Sunday, 28 May 2017

Unbundling Design and Construction

Complexity and Uncertainty

Despite the proliferation of contracts used in the building and construction industry the great majority of projects are delivered under either the traditional design-bid-build or design and build (D&B) and design and construct (D&C) contracts. The trend has been toward D&B and D&C contracts for large projects, so these account for a larger share of work done than number of projects.

There is some support for design and construct procurement of buildings and social infrastructure from school PPPs in Australia and hospital PPPs in the UK. This is probably due to the buildability issues found in complex buildings with many services, like hospitals, or the emphasis on maintenance costs with schools. However, problems found in D&C projects associated with design changes by the client and a conflict of interests between design team members and the contractor are common. These are typical of the principle-agent type issues found in transaction cost economics.

Design and delivery of major projects can be contracted separately to reduce project costs and risks so that, as far as possible, design and documentation is complete or nearly complete before tendering. The ‘nearly complete’ qualifier is important. A simple project can be fully specified just because it is simple. However, there is a limit to how much design can be completed in the initial stages of a major project, because the specification of a major project develop over time as the project details are refined and defined. Therefore, it is unreasonable to expect a major project to be fully specified at tender, and in most cases this would not be possible. On the other hand, it is not unreasonable for tenderers to expect the documentation they receive to be sufficient, because the extent and clarity of the design determines their project time and cost plans.

Using evidence from the 11,000 private sector resource, industrial and engineering projects in his database Ed Merrow argues the best form of project delivery is what he calls ‘mixed’: hiring engineering design contractors on a reimbursable contract and construction contractors on a separate fixed price contract. The evidence from the database is that this is the most effective form of project organization, and is basically traditional construction procurement where consultants are appointed to do the design and a competitive tender is held for one or more contractors to execute the works on site against a complete design.

There are a number of advantages of this strategy of unbundling design and construction, particularly for major projects. Breaking a project into smaller, sequential contracts spreads the cost out over time, and does not incur interest costs on finance for design work (as in a PPP). It makes quality control easier and more effective, by being focused on each stage, which is an important risk management tool. Separating the design stage from tendering and construction will also improve opportunities for consultation with the community and stakeholders. Most importantly, completion of design and documentation before tendering reduces contractor risk and therefore total project cost. Management of the interaction between designers and contractors can done by the client team, which would also take responsibility for overall design management.

This argument is for design and construction of projects to be contracted separately, because this will reduce project costs and risks. As far as possible, design and documentation should be complete or nearly complete before tendering or starting the works. There is good theoretical support for this from contract theory, for example Oliver Hart concluded: "Conventional provision (“unbundling”) is good if the quality of the building can be well specified, whereas the quality of the service can’t be … In contrast, PPP is good if the quality of the service can be well specified in the initial contract (or, more generally, there are good performance measures which can be used to reward or penalize the service provider), whereas the quality of the building can’t be."

The key factor is therefore the extent of the specifications, on some projects there may be a limit to how much design should or could be completed upfront. For many major projects these develop over time as the project details are refined and defined. It is unreasonable to expect a complex project to be fully specified at tender, and in most cases this would not be possible. It may also be advantageous to look for innovative ideas or design options, so for these projects an incremental approach would allow contractors and suppliers the opportunity for input during the development of the design. This also has the advantage of reducing uncertainty from poor tender documentation, thus lowering risk and cost for tenderers.

This issue of project definition and its relationship with complexity is the heart of the matter. Where on the spectrum from simple to complex does an individual project lie? The Shenhar and Dvir Novelty-Technology-Complexity-Pace model was used here as a way to measure project complexity, based on the score for each of those four dimensions. What that model lacks, however, is the world outside the project, all the measures are internal but projects are delivered in an uncertain world. This awkward relationship between project definition and certainty and external complexity and uncertainty is captured in this figure.

Figure 1. Project Characteristics

Even a well-documented, fully specified project is subject to some degree of environmental uncertainty, and such a project may be delivered in a complex environment (railway station upgrades for example). From this it is clear that the challenges on major projects become truly complex with a combination of these internal and external factors. Therefore, the central task of the project team is to minimize uncertainty due to internal factors, so tenderers can be invited to challenge the design and/or specifications if they can deliver a better alternative. For many projects providing an opportunity for innovative ideas to address complexity or functionality can deliver major benefits.

While it may be advantageous to look for innovative ideas or design options, using an incremental approach to allow opportunities for input during the development of the design, design input comes at a cost to tenderers and only one tenderer is successful. Therefore, clients should contribute to their design costs in return for ownership of the designs. If clients have purchased designs from unsuccessful tenderers any of their innovative ideas can be incorporated into the final design.
This can be seen as an extension of the bid cost reimbursement policies currently found in some countries: Canada typically reimburses a third to a half of losing bidders’ total external bid costs for design and legal components; and France, where the Government often reimburses up to 40 percent of design cost for the initial bid phase and 70 percent for the final phase to unsuccessful bidders, depending on the extent to which they participate in the competitive dialogue procedure and the detail of their offer. Australian state governments in Victoria and New South Wales have also used capped bid cost reimbursement for transport PPPs.

Hart, O. 2003. Incomplete contracts and public ownership: Remarks, and an application to public-private partnerships. The Economic Journal, Vol. 113(March), pp. C69–C76, pg.75.

Merrow. E.W. 2011. Industrial Megaprojects: Concepts, Strategies and Practices for Success, Hoboken, N.J.: Wiley.