Construction procurement guide: contract systems

A documented design contract may be appropriate for projects where:

• design quality is critical and the agency wishes to control the design process and be involved in selecting, engaging and directing the design consultants
• the agency has the skilled resources required to manage the design process
• the design parameters are likely to change as the design develops
• the optimum design can be developed without involving the prospective builder/contractor or specialist subcontractors, or
• there is enough time available within the project program for the detailed design to be completed before tenders for the work are called.

A documented design contract offers the following benefits:

• the agency maintains the maximum control over all phases of the design, and is able to ensure its requirements are incorporated
• if the agency changes its requirements during design process, the project cost increases will not include the cost of delays to the construction contractor
• tender prices do not need to allow for design or other project risks
• tendering and tender evaluation costs are relatively low
• the pool of suitable tenderers is maximised, increasing competition and the likelihood of obtaining value for money
• the contractor assumes the construction risks.

A documented design contract has the following risks:

• agency personnel have flexibility to change the project brief during the design process, which can result in additional costs or delays
• delays during design will delay the project, since construction cannot commence until the design is completed
• the volume and complexity of the tender documents increases the risk of errors and omissions that can give rise to variations and associated additional costs and delays.

Projects suited to a DD&C contract are those where:

• the agency wishes to determine the concept design
• there is a significant risk of delays or changes to project scope as issues are resolved with stakeholders or investigations are completed, and the agency is best placed to manage these activities
• the requirements for the developed design can be clearly described, for example through established standards for products and materials, details and finishes
• a fully developed design would introduce risks associated with buildability or the coordination of design and construction
• there are proprietary designs or construction processes that may offer advantages over special one-off designs, or
• the agency does not have sufficient time to manage the design to completion.

A DD&C contract offers the following benefits:

• the agency is able to substantially determine the concept and functional design before a contract is awarded, reducing the likelihood of contract variations
• the contractor has flexibility to incorporate innovations and improve buildability through the design development, potentially saving costs
• the contractor assumes responsibility for the fitness for purpose of the finished product, buildability of the detailed design and usually latent conditions
• project time targets can be maintained by starting construction prior to finalisation of detailed design, if necessary, at the contractor's risk
• tender prices do not need to include allowances for the risks of performing extensive investigation work or interacting extensively with outside authorities
• the risk of contract claims due to errors and omissions in the design is reduced.

A DD&C contract has the following risks:

• if the design documents supplied by the agency are unclear or in error, the desired outcomes may not be achieved without disputes over interpretation, variations and additional expense and delays
• changes to the agency’s requirements during design development are likely to be costly, due to their potential to impact on the contractor's work and program
• tender prices are likely to be higher to allow for the contractor’s increased risk
• the number of potential competent tenderers is less and tenderer interest may be reduced due to the higher cost of tendering, resulting in higher tender prices.

A DN&C contract is suitable where:

• the agency wishes to control the concept design
• the project has special design needs
• there is significant extra benefit in making the contractor responsible for all design and documentation, and giving the contractor full access to the original designer and its knowledge of the design issues, or
• the specification for the developed design can be clearly described, for example through established standards for products and materials, details and finishes.

A DN&C contract offers the benefits of a DD&C contract plus the following:

• there is continuity of the designer“s involvement in design and documentation, reducing the risk of the completed design not meeting the agency’s requirements.

A DN&C contract has the risks associated with a DD&C contract plus the following:

• the contractor and the designer may load their tender prices to cover the risks of entering into a contract with an unknown entity, on terms predetermined by others
• some potential service providers may be reluctant to tender
• there is potential for complex litigious problems if the relationship between designer and contractor deteriorates.

