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Industrialised construction: aligning supply chain interests

Out-Law Analysis | 23 Nov 2021 | 9:37 am | 8 min. read

As main contractors on construction projects do very little work directly, true collaborative contracting will require full buy-in from subcontractors and the rest of the supply chain.

Typically, collaborative models and incentives concentrate on the contractors furthest up the chain – the tier one contractors. Successful alignment of project managers, contractors, suppliers and designers and other professionals requires fostering a single, ‘best for project’ identity with incentives, where possible, for professionals and the wider supply chain alongside those at tier one.

Design for success

Experience suggests that main contractors generally pass on all main contract terms into the provisions of subcontracts and add their own domestic, additional risks. This has been partly due to the pre-eminence of ‘design and construct’ as a procurement route, but does little to encourage collaboration

Blundell Nigel

Nigel Blundell

Partner

There has been a marked increase in the use of more collaborative forms of contract in recent years 

Indeed, this form of contracting is particularly contradictory, as clients have little role in deciding who actually carries out the work they are paying for. Since the abolition of the nominated subcontractor regime it is generally the main contractor, who does very little construction work directly, who chooses who undertakes these tasks.

Clients will be particularly interested in professional appointments such as designers, bearing in mind the importance of good design to the success of the project. For this reason designers belong at tier one where the contractual structure allows, with mechanisms found to incentivise them for good work. Traditional professional indemnity insurance arrangements may, however, create a barrier here: there may be perceived risks for professsionals of tier one design obligations creating ‘fitness for purpose’ obligations, with consequences for the validity of the designer’s professional indemnity insurance.

Consider collaborative contracts

Parties are increasingly realising that bringing a team to work together for the first time, with multiple disciplines and stakeholders, is unlikely to succeed using traditional contractual models, with their tendency to be adversarial and to focus on risk transfer and blame allocation. As such, there has been a marked increase in the use of more collaborative forms of contract in recent years, from standard forms such as NEC and PPC 2000 to bespoke alliancing structures.

Where repetitive processes are used to produce industrialised products flatter, coordinated contracting structures tend to be more efficient, in contrast to the more common vertical supply chain model used to deliver bespoke solutions with the attendant risks of errors and defects.

According to Graeme Culliton, UK managing director of the Skanska-IKEA joint venture BoKlok, one of the reasons that horizontal collaboration is not currently being properly used in the supply chain is down to traditional methods of procurement and contracting, which create too many peaks and troughs to make factory manufacturing efficient. Culliton told us that housing manufacturers often start out with the intention of collaborating horizontally, but quickly realise that they have to vertically integrate to be able to provide the factory with a consistent volume of work.

Culliton is also of the view that attempts to incorporate more collaborative methods into the existing standard form contracts are insufficient. He believes that the main bodies producing these contracts, including the NEC and JCT, should instead focus their efforts on creating an entirely new form of contract for industrialised procurement.

But appointing individual suppliers which do not have horizontal contractual relationships with other suppliers also leads to inefficiencies. For example, on any given project, numerous supply chain members may need to work independently at the same time at the same location. Where no horizontal relationships exist, coordinating these suppliers at the project’s numerous inter-dependency points becomes challenging.

Working collaboratively brings greater prospects of capturing innovation and best practice and reducing waste. A review by McKinsey of eight collaborative contract pilots found that there was a 15-20% improvement in cost and programming performance.

Potential contracting models

Collaborative contracts can be used as project contracts, but also as frameworks under which collaborative alliances can be formed to drive value. The standard Framework Alliance Contract (FAC-1), for example, uses supply chain collaboration to find efficiencies for the benefit of a long-term programme.

With the greater standardisation which comes with industrialised products and construction, supply chains have the potential to be more integrated as they can move from project to project, driving efficiencies from the repetition of the processes. A structure that enables all of the main contractor (‘integrator’), designers and specialist contractors and manufacturers to work closely together and be aligned is desirable.

For the largest projects, enterprise models, such as Project 13 by the Institution of Civil Engineers (ICE), can be adopted. In enterprise and alliance models, the specification and rewards are outcomes-based so that success is measured on the overall, long-term outcome of the project rather than payment solely for service delivery. The client is also at the heart of the project, engaging with key suppliers and advisers and appointing an integrator to manage the project. These models allow key supply chain members to work as part of the project team, making joint decisions with a view to the project succeeding.

One issue that frequently arises in the alliancing context is whether the alliance members should be able to bring proceedings against each other if there is a breach of contract. ‘No claims’ clauses are often included in alliance contracts which exclude the ability to sue for issues which commonly lead to disputes such as cost and time overruns and defects. Disputes can only be brought for significant issues such as wilful default.

