What Is Sensitivity Analysis in Project Management?
Introduction to Sensitivity Analysis in Project Management
Dealing with the complexities of project management can sometimes feel like a true challenge. With so many variables, how can you anticipate the impact of changes on a project’s outcome? That’s where sensitivity analysis comes in, serving as a statistical early warning system.
In this article, we’re going to define project sensitivity and describe how to conduct a sensitivity analysis in project management. Finally, we’ll also share a practical example.
What is project sensitivity?
Project sensitivity is a holistic evaluation of how likely it is that a project will succeed through data-driven forecasting. It also identifies risks, quantifies their impact, and separates high-risk tasks from low ones.
Project sensitivity is defined by both a written analysis and a mathematical formula that includes average task durations based on past data, simulated durations based on hypothetical models, and an average task duration for both of those projections.
It refers to the project as a whole however key phases or components of the project (like project schedules) can also have their own sensitivity analysis. Project sensitivity is primarily used to choose the right approach or solution to the project’s main problems based on the greatest impact.
What is sensitivity analysis in project management?
Sensitivity analysis in project management (also known as risk and sensitivity analysis in project management) is a method for modeling risk in any given assignment. Project sensitivity looks at the big picture to see what, out of all the elements involved, could potentially prevent you from achieving your goal or goals.
It also ranks these threats by order of importance from most to least impactful. Then, it’s up to you and your team to prevent these issues from either coming up or derailing progress.
In essence, sensitivity analysis is a proactive risk management strategy that allows teams to understand the impact of different variables on the project's outcome.
Cost-benefit analysis vs. sensitivity analysis
Now you might be wondering the difference between a cost-benefit analysis and a sensitivity analysis. So, let’s cover that.
A cost-benefit analysis is used to estimate the pros and cons of alternative solutions for a project. A sensitivity analysis determines which of these solutions is the most viable given what we know about the rest of the project.
A sensitivity analysis is often used to support a cost-benefit analysis, but can also be done independently.
How to perform a project sensitivity analysis
There are a number of key steps involved in making your own project sensitivity analysis. These include:
- List project elements that impact net present value (NPV) or internal rate of return (IRR): Include the material costs, freelancer project estimates, overhead costs, and any other major area susceptible to change once the project is up and running. You should also include fixed expenses in case they go out of stock, cost more than what was originally agreed on, or are subject to market demand. For example, in a construction project, you may need twice as many building materials as you originally thought once contractors have begun working on the foundation.
- Write an analysis of all project element dependencies: Project elements might cost more, become obsolete, or become redundant if one or more of the other elements change. List out all the elements then compare the list to one individual element at a time to see what happens to its duration, cost, and effectiveness whenever another element is affected.
- Determine how each of your dependencies affect the NPV: Compare each detailed dependency against your NPV to determine which will make the most significant difference.
Project sensitivity analysis example
Let's consider a practical example of sensitivity analysis in project management. Company A, a doll manufacturing enterprise, has a third-party stuffing wholesaler that has recently introduced a 2% processing fee. This additional expense can potentially create a 5% change in the Net Present Value (NPV) of the project to accommodate the increased cost.
In this scenario, the sensitivity analysis would involve assessing the potential impact of this 2% processing fee on the overall project. The team would need to determine how this cost increase would affect the project's profitability, schedule, and overall success.
For instance, the team might find out that the increased cost would lead to a delay in the production schedule as they look for ways to offset the additional expense. Alternatively, they might discover that the increased cost would cut into their profit margin, making the project less financially viable.