A Framework for the Comparison of Infrastructure Procurement Strategies

Transcription

1 A Framework for the Comparison of Infrastructure Procurement Strategies E. Witt Dept. of Building Production, Tallinn University of Technology, Tallinn Abstract: Infrastructure assets and the services derived from them are obtained through an ever increasing miscellany of procurement strategies and by a diverse range of both public and private sector organisations. To enable the comparison of different procurement arrangements, a common basis of assessment is required. This paper proposes a conceptual framework within which any infrastructure procurement strategy may be described. The framework is based on a consideration of the roles and responsibilities of each of the parties involved in any particular procurement arrangement which parties undertake which elements of the procurement process and how this affects the ownership of project risks. In addition to providing a tool for eliciting comparable data regarding infrastructure procurement and risk transfer, the framework is seen as contributing to the understanding of the relationship between procurement strategy and project risk allocation. Keywords: Infrastructure, procurement, risk 1. Introduction The availability and effective operation of a wide range of both economic infrastructure (roads, rail, water supply, etc.) and social infrastructure (schools, hospitals, etc.) are essential for modern society. (English and Guthrie, 2003) The underlying infrastructure assets are typically capital-intensive, built facilities obtained via a process which includes identifying requirements, designing a facility to meet the requirements and constructing it before yielding the asset s benefits to society through its operation. While this process has remained largely constant, its component elements (needs identification, design, construction, and so forth) have historically been undertaken by a variety of different actors (political, religious, military authorities, private and voluntary organisations, etc.) and in many combinations (for example, with design and construction undertaken separately or combined in a single package ). From the early 1900s, with the public sector largely in control of the provision and operation of infrastructure, the separation of the design, construction, operation and maintenance elements became common practice in many countries (so-called traditional procurement). Recent years, however, have seen renewed interest in integrated procurement routes as a means of faster and more efficient delivery (Pietroforte and Miller, 2002; OGC, 2007b; Egan, 1998). In parallel, increased government efforts to encourage private investment in infrastructure (as in public private partnerships (PPPs)) have stimulated a proliferation of procurement models to accommodate this. The relationship between the arrangement or packaging of the elements of the procurement process and the relative efficiencies of these arrangements has thus become increasingly topical. 217

2 1.1. The Procurement Strategy Risk Relationship Pitt et al. (2006) note, with particular reference to the UK Government s Private Finance Initiative, that the basis for procurement process selection must be value for money and that the most crucial element in achieving this is the optimum allocation and valuation of risk. The accepted principle that risk should be allocated to the party best able to manage it in the most cost effective manner seeks to ensure that not only are risk premiums minimised but also that incentives to perform efficiently are in place (European Commission, 2003). If we assume a public sector client bears overall responsibility for the provision and operation of an infrastructure asset, it appears logical that the more integrated the procurement arrangement, that is, the more elements of the procurement process which are packaged together and contracted out to the private sector, the greater the scope for risk transfer to the private sector. A simple, linear model of this relationship is offered by Smith (2003) as shown in Figure 1 (below). Degree of risk transference Government owned and operated and maintenance contract Degree of private sector responsibility Build-transferoperate Build-ownoperate-transfer Build-ownoperate Fig. 1. Relationship between Risk Transfer and the Packaging of Procurement Elements (Smith, 2003) However, such a model considers only a single private sector actor and incorporates an assumption of equivalent risk transfer. For example, a government may be expected to contract out the design and construction of an infrastructure asset to the private sector as well as award the operation and maintenance contract (in Figure 1) to a private firm thus involving at least two private sector entities. With regard to assuming a certain, common level of risk transfer, the precise terms of the operation and maintenance contract or the build-transfer-operate agreement, etc. would determine the actual extent of risk transfer to the private sector which could, conceivably, be minimal or (disproportionately) great. Despite these reservations, the notion that particular risks are associated with particular elements of the procurement process and that, by including additional elements in a contract package, additional risks can be transferred to the contractor, provides a convenient basis for comparing procurement arrangements and the value for money which they offer. 218