D&C contracts are suitable for projects where:

• the agency does not wish to control the design or determine the design details
• it is unlikely that the project brief will change after the contract is entered, for example through stakeholder involvement
• the desired outcomes, project scope and performance requirements can be clearly articulated in the tender documents
• the agency has well-established standards for components, finishes and other aspects of the design
• contractors or specialist firms are expected to be able to offer proprietary systems or innovative designs or construction processes that result in cost savings and benefits for the agency, or
• there is insufficient time to produce the design required for a developed design or DD&C contract before construction work is scheduled to commence.

If the agency’s requirements cannot be clearly identified when the construction contract is entered or there are possible latent conditions or other risks, the tenders may be heavily qualified or include large contingency sums, reducing the anticipated cost advantages.

A D&C contract offers the following benefits:

• the contractual cost implications provide a disincentive for the agency to change its requirements after the contract is entered
• the contractor has flexibility to incorporate innovations, use proprietary designs and products and improve buildability, potentially improving project outcomes and increasing value for money
• the contractor can maintain project time targets by starting construction before the detailed design is finalised, if necessary, at the contractor's risk
• accurate cost forecasts can be made before design commences, on the basis of tender prices
• the risk of contract claims due to errors and omissions in the design is low
• the contractor assumes responsibility for design and construction, fitness for purpose of the finished product, buildability and usually latent conditions
• responsibility for obtaining authority approvals and meeting authority requirements can be allocated to the contractor.

A D&C contract has the following risks:

• if the tender documents are unclear or incomplete, the desired outcomes may not be achieved without disputes over interpretation, variations and additional expense and delays
• design activities are suspended during a relatively long tendering period, and progress may be delayed by complex tender reviews
• tender prices will include allowances for the additional design risks
• tender evaluation is complex and may increase costs and cause delays
• higher tendering costs and a lower number of competent tenderers may reduce competition and increase tender prices
• changes to the design requirements are likely to be costly, due to their potential to impact on the contractor's work and program.

Projects are suitable for DC&M contracts where they are suitable for D&C contracts (see above) and where, in addition:

• the asset will involve significant ongoing maintenance effort and costs that are directly impacted by the design and construction outcomes
• there is no advantage to be gained by the owner maintaining the asset or including it in a portfolio of assets in a separate maintenance contract, and the agency wishes to transfer the risk of routine maintenance to the contractor
• the agency has established standards for maintenance or the expertise necessary to define its maintenance requirements
• there are likely cost and other benefits to be gained from encouraging tenderers to offer alternative design concepts and maintenance ideas.

This type of contract is inappropriate if the agency’s maintenance requirements cannot be clearly described at the time of entering into a contract. It is not suitable for smaller projects.

As is the case for D&C contracts, the tenders may be heavily qualified or include large contingency sums if the contract requirements are not clearly defined, reducing the anticipated cost advantages.

It is unlikely that the construction contractor will have a maintenance capability, and a cost premium will be incurred for the contractor to establish an arrangement to meet its maintenance obligations.

A DC&M contract offers the benefits of a D&C contract plus the following:

• the contractor has an incentive to construct a higher quality product in order to minimise maintenance costs, potentially increasing value for money
• maintenance costs can be forecast before design commences
• the contractor is responsible for the fitness for purpose of the asset and the maintenance procedures, and the interfaces between design, construction and maintenance
• the contractor’s liability for defective works can be extended beyond what is normally the limit by law (6 years in NSW unless a deed is entered into).

A DC&M contract has the risks associated with a D&C contract plus the following:

• if the maintenance requirements are not clearly defined and performance measures specified, the maintenance work could be below the anticipated standards or the contractor could claim extra in order to meet those standards
• variations to maintenance requirements may be costly
• most construction contractors do not have a maintenance capability and would subcontract the maintenance activities, introducing additional administration costs and the risk of conflicts between the constructor and the maintainer
• coordination and cooperation between the contractor and the occupiers of the site may not be achieved.

GMP contracts are suitable for projects where:

• it is critical that the allocated budget and time are not exceeded, and the agency is prepared to accept a higher tender price to ensure these targets are met
• the agency does not wish to control the design
• the project requirements can be defined clearly when tenders are called
• the agency is prepared, if necessary, to sacrifice project scope or quality in order to prevent time or cost growth.

