Published on LinkedIn in 23 March 2018
The construction industry has suffered from poor productivity growth for decades. Labour-productivity growth has lagged well behind that of manufacturing and the total economy. The problem is not unique to Australia – it is a global phenomenon. Given spending on construction equates to about 13% of global GDP, a lift in construction productivity could have a massive impact on our ability to meet our infrastructure needs.
The causes of poor productivity growth are many, and include extensive regulation, site-specific complexities, high dependency on fluctuating public sector demand, inexperienced buyers/owners, the fragmented nature of the industry, and underinvestment in technology. According to contractors and suppliers, however, the most significant cause of inefficiency is the misalignment of incentives between project owners and the other participants involved in the delivery of construction projects – designers, main contractors, specialist sub-contractors, equipment suppliers, consultants and the like.
Conventional procurement models have long been preferred by most project owners for their simplicity and the certainty that they provide to owners. But they have features that discourage the collaboration needed for significant productivity improvements. This article identifies the features of conventional contracting that impede greater productivity, and explains how changes to contracting approaches can improve productivity, especially when combined with complementary project management techniques and technology that require collaboration.
Allocating responsibilities and risks encourages the blame game, rather than problem solving, when things go wrong
Conventional procurement models allocate specific project responsibilities and risks to each participant. The designer is responsible for completing the design, and bears the risk that the design does not comply with relevant design standards. The main contractor is responsible to the project owner for all construction work, including that performed by sub-contractors, but isn’t responsible for defects in the works caused by a hidden design deficiency. Sub-contractors are responsible to the main contractor for the quality of construction work performed by them, but not for the construction work performed by other sub-contractors. And so on.
Under this arrangement, and variants of it, each project participant has strong financial incentives to perform well the responsibilities that are allocated to it, but is far less invested in how other project participants perform their responsibilities. The project essentially becomes a collection of sub-projects, where each non-owner participant is rewarded by reference to the performance of the sub-project for which it is responsible, rather than the performance of the entire project as a whole.
Indeed, late or poor performance by another participant will typically excuse a project participant from the need to strictly fulfil its own obligations as originally proposed. Accordingly, when things start to go wrong, the financial interests of participants are usually best served by demonstrating that another participant is to blame for the problem, rather than working cooperatively with the other participants to overcome the problem.
Fixed prices motivate participants to do the minimum required, even if doing more would result in better project outcomes
When a project participant is engaged under a conventional fixed price contract, it is financially motivated to minimize the cost of performing its obligations, in order to maximize its profit margin. Accordingly, when the project owner separately engages the designer and the main contractor under fixed-price contracts, each of them is financially motivated to do no more than the minimum required of them, even if doing more would reduce the costs incurred by the other, or result in better outcomes for the project owner.
For instance, having agreed to produce a design for a fixed price, there is little if any incentive for the designer to do extra work to produce a better than required design that will reduce the cost of constructing the asset, or minimize operation and maintenance costs.
Likewise, if the main contractor encounters unexpected ground conditions, there is no incentive for the designer to change the design to overcome the unexpected conditions, unless the owner agrees to pay the additional costs incurred by the designer in adjusting the design. Conversely, if a deficiency in the design is discovered during the construction of the works, there is no incentive for the main contractor to develop a construction solution that overcomes the deficiency, if doing so will increase its costs without a corresponding increase in the fixed construction price.
If the project owner wants a project participant to do more than the bare minimum required of it, to overcome a problem and achieve a better outcome for the project, the project owner will usually have to compensate the participant for the additional costs, to restore the participant’s profit margin.
No incentive on other participants to contain the cost impacts of changes
Conventional procurement models provide no incentive for project participant to minimise the cost impacts of changes to the project. Rather, they provide an opportunity for the incumbent project participants to charge ‘monopoly’ prices for the additional work, as it is usually impractical for the owner to competitively tender the extra work.
Obligations to co-operate don’t really work
It’s easy for the participants to say they will cooperate and collaborate with one another at the commencement of a project. Indeed, undertakings to cooperate and collaborate can be given contractual force by including them in the contracts.
But when a project runs into trouble, the benefits to a participant of blaming others, and putting its own interests ahead of the interests of the project or other participants, can soon outweigh the potential downsides of breaching an obligation to co-operate. It’s at this point that the commercial incentives built into conventional contracts render useless commitments by project participants to working co-operatively to jointly solve problems. Commencing legal proceedings to recover losses arising from a breach of an obligation to cooperate is rarely an attractive or effective remedy.
Is there a solution?
It was out of this commercial reality that ‘collaborative contracting’ was born. Collaborative contracts are contracts that incorporate features that are specifically designed to overcome the misalignment of commercial incentives associated with conventional fixed price contracts. These features can range from:
- contractual commitments to co-operate and act in “good faith”;
- early warning mechanisms, designed to alert other participants to emerging issues, so that solutions can be developed and agreed before the issue escalates;
- early involvement of the main-contractor and key specialist sub-contractors in the design process;
- governance arrangements that facilitate collective problem solving and decision making;
- payment arrangements that financially motivate each participant to act in a manner that is best for the project, rather than best for the participant;
- the agreement of each participant to waive its right to sue any other participant for mistakes, breach or negligence by another participant (except in the case of wilful default).
