7 Risk allocation and

procurement decisions

The purpose of this Chapter is to outline the major areas of risk in construction
projects. We shall also examine some of the methods of dealing with these risks.
The apportionment of risk leads to a consideration of contract structure and
procurement strategy including the important issue of deciding which form of
contract to use.

7.1 TYPES OF RISK IN CONSTRUCTION CONTRACTS

In Chapter 1 we considered the nature of risk. Here we detail the particular types of
risk that are of interest in construction projects. Any construction project by its
very nature involves unavoidable risks of various kinds. These have occasionally
been analysed and classified, but such analyses are all too infrequent. Typically,
the wide spectrum of risks is reduced to a handful of broad categories, such as
time, cost, performance/quality, health and safety and perhaps environmental risk.
The following examples summarize many of the risks (based on Abrahamson
1984, Bunni 1985).
x Management, direction and supervision: greed; incompetence;
inefficiency; partiality; unreasonableness; poor communication; mistakes in
documents; defective designs; inadequate briefing, consultation or
identification of stakeholders; compliance with statutory requirements;
unclear requirements; inappropriate choice of consultants or contractors;
changes in requirements.
x Physical works: ground conditions; artificial obstructions; weather;
defective materials or workmanship; tests and samples; site preparation;
inadequacy of staff, labour, plant, materials, time or finance.
x Delay and disputes: possession of site; late supply of information;
inefficient execution of work; delay outside both parties’ control; layout
disputes.
x Damage and injury to persons and property: negligence or breach of
warranty; uninsurable matters; accidents; uninsurable risks; consequential
losses; exclusions, gaps and time limits in insurance cover.
x External factors: environmental regulation; government policy on taxes,
labour, safety or other laws; planning approvals; financial constraints;
energy or pay restraints; cost of war or civil commotion; malicious damage;
intimidation; industrial disputes.
x Payment: delay in settling claims and certifying; delay in payment; legal
limits on recovery of interest; insolvency; funding constraints; shortcomings
in the measure and value process; exchange rates; inflation.
94 Construction contracts

x Law and arbitration: delay in resolving disputes; injustice; uncertainty

due to poor records or ambiguous contract; cost of obtaining decision;
enforcing decisions; changes in statutes; new interpretations of common
law.
In examining this list of items, it is important to consider the extent to which
they can be priced for at tender stage, and indeed the extent to which they can be
predicted at all. However, empirical research has shown that, in practice,
contractors do not actually seem to carry out systematic analyses when preparing
tenders for their routine workload (Laryea and Hughes 2011).
Some things may be extremely unlikely to occur; others may be likely to occur
but difficult to specify accurately. These factors should have a significant effect on
responses to different risks. Extensive research has been undertaken in this area
and it has been shown that the development of an adequate contract strategy must
be based upon choices about how to respond to risks (Smith et al. 2006). Each risk
may be amenable to analysis regarding its likely range of outcomes. Responses to
the risks can then be chosen. Indeed, there is widespread practice in the
construction industry to compile ‘risk registers’. These are commonly seen as good
practice. They involve listing out the kinds of risk that may be encountered,
allocating a probability (statistical of qualitative) and an estimate of the magnitude
(in money terms or qualitative). If probability and magnitude are numerical, then
multiplying one by the other will indicate the relative importance or a ‘risk score’.
A risk register will also identify what steps can/should be taken to mitigate the
phenomena and what kind of contingency action might be used to deal with it,
should it occur. It is common to identify who should take such actions and when.
While these risk registers are a part of professional practice, there is a tendency for
their use to be accepted uncritically. However, the discussion earlier in this book
(Section 1.3.1) about the frequency with which someone engages with a risk seems
to have no place in a risk register. Moreover, as Drummond (2011) discusses, one
danger of the use of risk registers is that they cannot eliminate surprises. Rather,
they provide only an illusion of control. Indeed, it is likely that a contractor will
only include those items that are not specifically allocated already in the contract.
In this sense, at least in an NEC contract, the risk register may be little more than a
communication tool from the contractor to the project manager, in order to advise
the project manager about residual risks that are not clearly allocated by the
contract. If this happens, then the risk register may end up as a list of those risks
about which there is no agreement on who is responsible. Such a register would not
fulfil the aims of recording how risks are allocated or how they will be managed. It
is likely that in practice, such a register would only contain low frequency, high
value risks. For these reasons, risk registers in practice may not fulfil their promise.

7.2 DEALING WITH RISK

There is a common misconception that everyone wishes to avoid risk, known as

risk-aversion. Uncertainty is indeed a problem but it must be remembered that the
aim of engaging in construction is to take calculated risks. The life-blood of any
business is to make money by dealing with the risks that others do not want to
bear. Therefore, rather than shy away from them, we should make risks explicit so
 Risk allocation and procurement decisions 95

that rational commercial decisions can be taken about who should bear them.
Indeed, as pointed out in Section 1.3.1, by taking on multiple risks, probabilistic
uncertainties become less uncertain.
Understanding this point helps construction consultants to advise their clients
about risk allocation. The aim of contract choice should always be to distribute risk
clearly and unambiguously. Unfortunately, and historically, there has been a
general failure within the construction sector to appreciate this and the results of
this failure were seen in excessive claims and litigious disputes.
In line with the practice of risk registers, the process of dealing with contractual
risk falls into three stages:
1. Identify the risks: The list given at the beginning of the Chapter
exemplifies the types of risk that may occur. This is a useful preliminary
checklist for promoting discussion about those risks that may be important
on a project. Identification of risk must be linked to a clear statement of the
client’s priorities for a project. For example, if the timing of the project is
critical, the severity of time-related risks is automatically increased.
2. Analyse the risks: The second step in the process is to analyse each of the
risks, in terms of likely probability of occurrence, frequency with which the
risk is engaged with, likely severity of impact and the range of possible
values in terms of minima, maxima and medians for each of these aspects.
This may be fairly subjective so that it can be done quickly but is an
important step in raising awareness about risk exposure. Some risks may be
deemed to be so critical that they need detailed quantitative analysis but
most risks are dealt with more subjectively because they have lower
priority. A note of caution should be sounded in relation to analysing risks.
There is a routine and habitual tendency among those who appraise projects
to be over-optimistic about risks and costs (HM Treasury 2003). Indeed,
were it not for this tendency to optimism, many projects would never get off
the ground. The effect of this ‘optimism bias’, though, is that risks, costs
and programmes are often underestimated.
3. Respond to the risk: A suggested range of possible responses in terms of
contractual responses is discussed below. In terms of identifying a contract
strategy, the previous steps will provide an insight into the priorities of the
client and the major risks involved. The final step is to decide who is best
placed to manage a risk. The choices lie between employer, consultants,
contractor or insurers. Any decision about laying off risks to others must
involve weighing up the frequency of occurrence against the level of
premium being paid for the transfer (see Section 1.3.1). It is also important
to consider the extent to which a risk can be controlled by certain parties.
For example, risks connected with the design of the project are best
controlled by designers; hence liability for defective design is usually
allocated to them. For this reason, different procurement options allocate the
risks associated with sub-contractors, for example, in different ways.
This discussion should make it clear that any arguments about whether one
standard-form contract, or one procurement system, is ‘better’ than another are
specious. Each has a role to play in certain circumstances and the consultant who
habitually recommends one over another, without identifying and analysing the
96 Construction contracts