A GMP contract offers the following benefits:

• there are contractual mechanisms to inhibit the end cost from exceeding the original contract price, by restricting the contractor’s entitlements
• the contractor is more likely to complete the work on time due to limited opportunity to claim extensions of time
• contract administration costs are lower due to the limited scope for claims
• agency-initiated variations that increase the scope of the work are discouraged.

A GMP contract has the following risks:

• agency expectations may not be met, if project scope or quality is reduced to meet cost or time targets
• tender prices are likely to be high, as tenderers need to price significant additional risks that may not eventuate
• tenderer interest may be limited due to the risks imposed on the contractor
• contract provisions that limit the contractor’s capacity to recoup losses may result in disputes.

Managing contractor contracts are only warranted for major projects with special needs, such as those where:

• there are many or significant unknown factors, such as undefined scope, unpredictable risks and changeable project objectives, that cannot be resolved before it is necessary to let a contract in order to meet the project program
• project threats and opportunities are complex and require management collectively by the contracting parties and other participants
• there are many complex or difficult stakeholder interfaces and relationships
• the interests of key participants need to be brought together early in the project
• industry input and innovation during the design stage are desirable, for example to take advantage of emerging technology, specialist construction expertise or other opportunities
• completion times are tight and fixed
• project funding is fixed.

A managing contractor contract offers the following benefits:

• the agency and the contractor work together to determine project requirements, resolve issues and develop the design, reducing the risk that the agency’s requirements will not be met and promoting optimum design outcomes
• *involvement of the contractor and stakeholders in design decisions facilitates the development of appropriate responses to the project objectives
• the agency controls the design and can make changes without incurring the disproportionate additional costs, including delay costs, likely with a D&C or DD&C contract
• the contractor assists the agency to control the costs during the design phase
• once a GCS is agreed, the contractor will not be paid more unless the agency directs a variation
• the contract includes incentives for the contractor to make cost savings
• design activities can continue during the tender process, minimising delays
• it is possible to commence construction before the design is completed, normally once the GCS is agreed
• the need for separate project management services is reduced, since the contractor undertakes most project management functions
• the tender prices need not allow for as much risk as for a D&C contract
• tendering costs are low since tenders include only fees and non-price information
• the contractor is responsible for design/construction interface risks and coordination of all subcontractors and consultants
• the contract can incorporate non-adversarial mechanisms for resolving differences efficiently, such as the establishment of a dispute resolution board.

A managing contractor contract has the following risks:

• success depends on cooperative relationships and the contractor efficiently managing project risks and controlling costs
• to achieve the optimum cost control, the agency must be prepared to amend its requirements if the contractor identifies a cost increase
• design development work is paid on a 'cost plus' basis and the contractor has little incentive to expedite progress in the early stages
• contract administration is complex and requires more agency resources in the early stages to establish the project scope and objectives
• margins on the cost of the work are likely to be high
• target prices set at the outset, when the scope of the work is uncertain, may not be achievable
• the GCS is set without competition and may not offer value for money
• the agency’s expectations may be unrealistic and agreement on a GCS or time targets may not be reached, leading to termination of the contract and significant time delays
• the number of willing and competent tenderers is limited.

Alliance contracts may be beneficial for complex projects of moderately long duration (greater than 12 months) with some or all of the following characteristics:

• unclear or uncertain scope, unknown factors, unpredictable risks or changeable project criteria
• threats and opportunities that are best managed collectively by the participants, rather than allocating them to a single party
• a requirement for early input from a range of stakeholders, including end users
• exceptionally challenging issues requiring special stakeholder and community involvement
• particularly difficult and complex stakeholder, consultant and contractor interfaces and relationships requiring a special management approach
• a need for early advice from construction industry experts to help define the project scope and resolve issues
• a high profile and a requirement to achieve extraordinary outcomes under extraordinary circumstances
• limited time to resolve issues and define the project scope
• a fixed and limited budget
• willingness on the part of the agency to participate in a relationship contract.

