Procuring major projects in uncertain times: key challenges and possible solutions

20 October 2022

The swift, innovative procurement decision-making seen at times of crisis like the Kaikōura Earthquake or Auckland drought response could be well suited to the current inflationary environment.

That’s according to one of the experts participating in Bell Gully’s upcoming Construction Panel 2022 event on 27 October 2022. 

As widespread inflation and labour shortages add to the challenges facing the construction sector, panellists were asked their views on the procurement issues that need to be resolved most urgently in order to routinely and successfully deliver major projects in New Zealand.

Decision-making and procurement processes

Fletcher Building General Counsel, Construction, Sam O’Malley said procurement processes are costly for all involved, and the strain on principals’ project budgets is heighted by the escalation pressure currently being seen. “Given the choice, I think mature participants are better able to navigate a level of imperfect information rather than lengthy procurement delays, waiting for additional information to become available,” he said. Delays in getting a project to market mean the real cost of its delivery will rise. “In the procurement context, this means additional pressure on the project budget, increasing the risk of a distressed project in the delivery phase,” he said.

When asked what changes could be made to infrastructure decision-making to expedite the delivery of major projects, O’Malley said there were recent examples during times of crisis where necessity led to quick, decisive and innovative decision making and procurement. Some of these approaches would probably suit in an inflationary environment “where the planning phase and time to market comes at a very real cost to a project,” he said.

Supply chain delays and cost escalation

Fleur Aldridge, Principal Solicitor, Construction and Infrastructure at Auckland Council, highlighted supply chain delay, along with uncertainty of material costs, as among the critical challenges facing the sector. While these risks are habitually owned by contractors, she said Auckland Council, as the second largest procurer and sponsor of public works in New Zealand, has addressed such risks by providing advance payments, agreeing to provisional sums and cost fluctuation indices where appropriate – for instance where there is evidence of significant cost fluctuation in key commodities. “However, we expect our contractors to keep apprised of their key suppliers’ capacity, and to better understanding lead times,” she added.

Rigid procurement processes that aren’t specific to a particular project are problematic, said Fletcher Building’s O’Malley. Procurement processes that don’t allow for a sensible approach to cost-escalation pressures are “not fit for purpose” in the current environment. He said addressing project risk during procurement could be as simple as risk allocation negotiations, but in more sophisticated procurement processes it could involve collaboration on mitigation strategies to save time and cost, or an exploration of value engineering options that avoid or reduce risks.

Allocation of risk

Bell Gully construction partner, Ian Becke, the moderator of the Construction Panel, has noticed a significant improvement in market procurement practices over the last 12-24 months, and suspects that the catalyst was COVID-19. “COVID, and the contractual response to COVID, was the first time I have seen a relatively cohesive and aligned market response to treatment of a specific event or risk”, he said. He has observed that as the impact of COVID on projects has lessened, the collaborative, ‘generally sensible’ approach to risk allocation has continued to permeate contract negotiations: “it seems as though we needed to experience the market response to COVID in order to collectively realise that there are mutual benefits to proper risk allocation.” 

Becke notes that for proper risk allocation to occur there first needs to be a common understanding between the parties as to the nature of the risk and its potential impact before the parties turn to consider the commercial treatment of that risk. For this reason, he recommends considering the use of a variation benchmarking register outside of its traditional Alliance context, as “even the exercise of pulling together the register helps to crystallise in both parties minds the risks of the thing they are dealing with, even if ultimately the register does not form part of the contract documents”.

Other key challenges

Not unexpectedly, panellists highlighted resource constraints as another key challenge. O’Malley said it is increasingly common for one or more of the usual players not to participate in a tender due to resourcing constraints. Aldridge noted that even with Auckland Council and other major public works procurers ensuring a steady pipeline of activity and incentivising contractors to take on apprenticeships and implement training regimes, New Zealand “cannot complete with Australia on salary terms”.

Other areas in need of focus were the infrastructure deficit, project prioritisation and funding tools, said Aldridge, who also identifies ‘optimisation bias’ by designers and principals as an issue. Some projects are designed “beyond budgets or buildability” at the outset, leading to delays to de-scope or value engineer them. “Collaborative ways of working like early contractor involvement are going some way to meet these challenges, but we need better design-thinking of the public sector in New Zealand,” she said.

Overly complex project documentation and the much-debated dual role of the engineer under NZS 3910 were the focus of scrutiny by Fletcher Building’s O’Malley. He said the engineer is in the difficult position of being “in the principal’s service” in one capacity, while needing to make impartial decisions under the contract in another. Rightly or wrongly, this dual role makes it easy to complain the engineer has become an advocate for a principal’s position when decisions don’t go a contractor’s way, he said. “Once this perception arises on a project, it is usually on a path to becoming combative,” he added.