attendant risks, is hardly acting with that degree of skill and care which the client is
entitled to expect.
We may now consider in more detail the range of possible responses to
contractual risks. The choice lies between transfer, acceptance, avoidance or
insurance of risk or even, perhaps, doing nothing.

7.2.1 Transfer of risk

Risks are inevitable and cannot be eliminated. They can, however, be transferred.
In accordance with the basic general principle given in Section 1.3.2, the transfer
of a risk should usually involve a premium. Because of this, it is unwise to try to
burden other parties with risks that are difficult to manage.
The transfer of risk is achieved through appropriate wording in the clauses of a
contract. It is absolutely fundamental to any study of building contracts to
understand that contractual clauses are intended to allocate risks. To appreciate the
extent to which they transfer risks, it is necessary to understand what the legal
situation would be with and without the relevant clauses. This is a basic aim of this
book and it is intended that the reader should develop an understanding of the
transfer of risk by studying it.
As a general principle, it is unwise for the employer to try to pass to the
contractor a risk that is difficult to assess. Conscientious and skilled contractors
will increase their prices to deal with them or they may insert qualifications in their
bids to avoid them. Unscrupulous or careless contractors will disregard these risks
when preparing their bid and may then find themselves in difficulty at a later stage.
Once this happens, they may try to pass the cost back to the employer. If this fails,
they may even be forced into liquidation, which will not help the employer at all.

7.2.2 Acceptance of risk

Clients should avoid imposing undue or unbalanced risks on to contractors. It is not

good business practice to try to steal an advantage over the other party in this way.
It may be possible in the short term to lay off a risk on to someone else without
having to pay a premium for it. In the long term, however, someone will have to
pay. Therefore, if one continues to indulge in unbalanced contracts, eventually the
worst will happen and the unwilling bearers of the risk will probably be sent out of
business. When this happens, it is their creditors who pay the price and the
employer may be one of those creditors. In the long term, this process of shifting
too much risk on to contractors who must accept it in order to stay in business will
gradually reduce the available number of contractors tendering for work. All their
competitors will have been put out of business.
There are many risks that should lie with the employer. If none of the project
participants can control or mitigate a particular risk, it is unwise to assign that risk
to them. Any explicit transfer may carry a huge premium. Similarly, a client who
repeatedly engages in building procurement is wasting money by paying a
premium for people to take on risks that need not be passed on (see Section 1.3.1).
It makes sense for the employer to also carry highly unpredictable and poorly
 Risk allocation and procurement decisions 97

defined risks because the alternative may be tenders that are so inflated as to be
unacceptable. Examples of such risks are those associated with war, earthquakes
and invasions, which would be impossible to quantify or predict.
The principle that contractual risk can be off-set by including a premium in the
price is widely understood and accepted. However, Shash (1993) has discovered
that although the risk profile of a project may influence a contractor’s mark-up it
does not seem to affect a contractor’s willingness to bid. Even more surprising was
the finding of Laryea and Hughes (2011), where it appeared that in the preparation
of bids for construction work, estimators do not consider whether operational risks
might impact their price. Another problem with building up a contingency based
on an analysis of risk is that contractors are expected not to know who they are
bidding against. The danger of bidding against unknown competitors is not
knowing whether they have the professionalism and experience to price the risk.
Thus, a careful bidding strategy that covers risks may cause contractors to lose by
pricing their work too highly (Hughes et al. 2006: 100).

7.2.3 Avoidance of risk

The third option to consider is avoidance. Once the risks have been identified and
considered, it may be decided that some risks are simply unacceptable. Their
explicit definition may persuade the employer that the building project should be
redefined or even abandoned. By examining the funding limits of a project and the
range of possible outcomes of some of the more likely risks, the feasibility of a
project may be compromised. Redefining the project is a method of avoiding a risk
altogether. For example, if the financial viability of the project is entirely
dependent on the existence of a particular government subsidy, and if there are
legislative moves afoot to end such subsidies, it may be prudent to redefine the
project so that it is not dependent on such ephemeral support.
In addition to risks between contractor and employer, each consultant takes on
risks. The principles of risk identification and avoidance apply here too. Indeed,
the most important message from a RIBA report on risk avoidance for architects is
to ensure that the commission is clear and unambiguous (Cecil 1988). The
clarification of responsibilities, remuneration and expenditure at the beginning of
the consultant’s appointment will help to avoid many problems for consultants.

7.2.4 Insuring against risk

In dealing with ‘acceptance of risk’ above, we have remarked on the similarity

between insurance and laying-off risks. Insurance is an option in some situations.
Several risks can be insured, and most of the standard-form contracts insist on
certain types of insurance. Standard insurable risks are items such as indemnity
against third party claims for injury and insurance against fire. There are also
opportunities to insure against loss of liquidated damages and other forms of
consequential loss. The actual insurance needed for any particular project should
be considered very carefully. Consultants will usually take out professional
indemnity insurance, to cover themselves and their clients against the risk of
98 Construction contracts

failure to perform the duties with the requisite level of skill and care. These issues
are discussed more fully in Chapter 17.

