Pricing out risk in procurement processes.

There are enthusiastic announcements everywhere that the economy is picking up and the crisis is over. This news has resulted in an unprecedented demand for building production: "If you still want to move, now is the time, interest rates are low and you can get rid of your own house in no time" is heard at every birthday party. Of course, all players in the construction process benefit from this positive trend. However, what is often forgotten is that there is also a downside. Consider, for example, the following developments:

• the increasing number of procurement failures;
• rising construction costs;
• the shortage of good and affordable staff;
• the increasing number of completion points;
• the difficulty of maintaining long-term contracts (contingencies);
• the increasing demand for (working) capital;
• liquidity needs due to rising construction costs and pre-financing of work in progress;
• delay and mounting costs due to objections to granted permit.

This article will discuss the increasing number of procurement failures, often due to rising construction costs.

Museum Arnhem tender fails

Prior to tendering for a construction project, clients usually have a clear picture in their minds: the building to be constructed must look a certain way, the budget is fixed and the process must go smoothly. Things often turn out differently during the tendering process: the design is not feasible, the budget is insufficient and the planning is unrealistic. The result: many questions during the information rounds and few or no tenders. Both the client and the contractors feel short-changed. Contractors feel they are being squeezed out and the client feels that he is still paying too much. If the project goes ahead at all, a new "fighting project" is born.

A striking example is the tender for the renovation of the Museum Arnhem. After a European tender, Benthem Crouwel Architects' design was selected by the jury in June 2016. The Municipality of Arnhem then issued a tender to find executing parties to realize the design. By the tender deadline, it turned out that only one contractor was willing to perform the architectural specifications, there was one valid tender for the mechanical specifications and two valid tenders for the electrical specifications. The tender budgets were also on average 75% above the municipality's estimate. This made the municipality of Arnhem decide to withdraw the tender. A drastic political decision in which there are really only losers.

It follows from the evaluation of the Municipality of Arnhem that the tender failed in part because the draft budget was overly optimistic and there were substantial overall price and labor cost increases. It follows from the law and common general conditions that it is possible to pass on rising construction costs to clients. This will be discussed in another article. It also follows from the municipality of Arnhem's evaluation that the contractors saw major risks in the project and discounted those risks. In the public council letter from the college dated May 15, 2018, the municipality seems to blame the contractors for this. But is this justified?

Pricing of risk

Risk is discounted when there is uncertainty. Examples include incomplete information, a very ambitious design, tight deadlines or unilateral contract terms. During the tender phase, a contractor often cannot exert any influence to manage risks. He can of course ask questions, but usually this does not lead to a serious response from the contracting authority. This is also because there is often no room built into the planning of procurement procedures to add additional studies. Given the high demand for construction projects, when uncertain, a contractor will either charge a higher risk margin or choose not to bid. For clients, both options are disadvantageous.

To avoid failed tenders, clients could simply make more budget available. However, the question is whether clients would not be selling themselves short in doing so. A client could also choose to conduct a comprehensive risk analysis. After mapping out the risks, the client can draw up a balanced risk distribution. Risks over which the principal can exert his own influence can then be kept to himself or removed by taking control measures. For example, consider the situation in which the client discovers that little information is available about soil conditions. The client can simply 'contract away' this risk, but will probably be much cheaper if he commissions additional research prior to or during the tendering procedure.

Conclusion

Clearly, construction is currently benefiting from the growing economy. Construction plans that were on the shelf for years are now being dusted off and put out to tender. This has many positive effects, but also some negative side effects.

It must be prevented that companies that were able to keep their heads above water during the crisis still fail due to the aforementioned negative effects of economic growth. An example of this is the bankruptcy of Bouwgroep Moonen, which is still causing a stir. It is therefore good for all players in the construction process to be aware of current developments in the construction industry so that disappointments and conflicts can be avoided.

This article has focused on discounting risk in procurement processes. The attorneys branch team Construction will keep you informed about other effects of economic growth on construction through various channels and from different perspectives in the coming period.