Shifting risk will drive innovation in construction

31 March 2015

Outdated liability models mean contractors are taking on too much responsibility, leading to work that does not do the industry justice, say construction leaders

Ahead of the upcoming MEED Construction Leadership Summit on 27 May, MEED asked the heads of major regional construction firms about risk allocation in contracts. They agreed that at present, contractors are forced to take on too much responsibility.

The construction leaders were divided over whether this would best be remedied by adopting international standards such as those espoused by the International Federation of Consulting Engineers or by adopting a standardised GCC contract model, but they all agreed that by concentrating liability further down the supply chain, the construction projects market suffers.

If clients are prepared to assume more risk, they may appear to pay more when the contract is signed, but the results will be better projects that adhere more tightly to time and cost budgets, and are executed more innovatively. It will also strengthen relationships between clients and contractors, and improve the regional construction market in general.

David Welch

Regional president, Europe, Africa and Middle East, and senior vice-president, Bechtel

Are the current risk allocations in construction contracts fair for the consulting and contracting community?

It is difficult to generalise, as risk allocation depends on the terms of each contract. In competitive markets, businesses may be inclined to take on greater levels of risk as they seek to maintain their market share. This trend can result in an imbalanced risk allocation between the various contractual parties. In the short term, this can lead to companies failing to deliver on their promises and negative impacts on project delivery, and in the longer term, can result in higher prices. If contracts follow FIDIC [International Federation of Consulting Engineers] forms, they offer a good basis for a fair agreement.

How can construction contracts move towards win-win partnerships?

Every project is unique; different geographic, socio-political, economic, urban/regional planning, engineering and construction challenges require a tailored project structure. A win-win situation is when a contract allocates risks to those who are best suited to manage them. We find most customers in the region are willing to discuss this for the benefit of their projects.

Tom Topolski

Executive vice-president and managing director, Middle East and North Africa, Louis Berger

Are the current risk allocations in construction contracts fair for the consulting and contracting community?

At times, risk allocations can fall disproportionately onto contractors and consultants. The best practice is to allocate risk to the party best able to manage the particular risk item. Failure to do so generally results in higher-priced bids as contractors typically price in risk they are contractually obligated to take on.

How can contract conditions be improved towards win-win partnerships?

Increasing the use of project charters and teaming agreements, as well as the adoption of innovative compensation structures used in other markets, incentivises cooperation in project delivery by linking everyone’s remuneration to the overall creation of value for the project owner.  

Simon Moon

CEO, Atkins Middle East

What is your view of risk allocations in construction contracts?

It is incumbent on any company to ensure it is taking on an acceptable level of risk. The more fundamental issue is that our markets are still immature and few clients or stakeholders are really ready to have a fully partnering approach. There can often be an inherent lack of trust. We need a more mature approach to delivery, where clients and their supply chain seek ways of working towards aligned goals, to achieve the best result for everybody. We see this in other construction markets around the world, and it needs all parties to look to a more mature way of working together.

You cannot manufacture a strong partnership. You have to work hard to achieve it and that demands determination and trust from both sides. It sounds facile, but it is a simple truth.

Neil Reynolds

Senior vice-president and managing director, Middle East, North Africa and India, CH2M Hill

Are the current risk allocations in construction contracts fair?

Getting the best deal in the Middle East is, unfortunately, more often than not translated to awarding the project to the low bidder. More emphasis needs to be given to value-added and changing to a capex-opex [capital expenditure-operating expenditure] (totex) balanced approach (a move from measured outputs to outcomes), and looking at the whole life cycle of the project, which can also mean adaptability to change in use over time. Clients need to be able to adapt to change and thus remove the risk from their investments. Only by changing the low-price mindset to a value-added mindset will clients see the real value of good solutions, and the quality of the supply chain will improve overall.

Today, shifting the risk to the supply chain is not sustainable, as this way innovation suffers. Through innovation, prices will come down, but innovation is not free.

The current contracting environment in the region needs and requires a major overhaul so that the risk is placed with the party best able to manage it. A better procurement process, for example, will also provide companies the confidence to invest time, money and effort in the development of talent, passing on accumulated knowledge to governments.

What’s happening today is there is always one bidder that will take a low price, and because of this, the industry will not improve.

How can contract conditions be improved towards win-win construction partnerships?

