Managing contract risk
By Malcolm Abernethy
Executive Officer, NZ Contractors' Federation
When a tender is submitted the contractor accepts whatever risk associated with the project. Contracts generally allocate those risks to the party best able to manage them. In accepting or managing risk, the risks identified by the contracting parties will be reflected in the final cost of the project.
Risk management allows clients, consultants and contractors to identify, evaluate and analyse the risks associated with a project and then to manage those risks and their impacts on their business operations for the type and size of the project being tendered or constructed. Many risks can be eliminated or treated to reduce their effect both on construction and maintenance costs – whole of life costs.
Risk occurs due to many different factors from; investigation, design, unknown ground conditions, physical site characteristics, site location, design complexity, new materials and/or construction methods, climatic conditions, contract conditions and contract period (there may be others). Each of these risks can be managed to some extent when the project is conceived and through construction and on then for the life of the project.
Risks associated with unknown ground conditions can be mitigated by carrying out appropriate investigations to determine materials that are likely to be found. Ground condition may present some risk to the project no matter how thorough the investigation and design. Ground condition risk and its consequences in terms of cost and time are generally shared by the client and the contractor. There may be some risk to the consultant if it can be shown that investigations and design were not appropriate or thorough.
Physical site characteristics may include ground conditions that are easily
identified, e.g. swamp, tidal, steepness, access, boundary constraints etc. Site characteristics are easily identified by the client, consultant and the contractor. The client and consultant should allow for these risks when designing the project and the contractor should allow for the risk when inspecting the site before preparing the tender. With the risk identified design should mitigate the risk as will the contractors’ construction methods and programme. The tender price may reflect an element of risk in the rates being tendered.
When physical conditions are encountered that could not reasonably be foreseen by an experienced contractor a claim may result to cover the costs associated with mitigating the physical condition.
Design and technical complexity including new materials and construction methods risks may be compensated for within the tender price. Alternatively, contractors can further reduce their risk exposure by employing appropriate resources and developing innovative construction methods that may result in savings to the project.
Design and over all project risks can be reduced when clients change their drivers. Many projects are driven principally by cost which creates far reaching risk to the project during construction and through its economic life. The risks associated with making lowest initial price as the main driver when designing or constructing a project can result in a very low quality completed project. Lowest price is not the best price particularly when dealing with construction activities.
The NZ Transport Agency Procurement manual confirms this by including the concept of cost being an unreliable indicator of value for money. The manual then requires that contracts are procured based on whole of life costs.
When procurement focuses on lowest initial price then the outcomes for the project are lowest quality with potentially very high maintenance and/or operational costs.
Contractor Vol.33 No.10 November 2009
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