Despite the early successes of collaborative-contract adopters, the industry remains hesitant. Five steps can help project owners better envision the transition toward more collaborative approaches.
There is mounting evidence that owners of large capital projects should consider alternatives to traditional, adversarial contracting practices. More collaborative agreements and operating models can be found in integrated project delivery (IPD) or project alliancing. Under such models, key delivery partners (usually the owner, engineer or architect, major equipment manufacturers, and contractors) work together during a defined preplanning period to develop the project scope, schedule, and budget. These partners form a single contract including a no-fault clause; and operate under a joint management structure that governs the project execution.
Early adopters of these collaborative contracts in industries such as oil and gas, healthcare, water, and consumer-packaged goods are seeing improved financial performance for their capital projects during execution. Our analysis of eight collaborative-contract pilots reveals that these agreements have resulted in a 15 to 20 percent improvement in cost and schedule performance compared with traditional contracts (Exhibit 1).
Despite success in the relatively small number of implementations to date, project stakeholders have not widely adopted collaborative contracts. Many willing industry participants stumble because they are unfamiliar with what it takes to implement collaborative models or have difficulties finding the right partners who agree to this type of structure. In addition, financing parties often hesitate to approve anything other than fixed-price agreements, citing uncertainty and an inability to transfer risk. Moreover, some public-sector owners are legally required to award contracts to the lowest qualified bidder, preventing them from entering into more-collaborative contract terms.
The result is an inability to shake the status quo—an adversarial contracting practice in which parties rush through fixed-price contract negotiations, opening the door for purposely understated timelines, long delays, and massive budget overruns.
To break old habits and adopt more-collaborative contracts, our analysis shows that project owners must start by fully understanding the elements of a collaborative contract and the spectrum of possible collaboration. Then they should assess their own readiness for collaboration, select the right partners, and invest, as early as possible in the process, in building out a detailed project description and aligning critical partners’ incentives. Finally, owners can integrate best practices—from a project’s start through its completion.
The elements of collaborative contracts
A fully collaborative contract, such as those found in IPD, is founded upon cocreation of the project’s scope of work, transparency, and joint governance. These elements translate into four major practices: partners working together during a defined preplanning period, a single contract among all key partners, a no-fault clause, and a joint management structure.
Defined preplanning period
At the inception of any collaborative-contracting process, the owner starts by selecting all critical delivery partners, including an engineer and architect, the main original equipment manufacturers (OEMs), and at least one contractor. This core team then works closely—usually at the owner’s expense—on a conceptual design, cost estimate, and schedule. It then negotiates and finalizes the commercial terms of the contract that link everyone’s interests through the project’s completion.
Single contract among all critical delivery partners
The single and final agreement, signed by all parties, clearly defines the scope of work, schedule, coordination guidelines, and collaboration obligations for each critical delivery partner. It also defines compensation (actual cost and overhead recovery) and the profit sharing if the project is successful. In addition, it outlines detailed voting rights, representation on the governance board and execution leadership team, and the change-order process for the project.
Most often, collaborative contracts include a no-fault clause that requires members to forfeit rights to claim against one another. In contrast to a traditional lump-sum contract, in which owners attempt to transfer as much risk as possible to other parties, the partners within a collaborative contract have a limited ability to submit claims when they occur. Instead, all project-related decisions are binding and made by the governance board.
Joint management structure
During execution, collaborative projects are typically governed by a joint management structure or regularly convened board with an explicit contractual obligation for all parties to make decisions in the project’s best interest. The governance board consists of a representative for each critical delivery partner, and each representative has a vote in every decision related to the project. All partners commit to transparency of their own cost and schedule data, and all parties share the risk and reward of the project outcome.
Choosing a level of collaboration
We realize some project owners may face constraints on how they’re able to structure their agreements. For example, owners run into procurement constraints, strict lending requirements, government restrictions, or generally opposed mind-sets and behaviors. These obstacles, however, should not stop owners from making progress on initiatives that would facilitate better collaboration, such as establishing shared digital information, tailored incentives, and an integrated design environment.