7.2.5 Doing nothing about risk

It frequently happens that none of the project team considers the risks at the outset
of a project. If a client is poorly advised and advisors fail to appreciate the level
and disposition of risks, the eventual occurrence of disasters takes everyone by
surprise. On the other hand, consultants who carefully consider the balance of risks
and decide that they already lie with those parties who can best control them, may
also choose to do nothing. Both courses of action may look the same to the casual
observer. In the latter case, perhaps, the people concerned should not keep quiet
about the fact that they have considered the apportionment of risk and decided to
do nothing but should make their decisions explicit so that they can be challenged.
A further example of ‘doing nothing’ lies within the main standard-form
contracts. Certain events are not envisaged by the contracts, which therefore make
no mention of them. In such a case, it would be a mistake to believe that the
contract does not apportion the risk. Even by remaining silent, the contract still
allocates the risk to one or other of the parties. The problem with allocating risks in
this way is that it may lead to misinterpretation and ambiguity, which is a risk in
itself. Such a situation can rapidly lead to disputes and claims when problems arise.

7.2.6 Allocating risk through methods of payment

One of the most fundamental issues in apportioning risk is the way that prices are
calculated. The issue is about who takes the risk of the actual price differing from
what was estimated. In construction contracting, the price tends to be related
primarily to costs, with an addition for overheads and profit. The contractor’s work
is generally dealt with as a list of quantified items (bill of quantities), to be priced
by the bidding contractor. It is convenient to analyse prices in two categories;
either ‘fixed price’ or ‘cost reimbursement’. All items of work fall into one of these
types. The difference between them is as follows (Hackett et al. 2007):
x Fixed price items are paid for on the basis of a contractor’s predetermined
estimate, including risk and market premiums (Section 3.4.1). The
estimated price is paid by the employer, regardless of what the contractor
spends.
x Cost reimbursement items are those paid for on the basis of what the
contractor spends in executing the work.
These two types are not independent. It would be unusual to find a contract
exclusively discharged by one method alone. Usually both methods will be used, to
varying degrees, in combination. The contract will be described in terms of the
dominant method. Thus, most of the items in a bill of quantities for a job let under
JCT SBC/Q 2011 (i.e. JCT’s ‘with quantities version’ of their standard building
contract) will be fixed price. The employer will pay the rate in the bill multiplied
by the relevant quantity in the bill. Similarly, under an NEC3 Option B contract,
 Risk allocation and procurement decisions 99

which is a remeasurement contract, the rate in the bill will be multiplied by the
quantity of that item fixed. In both cases, the basis of payment is the contractor’s
estimate and the amount of money paid has no relationship with the contractor’s
costs. This type of contract is known as a fixed price contract, even though it may
have some cost reimbursable elements. Such elements could include fluctuations,
which are often related to actual changes in market prices.
By contrast, a fixed fee prime cost contract will give detailed provisions for
payment based upon the contractor’s actual expenditure. Even though the contract
is based upon cost reimbursement, the contractor’s attendance and profit margin is
based on a pre-determined proportion of the prime cost. As such, the calculation of
that portion bears no relation to actual costs and is therefore of a fixed price nature.
This demonstrates how each type of contract contains elements of the other.
The important point in terms of the distribution of risk is that, under fixed price
arrangements, the contractor undertakes to submit an estimate for the work and
agrees to be bound by that estimate. Thus, any saving over the original estimate
will be to the contractor’s benefit, and any overspending will be the contractor’s
loss. Under cost reimbursement arrangements, the employer takes the risk of the
final price being different from the estimate, keeping any savings and paying for
any increases.
The two aspects of cost-based pricing in a construction contract may be placed
into a wider context. When leasing or purchasing a completed building or facility,
the price tends to be related to value rather than cost. For example, in buying a
house from a housing developer, the location of the property may have more of an
impact on the price of the house than how much it cost to build. Indeed, the value
of development land tends to be related to location. This kind of value-based
pricing is closer to the way that almost any other price is determined. In markets
for cars, computers, furniture and many kinds of plant and equipment, the price
determination follows this same principle. The customer pays for these things on
the basis of value, not on the basis of how much resource was used to make them.
This shows the importance of distinguishing between cost, price and value. Cost is
the amount has to be paid to buy something (e.g. the amount of money spent on
supplies when making something). Price is an amount required as payment when
selling something. Value is what something is worth to someone. For the
manufacturer or contractor, the idea is that the price is higher than the cost, and
that the value to the buyer is higher than the price. If either of these aspirations are
not met, then someone in the transaction is going to be dissatisfied.
One final point in defining types of contract is that the phrase firm price
contract should not be confused with fixed price contract. Firm price usually
refers not to the method of calculating the price but to the absence of a fluctuations
clause, increasing the chance of the final price being the same as the tender sum.
While this section has dealt with the method of calculating the price, Chapter 15
deals with contractual provisions relating to payment.

7.3 PROCUREMENT

Procurement is a concept that is curiously difficult to define. Part of this difficulty

is that it means different things to different people, or even to the same people at
100 Construction contracts

different times. In common use, for example, to procure means simply to obtain.
Thus, procurement may simply be the act of obtaining something. In commercial
terms, it typically refers to the processes associated with buying things. Thus,
many organizations have a procurement department with overall responsibility for
dealing with purchasing and with supplier relationships. So, in this context,
procurement refers specifically to the act of purchasing, involving a structured and
deliberate approach to the market in order to develop close relationships with a
specific group of suppliers, in return for favourable pricing and after-sales services.
However, an organization’s procurement department rarely deals with construction
projects. Constructed facilities and buildings tend to represent an extremely large
proportion of an organization’s investment. The process takes a significant amount
of time, a lot of management resources and usually a wide range of contracts with
various consultants and suppliers of goods and services. Moreover, the success or
failure of such a project may be critical to the success or failure of the organization.
So in this sense, procurement involves capital planning, design, legislative
approvals, selection and organization of a team of consultants, selection and
organization of a construction team, commissioning, occupancy and eventual
disposal. Much of this work has to be carried out in the context of policies and
laws relating to health and safety, sustainability, acceptable business practices and
so on. So, for some purposes, procurement means the act of obtaining or the act of
buying. When we buy things that are important and expensive, the need to manage
the buying activity leads to the need for applying resources to managing all of the
related decision-making processes, as well as purchasing activities. For the
purposes of this book, procurement is defined in Section 1.4. It covers the
management of the processes involved in the acquisition of major capital items
such as civil engineering structures and buildings, including organization,
management, finance, design, construction, operation and disposal, within the
relevant policy and legislative contexts. Specifically, procurement involves
decisions in four areas: commercial issues of risk and finance, professional roles,
contracting methods and tendering processes. These decisions affect and are
affected by relational issues. Procurement methods are often closely associated
with contracting methods, but there is more to procurement than contract methods.

