The purpose of this article is to highlight some of the commercial pressures that Contractors and their supply chain will face in an ever-demanding and competitive market.
General contract arrangements
In general, the Contractor is the party on a construction or engineering project who has the responsibility of actual execution of the work that delivers the project, and who may be supported by sub-contractors of varying capability. The extent of the Contractors responsibility and liability will be defined in the Contract Agreement where it ultimately defines the risk proportions between the Client and Contractor. Generally, and subject to the form of contract, the works appointed to the Contractor are likely to be first developed by the Client’s team, that likely consisted of consultants of varying disciplines, and resulted in outputs from each consultant that contribute to the designed basis for the proposed project. Therefore, the Contract Agreement will capture the developed designed works to-date (if any) and form the basis for deliverables in the realisation of the project from both the Client (i.e. Client’s Design Team) and Contractor.
The documents forming the Contract Agreement will define the scope of the works, the timing(s) for completing the works, the cost (or basis of calculating the cost) of the works, the quality criteria and assurance arrangements the works shall be in conformance, and other standards that shall be achieved in the delivery of the works (e.g. EH&S); and thereafter provide that the Contractor is responsible for delivery of the works within the agreed time and for the agreed cost based on the agreed scope, subject to adjustments in accordance with the Contract Agreement. To arrive at this point, which sounds logical thus far, means the Contractor has accepted various risks events, and therefore, has accepted the mechanism(s) that would provide entitlement and how such events would be calculated, if they were to occur. These risk events could cover ground conditions, scope, design, workmanship, quality, fit for purpose, co-ordination of work, local authority connections, etc, and more so, the known (or ought to have known) data about such risk events at the time the Contract Agreement was concluded. In addition, the Contractor will likely be ‘at-risk’ for non-completion by the Completion Date (save for relief under the Contract), have retention around 5-10% of the contract sum applied, and under some forms of contract, be required to provide a Performance Bond / Guarantee representing 5-10% of the contract sum.
(Early) Warning signs
To put risk events into some kind of perspective, it was stated in the Linked In Group – FIDIC, JCT, VOB, AIA, NEC, JBCC…Bespoke Contract Forum that in the first nine months in 2013 on the UK Crossrail Project that:
13,406 Early Warning Notifications were issued with 12,237 being closed;
10,063 Notifications of Compensation Events were issued, of which 931 were withdrawn or rejected;
By the end of this first nine months in 2013, 7,432 Compensation Event Events were recorded and accepted.
Note: To generate and manage the volume of above notices, and to evaluate the relevant supporting particulars; a significant multi-disciplinary contract management team would be required within the organisations of the Client (incl the Client’s Representative(s) and Consultants) and the Contractor. In addition, what would not be captured by this data, is the impact to the working environment and culture between the site team(s). Irrespective of whether a party is right or wrong in their assertions, claims on a project inherently promote an adversarial working environment.
In addition, a Global Construction Disputes Report 2018 stated the three prominent causes for disputes in 2017 were (1) Inadequate or improper contract administration, (2) Inadequately drafted or unsubstantiated claims, and (3) Inadequate understanding of contracting Party’s obligations or non-compliance with contractual obligations. It is unclear from this report whether these prominent causes for disputes were more attributable to a Clients or Contractors; however, anyone who knows anything about contracts will know these causes are contract management basics.
Therefore, issue and risk management by a Contractor, and consequently, the effectiveness of a Contractor’s risk management strategy will be crucial to its commercial success.
At who’s risk?
Recently, the Spurs Chairman stated that “…Anyone who has had anything to do with construction knows that things are always late finishing and always cost more, and that’s exactly what we’ve experienced….”. An interesting Client perspective following the delivery of the world-class New Tottenham Hotspurs football stadium, but the question is at who’s risk? And consequently, at who’s cost? This statement by the Spurs Chairman appears to be a generalisation for the industry, however one thing is for sure, either the Client or Contractor(s) would be responsible and accountable. The answer of ‘who’ to this type of question can only be objectively answered by the known circumstances giving rise to issues against the relevant risk apportionment under the provision(s) of a Contract Agreement. However, save for relief under a contract agreement, it is likely the overall risk is significantly apportioned more to the Contractor, and it is the Contractor who will lead the resolution of issues that impact the delivery of his works.
If, for example, a Contractor agrees to a contract that has retention at 5% and a performance bond at 5%, then the aggregate liability subject to satisfactory performance would be 10%, without taking into consideration any other liability under the contract. This 10% is a cash liability as retention may be cash-retained (or perhaps a bond), and the performance bond, and where applicable – the retention bond, are likely to be ‘irrevocable and on-first demand’ cashable instruments, and subject to contract conditions on any redemption. Note: in this example, retention is relative to workmanship and the performance bond relative to performance of the contract.
In addition, the Contractor will have a liability for non-completion within the time for completion, perhaps between 5-10% of the contract price.
The bottom line
In 2017, it was reported “The UK’s Top 100 Construction Contractors collectively achieved a pre-tax profit margin of just 1.5% last year” on or around an average revenue of £1.5bn per Contractor. These are staggering and unenviable margins for so much responsibility and liability, and incomparable to any other industry.
The unsustainable procurement culture that is promoted by ‘lowest price tendering’ will continue to impact Contractors, and consequently to their supply chain, unless change in these practices are driven by the industry as a whole.
In the interim, Contractors will continue to optimise ways of working and it is likely the brunt of any impact will be felt on its supply chain. Such efforts could be seen as (rhetorically) cutting your toes off so your shoe can fit instead of optimising the input of the supply chain throughout the Contractors processes, so the best value can be offered for both the Contractor and the supply chain.
For example, it has recently been reported that one main Contractor has been piloting a 1.5% management fee levied on its strategic partners (key supply chain). While such a practice has not be well received, nor is it likely to be anything new, this Contractor asserts they “…are continuously developing new ways of working with our supply chain….”. Somehow, it is unlikely the supply chain will not share their enthusiasm!
In addition, the strain on Contractors is evident when it comes to the payment of the supply chain. Not more so than a much-needed public sector initiative imposed on Contractors who pay late, as a safeguard to the Contractor’s supply chain. Welcome news for the supply chain. It will be interesting to see what develops for the private sectors, if anything, but for sure more will follow.
It would appear for Contractors that the risks have never been higher to achieve cut-throat margins, and with ‘lowest price tendering’ still prevalent in industry, the question is how much more ‘give’ can be given by Contractors, and consequently, by its supply chain. However, for the UK Contractors, too much risk for too little reward seems to be the accepted norm.