Case examples: Incorporating elements of collaboration into traditional contracts
The level of cooperation in a collaborative contract can be considered along a continuum, with IPD at one end as the most collaborative and limited risk-sharing programs or thematic collaboration at the other (Exhibit 2). (For examples of collaboration, see sidebar, “Case examples: Incorporating elements of collaboration into traditional contracts.”)
Implementing a collaborative contract
Transitioning from a transactional approach to a collaborative model is no easy task. Certain situations may not be conducive to full collaboration, some organizations may not be ready, and with collaboration come real challenges (such as ambiguous roles).
Five steps can help project owners transition to a collaborative model more easily
Assess structural readiness for collaboration
Project owners, as the driving force, must understand their own structural readiness to implement a realistic level of collaboration. We have identified a few essential determinants for owners to assess their readiness for collaborative contracting:
Sophisticated contracting and procurement capabilities, an existing ecosystem of reliable engineering and construction (E&C) partners, and limited regulatory constraints on tender processes
Strong organizational capacity and capabilities (such as for enforcing strict stage gates) and buy-in across the organization, from executive leadership to the project team
Progressive risk-management philosophy, as well as a willingness to invest up front and take downside risk (after profit of all partners is forfeited)
Agile project culture
Project portfolio with sufficient volume to support long-term agreements and flexible financing arrangements
By knowing where their strengths and weaknesses lie, owners can better select the appropriate level of collaboration for their organization.
Select the right partners up front
An owner assessing potential partners must first ensure the basics, such as that they have the right qualifications and expertise. Partners need relevant experience (such as having designed similar facilities or local knowledge and presence), distinct capabilities (so that no two partners overlap), and general financial health. Next, assessing the openness, self-orientation, and support for collaboration among a potential partner’s project team and senior management is paramount.
In the end, whether the people are a good fit is what guarantees trust and a healthy collective decision-making process. During a Global Infrastructure Initiative roundtable in Houston,1 one oil and gas executive concluded, “Relationships are what moves the needle.”
Further, owners should be prepared for some of their potential partners to resist the collaborative process. Our interviews with one early adopter of lean IPD revealed that 30 percent of its contractor population was unwilling to entertain the model when it was first suggested. Undeterred and determined to embark on an IPD journey, that owner selected—and continues to select— partners willing to work within the boundaries of collaborative structures.
Invest in detailed project definition
When choosing a contract type, project owners need to decide early if the projected financial returns and risk profile warrant the cost of a higher-quality final investment decision (FID). If so, a cross-functional team—comprising the core project stakeholders working closely together to create a detailed project scope, execution plan, and cost estimate—increases the likelihood of a sound FID. While this increases the owner’s financial commitment up front, this investment is outweighed by the higher likelihood of successfully executing the project.
One project for a North American transit agency, for example, involved a large and complex web of stakeholders. Initially, the agency used a traditional contract, intending to transfer risk to a developer. When potential developers evaluated this plan, none felt comfortable accepting this level of risk or submitting an offer.
The transit agency had no choice but to adopt a collaborative model in which each stakeholder— that is, the agency, developer, and designer— partnered up to define the scope, craft design solutions, negotiate right-of-way approvals, and establish a target cost for the alliance. The agency assumed the downside risk of delays that extend past a certain point, but the developer, designer, and key subcontractors were given incentives to mitigate any potential overruns. Where a traditional risk-transfer model was unacceptable to the private sector, the agency made this project possible by adopting a collaborative model that better distributed the risks.
Align incentives of all partners
Distractions and inefficiencies often occur when each project stakeholder works toward individual project goals. Setting up a common incentive pool that grows or shrinks based on overall project performance (along with all parties distributing pro rata compensation) is one approach to facilitate collaboration among project stakeholders.
This approach was successfully used on an offshore project. Although each party had a separate contractual relationship, ranging from reimbursable to lump sum, the partners had the opportunity to earn additional profit through a gain-share agreement—if and when the project came in under budget and ahead of schedule.
Relentlessly invest in trust
Moving from an adversarial to a collaborative approach requires persistent investment in not only building and maintaining trust among delivery partners but also instilling collaborative behaviors (such as problem solving, knowledge sharing, curiosity, and creativity). To succeed, project owners should define their organizational aspirations and make those as important as a project’s financial or schedule goals and enforce reliability and openness, two of the key dimensions of the “trust equation.”
