It is public knowledge in NZ that Fletcher Construction has taken a large profit write down on two significant projects in Auckland and Christchurch to the tune of more than $250 million.
Board members have taken a pay cut and some senior functional staff have apparently been ‘moved on’.
The group net earnings for 2017 on $9.4 billion turnover was $94 million, or one per cent net profit. The balance sheet looks reasonably healthy, but the ability to pay dividends and satisfy shareholders derives from the P&L.
It must be asked, with 21,000 people globally and a $9.4 billion turnover, is one per cent really worth the effort? Socially it creates a wealth of employment, and that has merit, but as a business proposition it is not a viable or sustainable return. The 2016 net earnings were circa $450 million which is around 4.8 per cent, which is where large conglomerate net earnings ought to be.
I want to look at management of risk at the governance level where the types of risk that Fletcher has been exposed to can be assessed. That usually sits somewhere between the project control group, steering group and executive director levels. I’m taking a contractor’s viewpoint and will outline the steps in a typical project chronology where mitigation/management of risk can be achieved.
The first critical stage is tendering. The governance group should be ensuring that the resources required to manage the project and the plant and equipment and health and safety measures necessary to construct it safely are adequate. These are preliminary and general (P&G) costs, and if this is wrong, then an uncompensated prolongation of the contract will cost the contractor dearly. As a percentage of build costs, crudely (and it varies) these can sit anywhere between eight and 15 per cent. At the latter figure, on a $300 million turnover over a two-year period, that would equate to $432,000 per week. If that is the cost recovered by way of a prolongation claim, all is well; if that is the cost borne by the contractor consequent upon its own delay, it’s not so good.
Submitting a tender, whilst revocable until acceptance, is a major step. Once the offer is accepted, there is generally no going back and making sure the tender is correct on a major project can be key to the company’s performance over the next few years. Getting it wrong could destroy it.
On any construction project, time is money; the programme and the timescale committed to must be achievable and failure to meet the completion date invariably involves the imposition of liquidated and ascertained damages (LADs), a sum payable, per day or week in recompense of late delivery. Whilst the sum varies depending on the project, this too could be a significant figure, and this would be in addition to the P&G costs borne by the contractor. Inextricably linked to the risk – reward parameters. Major contracts are not won on fat margins.
If the profit level is perhaps only five per cent, that is easily wiped out if costs such as these have to be borne. How these figures compare and the risk profile that prevails on the project require careful consideration.
Linked to this are the demands the contract imposes by way of securities; often an on-demand performance bond will be requested, typically for 10 per cent of the contract sum, retentions may be required, LADs invariably, along with a number of guarantees, warranties and indemnities. All of these pose a risk to the contractor and (the bond particularly) carries a cost. The cumulative amount of exposure to these obligations needs to be understood and quantified and assessed in terms of manageable risk. Not only in isolation but in the overall context of the risk profile of the project. Sometimes, clients ask too much and blind acceptance does no one any favours as invariably, these risks where accepted, translate into tendered costs.
At the time of committing to the tender, the company must be sure it has covered all its bases. That means the risk-reward structure is correct, the right resources are allocated, the time commitment can be met.
Once the project is underway, the governance body then must take an intermittent critical look at a few key elements. Some key broad assessment parameters include:
This can be a simplistic measure of actual vs forecast or, if required, a more detailed earned value analysis. My view is that if the cash flow actual is circa 10 per cent of target, things aren’t too far awry. At governance level, that is all that is required.
At contract award stage, it is unlikely that all sub contractor’s contracts will be concluded; the challenge is to get them over the line in accordance with the tendered price. This shouldn’t really be an issue, but is worth keeping an eye on. Labour only on kitchen tiling is probably not a big issue, whereas M&E for the entire building may be a bit more critical.
Long lead items
Lifts, escalators, major items of plant and equipment should be key dates on the programme. Overseas purchases add both supply and currency exchange risks. Equal alternatives are generally worth consideration particularly if a cost saving can be offered.
Major claims and respective estimated final costs (EFC)
On large projects, the PQS and contractor’s QS will be carrying their own forecasts of the final cost. If possible, it would be good to compare the two and too much daylight between them may be indicative of a problem.
Major claims should not be left to lie until an end of contract bun fight. They need to diligently progressed and agreed or, ultimately, disputed. Any governance board should be cognisant of and tracking the progress of these issues.
Health, safety and environment
This now plays a large role on a site; legislation is extensive and there cannot be too much focus on ensuring everyone goes home safe at the end of the working day. Generally measured by stats, any spike or marked change in accidents or near misses will be worthy of further scrutiny.
As a monetary expenditure, usually the sum of a number of individual allocations of money against specific, quantified risks, should be rigorously managed and regularly reviewed.
When part of such governance, I would attend the main project progress meeting perhaps quarterly to get a feel for how the issues are being handled, the tension in the room, whether there is a collaborative working relationship and so on.
The contract documents and contractual commitments should speak for themselves. Either completion or phase completion dates will be contractual obligations; do not depart from them unless such departure is the subject of a bilateral agreement and contract variation.
On any complex project, there will be a plethora of other issues to deal with in different areas of the contract, relating to different aspects of it. Governance should address these where appropriate but be careful to leave the day to day management of the project with the project team, a fine balancing act. Direction and guidance are the watchwords. Intervention at times may be appropriate, but only where escalation of disputes is prescribed in the contract or things are off course and correction is needed.
Good governance requires experience and should be driven from board level. If no one on the board has the ability to understand what is required, it clearly won’t get done or, it won’t get done efficiently.
If all those elements can be achieved, with a bit of luck and a fair wind, there may well be a profitable outcome at the end.