As decarbonisation becomes an increasingly important issue, parties must be able to work together to harness new technologies potentially before their technical capabilities and performance are fully established. The enterprise/alliance model will facilitate this innovation, rewarding success and not unduly penalising failure. No claims clauses, together with the growing acceptance from investors that not all risk and cost can be passed to the contractor, will also give parties the confidence to be innovative.

Engage and incentivise the supply chain

The starting point for any collaboration is early supply chain involvement. This can add significant value in the design stages – indeed, the optimum time for a contractor to become engaged is soon after the outline design stages. If the contractor’s engagement is made as soon as possible, the separation of design and construction is minimised and developing an integrated solution becomes easier.

The earlier the contractor is engaged, the more practical input there can be in relation to the strategic brief, investment target and the target cost, as well as the ability to reduce the risks associated with inaccurate project budgeting.

This needs to be wider than early engagement with the tier 1 contractor. Key elements of the supply chain below tier 1 should also be engaged. Suppliers and specialists in tier 2 and below can easily account for 70-80% of expenditure on a construction project, so the majority of the understanding and value can be gained from this early specialist engagement. The same, says Graeme Culliton, is true of manufacturers: these must be selected before the concept design develops, or many of the advantages of early engagement will be lost. Design cannot take place without the knowledge and input of the manufacturing process. Design needs to meet factory requirements.

Incentives should cascade through the supply chain where all parties are willing, with the idea being that those who assist in the pricing and successful delivery of the work also share in the benefits and there are common goals for the client, its advisers and throughout the supply chain. However, a realistic assessment of whether there is sufficient margin in the project to enable this, will need to be carried out.

The time and effort required for vertical alignment of project risks is underestimated as a challenge. Sophisticated clients will want to know the maturity of the supply chain, but there are issues and barriers which need to be addressed by main contractors before the supply chain can be fully aligned on a best for project basis.

One of the ways for the main contractor to collaborate with the most significant members of the supply chain is to create a limited number of preferred parties in specialist disciplines to assist the contractor on all its projects over a longer period. This type of long-term collaboration enables contractors to address the historic tendency to pass all risk through the supply chain: strong contractors retain rather than transfer certain risks, whilst commitment to long-term performance and delivery engenders trust.

As part of this alignment exercise, however, the risks borne by the main contractor and subcontractors should be properly reflected in each’s share of the reward.

Greater understanding is needed of the impact of ‘fee on fee’ models, where contractors use a company within the same group as a subcontractor to undertake specialist services. There is sometimes a perception that this generates additional profit for the main contractor, but this is not always the case: there is a distinction between the main contractor’s margin and the need for a specialist to price specialised pieces of equipment, for example, which can only be priced at the market rate.

Overhead works differently in specialist subcontractor businesses, which tend to be capital intensive and so need a higher rate of return than a main contractor that is generating substantial amounts of cash. For example, a tunnelling package may be priced with a higher margin than a general civil engineering package.

Regional challenges

Middle East

The shift to industrialisation comes with particular challenges in the Middle East, where there is a reluctance to change and innovate within the construction industry. However, this goes against a drive towards change from many governments in the region, which are keen to move away from the traditional reliance on hydrocarbons and diversify the economy and the jobs that go with it.

One area of traction for industrialised construction in the Middle East is in modern methods of construction (MMC), particularly in relation to housing. However, fully bringing in the ‘thinking’ side of this and the relevant contracts to support will take time.

Another challenge arises in the context of employment. Culturally, many industry-specific jobs in fields from hotels and retail to petrochemicals are held by ex-patriate workers. Governments are trying to change this, with various initiatives around localisation.

During procurement, the focus tends to be on achieving the lowest price rather than the best value for money – something which often prevents international contractors from bidding for work. As we have seen, improving design and change management requires investment, something that is just not happening in the region.

Western consultants advising clients in the Middle East tend to be reluctant to change the status quo due to bad experiences in the past, instead effectively coming in, earning their fees and leaving again. However, international expertise potentially has a hugely important role to play in embedding global best practices in relation to industrialised construction.

Asia Pacific

Similarly, collaboration is not really on the radar of clients and contractors in Asia, who are way behind the likes of the UK and Europe in terms of thinking in this area. Again, employers and their advisers are generally concerned with getting the lowest possible price – it is them who have to be the drivers of a change in mindset, rather than the contractors.

Where collaboration is taking place, this is being driven more by political circumstance than by specific forms of contract.

To encourage uptake among the major players in the region, it will be important to use language that clients and contractors understand: so less of a focus on “collaboration” in “industrialisation of construction” and more around “early contractor involvement” and “modern methods of construction”.

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