7.3.1 Contracting methods

It is important to understand the broad picture of responsibilities for each

contracting method. If this is understood, then the remaining procurement
decisions can be chosen in relation to the needs of a particular client. Many clients
are reliant upon the advice they get from their consultants. That is, after all, why
they appoint them. The power struggles between the professional institutions in
construction shed light on the relative importance of each of the contracting
methods. General contracting (GC) represents the traditional triumvirate of
architecture, quantity surveying and building. It involves a particularly strong role
for traditional quantity surveyors (QSs), and the specific documentation that is
required for the QS role. Builders are also fairly comfortable with GC because they
only have an obligation to build what is documented; therefore they have little
liability, other than for decisions around materials and workmanship and for
 Risk allocation and procurement decisions 101

performance in relation to time, cost and quality. Typically, the architect’s role in
GC provides the greatest scope for design leadership, especially given the
architect’s certification role during the construction process (see Chapters 13 and
18).
Clearly, there have been many problems with GC. These have been
documented over decades of UK government reports (as critiqued in Murray and
Langford 2003). One possible way to overcome these recurrent problems is simply
to turn the tables and have the contractor employ the architect (a typical design and
build (DB) pattern). On the face of it, DB can make GC seem odd by comparison;
in what other kind of purchase would you specify and pay for the labour and
material content, rather than the value of the required performance? In DB practice,
production exigencies prevail over design ideas, and therefore the ideal of equal
status between builder and architect may not be achieved. Worse, the healthy
debate between the opposing views may be quietly resolved within the DB
organization, and conflicts are thus hidden from the client. One of the driving
forces behind the development of construction management (CM) is to engender
an open and participative process, where decision-making is overt. Participation is
not possible in a hidden process. In terms of professional roles, CM balances the
power struggle, and is supposed to give design exigencies equal weight with the
production exigencies. The emergence of DBFO and subsequently the UK’s
domestic implementation, known as the private finance initiative (PFI), moved the
focus away from contracting and procurement methods to project funding. The
utilization of private sector finance for public sector infrastructure led to some
interesting and difficult contracts for financial aspects, but the underlying
construction contracting and selection methods, though complicated, were
essentially drawn from the same limited range of options that were familiar.
Finally, for those clients, public or private, who wish to acquire real estate, there
are many property developers willing to take on all of the risks of development and
simply lease or sell a completed building to a client. While the idea of property
development tells us little about contracting and tendering methods, or any of the
other procurement options, it represents the greatest distance between the
purchaser of real estate and those responsible for site processes. At the opposite
extreme are sub-contractors and specialists whose business is solely based around
construction sites. Figure 7.1 represents the myriad contractual connections
through the various supply chains that connects these ends. This network of
contracts is what ties together the different firms and organizations involved in a
construction project. Each connection in Figure 7.1 requires a contracting method,
a tendering method, a relationship to be managed and clear delineations of
professional and commercial roles.
It is interesting to compare the complexity of Figure 7.1 to the straightforward
arrangements usually used to describe procurement methods in Chapters 3–5
(Figures 3.1–5.1). Figure 7.1 unpacks a wide range of the contractual relationships
in a project. It could be read anti-clockwise, commencing at the top. The end users,
occupiers or tenants of a facility are often the justification for a construction
procurement exercise. Perhaps they initiate it themselves, or perhaps someone else
(government or developer) deems that there is an opportunity to do something that
requires infrastructure or real estate. A construction client may be known as the
102 Construction contracts

End use rs/occu piers/ten ants Advisors

Service a<|iee!iiHiH /ieas « Reports

Lender
Credil
Reports
Independent
approvers
Constructio n
Investors Equity

Clien t Operation
Operator
noreemenl'

Insurance insurance
agreement
company
Design Construction Maintenance
agreement Operational
agreemenl agreement
supply chain

Design team Main Facilities

leader contractor manager

Construe! ion
Advice chain FM supply chain
supply chain

Figure 7.1: Typical contractual network in a construction project

owner in infrastructure works, or as the developer in private sector property
development. Some corporate clients are their own developer. The construction
client in Figure 7.1 is the focal organization that organizes the funding and
undertakes the procurement exercise. Moving to the funding arrangements, there is
often a combination of equity and credit. Interestingly, in PFI projects, the
construction client is a so-called special–purpose vehicle (SPV), set up with equity
from the main parties who will provide various combinations of the design,
construction, maintenance, operation and/or use. However, up to 90% of the
funding may come from loans. Various insurance policies are required, as well,
and the left-hand part of the Figure represents some of the contractual
arrangements to do with financing the project. A design team will be
commissioned, either directly by the client, as in Figure 7.1, or the design team
may be subsumed into the main contractor’s network of contracts (or employees)
in the case of a DB project. Then a main contractor (GC or DB) will be contracted
to the client, and below this is a supply chain for construction resources. In the case
of CM, the main contractor is omitted and the main supply chain contracts are held
by the construction client. On completion of the building, arrangements will be
needed for facilities management. Again, this may be in-house for a large
organization or part of the SPV’s responsibilities in a PFI project. Finally, the
operation of the facility may need a further contractual chain, or this may be done
in-house by the construction client. One key concept in this discussion is the idea
that the client is not one organization. Much of the top part of this Figure covers
various aspects of what is meant when the client is mentioned. Some or all of the
 Risk allocation and procurement decisions 103

rest of the boxes in this Figure may be a part of the client organization. Even if
they are, these roles are still fulfilled, and they may have different labels on them.
This discussion demonstrates that it is basically unrealistic, if not impossible, to
develop an ideal procurement system. Just as there is no one best way to organize a
firm (Woodward 1965), so there is no one best way to organize a project (Hughes
1989). Many projects suffer from inadequate or inappropriate procurement
decisions. The industry has, for a long time, lacked a sensible and systematic
policy for choosing appropriate procurement systems, although this is now
changing with the emergence of British and international standards (British
Standards Institution 2010, 2011). The most useful protection that can be offered to
a client is a clear policy for developing a procurement strategy for each building
project.

