Construction Economics and Procurement Methods - Case Study Example

Construction Economics/Procurement Methods Construction Economics/Procurement Methods Introduction As businesses respond to the 2008 economic crisis, the construction market is also undergoing key global transformations. However, the construction sector in the UK, despite the challenges that resulted from the 2008 economic crisis, remains vital to the UK economy and also one of Europe’s largest construction markets. The transformations are mainly founded on the shift towards sustainable and green construction while seeking to take advantage of the opportunities to optimise efficiency and effectiveness that the digital economy offers (Park & Glascock 2010, p. 12). For the purpose of this report and from the perspective of a consultant project manager, the construction sector is considered as the provision of materials, products and professional services related to construction as well as construction contracting industry. The report, addressing the Oldcross Borough Council, will explain the basis of “Design Build Finance and Operate” for public project procurement as well as its advantages and disadvantages. It will then discuss the benefits available for clients, contractors and the supply chain when they get into partnering relationships when designing and constructing civil engineering projects. Finally, it will explain the way considering cost risk affects the choice of procurement method. 1. The “Design Build Finance and Operate” (DBFO) Approach In DBFO, it is the bundled responsibility of a contractor to design, build, finance and operate a client’s project (Minnow & Freeman 2009, p. 69). This approach has its basis on the pressure and need to change public procurement models specifically to reduce public debt. It is then driven by the success of partnerships between public and private sectors, refered to as PPP, in infrastructure as it stems from and takes advantage of the expertise of both sectors. Its essence is the sharing or transferring of risk and responsibility (Olsen & Osmundsen 2005, p. 517). Characterised by long-term relationships and the lack of an actual transfer of ownership, this project delivery approach describes a mechanism used by government entities mainly for constructing public infrastructure projects. They usually entail dams, bridges, toll highways, hospitals and waste and water treatment facilities. The public sector is able to initiate projects even though they may not be financially, operationally and technically able on their part at that particular time. In a PPP, rather than specifying or determining the manner in which the project will be developed, the public partner is only required to specify what they need the project to achieve for them (Yu & Ive 2008, p. 699). They express these requirements in terms of objective and measurable performance, which are among the most common criteria in the construction industry. On their part, the private partner will commit to a long-term relationship that can run into several decades. Their responsibility starts from designing the project’s operational as well as lifecycle cost efficiencies. Their contribution of ideas and service quality are geared towards not only ensuring that the public gets value for its money but that the private partner itself also earns a fair return. An example of a successful PPP is the London Underground Public-Private Partnership, where the two sectors partnered to manage and develop London’s underground infrastructure. In this approach, the private contractor will bear the risk of financing the project till the completion of the contractual period after which the true owner, a government entity, will assume operation and maintenance responsibilities after a considerable period. The risk includes financing, delivery and performance starting from design and runs through architectural, structural and long-term maintenance plans (Yu & Ive 2008, p. 702). Advantages The underlying advantage of PPP to the contractors and consultants is that it offers more effective control of a project and its lifecycle. Its pay-for-performance orientation also facilitates innovation and governance while providing better control to risk management when compared to traditional methods of public procurement. For the client, the return on investment is higher than compared to traditional procurement and this is facilitated by the contractor’s innovativeness to ensure that they deliver the project as specified by the contract. It will also put them in better positions to pass public audits since they will have delivered as promised and expected. Politically, this is a significant point of leverage. Because the project design and build is based on the contractor’s expertise as well as emerging innovation, the client will consequently be able to provide the public with greater and more effective infrastructure solutions (Park & Glascock 2010, p. 8). That is another reflection of greater returns on investment. The fact that the risk of financing, delivery, performance and maintenance are assumed by the private sector is an advantage and relief to the client. Viewed from the contractor’s and consultant’s point of view, being able to better control risk management is an advantage because they essentially control how they are investing their capital. From the conceptual stages, the contractor is able to weigh risks and determine a project’s feasibility. Essentially, when the client only pays after delivery of what was exactly contracted for, it does not become its (client’s) responsibility to finance any occurring delays and overruns. However, from a wider perspective, it essentially becomes beneficial to both sectors and, more importantly, the project because the PPP framework will be better placed to control the factors that would have otherwise led to delivery delays and cost overruns (Park & Glascock 2010, p. 8). Such delays and overruns are common in traditional procurements methods particularly when they involve complex or large projects. Disadvantages A key disadvantage for the contractor and consultant is political interference. This is especially so because the PPPs are usually high-stake projects that concern public and national infrastructure and, inevitably attracts political, media and public interest. With the dynamic nature of political considerations, politicians will often interfere with the implementation to the disadvantage of the contractors who may not be placed well politically (Park & Glascock 2010, p. 16). This may often involve cost renegotiations that will negatively affect profit. Further, since clients will only pay when the project is delivered and only if it satisfies the client, it is another contractor and consultant disadvantage. This is mainly because the contractor will have to finance any changes that occur in the project’s implementation and are most apparent in the form of delays and cost overruns. For the client, the key disadvantage is the loss of total control and especially in the perspective of the master plan and strategies as well as facility management. Since the client may sometimes want to negotiate the terms of control, there may be delays in the initial implementation of the project to their own disadvantage. Then, even though a considerable amount of risk is either shared with or transferred to the contractor, the client will essentially pay for that as will be reflected in the financial proposal presented by the contractor (Olsen & Osmundsen 2005, p. 519). Although not always the case, the client may realise much later into the project’s lifecycle that the contracting alternative they opted for is not exactly suited for the particular project. One perspective may consider that the client is still safe because they will only pay after the project is delivered as per contract, but it can also be argued that the client (government entity) will be losing public confidence. 