3 1.2. The Wider Research Context In attempting to determine the potential for infrastructure PPPs in Estonia, an initial survey of current procurement and operational practices employed by Estonian state and local government authorities is in progress. It is intended that the procedures currently in use will be compared and analysed with regard to their effectiveness, value for money and the risk transfer to the private sector which they entail. Since a complex range of possible current arrangements exists (as a consequence of the Soviet era legacy, neo-liberal reforms of the 1990s and European Union initiatives since its 2004 accession) a common basis for describing the procurement arrangements and relating these to risk allocation is called for. The relationship between procurement arrangement and risk transfer implied by Figure 1 raises the possibility that a framework based on: (1) which parties undertake which elements of a generic procurement process, and (2) what risks may consequently be transferable, may be formulated to provide this common basis. 2. The Procurement Process and its Elements Numerous generic procurement process models for built facilities and for services derived from built facilities are available from public authorities (e.g. OGC,2007a; OGC, 2007b; CIDB, 2007; ACT, 2003 ) and the academic literature (e.g. Ahadzi and Bowles, 2004; Pietroforte and Miller, 2002; Yeo and Ning, 2002). However, procurement processes elaborated by public agencies tend to reflect procurement policies specific to them and refer not only to procurement of the project but also, explicitly, to the procurement of design, construction, and other services within this overall procurement. For example, the process described by the UK Government s Office for Government Commerce (OGC, 2007a) accommodates early contractor involvement and framework agreements and both the OGC (2007a) and CIDB (2007) processes refer to lower level procurement of services as illustrated in Table 1 (below). The examples drawn from the academic literature provide a highly generalised procurement process (Yeo and Ning, 2002), the stages of PPP project procurement (Ahadzi and Bowles, 2004) and the life-phases of capital investment projects (Pietroforte and Miller, 2002). An attempt at correlating the steps of the processes illustrated in Table 1 has been made (by adjusting the vertical dimensions of table cells) but their incompatibility limits the effectiveness of such an exercise. However, an underlying sequence of elements is observable from the examples in Table 1 of the form: Needs identification => Concept / feasibility => Finance => Design => => => Maintenance => Decommission, and a procurement process for infrastructure assets and services derived from those assets would incorporate these elements. It is notable that such a sequence reflects the Yeo and Ning process stages of plan, make and deliver without source since source would tend to refer to a different level of procurement the procurement of design, construction and similar services rather than project-level procurement. By eliminating consideration of source any presumptions relating to who takes responsibility for which element of the sequence or the way in which elements are separated or packaged together may be avoided. 219

4 Table 1: Generic Procurement Processes OGC (2007a) CIDB (2007) Ahadzi and Bowles (2004) Pietroforte and Miller Yeo and Ning Possible need for project raised Identify business needs Options to meet business needs confirm project required Contract preparation Confirm arrangements with Integrated Supply Team (IST) or invite expressions of interest Tender process (procurement of new IST or agree terms under existing framework agreement) Award contract Outline design Prepare high level business case Project brief Feasibility study Procurement route and outline business case Output-based specification Detailed design Contract management Disposal Identify needs Document the brief Check the facts Secure the finance Understand the construction procurement regime Allocate risks Identify and implement procurement strategies, methods and techniques Monitor impacts Review the process Planning and feasibility Bidding and negotiation Transfer / renegotiation Planning Finance Design Maintenance and upgrading Replacement Plan Source Make Deliver The proposed sequence is neither necessarily comprehensive (elements may be missing) nor of a rigid order (for example, finance may be secured before outline design with most public sector projects but private finance would probably be arranged with the design at a more advanced stage of development). Rather it reflects an initial articulation of elements common to the process of infrastructure procurement in approximate sequence without presumption that any element will be undertaken by the client or by an external contractor, or that any particular packaging of elements will take place. 3. Risk Classification Systems Project risk classification systems tend to refer to both higher-level risks (e.g. country political, legal, commercial/macroeconomic and environmental risks) which affect all 220

5 commercial transactions in a particular location including those related to the project and project-level risks (technical, project finance, quality, etc.) specific to the project in question. (Refer to Table 2) In addition, Bing et al (2005) note the existence of micro-level risks (e.g. relationship risks) which, again, are common to all transactions within and without the project. Since both higher- and lower-level risks pervade all transactions we may accept that they are present within all elements of our procurement process and thus their allocation among parties is not a function of who undertakes which element. Only project-level risks may possibly be associated with particular elements of procurement and any attempt to make such associations must necessarily be confined to these. Table 2: Risk Classification Systems Bing et al (2005) Gibson et al (2003) Witt (1999) Macro Political & Commercial Business plan Global Environmental level risks government policy Macroeconomic Finance / Political funding Legal Country Tax / tariff Legal Social Political Commercial Natural Culture Other Meso Project selection Legal Elemental Technical level risks Project finance Facilities Project scope Quality Residual risks Sourcing and Financial supply Design Design / Physical engineering Logistical Start-up Communication Micro Relationship Production / People Administration level risks Third party s Legal Other Technical 4. Assigning Project-level Risks to Procurement Elements An attempt to arrange a selection of the (project-level) risk factors cited by three different sources into groups corresponding to particular elements of the procurement process identified above is shown in Table 3a (below). In addition, certain risk factors are clearly associated with the interfaces between the procurement elements rather than the elements themselves, for example, buildability or constructability risks relate to the interface between design and construction elements rather than either individual element. Selected risk factors corresponding to interfaces between elements are listed in Table 3b. Although no examples emerged from the classification exercise illustrated in Table 3b, it appears that risks could be associated with all interfaces between elements and not just the interfaces between consecutive elements in the process as risks corresponding to the interface between design and operation and that between construction and maintenance are certainly in existence. Table 3c contains risk factors generally applicable to all elements. Although not clearly labeled in their original source documents as such, these risks appear to fall into either the 221