7.4 IDENTIFYING AND CHOOSING PROCUREMENT METHODS

It is clear from the discussion so far that there are many different variables to take
into account when selecting procurement methods. It can be difficult, in practice,
to make clear distinctions between procurement methods, since procurement
methods differ from each other in unique ways. For example, GC differs from DB
in terms of where the responsibility for design lies, whereas it differs from CM in
terms of how site co-ordination is achieved. Some developments in procurement
practice have made the situation more complex, for example, the use of private
sector finance for public sector projects (see Section 2.2.1).

7.4.1 Identifying procurement principles

The discussion so far reveals that each procurement option differs from the others
on its own basis. In other words, in many cases they are not simply alternatives to
each other and the procurement decision is not, therefore, simply a case of
choosing between this bewildering array of options. They can be combined in
different ways. For example, a general contract may or may not be partnered, it
may be financed by the private or public sectors, and it may or may not involve
much sub-contracting. The key to thinking through the procurement method for a
project is to take certain issues in a specific sequence because some decisions may
preclude the need to consider all of the other issues. This is illustrated in Figure 7.2
and explained below.
The first issue confronting a procurer is the question about how to fund the
project. We have seen that private finance initiatives and buying real estate from a
developer are two ways of funding the process by someone other than the eventual
client. If the client chooses to fund the construction work, then other procurement
methods come into play. But the client may decide from the outset to go to the
market, seeking a completed facility as a package, including funding, whether
purpose-made or ready-built. In this event, the client has no further procurement
decisions to make, apart from the decision about who the supplier will be and how
the price will be calculated, usually related to value. There are two options for the
104 Construction contracts

Start

F u n d i ng Ownership I'li C Lease Value-based price

M lk Mkt
Client Client
DBFO.'PF
I Unit performance price

Price Tor whole huilding or

Designing DIJ stEige; eosl-based unit rales
Mkt or cost reimbursement

Client

C o o r d i Hitting Whole building, stage of

GC work, unit rates or cost
M lk reimbursement
C l i e nt
Whole packagestage of
CM work, unit rates or eosl
reimbursement

Figure 7.2: A decision-led approach to contracting methods

client who does not choose to fund a project; either the supplier of the service
remains the owner of the facility, or ownership is transferred to the client as part of
the deal. Either way, the client pays for performance through some kind of lease or
service agreement. While PFI/DBFO are an examples of a decision that results in
ownership being transferred to the client at the end of an agreed period, typically
performance-based contracting (PBC) is an example of only paying for
performance and not acquiring the facility.
The client who decides to fund the development will become a client of
construction. In this case, the next decision is whether to go to the market for a
package deal, including design, or whether to develop the design before going to
the construction market (in-house or with a consultant design team). The outcome
of this decision is typically a DB contract, where the design work is part of the
package and, as in the previous decision, the only remaining decisions are about
price determination and selecting the supplier (DB contractor).
If the client chooses to carry out the design in-house or commission a design
team independent of the contractor, then the next decision is whether to co-ordinate
the construction work, or include co-ordination of construction in a single building
contract. The latter would lead to GC, whereas the former would lead to CM.
This decision process shows the sequence of the key decisions client’s point of
view in relation to construction work. At any point in this process, when work is
contracted to a supplier, that supplier then becomes a buyer of goods and services
and therefore has a similar decision process to make about procurement of
supplies. In this way, any procurement method may contain elements in the supply
chain that are procured differently, leading to a very diverse and complex situation.
 Risk allocation and procurement decisions 105

Table 7.1: Principles of procurement

Principle Examples
Source of funding Owner-financed, public sector-financed, developer-
financed, PFI, PPP…
Price basis Work and materials as defined by bills of quantity,
cost reimbursement, whole building, a fully-
maintained facility, performance…
Responsibility for design Architect, engineer, contractor, in-house design
teams, supplier…
Responsibility for construction Client, lead designer, principal contractor, joint
coordination venture, construction manager…
Supply chain integration Single-source, integrated, fragmented, competitive,
collaborative…
Selection method Negotiation, partnering, frameworks, selective
competition, open competition…

7.4.2 Defining a procurement strategy for a project

The range of procurement options and the different ways of combining them reveal
a confusing array of methods, as each is distinguished from the other on a different
basis. The combination of contracting, funding, selection and payment methods
can all be combined with different modes of ownership in many different ways.
Simple labels such as PFI, partnering, general contracting, and so on, communicate
little about the way that a project is structured. As we have seen, these different
methods are not mutually exclusive categories of doing work. By grouping the
procurement variables, it ought to be possible to describe any construction
procurement method. These principles of procurement are variously represented in
every procurement method, even though a procurement method is usually
characterized by only one factor. For example, PFI involves private sector
investment in major infrastructure projects, whereas in DB the contractor’s
responsibility for design is the defining characteristic. To bring more clarity to the
distinctions between procurement methods, the categories in Table 7.1 are
suggested.
These principles have been derived by identifying the questions to which each
common procurement strategy seems to be an answer, then listing some alternative
answer to that question. The way to put more detail on to the decision tree in
Figure 7.2 is to deal with each of the procurement principles in turn.
As we have seen, the source of funding is key to developing a procurement
strategy. Examples are given in Table 7.1, including PFI, which is an archetypal
funding method. Part of the financial decision-making is related to the way that the
price is calculated. This is a decision for the purchaser at each point in the supply
chain. While a contractor may be paid monthly for work in progress, the
contractor’s suppliers may be paid a lump-sum after installing something they have
designed. Business models throughout the supply chain vary considerably and it is
this variety that results in different cash flow patterns for different suppliers.
The principles of design and co-ordination, and their impact on the
procurement strategy, have been discussed in the previous section in relation to
106 Construction contracts

