Incentive Based Compensation for Public Sector Construction Projects in India

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1 Incentive Based Compensation for Public Sector Construction Projects in India A. Rushi Nandan M.Tech (Construction Management) student, Department of Civil Engineering, Visvesvaraya National Institute of Technology, Nagpur, Maharashtra, India Abhay Tawalare Assistant Professor, Department of Civil Engineering, Visvesvaraya National Institute of Technology, Nagpur, Maharashtra, India Abstract: Poor performance against the time, cost and quality parameters is a major concern for construction industry in India especially that of public sector projects. To motivate the contractor for higher performance through incentive mechanism is a proven methodology worldwide. This paper aims to evaluate the effectiveness of incentive based compensation for completion of project within cost, within time and quality and to identify the adequacy of the present incentive system adopted by Indian public sector to motivate the contractor to complete the project within cost, within time and quality. The questionnaire survey is carried out in which 53 valid responses received against the 150 randomly selected respondents across various public sectors. The analysis is carried out by using software SPSS. The results confirm that 1) Use of incentives is an effective method for improved project performance. 2) Incentives motivate the contractor to complete the work within time, cost and quality. 3) If incentive is provided for implementing environmental norms can reduce environmental damages. 4) Indian public sector construction contracts are not providing adequate incentives for completing the work within time, cost and quality. 5) Lack of incentive mechanism is one of the reasons which are hampering the successful completion of public sector projects in India. Keywords: cost incentive, time incentive, public sector, construction industry, India 1. Introduction The Indian construction sector has acted as an engine of growth for the Indian economy for over the past five-decades and becoming a basic input for the socio-economic development of the country. Construction is the second largest economic activity following agriculture. India's GDP over the past five years is registering 8 to 10% growth per annum. The Indian public sector construction projects are facing schedule problems & cost over runs. The quarterly project implementation status report on Central Sector Projects (each costing Rs.20 crore and above) for the quarter April-June, 2009 covers 951 projects. It provides information on 112 mega projects (each costing Rs.1,000 crore and above), 499 major projects (each costing between Rs.100 crore and Rs crore ) and 340 medium projects (each costing between Rs.20 crore to Rs. 100 crore). The anticipated cost of these 951 projects is Rs. 6,07,188 crore. The total expenditure till was Rs. 2,43,431 crore, which is 40.09% of the total estimated cost. Against an approved outlay of Rs. 69,278 crore for , the expenditure incurred till June, 2009 is Rs. 23,601 crore. Major and Mega projects account for about 64.25% of the total number of projects and about 96.79% of the total anticipated cost. While the cost overruns due to general inflation cannot be avoided, the escalation on account of delays can be minimized (Ministry of Statistics and Program Implementation, Govt. of India). Regardless of the economic importance and employment generation of the sector, issues such as low productivity, limited mechanization and lack of professionally qualified employees plague the industry. While the importance of Indian construction sector over the past five years has grown significantly, lack of standardization across the construction supply chain is one of the key issues in the industry. Strong evidences of inconsistent performance of Indian construction projects have been witnessed in the recent past and the trend is growing rapidly. Projects are reportedly failing across all the key performance such as cost, time and quality performances (Doloi et al. 2012). The rewards and penalties have been a traditional old way to increase performance levels of contractors. To improve the performance level of the project, contractors are motivated by providing incentives along with penalties worldwide. Incentives play a crucial role in construction contracts. The role of incentives is to motivate the contractor to adopt the client s project objectives. Incentives > RJSSM: Volume: 04, Number: 11, March 2015 Page 103

