The core lesson of the National Audit Office report on cost and time overruns on infrastructure projects
The National Audit Office has issued a report looking at cost and time overruns on higher‑value construction projects. Some who read Managing Infrastructure Projects on Nuclear-regulated Sites will simply ignore the report, asserting that it does not apply to the building sector but is limited to the highly regulated and highly technical nuclear sector. Other readers will grasp the opportunity and want to understand what the report has concluded and what it tells us about mitigating cost and time overruns. Reader fatigue is not surprising when one recalls the various “concepts” canvassed over the years to counter cost and time overruns: early contractor involvement; partnering and alliancing, target cost contracting, hybrid contracting.
This report from the NAO is excellent, not least because it has identified one specific issue that needs to be properly understood before the aforementioned concepts can ever be successful. “The economy, stupid” – usually misquoted as “it’s the economy, stupid” – is a phrase coined by James Carville in 1992 for Bill Clinton’s successful presidential campaign. In the present discussion, the phrase “it’s the design, stupid” is perfect.
What’s the big deal with design?
The NAO found that on the three projects it reviewed there was a £1.35bn cost overrun (an increase of 115%), of which £647m arose because construction was started too early. The report states: “The department has experienced similar challenges to those identified during its last cycle of nuclear-regulated site investment in the 1980s and 1990s. These include starting to build before requirements or designs were sufficiently mature, increasing risks through inappropriate contracts, and failing to engage with regulators to understand requirements.” So what’s the big deal with design?
The report found that in practice less developed designs mean employers or owners are more likely to hold more of the contractual risks and that the inherent uncertainties of early designs do not incentivise contractors, or their subcontractors, to negotiate and share risks, thus increasing risks for employer.
The risks are further increased when building is started before the design is mature. What this means is that those concepts discussed above, designed to place the design risk on the contractor, do not really work and certainly do not meet the textbook paradigms that the contractor possessed of significant design expertise is readily incentivised to innovate and value-engineer to the benefit of both the employer and the contractor.
Making later changes can often be costlier and more time-consuming than earlier in the process
NAO report, paragraph 3.16
Paragraph 3.16 in the report is key: “Constructing buildings before finalising requirements or developing detailed designs increases the likelihood of later changes. As we have seen, making later changes can often be costlier and more time-consuming than earlier in the process. For each of the three programmes in our review, the department approved the start of construction either before the facility requirements were fully understood or the designs were sufficiently mature. As we highlighted in part one, this has led to almost half of the cost increases for the projects we reviewed, explaining some 48% of the £1.35bn increase.”
Standing back a little, what the report is telling us is that a deeper understanding of the design and the level of maturity in the design are fundamental to setting a target cost, or to soliciting a fixed price and to commencing the construction phase. Put another way, employers ought to think whether it is more appropriate to separate out the design and construction in order to get a fixed price for the construction phase.
[The NAO report suggests that] the duration of the design phase ought to be increased relative to current practice
Further, if some aspects of the design cannot be advanced without contractor involvement or some enabling works, then perhaps a cost reimbursable approach ought to be used for that specific scope of work.
Some readers may take the view that single-point responsibility is the key (and especially so in the context of commercial development for institutional investors), which requires the design risk to shift to the contractor. Others may take the view that two-stage tendering is better because agreeing a price takes place only when the design has reached a sensible level of maturity.
The NAO report is nuanced and the subtle messaging for the wider building and construction industry is, firstly, that there should be greater awareness, assessment and obsession with the design phase relative to current practice and, secondly, that the duration of the design phase ought to be increased relative to current practice. These are provocative propositions but ones that place design at the centre of the construction procurement process.
Hamish Lal is a partner in Akin Gump Strauss Hauer & Feld