Figure 7.2. A further issue is the principle of supply chain management. For some
clients, the management of supply chains is seen as a domestic issue for the
contractor/supplier to take care of. However, increasingly, it is seen as an issue of
great concern to the employer. A primary reason for supply chain management is
that an employer wants to save costs, either by eliminating part of the supply chain
costs (having a framework of suppliers that are used for many jobs, rather than
retendering every time) or because they want to work with the supplier on
innovation, again to lower costs. For example, one supermarket chain in the UK
works directly with a fridge manufacturer to change the design of fridges to better
fit the dimensions of their store layouts. The relationship with one manufacturer
means they get a bargain price because the manufacturer has a three-year deal
covering 250 stores. There may be other reasons for wanting to get involved in a
contractor’s supply chain; whether for sustainability imperatives, quality assurance,
health and safety or a corporate social responsibility agenda, many clients need to
control the source of materials, or other aspects of the work. Some collaborative
practices discussed in Chapter 6 and some procurement strategies discussed in
Chapter 7 are defined by the need for an integrated or partnered supply chain. This
imposes a particular selection process on the immediate supplier that extends into
the supply chain.
The final principle of procurement is the selection method. At every point in
the supply chain, there is a relationship between a buyer and a seller; a contractor
and a sub-contractor; a client and a supplier. While partnering and frameworks are
often encountered in construction projects, the practices of tendering in open or
limited competition are options.
Using Table 7.1, it is clear that describing a project as, for example, PFI does
not indicate where the responsibility for design lies. Describing a project as general
contracting does not indicate how much sub-contracting there is, or how the
contractor was selected. To adequately describe how something is procured, all six
principles are needed.
In setting up a construction project, discussion and decisions are needed around
these principles. Of course, in some projects, not all options are open. For example,
the source of funding may simply be a matter of policy or even regulation for any
given client. But it needs to be explicit. The methods of selection open to the client
may be a matter of choice or preference, but in many cases, particularly in the
public sector, there are regulations about how suppliers may be selected. The
choice about how the price is calculated is a mechanism for apportioning risk, as
discussed in Section 7.2. Responsibility for design and responsibility for
management define where the liability lies in the event that the project does not
meet expectations. The extent of supply chain integration is an indication of the
scale of the co-ordination and management task for a project, but is also a response
to the technical complexity of the project, as discussed in Chapter 1.
By working through each of the principles and making a clear decision or
statement about the approach used in the project, the procurement strategy can be
made clear.
One interesting and somewhat surprising point about Table 7.1 is the number of
combinations of the six variables. Given that there are at least five options in each
of the six categories, there are at least 15,625 different ways of procuring a
building. In fact, there are many more, because the options given here are only
 Risk allocation and procurement decisions 107

examples, and the buying decisions at every point in the supply chain creates many
more different ways of structuring a procurement method.

7.4.3 Exit strategies

In any commercial engagement, it is important to be clear about exit strategies.

Each participant, especially the client, will enter into contractual arrangements with
a clear view about how they will be concluded. Entering into a contract is not a
decision for life. The exit strategy will be structured around the achievement of the
basic objectives of the project. In some cases, there may also be an exit strategy in
the case of extreme non-achievement. The termination of a contract may occur
because one party feels that the other has not fulfilled obligations under the
contract and legal action is to follow. It is the task of the project team to ensure that
an atmosphere of partnership and negotiation prevent this adversarial eventuality
from happening. Either way, whether through legal recourse, through the complete
fulfilment of contractual obligations or simply through a desire to waive
contractual rights and depart, exit strategies can be written in to the contractual
documentation for a project.
One interesting exit strategy in commercial property leases relates to the
tenant’s obligation to maintain the property. In coming to the end of the lease, there
is a process of identifying dilapidations that have to be repaired by the tenant
before handing the property back to the landlord. These repairs can be very
expensive and a tenant who has not planned an exit strategy may be unpleasantly
surprised by the extent of the financial obligation that is related to this.
Whatever the actual contractual arrangement is British Standards Institute
(2011) make this suggestion in their guide to construction procurement:
To effect smooth transitions of responsibilities at the close of a contract,
good record-keeping and clarity of rights (such as ownership of materials,
insurance policies) should be implemented to help make the process more
straightforward and give confidence to those who are taking over
responsibilities.
The checklist given in the British Standard is a useful list of point to be taken
into consideration at the end of a project, especially if the parties are interested in
continuing business relationships.

7.5 CHARACTERISTICS OF PROCUREMENT METHODS

Each procurement method has relative advantages and disadvantages in relation to

specific factors. Not all of these factors are important in all construction projects,
but where one or more of these factors is a priority, it may influence the choice of
procurement method to the extent of challenging the basic, client priorities set out
in Section 7.4.1. What follows is based upon the descriptions and assumptions
underlying each method as outlined variously in Chapters 3–7, which have
highlighted the key characteristics and circumstances for the use of each of the
108 Construction contracts

Least Most
PBC
PFI
GC
DB
CM

Figure 7.3: Client’s relative level of involvement

procurement methods. The most significant project characteristics that typify
different procurement methods are:
x Involvement of the client with the construction process.
x Separation of design from management.
x Reserving the client’s right to alter the specification.
x Clarity of client’s contractual remedies.
x Complexity of the project.
x Speed from inception to completion.
x Certainty of price.
The next seven Sections discuss each of these criteria in turn, showing how each
procurement method fares.

7.5.1 Involvement of the client

As set out in Section 7.4.1, the first question to consider is the extent to which the
client wishes to be involved with the process. Some clients would wish to be
centrally involved on a day-to-day basis and to fund the project as it progresses,
whereas others might prefer simply to let the project team get on with it and pay
for it when it is satisfactorily completed. There are many points between these
extremes. The decision will depend, at least partly, on the client’s previous
experience with the industry and on the responsiveness of the client’s organization.
Figure 7.3 indicates the extent to which each of the procurement methods relies
on the involvement of the client. PBC enables clients to be disengaged from the
construction process. PFI requires some engagement in terms of setting
performance specifications and in organizing a complex and time-consuming
tendering process. GC demands the client organizes not only the funding and
tendering process, but also the overall control of the head contracts for design,
construction, FM and operation, although it involves delegating most of the
management functions to an architect or civil engineer. While it is not necessarily
advisable, it is certainly possible for the project to be left in the hands of the team
for its full duration. By comparison, DB does not involve a contract administrator
in quite the same role. This places extra demand on the employer. CM removes the
role of a main contractor completely and thus the client takes on the most active
role. These relative levels of client involvement are summarized in Figure 7.3. The
 Risk allocation and procurement decisions 109

Least Most
PBC
PFI
GC
DB
CM

Figure 7.4: Separation of design from management

bars on the Figure are an indication of the range of levels for which each
procurement method might prove suitable.

