Published on LinkedIn on 12 August 2019
The contracting market for major civil construction works on Australia’s east coast has become fraught – for project owners, major contractors, and the rest of the supply chain.
Projects have become more complex and expensive for project owners to deliver – just look at the number of projects currently being procured by Australian governments valued at more than $10 billion. Yet despite rising contract values, major contractors are struggling to make them profitable.
There are many reasons for this. Perversely, one is the record level of spending on public infrastructure by the NSW Government, which has filled the order books of major contractors but left them struggling to find the people they need to bid and deliver projects well. Consequently, major contractors are now declining to bid for some new projects, and are refusing the accepts risks that project owners have previously transferred.
The rising value of projects is also resulting in projects being too big for tier one contractors to take on alone. The tier ones are joint venturing to share the work between them, which reduces the pool of competing bidders, making it harder for project owners to obtain attractive tenders.
Given these conditions, Australian governments and other project owners are considering alternative procurement and contracting strategies for their major projects. So, what strategies are being considered? And what’s the relevance of these strategies to other, international, construction markets?
More contract packages
A common response by project owners is to break the project into a number of separate contract packages that can be separately tendered. Smaller contract packages, or packages involving fewer disparate activities, enable smaller or more specialised contractors to compete in their own right rather than as part of a joint venture, thereby expanding the pool of potential bidders. It also reduces the level of risk borne by any one contractor.
Recent examples of Australian projects that have employed this strategy include Sydney Metro Northwest, WestConnex, Melbourne Metro and Cross River Rail. It’s been taken to new levels with Sydney Metro City and Southwest, where the project has been separated into no less that 15 contract packages!
But this strategy also brings with it many risks that need to be carefully managed. I discuss these risks in some detail in Breaking mega projects into smaller contract packages – a fraught response to a fraught market?
Less risk transfer
Because risks are being more fully priced by contractors, many project owners are considering alternative contracting models that transfer less risk to the contractor. More collaborative forms of contract, such as those that provide for reimbursement of the contractor’s reasonable costs, rather than a lump sum price, are becoming more prevalent.
Less aspirational target completion date
The target completion date sought by project owner is often too aspirational and aggressive, placing unnecessary pressure on contractors and their supply chain. This typically results in:
- the contractor having inadequate time to properly plan, collaborate and innovate, to optimise cost and schedule;
- construction of packages starting before the package design is finalised, leading to engineering changes, reduced productivity and rework;
- unnecessary costs being incurred, attempting to accelerate delivery against an unachievable deadline; and
- more industrial relations pressures, as unions seek to exploit the commercial pressures faced by contractors as a lever to secure benefits for their members.
A less aspirational target completion date can avoid these consequences.
Attract more international contractors
Australian governments have been working hard to attract more international contractors to the Australian market for the last 10 or so years. These efforts have intensified over the last few years as the market has become tighter. The strategy has had some success, with the entry (or re-entry) of many international contractors including Bouygues, Salini-Impregilo, Ghella, Acciona, Samsung C&T, Vinci, BAM, GS Engineering & Construction, Bechtel, OHL, SNC-Lavelin and WHBO.
But many international contractors, particularly Chinese, Japanese and American contractors, remain reluctant to enter the Australian market. To further improve market capacity and competition, Australian governments need to address the underlying reasons for the reticence of such contractors — which generally revolves around the risk/return equation.
Governments and owners could intensify efforts to reform procurement processes to reduce bidding costs, and improve the contractor’s perceived returns (without increasing construction prices). They could remove remaining barriers to entry and competing effectively, and work to eliminate perceptions of bias.
Projects could be structured and presented in a manner that is more attractive to both local contractors and new international contractors. Governments could also reduce the perceived threat to contractor profits represented by client/buyer power in Australia by moving to more balanced, less client friendly, risk allocations and contract forms.
Increased use of Dispute Avoidance Boards and other forms of accelerated dispute resolution would also increase the attractiveness of the Australian civil engineering market to international contractors.
Encourage industry investment in skills and capacity development
Australian governments have recently introduced procurement reforms aimed at encouraging greater investment in skills and capacity development. Local and indigenous industry participation plans are being demanded, and increased weight is being given to them in tender evaluation processes.
But there’s more that governments and project owners could do to create an environment that allows sustained industry investment in skills and capacity development, beyond a single project. Longer term contracts with a guaranteed or relatively secure volume of work would create an environment where it actually made commercial sense for the contractor to invest in skills and capacity development directed at the relevant owner. Longer, more robust pipelines of future projects would likewise give contractors greater confidence in making such investments.
The Australian federal government could also relax current immigration constraints to attract more skilled migrants to the civil engineering sector.
The current market conditions being experienced in Australia are not unique. They occur in most construction markets from time to time. The strategies discussed above can assist in creating more competitive, yet sustainable, global market conditions for all industry participants.