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Cost assurance on infrastructure projects

  • United Kingdom
  • Construction and engineering

25-07-2022

In the current economic climate cost assurance is more important than ever.  There have been sharp increases in the baseline cost of projects, sometimes up to three times more than comparative projects in recent years.  Parties are well experienced in managing cost escalation on projects (where the cost increases once the contract has commenced).  However, when this is compounded with vast increases in other costs due to supply issues and labour demands, there is a pressing need in the industry to adapt and respond to these changes.  Having cost assurance protects the financial viability of a project, instils investors with confidence to finance the works and, in instances where disputes cannot be altogether circumvented, provides transparency and knowledge to facilitate early resolution.

On 8 July, the construction disputes team hosted a multi-disciplinary conference in association with CFBL Consulting, CICES and Turner & Townsend. Eversheds is a member of an industry-wide multidisciplinary steering group comprising a diverse group of industry experts and professionals with the vision of enabling all infrastructure projects and businesses to optimise cost, profit and strategy sustainability.

The conference pulled together the findings of key outputs produced by the steering group over the last three years.  These key outputs are:

  1. developing a proactive risk based methodology
  2. people competencies and team capabilities
  3. utilising technology and innovation
  4. value of upfront investment and insight provided
  5. open book culture
  6. role of technology in reducing dispute burden
  7. cost assurance in mitigating cost/revenue risks
  8. importance of processes and protocols.

The conference focused on (i) the future of assurance; and (ii) the future of construction.   Some common themes emerged within the conference on how cost assurance can be achieved:

  1. Cost reimbursable and target cost contracts

Parties may want to consider how the pricing of the works can be best managed to facilitate better cost efficiencies. A cost reimbursable contract allows a contractor to be paid its actual cost, sometimes with an agreed percentage uplift for profit. This option can be useful where the full project scope is unknown at the contracting stage, the client and contractor have a long established relationship, are both experienced in the delivery of such projects, and can work together to collaboratively manage the pricing of the works. An alternative is a target cost contract, whereby a base cost is established and the contractor is incentivised to save costs where possible. The contractor shares in any price savings that are made, but also shares in any losses sustained, by way of an agreed methodology.  This encourages the contractor to make suggestions on how price savings may be achieved and to avoid cost overruns. Such pricing mechanisms are transparent, flexible, and utilise the experience of the employer and contractor from similar jobs.  They avoid using traditional measures, where a cautious contractor may over-price its initial cost in order to cater for any perceived risks, which may not arise in practice.

  1. Alliance contracts

There has been an increase in the use of alliance contracts whereby parties work together to promote greater co-operation, communication, and cost savings.  This can be achieved in two ways.  The parties may have separate contracts, like in a traditional design and build arrangement, but these contracts are overlaid with increased collaboration obligations so that the parties work together towards common aims and objectives.  For example on a NEC contract this could be achieved by including the partnering obligations in X12 and introducing standardised KPIs. Alternatively the parties may have greater integration whereby they are all included within a single contract and work together as one.  Alliancing has become more popular due to the fact that risk is shared collectively across the whole project team.  This minimises the impact felt by one party and also incentivises the parties to work together to mitigate the effects of any difficulties encountered. These arrangements have also been praised for promoting a “no blame” culture, so that any disputes are dealt with proactively and efficiently, without incurring additional time and costs. The Alliance contract requires complex governance protocols as the alliance team signs up to a single set of terms that include shared rewards and risks of the success or failure of the project.

  1. Identifying and managing risk

A continued theme in managing cost is a clearly communicated strategy and risk-based methodology to identify and manage cost risk.  The ability to do this comes from experience.  At present there are some difficulties in making sure that the current labour market has the necessary skills and knowledge to be able to proactively respond to these issues. Upskilling staff, putting in place appropriate management cascades, and making sure that each person has clarity on their role and responsibilities are really important.  This can ensure that the individuals working on projects have the expertise to respond to issues in real time and reduce their potential cost.

  1. Open book accounting

Open book accounting is where a contractor keeps transparent records of the costs it incurs.  This can include the number of hours worked, cost of materials, head office costs and overhead costs.  This promotes discussions on what costs can be adjusted or redeployed to allow a global budget to be maintained as far as possible. For example, when considering the cost of insurance, there may be other ways in which such insurance can be procured or shared between the parties to achieve cost savings.  As well as facilitating the ability to operate on a reimbursable or target cost contract, it also promotes greater accountability, trust and co-operation between the employer and contractor.

  1. Independent cost assurance

Before commencement of a project it might be worthwhile engaging cost assurance services from a qualified professional.  Such services provide an independent opinion on the commercial, financial, contractual controls and data management of a project.  This could include matters such as the auditing of accounts or an evaluation of the interpretation of the contract. This promotes confidence for external stakeholders who may be investing in the project. It is also a sign of good financial governance, as the parties can demonstrate compliance and accountability with agreed processes.

  1. Data analytics

A key component in assessing costs and anticipating any overruns is to ensure that there is good data analytics in a project.  Access to this type of information can identify key trends, spot issues before they arise, and provide explanations on where things go wrong to avoid repetition. The collection and analysis of such data requires appropriate technology.  This requires financial outlay, upskilling of staff, and changes to everyday working practices.  There are also issues in preserving the confidentiality and security of such data and ensuring that the technology remains relevant and up to date.  However, the returns on such investment offer perhaps the most tangible benefit towards cost assurance.  Having real time data helps with project management and avoiding disputes by promoting communication, strengthening relationships, and encouraging the proactive avoidance and management of any potential risks as they arise. 

  1. Horizon scanning

Through strategic polls and Q&As conducted during the conference, it became clear that the future of cost assurance on construction and infrastructure projects needs to take account of more than just the rising cost of materials, supply chain availability and a move towards alliancing and collaborative risk-sharing. Other key themes for the future included: (i) managing sustainability obligations (in particular carbon offsetting); (ii) establishing best practice across non-cost aspects of the project (including ESG and legal) adopting a standardised approach; and (iii) identifying and best utilising technology across all aspects of the project.

As we continue to work in challenging economic times, construction professionals are going to have to be more creative and inventive in how they manage risk.  Established practices may no longer be sufficient to create the cost certainty that parties require.  Higher standards of cost assurance are required, as there is less flexibility in being able to accommodate price overruns. Upskilling and adoption of these increasingly popular methods may help in fulfilling the need for providing economical and important infrastructure services.