At all levels of the construction supply chain companies are under growing pressure to deliver high-quality goods and services at low prices. Although the region’s construction sector maintains a robust pipeline of projects, with more than $2.5 trillion planned or under way, there has still been cooling off across the sector in line with the global downturn. And right across the construction supply chain the level of competition to win business has increased and many companies are being forced to look at new areas, both in terms of working with new clients and entering new sectors and markets.

The result of the changing market conditions is that project risk profiles now look different. Construction firms are already in a higher risk position as they explore the relatively unknown. At the same time, clients are looking to use contract terms that protect their own interests and pass as much risk as possible on to the contractors. Under these conditions, contractors have to maintain tight control over their own supply-chain and minimise the potential for cost overruns.

“Price is everything but low cost doesn’t mean quality suffers. The specifications are still legal documents, so contractors are having to work harder to make jobs successful,” says Phil Dalglish, regional managing director at UK consultant Buro Happold.

Key number

  • 80 per cent: Amount of a project’s cost already committed by the end of the conception phase

Risk management

Although lump-sum turnkey (LTSK) contracts – invariably awarded to the lowest bidders – remain the most popular procurement method in the region, there is also a shift towards using more design and build contracts.

Design and build schemes pass all risk to the contractor as it entails the winning bidder undertaking both the detailed design and the construction, unlike LSTK where the client will engage a designer to produce the detailed design before tendering the construction contract.

“Design and build is being used more. [Abu Dhabi’s] Mubadala has used it for example, and it means that the client is not so exposed. It transfers all risk on to the contractor, who of course puts a premium on the price due to the extra risk they are carrying,” says Dalglish.

A successful design and build delivery is often handed over early, and sometimes at a cost below that in the original bid, as the contractor has the freedom to adapt the design to suit the most cost effective construction methods. The interface risk between different contract parties is reduced as there is a single point of responsibility for the scheme and this again reduces the likelihood of claims.

The quality of a project greatly depends on the quality of the products … it is important to use quality materials

Yusuf Akcayoglu, TAV

However, there are also some major pitfalls with using this contract mechanism, which are particularly common in the Middle East. Changes to the scope of works can lead to enormous cost and time overruns as the contractor finds his entire contract changed. The most successful design and build projects work when the client fixes its requirements at an early stage and then rests full control with the contractor team. For some Middle Eastern clients, this would require significant change in habit as the scope of projects are frequently altered once construction is under way.

To date a number of schemes have already been delivered successfully using this contract mechanism. Saudi Arabian government clients have used design and build for several schemes. King Abdullah Financial Centre and King Abdullah University of Science and Technology were built using this type of contract.

Looking ahead, projects such as Abu Dhabi’s $2bn Strategic Tunnel Enhancement Programme (Step) are design and build, as is Kuwait’s $3.7bn Subiya Causeway scheme.

Supply chain management

Whatever the contract mechanism clients choose, contractors and consultants are confident that if their supply chain is properly managed, the likelihood of meeting cost and time targets is high.

For some this means extensive due diligence on the construction partners before working together to develop a preferred network of firms, as well as continuous performance management throughout a project life.

“At Hyder, we have developed a Supplier Management System, which includes an accreditation process, online database, audit process and performance management system. The result is a preferred supply chain that works in partnership with us and we can offer our clients confidence of an enhanced level of performance delivery,” says Karl Simons, integrated management services director at Hyder.

“Each of our project management teams will monitor the performance of our project supply chain and provide regular feedback, thus influencing proposed technical bid reviews and knowledge sharing with our clients,” he adds.

Another key area where best-practice in terms of supply-chain management is crucial is logistics and materials.

“The quality of a project greatly depends on the quality of the products that are used in it. Hence, it’s important for the industry to use the right quality of materials,” says Yusuf Akcayoglu, Gulf regional director at Turkish contractor TAV. “At our projects, our target is to make sure that raw materials for the products are procured from the right sources, manufactured in the right factory under proper quality assurance supervisions and tested as per project specifications or international building code in the absence of any specification.”

Contractors have various options when it comes to procurement of materials and again these contract mechanisms are all about risk. Ex-works contracts are most commonly used in the region and allow the seller to minimise risk by making the goods available at their premises. The delivery risk is passed on to the buyer who collects the products at an agreed point in time.

“For us with facilities in logistics field, it’s usually better for going with ex-works. It gives a much better control over the delivery of the materials and it’s a must, in cases, where the suppliers don’t have their own facilities in the logistics part,” says Akcayoglu.

However, for suppliers with better logistical capacity, for example in the case of imports, the contractor may opt for mechanisms such as free on board contracts or cost, insurance and freight arrangements, where the risk stays with supplier or with his insurer until the goods reach the specified destination.

Alongside careful consideration of contract terms, contractors must also keep a close eye on the schedule of materials.

“We use a material tracking system, which is a chart showing the specifications, dates of material, mock-up and fabrication approvals, factory tests and all other inspections, including the estimated and actual dates. Our project teams continuously monitor and update this chart,” says Akcayoglu. Such data can then be used to monitor the performance of suppliers and evaluate budgeted cost against actual spend. “With this system, we can observe their accuracy in production, success in inspection and punctuality in delivery dates,” he adds.

Beyond the physical control of materials and suppliers, how parties on a project work together is also critical.

In the boom times of 2006-07, clients went as far as entering partnership agreements, where the client and contractor set up as a joint entity to deliver mutual objectives. This involved the use of ‘open book’ contracting, where the client reimbursed the contractor for all costs on the understanding that by ensuring a totally transparent arrangement, there was more scope for efficiencies.

Contractors jumped at the chance to effectively pass all risk to the client, and secure long-term working arrangements, and clients were pleased to have the best contractors dedicated to their schemes.

However, sources close to some of the most high-profile partnerships tell MEED that in practice it often led to soaring costs with clients feeling that contractors were taking advantage of the total reimbursement model. “There is a feeling that it did more harm than good,” says an  engineer involved in a partnering contract.

Despite the success of partnering internationally, the consensus in the region is that it was tried and tested, but failed. Instead clients like to use a preferred network of consultants and contractors often on a list of preferred suppliers. They then select clear contract terms that pass on the risk.

Although time and cost remain the main indicators for project success, there are also other benchmarks that are important in terms of future working arrangements, particularly for consultants, who are not responsible for the physical construction.

“Success cannot be judged on physical delivery alone, it must also be assessed on subjective issues, such as the team’s commitment and enthusiasm to complete the work in a satisfactory manner, and the perceived level of support the team provides to the many project stakeholders,” says Simons.

Value engineering

An area where consultants can make a big difference to clients is in the early stages of the project where methods such as value engineering are becoming increasingly common. This can be defined simply as the search for unnecessary cost by analysing materials, processes and products to ensure the required function is achieved at the lowest overall cost, consistent with performance.

“For value engineering to be truly effective, it is essential the exercise commences at the start of a project’s inception. Studies of our construction projects suggest that by the end of the concept stage, 80 per cent of a project’s cost is already committed. By this time, fundamental decisions such as basic structure, utility parameters and material specifications have already been taken,” says Simons.

Regardless of the contract mechanisms used, project parties that maintain strong relationships and ensure careful monitoring of suppliers and materials will minimise the project risk. As arrangements, such as design and build, become more common on major schemes, contractors that have the best control over suppliers and understanding of design, will maintain quality at low cost, and maintain a competitive edge.