7.5.2 Separation of design from management

The relationship between design and management was mentioned in Section 5.2.5.
The principle that applies is the extent to which the design should form the basic
unifying discipline of the project, or whether more quantifiable aspects should
prevail. In the former case, it would be inadvisable to remove management from
the traditional purview of the design leader. Such a distinction may emasculate the
architectural processes and reduce it to mere ornamentation. But this is not always
the case: not all projects are architectural. There is a marked difference between the
contracting methods in this respect, as shown in Figure 7.4. However, when it
comes to the use of PBC and PFI, the position is not so clear-cut. Whether the
project is design-led or management-led is not dictated by the use of PBC, since a
developer has a free choice about which contracting method to use. In PFI, in
theory, any contracting method may be used, but in UK practice, the construction
work in a PFI project is generally let under a DB contract.
GC unites management with design by virtue of the position of the architect (or
civil engineer) in the process. As design leader and contract administrator, the
architect is in control of most of the major decisions in a project. Moreover,
general contracts usually contain mechanisms for the contract administrator to
retain the final word on what constitutes satisfactory work. In building contracts,
such items have to be described as such in the bills of quantities (for example JCT
SBC 11, clause 2.3.3) whereas civil engineering contracts tend to reserve much
wider powers of approval for the engineer (for example ICC 11, clause 13). GC
therefore displays the least separation of design from management. (See Section
11.1)
On the face of it, DB contracts should also exhibit no separation of design from
management since both functions lie within the same organization. While this is
indeed true, it also means that where design issues must be weighed against simple
cost or time exigencies, issues are resolved within the DB firm. This excludes the
involvement of the client from such debates. Further, DB contractors are typically
contractors first and designers second (though not always). The fact that DB
projects are let on a lump sum will motivate the DB contractor to focus on time and
cost parameters over other considerations.
110 Construction contracts

Least Most
PBC
PFI
GC
DB
CM

Figure 7.5: Capacity for variations

In CM there is a clear and deliberate separation of design from management.

The design leader has a role in co-ordinating and integrating design work, but the
construction manager must ensure that design information is available at the right
time and that trade contractors’ design is properly integrated. Additionally, the
construction manager is typically the leader of the construction site.

7.5.3 Reserving the client’s right to alter the specification

There are three reasons for altering the specification. First, the client may wish to
change what is being built. Second, the design team may need to revise or refine
the design because of previously incomplete information. And third, changes may
be needed as a response to external factors. Although it is quite clear that a
construction contract imposes obligations on the contractor to execute the work, it
is often overlooked that this also gives the contractor a right to do the work and
that right cannot lightly be taken away. If a client wishes to make changes to the
specification as the work proceeds, or wishes to allow the design to be refined for
whatever reason, then clauses will be needed to ensure this. The procurement
decision affects the extent to which the contract structure (rather than clause
content) facilitates changes, as shown in Figure 7.5.
General contracts typically contain detailed clauses defining what would be
permitted as a variation, but common law restricts the real scope of variations
clauses to those that could have been within the contemplation of the parties at the
time the contract was formed.1 Therefore, despite extensive provisions for
instructing and valuing variations, their true scope is limited. PBC would not
normally involve the client in the design and construction process, rendering the
opportunities to vary the specification as practically zero. PFI tends to involve the
client along the lines of a DB contract, but with the role of the concessionaire
intervening in the contract structure, there may be only a slight possibility to
influence and change the specification. DB contracts usually lack the detailed
contractual machinery and bills of quantities for valuing variations. Further, as a
lump sum contract for an integrated package, variations to the specification are
awkward and best avoided. CM involves a series of separate packages, each of
which can be finally specified quite late in relation to the project’s overall start

1
Blue Circle Industries plc v Holland Dredging Co (UK) Ltd (1987) 37 BLR 40, CA.
 Risk allocation and procurement decisions 111

Least Most
PBC
PFI
GC
DB
CM

Figure 7.6: Clarity of client’s contractual remedies

date, but before the individual package is put out to tender. Therefore, this
procurement method has the highest flexibility.

7.5.4 Clarity of client’s contractual remedies for defects

An important part of the contract structure is the degree to which the client can
pursue remedies in the event of dissatisfaction with the process. Some contract
structures are simple, enabling clear allocation of blame for default, whereas others
are intrinsically more complex, regardless of the text of actual clauses. One of the
fundamental aims behind a contract is to enable people to sue each other in the
event of non-performance or mis-performance (defects). The relative ease with
which contractual remedies can be traced is shown in Figure 7.6.
PBC involves a direct relationship between a buyer and a supplier based upon
how a product will perform. Even when the product is a building, or item of
infrastructure, the clarity of remedies relies almost exclusively on the clarity of the
performance criteria. For example, as PBC for a highway based on traffic flow
requires only the measurement of traffic flow to determine whether there has been
a failure in the supply, this is a very clear route to a contractual remedy. PFI, by
contrast, involves a complex network of contracts. While there is usually a
performance-based contract at between the client and the concessionaire, the
network of contracts and the potential for the involvement of the client on both the
demand side and the supply side render this potentially a difficult situation.
The least clear contractual remedies arise from GC because the contractor is
employed to build what the client’s design team has documented. Therefore, any
potential dispute about some aspect of the work first has to be resolved into a
design or workmanship issue before it can be pursued. The involvement of
nominated sub-contractors typically makes the issue much more complicated and
difficult. By contrast, DB with its single point responsibility carries clearer
contractual remedies for the client because the DB contractor will be responsible
for all of the work on the project, regardless of the nature of the fault. However,
this clarity would be compromised if the client had a large amount of preparatory
design work done before the contractor was appointed. Under CM, the direct
contracts between client and trade contractor also help with clear lines of
responsibility, but the involvement of a design team and a variety of separate
trades, some with design responsibility, make the situation more complex than DB,
112 Construction contracts

Least Most
PBC
PFI
GC
DB
CM

Figure 7.7: Complexity of projects

although not as complex as GC. PBC and PFI both have very clear lines of
accountability, since the end user/tenant has a single relationship with the service
provider. On the other hand, since the concessionaire or the landlord is the client
for the purposes of the construction works, contractual recourse for faults depends
entirely on the contracting method, so there is no line shown in Figure 7.6 in
relation to this aspect. The answer to the question about contractual remedies is
never PFI or PBC, since these are not contracting methods.

