How to reduce risks in contractors' management
Hiring contractors in construction projects can significantly increase the execution risks, if some essential measures are not taken by the project management team. Instead of transferring, the contract risks to the contractors, in practice, the construction company ultimately ends up assuming new responsibilities and risks that are not always evident. This paper presents some actions that project managers should take to avoid or reduce the risk exposure in construction projects that use the work of contractors.
Hiring contractors for construction projects is, today, the most common way of executing construction work. However, hiring a contractor without clear and specific rules will significantly increase the project execution risks. Many project managers are not aware of all the risks they are taking, and therefore, fail by not taking preventive actions.
This paper presents some actions that should be executed by the project manager to avoid or reduce, in a proactive way, the risk exposure when hiring contractors for project execution and enhancing the project performance through better contract administration. In practice, the traditional lack of time for adequate contract planning forces the project manager to make contracts with contractors without a detailed scope and a good evaluation of the proposal. As a result of not investing the time in planning, the usual problems appear: schedule delays, projects finishing overbudget, and contractors claiming extra.
The main objective of this paper is to provide some steps that can be immediately followed by a project manager of any kind of construction project to reduce the contracts´ risks, to facilitate the contract administration, and improve the expected results.
Contractors – One of the Main Sources of Problems on Construction Projects
Even though hiring contractors to execute construction projects of all kinds is a common practice, there are many problems for the contracting companies. However, the contracting companies are not always prepared to actively limit these risks. Not much attention is given towards preventing common problems, and project managers end up responding reactively, which can then cause significant financial losses for the contracting company.
The most frequent risks faced by the hiring company are:
- Fiscal and labor risks;
- Accidents on the job site;
- Delays in project execution and surpassing the project budget;
- Risk of receiving a product of low quality/durability; and
- Risk of not receiving a warranty from the contractors.
When contracting another company to execute part or all of a project, it’s not possible to transfer 100% of the risk. The ultimate responsibility remains with the hiring company, and the same is true for promises made to the final client. It’s rarely possible to transfer fines to the contractors, or transfer costs for extensive repairs and/or delays which might occur.
Without preventative action against risks, the planned profits from the contract can easily turn into huge losses to the hiring company. To guarantee the advantages of partnership with contractors, the hiring company must do the preparation for the entire contract process, paying special attention to the documentation done by the sub-contractor candidates and to creating a good risk response plan.
How to Prevent Risks
Two factors are fundamental in preventing the risks that arise when a contractor is hired: the contracting policies of the company and the attitude of the project manager. The contracting policies of the hiring company can cause many constraints in the project manager’s work (e.g., many companies always hire the contractors that offer the lowest prices, without analyzing their structure or experience). Changing the company’s policies is difficult, because it depends on the level of influence and autonomy of the project manager inside the organization, but a preventative attitude against risks during the contracting process is his/her obligation. The project manager plays a decisive role during the contracting and management of contractors, and therefore must always use the best practices that can help to reduce risks.
Based on the procurement management processes in A Guide to the Project Management Body of Knowledge (PMBOK® Guide – Third Edition) (Project Management Institute [PMI], 2004), it is possible to suggest four steps that can help a project manager with the efficient management of contractors:
- contract planning,
- contractor selection,
- contract administration, and
- corrective actions.
These four steps will be further elaborated in the following:
Contract Planning – Take the Time to do it Right
One of the first problems faced by a project manager when hiring a contractor is also often one of the biggest obstacles throughout the whole project: lack of time! Many times the construction needs to start instantly after the signing of the contract, obliging the hiring company to select only those contractors that can start immediately. As many companies do not have an updated list of prequalified contractors, this lack of time in the initial preparation can cause failure in the contracting.
To start a contract off the right way, it’s first necessary to reserve enough time to prepare the contracting process. It’s necessary to define what exactly will be contracted and in which way, to decide how many contractors will be asked to give a quotation, and to prepare the detailed scope that will accompany each one of the contracts. It’s also important to define in good time the selection criteria for the contractors (cost, structure, good references, documentation) and the requirements that will be demanded from each company.
