School of Engineering & Construction

5510BEQR Construction
Procurement
Week 5

Introduction procurement
strategies
 Last week
1. Introduction to RIBA Plan of Work
2. Evolution of RIBA Plan of Work & relevance to
construction procurement
3. Introduction to assessment (coursework)

3
 In this session…
• Awareness of different procurement routes
• Introduction to developing a procurement strategy

4
Procurement Options / Routes
Some of the procurement options available to a client within the
Built Environment:

1. Traditional (lump sum and re-measure variants)

2. Design and Build

3. Management Contracting

4. Construction Management

5. Prime Contracting (albeit a Traditional variant)

6. Private Finance Initiative (PFI)

Framework - not a procurement route

 Traditional
• The traditional procurement route involves separating
design from construction. The client first appoints
consultants to design the project in detail and to ensure
cost control and inspect the construction works as they
proceed.

• Contractors are then invited to submit tenders for the

construction of the project on a single-stage competitive
basis.

• Traditional procurement is typically undertaken under a

lump sum contract
Traditional
 Management contracting (MC)
• MC is a procurement route in which the works are
constructed by several different works contractors who are
contracted to a management contractor.

• The MC is appointed by the client early in the design

process so that their experience can be used to improve the
cost and buildability of proposals as they develop, as well as
to advise on packaging and the risks of interfaces.

• Management contracting can be beneficial on complex

and/or specialist projects made up of several packages
individually appointed to the best-suited subcontractor.

• This means that there is the potential for the highest-quality

of delivery.
 Management Contracting
Characteristics
• Management contractor manages the work
• The client appoints designers (consultants) and a
management contractor separately
• and pays the management contractor a fee for managing the
construction works.
• Early appointment of management contractor to work
alongside the design team to develop a programme for
construction and contribute to the design and costing of the
works.
• Management contractor to let competitively the works to
subcontractors in appropriate works packages.
 Management Contracting
Characteristics

• Overlap of design and construction

This approach often means that design and the start on site can
overlap, with the design and tender packages becoming available
‘just-in-time’ to suit the construction programme.
• Management contractor does not carry out construction but
is accountable for the work package contractors (unlike
Construction Management where the client is responsible for
them)
 Management Contracting
Characteristics

• There is less price certainty at the outset, because

construction tends to start ahead of completion of all design
stages and at a point when many of the work packages have
yet to be tendered.

• This often means that adjustments are made to the design and
specification of works packages later in the programme to keep
the project within budget.

• However, the overall process of design and construction tends to

be shorter/compact than in either traditional or design and build
situations.
3. Management Contracting
 Management Contracting
Advantages
• Parallel working
• Time saving potential for overall project time
• Buildability potential
• Breaks down adversarial barriers
• Late changes easily accommodated
• Work packages let competitively

Disadvantages
• Need of good quality brief
• Poor certainty of price
 Management Contracting
When would you use and not use this approach?
(think about the characteristics and ads/dis-advantages)

• This approach is suitable for:

– fast track projects
– complex buildings
– a developing brief

• It is less suitable for:

– inexperienced clients
– cost certainty before starting construction
– clients wanting to pass risk to the contractor
 Construction Management
• This approach is similar in concept to Management
Contracting.

• Work Package (WP) Contractors are contracted directly to

the client

• The construction manager (CM) manages the process for

the client on a simple consultancy basis.

• Therefore the CM is not accountable for the WP

contractors

• Construction Management requires constant involvement by

the client so it is really only suitable for experienced clients.
 Design and Build (D&B)
• D&B is a procurement route in which the main
contractor is appointed to design and construct
the works, as opposed to a traditional contract,
where the client appoints consultants to design
the development and then a contractor is
appointed to construct the works.

• The contractor is responsible for the design,

planning, organisation, control & construction of
work to client’s requirement.

• D&B is a single point of responsibility for

delivering the entire project.
 Design and Build
Advantages
• Single point contact and responsibility
• Inherent buildability
• Cost certainty
• Reduced total project time

Disadvantages
• Relatively fewer firms, less real competition (textbook, not
so prevalent now!)
• Client needs to commit himself before design is complete
• No design overview unless consultants appointed
• Bids difficult to compare
• Client driven changes can be expensive.
Design and Build
 Prime Contracting
JCT Prime Cost Contracting (PCC)

• PCC is a specialised, cost-reimbursable contract.

• It is generally for use only where an early start is required.

• But within that time it is not possible to define the extent

and nature of the required work sufficiently accurately to
obtain a firm lump sum price for it, or sufficiently to define
its nature to use a re-measurement contract.