We must not forget that the construction industry in most Middle East countries is very young, yet it has seen a massive development, mainly funded by high oil and gas prices. Construction prices have fluctuated greatly over time. With the exception of very complex projects that attract fewer bidders, construction and engineering prices are very low today. This may look good to clients, but only acceptable quality is being delivered. By removing risk and adversarial conditions of contract, money can be diverted to innovation across the whole supply chain and will attract more and higher-quality competition.

There are many examples around the globe where the construction industry has been revamped, such as in the UK and Australia, where more collaborative forms of contract have been introduced. There will be lessons learned, and a unique form of contract could be developed that captures traditions and best practices from around the world.

As an example, alliance-type contracts encourage the parties to work together collaboratively and seek to move away from the traditional adversarial approach, in which parties are first of all competitors. Alliance contracts involve a collaborative process and aim to promote openness, trust, risk- and responsibility-sharing, and the alignment of interests between clients and contractors. The focus is on the best arrangement for project delivery rather than on self-interests typical of traditional contracts.

More contractors are likely to bid on such deals because of the shared liability exposures and a greater ability to prevent and pass through cost increases and delay risks. The design process can, in principle, be more innovative and cooperative when unconstrained by liability apportionment issues.

Louay Khoury

President and CEO, Projacs International

Are the current risk allocations in construction contracts fair for the consulting and contracting community?

Historically, construction contracts are biased towards the client and put a lot of burden and liability on consultants and contractors, with more emphasis on the latter. With the evolution of alternative dispute resolution methods and clients adopting international arbitration, certain clauses have found their way into contracts, making them fairer towards all parties. Having said that, contractors are expected to take more risks than clients except for adopting force majeure and war risks, which are equally borne by both parties.

How can contract conditions be improved?

Adopting alternative and amicable dispute resolution methods could improve the relationship between the parties and could reflect positively on projects. Additionally, adopting partnering contract techniques would improve on the risks, as everyone feels they are working towards one mission.

Elias Zraicat

Executive general manager, UAE, Oman and Northern Gulf, Habtoor Leighton Group

Are the current risk allocations in construction contracts fair?

Commercial advantage is still very much in favour of the employer. However, this mindset will need to change. In order to achieve the best results for all, there must be a partnership approach to contracting and construction, and all must work to achieve a common goal by means of open communication, respect for all and maintaining a high standard of ethics.

How can contract conditions be improved?

Currently, contractual terms are decided upon by employers and, in the majority of cases, contractors can either agree to the terms or walk away from the deal. Contracts have become more ambiguous and complicated, with more special conditions and ad hoc changes. Maybe it’s time to review current contracts and see if a new standard GCC contract can be introduced.

A residual impact of global financial crisis market conditions is the do-now-pay-later (if at all) approach. A proper balance of risk allocation, with the party best placed to manage that risk, needs to be acknowledged.  More collaboration would see that contractual terms are fairer to both parties. In addition, by introducing streamlined, cost-effective, binding dispute resolution procedures, we will be able to avoid prolonging costly disputes for both parties. 

Adnan Mian

President and CEO, Mercury Mena

What is your view of current risk allocations in construction contracts?

Selection of the contract strategy is one of the most important decisions facing the client. Put negatively, an inappropriate procurement route matched to the wrong client and project can spell disaster. It is a question of balancing the needs of various parties with the particular circumstances of the project. Construction contracts continue to be Dutch-auctioned in the Mena [Middle East and North Africa] region, with little or no attention paid to the risk element. Instead of managing and mitigating risk, it is passed down the supply chain.

When looking at fixed-price, lump-sum tendering, which is how the majority of projects are procured in this region, I think both sides [contractors and clients] need to take a look at their actions and the adversarial environment it creates. Repeat business and working relationships take time and often cost more compared with the alternatives. Are we ready to accept this in order to improve? 

How can contract conditions be improved?

The procurement route is the single biggest decision the client makes on a project and yet we seem to only explore very limited options in the Mena region.

Personally, I like the management routes of either construction management or management contracting, allowing all members of the team to focus on their core competences. These procurement routes also improve cash flow for the project, which is a major factor in the Mena region. Some of my peers working for large multinational consultancies inform me that they regularly advise their clients in the region to think differently. I’m hopeful the tipping point will come soon; change takes time.

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