Procurement in the Construction Industry

The Impact and Cost of Alternative Market and Supply Processes

William Hughes, Patricia M. Hillebrandt, David Greenwood, Wisdom Kwawu

• Publisher: Routledge
• Year: 2006
• ISBN:
  9781134157464
• Edition: 1
• Topic: Architecture
• Subtopic: Architecture Methods & Materials

Do recent moves in the construction industry towards collaborative working and other new procurement procedures really make good business sense? Procurement in the Construction Industry is the result of research into this question and it includes the first rigorous categorizing of the differences between procurement methods currently in use. In the process of carrying out this research, the team has produced a comprehensive study of procurement methods which looks in detail at the relative benefits and costs of different ways of working, with sometimes surprising results. As such, it is not only a valuable guide for practitioners on the complexities of the procurement process, but also an outline of the relevance of economic theory to the construction sector.

1 Introduction

The idea for this research project into the costs of procurement in the construction industry was born at a time of great interest throughout the industrialized world in the development of innovative working practices in the management of the commercial processes of the construction industries. The new thinking included new methods of financing projects, such as the development of PFI (PPP); new methods of procurement and new collaborative working practices. These were sometimes introduced as separate innovations but in many cases there was a combination of two or three of the developments in one project or group of projects. One of the changes taking place was the increasing involvement of the client in the movement for change, not only in the public sector, but also by the private client organizations with long term construction programmes. The impetus for change was so great that it seemed that a new era was dawning in the commercial arrangements for contracting, replacing the largely confrontational and adversarial approaches of the past. There had been a considerable amount of discussion on the advantages of the new methods of working, both realized and anticipated, in terms of a better or cheaper product or faster delivery times. However, there was very little consideration on the costs of procurement throughout the whole construction process.

Prior to the commencement of this project there were a number of industry views about the costs of procurement, most of which concerned the costs of tendering. They were typically quoted as ½ -1% of turnover or 2-3% of bid price for PFI (PPP). However, the costs of procurement are greater than the costs of tendering alone and include marketing prior to tendering. In addition, some other costs of the project, including the costs of enforcement are affected by the type of procurement. Each member of the construction team, including the client, incurs costs in procuring any project. All these costs are of concern to the research team. Innovative approaches to business processes reduce the reliance on competitive tendering and focus instead on building co-operative and collaborative business relationships over the medium to long term. The costs in collaborative arrangements change substantially but remain significant.

The commercial process involves making deals. The costs associated with bidding and tendering are only a part of the costs of making deals. In order to get into a deal-making situation, any construction vendor (seller of construction goods and/or services, including consultants) will engage in marketing activity of some kind. This costs money. The process of striking the deal, then, is the second step in the commercial process. If the deal is struck, a contractual relationship comes into being, and since this involves services, not just goods, it is a relationship that occupies time. Thus, the negotiated deal reflects only the situation at the time the deal was struck, and may not reflect the continuously evolving relationship. However, the parties to the contract are bound by their agreement. Their performance will be subjected to continuous or intermittent monitoring to ensure that they deliver what they have promised. This monitoring is a cost of procurement and is the third stage in the commercial process. Finally, when the work is completed, or otherwise brought to an end, the contracting parties may be in dispute about the extent to which each has fulfilled his or her part of the bargain. The resolution of such disputes is the fourth stage in the commercial process.

The selection of building contractors usually depends on some form of market competition. In those countries moving away from centrally planned economies, such as China, there is a clear perception that competitive tendering increases the quality and efficiency of contractors’ performance (Wang et al. 1998, Shen and Song 1998). Similarly, in Hong Kong, the move towards fee-bidding for consultancy services seems to be gathering momentum (Ng, Kumaraswamy and Chow 2001). Connaughton (1994) described how to apply competitive processes to the selection of consultants, at a time when moves towards fee-bidding were growing increasingly popular.

Competitive tendering has been used extensively for a long time, but there is plenty of evidence that it does not necessarily result in value for money (see, for example, Pasquire and Collins 1996). Indeed, there are signs of increasing disenchantment with competition on price, particularly in the UK (Lingard et al. 1998, Wong et al. 2000). The costs associated with traditional tendering practices seem unnecessarily high, due to excessive detail in the information required for the bidding processes (Poh and Horner 1995).

In Sweden, Svensson (2001) examined the factors that influence the choice of consulting firms for international projects. He found that long-term relationships were at least as important as traditional skill and experience factors. Such research highlights the marketing effort that consulting firms require when obtaining work, although there is no assessment of their costs. It also has resonance with the moves in the UK towards innovative working practices, and away from straight price competition. This move follows the public sector’s discarding of compulsory competitive tendering and replacement with the idea of “best value”. Indeed, the use of compulsory competitive tendering for local authorities led to widespread criticism of lowest-price bidding in the UK. The recent move to “best value” as opposed to “lowest price”, following the Local Government Act 1999, should help to avoid the negative effects of fragmentation and duplication in terms of monitoring, supervising and inspecting (Nettleton 2000).