This time, which is necessary at the beginning of the contracting process, is an investment of the hiring company for risk prevention. Many times, hiring the first contractor available to begin immediately seems to be the only way out for the project manager, but the results of this practice show that things do not work out that way. Contractors hired in this manner hardly ever meet the real needs of the company and, hiring a contractor in this way is no guarantee that your project will be delivered on time. Contract planning is essential to a successful partnership, and during the contracting process, the project manager must stick to the selection criteria established during planning.
Selecting Contractors – Use Your Planned Criteria
Once the scope is defined and the selection criteria agreed, the moment of hiring the contractors comes. Beginning with the contractors’ proposals, the project manager and his or her team must select the contractors based on the advantages and risks that each one can bring to the project. A necessary part in evaluating a contractor is to review:
- The documentation of the company and employees,
- Good references of past work,
- Price, and
- Company structure
Hiring a contractor without their documentation (of the company and employees) in order can cause the failure of the project. Labor disputes and legal battles can cause serious losses to the hiring company. Should the contracted company be remiss in any of its requirements, it ultimately reflects back on the hiring company, so it’s necessary to take care, verify the contractors’ documentation, and keep an updated registry throughout the whole project.
It’s also important to check the references from previous work by the contractor: (1) to see if any of their previous work was similar in size, complexity and quality of finish to the current project; and (2) to certify that the relationship between the contractor and the contracting company was good and, in particular, find out if the contractor gave assistance and guarantees in cases of construction issues.
The contractor’s price should not be treated as the only criteria for the contracting process. It is certain that the price is important and that a project manager will always be trying to get the best financial result for his or her company. Normally, the problem is that the price ends up being the ONLY criteria used in practice when hiring contractors. The hiring company believes that the savings from the lower price compensate for the risk taken—a decision that’s often wrong. According to Choma (2005), hiring the cheaper contractor is rarely the low cost solution.
Together with the analysis of the price proposals, the contractors themselves must be evaluated. A contractor without an adequate structure may not have the proper conditions to execute the contract on time and with the expected quality. The hiring company must, therefore, give more weight to the contractors with the most adequate structure: sufficient and trained labor, appropriate equipment, and trained technical personnel. In the majority of situations, it’s worthwhile to pay a bit more upfront in order to have a better contractor who’s able to execute the contract as specified, without causing problems that can cause large losses during or after the project execution.
Contract Administration – REALLY be in Control
Once there is a well-detailed contract with all the conditions agreed, the work starts up on the job site. From now on, the project manager has the responsibility of making the contractors fulfill everything that is in the contract, applying all of his or her efforts to manage the contract as best as possible. One of the few things that the project manager knows for sure is that things will change, and it might be necessary to change the contract during the execution of the project.
In order to control the contract (and the project), good planning is essential, and this will be discussed more specifically in the next topic. Assuming that adequate planning has been done, the project manager and his or her team work to follow the contractors’ performance closely, comparing it to the contractual requirements. Different events can happen: project milestones are not met, triggering penalty clauses against the contractors; and design modifications or change requests from the final client can occur. These can cause alterations to the project scope, time, and cost. For that reason, the project management team must constantly be aware of all changes and keep the contract synchronized with the actual work been completed on the job site.
Another aspect needing attention throughout contract management is communication. The project team must have a communication plan and be using it all the time. The official communication channels must be evident, as well as which individuals have responsibility within the different teams involved. The project manager must be constantly aware that information exchanged through official channels has the possibility to impact the contract, and therefore, must be closely tracked.
Beyond the attention given to the project time, cost, and quality, it’s also necessary to follow the contractors’ documentation throughout the execution to avoid surprises, such as future legal problems. This documentation has a huge impact on the project’s success, and in some countries it must remain on file for up to 20 years.
To be in control of the contract means to closely follow the contractors’ results, in order to note any deviation from the plan and to regularly perform trend analyses. To correct deviations, the project manager must decide which actions will bring the project back to what was planned.
Corrective Actions – Take Actions Based on Trustworthy Data
How can one determine which actions are necessary to put the project back on track? Closely follow the results obtained from the contractors, comparing them to the contract and to the project schedule. Because of an insufficient planning capacity in the majority of contractors, the general contractor is obliged to keep close control of the contractors’ work and try to anticipate any problems.
