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A balanced framework

01/10/2011

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United Kingdom

Construction procurement in uncertain economic times, parties have even more reason to look for cost efficiency in their construction contracts.

By Alan Woolston

Construction procurement in uncertain economic times, parties have even more reason to look for cost efficiency in their construction contracts. Alan Woolston examines options that may provide significant savings

It is fair to say that there is a difficult economic market for development or for anyone in need of construction works on limited funds. For the short term at least, the situation is unlikely to change. Parties therefore need to consider how to make sure they get the most for their money.

Experience shows that simply squeezing price without regard to any other factors can store-up expensive problems for the future, whether they are quality issues or "price creep" through claims as works progress. Downgrading the scope of works can be a short-term approach but is likely to lead to problems with user satisfaction or have a negative effect on lifecycle and maintenance costs.

What about the way parties should approach their contracts? An area that can provide much scope for significant cost efficiency, but that is all too often overlooked, is the approach to procurement and contract structures.

To understand how new and emerging ways of procuring construction projects can drive cost efficiency, it is helpful to first consider the status quo.

Traditional approach

Traditionally, there have been two approaches: (i) lowest cost O putting a substantially developed project to tender and relying on the market to produce the lowest price; and (ii) best value O aimed at achieving greater transparency and long-term sustainability.

The perception has always been that one or the other can be achieved but not both.

Shortly after the recession took hold, there were clear signs that the market was reverting to lowest-cost tendering as a way of squeezing projects into the available funds. Coupled with significant descoping or compromises on specification, many projects suffered from poor quality, difficult relationships and increased claims.

More recently, the industry is showing signs of revisiting some of the emerging ways of procuring works. So what are these alternative procurement routes and what do they mean in practice? This article gives an overview of some of the main alternatives and their key features.

Early contractor involvement

Early contractor involvement seeks to tread the middle ground between lowest cost and best value. The contractor is involved as part of the team much earlier in the project, either at initial concept or outline brief stage and is not regarded as the last piece in the puzzle.

The benefits include:

  • "buildability" risks are removed at design stage, reducing the risk of expensive changes after works commence
  • contractors can identify information that would help remove risk, not merely price the risk in their tender
  • early input from the supply chain allows integration of specialist works in the main design
  • supply chain selection and pricing becomes an integral part of project development, not a mysterious art shrouded in the tender process and
  • common programmes and shared information systems allow more effective project management.

 

These help to control and manage costs proactively and economically.

However, early contractor involvement is not without risks. For example, maintaining competitive market tension until a final price is agreed, and contractor reluctance to commit to a project still in its formative stages requires careful consideration. However, if properly administered using robust contract structures, early contractor involvement can be a useful tool to help make cash stretch further.

Alliancing

Alliancing is not a new phenomenon. Before the recession, it was increasingly used as a way of driving up quality, lowering cost and improving the experience for clients. However, as the market fell, some parties perceived it as a luxury.

Alliancing covers a spectrum of contractual (and non-contractual) relationships and sometimes goes by other names, such as partnering or collaborative contracting. Whatever terminology is used, at its heart is a move away from arm's-length, or perhaps adversarial, contracting that focused on the transfer and pricing of risk in favour of encouraging genuine collaboration in an environment where parties share the same objectives, risks and incentives.

Although alliancing contracts can take many forms, some of the common features embodied in the contract terms are:

  • parties sharing the known and the unknown risks
  • joint decision-making, usually through a project board comprising members of the key parties with no single decision-making influence
  • decisions taken on a "best-for-project" basis
  • a no blame culture with rectification measures decided by all
  • pain/gain sharing mechanisms
  • meaningful key performance indicators and
  • open book accounting.

 

Perhaps most interesting from a lawyer's perspective is that it often involves giving up the right to sue for anything except deliberate breach or fraud. This is said to support and demonstrate buy-in to the alliancing objectives and the underlying relationship of trust.

The alliancing arrangements are often supported by a charter, signed by all the alliance parties, which sets out the aims of the project and the principles that each party undertakes to adhere to.

Alliancing has particular potential where a project has novel or innovative elements or has risks that are too big to allocate or price. It is a very practical and effective alternative to just crossing fingers and hoping for the best while waiting for the worst to happen.

Alliancing does not work for everyone. Contract documents alone will not make for a successful relationship a bond of trust must be at its core, otherwise the collaboration will almost inevitably fail. However, the balance of sharing and jointly managing risks with both parties incentivised to drive the best performance for the project, can bring significant cost savings. Get it right and the traditional risk premiums associated with buying and selling risk will disappear as will the exploitation of risk as opportunity.

Framework agreements

The term "framework agreement" again covers a multitude of arrangements but, in general terms, they provide a longer-term structure within which terms are established that apply to any number of specific call-off contracts placed over the life of that framework. The detail in the framework terms varies considerably with frameworks requiring full contracts to be entered into for each package of works and others enabling works to be instructed by way of a simple task order.

There are no fixed rules for when they should be used, but, in general, they are worth considering where:

  • the purchaser has an ongoing requirement for a particular type ofworks or services, for example, fit-outs across a range of franchised or consistently branded premises
  • there are repeat requirements for a relatively standardised or small value works where procurement of each package would not be cost effective, such as planned maintenance or servicing
  • the nature of the works or services is not going to change much over a fixed period and
  • the parties can estimate and price the likely value of the requirements.

 

Although not exhaustive, if works satisfy two or more of these criteria, a framework is worth considering.

Benefits

Frameworks have many benefits, some more obvious than others. For example, setting up a panel of pre-tendered suppliers with pre-agreed terms and conditions significantly reduces the organisational overheads and expenses of running multiple procurement processes over time. Similarly, it can be more cost-effective to purchase services in high volume over an extended period, rather than as a series of small one-off procurements as contractors (and where relevant, their shareholders) valuea long-term order-book. Tendering a contract for painting a suite of offices over four years for example, is likely to attract better rates than a contract to paint one office on one occasion.

There are also less obvious or incidental benefits of a framework relationship, including where long-term working on repeated requirements drives value engineering, operational efficiencies, improved health and safety records and fewer defects.

Driving value depends, of course, on getting the right balance of risk, incentive, commitment and rewards. Get the balance right, and framework agreements can be an effective tool for driving cost efficiencies over time.

Many procurement options are available and, clearly, a "one size fits all" solution does not exist. However, it shows that there are alternatives to traditional contracting and in a market when the natural response is to "stick to what you know", there can be significant benefits in taking time at the outset to consider whether a procurement strategy can better serve the needs and interests of construction requirements, in particular, to help make money go a bit further.

Alan Woolston is a partner in the construction team at Field Fisher Waterhouse LLP

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