses To mitigate risks requires resources The challenge faced by project planners and estimators is how large the reserve should be Estimating a value that is too small means that the project will lack the necessary funds to perform the mitigation actions or to cover the costs associated with the damage due to failures On the other hand choosing an amount that is too large means that the bid price will be excessively high resulting in loss 02002 by Richard D Stutzke Richard Stutzke Estimating Project Risk Reserves v7 Stutzk of the bid Another concern in many organizations is that the reserve be quantitatively justified This is called a hard reserve In contrast a soft reserve is simply in monetary amount that is asserted without any quantitativejustification Planners must also decide how to expend the reserves that are provided Some risks have a very low probability of occurrence and so it may make sense to wait to see if the situation develops before expending funds to perform mitigation actions Other risks have a high probability of occurrence and so it makes sense to take perform mitigation actions The planners plan and schedule the mitigation actions with the other project tasks The next sections describe a method to estimate an optimal reserve for a list of identified risks and a spreadsheet that implements the method The description includes an example showing how the reserve is calculated 2 0 Basic Calculations For each risk there is a probability of occurrence and a


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