6 higher-level risk (e.g. unproven engineering techniques) or lower-level risk (e.g. labour and equipment productivity) categories. Table 3a: Risk Factors Corresponding to Elements Bing et al (2005) Gibson et al (2003) Rahman and Kumaraswamy Concept / Feasibility Land acquisition (site Environment, health, and Physical impossibility availability) safety Legal impossibility Finance Availability of finance Design Design deficiency Design/engineering process Defective design cost overrun Logistics Unforeseen site conditions time delay delivery method method Poor quality workmanship Safety during construction Weather Low operating productivity al safety Maintenance costs higher than expected Maintenance FM and maintenance Table 3b: Risk Factors Corresponding to Interfaces between Elements Bing et al (2005) Gibson et al (2003) Rahman and Kumaraswamy Interface: Concept / Feasibility - Design Scope development process Change in scope of work Interface: Design - Late design changes Constructability Conflicts in documents Interface: - Facility turnover Interface: Maintenance Shutdowns and startups Table 3c: Risk Factors Applicable to All Elements Bing et al (2005) Gibson et al (2003) Rahman and Kumaraswamy Unproven engineering Contractor payment Financial failure of Client techniques Communication and data Financial failure of contractor Excessive contract variation transfer Public disorder With this selection of risk factors, a concentration on the construction element and a lack of identified risks at certain others (for instance decommissioning which, in some cases, e.g. for nuclear energy projects, is not risk free) is apparent. 222

7 5. Relating Procurement Arrangements to Risk Transfer By expressing the procurement process as a sequence of common elements, any procurement arrangement may then be described in terms of who takes responsibility for delivering each element. Since risk factors may be classified in accordance with these same elements and the interfaces between them, the corresponding scope for risk transfer may be determined. Thus, if a package of elements is allocated by a client organisation to an external contractor, we might assume that some or all of the risks associated with these elements and the interfaces between them would be best managed by the contractor and the client would therefore be in a position to transfer some or all of these risks to the contractor. Conversely, the transfer of risks associated with a particular element which is not included within the contractor s responsibility would not be efficient. It is important to note that we can only refer to the scope for risk transfer rather than determine which individual risk factors are allocated to a particular party as this depends not only on who is responsible for delivering the associated element in question but also the contractual relationship between the parties involved and the effectiveness of this relationship in transferring risk (Smith, 1995). Gao and Handley-Schachler (2004) draw attention to a number of constraints to achieving risk transfer including difficulties relating to the definition and quantification of risks and reluctance to accept transferred risk. Table 4 (below) illustrates an example of a procurement arrangement which involves a design and build contract with Contractor 1 and a separate maintenance contract with Contractor 2, the remaining elements of the procurement process being undertaken by the client organisation. (Responsibility for the delivery of an element is indicated with an ). Risks associated with those elements undertaken by the client and the interfaces between them are retained by the client while those associated with elements which are contracted out to a particular contractor and the corresponding interfaces may be transferred to that contractor or retained by the client. Where the risks associated with an interface between two elements contracted out to different contractors are concerned (for example the risks associated with the Maintenance interface shown in Table 4), there exists scope to transfer them to either contractor or for the client to retain them. (The scope for risk transfer is indicated by grey shading). For convenience, Table 4 shows only a selection of the interfaces between elements. Table 4: Design and Build - responsibility for delivery of specific procurement elements and scope for risk transfer Element Selected Interfaces Contractor 1 Client Contractor 2 Needs identification Concept / feasibility Finance Concept / feasibility - Design Design Design Maintenance - Maintenance Maintenance Decommission 223

