Face the Oncoming Tsunami
In our article “The Tsunami Facing Construction”, we provided a commentary on what we perceive to be a unique set of circumstances and events that are creating and will continue to create difficulties for many industries including construction.
We have been asked by some of our readers for guidance as to what contractors might do to minimise the potential effect, assuming that the situation does not improve or even deteriorates. We suggest the following.
Current or Future Tenders
At the risk of stating the obvious, be very careful. Fixed price contracts and fixed term contracts even those containing time and money entitlement clauses need to be examined carefully by contract and legal advisors to ensure that they provide sufficient and / or specific grounds for more time and / or more money to cover for the increased costs of:
a. delays;
b. labour;
c. materials;
d. energy;
e. equipment; &
f. subcontractors.
Our advice?
Before submitting a tender
Carry out a reality check on the possible effect on your price and programme in the event that your tender is accepted. Before cutting your price in an effort to win the project, try to imagine what the impact might be if the current situation deteriorates and ensure by checking with your legal and contract advisors, that the contract conditions contain sufficient safeguards.
If not, and if possible, qualify your tender with a form of words that will ensure that your concerns will be addressed and covered in case the current situation worsens and the project is affected.
In addition try to assess what the risks might be in the future and either:
a. Try to negotiate sufficient safeguards to be included within the contract yet to be signed.
or
b. Include in your estimate and tender, contingency amounts that you assess will cover you. Apart from the risks of increased costs, think about and assess future delay costs and do not forget the potential cost of liquidated damages.
or
c. Cross your fingers and hope for the best – (not recommended!)
Live Contracts
If you have submitted a qualified tender and / or the contract conditions contain sufficient safeguards, then you will need to set up systems in order to maximise your income and minimise your risk. Given the current situation, these may well need to be more sophisticated than your normal procedures. We will address those issues below under the headings of money and time.
Losses Generally
All contractors need to make a profit. Unfortunately, when costs start to escalate the first thing that is threatened is profit, often followed all too quickly by contributions to head office overheads; then site overheads; and ultimately direct cost. (Refer to our article “Disruption Claims – The Art of the Possible”).
Money
The following costs are all considered to be direct cost:
- Labour
- Equipment
- Materials
- Subcontractors
All can be affected by delays in material supplies with consequential increases through late or sporadic deliveries.
Addressing the potential consequences of the direct cost items in turn.
Labour
Loss of productivity or even idle time of the labour force can occur if material supply does not keep up with regular and achievable progress and productivity.
Equipment
Same point. Equipment needs to maintain regular progress in order to be cost efficient in line with contractors’ estimates. Some items of equipment are linked to productivity, some to time, and some to both.
Materials
Material supplies are the life blood of all projects.
If the supply of materials; slows; is delayed; or even dries up, then dependent upon the circumstances, the effect might be to bring the project to a complete halt. Alternatively, it may be that work might continue in a different sequence or at a reduced pace, but at a much increased cost.
At the risk of stating the obvious, lack of materials can and does have a dramatic effect on the three P’s, productivity, progress and profit.
The worst contract one of the authors was ever involved with, was a project for the Saudi energy company Aramco where the bulk of the materials were coming from the USA. The material supplies delivered were; out of sequence; substandard; late; and incomplete. The project was a shambles and because of the problems of material supply, the contractor’s direct costs were 35% more than its income. In addition, it incurred several million dollars in liquidated damages.
The lessons that were learned from that experience and from other contracts, by one or more of the authors of this article, (apart from that contractors need to be very careful in pre-vetting and monitoring the competence and capabilities of key suppliers and subcontractors) include:
- Insist on a detailed programme from the suppliers / subcontractors. Dependent upon the details, be prescriptive about the information that will be required to be included in the programme required from the supplier / subcontractor;
- Monitor that programme closely; do not assume that the suppliers or subcontractors will necessarily let you know in advance if problems are looming;
- If potential problems become apparent, advise the Engineer or Contract Administrator (hereinafter the Engineer) immediately;
- With the supplier or subcontractor and the Engineer consider and propose (if possible) substitute materials or equipment;
- If delays are inevitable, be open and honest with the Engineer and keep them in the information loop; &
- As noted below implement an “Open Book” policy.
We realise that this sounds expensive but ultimately cheap when compared with a 35 to 40% increase on the contract price that occurred in the contract described above.
In addition to the incidence of delayed or otherwise disturbed material deliveries it is the case that increasing energy costs will have a direct impact on the cost of numerous key material components of a project – the manufacture of items such as cement and steel for example, being energy intensive.
Subcontractors
The same issues noted above affect the performance of most if not all subcontractors. They in turn will affect the overall performance of the contractor. In extreme cases some subcontractors may simply be unable to continue with the project. Whilst in theory this might entitle the contractor to damages from the subcontractor, in practice the subcontractor might not be able to survive.