2 include cost, quality, safety, and schedule. Incentives enable all parties to make a reasonable return, to bear appropriate risks and help to build a flexible system. Incentivization is used to achieve extra value-added services over those specified originally and which are of material benefit to the user. In India some of the Government departments provide incentive to the contractors. The Central Public Works Department (CPWD) and Bharat Sanchar Nigam Limited (BSNL) a government of India enterprise provide bonus if the contractor completes the work ahead of scheduled completion time, a 1% (one per cent) of the tendered value per month computed on per day basis, shall be payable to the contractor, subject to a maximum limit of 5% (five per cent) of the tendered value. However, till date no publication is available on performance achievement of incentive provided by these two departments. Similarly, what is the reason that other public sector organizations have not adopted such time incentive? Whether incentive mechanism is effective or not? Indian contract conditions motivate contractors by some other indirect ways? It is necessary to find the answer of these questions. Therefore, this research has two objectives. First one is to evaluate the effectiveness of incentive based compensation for completion of project within cost, within time and quality. Second one is to identify the adequacy of the present incentive system adopted by Indian public sector to motivate the contractor to complete the project within cost, within time and quality. 2 Literature Review 2.1 Types of Incentives Through literature review, following incentives have been identified which are being adopted by construction worldwide, Cost Incentives The aim of this arrangement is to motivate the contractor and client to work together to minimize actual costs, as the contractor is able to maximize their profit margin by sharing the benefits of reduced project cost, and the client is motivated to minimize the total cost paid out. Cost containment rewards are one of the most widely used forms of incentive and can be applied to either fixed price, or modified cost reimbursable (cost-plus) contracts, depending on how the incentive is structured (Rose and Manley, 2010). Cost incentives are generally thought of as a combination of an inducement and threat. With cost incentives, a target cost is agreed between both parties and under runs and overruns are shared according to an agreed formula this is a fixed-price incentive contract. The same principle applies for cost plus incentive fee contracts, but in this case, the fee is shared (Bower et al., 2002). Generally, under a cost plus incentive arrangement, the client s target cost is introduced into a reimbursable contract. It acts as the fulcrum where savings achieved below the target cost are split between the contractor and client based on a predetermined share profile (Rose and Manley, 2010) Schedule Based Incentives Schedule incentives have traditionally been those of threats or penalties. Bower et al. (2002) described schedule incentive as the premium paid to the contractor whenever the delivery is made earlier than a target date. This premium often becomes negative once the target date has been passed. They are designed to reward contractors for early completion of work at the same time to penalize them for late completion. Schedule incentives offer stakeholders a bonus for project completion earlier than the target dates. It is usually based on a predetermined amount paid for each day of early completion. It is closely linked to project costs, since time delays usually increase costs. Therefore, schedule incentives should be negotiated concurrently with cost incentives, as incentives encouraging early completion will reduce construction costs (Rose and Manley, 2010). Schedule incentives are especially applicable to projects for which a certain date of completion is critical. In such cases, early completion produces sizable savings for the owner and late completion results in significant costs (Abu-Hijleh and Ibbs, 1989) Technical Incentives Technical incentives as those tied to performance measures, other than cost and schedule. Typical measures include quality and safety performances of project. Safety bonus is provided to minimise the risk of accidents on the construction site as the direct and indirect cost of accidents to the contractor and client can be major. Similarly, quality performance bonus works on the premise that contractors are offered additional profit if they are able to achieve predetermined quality performance levels (Rose > RJSSM: Volume: 04, Number: 11, March 2015 Page 104

3 and Manley, 2005). Eriksson, (2013) mentioned about innovation bonus. The innovation bonus aimed to promote initiatives during early design that would create cost reductions during this or later phases. They may, however, cover any area of performance that a client wants to enhance. The basic principle is the same as with cost incentives. The contractor is offered a reward of additional profit if he achieves one or more specified levels of performance related to one or more performance elements of the specification (Bower et al., 2002). Technical performance incentives can be used in fixed price and cost-plus contract types but, depending on the project goals, have been argued to work best when used in cost-plus contracts. The main objective of this bonus incentive is to motivate the contract agent for exceeding minimum acceptable levels of technical performance. It is generally based on evaluations undertaken after performance has been achieved. Performance bonus incentives can be used to motivate the contract agents in many