While there are plenty of articles extolling the virtues and benefits of different ways of working, the benefits are rarely placed against the costs associated with collaborative working practices (see, for example, Gordon 1994, Pokora and Hastings 1995, Rahman and Kumaraswamy 2002). It is far from clear that the adoption of new ways of working is anything more than lip service, with subcontractors continuing to report the same treatment at the hands of main contractors, regardless of the incidence of these new collaborative working practices (Greenwood 2001). Although many new ways of working are referred to as collaborative, this is a vague term which can be misleading because every construction project requires collaboration between many people at every stage. In the context of this study, it is taken to mean procurement where:

• competitive bidding is not the only criterion upon which contractors, consultants and suppliers are selected,
• some reliance is placed on the deliberate development of long-term working relationships,
• there is a limited number of partners.

Miller et al. (1999) report that it is unlikely that collaborative working methods will produce promised gains and reduce transaction costs if the sub-contractors are not fully integrated into the process. And there is plenty of evidence that they are not. Indeed, Moore and Dainty (2001) demonstrate that there are enormous cultural barriers in typical professional practices in construction that prevent the achievement of team integration in novel procurement routes. The idea that there is a single better way to organize construction projects seems not to be borne out by empirical work (Kumaraswamy and Dissanayaka 1998). Lingard et al. (1998), in their review of the literature on this topic, concluded that there was much still to be done in evaluating the impact of different ways of working on the costs of entering into a contract. Wang and Wu (2000), in their development of “cyberspace” procurement methods, acknowledge the enormous cultural difficulties in re-engineering the tendering process such that it could be automated.

The need for this research is clear. There has been tremendous interest from academics and industrial partners in equal measure. This report sheds light on some very complicated and difficult issues connected with contemporary moves towards different ways of working. It deals with the costs of procurement to all of the parties involved with the construction process and points out some of the implications for the economy as a whole. This should assist in evaluating the balance between costs and benefits of various different procurement routes.

2 Review of existing knowledge

There is much research that helps provide a context for work in this area. The research was based on the idea of investigating the cost consequences of the kind of collaborative working practices called for by various strategic reports on the construction industry. In order to deal with these consequences, the distinguishing characteristics of different procurement methods need to be articulated. Further, since there are commercial transactions at every level in the supply chain, work on supply chain mapping sheds light on the scale of transactions in construction projects. There has been much theoretical work, based on the costs of transactions, which seeks to provide explanations for the existence of firms and markets (i.e. the decision about whether to make or buy supplies). While this work provides a useful starting point for defining transaction costs, the focus is not on the choice between firms and markets, but on different ways of selecting and contracting with supply chain partners. There has been some interesting work investigating the factors that affect the costs of procurement, and some work on assessing the costs. This section of the report describes the previous work done in these areas, providing the context for the research carried out.

2.1 CALLS FOR CHANGE

Tendering was among the main issues tackled by the Latham Report, a joint government-industry review of procurement and contractual arrangements, published in the UK in 1994. It would probably be no exaggeration to say that Latham sees traditional tendering as “the root of adversarial attitudes” (for example, Latham 1994: 58). In his earlier, interim report, he levelled a number of serious criticisms at the industry’s traditional tendering process. These included the sheer expense of complying with tender procedures (particularly for design and build work), the excessive length of tender lists, and the existence, particularly at the level of sub-contract tendering, of “malpractices” such as “Dutch auctioning” and “bid peddling” (Latham 1993: 28). The prevalence of Dutch auctioning and bid peddling are perfect examples of the failure of traditional tendering: carried out with the aim of price-reduction, the effect of both is to undermine the willingness of a prospective contractor to commit to best price in the initial tender (Construction Industry Board 1997a: 21). Latham’s recommendations on tendering show a particular concern that public sector clients, while being aware of European Union Directives, should tender selectively and adhere to established codes of procedure. Clients who “seek tenders on a design and build basis” should be particularly aware of the costs of bidding for this type of work, and modify their selection procedures accordingly (Latham 1994: 57). Latham also noted that local authorities were being “severely hampered by being forced to accept the lowest tender” often neglecting other aspects of “value for money” (Latham 1994: 58). Four of Latham’s 30 specific recommendations in the executive summary (Latham 1994: vii-ix) refer to tendering:

• The Construction Industry Council should publish a code of practice dealing with “project management and tendering issues”.
• “Tender list arrangements should be rationalized … and advice issued on partnering”.
• “Tenders should be evaluated … on quality as well as price” and recommendations on tender periods should be followed.
• “A code of practice for the selection of sub-contractors should be drawn up” … with “short tender lists” and “fair tendering procedures”.