7.5.5 Complexity of the project

Complexity cannot be considered in isolation because it is inextricably bound up

with speed and with the experience of those involved with the project. It is also a
very difficult variable to measure. Although technological complexity is a
significant variable, it can be mitigated by using highly skilled people. Of more
concern in the procurement decision is organizational complexity. Roughly
speaking, this can be translated into the number of different organizations needed
for the project. Because of fragmentation, this means that a project with a large
number of diverse skills is more organizationally complex than a project with
fewer skills, even though the few may be more technologically sophisticated. Each
of the procurement methods can be used for a wide range of complexities, as
shown in Figure 7.7, but the limits differ.
PBC is a method of buying things that applies in practice to anything. From a
piece of cutlery to the complete development of a major infrastructure project, the
deal can be set up on a value-based price with the vendor funding the entire
development. Thus, PBC may be applied from the simplest to the most complex
project. PFI, on the other hand, requires a large up-front effort in setting up the
finance and going through a complex and difficult tendering process. This
overhead makes it inappropriate for simple projects.
GC involves an organizational structure that is probably too complex for simple
projects. The idea of fully designing or specifying all of the work to be done before
a contractor bids for it assumes that the design is beyond the skill of the contractor.
In simple projects this is not so and it would be better to rely on the skill and
judgement of a contractor by utilizing DB. Complex projects may require
nominated sub-contracts because of the need to incorporate the design skills of
specialist trade contractors. When this forms a large part of the contract work, GC
 Risk allocation and procurement decisions 113

Least Most
PBC
PFI
GC
DB
CM

Figure 7.8: Speed from inception to completion

breaks down as it is based on the assumption that the main contractor will be doing
most of the work, not simply managing work of others. With its single point
responsibility, DB is ideal for simple jobs but this does not preclude its use for
more sophisticated work. However, if the project is too complex, DB contractors
may lack the experience and skill needed for the high levels of co-ordination and
integration required. For very complex projects, CM is suitable. Perhaps
construction managers tend to be more experienced, but the contract structure of
CM means that the construction manager should have no vested interest in
conflicts between design and fabrication exigencies or between trade contractors.
This independence, coupled with a professional management role, renders CM
ideal for dealing with organizational complexity. However, there is no reason to
avoid CM just because a project is simple. It has been used with great success on
small projects where the participants are familiar with CM and with each other.

7.5.6 Speed from inception to completion

One of the most distinctive features of construction projects is the overall duration
of the process. Since a single construction project typically constitutes a large
proportion of a client’s annual expenditure and a large proportion of a contractor’s
annual turnover, each project is individually very important. Many developments
and refinements to procurement methods have been connected with a desire to
reduce the duration of projects. Much of the process of construction is essentially
linear. Briefing, designing, specifying and constructing must follow one from the
other. If these steps can be overlapped, then the overall time can be reduced
significantly, provided that there is no need for re-work due to changes and wrong
assumptions, in which case too much overlapping can slow the process and cancel
any gains due to overlapping.
Figure 7.8 shows a wide range of possibilities for PBC. It may offer an
extremely quick solution in the building sector, since speculative developers may
have completed buildings ready for occupation. There is little to do other than
finding the building and negotiating the lease. In infrastructure projects, there will
not be completed projects awaiting negotiation, but a PBC may still be used for
aspects of a project that may be out-sourced to suppliers with standard items of
plant or equipment ready to deliver. But PBC may involve a complex, drawn-out
process for identifying funding, time for design and development and so on,
leading to a potentially long process. Because of the need to procure finance and
114 Construction contracts

Least Most
PBC
PFI
GC
DB
CM

Figure 7.9: Certainty of price

take tendering consortia through a bidding process that includes design work, PFI
tends not to be a quick solution. Similarly, the need in GC to design and specify the
whole of the works before inviting tenders, means that GC is generally one of the
slower methods. This overall slowness often leads to techniques for starting on site
early such as the letting of early enabling contracts, like demolition or earthworks.
Another technique to speed progress is to leave much of the detailed design until
after the contract has been let by including large provisional sums in the bills of
quantities, a bad practice that should generally be avoided. Other procurement
methods are inherently quicker simply because they enable an early site start. Since
a DB contractor will be undertaking design, early assumptions are fairly safe.
Further, DB is generally used for projects that are straightforward. CM can be very
quick because the relationships are conducive to quick working and overlapping.

7.5.7 Certainty of price

Price certainty is not the same as economy. It is doubtful that there is any
correlation between economy and procurement method. The reliability of initial
budgets is highly significant for most clients. However, this must be weighed
against the financial benefits of accepting some of the risks and with them, less
certainty of price.
Figure 7.9 shows that PBC and PFI are at opposite extremes in terms of
certainty of price. PBC offers certainty because, in principle, it is a contract for
performance and the buyer only pays the agreed amount when the service is being
delivered. PFI involves setting up contracts and agreements long before there is
any certainty of the required performance or the design. Therefore, it is some way
into the process before there is certainty of price for the buyer.
GC comes in a wide variety of forms. One of the most wide ranging variables is
the pricing document, the bill of quantities. This may be a fully measured bill
(known as ‘with quantities‘), a bill of approximate rates (‘approximate quantities’)
or there may be no quantities at all (‘without quantities’). However, even with a
schedule of rates, contractors are paid according to their own pre-priced estimates
in line with the principles of fixed price contracts explained in Section 7.3.
Therefore, Figure 7.9 shows that GC tends toward the more certain but there is a
huge range of variability in this because the final price depends on many other
factors such as the adequacy of the initial budget, the quality of the design and so
on. By contrast, DB is a contract for a lump sum for all of the work required.
 Risk allocation and procurement decisions 115

Although the contractor may add contingencies in to the price to deal with the
unexpected, they remain the responsibility of the contractor. This may, in theory at
least, result in a higher price, but the benefit is that the final price is agreed at the
outset. Finally, CM consists of a series of contracts, which are let as the work
proceeds. Therefore, it is impossible to be confident about the final price until the
project is nearly completed. Moreover, there is no fundamental reason to prevent
some of the contracts being let as cost reimbursement packages.

7.5.8 Balancing the requirements

The seven individual criteria provide an indication of how no single procurement

solution can satisfy all requirements. A selection process can never be
comprehensive: it is merely a technique for recording observations and views. The
aim of the Figures is to act as a vehicle for guiding the client through the decision.
Clearly, there may be other, more important factors for particular clients. Similarly,
some of the factors chosen here may not apply to every project. However, the
principle remains. Before entering into contracts, a client should be advised about
the major areas of risk and the suitability of various procurement options so that an
appropriate procurement method can be identified.