areas other than cost, which is usually more simply managed by the cost-plus incentive contract mechanism (Rose and Manley, 2010) Multiple Incentives Rose and Manley (2010) stated that Multiple Incentives are combination of cost-plus and performance incentive arrangements, are offered by clients occasionally. In this arrangement performance is measured on the cost savings made below a target cost combined with the achievement of set performance goals. This arrangement maximizes the opportunities to incentivize all areas of performance. Financial incentive mechanisms can be applied to either fixed price or cost reimbursable contract variations, depending on the incentives structure. Bower et al. (2002) explained that in a Multiple Incentive contract, the incentives should be balanced to reflect the client s priorities. A multiple incentive arrangement encourages the contractor to strive for outstanding results in all incentive areas. At the same time, during the course of the contract, if contractor realizes that he will not able to achieve targets, he is encouraged to take a trade-off decision, which is in the best interest of the customer. Combined incentives have proven complicated to administer but, proved fairly successful. 2.2 Purpose of Incentives Incentives play an encouraging role in construction contracts. The role of incentives is to motivate the contractor to adopt the client s project objectives. Some of the benefits that can be delivered by incentives in addition to those inherent in the base contract include, i. Lower cost, faster or more timely delivery of service with no compromise of quality (Bower et al., 2002). ii. Full understanding of the relationship cost, the quality of the service delivery, and the ability to deal more effectively with changes during the contract (Bower et al., 2002). iii. Increased service level, greater price stability, better utilization of services (Bower et al., 2002). iv. Enhanced achievement of the desired outcome, improved management of information (Bower et al., 2002). v. Improved management control and monitoring of contract deliverables along with improved customer satisfaction (Bower et al., 2002). vi. The use of incentives aligns the contractor s objective with the client s expectations in a project and ensures that contractors pay attention to the issues that are important for the client (Volker and Rose, 2012). vii. Construction Company, architect, engineer, project manager, and subcontractor can be motivated by the incentives of the incentive system to deviate from their actual uncooperative position to choose cooperative strategy (Schöttle and Gehbauer, 2012). viii. Schedule incentives in construction contracts can significantly reduce project duration and ix. produce substantial savings (Ibbs and Abu-Hijleh, 1989). Applicable especially to projects for which a certain date of completion is critical (Ibbs and Abu-Hijleh, 1989). 3. Research Methodology For this research, a questionnaire survey approach has been adopted. Prior development of questionnaire, literature review is carried out on two fronts. Firstly, the literature review is carried to identify the various incentives adopted by construction industry worldwide and what are the > RJSSM: Volume: 04, Number: 11, March 2015 Page 105

4 advantages and disadvantages of each type of incentive. Secondly, the contract documents of various public sector and government departments in India are reviewed to study the incentive system adopted by them. The questionnaire is developed on the basis of literature review and to test the two hypothesis (1) Incentive based compensation has a significant effect on completion of project within cost, within time and quality. (2) Present incentives in public sector construction in India are inadequate to motivate the contractor to complete the project within cost, within time and quality. The total 15 questions are designed. The first 8 questions are designed to test the first hypothesis and later 7 questions are designed to test the second hypothesis. A five point likert scale (1 strongly disagree, 2 Disagree, 3 Neutral feeling, 4 Agree and 5 strongly agree) is adopted where respondents are asked to mark their level of agreement to each question. The respondents are identified from the list of various public sector and government departments in construction sector in India and approached to give their views. The respondents belong to two categories. First category consists of senior officials from public sector and government departments hereafter called as client group. Second category consists of officials from contractor companies working for public sector and government departments hereafter called as contractor group. Total 150 respondents from all over the country, selected randomly and questionnaire is mailed to them through and hard copy. Few respondents are contacted personally and questionnaire is handed over to them, subsequently they sent back their responses through messenger. The questionnaire survey is conducted during February to April In total 53 valid responses obtained against the 150 respondents. The response