2. The Range of Benefits Expected by Clients, Contractors and Supply Chains when Partnering for Civil Engineering Projects For these three crucial stakeholders, benefits expected from partnering range from profit; functional projects delivered to the client’s specifications; greater work continuity; credible and comprehensive reports to the funding industry and organisations; stable environments of operating; academic outputs and; practical guides for the industry (Zheng & Lewis 2008, p. 48). When clients, contractors and supply chains invest in time so as to form the right team, all parties expect it to result in the best possible projects. Although supply chains generally consist of all the participants responsible for the delivery of a service or product. But viewed from the perspective of construction projects, there are several specialised supply chains that form an integrated supply chain designed to deliver design services, manufacturing services, assembly services and construction services. On the other hand, an integrated project team will be composed of constructors, the client and its project team and a team of supply consultants. Civil engineering projects are characteristically large and complex. This means compliance to contract requirements must be measured at every step to ensure compliance. Benefits For the client, this spells the first benefit to expect because it means both the contractors and supply chains will strive to comply with the requirements, which further means that their performance will improve in order to satisfy the client. The client further benefits because they also have some control and contributions towards the design of the project, rather than it being the exclusive responsibility of the contractor. Small and Medium-sized Enterprises (SMEs), form the construction industry’s contractor’s bulk, albeit in numerical expressions. However, their relatively smaller size often raises concerns about their individual financial ability and relevance to modern modes of integrated supply chains (Zheng & Lewis 2008, p. 44). However, a key benefit they expect from partnering with clients and the supply chains in the design of civil engineering projects is greater work continuity that leads to profitability. The concept is founded in the SME’s characteristic of being flexible, which allows them more innovative approaches, greater commitment, and faster uptake. This flexibility is occasioned by their being equipped better to work collaboratively in which their shorter communication lines and business processes can be adapted to the project design rapidly. This translates into a benefit for the client since the design will be more focused and responsive to their needs. Hence, a combined benefit for clients, contractors and suppliers in partnering to design civil engineering projects is that each of them is profitably relevant in the construction continuum (Yu & Ive 2008, p. 701). Each can be placed at any point of the supply chain as a designer, manufacturer, client, intermediary, value-adding agent or contractor. Disadvantages However, disadvantages also occur, and one is in the form of committing to change. This is because the decision to partner with other parties in pursuit of common business entails more than simply signing commercial contracts. More importantly, it involves change of direction and focus for some or all the partners (Kalvet & Lember 2010, p. 116). This represents a major leap of faith because it is not easy, regardless of how small it is, for a company to fully move into a partnered relationship that is not really a merger or acquisition. For example, when clients, contractors and suppliers partner, it means there will be considerable sharing of information and, inevitably, systems and resources. However, each has their own security measures to protect them against vulnerabilities and malicious attacks. The greatest disadvantages, therefore, for all parties, will be that their systems and resources will be compromised to some degree if they are to partner with the other parties on some aspects of the project. To minimise this disadvantage, the Information Security Management System would be recommended to protect all partners. Another disadvantage would be negative environmental impacts, mainly because it is a civil engineering project. As individual partners, each may have distinct environmental responsibilities and obligations as require by law. However, after partnering, there may be overlaps of some of these responsibilities, which could result in conflict and, worse still, overlooking the responsibilities. In such a case, the Environmental Management system would be recommended to clarify the responsibility of each partner towards the environment (International Organization for Standardization 2004, p. 112). 3. How Consideration of Cost Risk Affects Procurement Method Choice Without necessarily targeting the method that has the least cost risks as in traditional methods, this consideration is driven by the need to get the best possible value for resources and money during the life of the facility being procured (Gatti 2007, p. 32). Since risk costs are the commonest cause of completion delays and extra expenses, they considerably feature in the procurement method choice. Hence, when cost risk is considered, the procurement method will be affected because the choice will target methods that offer long-term value for money. These are methods that combine innovation in procurement and competition while managing and controlling risk factors effectively. Further, when cost risks are considered, procurement methods of choice will be those that ensure key outputs are delivered punctually, are of appropriate quality and reflect the client’s budget estimates (Kalvet & Lember 2010, p. 114). Effectively, this consideration means that some procurement methods will be locked out, especially those that display high possibilities of waste, fraud and financial impropriety. Another effect will be that the choice of procurement method is informed by transparent justification of the need of goods rather than just going for the lowest-priced method. There will be an analysis of the goods identified as key to the project alongside their priority and cost as well as assessment of how they are to be procured. References Gatti, S 2007, Project finance in theory and practice, Academic Press, New York. International Organization for Standardization, 2004, Environmental management systems-specifications with guidance for use, Author, Geneva. Kalvet, J & Lember, V 2010, ‘Risk management in public procurement for innovation: the case of Nordic Baltic Sea cities’, The European Journal of Social Science Research, vol. 23, no. 3, pp. 112-117. Minnow, M & Freeman, J 2009, Government by contract: outsourcing and American democracy, Harvard University Press, New York. Olsen, T & Osmundsen, E 2005, ‘Sharing of endogenous risk in construction’, Journal of Economic Behavior & Organization, vol. 58, no. 4, pp.511-526. Park, A & Glascock, J 2010, ‘Sustainable competitive advantage and corporate real estate’, Journal of Real Estate Literature, vol. 18, no. 1, pp. 3-19. Yu, M & Ive, G 2008, ‘The compilation methods of building price indices in Britain: a critical review’, Construction Management and Economics, vol. 26, no. 7, pp. 693-705. Zheng, J & Lewis, M 2008, ‘The dynamics of contractual and relational governance: evidence from long-term public-private procurement arrangements’’ Journal of Purchasing and Supply Management, vol. 14, no. 1, pp. 43-54. Read More