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APPEND TX F Building Flexibility into Projects to Manage Uncertainty Many potentially critical factors can introduce uncertainty into the design, construction, and management of DOE projects. These factors range from tech- nical challenges inherent in research and development, to design and construc- tion, challenges imposed by regulatory aspects and third party influence, and challenges emanating from changing conditions over the lifetime of extended projects. Managing this uncertainty calls for integrating flexibility into project management. This flexibility is particularly needed when an uncertain condition can generate an outcome that should be avoided (e.g., large costs) or captured (e.g., improved performance). One way to achieve flexibility is through develop- ing alternative options. An option is a right to take action without an obligation to take specific actions or to change strategies. Options add value by allowing managers to shift risk or capture added value, depending on how one or more uncertain parameters behave. For example, a contract clause permitting termination of a contract if a critical technology is not developed provides an opportunity (but not an obligation) to terminate. An options approach also inherently improves strategic thinking and project planning by helping to recognize, design, and use flexible alternatives to manage uncertainty. Delaying commitment to a strategy until sufficient information becomes available to resolve the uncertainty is an example of managerial flexibility. An example could be a project manager recognizing that the cost and development of a specialized component depends on the design expertise of a particular vendor. The depletion of that vendor's capabilities could increase costs beyond the budget limits, constrain development of the component, or both. Alternative options are 108
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APPENDIX F 109 needed that would ensure design performance or mitigate the effects when a vendor's capabilities depleted. One option might be to guarantee the continued employment of critical employees. The use of an options approach is premised on specific rules for implemen- tation that describe the conditions that would trigger a change in strategy. The process includes continued monitoring of the uncertain parameters, evaluating their status and impact, and changing strategies if alternative options are war- ranted. This should be a proactive not a reactive process. Options in procurement for the National Ignition Facility (NIF) have been used to manage uncertainty. The following description illustrates how this has been done. The current managers of the NIF project use options (although they do not typically use that term) to manage many of the large uncertainties inherent in the project. The LLNL project manager attributed the management team's frequent use of flexibility (including options) to their focus on project objectives instead of specific solutions. This allows managers to identify multiple potential strategies to achieve success. These strategies or scenarios were used to design options. Several principles for managing uncertainty guided procurement for NIF. Examples were having two or more vendors for all major components to reduce the risk of a sole supplier inflating prices and avoiding a manufacturing role for LLNL to reduce the risks of uncertain project funding and schedules. LLNL contributed its strength (scientific expertise and funding) and focused vendor efforts on their strengths (technology development and manufacturing). The laser glass production strategy for NIF illustrates the use of options to address a common but important acquisition question: How many parallel devel- opment efforts should be supported? More than $350 million will be spent to produce more than 3,000 pieces of laser glass, weighing about 150 pounds each. Laser glass begins as slabs of very high quality glass called "blanks." The large volume of blanks and the project schedule and budget required a production rate 30 times faster and 5 times cheaper than had been demonstrated on prototype lasers, necessitating the development of a new glass production technology and manufacturing facilities. Because glass vendors could not justify funding the development of glass production technology, the project itself invested in this technology. The development of a high-volume, continuous-melting glass pro- duction process included two critical uncertainties whether the technology could make the glass and whether the quality of the glass would be acceptable. The threat posed by these uncertainties was that if development efforts failed in either way, the project could be delayed too long to meet its deadline and would incur very high unbudgeted costs. Although LLNL had established relationships with experienced laser glass vendors, none could guarantee successful development a priori. Therefore, it became clear during laser glass procurement planning that alternatives to a one-vendor strategy should be considered. LLNL considered two types of procurement strategy for glass production technology development. A base strategy was to invest in a single production development effort, helping
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110 APPENDIX F the manufacturer where possible and hoping for a successful development. An alternative strategy would simultaneously invest in two independent develop- ment efforts by two glass producers, increasing the likelihood that at least one effort would be successful. This strategy allowed LLNL to avoid the conse- quences of having no successful glass production system if only one effort was successful. The cost of the basic strategy is the cost of investing in one vendor (approximately $12 million). Investing in multiple vendors would purchase opportunities to proceed with successful vendors at two or more points in time, when each uncertainty was resolved. The option costs are the funds required to invest in a second vendor up to the uncertainty resolution times (approximately $12 million each). The flexible strategy uses two options to abandon an unsuccess- ful vendor when the technology feasibility and glass quality uncertainties are resolved. NIF managers considered the two-vendor strategy attractive for both eco- nomic and noneconomic reasons. The following factors were considered. If a single vendor was selected the development might succeed. But if the single vendor failed, the costs to the project in time, money, and political consequences would prevent the project from meeting its targets. In contrast, if two vendors were selected, none, one, or two could succeed. The likelihood of two failures was considered low. One success would allow NIF to exercise its option by abandoning the unsuccessful vendor, and two successes would provide manufac- turing and pricing flexibility in addition to meeting minimum needs. The avoided costs of project failure if investments were made in two vendors were informally estimated to greatly exceed the additional cost of investing in a second vendor (0.5% of the project budget). Therefore, the option was considered more valu- able than its cost. Based on this reasoning, DOE and LLNL contracted with two vendors to support parallel development efforts. The uncertainty about the technology's viability was resolved in early 1999, when both vendors successfully produced pilot runs of glass using a continuous- melting process. Largely because of the remaining uncertainty surrounding the quality, NIF chose to not abandon either vendor. Uncertainty with regard to quality was resolved near the end of 2000, when both vendors demonstrated the ability to generate the required glass quality. Because both vendors succeeded, NIF purchased valuable production and pricing flexibility that can help manage other project uncertainties (e.g., schedule). CONCLUSIONS DOE has used flexible project management strategies to manage highly uncertain projects. Successfully managing uncertain project conditions requires a proactive approach that models multiple possible conditions, forecasts the out- comes of potential actions, and guides managers as the project develops. A proactive approach includes plans for specific actions that will be taken based on
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APPENDIX F 111 specific future conditions and does not merely react to conditions after uncer- tainty has been resolved. In 1997, the National Ignition Facility Risk Management Plan identified the major cost and schedule risk at NIF to be the risk of "not getting congressional required budget authorization and appropriation" (LLNL, 1997, p. 10~. In fact, there were many greater risks at NIF having to do with technical and project management issues, as events were to show. However, in a more recent example at the Office of River Protection (ORP), Waste Treatment Plant (WTP), the major project risk is identified as "unfunded estimated project cost (EPC) owner's contingency: If Congress does not authorize an additional $435 million to cover ORP contingency allowances (includes normal estimating variability and risk allowances), then the WTP will not meet schedule and life-cycle ORP costs will increase and schedule milestones will be missed." Risk assessments should deal with risks, and not be vehicles for passing the buck and evading accountability for managing risks. REFERENCE LLNL (Lawrence Livermore National Laboratory). 1997. National Ignition Facility Risk Manage- ment Plan. Livermore, Calif.: Lawrence Livermore National Laboratory.