Executive Summery

Procurement methods play a key role in the success and performance of projects, particularly projects of construction and civil engineering (Ruthankoon and Ogunlana 2003, p. 335). The project teams’ development and behaviours are resultant functions of the specific procurement method adopted by companies for the completion of the particular projects. Procurement methods have been experiencing various changes throughout the last many years. According to Ruthankoon and Ogulana (2003, p. 333) traditional systems of procurements and other procurement methods have transformed their frameworks and mechanisms of building procurements.

As a consultant project manager for Oldcross Borough Council, Department of Community Service, the following report is constructed to examine various procurement methods, comparing it with Design-Build-Finance-and-Operate (DBFO) for procuring a major public sector project. Furthermore, a discussion will take place on benefits that can be expected by the client, contractor, and supply chain when entering into a civil engineering project. The report will also look to examine considering cost risk and its effects on the choice of method of procurement.

Section 1:

The basis of "Design Build Finance and Operate" for procuring a major public sector project; advantages and disadvantages in comparison with other procurement methods for clients, consultants and contractors

To begin the processes of getting a project built relies on the mechanism of procurement. Generally, procurement systems are described as an organisational system that assigns responsibilities and authorities to people and organisations, and defines various elements in the construction project (Love et al. 1998, p.222).  Often procurement is defined as the activities that are taken by a client or an employer who is looking to bring about the construction or refurbishment of a construction project (Wardani, 2004; Bygballe et al., 2010; JCT, 2015a; NBS, 2015,). On a majority of projects, it is common for clients to begin the phase of procurement by first developing a project strategy. The strategy involves calculating the benefits, risks, contract type, construction strategy, information transfer mechanism and budget constraints of the concerned projects in order to decide the most applicable procurement method. According to various literature (Smith and Charles, 1995; Wardani, 2004; Mishra, 2006; Bygballe et al., 2010; JCT, 2015a; NBS, 2015,) four main procurement methods/systems are identified which are as follows;

1. Traditional/Conventional- It is the traditional system used in the construction industry for more than 150 years. Most popular method amongst smaller and middle sized construction projects in which the constructor works according to a detailed plan provided by the investor (Bygballe et al,2010).
2. Design and Build- Popular amongst middle sized and larger projects. It obligates the contractor to undertake a large part of the project works including preparing a detailed project designs and construction methods, while the investor provides the just the outline of the project (Mishra, 2006).
3. Management- The method is more often used for technologically complex projects where rapid completion is critical. Under this type, the contractor works as a consultant and they manage construction works that are undertaken by subcontractors, but are not directly responsible for the subcontractors.
4. Integrated- at times known as collaborative procurement; places an emphasis on participants of a projects on the mutual objective of delivering the project on time, to the budget and quality. It involves working as a team, disregarding limitations of organisation or location in order to meet the needs of a client (JCT, 2015b.

Generally, factors such as below are normally evaluated before confirming the type procurement method;

• External factors- This includes economic, commercial, political, societal, legal, and technological factors which influence the client and their business, and the project team during the project’s lifecycle (Rowlinson 1999).
• Client resources- This includes the client’s own knowledge and experience of the organisation with procuring building projects and the environment in which the client operates (Morledge et al. 2006).
• Project characteristics- This includes factors of the size, complexity, location, and uniqueness of the project as it influences the time, risk, and cost of the project (Morledge et al. 2006).
• Ability to make changes- This includes considering to what extent to which design of the project can be completed and the plausibility of any changes that may occur in terms of technology and scope (Rowlinson 1999).
• Cost issues- This includes assessing the need for price certainty by the client since there is a time delay from initial estimates to when tenders are received (Rowlinson 1999).
• Timing and risk assumptions- This includes assessing time cost and other risk trade-offs (Davis et al. 2006).

Deciding the procurement method is affected by factors such as the client’s policies regarding the risk assumptions, resources, desired contractual agreements, and organisational structure. These procurements methods are tailored especially for large scale public sector projects where finance is considered as pivotal factor. For instance, the Design- Build- Finance- and Operate (DBFO) is one systems that is based upon this integrations, and it used for the private-finance-initiative (PFI), which is derived through the design and built procurement system. Under this system, a private organisations assumes the responsibility of designing, financing and operations of the project.