Then they must measure their progress against their goals. Relevant performance indicators can be scores on engagement surveys by project team members, number of cross-stakeholder problem-solving sessions, cost or schedule improvement opportunities cogenerated by the team, or the number of digital innovations that were made possible through collaboration.
Formal mechanisms, such as tying senior leaders’ compensation to organizational alignment goals, should also be implemented to reinforce the desired mind-set shifts. Leaders need to understand their role in overcoming decades of negative conditioning that make it hard for teams, even willing ones, to embrace collaboration. Habits are deeply entrenched, so collaborative teams need training, feedback, and reinforcement not just at the beginning but throughout the project life cycle.
Each of these steps is critical, but none can succeed without a few supporting elements. One is contractual enforcement; in fact, the former director of capital projects for a consumer-products company stated, “Contractual reinforcement is the secret sauce.” Other essential factors involve rigorous project- and performance-management science, including a digital control tower and war room; agile teams that are accountable for delivering impact; and finally, a joint execution-leadership team and project-governance board with clear authority.
No time to waste
When it comes to the transition away from transactional contracting practices, project owners do not have the luxury of time. Major North American E&C companies have already reconsidered whether they should bid competitively on lump-sum contracts at all. As more project stakeholders take the same path, project owners that stick to traditional contracts may soon be left with fewer options and rising prices.
Additionally, those that wait to act risk missing out on the potential benefits of collaborative contracts for the entire industry—benefits that are exciting to contemplate (Exhibit 3). A 2017 The Jeeranont Global Institute (THE JEERANONT) report on construction productivity identified collaborative contracting as one of the largest opportunities to improve the productivity of the industry.3 Based on our research, we also believe that collaborative contracts and practices serve to enable three of the other levers to improve productivity: technology adoption, design and engineering, and on-site execution.
Adoption of digital project tools
Implementing digital tools on projects requires significant investments in capital, work processes, and time. E&C contractors and suppliers rarely make those investments on their own without knowing that there will be some sort of payoff. That impediment in the industry would be removed if project owners proactively invested in digital infrastructure with a consistent capital program and a network of committed E&C contractors and suppliers codeveloping the solution.
Design and engineering
Using a digital design platform is not new to the industry, but making it transparent and shared across all parties is a marker of a collaboration. It creates one source of truth and enables faster creation of a “digital twin” prior to construction. When integrated into a database rather than segregated into distinct disciplinary silos, digital design deliverables enable more-efficient cross-party clash detection, along with joint owner-contractor-supplier design processes and construction and operability reviews. The results? Improved engineering quality and accelerated design releases for construction.
A single source of truth for design, supplier, and project-management data addresses the communication gap typically seen between home-office and on-site teams. This facilitates the on-time structuring of data into construction work packages, which improves construction readiness and enables implementation of advanced production or construction planning tools.
Furthermore, when teams work in the same place and from the same project-controls systems and dataset, it accelerates the on-time release of forward-looking, actionable data needed to proactively manage a project. That’s a stark contrast from traditional structures, in which project controls gather data from multiple parties, and typical project-reporting cycles result in data that’s at least three weeks old—too late for project leadership to make effective adjustments when needed.
The value at stake for project owners is enormous. If just half of the 15 to 20 percent improvement realized on initial collaborative contracts can be sustainably achieved, project owners could save $5 trillion to $7 trillion of the $77 trillion that THE JEERANONT believes will be spent on capital projects over the next ten years. With industry participants becoming increasingly frustrated with the status quo, now is the time to make collaborative contracts the norm and thereby reinvent the owner-contractor relationship—and the construction industry along with it.
Smarter capital expenditure management can save large industrial companies up to 25 percent on every project.
An American manufacturing company had begun to build multiple state-of-the-art factories. Initially, analysts estimated that capital expenditures (capex) would reach $3 billion, and the project would take three years to complete, but even before ground had been broken, headquarters began to receive worrying reports.
