Collaborative contracting is gaining momentum, particularly for larger public sector infrastructure procurements, although the market has yet to settle on a preferred format. Instead, there is a continuum of options.
At one end is the alliance model and target outturn cost (TOC). At the other are simpler structures using open book trade letting to land on a fixed price. In between are the ‘managing contractor’ or ‘construction manager’ models, and even novated design. ‘Hybrid’ solutions are also possible.
This new popularity is driven by a need to buffer the project and to protect the interests of the contracting parties against current market volatilities, in particular COVID, the war in the Ukraine, lengthy lockdowns in China, high inflation, and abrupt changes in immigration settings.
New Zealand’s sizeable infrastructure deficit has also had an exacerbating effect as competing projects have challenged the capacity of our tier one, two and three contractor markets.
Other drivers are:
- Re-thinking incentives: there is a developing sense that the traditional incentives on contractors to minimise costs within a set of defined quality requirements make it difficult to put the project first when challenges emerge (delays, cost overruns, shortages in material or labour, design co-ordination issues), instead encouraging a focus on contractual and commercial positions.
- Flexibility: design co-ordination is not easy, and it takes time – especially on large projects with complicated services. Collaboration provides greater flexibility during the construction phase.
- Transparency: this goes to price, programme and the supply chain. Once transparency is provided, the parties can more easily discuss and agree pricing and risk allocations.
All types of collaboration can be successful if implemented properly. All make a move away from the traditional build-only lump sum, which dominated New Zealand procurements for over a decade.
TOCs are common on larger horizontal procurements but have yet to be used in New Zealand on a large-scale vertical build, although we expect this may happen in the near to medium term.
They respond well in circumstances when:
- The extent of works is not fully defined at outset (e.g., design and build).
- A reasonable degree of flexibility in design and programme is anticipated.
- The parties consider that value engineering can decrease cost.
- Traditional risk sharing approaches would result in significant price premiums.
For a true TOC to work, it is important that the Contractor is able to do open book accounting in real time. New Engineering Contracts (NEC) guidelines, for example, strongly recommend that a contractor must have the sophistication to develop costs from first principles (rather than relying on market price), do their accounts monthly, and be able to allocate their internal costs to an individual project.
We support the introduction of a new target price option in the Standards New Zealand recent review of NZS3910, jointly commissioned by the New Zealand Infrastructure Commission, Te Waihanga and the Construction Sector Accord1. We expect parties will also look to introduce an early warning regime similar to NEC – this being central to the TOC model’s effectiveness.
Construction Management or Managing Contractor model
The contractor is typically responsible for design and construction. The engagement runs from the early design phases (even feasibility) and through to commissioning.
The Managing Contractor subcontracts its design and construction obligations in close consultation with the principal, who ultimately has approval rights. The Managing Contractor’s key responsibility is project and construction management. The principal may appoint a contract administrator as agent but this would not extend to the independence role the Engineer to Contract carries under NZS3910.
Main contractors, particularly on complex projects where it is difficult accurately to price risk or to avoid cost fluctuations, are essentially seeking a risk profile that aligns with them subcontracting out nearly all trades, in some cases confining their own costs to preliminary and general (P&G) items.
The main elements coming up for consideration are:
- Design risk/novated design: experienced contractors understand what properly co-ordinated design looks like. This makes a case for design consultants to sit under the managing contractor. To the extent designers have already been engaged by the principal, these can be novated. However, the principal will take the risk on design errors arising prior to the date of novation.
- Cost reimbursable/open book pricing: pricing structures can vary but a key principle of the model is subcontractor costs being passed through to the principal on a cost reimbursable and open book basis. A target cost can be agreed upfront, meaning a contractor will forgo margin on subcontractor costs incurred over the target cost. The same principle can be applied to the scheduled completion date.
- Overheads and margin: the contractor tenders its P&G costs, a management fee and its margin percentage (for offsite overheads and profit). The P&G cost could be a monthly fixed fee. The contractor may argue their P&G and margin should be higher under this model given the increased construction management and administration during the subtrade letting phase. Principals may push back on the basis that the contractor takes less risk compared with a traditional model.
- Subcontracts: these can be a mixture of structures (lump sum, cost reimbursable, measure and value/schedule of rates, TOCs) and the form of contract may vary depending on the scope of work. Managing contractor models in the United Kingdom can include the principal engaging subtrades directly. Australian examples typically see subtrades engaged by the contractor.
- Project bank accounts: we understand these are commonly used in most states in Australia.
- Subcontractor payment claims: these typically follow the traditional process. The managing contractor includes subcontractor claims in its monthly claim to the principal/professional quantity surveyor. Controlling subcontractor claims (and consequential Contractor margin creep) is similar to traditional lump sum in that the contractor tends to see itself as a ‘post box’. The PQS has an important role to play here.
- Subcontractor P&G: this is managed on an open book basis and the managing contractor prices all cranage, scaffolding etc. rather than asking a subcontractor to take on this risk.
- Fixing the price: it is still possible to convert to a fixed price when programme and design risk are suitably understood.
Progressive letting is still a popular form of contracting, which allows the parties to assess subtrade pricing against an agreed procurement schedule that aligns with design development. In recent years, we have seen this model replace the traditional lump sum model. Similar to the TOC and managing contractor models, the principal and contractor collaborate and work closely with each other in the review and award of subtrade tenders.
Chapman Tripp comment
New Zealand must deliver a significant number of mega-projects in the short term, meaning that the factors driving collaboration are not a ‘flash in the pan’. We expect the current discussion on collaborative contracting will soon be converted into signed agreements – a positive and timely step for the infrastructure sector.
1. Although supporting this element of the review, Chapman Tripp has concerns about other elements in the new NZS3910, see our commentary here