Based on these factors, it is obvious that financing of the project plays a critical role throughout the project process, particularly procurement strategies. Therefore, project financing can be considered for all the four popular procurement systems presented earlier. Project financing is the long-term financing of infrastructure and industrial projects based on the anticipated cash flows of the project instead of the balance sheets of investors or sponsors of the project (Hoffman 2007, p117). Project financing comes in various forms, particularly Build—Own-Operate-Transfer (BOOT); this form of project financing in which a private entity receives a concession from the private or public sector to finance, design, construct, and operate a facility, but the private company at the time of concession owns the and operates the facility to recover costs of investment and maintenance while trying to receive a higher margin on the project (Smith and Charles 1995, p. 189).

Design- Build- Finance- and Operate (DBFO) is a delivery method that shares characteristics with BOOT, the only exception being that there is no actual ownership transfer. The organization under this procurement methodology accepts to undertake large scale projects such as schools and hospitals, before leasing back to the public sector/client. Through adaptation of this methodology, the uncertainties related to the construction as well as operations are transferred to the private organisation and the financial responsibilities are spread over an agreed amount of time, which reduces any form of immediate risks. However this transformation of risk, in many cases, are reflected in the amount the client has to pay. According to Pekka (2002) under the DBFO model, since contractor assumes the risk of financing until the end of the contract period, it gives much leverage of risk transformation which is a major concern in public sector, and hence is considered as the primary advantage of this method.  Other advantages of this system according to Pekka (2002) on projects includes the following;

• Encouraging the increase in private investment
• Increasing and attracting new and foreign capital into the country in which project is taking place
• Transferring the technology and knowledge
• Completion of the project within a given time frame and planned budget often not present in other systems of finance
• Providing additional financial resources for other projects that are considered of more priority
• There is a release of burden on public budgets set up by the government for infrastructure development.

With the DBFO the government also has the advantage of remaining the owner of the facility but is also able to avoid getting into debt. Cash flows also are used as the mode of repayment on investment and reward for its shareholders.

Section 2:

The range of benefits that the client, contractor and supply chain can expect to see when entering into a partnering relationship in the design and construction of civil engineering projects; disadvantages and management systems to minimise them

Partnering relationships have been becoming a significant development in the construction industry that is said to have brought about improvement in project performance (Wood and Ellis 2005, p. 317). According to the Construction Industry Institute (1991) partnering is a long-term commitment between two or more organisations for the purposes of achieving specific business objectives by maximising the effectiveness of each participant resources. According to Bygballe et al. (2010) partnerships are seen as a strategic arrangement whereby a contractor is involved in a series of projects or a short term single project arrangement with the main goal of lowering costs and improving the efficiency.

Partnerships can be operated independently of strategic alliance in which collaborators cooperate and share their resources in order to achieve common aims and goals. Several studies have indicated that there is a great deal of positive aspects associated with partnership arrangements. Several large business groups such as Esso, Sainsbury, and British Airports Authority have reported a savings of 40 per cent on costs and 70 per cent on time from partnership relations (Gordon 1994).  According to Gordon (1994) clients and contractors have a more empowered relationship from partnering and work together more effectively.      

Lui and Fellows (2001) have concluded in their studies that partnering can enhance project performances under the conditions that (1) there is work assurance- that partners will work together for the cooperative whole and (2) there is benefit insurance- which is gains distribution is equitable. According to Chan et al. (2004) and Black et al. (2000) once project partnering is appropriately implemented there are various advantages which includes; reduction in cost and time of project implementation, establishment of good and less adversarial relationship, risk sharing, operational savings, increased implementation speed, construction projects cost savings, quality improvement, improvement in design, increased understanding of parties and customer satisfaction, enhancing of economic growth in a country, facilitation of solutions that are creative and innovative, enhancing of facility maintenance, improved return on resources, increased revenue generation contributing to national development, improvement of administration, greater financing options, and reduced risk exposure.

Such partnerships  can also be implied through ‘Design Build Finance and Operate’ system of procurement in the form of public-private partnership (PPP), which is a government service venture that is funded and operated through a partnership of government and one or more private sector companies (Fortune and Setiawan 2005). This strategic relationship involves a contract between public sector and private parties in which the private party is the provider of a public service or project and assumes the risk related to the project particularly financial, technical, and operational. Advantages of such collaboration includes imposing a budgetary certainty by setting present and future costs of infrastructure projects over a period of time.

Further, the use of this partnership allows for a way of developing local and private sector capabilities through joint ventures with large sized international firms and also grows opportunities for sub-contracting to local firms in areas of civil works, electrical works, facility management, security, cleaning services and maintenance services, hence benefitting the client, contractor and supply chain (Fortune and Setiawan 2005). The public private partnership and procurement systems such as DBFO also has the advantage supplementing limited public sector capacities to meet the growing demand for infrastructure development. Lastly, there is also the advantage of long-term value-for-money using apposite risk transfer to the private sector over the life of project which ranges from design and construction to operations and maintenance (Fortune and Setiawan 2005).

