Project Management Institute

Constructive negotiation

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In construction, technical execution difficulties offer consistent project challenges, and the best way to reduce the inherent risks is to negotiate responsibilities upfront.

BY VIRGINIA FAIRWEATHER

Escalating costs and crippling delays are the conjoined twins of construction: They are inextricably entwined. Knowledge-sharing and clarity are critical before project execution begins. If costs and schedule are not tied together in detailed planning meetings between the owner and the project team, “damage limitation is often all one can achieve,” says Paul Fanthom, senior project manager with Project Management Inc., Dublin, Ireland.

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The contract included a “stop-point” at which all parties looked at whether the projected [student-body] growth had occurred. If not, they could scale the work down.

DAVID O'MALLEY, DIRECTOR, OCTA ASSOCIATES, DUNEDIN, NEW ZEALAND

Fanthom works with contractors to identify possible problem areas and to develop action plans that can be instituted later. The project team looks at the possibilities of labor shortages, strikes, late shipments of supplies and other common risks, then constructs action scenarios to keep the job progressing. Contractors should have a sufficient contingency in the project budget and schedule to deal with unforeseen risks, he says, adding that weekly workshops early in the process helps project managers understand exactly what the client wants. Fanthom says the owner's priorities need to be spelled out clearly—and often.

Standard contracts in Ireland include a provision for the contractor to claim remuneration for inflation on materials and labor. This provision mitigates the contractor's risk, but increases risk for the owner. Fanthom prefers to negotiate a fixed lump sum in return for no future claims related to inflation.

Octa Associates, Dunedin, New Zealand, uses several tools that enhance communication and shared knowledge well before a project begins. A textbook example is the firm's project management for a library and information services operation at the University of Otago, Dunedin, New Zealand.

David O'Malley, Octa Director, says they coordinated the client-consultant interface over the two-year project briefing, which began with focus groups composed of owners’ representatives and designers. The groups’ findings resulted in an overall vision statement for the work, which was in turn used as the basis for the detailed design plan. O'Malley says different building layouts were considered against the vision to get the best design that met the owners’ needs for the allotted budget.

Octa prequalified prospective contractors, and O'Malley says the firm used this exercise to test its construction strategy, getting feedback from experienced builders. This approach gave the bidders project details before final tenders that helped them plan a construction approach. The materials marketplace also had an early heads-up, and suppliers had time to suggest some cost-effective options.

Octa's construction strategy for the project included staging work to maintain the number of student spaces over the three-year construction period and to provide for student-body growth. The contract included a “stop-point,” at which all parties looked at whether the projected growth had occurred. If not, they could scale the work down.

Octa communicated closely with contractors and designers to take corrective action before overall objectives were threatened. In the end, the NZ$35 million project was completed on time and with about $1 million of scope items included in the budget.

Cost estimations are crucial: The contractor must know how to bid, and the owner must approve the work cost. Munich, Germany-based project management consultant Andreas Lowinger advocates a three-point estimate method. As soon as the work breakdown structure is set, project experts formulate estimates, using scenarios of optimistic, likely and pessimistic to develop a range of cost estimates. The three values (per work-package) are summed up for the whole project—the overall estimated effort/cost for the project. A useful tool in negotiations, the variations calculate the standard deviation, which measures the accuracy of the estimate.

Checking the Contractor

Prequalifying contractors is becoming more popular. Bruce Brownell, a consultant with Muskego, Wis., USA-based BCMS Inc., like Octa, works only with contractors prequalified on the basis of experience in the industry and past performance. He also favors “negotiated bids” as a cost-control tool, as opposed to fixed-price bids. After he reviews the bids, he separately invites one or two low bidders to a scoping and award session at which they discuss the contractor's schedule, staffing and capabilities, in addition to the price. A checklist is used to guide and record the discussions. When accord is reached, and they are certain all parties are “seeing oranges to oranges,” the contract is signed.

Brownell mostly consults for the brewery industry, in which processing plants are designed under pressure and marketing departments set immovable deadlines, he says. Prequalified contractors are more likely to know the kinds of changes that occur in this industry and can estimate the price of various fixes and negotiate their final bid on that basis. With a fixed-price bid, change orders with price tags are inevitable. In the worst case, the owner paid on a time-and-materials basis to keep the contractor on schedule, he says.

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UNDERESTIMATING COSTS: A GLOBAL PHENOMENON

Although costs offer a frequent point of conflict in construction projects, they have been systematically underestimated worldwide for about 70 years, according to a study conducted by Bent Flyvbjerg of Aalborg University in Denmark. His study of 258 transportation projects, published in the American Planning Association's Journal last summer, presents some startling numbers. For these projects in 20 nations and five continents, planners had estimated costs 28 percent lower than the actual costs. In nine out of 10 transportation projects globally, costs were above those estimated.

Flyvbjerg posits several reasons. One is “appraisal optimism,” or the desire of participants to think the project will work. Public agencies have to generate a favorable cost/benefit ratio to successfully compete for funds. Self-interest is another possible factor. Engineers want to build, and politicians have “monument” complexes. He concludes that this “strategic misrepresentation” occurs for projects of all kinds.