• Works have not been fully designed and detailed contract

documents provided to the tenderers
 Prime Contracting
JCT Prime Cost Contracting (PCC)
• It was originally intended for use in cases of repair and
reinstatement after fire or other damage to existing
structures and for alterations and repairs to old buildings
where there are similar uncertainties as to the precise
requirements.

• But it appears to be used more widely.

• Within particular projects it may be appropriate to use it for

the first or early phases of such a project, with a lump sum
or re-measurement contract used to cover subsequent
phases, once the requirements have been sufficiently
defined.
 Prime Contracting
• It usually includes such features as:

– open book accounting: Where costs are made transparent to the

client.

– target cost pricing: where prices are agreed on the basis of a

reasonable profit for the supply team and value for money to the
client

And/or

– pain/gain share: where the Prime Contractor as well as the client

gains financially by reducing the project costs

Why would you include a pain/gain share mechanism?

New Approaches to Procurement
Examples: Cost overruns of conventionally procured projects

Guy’s Hospital
Guy’s Hospital
Outturn: £124m
Budget: £36m
Faslane Trident
Faslane Trident Submarine Berth
Submarine Berth
Outturn: £314m
Budget: £100m
Scottish
Scottish Parliament
Parliament
Outturn: £431m
Budget: £40m
Situation of the UK Infrastructure in the
1990s
• Traditionally infrastructure has been financed and managed
by governments
• Lack of investment in the construction of new infrastructure
• hospitals, schools, public buildings, housing
• Legacy of under - investment in the operation and
maintenance of existing infrastructure
• Backlog of school repairs in 1997 estimated at £7billion
• Backlog of NHS building maintenance of over £3billion
• Constrained capital budgets
 Infrastructure Provision – New Approaches
• Demand for infrastructure has been growing faster than
government funding available, particularly in emerging
economies.

• Turn to new project financing techniques/procurements such

as PPPs

• Recent trend has been to involve the private sector in the

supply and provision of services such as:
– Roads, Bridges and Tunnels, Light Rail Networks, Airports and
Airport control Systems, Water and Sanitation, Electricity
Generation, Hospitals, Schools, Prisons
PUBLIC PRIVATE PARTNERSHIP

P P P
Public Sector Partnership Private Sector

Service Requirement Service Delivery

History
• Goes back to the earliest construction in the
United States

• Used extensively in Europe and other countries

• Significant renewed interest in the 1980s

• More recent in emerging economies

Defining PPPs
• Lack of definitional clarity.
• Grimsey and Lewis (2005:346), “…fills a
space between traditionally procured
government projects and full privatisation”

• Need to distinguish PPPs clearly from

traditional procurement and privatisation, but
also from concessions.
Defining PPPs
• IMF:
– PPPs refer to arrangements where the private sector
supplies infrastructure assets and services that traditionally
have been provided by the government.

• European Investment Bank:

– PPPs are relationships formed between the private sector
and public bodies often with the aim of introducing private
sector resources and/or expertise in order to help provide
and deliver public sector assets and services.
 Defining PPPs
• Organisation for Economic Co-operation and Development
(OECD):
– PPP is an agreement between the government and one or more
private partners (which may include the operators and the
financers)

– according to which the private partners deliver the service in

such a manner that the service delivery objectives of the
government are aligned with the profit objectives of the private
partners

– and where the effectiveness of the alignment depends on a

sufficient transfer of risk to the private partners to ensure that
they operate efficiently.
Defining PPPs
• The private partners usually design, build, finance,
operate and manage the capital asset, and then deliver
the service either to government or directly to the end
users.

• The private partners will receive as reward a stream of

payments from government, or user charges (or annual
unitary charge) levied directly on the end users, or both
for 20-30 years for specified service quality.

• Government specifies the quality and quantity of the

service it requires from the private partners.
Defining PPPs

• ‘Arrangements typified by joint working between the

public and private sectors. In their broadest sense
they can cover all types of collaboration across the
private-public sector interface involving collaborative
working and risk sharing to deliver policies, services
and infrastructure.’ (HMT, Infrastructure
Procurement: Delivering Long-Term Value, March
2008)
Defining PPPs
• There is no one model for PPP. There are many possibilities.

• PPP is not a defined procurement model with a common

understanding across the world. When a project is described as a
PPP, do not make assumptions as to what that means!

• PPP is not simply a means of accessing private finance. Many

forms of PPP involve no capital investment by the private sector.

