Project ‘Fine Print’ Manages Risk

Posted on January 5, 2011

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Significant resources are used to manage the soft parts of a project to keep the project on time and on budget. Owners execute protracted RFQ / RFP processes with short-list interviews and selection committees trying to pick the right team out of a bunch of suits. Owners ask designers and builders how they manage quality on their jobs. Owners present a budget and then ask the team how they can creatively shave dollars off.

At times this can be a little circuitous. If an owner really wants to manage project risk, the best way to achieve this is with a tight contract—the hard part of the project.

A contract is in black-and-white, has legal backing and is totally within the control of the owner. Yes, it is a negotiation, but one that is naturally fair and balanced. Biased contracts that overburden one party and are not in line with industry standards are many times not enforceable, so why waste time trying to put a straitjacket on the other side?

In his book Broken Buildings Busted Budgets, attorney and author Barry LePatner estimates 5% project savings is possible simply by utilizing a tight contract.

From his experience, LePatner offers some important perspective and suggestions. From a trend perspective, the American Institute of Architects (AIA), which drafts contracts for its membership, has been revising its standard contracts to isolate architects from the construction process. This is mainly due to a dramatic increase (nearly 300%) in project litigation between 1960 and 1980. LePatner feels construction contracts between owners and design / construction professionals are inadequate because they have a lack of risk management and both sides do not consult legal counsel nearly enough. And owners do not have internal auditors who understand the construction business well enough to advise. In other words, no one takes it seriously enough to invest in smart contracts.

Currently, LePatner sees 60% of contracts as fixed price, 20% as guaranteed maximum price (GMP), and 20% as open-ended—a mixture of time-and-materials (T&M), cost-plus-fee, or fees on unit-cost basis. Based on his research, industries with fixed contracts (between consumer and producer) have high productivity:  airlines, autos, computers, consumer electronics. In industries with “mutable” contracts (i.e. costs change from beginning to end), productivity is low:  education, healthcare, legal services, and construction. Thus, he finds fixed contracts are a linchpin to higher productivity in construction, where the ideal fixed price contract is manifested in a spec building because there is no one to pin any cost overruns on—all inefficiencies and mistakes are eaten by the team.

Owners are at a disadvantage when purchasing design and construction services. Typically they have no representative capable of managing the project, while also negotiating hardline with subs and number crunching financial statements and project schedules from the builder. No wonder such a job description does not get many takers. Add to that the fact private owners have little market pull (legal recourse) against builders and no professional association to back or advise them against industry standard contracts from the AIA, DBIA or ACG. Finally, lawsuits have become more prevalent and successful because design and construction professionals have opted to document everything; ironically, this tendency for self-preservation via paper trail has provided a gold mine of discoverable data, which is ammunition for attorneys.

LePatner offers a few suggestions to save money on your next project.

  • 1)  Question the 10% contingency.  Why should the owner set aside money for problems and mistakes during projects?  Understandably, part of it shows goodwill (in the form of capital) on the owner’s part to want to be serious about and complete a project. Yet with proper bid preparation, scope can be further defined for the design and construction team, questions answered, and risk reduced that does not come out of owner pockets.
  • 2)  5-10% retainage.  Often this money is held ransom for warranty issues.  It should be clear what the funds are for, under what terms they are held, and when they get released.  There are other, less expensive ways to guarantee a project is completed than tying up money for the length of the project.
  • 3)  Diversify away as much risk as possible.  Too many times an owner is stuck with the financial risk of the unknown in a project, when much of it could be shared with the construction team. LePatner feels construction professionals should be able to generalize better from past experiences and have financial contingencies in their pockets figured in for both the unknown and for things to go wrong.  And when this is not possible, include a best guess place holder for the issue at hand with data to back it up.
  • 4)  Seek a true fixed price contract via “negotiated bid”.  Pay an architect to produce field work quality plans and pay a contractor a fee to create a budget to build to, with owner’s rights to the use the CDs to bid out.   Select a handful of teams to create a bid on the package where the team that produced the CDs and bid are still eligible (as a fallback option).  Choose the best team to negotiate a bid.  Selection is on merit and comfort with a reasonable fee negotiated so price is not a criterion and the winning team does not feel squeezed to reducing their profit margins to win the project.  Everyone in the process is compensated for work, allowed to compete for the project, and kept honest. The owner is not left with nothing if the negotiation falls through; they can use the documents again to go to the next team.
  • 5)  Remember:  “No contract is complete, but it should be as comprehensive as possible”.  Much like no construction document set is ever complete, a perfectly balanced and complete contract is an ideal—but still worth aspiring to.

To be clear, a project is too long with too much at stake and too many variables to not put in the contract time in early. The more work and thought done up front, the greater the chance to save money and headaches later.  Good luck in your next one.

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