In 1995 the Construction Industry Board (CIB) was set up with the primary objective of implementing the Latham recommendations. Among the CIB’s publications, several relate to tendering, and these include codes of practice for the selection of consultants, main contractors and sub-contractors, as well as related publications on partnering, briefing and pre-qualification. The common features of the codes for tendering (Construction Industry Board 1997b and 1997c) are the requirements that:

• Clear and transparent procedures should be followed.
• Tender lists should be compiled systematically and be as short as possible.
• Conditions should be the same for all tenderers.
• Confidentiality should be respected.
• Sufficient time is to be allowed for tendering.
• Sufficient information should be provided.
• Tenders should be assessed on quality as well as price.
• Tender prices should not change on an unaltered scope of works.

In July 1998 a rather more radical approach to tendering was exhibited in another UK construction industry report, commissioned by the Department of the Environment, Transport and the Regions and produced by a “task force” under the chairmanship of Sir John Egan. The report reflected a “deep concern that the industry as a whole is under-achieving” and that “too many of the industry’s clients are dissatisfied with its overall performance” (Egan 1998: paragraphs 4-6). In order to achieve the ambitious performance targets set in the report, Egan observed that the industry will need to make “radical changes to the processes through which it delivers its projects” with a view to “eliminating waste and increasing value” (Egan 1998: chapter 3). The report makes specific reference to the need to “replace competitive tendering with long term relationships based on clear measurement of performance and sustained improvements in quality and efficiency” (Egan 1998: paragraphs 67-71). This involves “new criteria for the selection of partners” based, not on “lowest price, but ultimately … best overall value for money” (Egan 1998: chapter 4). According to Egan, “the most immediately accessible savings from alliances and partnering come from a reduced requirement for tendering”. While this admittedly “goes against the grain, especially for the public sector”, and causes concern with all clients that that they are getting value for money, it is considered vital, since “cut-throat price competition and inadequate profitability benefit no-one” (Egan 1998). The influence of the Egan report has prompted a number of further initiatives in the UK industry, including the Movement for Innovation (M4i) and the Best Practice Programme of the Construction Innovation and Research Management Division of the Department of the Environment, Transport and the Regions, both of which retain an interest in the reform of tendering practice.

However, perhaps the single most significant shift in procurement policy has come from the implementation, on 1 April 2000, of the Local Government Act 1999. Under the Act, the requirement for compulsory competitive tendering had been abolished, and replaced with “Best Value Procurement”. Broadly speaking “Best Value” requires a council to seek improved performance by whatever means is best. The legislation requires authorities to challenge whether existing practices are still relevant, consult on better cost-effectiveness, compare its performance with others through benchmarking, and compete with the best solutions (Joseph Rowntree Foundation 1999: 47). The result is that local authority clients are enabled to experiment with alternatives to tendering.

2.2 CHARACTERISTICS OF PROCUREMENT OPTIONS

Within the construction sector, procurement has become a complex and difficult topic. This is because it refers not only to what is bought, but also to a diverse array of methods for acquiring a huge range of buildings and infrastructure facilities. Before developing a general view of how procurement options differ, it is useful to identify the main features of current procurement approaches. There are methods of contracting and/or funding, methods of selection and methods of payment.

2.2.1 Methods of contracting

• General contracting: Design is provided by independent consultants in direct contract with the client or (in the public sector) designers that are part of the client organization. A separate contract for the construction of the project is placed with a building contractor, who then sub-lets elements of the work. Payment for the building work is monthly, based on how much work has been done to date, in relation to a tendered lump sum, based on unit rates in a contractual bill of quantities. Selection is normally by competitive tender, though the tender list is often pre-selected, rather than open.
• Design and build (pure): Design and Build (D&B) is a procurement system where a single organization undertakes the responsibilities and risks for both the design and construction phases. There may be various levels of employer-involvement in the design: in the “pure” form of D&B, the client engages a building contractor at the outset (after competition or otherwise) who is then responsible both for the design and the construction of the work. The typical payment method for D&B is a lump sum, payable in monthly instalments, based on a cost document that forms part of the “Contractor’s Proposals” which is itself a tendered or negotiated response to the “Employer’s Requirements”, documents that form the basis of the contract.
• Novated design and build: A widely used variation of D&B occurs when the client employs a design team for the early stages of the project (typically up to the planning permission stage) to prepare the outline design and an “Employer’s Requirements” document. A building contractor is selected by tender or other means and the design team is then transferred to this builder, and it is this transfer of contracts from the client to the builder that is called novation. The design team then continues to prepare a detailed design. The...

Table of contents

• COVER PAGE
• TITLE PAGE
• COPYRIGHT PAGE
• ACKNOWLEDGEMENTS
• EXECUTIVE SUMMARY
• 1. INTRODUCTION
• 2. REVIEW OF EXISTING KNOWLEDGE
• 3. RESEARCH
• 4. FRESH PERSPECTIVES ON CONSTRUCTION PROCUREMENT
• 5. CONCLUSIONS AND RECOMMENDATIONS FOR FURTHER WORK
• 6. REFERENCES
• APPENDIX A: GLOSSARY OF TERMS
• APPENDIX B: ANNOTATED BIBLIOGRAPHY