Is it Time for Australian Contractors to Take on Extra Risk? 2

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Tuesday, February 3rd, 2015
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Build-only contracts continue to be the construction industry’s biggest deterrent to the delivery of better and leaner buildings with greater certainty.

Owners expect that construction will cost more and take longer than promised because of design discrepancies and latent conditions. If this is true, then there is an opportunity for builders to offer a higher price for a warranted lump sum as an alternative to a hard dollar build-only contract.

For builders, this is a huge leap because they sit in a highly price-competitive market and experience shows that build-only contracts are decided on price.

Tradition dictates that resolution of design inconsistencies is not a reasonable risk for a builder to carry without novation of the designers, but the establishment of BIM as a robust virtual design and construction (VDC) process means under-pricing of risk should be a thing of the past.

Fast and reliable tools now exist for interrogation, validation and review of extensive design information. BIM provides the greatest level of certainty the industry has ever known and at all levels of design and construction. If adopted early and the entire supply chain is engaged, it becomes the critical tool in managing risk and cost overruns during construction.

Despite this, builders continue to offer the same marginalised product. As if it were an excuse, a recent Australian Construction Industry Forum (ACIF) framework document stated “Industry is but a servant of those who commission new assets or decide to refurbish existing ones. It will adopt new technology and systems when its clients demand them…”

Warranted Lump Sum – Head Contractor Risk and Return

Just over a year ago, KPMG released its global survey on the construction industry and of the 165 senior executives personally interviewed for the survey, 77 per cent reported under-performing projects due to delays, poor estimating processes and failed risk management as the key challenge for the sector.

We know that typically 83 per cent of a contractor’s price is made up of the subcontracts. We also know that controlling time and cost will generate significant savings. Our goal as an industry must be to bring decisions forward and identify issues and clashes early in the process when the ability to change elements is high and the risk to the programme and to budgets is low.

BIM and the technology supporting every member in the supply chain have a direct impact on creating cost, design and time certainty. Poor risk estimation and management should be a thing of the past. Builders have a unique opportunity to take on known risk and push the project programme to ensure that visualisation technologies can create a virtual build and identify clashes and design changes much earlier and for much less than dealing with problems during construction where rework, delay and disruption explode costs.

From the development industry perspective, this will generate significant project savings because a more certain industry means that the total funding required for any form of a development is reduced. Banks require a contingency for every development loan. A $100 million apartment building typically requires an extra $8 million in contingency and this translates into a need for an extra $1.6 million to $2.4 million in equity, depending on the risk profile, to make the project happen.

The builder that masters VDC can turn this expectation into an opportunity by offering a higher alternative price (perhaps half or more of the expected contingency) for a warranted lump sum in lieu of a traditional lump sum. The alternative could be as simple as altering the standard clauses that appear in most hard dollar contracts and entitle the builder to additional payments for:

  •  an inconsistency, ambiguity or discrepancy in a contract document; and
  • a material difference in a physical condition to that which could be anticipated by a reasonably competent contractor.

What about Subcontractors and the Supply Chain?

In Australia, most of our construction contracts are hard dollar (either traditional or D&C). With traditional design + bid + build procurement there is no ability to engage with subcontractors during design other than some limited interactions driven by progressive designers.

To engage the supply chain, one obvious approach is to go back to the old school nominated subcontractor (NSC) clauses which were common in the 1980s in Australia. With the advent of BIM, those NSC clauses are likely to have far more upside than downside.

With design & construct there is a far greater ability to engage with subcontractors during design but there is no contractual obligation to do so. The issue here is more about culture.

Often, the behaviour is to avoid letting a subcontract early because there is a perception a better financial outcome will be achieved by maintaining competition for as long as possible. The cultural problem means that any head start and lead time is lost because subcontractors are unlikely to handover information and expertise without a guarantee that the subcontract will be won. For example, there is no incentive for a mechanical subcontractor to have racks designed prior to commencement of construction and where construction has started, it is impossible to place blue banger hangers in a formwork deck where the concrete has already been poured.

Knowledge and understanding of the certainty offered through early collaboration is the missing ingredient here not so much the contractual frameworks. There are plenty of design and construct, construction management, early contractor involvement and alliance contracts that can accommodate early involvement of subcontractors. The problem lies in the appropriate level of risk taken on by the head contractor. Traditionally, risk has been shifted down the chain of supply. This has always resulted in tight margins for head contractors and less incentive to become immersed in the virtual build.

The first builder to own the risk and become famous as Australia’s “BIM builder” stands to gain significantly, not only in the successful delivery of their projects but in the increase in profit margins in correctly identifying the level of risk and certainty available in the design information and prior to allocating any risk to sub-contractors.

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2
  1. Matthew Crossling

    Hi David,

    BIM has a long way to go to eliminate risk for the builder. One of our staff were recently on a job using BIM and the structural drawings were inconsistent with the architecturals with regard to precast concrete walls! How can the builder have price certainty when errors such as this are costly?

    I also don't agree with your take on nominated subcontractors. Without a competitive tender, the nominated subcontractor will build in their own contingencies and add higher margin. It also removes the reward for innovation to win a tender, such as alternative products or constuction methodology.

    If builder are organised with procurement and let trade packages early enough, such as your hanger example, they can still use competitive tendering and accomodate the design.

    I don't think BIM will change the builders risk allocation to subcontractors. Fair enough, if the documentation is better, the risks will be smaller. But they will still be allocated to the subcontractor, in my opinion.

  2. Derek Hammond

    I agree totally with Mathew, we used BIM on my last problem and we still had considerable errors from the consultants.

    The other issue to consider when using Novated or full blown D&C contracts, the client will be looking to get the best possible price for the project. This will ultimately mean the contingency will be eaten up during the tender process.