Balancing infrastructure risk and reward with the right contracting model

While people tend to think of contracts in transactional terms (a legally binding agreement for one organisation to deliver work on behalf of another), they are also an important mechanism for sharing project risks, responsibilities, and rewards.

It’s in everyone’s best interest to minimise their exposure to risk while maximising their returns. That’s why different approaches to contracting have emerged over time. But how do we select the right contracting approach for your project?

Here are some of the key questions we support clients to consider when selecting a contract model.

How works are packaged is an important consideration when it comes to selecting a contract model.

Say you are delivering a new rail line that’s 500km long. You could opt to package all components of the work in geographically (vertical packaging) in determined sections (civil works, rail track, signalling) and procure them all together.

You could also choose to package and procure each component separately (horizontal packaging), where one contractor looks after the civil works, another the signaling, and another the rail.   

In making a decision, you need to ask certain questions...

Will there be enough contractors with the capacity and capability to deliver all aspects of the works as one project? Can they do it within the budget ballpark of the project’s anticipated value? If not, packaging everything together could make procurement less competitive, and place upward pressure on project costs.

On the flipside, breaking works down into smaller packages could increase management complexity and interface risks (where parts of the project delivered separately don’t fit together as well as if all work was delivered in one go). This can also impact on the number of resources required by the project owner.

Perhaps multiple contracting approaches are needed for different phases?

While proponents are often wary of talking to contractors in the early phases of an infrastructure project’s development, a structured market engagement process can be really helpful in informing decision-making about both packaging and the contracting model.

It allows project owners to tap into contractors’ insights about which strategies might work best for the individual project’s context and needs, drives market interest in the job, and allows contractors to prepare competitive options for delivery.

As ‘mega projects’ become the norm, having access to alternative streams of funding is becoming increasingly important. There are a number of avenues available for funding projects (value sharing for example), but where funding is a key concern, contracting approaches like Public Private Partnerships (PPPs) can give government infrastructure proponents access to private sector finance to help fund delivery.

While access to private funding is a welcome reward, this approach does transfer some of the longer-term financial benefits to private partners who gain the exclusive right to operate, maintain or collect revenue from the project once it is complete (toll roads are a typical example).

PPPs can be a great option for big projects that government may struggle to fund alone, but if the proponent’s long-term objective is to use the asset as a revenue stream, a different funding and contracting approach may work better.

Where projects are complex or the scope is open to change, determining a framework for scoping and pricing is difficult. Contractors don’t feel confident submitting a proposal - it’s risky business.

Alliance contracting is one model designed to address this. It establishes a more relationship-driven approach. Various parties come together to determine scope, design, and costs collaboratively, manage risks together, and share rewards accordingly.

Say you were working on a project to enhance road infrastructure across a city. In some areas you might be doing simple upgrades to existing roads. In other areas you may be building an entirely new bridge or adding new lanes. The water, traffic, geotechnical and other conditions will be completely unique for each project within this broader program.

Alliance contracting is a flexible option that allows project owners to select the best partners to solve the challenges of by individual pieces of work, rewarding them via a performance-based renumeration agreement. When there are a lot of unknowns, Alliance contracting can be a good solution.   

For projects that are less complex, and proponents have a high level of confidence in the capacity of contractors to deliver the outcomes they need, Design and Construct (D&C) contracts are a popular approach.

They allow owners to handover the responsibility and risk for both the design and construction phases to the contractor, who agrees to complete the work for a lump-sum price.

There are benefits on both sides, as by having full control over design and delivery, contractors can work to improve their margin through cost savings and value management. In theory, this means less input and involvement from the project owner.

While D&C contracts are ostensibly fixed price, this is rarely the case in reality. Variations and claims are common practice, and this can increase the actual cost of delivery significantly. These can be managed successfully, but open communication and strong contract management are vital for avoiding the common pitfalls of a transactional approach to delivery - disputes over cost, time, and quality.

As a project owner, you need to ensure you have sufficient resources to support good contract management.

Looking beyond the boundaries of a project has become more important than ever over the last two years.

COVID-19 has impacted global supply chains, increased the cost of materials and disrupted labour markets. At the same time, governments are looking to infrastructure to stimulate economic recovery. All of this is increasing demand for expertise, materials, capital and labour.

These uncertainties have sparked a shift towards target cost based contract options, rather than lump-sum agreements. Incentivised Target Cost (ITC) contracts provide a target cost for the project which is kind of like the par score in golf. The aim is to deliver the project ‘under par’. This is encouraged through a ‘pain and gain’ system where the contractor and project proponent split (through an agreed percentage split) any over or under-spend.

Transitioning from design to delivery can be the highest-risk phase of a project’s lifecycle. A lot can be lost in translation and that can cause huge flow on problems in terms of cost, quality, and time. A poor transition can be a breeding ground for disputes, which is why Early Contractor Involvement (ECI) can be a good option to consider.

ECI allows selected contractor/s to be involved in a project from the earliest design phase. While incumbency provides a natural advantage to the contractor/s, who usually go on to be selected for the construction phase, project owners do reserve the right to move to a competitive tender process after the design phase is complete.

By participating in a project pre-delivery, contractors gain a far better understanding of the logic and intent behind the design. This can help de-risk the transition into delivery and reduce future variations and disagreements between owners and contractor/s down the track.

At the end of the day, successful project delivery is all about relationships.

By asking the right questions and choosing the right contract model, the foundation is laid for positive partnerships between proponents and contractors where risk is laid with the appropriate party who can manage it.

Such relationships ensure that infrastructure’s rewards are realised on both sides of the delivery ledger. If this isn’t considered at the outset, projects are unlikely to be successful and further consequences can materialise for contractors which we all must work hard to avoid.