rate is % which is quite satisfactory. The experience profile of all the respondents is shown in figure 1. Amongst the 53 respondents client group respondents are 24 i.e % and contractor group respondents are 29 i.e %. As the respondents are nearly equal among client and contractor group this removes the chances of biases in the result towards one particular group. The average experience of all the respondents is 13 years. Though the sample size is relatively small as compared to big size of construction industry in India, the quality of the responses should be considered highly reliable for analysis due to relevant industry experience of the respondents. Focus towards experienced personnel of construction industry gives reliable analysis though the sample size might be less. Moreover, statistical analysis could still be performed because in accordance with the generally accepted rule, the central limit theorem holds true when the sample size is no less than 30 (Ott & Longnecker 2001). 4. Data Analysis and Results Data was analyzed using the software STATISTICAL PACKAGE FOR SOCIAL SCIENCES (SPSS). The descriptive statistics such as mean and standard deviations of different groups of respondent s i.e client, contractor, and combined are calculated and tabulated in Table 1. To check the reliability of scale Cronbach s Alpha test is carried out at significance level of The Cronbach s Alpha value comes out which is greater than 0.5. This means the scale is moderately reliable. In order to find out whether different respondent groups have different perceptions on the relative importance of various questions, independent samples t- tests and ANOVA are carried out. The null hypothesis (H0) was that the corresponding two groups of respondents (Client group & contractor group) have the same perceptions toward all the questions i.e. both group means are equal. It is decided that if p < 0.05 then accept (H1) and reject (H0). The independent samples t- tests is carried out at 95% confidence level. The significance value comes out which is greater than Similar finding are also found for analysis of variance (ANOVA), which is carried out at 95% confidence level. The significance value comes out which is greater than This means null hypothesis cannot be > RJSSM: Volume: 04, Number: 11, March 2015 Page 106

5 rejected; there is significant agreement in the perception among contractor and client group. To decide the level of agreement among contractor group and client group Pearson correlation test is carried out. The correlation coefficient comes out This suggests strong correlation between client group and contractor group. Table1. Descriptive statistic for the client group, contractor group and combined group S.No. Questions 1 Use of incentives is an effective method for improved project performance. 2 Incentives motivate the contractor to complete the work within time, cost & quality. 3 Monitory benefits through incentives can compel the contractor to align his objectives with client for successful project. 4 Contractor can complete the work on schedule if incentive is provided for completion of work within time. 5 Contractor can complete the work within tendered cost if incentive is provided for completion of work within cost. 6 Contractor motivated for quality work if incentive is provided for quality of construction. 7 Contractor maintains safe working environment if incentive is provided for safety. 8 If incentive is provided for implementing environmental norms can reduce environmental damages. 9 Indian public sector construction contracts emphasis more on penalties and less on incentives. 10 Indian public sector construction contracts provide adequate incentives for quality of work. 11 Indian public sector construction contracts provide adequate incentives for safety at work. 12 Indian public sector construction contracts provide adequate incentives for completion of work within schedule. 13 Indian public sector construction contracts provide adequate incentives for completion of work within tendered cost. 14 Incentives provided in public sector construction contract are inadequate to motivate the contractor. Client group Contractor group Combined group µ S.D. µ S.D µ S.D Lack of incentive mechanism is one of the reasons which are hampering the successful completion of public sector projects in India The results showed the first hypothesis i.e. incentive based compensation has a significant effect on completion of project within cost, within time and quality cannot be rejected. The client group, contractor group and combined group have strong agreement over two issues that use of incentives is an effective method for improved project performance; Incentives motivate the contractor to complete the work within time, cost & quality. They have agreement over the issues such as contractor can > RJSSM: Volume: 04, Number: 11, March 2015 Page 107