However, this form of partnership also comes with disadvantages that can be mitigated with certain management approaches. Firstly, the on-going costs, development and bidding costs in partnered projects are more probable to be expensive than traditional government procurement processes (Fortune and Setiawan 2005). Therefore, the government or public sector organisation should determine if the greater costs are justifiable. Other disadvantages include a cost attached to debt; private sector organisation can make it easier to get finance (Fortune and Setiawan 2005).

Moreover, finance is only made available where the operating cash flows of the project company are expected to provide a return on investment. There is also no limit to risk bearing, that is why private firms and their lenders are very cautious when it comes accepting major risks that are considered to be beyond their control (i.e. exchange rates risks, risks of existing assets) (Fortune and Setiawan 2005). If private sector were to bare these risks the price of their services will reflect these various risks. There is also the disadvantage of the private sector only doing what they are paid to do and not more than that. Thus, it becomes necessary clearly state incentives and performance requirements within the contract. Thus, it is suggested that management focus on performance requirements that are out-put based and considerably easy to monitor. Also, management will need to focus on legal and regulatory framework to achieve sustainable solutions.

Section 3:

Consideration of how cost risk affects the choice of method of procurement

Construction cost becoming overrun is considerably a major risk that is likely to be witnesses in infrastructure projects. Being able to know the plausibility of cost overruns occurrence and its impact is imperative in project planning and implementation. This vital information can also be used as an input factor to determine risk in pricing exercises, in order to raise equity and debt finance for construction projects. Various studies on the accuracy of cost estimates for construction procurement have shown a probability distribution of cost overruns revealing systematic risk and a continuous and positive skew (Flyvbjerg et al. 2002; Cantarelli, 2012; and Makovsek, 2012).

From the literature reviewed, the conclusion drawn can be that the construction risk in public sector projects is considered to be expressively high. Construction risk arises from two major factors; exogenous risks which include ground conditions, weather, engineering challenges, unexpected archaeological sites, and other such as these. The second risk deals with which parties’ exposure to uncertain costs and what can be done about it; known as endogenous construction risk. The second form of risk is considered an agency problem; if the higher risk in construction costs is not tolerated by the party in-charge of the building there is a resultant rise of ‘moral hazard’ (Blanc-Brude and Makovsek 2013).         

According to Luu et al. (2003) the selection of an appropriate procurement method can reduce the cost of construction projects with an average of 5 per cent while also enhancing the probability of project success. It is found that reduction in cost risk in the traditional procurement method results in maximum cost certainty for a project that is often defined fully in the project. Also, it is also considered to be inflexible in design changes which can result in excessive cost implications.

In design-build project procurement, the design build contractor takes on the increased risk and will price the risk based on the level of scope definition. The impact of risks the design build contractor is expected to carry needs to be covered by the public sector’s cost estimate (Flyvbjerg et al. 2002). Thus, the decision to use the design build procurement method should be made during early phase of programming; at a time in which baseline budgets are being developed. Other procurement methods may reduce the time of construction, for cases where costs as well as time of project completion if critical, and where incentive/disincentive approaches are required (Flyvbjerg et al. 2002).

These are types of procurement methods and approaches that enables the shift the risk of cost to the contractor. When choosing a particular procurement method, there are various factors related to cost risk that need to be taken into consideration. Tendering system which is mainly found in the traditional procurement method contribute to uncertainty of the contracting system. Also, the traditional method commonly needs to have design completed before any work is commenced, making this difficult to achieve. There is also the risk of variations that may occur during the construction stage, leading further to cost increases (Flyvbjerg et al. 2002). There is also incomplete documentation during the tender stage making it difficult for the contractor to give an accurate price estimation.

In procurement methods of design and construct there is a greater certainty of cost, to the extent that if needed the responsibility for investigating site and ground conditions can be made entirely through the contractor (Flyvbjerg et al. 2002). However, on the hand, any changes that may come from the employer’s requirements can affect the contract sum and at time are considered to be costly. On the other hand, in procurement method of management, there are standard concrete costs such as a proposed management fee and the management contractor undertakes the work on the basis of contract, and cost plans that are based on project specifications. The client is then seen to accept the majority of the risks that are associated with the project as there is no certainty about the costs and the programme. Under this umbrella is also the design and management strategy which is similar to management contraction but under this contract, the contractor is paid a fee and assumes the responsibility for work contractors and the design teams (Flyvbjerg et al. 2002).      

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