Paradoxically, the transportation sector is exactly where a brand new cost- and risk-estimation technique is being used for the first time. The cost estimation validation process (CEVP) was developed by the Washington State Department of Transportation (WSDOT), working with outside consultants, including John Reilly, John Reilly Associates International, Framingham, Mass., USA. One CEVP catalyst was a package of publicly funded transportation projects with a potential $30 billion price tag. WSDOT needed to present realistic and accurate total cost ranges to make the proposed 10-year construction plan palatable to voters, says Jennifer Brown, WSDOT cost/risk manager.

In Washington, the CEVP began with a week-long workshop of invited experts from the public and private sectors who identified base costs and schedules and then incorporated defined risks and opportunities. Their data was run through a Monte Carlo simulation that does about 1,000 iterations to produce the probable ranges of costs and schedules. Estimates of the CEPV cost are about 1/100 of one percent of the project costs, Reilly says. The experts’ up-front estimates convince voters and the designers and contractors who work on these projects that the owner has a realistic fix on the costs. This new tool should minimize conflict and negotiations later on.

Risks can include anything from code changes to earthquakes. Reilly's own study shows the owners’ expertise and policies and the local procurement procedures that most directly influence success or failure of a project.

LAY DOWN THE LAW

While a standard construction contract clause requires a contractor to give the owner a monthly progress report, the clause often is ignored or, at best, its importance is underestimated, says Robert A. Rubin, partner in Postner & Rubin, a New York, N.Y., USA-based construction law firm. He says owners can strengthen the clause by adding a substantial monetary penalty for failure to deliver the report. Similarly, contractors can add such penalties in contracts with their subcontractors.

How can you prevent a construction snag that hasn't happened yet? Partnering and dispute review boards (DRBs) seek to prevent problems through an informed early warning system, says Sherrill McDonald, professor and lecturer of engineering and project management at the University of California, Berkeley, USA. In partnering, a facilitator helps project participants to look at the stakes well before construction begins to share knowledge and, ultimately, to develop a common vision. Partnering sounds simplistic, he says, but when it works, people do get to a “higher level” of understanding and trust.

With a DRB, the project's owner and the contractor each select a representative, a respected member of the construction industry. These two board members then select a third objective party and meet early in the planning stages as well as during construction. Ideally, this trio of disinterested experts should anticipate potential problems and formulate solutions. The owner and the contractor agree to abide with the DRB's decision beforehand.

F. Michael Babineaux of the FedEx Corp., Memphis, Tenn., USA, also prefers prequalified contractors and vendors. He uses a criteria references evaluation method that determines and weights the requirements, sets up a scale to rate suppliers against those needs and multiplies each criteria weight by the supplier rate. When all “weighted-and-rated” scores for each supplier are added, he offers the contract to the highest-scoring bidder.

When contractors submit proposals, they must include a plan as to how they will achieve on-time performance. Typically, part of this plan is having a dedicated project manager at the site at all times. During the negotiation and selection process, FedEx may look at where one contractor is stronger or weaker and negotiate improvements. If a contractor gets the contract but fails to perform, the project manager and the contractor meet to find ways to get back on schedule, Babineaux says. Failure can result in a financial penalty. For design services, he says, the criteria might be different, but the method is the same.

Shifting Responsibility

The total cost devoted to project management is getting smaller and smaller, according to Dan Cooprider, CPM Inc., Denver, Colo., USA. Contractors on large projects are shifting the project management responsibility to subcontractors, thereby reducing their own overhead and pushing the project management responsibility to others. This doesn't work, he says.

Any large project must be broken down into as many packages as possible, says Cooprider, noting that constructability reviews must be conducted as early as possible. In these exercises, the contractor determines how and if a design can be built. Multiple packages with multiple project managers make the project more complex but give the owner ultimate control, which poses a subtle threat to contractors, he says. If one fails to perform—if work slips or costs rise—another contractor takes over. When the owner is locked in with one contractor, there is no recourse.

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Multiple packages with multiple project managers make the project more complex but give the owner ultimate control, which poses a subtle threat to contractors.

DAN COOPRIDER,
SENIOR PARTNER, CPM INC.,
DENVER, COLO., USA.

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If a contractor gets the contract but fails to perform, the project manager and the contractor meet to find ways to get back on schedule.

F. MICHAEL BABINEAU X,
SENIOR BUSINESS SPECIALIST, STRATEGIC SOURCING AND SUPPLY CHAIN MANAGEMENT, FEDEX CORP.,
MEMPHIS, TENN., USA

For example, Cooprider cites a problem job that was resolved only after a lengthy and contentious meeting. The project manager delivered an ultimatum to one contractor: If he did not perform by a fixed time, the whole job would go to another contractor. Cooprider emphasizes that the owner must retain control, and the work must be split in a fair and equitable manner. Sometimes conflicts arise when one contractor wants a larger share of the pie, arguing that they have the best capability. The best tool is to explain simply the business decision behind maintaining the owner's control, says Cooprider. “Most reasonable contractors will accept that logic.” PM

Virginia Fairweather is co-author of Construction Claims: Analysis, Defense and Presentation, Third Edition [John Wylie, 1999] and former editor-in-chief of Civil Engineering, the monthly magazine of the American Society of Civil Engineers.

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI.

PM NETWORK | MARCH 2003 | www.pmi.org
MARCH 2003 | PM NETWORK

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