Following the productivity of the contractors’ workers is not the responsibility of the general contractor’s team, but we know that this is often necessary because few contractors have real control over the productivity of their workers. The biggest problem is that many general contractors do not prepare the planning structures necessary in order to closely follow the contractors’ work. This practice can make the hiring company only notice a problem when an important milestone is not achieved on time.
Based on the project plan and scope of the contract, the project manager needs to anticipate problems by meeting regularly with the contractor to decide together, if necessary, what corrective actions must be taken. The action plans that result from these meetings must be followed by the project management team to ensure their effectiveness. Contractors who repeatedly do not follow the stipulated plan must have their contracts reviewed and, depending on the evaluation, their contract could be rescinded.
Planning and Control – There is No EFFECTIVE Management without EFFECTIVE Control
The contractors’ work plan is the basis for contract control, that is, there is no effective control if there is no planning. After deciding on the final construction schedule, the main deadlines are put into the contractors’ contract as constraints to guarantee that the most important stages of the project will be delivered on time to the general contractor. Performance and productivity goals are also specified in order to facilitate the control of project execution.
Periodically, the project management team must update the project controls, calculate the actual performance index, and compare it to the project plan. The frequency of these updates will depend on the length and type of the project, but usually a weekly update is enough. With the deviations identified, the project manager must meet with the contractor and define the strategy for correcting the problems and bringing the project back in line with the plan.
To reduce the problems that can result from the contractors’ lack of management expertise, the project team can help with problem identification (e.g., low productivity) and propose problem solutions in order to guarantee that the project will succeed in meeting the contractual requirements. This additional planning effort by the general contractor will be compensated for by the reduced risk to the construction project as a whole, and by ensuring better control of the contractors’ actions.
It is also important to remember that the planning phase does not end when the construction starts; all control actions generate action plans that must be followed and carried through. If the risk impact is big, or if the risk exposure of the contract changes during the project execution, probably the project plan will need to be changed. The project management team must stay alert, keeping project information and the project plan “alive” all throughout execution, so it’s available, and therefore, useful for control actions.
What is, therefore, understood by effective control? Following the contractors’ work closely, utilizing an up-to-date project plan, with detailed up-to-date performance information from the job site.
Critical Success Factors
To successfully reduce risk in any project, the following factors must be considered:
- Paying attention to project planning and control: We have already touched upon the importance of project planning as it relates to contract control, but the culture of ABSOLUTELY no planning is so strong in some kinds of construction projects, that its importance cannot be overstated. The general contractor must have, at a minimum, a performance baseline (productivity, quality criteria) written into the contract where it specifies the demands which the contractor must fulfill during project execution. Deadlines for specific work and dates for key milestones throughout the project life cycle must be stipulated, demanding a high level of organization from the general contractor.
- Establishing a process for hiring contractors: Hiring contractors cannot happen in a haphazard way. To standardize the company’s hiring process, it is necessary to establish a procedure that stipulates the steps that must be followed to guarantee that the contractor is qualified to do the work on your job site. This is essential to avoid at least two serious problems: hiring contractors based solely on price and allowing contractors to begin work before having delivered all the required documentation.
- Commitment of senior management: As discussed in the previously, hiring contractors based solely on price is a dangerous practice, and much of the time it is a practice dictated (or encouraged) by the company’s senior management. While internally lip service may be given to the value of the contractor’s structure and quality, in practice they are put aside, and the hiring company bases its analysis on the contractors’ price. Without strong support by senior management for risk reduction processes, the project results can be seriously damaged.
- Active risk management: Risks constantly change during project execution and, the longer the duration of the project, the higher the chance of changes and the greater the need for modifications to your planning assumptions. A missed milestone can make evident a new risk, just as can a contractor failing to deliver required documents during project execution. The project team must be ever alert to such situations in order to keep risk management alive.
- Using historical data and lessons learned: All projects face difficulties, and each experience should be shared with the other professionals in the company. In this way, the company can “learn” how to hire contractors, taking fewer risks. This learning manifests itself as improvements in contract administration and the contracting process. Information effectively disseminated within the company can prevent common risks from occurring again. Systems for keeping and transmitting lessons learned throughout the company are essential for improving results when managing contractors.
