Megabang for megabucks: getting better value from transport infrastructure projects

Infralegal is delighted to have participated in today’s Grattan Institute webinar on getting better ‘bang-for-buck’ from transport infrastructure projects.

As our founding principal, Owen Hayford, said, Australian taxpayers do pay too much for our transport infrastructure but not for the reasons that the Grattan Institute suggests.

Grattan suggests it is because governments don’t drive a hard bargain.

On the contrary, the competitive tender processes that governments run on megaprojects deliver outstanding value to the taxpayer, because contractors routinely under-price the risks in order to be competitive.  

As a consequence, governments get a great deal at the time they award these contracts.

Grattan’s criticism is really directed to the difference between the initial tendered contract price and what government ends up paying.  Put simply, Grattan is saying government fails to enforce the fixed price.

There are occasions when this is true, and government settles a claim for more than the contractor is legally entitled to.  But this line of reasoning fails to recognise that there is no such thing as a fixed-price construction contract.  

Every fixed price or lump sum construction contract includes a mechanism for adjusting the initial contract price in circumstances where the contractor should be entitled to increase the price. For example, if the project owner directs variations to the contractor’s scope.

The main reason why 25% of projects end up costing more than the initial contract price is because the contractor was legally entitled to an increase under the agreed terms of the contract, rather than any failure by the government to enforce the contract.

The real reasons why taxpayers end up paying too much for transport infrastructure can be put into three buckets:

  1. The first is wrong projects prematurely announced. Our politicians love to announce big projects, and they routinely do so prematurely – before a business case has been developed and all available solutions to the problem have been considered. The Grattan Institute has separately done some excellent research on this.
  2. The second bucket of reasons why we pay too much for our transport infrastructure relates to scope.  Many projects end up with a gold-plated scope.  Also, our regulatory environment burdens projects with a lot of requirements that are over-the-top and add unnecessary costs.
  3. The third and final bucket of reasons relates to the way governments procure and contract transport megaprojects.  Contracts for the design and construction of projects are typically awarded based on competitively tendered fixed prices.  Grattan’s report says that this practice places downward pressure on the cost of megaprojects.  Infralegal agrees with this to a point – it certainly places downward pressure on prices during the tender process. But once the contract is awarded, fixed prices end up having the opposite effect, and place upward pressure on cost. We appreciate this is counterintuitive, so let us explain why.

Why fixed prices drive project costs up

Once the contract is signed, the fixed price starts to work against the government’s interests 

Fixed prices work against the government’s interests because they become an obstacle to the cooperation and collaboration that the government needs from the other project participants to successfully deliver a complex mega project.

Mega transport projects are inherently complex due to the need to integrate different systems from different suppliers to make the whole thing work.  

Take, for example, the Sydney Metro projects.  To make a new metro line work you need to successfully integrate many complex systems including:

  • the tunnel systems (fire, ventilation, drainage);
  • the track system;
  • the signaling and train control systems; 
  • the traction power system;
  • the trains;
  • the stations and station systems, including platform screen doors, electronic ticketing etc;
  • the stabling and maintenance facility; and
  • security systems;

Many of these systems are manufactured by different suppliers, and they all need to be installed and integrated with one another.  

This requires the different suppliers and contractors to cooperate and work out who will plug each system into the others, and what the others need to do to enable the plugging-in to occur.

The cooperation and collaboration activities take time and cost money.  Under a fixed-price contract, every dollar of additional cost means one less dollar of profit for the contractor.  

So each contractor and supplier wants the other interfacing contractors to do the cooperating and collaborating.  

There’s no incentive for them to do anything beyond what’s contractually required of them, even if doing so will deliver cost savings and other benefits to:

  • the government, or 
  • the government’s other contractors, or 
  • even the relevant contractor’s subcontractors.

Accordingly, they will only cooperate and collaborate to the extent they need to do so to fulfill their own contractual obligations – to deliver their bit of the project on time.

So, the fixed price becomes an obstacle to the cooperation and collaboration that is needed to successfully deliver the project.  Consequently, fixed price contracts are a key cause of cost blowouts on complex transport megaprojects.

How to do it better?

There are lots of things governments could do better when it comes to procuring and contracting mega projects.  We wont mention all of them now.

But a big one, that is often overlooked or underestimated, is the negative impacts of fixed price contracting. The payment regimes in our megaproject contracts need to be rewired.

More specifically, governments need to separate that part of the price that covers costs, from the part that covers profit. Under a fixed price contract the contractor maximises its profit by minimising its costs. Governments needs to change this because it drives the wrong behaviors.

Instead, governments need to tie the profit margin of the other project participants to how well the project as a whole performs against the outcomes that the government is trying to achieve.

The outcomes that deliver value to government and taxpayers if done well, or that destroy value if done poorly, differ from project to project, but they commonly include:

  • Minimising the costs government incurs in getting to completion of construction, or better still, optimising  the whole of life costs of the asset including operating and maintenance costs;
  • Timely or early completion of construction;
  • Happy stakeholders;
  • Better than business-as-usual (BAU) sustainability and environmental outcomes;
  • Better than BUA training, skills development and diversity outcomes;
  • Better than BAU involvement from local industry or Aboriginal-owned businesses.

If government links each participant’s profit margin to how well the project performs against these objectives, rather than simply minimising the cost of delivering its part of the project scope, then each project participant will be incentivised to optimise project performance against these outcomes. This is how governments and taxpayers can get better bang for their buck.

Want to read more?

For a longer version of this article, see Megabang for megabucks: driving better value on megaprojects 

Owen Hayford

Infrastructure lawyer

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