Success stories

In a market plagued by challenges in recent times, it can be easy to lose sight of the success stories – and there are plenty to note.

O’Malley calls out the positive impacts resulting from use of Watercare’s Enterprise Model, where Watercare has leveraged its programme of works to procure a panel of contractors to deliver over a multi-year period.  Aldridge remarks on the success of the collaborative “best for project” approach taken by the participants of the Wynyard Edge Alliance, which delivered under budget, and ever-so-slightly early.

Becke identifies the increased use in collaborative contracting models, including the implementation of Alliance-type concepts such as price-risk sharing in standard form build-only contracts, as being evidence of a maturing market. He has seen this model successfully deployed on the Downtown Infrastructure Development Programme and on other significant infrastructure projects in New Zealand. Becke’s view is that while the procurement model will be highly project dependant, better overall outcomes will be able to be achieved if the market understands the different models which are available for use.

Another panellist, Bell Gully senior associate Scott Lochhead, highlights the use of early contractor involvement as a way to setup projects for success, including by mitigating material cost escalation through early procurement, and interrogating buildability of design. Whilst recognising the ECI phase does not always produce the desired outcomes, in his experience if the scope is properly defined and all parties work together, including the consultant team, better project outcomes can be achieved. Interestingly he observes that “we have seen ECI used not only as a precursor to 391X contracts, but also in conjunction with FIDIC contracts where the parties recognise the value to be derived from a common understanding of the project”.

Procurement models

Are current procurement models fit-for purpose in this challenging environment? And what developments could be on the way?

O’Malley said pure alliances, currently being used widely throughout New Zealand, have broadly served the industry well. But he said the model would need to continue to take account of emerging market issues, such as the retraction in the professional indemnity insurance market seen in the last 18 months. Aldridge said pure alliances work when “all risks, liabilities and all costs are factored into the target cost and target delivery date.” She was seeing things go wrong, however, when non-owner alliance participants pushed to keep too much risk outside the target cost, or where the variation benchmark register is used to designate changes or risks as variations, that are ordinarily shared.

Lochhead notes Engineering, Procurement and Construction contracts (EPC contracts) are widely used offshore for a range of major energy and infrastructure projects, but there has been some hesitancy around their uptake in New Zealand. EPC contracts have the key advantage (from a principal’s perspective) of providing a single point of responsibility for the entire contract works for a fixed-price lump sum, and are particularly popular in the context of project-financed transactions where ensuring time, cost and performance certainty are essential to achieve a ‘bankable’ construction contract.

With a significant uptick in renewable projects now being planned and consented, especially in the wind and solar industries, those adhering to the traditional ‘build-only’ model will need to grapple with how to mitigate the resultant interface risks. This is especially so in projects requiring procurement of multiple key components (often from different suppliers) then assembly, testing and commissioning, before having a viable project.

Lochhead said effective project management and the use of early contractor involvement may help ameliorate interface risks under a ‘build only’ scenario to some extent, but they could also be more directly curtailed under an EPC model - assuming sufficient contractor appetite existed.

“As interest from independent power producers continues to grow in New Zealand, we may see increased appetite for an EPC-based risk allocation, as those funding privately-developed renewable projects require more of the time, cost and performance certainties offered under an EPC model,” he said.

Panellist, Mair Brooks, Partner, Infrastructure Advisory at KPMG emphasises the importance of having visibility over a pipeline of projects to assist the market and sectors to invest in capacity and capability. “We also want to encourage the industry to look at a wide range of procurement delivery models to identify the most appropriate model, whether D&C, ECI, EPC, or Alliance, by considering which model will best balance the control of project cost and risk against achieving project objectives and broader outcomes”, said Brooks.

Bell Gully’s Construction Panel event will take place on Thursday 27 October 2022. Ian Becke (Bell Gully Partner, Construction and Infrastructure) will moderate a panel of experts including Sam O’Malley (Fletcher Building General Counsel, Construction), Fleur Aldridge (Auckland Council Principal Solicitor, Construction and Infrastructure), Mair Brooks (KPMG Partner, Infrastructure Advisory) and Scott Lochhead (Bell Gully Senior Associate, Construction and Infrastructure). The panel will discuss the procurement of major projects in New Zealand in today’s challenging market conditions. Bell Gully is delighted to have Bruce Cullen (Downer New Zealand, General Manager Business Support and Performance) share his views on the current state of play in the construction market in his opening address to the panel discussion.

For further information on the topics discussed please get in touch with the contacts listed or your usual Bell Gully adviser.

Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.