What can a company gain by using these best practices in the hiring and management of contractors’? The benefits are many:
- Reduced liabilities: Badly done or poorly managed contracting can cause serious losses for the hiring company. Labor problems and other legal issues can result in financial loss and put the hiring company in a delicate market position.
- Improved financial results: Reducing liabilities, combined with the practice of hiring the best qualified contractors to perform the contracted work, can reduce the risk of financial loss caused by problems with the work force and improve the chances of completing the project according to the requirements of the contract.
- Higher quality of construction execution: By using contract planning and control systems, the general contractor is much better able to identify, early in the project life cycle, deviations from the contract baseline. A well-planned and controlled construction job has a much greater chance of achieving its goals.
- Standardized hiring process: By establishing a process based on best practices in managing and contracting contractors, the general contractor will guarantee standards for the contracting procedures. This should result with the verification of the required documentation and should guarantee that none of the initial steps (like verifying the contractors’ references and structure) are left out.
- Technical and legal integration: For the contract to truly match the required scope, it is essential that the technical and legal teams of the company are in agreement. The lawyers alone may elaborate complete and complex contracts, but may only consider the legal aspects. Without a complete scope definition from the engineering team, and without specific references to design documents and other necessary technical documentation, the value of the contract is questionable. For a contract to be complete, and to serve its purpose, it is necessary to give equal importance to both the technical scope and the legal aspects.
- Internal exchange of best practices: If properly organized, it is possible to create structured ways to encourage the exchange of professional experiences within the company. Small internal seminars can be organized to focus on specific case studies, and the documentation from these sessions can help the company internalize the knowledge acquired throughout the years.
- Procurement Audits: According to the PMBOK® Guide (PMI, 2004), a procurement audit is a structured analysis of the entire procurement process, from procurement planning through the end of contract closeout. The objective is to identify successes and failures. These can then be used as a basis for developing better practices in future contracts. The company should always take advantage of every opportunity to disseminate the best practices internally and avoid, as much as possible, the reoccurrence of risk situations that have already happened in previous projects.
- Development of your subcontractors: Many general contractors hope in vain that their subcontractors will invest in training, or that their competitors will train the subcontractors and that they can benefit from that qualified labor pool, but this never happens. The work of planning and controlling a project together with your subcontractor, having them participate in decisions, and helping to identify alternative solutions for on site problems, the general contractor begins slowly to train the subcontractor in the better management of his work. In the extremely competitive market of today where it is so difficult to find qualified subcontractors, an investment in the training of your good subcontractor partners is essential.
- Heightened awareness of risks: By creating a better working relationship between the general contractor and the subcontractor and utilizing good management practices and effective legal support, the project leader will have a heightened awareness of the possible risks and their consequences, be it for the project and/or the company. Awareness of the risks entailed in your project is the first step towards acting to avoid them.
For the process of hiring subcontractors not turn into a torturous experience for the general contractor, the project manager, together with his or her team, need to give them adequate time in order to complete the hiring process correctly. Not following some of the essential steps before hiring subcontractors, can significantly increase the risk exposure of the project. A result of poorly made subcontractor agreements is that some of the most damaging financial problems can appear long after the project has been delivered, via labor disputes, quality problems, etc. Adopting a mindset of prevention towards contractual risks is an obligation of the project manager; his or her company needs to give him or her the necessary support and avoid that subcontractors are selected, in the end, solely because they are the low cost provider.
Choma, A. A. (2005). Como gerenciar contratos com empreiteiros [How to manage contractors – 2nd ed.]. São Paulo, SP/Brazil: Editora PINI.
Project Management Institute. (2004). A guide to the project management body of knowledge (PMBOK® Guide) (3rd ed.). Newtown Square, PA: Project Management Institute.
© 2008, Andre Augusto Choma, PMP
Originally published as a part of 2008 PMI Global Congress Proceedings – Denver, Colorado, USA
This standard focuses on the “what” of risk management, including: core principles; fundamentals; and life cycle.