• Different models of PPP have gained popularity in different

jurisdictions.

• When reference is made to PPP, people are generally referring to

private finance models so that is what we will focus on.
Defining PPPs

• Many forms of partnerships between public

and private sectors depend on the political
environment, the nature of the assets and the
level of private sector participation.
Why?

In short, PPPs are tool that can help

governments meet demands for the development
of modern and efficient facilities, infrastructure
and services while providing value for
taxpayers.
PPPS ARE NOT STANDARDISED
INTERNATIONALLY

Each country’s approach to PPP is:

Designed to meet the policy objectives of its Government

Developed to complement other public procurement and public service delivery
methods
Implemented according to the available public and private sector resources
Tailored and Unique
 Private Participation in Infrastructure (PPIs)

• For a PPP to be successful, there has to be a clear benefit for

both the public and the private partners

• Private sector involvement requires commercial rates of return

• Projects have to lend themselves to generating these returns.

• The public partner typically gains in the sense that a desired

project is implemented without any financial strain on the
budget
Private Participation in Infrastructure (PPIs)
• In many instances, the governments receive
tax payments from the project and in certain
cases, a share of the profits.

• The structure of the partnership can vary along

from a leading private sector role to a marginal
one.
PPP model
BENEFITS
• Bring in private capital and make projects
affordable
• Budgetary certainty
• Whole life costing and synergies of
integration of DBF and M
• Maximise use of private sector skills
• Public sector only pays when services
delivered
• Quality of service has to be maintained
• Accountability
• Ensures that assets are properly
maintained
•Strong Customer Service orientation
DISADVANTAGES
• Long term relatively inflexible structures
• Procurement delays and high procurement
costs
• Loss of management control by the public
sector
• Private sector has higher cost of finance
• Does not achieve absolute risk transfer
• Requires public sector capacity and skills
that may not be available
• Potential for negative public reaction to
profit and control
 Basic PPP Model Structure – Special Purpose Vehicle
(SPV)

• An independent SPV is created to hold the project

assets and to integrate all legal contracts in an effective
and efficient manner for funding, building and operating
a single purpose project. SPV is owned by one or a few
sponsors.
 Special Purpose Vehicle (SPV)
• The legally independent project company is financed
with:
• Non or limited recourse debt
• Equity provided by one or more sponsors
• Providers of the funds look primarily to the cash
flow from the project as the source of funds to pay
back the loans (interest & principal) and to provide
the return on the equity invested in the project
• Note:
• This arrangement relies on:
• a simple cash-flow stream generated by a single
project and the collateral value of the project assets
&
• the source of the cash-flow may be a single buyer
or consumers.
Parties Involved in a PPP model
 Parties Involved

• Sponsors and Investors:

• A controlling stake in the equity of the company
will typically be owned by a single sponsor or
group of sponsors, who will generally be involved
in the construction and management of the
project.
• Other equity-holders may be companies with
commercial ties to the project including customers
and suppliers
• Financial investors may also take an equity stake
in the project (Funds)
 Parties Involved

• Lenders:
• A large fraction of the substantial investment
needed is usually raised in the form of debt from a
syndicate of banks
• Bond issues in capital markets
 Parties Involved
• Government:
• The project company will in most cases need to
obtain a concession or license from the host
government in an infrastructure investment
• The government may need to establish a new
regulatory framework, guarantee currency
convertibility, non-compete clause and provide
environmental permits
• In many cases, the project company retains
ownership of project assets (BOOs);
• In other cases, ownership of project assets is
transferred to the government at the end of the
concession period (BOTs)
 Parties Involved

• Contractors (Construction / Operating

Company)
• The main contractor of the plant (project) will often
hold a stake in the equity of the project company
• Other contractors will sometimes also hold an
equity stake, but generally to a lesser stake
 Parties Involved

• Suppliers and Customers

• Once the project facility has been built and becomes
operational, the project company will need to
purchase the supplies it requires and sell the
products and services it provides.
• The government is often the sole customer for some
infrastructure projects.
 Typical Structure of Conventional PPP(PF)

Shareholders Agreement Central/local

Sponsors License/permit
Equity Government

Multilateral/ Loan Agreement Concession Concession

bilateral Lenders Agreement
Debt Authority
agencies
Insurance
Insurers
Equipment Construction
Contractors Agreement
suppliers

Supply Off-take agreement

Input
agreement
supplier Project
Off-take
company
purchaser
(SPV)
Power/utility Operation/maintenance Agreement

Operator
 Different PPP Models

Privatisation

Buy-Build-Operate
Degree of Private Sector Risk

Build-Own-Operate

Build-Own-Operate-Transfer

Build-Lease-Operate-Transfer

Lease-Develop-Operate

Design-Build-Operate

Operation / Maintenance
Service /License
Design-Build

Government

Degree of Private Sector Involvement

 Public-Private Partnership Models

• Design-Build (DB): Under this model, the government

contracts with a private partner to design and build a facility in
accordance with the requirements set by the government. After
completing the facility, the government assumes responsibility
for operating and maintaining the facility. This method of
procurement is also referred to as Build-Transfer (BT).

