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CHAPTER 6 Tier 3--Optimal Risk-Based Approach Introduction The Tier 3--Optimal Risk-based Approach leverages risk-based cost-estimating methods that have emerged in transit and highway agencies in the past few years (Touran, Bolster, and Thayer 1994; Parsons, Touran, and Golder 2004). Tier 1 and Tier 2 approaches should be completed before the Tier 3 approach is introduced. Most of the time, it will be possible to make the deliv- ery method decision by completing Tiers 1 and 2. Even if a clear choice cannot be established after going through the first two tiers, at least the completion of the first two tiers will yield a short list of viable choices. It is expected that by the time decision-makers get to Tier 3, they are looking at only two delivery method candidates. It is important that there are only two delivery method candidates because the effort involved in using Tier 3 (especially the quantitative approach) is considerably larger than effort involved in either Tier 1 or Tier 2. The Tier 3 approach consists of two phases. The first phase involves a qualitative analysis: devel- oping a risk-allocation matrix that clearly portrays an owner's risk under competing delivery methods. Through review of these risks, the owner (in this context, mostly transit agencies) will have an opportunity to decide whether a specific delivery method is more appropriate than others. If the qualitative analysis does not provide a definitive answer to the delivery selection question, the second phase--a quantitative analysis--should be considered. The quantitative approach emphasizes the effect of the project delivery method on project cost and schedule. The two-phase process (depicted in Figure 6.1) should be repeated for each project delivery method that survives the Tier 2 process. Due to cost escalation on large transit projects, since 2002, the FTA has required that each "New Starts" project undergo a formal risk-based cost estimate. Specific requirements for these risk assessments are provided in FTA guidance documents such as "PMO Operating Procedures No. 40, Risk Management Products and Procedures" (2007). A risk-based cost estimate gener- ates a range of possible project costs rather than a single point estimate, as shown in Figure 6.2. This distribution represents the combined effect of various risks that affect project cost. Using this distribution, the project owner would be able to estimate the probability of finishing the project within a specified budget. Alternatively, the owner can establish a sufficient contingency budget to keep the probability of cost overrun or schedule delay below a specified threshold. The same modeling method (and much of the same data) that is used to generate the cost and schedule risk analysis can be used to make more informed decisions and allocate risks appropri- ately, in essence, optimizing the project delivery and contracting decisions. One of the major findings of the structured interviews (conducted with transit agencies as part of this research effort) was the apparent effect of a rigorous risk analysis on project success. It 87