The collaborative contracting spectrum
Collaborative contracts take different forms. For example, many conventional contracts try to facilitate greater collaboration by incorporating contractual promises to co-operate, and early warning mechanisms. But these contracts fail to address the real obstacles to greater collaboration that are inherent in conventional fixed price contracts. To address these issues, more radical approaches are required.
Other forms of collaborative contracting that begin to address these obstacles include the Delivery Partner Model and the Australian Department of Defence Managing Contractor model. The high-water mark of collaborative contracting, however, is the project alliance model that incorporates all of the features mentioned above. The project alliance model become very popular in Australia during the first decade of this century, before falling out of favor with treasury departments in various Australian state governments. More recently, the project alliance model has been discovered by the American construction industry, where it has been called ‘Integrated Project Delivery’ (IPD) and is increasingly being used with great success.
Room for further improvement?
The benefits of the remuneration model, and the collective sharing of risks, found in the models at the more radical end of the collaborative contracting spectrum are well known. They are explained in detail in my recent paper on Collaborative Contracting. Less well known, however, is that these forms of contract can be combined with other concepts such as Critical Chain Project Management and Building Information Modelling, in a way that simply isn’t possible under conventional procurement approaches, to achieve even greater efficiencies.
Critical Chain Project Management (CCPM)
Projects comprise many tasks. The traditional approach to project management is to expect each task manager to manage the uncertainty in their task, and ensure the task is completed on time. When considering how long a task will take, we usually consider the shortest, the longest and the average duration for the task. When asked to commit to a duration, we don’t want to be late, so we’ll usually only commit to a duration much greater than the average task duration.
The same applies when we ask sub-contractors and suppliers to commit to completion deadlines for their tasks, and seek to impose liquidated damages for late task completion. This means most tasks are planned conservatively, even if the task manager is pressured to reduce their estimated duration. Giving the planner an ‘average’ duration is high risk, because by definition half the time you’ll take longer than the average.
Building some safety into the duration of a single task is not significant by itself. But when a project consists of hundreds or thousands of task, it becomes a major issue, as far too much ‘safety time’ gets built into the overall program. This extra time leads to unnecessary cost, as we plan to have resources on site longer than necessary.
This traditional approach to project planning also means we fail to benefit from tasks that finish early, as we aren’t ready to commence subsequent tasks early. If each task estimate contains sufficient time to complete in 90% of situations, then there is an 89% chance that the task will be completed earlier than planned.
If we remove the safety buffer from the estimated duration of each task, and instead put it in a pool that can be used by those tasks that actually need it, then the total time needed in the safety pool can be much less than the total time that is removed from each task.
By agreeing to share the safety pool with each project participant, rather than requiring each participant to manage the time uncertainty in its tasks, the project owner can reduce the planned duration of a project (and the time related costs). This is precisely how time risk is allocated among project participants under a project alliance/IPD contract. All non-owner participants share in any gain-share payment from the owner arising from early completion, and any pain-share to the owner arising from late completion. Under IPD, it is not possible for any one participant to benefit from early completion of its task, if the project is completed late.
However, if the project owner separately contracts with each project participant and requires the participant to commit to a deadline for completion of its tasks, then it’s simply not possible for the project owner to adopt the CPPM approach and share a time safety pool with each participant. A project owner can’t access the benefits of the CPPM approach under conventional procurement models.
The same logic also applies to contingencies or allowances that task owners include in their cost estimates to manage uncertainty. The IPD remuneration model allows a pooled allowance for cost overruns to be shared between all project participants, thereby reducing the total quantum of the allowances that would otherwise be incorporated into the fixed prices charged by each participant.
A bright future for collaborative contracting
Project alliances fell out of favour in Australia as the negotiating power of non-owner participants dissipated following the end of the resources boom, when demand for construction and engineering services returned to more usual levels. This was unfortunate, and contrary to the interests of project owners, as the return to more conventional contracting models reinstated the misalignment of commercial objectives between project owners and non-owner participants that impedes improved productivity.
But the recent uplift in government expenditure on public infrastructure in New South Wales and Victoria has once again caused the construction and engineering market in those states to become overheated. This is likely to force project owners in Australia to adopt more collaborative contracting approaches in response. Whilst many project owners will bemoan the lack of price certainty, and the need to share construction risks, the more enlightened ones will view this as a positive development from a productivity and value for money perspective.
 McKinsey Global Institute, Reinventing construction: A route to higher productivity, February 2017.
 McKinsey Global Institute, Reinventing construction: A route to higher productivity, February 2017, p1.
 This section draws on the innovative idea of combining IPD with CCPM first published in The Executive Guide to Breakthrough Project Management by Ian Heptinstall and Robert Bolton, Denehurst Publishing, 2016. See www.BreakthroughProjectManagement.com for further information.