Understanding Risk

Value-for-money construction outcomes through better risk allocation

“When public sector clients force liability for a risk onto their contractor, it can seem like a little win in the name of taxpayer value. Ultimately, though, that forced risk will more often than not, one way or another, come back to bite.”

So says Beth Revell, Vice-Chair of CIOB London Hub and co-founder of construction project management consultants The Blue Iris Partnership, which is currently applying for Chartered Company status with the CIOB.

Beth’s warning comes from deep experience. Before setting up The Blue Iris in 2020 and after stints at the Royal Borough of Kingston and Turner & Townsend, she was a Director at Gleeds for four years. With a specialism in public sector capital construction projects, she’s seen enough delay, claims and disputes to diagnose the central importance of fair risk allocation and, potentially, to prescribe some solutions.

The problem with passing on risk and liability

She cites the example of a contract negotiation for a refurbishment project she’s recently brokered.

The client wanted to appoint a contractor for a fixed price, but they hit a snag over who should hold the liability for asbestos risk.

This is big: the costs of dealing with asbestos can quickly escalate. In their quest for price certainty and thus value for money, the client pushed for the contractor to accept the risk for no extra fee.

Under normal circumstances, the contractor has just four options when faced with this situation – none of which is good for the client.

Option 1: walk away

First, the contractor can calculate that the risk is too great and walk away. This is a tough choice when order books need filling and the contractor has already spent considerable time and money on bidding. Optimism bias is likely to sway them to go ahead. If the contractor does walk away, though, it has time and cost implications for the client, who must find a replacement. And as Beth Revell says, “The industry is not always flush with alternatives.”

Option 2: accept and pray

Second, the contractor can simply accept the risk and pray for good fortune. This probably only happens unwittingly, when the contractor is relatively small and doesn’t have the knowledge or resources to invest in planning for risks. If the contractor’s prayers are answered there’s no issue. If the risk is confirmed, though, the consequences will ripple through the whole project, sometimes with brutal impacts for the client as the contractor struggles to perform.

Option 3: pass on the risk

Third, the contractor can accept the risk and plan to pass it on to their subcontractors. While this sounds smart, the farther down the supply chain the risk is passed, the less likely the parties are able to bear it. If the impact puts the unfortunate subbie out of business, it’s a costly headache for everyone higher up the supply chain – all the way to the client.

Option 4: compensate in other ways

Fourth and finally, the contractor can accept the risk and plan to rake back any consequential losses in inflated claims and/or reducing their project costs by, for example, substituting planned-for materials with cheaper ones. This virtually guarantees delay, disagreements, and disputes, all of which are unwelcome.

All these scenarios are unwelcome, adversarial and unsupportive of the smaller suppliers that the industry relies on so heavily.

Of course, these scenarios don’t just arise from physical risks like asbestos or, also very commonly, groundworks. They can arise from other kinds, too, including the risks from clients altering standard forms of contract in ways that impose uninsurable obligations on contractors. administering complex contracts, basing appointments on lowest cost, or not allowing enough time for pre-construction activities.

Indeed, in a recent statement by the Construction Leadership Council, the practice of amending terms in standard contracts too frequently imposes disproportionately onerous liabilities on contractors that can’t be covered by their PII insurer. The contractor is exposed to financial ruin. The client is left with a claim that can’t be recovered. As the CLC put it, “This is not in the best interest of any party.”

In the case of Beth Revell’s project, the contract negotiations became protracted, ultimately delaying construction and increasing costs across the board at a time of significant inflation.  Even with a workable compromise, each party lacked trust in the other, which was a less-than-ideal way to kick off a new project.

The solutions

The problems Beth Revell diagnoses have been around for years and, unsurprisingly, there are plenty of potential ways of resolving them, as alluded to in CIOB’s Client Guide. All involving a culture of openness and transparency, they include early supply chain engagement, partnering or alliancing contracts, project insurance, and all parties sharing pain and gain equitably.

Indeed, these ideas were recently joined up into best practice in the government’s Construction Playbook, the most recent 2022 revision of which advises: “Ensuring that risks are owned or jointly owned by the party or parties best able to manage and bear them, and understanding how they intend to handle them, is key to delivering value for money and successful outcomes.”

Preconditions for success

The Construction Playbook includes tools for doing this, but they will only work if clients understand two things.

As already discussed, they need to understand how superficial value-for-money wins at contract negotiation can backfire later in unintended consequences. This requires adequate insights into how the web of subcontracted relationships work.

Also, they need to understand how fixed prices in the name of value for money can be counterproductive. By demanding fixed prices at tender when budgets are based on stripped-to-the-bone ‘should costs’ is asking for trouble, especially when the project might last three or four years. As Beth Revell puts it, “You can’t ask contractors to price the unknown and not pay a premium for it.”

According to Beth Revell, the keys to success lie in your project planning, and how you set your budget contingency. Understand current market conditions and how value might be lost, and plan accordingly. Engage with your contractors fairly and openly, and accept that good project outcomes come at the cost of retaining some of the risk.

As Revell says, “Don’t insist that contractors make promises you know they can’t keep.” Instead, embrace risks by allocating them fairly. It will breed trust that transforms projects for outstanding value.