Around the world, shared risk and reward contracts are becoming more prevalent. In the United States several forms of agreements for construction projects including: Sutter Health’s Integrated Form of Agreement (IFOA), the ConsensusDocs 300, and American Institute of Architects (AIA) contracts have provisions for sharing the profit and the losses of a construction project between the owner, contractor, architect, specialty trade contractors, and other service providers. These contracts are designed to support Integrated Project Delivery (IPD) and Target Value Design (TVD). In Europe and Australia a similar trend has been taking place under the name “Project Alliancing”. The goals of these shared risk and reward contracts are to: (1) better align the business models of the AEC service providers with the business objectives of the owner, (2) to promote early involvement and collaboration, (3) to remove barriers of communication, (4) to promote innovation, (5) to reduce the likelihood of cost overruns, and (6) minimize change orders and unnecessary litigation.
Research has shown that projects with shared risk and reward provisions that also utilized IPD and TVD have delivered products with superior quality, schedule, and cost performance relative to the industry norm. In the United States, data on TVD and IPD show that these projects are delivered 15% to 20% below market price and with fewer incidents of project cost overruns1,2. There are; however, some problems with shared risk and reward. Anecdotal evidence from TVD and IPD construction projects in the US showed that 15% of these projects resulted in the team depleting the profit and and contingency pool, thus earning 0 profit for their work3. The goal of this blog post is discuss how we can make shared risk and reward a more sustainable business practice within the AEC industry.
Making Shared Risk and Reward Sustainable
For shared risk and reward to remain a viable project delivery option, it must be sustainable3. That means that owners get value for money and at-risk service providers make an acceptable profit. Here some ways to reduce the probability of project failure:
1. Align the objectives of the entire project team, owner included, to delivering value to the owner while enabling AEC service providers to earn a fair profit.
The owner must commit to the economic success of their service providers, and likewise service providers must commit to the delivery of customer value. Only projects that achieve both value delivery and economic profit are truly successful.
2. Anchor target cost base on the business case of the owner.
A project needs to be viewed as a business investment for the owner. The role of the service providers is to assess the feasibility of the project based on the market cost and what the owner can afford to pay (their allowable cost). If the gap between the market cost and the owner’s allowable is too large during the validation process, service providers have be prepared to abandon the project or accept the risk of working for free. For this practice to work, the owner needs to share his allowable cost and business case with the project team.
3. Clearly identify the scope that is at risk and the scope that is to be performed for a fixed price.
It is a misconception that a shared risk and reward project has 100% of the project at risk. Typically 80% to 90% of the work is performed by the at-risk service providers with the remainder being performed by external members at a fixed price. For the members inside the risk pool, it is important document the scope of work that is part of the risk pool. If the scope of the at risk work changes, then the target cost should also be updated to reflect the change. Certain types of owner's changes are included in the risk pool and certain types of owner's changes are not. It is important to clearly define this boundary so that unnecessary disputes do not occur in the middle of the project.
4. Involve the right people at the ‘earliest responsible moment’ to maximize the impact on design and constructability.
Engage the craft workers/supervisors who will actually build the project to get their inputs during the design phase to avoid unconstructable design. Owner representatives on the project should also have decision-making authority to avoid problems that occur from untimely decisions.
5. Have owner and risk pool members decide which companies and individuals to include in the risk pool.
Shared risk and reward requires a high level of trust, transparency, and a working culture that is different than traditional Lump Sum and GMP projects. Not all individuals and companies are the right fit for such a project. The project team needs to be highly selective of the companies and individuals to include in the risk pool. Additionally, parties that require high degree of coordination and have major impact on the project's success should be in the risk pool.
6. Maintain shared governance throughout project execution.
Shared risk and reward requires shared governance. The profit and losses of the each individual firm is tied to the success of the project and can be negatively impacted by the actions of any uncooperative party. As a result, all companies inside the risk pool must have adequate representation and share in the responsibility of managing the project. It is not just the architect or contractor who has to manage the success of the project.
7. Use transparent productivity and financial measuring systems.
Shared risk and reward projects needs a new set of transparent KPIs that typically do not exist on Lump Sum or GMP projects. At any time in the project, the risk pool members must know the financial position of the team (i.e., expected profits, cash spent to date, burndown rates, and future expenditures) so that they can take proactive actions to ensuring a successful project delivery. During the construction phase, the team needs to share their manpower curves, productivity rates, schedule, lessons learned, etc. so that everyone can be on the same page and their actions can be in alignment with the objectives of the project.
References
1. Zimina, D., Ballard, G., & Pasquire, C. (2012). Target value design: using collaboration and a lean approach to reduce construction cost. Construction Management and Economics, 30(5), 383-398.
2. Do, D., Chen, C., Ballard, G., & Tommelein, I. D., 2014. Target Value Design as a Method for Controlling Project Cost Overrun. International Group for Lean Construction.
3. Ballard, G. , Dilsworth, B. , Do, D. , Low, W. , Mobley, J. , Phillips, P. , Reed, D. , Sargent, Z. , Tillmann, P. & Wood, N. 2015, 'How to Make Shared Risk and Reward Sustainable' In:, Seppänen, O., González, V.A. & Arroyo, P., 23rd Annual Conference of the International Group for Lean Construction. Perth, Australia, 29-31 Jul 2015. pp 257-266