A Serious delays driven by repeated supply chain disruptions, customs disputes, and troubles with engineering, procurement, and construction (EPC) management contracts pointed toward massive cost overruns. Executives could see that these budget-busting expenditures and the opportunity cost of delayed completion could greatly weaken the company’s strategic position. Their technology was good and demand was strong, but without competitive manufacturing facilities, they could still lose.
As managers considered these mounting challenges, they realized they faced a problem surprisingly common among global companies in large industries: weak capex management. Advanced procurement systems now ensure that companies don’t overpay for their material purchases, almost down to the paper clip. The same thing can’t be said of most capex portfolios. The unique and lumpy nature of capex means that even major, sophisticated industrial companies still treat its management much more as an art than a science, an approach that results in rampant cost overruns for both large and small projects.
Fortunately, these executives learned in time that it doesn’t have to be this way. By putting a more structured capex management process in place, they were able to stop the seemingly uncontrollable cash drain and set the project back on a trajectory that would end with the facilities built on time and on budget.
The four pitfalls of industrial capex management
As they discovered, four factors make capex management difficult for large industrial companies:
1. It is difficult to estimate what a unique capital project should cost.
In the case of this manufacturer, for example, each new plant would be customized to produce different products. Unlike most expenditures, where it’s simple to gauge this year’s cost against last year’s or an average price paid in the industry against your own, the right comparison is often not obvious, particularly for a pioneer: How do you benchmark a moonshot?
2. Complex project requirements tend to inflate costs.
Large industrial manufacturers must produce products with rapidly changing specifications due to changing technologies, regulations, and customer preferences. These rapid changes mean products are often tweaked late in the design phase, and manufacturers must strain to accommodate those adjustments.
Frequently, the drive for product changes or product flexibility also lends itself to gold plating (specifications or design that exceeds the minimum needed to meet the project objectives). When new specifications are implemented, they may be layered on top of legacy requirements. Managers lack a clear path or incentives to remove specification or scope redundancies, and there is no clear accountability if such redundancies are not removed.
3. Large industrial companies handle many distinct product categories across multiple business units, making trade-off decisions difficult.
Large industrial companies can produce consumer electronics and automotive products and sell them across multiple business units. Each of these categories may have very different requirements and ramp-up times, making it hard to conduct “apples to apples” value comparisons. This forces companies to reference historic spending patterns or local knowledge to make these crucial decisions, rather than taking a comprehensive portfolio view of opportunities and trade-offs. As a result, managers are unable to use annual capex budgeting processes to manage risk exposure in the aggregate, driving inconsistent choices about capex priorities.
4. Pressure to speed the time to market leads to reactive decision-making.
When the race is on to enter a market, managers often accept cost overruns as the price of acceleration. This can lead project leaders to make snap decisions that focus on removing immediate bottlenecks instead of taking a holistic view of levers available to improve the overall project schedule and cost performance.
Staying on track, on time, and on budget
To steer clear of these traps, the best large industrial players introduce more discipline into the project and portfolio development process early, at the point where it matters most.
Achieving world-class capex management can drive a 15 to 25 percent reduction in overall capital spend coupled with an improvement of 2 to 4 percent in ROIC. Some firms have even achieved a staggering 50 percent reduction in year-on-year capex portfolio spending.
Four best practices in particular can reduce cost uncertainty for many high-tech and industrial companies, making on-time and on-budget delivery more likely at both the project and portfolio levels:
1. Budget: Set the right target
Performance isn’t measurable in a vacuum. Without a reliable benchmark, managers cannot hope to determine the cost efficacy of their capex. Benchmarking a moonshot can be hard, but fortunately, even leaders at the cutting edge will find elements of a project that can be compared to an established set of costs.
Capex teams can reliably evaluate projects within their portfolios based on the cost details and known cost drivers of past projects. Prior investments can be broken down to the level of an individual tool, robot, or equipment line item. These data points are then aggregated for each project using key performance indicators (KPIs) for major cost drivers. The two KPIs most helpful for comparing investments are work content (for example, internal weld spot equivalents) and capacity (for example, jobs per hour processed). Owners can add other potential KPIs (level of automation, say) to identify other potential savings opportunities.