8 6. Conclusions and Recommendations At an overall, project level, the procurement of infrastructure-based services tends to follow a standard process (of the form: needs identification - concept / feasibility finance design construction operation maintenance - decommission). By identifying the component elements of this process, any such procurement arrangement may be described in terms of which party takes responsibility for delivering each element. Project-level risks may also be classified according to the same set of fundamental elements so that, in conjunction with describing the procurement arrangement, the scope for (efficient) risk transfer between parties becomes apparent. However, actual risk allocation depends not only on who does what but the nature of the relationships between parties. Additionally, even where risk transfer is intended, it may not necessarily be achieved in practice so a full understanding of who carries what risks is not determinable on this basis. This conceptual framework for the classification of infrastructure procurement arrangements and the associated scope for risk transfer enables the elicitation of comparable procurement and risk data regarding current infrastructure procurement practice and, in this way, solves a current research problem. It provides fresh insight into the relationship between procurement arrangement and risk transfer which, rather than being simple and linear as implied by Figure 1, appears multidimensional and complex. Additionally, it presents an alternative system of risk classification. The framework was conceived in order to enable data collection within a survey of current infrastructure procurement practice. It is recommended that, in using it as a tool, it would be further developed. Consideration of additional factors, such as the nature of the relationships between parties, which affect risk allocation would further enrich the framework and lead to a more thorough understanding of the procurement arrangement / risk allocation relationship. References: ACT (2003), Implementing Private Provision of Public Infrastructure Projects in the ACT: Procurement Circular 2003/03, Australian Capital Territory Government Procurement Board, May A8C4A256D38007BBE6D (Accessed 20 th February 2008) Ahadzi, M and Bowles, G (2004), Public-private partnerships and contract negotiations: an empirical study, Management and Economics (November 2004) 22, pp Bing, L; Akintoye, A; Edwards, P.J; Hardcastle, C (2005), The allocation of risk in PPP/PFI construction projects in the UK, International Journal of Project Management, 23 (2005) pp CIDB (2007), Procuring Best Value in Works, Practice Note #4 May 2007, Industry Development Board, Government of South Africa, (Accessed 20 th February 2008) Egan, J (1998), Rethinking, Report of the Task Force, Department of Trade and Industry, HMSO, London 224

9 English, L.M and Guthrie, J (2003), Driving privately financed projects in Australia: what makes them tick?, Accounting, Auditing & Accountability Journal, Vol.16 No.3, 2003, pp European Commission (2003), Guidelines for Successful Public-Private Partnerships, Directorate General Regional Policy, Brussels (Accessed 20 February 2008) Gao, S and Handley-Schachler, M (2004), Public Bodies Perceptions on Risk Transfer in the UK s Private Finance Initiative, Journal of Finance and Management in Public Services, Vol.3, no.1, pp (Accessed 20 February 2008) Gibson, G.E; Walewski, J; Dudley, G (2003), Life Cycle Considerations to Optimize Risk Assessment and Management for International Projects, Proceedings of the Research Congress, March 19-21, 2003, Honolulu, Hawai OGC (2007a), Achieving Excellence in Procurement Guide: Project Procurement Lifecycle the Integrated Process, Office of Government Commerce, United Kingdom (Accessed 20 th February 2008) OGC (2007b), Achieving Excellence in Procurement Guide: Procurement and Contract Strategies, Office of Government Commerce, United Kingdom (Accessed 20 th February 2008) Pietroforte, R. and Miller, J.B. Procurement methods for US infrastructure: historical perspectives and recent trends, Building Research & Information 30(6) pp Pitt, M; Collins, N; Walls, A (2006) The Private Finance Initiative and Value for Money, Journal of Property Investment and Finance, Vol.24, No.4, pp Rahman, M.M; Kumaraswamy, M.M, Risk management trends in the construction industry: moving towards joint risk management, Engineering and Architectural Management, 2002 Vol. 9 Issue 2 pp Smith, A.L (2003), Public-private partnership projects in the USA: risks and opportunities, Public-private partnerships: Managing risks and opportunities, edited by Akintoye, A; Beck, M and Hardcastle, C; Glasgow Caledonian University, Blackwell Science, pp Smith, N.J (1995), Engineering Project Management, Blackwell Science, Oxford, p197 Witt, E (1999), Commercial Risk in a Portfolio of Projects, unpublished MSc dissertation, University of Manchester, Institute of Science and Technology, pp Yeo, K.T. and Ning, J.H. Integrating supply chain and critical chain concepts in engineer-procure-construct (EPC) projects, International Journal of Project Management, May 2002, Vol. 20 Issue 4, p