Advice to Tendering Contractors
Qualify your tender
Yes, we know that some tenders specifically prohibit qualified bids. It is obviously up to the contractors’ involved if they want to risk being disqualified, if they qualify their bids.
Consider what could happen if you do not qualify your tender.
If the contract conditions are extremely onerous (and only the contractors can judge for themselves how much risk they are willing to accept) then the ultimate consequences might range from managing the process with a degree of success through to incurring disastrous losses.
Only the tendering contractors can decide for themselves the risk they may wish to take.
If contractors have submitted a qualified tender, then this may well cause problems and their tenders may well be rejected. However, the consequences of submitting an unqualified tender and adopting a “wait and see position” may well be fatal.
If you can negotiate safeguards what ought to be done and provided?
If you have submitted a qualified tender that was accepted and you are incurring unforeseen increases, in order to convince the Employer (through the Engineer) that you are entitled to additional costs, then you must be prepared to “open your books” for inspection.
This must also include the subcontractors and suppliers involved and it MUST be incorporated as a condition of the subcontractors or suppliers bidding documents and ultimately in their contract with you.
This is better done in a structured format in which you demonstrate to the Engineer the amounts that you are claiming are in fact direct costs. That claim may also entitle the contractor to onsite overheads; offsite or head office overheads and profit. It all depends upon the detail and evidence.
Open Book Policy
This will involve the Engineer on behalf of the Employer being provided with access to discrete parts of your estimate including supply and subcontract quotations incorporated in the accepted contract value and actual costs incurred.
Before you do so however, you might be well advised to examine your cost and programming systems and determine if they will provide adequate advice to you, let alone the Engineer.
Alternatively, we have seen on major international contracts where the Employer procures some of the major and high costs items and thereby accepts the risk of high cost increases.
The Estimate
The Engineer will need to be satisfied that the prices being quoted as a base price were drawn from your estimate. Access will be required in order that the Engineer will subsequently be able to carry out spot checks comparing actual costs with estimated costs. This can be done in a discrete manner providing access to selected and affected parts of the contractors cost information.
Costing Systems
These ought to include details of your direct and indirect cost items including (see also our article titled “Disruption Claims – The Art of the Possible”):
1. Direct costs
a. labour;
b. equipment;
c. materials; &
d. subcontractors.
2. Indirect costs
a. supervisory and administrative staff;
b. on and off-site facilities including temporary and common facilities and facilities for the Employer’s supervisory staff;
c. indirect labour; &
d. indirect equipment, e.g. general site transport, tower cranes and the like.
3. Overheads
a. head office overheads;
b. insurance; &
c. bonds, financing, etc.
4. Profit
Procurement Systems
These will include details of the direct costs of materials purchased for the project and some form of comparison between the estimate and actual costs. That comparison might include for example extraordinary costs such as air freight costs instead of conventional transport and shipping costs.
As a great deal of work may be subcontracted, the same issues and requirements must apply to the contractors directly contracted suppliers and to its contracted subcontractors (and by necessity their key suppliers) with regard to estimates and required documentation.
Contractors would be well advised to make it a condition of their subcontracts and supply agreements that selected access is provided of estimated and actual costs to permit claims for additional cost to be examined and if agreed, paid.
The issues of timely notices and submissions ought to be conditions of any agreement.
The Programme
As much of the problem of delays might be related to either delays emanating from suppliers, or the physical delivery of materials and equipment, it is essential to include planned key material delivery dates in the programme and record the actual key material delivery dates.
In turn, those key materials must be linked to pertinent construction activities. This information must be made available to the Engineer.
The systems ought to be sufficiently sophisticated to ensure that forecast or actual delivery of materials can be compared with planned or scheduled deliveries. In the event of a forecasted delay it should be possible to demonstrate and analyse the impact of any delay and advise the Engineer.
It may be necessary to add more detail to the programme by adding activities and milestones to reflect, monitor, and consider the more critical supply chains. This additional detail may then be monitored more closely; it may be prudent to assess progress more frequently to monitor and advise on any effects on the construction programme.
The actual impact of any delays on the project programme will need to be assessed, and once confirmed, the programme updated to reflect the impact.
This undoubtedly will mean that contractors, their subcontractors, and suppliers will need to be alert to the potential and actual consequences of delays emanating from the supply chains. All potential delays ought to be advised immediately and backed up with further information and detail to enable the Engineer to check and verify the facts, the programme and the financial effect.
For their part, the Engineer and his colleagues may need to become more involved and active in the monitoring of potential delays and considering the effects.
Looking to the future it may be that the current situation will remain with us for some time. Much depends on events outside of our control.
Ultimately, what we advise is more openness and cooperation. As I think Churchill once said, “To jaw-jaw is always better than to war-war.”
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