• Design-Build-Maintain (DBM): This model is similar to

Design-Build except that the private sector also maintains the
facility. The public sector retains responsibility for operations.
 Public-Private Partnership Models (Cont.)

• Design-Build-Operate (DBO): Under this model, the private

sector designs and builds a facility. Once the facility is
completed, the title for the new facility is transferred to the
public sector, while the private sector operates the facility for a
specified period. This procurement model is also referred to as
Build-Transfer-Operate (BTO).

• Design-Build-Operate-Maintain (DBOM): This model

combines the responsibilities of design-build procurements
with the operations and maintenance of a facility for a
specified period by a private sector partner. At the end of that
period, the operation of the facility is transferred back to the
public sector. This method of procurement is also referred to
as Build- Operate-Transfer (BOT).
 Public-Private Partnership Models (Cont.)

• Build-Own-Operate-Transfer (BOOT): The government

grants a franchise to a private partner to finance, design, build
and operate a facility for a specific period of time. Ownership
of the facility is transferred back to the public sector at the end
of that period.

• Build-Own-Operate (BOO): The government grants the right

to finance, design, build, operate and maintain a project to a
private entity, which retains ownership of the project. The
private entity is not required to transfer the facility back to the
government.
 Public-Private Partnership Models (Cont.)

• Design-Build-Finance-Operate/Maintain (DBFO, DBFM or

DBFO/M): Under this model, the private sector designs, builds,
finances, operates and/or maintains a new facility under a long-
term lease. At the end of the lease term, the facility is transferred to
the public sector. In some countries, DBFO/M covers both BOO
and BOOT.
 Public-Private Partnership Models (Cont.)
• PPPs can also be used for existing services and facilities in
addition to new ones.

• Some of these models include:

– Concessions: The government grants a private entity exclusive
right to provide, operate and maintain an asset over a long
period of time in accordance with performance requirements set
forth by the government.
– The public sector retains ownership of the original asset, while
the private operator retains ownership over any improvements
made during the concession period.
 Public-Private Partnership Models (Cont.)
• Service Contract: The government contracts with a
private entity to provide services the government
previously performed.

• Management Contract: A management contract

differs from a service contract in that the private
entity is responsible for all aspects of operations and
maintenance of the facility under contract.
 Public-Private Partnership Models (Cont.)
• Lease: The government grants a private entity a
leasehold interest in an asset. The private partner
operates and maintains the asset in accordance with
the terms of the lease.

• Divestiture: The government transfers an asset,

either in part or in full, to the private sector. Generally
the government will include certain conditions with
the sale of the asset to ensure that improvements are
made and citizens continue to be served.
 Main characteristics of PPPs

• Private sector is given responsibilities for one or

more of the following tasks:
– Defining and designing the project

– Financing the capital costs of the project

– Building the physical assets (road, bridge)

– Operating and maintaining the assets in order to deliver the

product/service

– Significant risks is transferred from the government to private

sector
 Transport Education

PPP COMMON SECTORS

Prisons Health
 Also
Also
•• Housing
Housing
Defence Leisure
•• Courts
Courts
•• Technology
Technology
PPP COMMON SECTORS (CONT’D)

Government Offices Waste Treatment

 Delivery on time and on budget
2008 85% +
On time On budget
2005 80%

45% +
On time On
budget 30%

COMPARISON WITH CONVENTIONAL

PROCUREMENT
PFI - EVIDENCE Conventional
Procurement

Performance of completed projects

Source: National Audit Office – UK Parliament – Expenditure Auditor
PPP and Risk
• PPPs involve a range of risks:
– Construction risks: relate to deign problems,
building cost overruns and project delays
– Financial risks: variability in interest rates, exchange
rate and other factors affecting financing costs
– Availability risks: relate to continuity and quality of
service provided and in turn depend on “availability” of
an asset
– Demand risks: relate to ongoing need for the service
– Residual value risk: relate to future market price of
assets
Prerequisites for PPPs Success

• Political commitment
• Good governance
• Government expertise
• Effective Project Appraisal and Selection
 PFI – Private Finance Initiative
• PFI is a procurement mechanism by which the:
– public sector contracts to purchase quality services on a
long-term basis
– so as to take advantage of private sector management
skills
– incentivised by having private finance at risk.