6 complete the work within tendered cost if incentive is provided for completion of work within cost and contractor motivated for quality work if incentive is provided for quality of construction. Similarly, all the respondents agreed that if incentive is provided for implementing environmental norms can reduce environmental damages. But at the same time the respondents have neutral feelings on the issues like monitory benefits through incentives can compel the contractor to align his objectives with client for successful project and contractor maintains safe working environment if incentive is provided for safety. Similarly, second hypothesis i.e. present incentives in public sector construction in India are inadequate to motivate the contractor to complete the project within cost, within time and quality cannot be rejected. The client group, contractor group and combined group have strong agreement that lack of incentive mechanism is one of the reasons which are hampering the successful completion of public sector projects in India. At the same time they have strong disagreement that Indian public sector construction contracts provide adequate incentives for quality of work, safety at work and completion of work within schedule. But, they have neutral feelings towards the issues like Indian public sector construction contracts emphasis more on penalties and less on incentives and construction contracts provide adequate incentives for completion of work within tendered cost. 5. Conclusions Through literature review, this paper identified four types of incentives i.e. cost incentive, schedule based incentive, technical incentive and multiple incentives being adopted in construction industry worldwide. Paper also discusses the purpose of incentives, which will be useful to adopt proper incentive type according to client s need. The aim of the research is to evaluate the effectiveness of incentive based compensation for completion of project within cost, within time and quality and to identify the adequacy of the present incentive system adopted by Indian public sector to motivate the contractor to complete the project within cost, within time and quality. From the data analysis, it is found that 1) Use of incentives is an effective method for improved project performance. 2) Incentives motivate the contractor to complete the work within time, cost and quality. 3) If incentive is provided for implementing environmental norms can reduce environmental damages. 4) Indian public sector construction contracts are not providing adequate incentives for completing the work within time, cost and quality. 5) Lack of incentive mechanism is one of the reasons which are hampering the successful completion of public sector projects in India. However, this research is having limitations that the conclusions are based on the analysis of only 53 valid responses. The numbers of respondents are few as compared to size of Indian construction industry. References 1. Bubshait A.A. (2003). Incentive/ dis-incentive contracts and its effects on industrial projects. International Journal of Project Management, (21), pp Bower D., Ashby G., Gerald K., and Smyk W. (2002). Incentive Mechanisms for Project Success. Journal of Management in Engineering, (18) pp Doloi, H., Sawhney, A., Iyer, K. C., and Rentala, S. (2012). "Analysing factors affecting delays in Indian construction projects." International Journal of Project Management, (30), pp Eriksson T. (2013). Designing and implementing incentives for engineering consultants- Bonuses for cooperation and innovation in the west link project, Engineering project organization conference, pp Ibbs W. and Abu-Hijleh S.F. (1989), Schedule-based construction incentives, Journal of Construction Engineering and Management, pp Ministry of Statistics and Program Implementation (2009), "Project Implementation Status Report of Central Sector Projects Costing Rs.150 crore & above. Government of India, New Delhi. 7. Ott R.L. and Longnecker M. (2001). An Introduction to statistical methods and data analysis, Duxbury, Pacific Grave. > RJSSM: Volume: 04, Number: 11, March 2015 Page 108

7 8. Rose, T.M. and Manley, K.(2010). Financial incentives and advanced construction procurement systems. Project Management Journal, Volume 41, Issue 1, pp Rose T.M. and Manley K. (2005). A conceptual framework to investigate the optimization of financial incentive mechanisms in construction projects. International Symposium on Procurement Systems. The Impact of Cultural Differences and Systems on Construction Performance February 7th 10th; Rose M.T. and Manley K. (2011). An integrated framework to assess financial reward systems in construction projects, Engineering Projects Organization Conference, The Engineering Project Organization Society (EPOS), pp Schöttle A. and Gehbauer F. (2012), Incentive systems to support collaboration in construction projects, Proceedings for the 20 th annual conference of the International group for Lean construction. 12. Volker L. and Rose T.M. (2012), Incentive mechanisms in infrastructure Projects: A casebased comparison between Australia and the Netherlands, In Working Paper Series, Proceedings of the 2012 Engineering Project Organizations Conference - Global Collaboration, University of Colorado, Rheden, The Netherlands, pp > RJSSM: Volume: 04, Number: 11, March 2015 Page 109