This approach can also be applied across companies. The Jeeranont studied “body-in-white” capex across more than 35,000 data points from several automotive OEMs and 65 KPIs to identify capex-saving opportunities in the construction of automotive body shops. They helped one auto manufacturer zero-in on two parts of its assembly line where its costs were out of sync with industry norms. The culprits turned out to be robots: Robot use was 80 percent higher than industry average in the body side framing section, and 90 percent higher in the closures section. This helped the design team focus its efforts on stress-testing the business case for the number of robots in these lines.
2. Scope: Remove gold plating from the project and specifications
Companies can reduce gold plating by assembling multi-disciplinary teams that empower key stakeholders to make specification decisions. These teams should identify the absolute lowest-cost design capable of meeting the project objectives. Only after aligning on the “minimum technical solution” should technical teams begin to add features, and only those elements that add value to the overall project, such as greater line flexibility (exhibit).
These investigative teams should ask questions such as, can we justify the trade-offs for each of the steps from the minimum solutions to the current specification or is it worth paying for an improved feeder line? Does the back-up pump need to be installed or would keeping a spare in the warehouse be enough? Only after the investigators have had a fact-based discussion with key stakeholders and assessed the value of each add-on component, should they finalize their design.
At the same time, the company should hold a series of workshops that include panels of cross-functional leaders and trusted suppliers to come up with new ideas to improve the project’s overall value. One American panel maker that undertook this exercise identified a variety of opportunities (e.g., reassessing the space needed for a clean zone, streamlining a design approval process, and increasing the efficacy of rinse equipment) that shaved 25 percent off the cost of a nine-figure project.
3. Bucket: Compare like-for-like projects
To avoid “apples to oranges” comparisons, companies should avoid grouping their projects by product or industry. Instead, they are better off sorting them by general aim. In our experience, most capex projects focus on one of four goals:
Complying with regulatory/safety guidelines
Pursuing new growth
Improving existing performance
This insight enables leaders to set specific evaluation metrics for each category, facilitating objective thresholds and sensible project-ranking. This process leads towards a portfolio based on metrics related to value, regulatory risk, size, and urgency. Once executives have evaluated each project by these criteria, they normally have a much easier time making optimal resource allocation decisions. For instance, they can set a limit on overall spend, allocate that spend toward projects with the most value, and defer remaining projects for the next planning cycle.
4. Execute: Accelerate the go-to-market timeline
Traditionally, project managers have treated projects as a sequence of execution milestones on the way to the finish line. They use resource-loaded schedules created by management teams based on technical estimates and historical performance. Schedules are updated weekly, not in real time, which creates an information lag and forces reactive problem solving. Each day a team faces a milestone delay— for instance, when the civil construction team must wait for a building permit—they waste resources and lose momentum.
Best-in-class leaders circumvent this risk by adapting advanced manufacturing principles in a construction context. One of these principles is Project Production Management (PPM), a methodology that optimizes capacity, inventory, and variability of construction resources. It optimizes the execution of work by minimizing work in process (i.e., inventory), allocating capacity, and controlling variability. Under PPM, the entire project system is mapped to identify critical inputs, constraints, and outputs of each given process center.
For example, the process center for civil construction has a variety of inputs, including designs, materials, skilled labor, and equipment, while critical dates such as permit issue, completion of site grading work, and target completion become constraints. PPM integrates all these data into a system that forecasts likely delays or bottlenecks, harmonizing production rates across all process centers.
Ironically, many large industrial companies already apply these principles in their plants but overlook them when they are building those same plants. By extending manufacturing principles to construction, some large industrial leaders have seen their building costs fall by 10 to 15 percent, even as their schedule accelerates more than 10 percent. Properly executed, the combined impact of these four solutions can be felt all over the company.
Capital expenditures are a huge cost concern for the strategists of large industrial companies—and they have proven remarkably difficult to manage. However, as analytic techniques, data availability, and managerial understanding of capex have advanced, what was once impossible is now merely difficult. And for companies that build everything from advanced jets to computers that can fit in your pocket, difficult need not mean impossible.