• This includes concessions

– where a private sector partner takes on the responsibility for
providing a public service
– including maintaining, enhancing or constructing
necessary infrastructure.

• Private investment implies that the level of government

borrowing falls and that risk is transferred from the
public to the private sector.
 PFI – Private Finance Initiative
• The Private Finance Initiative was introduced by the
Conservative Government of John Major in 1992, by the
then Chancellor of the Exchequer, Norman Lamont

• The primary objectives were to

– encourage private investment in major public building projects
(e.g. schools, prisons, hospitals and roads).
– bring private sector ‘efficiency’ to projects which have traditionally
been public sector (e.g. schools, prisons, hospitals and roads).
– increase the number of capital projects at a time when public
expenditure is being restrained.
– transfer risk from public sector to private sector
PFI – Private Finance Initiative
• “The role of Government is to make policy, not provide
services” – Quote from UK Conservative Government
1992

• If we consider a School – the Government’s role is to

ensure that children receive an education.
– Why do they need to own the School buildings?
– Why do they need to employ non-teaching staff?

• PFI is about a private sector consortium building and

operating the School – the education dept. using it.
 PFI – Private Finance Initiative
• PFI: How does it work?, for example in the NHS:
– A private consortium pays for a new hospital
– The consortium usually consists of:
– construction company
– a bank or financier
– a facilities management contractor
– consultants

– The local NHS trust then pays the consortium a regular fee for the use of the
hospital
– Which covers:
– construction costs
– the rent of the building
– the cost of support services
– and the risks transferred to the private sector

– Thus, in essence most new NHS hospitals will be designed, built, owned and
run by a consortium or grouping of companies.

– The NHS will employ some of the staff, mainly doctors and nurses

– The NHS will rent the building and other facilities from the consortium for at
least 25 years.
 PFI – Private Finance Initiative
Advantages
• Ability to implement projects earlier than would have been possible
under the affordability constraints of a conventional
procurement
• PFI can incentivise contractors to deliver projects and their
associated benefits more quickly
• Recognising the design benefits such as the use of innovative
materials and construction technologies

• More public buildings can be procured under PFI arrangements

• It allows the raising of capital that would not otherwise be available

• There is a risk transfer to the private sector which means that the
public sector is no longer responsible for cost overruns

• The private sector expertise is harnessed to improve efficiency

PFI – Private Finance Initiative
Disadvantages

• The bidding process are expensive

• Therefore, possibly anti competitive

• In such circumstances, consideration should be given to

refunding the unsuccessful bidder’s costs

• Problems with service level arrangements and quality of

service provided by the consortia

• Measuring the performance of the contract can be

problematic
 Framework Agreements
Framework Agreements are not a Procurement Option

• A framework agreement is an agreement with

suppliers to establish terms governing contracts that
may be awarded during the life of the agreement.

• Framework agreements are used typically where an

employer has a long term programme of work in mind
and is looking to set up a process to govern the
individual construction or supply packages that may be
necessary during that framework term.

• Framework agreements set out terms and conditions for

future separate contracts
 Example of a Framework
Agreement
Framework Agreements are not a Procurement Option

70
Framework Agreements are used
by:
Clients who have major construction spending over a period
of time would consider a framework agreement with supply-side
partners to:

• Reduce transaction costs

• Implement a programme of continuous improvement

with contractors

• Reduce risk of uncertainty

• Reduce Costs (learning curve?) = Better Value

Framework Agreements are not a Procurement Option

 Framework Agreements
Advantages

• No ad-hoc procurement, advertising costs lower

• Long term relationships – builds trust

• Improved efficiency, therefore less waste

• More potential for continuous improvement

• Lessons transferred from project to project

• Efficient teams kept together

• Continuity of work for supply side

 Framework Agreements
Disadvantages

• Difficult for new firms to get work

• Difficult for smaller firms to get work

• High setting up costs

• Usually open book accounting

What is open book accounting?

- Open-book accounting is a method of procuring work under which
contractors are reimbursed on the basis of transparent records of the
costs they have incurred.

– Client knows all the contractor’s costs and margins.

 Q&A
1. Any questions
2. Next session – tutorial + assessment support
3. Next week – more details on procurement
strategies

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