With other contract arrangements, these factors would place project outcomes at risk and provide more potential for claims and disputes.

An alliance contract will not be suitable if:

• the personnel involved (from the agency and other stakeholders, consultants and contractors) are not experienced at working together and unwilling or unable to adopt the attitudes and corporate cultures necessary to work as a team
• the agency is not prepare to invest the resources required to participate in a relationship contract and accept a risk sharing arrangement
• the project is relatively small, and the additional tendering and implementation costs are disproportionate with the cost of the work and the likely benefits, or
• more conventional contracts will achieve the outcomes required, since the project is not complex or there is little room for improving outcomes or issues can be resolved without contractor involvement early in the design process.

An alliance contract offers the following benefits:

• there is potential for reduced project costs, earlier completion and better outcomes in general, for special projects under extraordinary circumstances, through incentives for cost savings, cooperation and relationship management
• involvement of the contractor and stakeholders in design decisions facilitates the development of appropriate responses to the project objectives, providing potential for innovation to improve outcomes
• there is more certainty and less risk for non-agency participants
• fast-tracking of the project is possible
• issues that could cause claims and disputes are more likely to be resolved in the manner that is best for the project.

An alliance contract has the following risks:

• success depends on teamwork and the adaptability, performance and attitudes of individuals
• there are more demands on all personnel involved, and a change in culture and attitude may be required for many
• non-agency participants are required to make extra effort to achieve stretch goals, manage changes to culture and attitudes, set up accounts open to public scrutiny and commit the best people to one project
• non-agency participants expect and receive a substantially higher margin (including profit) for the additional input required
• more agency resources and higher costs are involved to manage tendering processes, establish the alliance, maintain relationships and determine costs
• quality can be compromised to meet cost targets
• risk allocation may not be clear, and the agency bears the risks once the specified liability of other participants is exceeded
• there is less price competition and less certainty of obtaining value for money
• consultant costs for project development and design are likely to be higher
• the agency loses some litigation rights, and reduced professional indemnity insurance cover is provided by the participants.

A PFP is suitable for projects where:

• the total contract value is $50 million or more
• the contract involves a long service delivery period, typically 25 years or more
• the required services can be specified in terms of measurable performance outputs
• a return can be provided to a private sector developer, for example over a concession or service delivery period
• the overall outcome for NSW Government can be shown (using comparator model assessments) to be better than for other procurement methods
• the benefits warrant the cost, time and resources required to develop tender documents and evaluate proposals, including implementing comparator assessments.

A PFP contract offers the following benefits:

• the impact of obtaining capital funding can be either totally or partially absorbed by the private sector, or spread over a much longer period than if the project were publicly funded
• asset development and, where applicable, associated service provision can be more efficient and economical when a single entity is responsible
• there are opportunities and incentives for the contractor to develop innovative solutions
• asset management considerations can influence the design and construction, resulting in improved service delivery
• design, construction and commissioning risks, including timing risks, can be allocated to the private sector
• agency resource requirements and costs are lower for construction of the asset
• asset management risk is allocated to the private sector developer during the maintenance or operation period of the asset
• where the responsibility for the day-to-day operation of the asset rests with the developer, the agency will most likely only be required to manage the asset lease and monitor asset management and operation.

A PFP contract has the following risks:

• public misconceptions about the benefits of private sector initiatives over Government initiatives may have to be overcome
• specialist contractual experience is needed to assess financial/technical proposals, manage the negotiations with potential developers and document and manage the PFP agreement
• the time and cost involved in negotiating a contract may be high
• tenderer interest may be limited due to the high cost of tendering
• the quality of the finished product and the services may be compromised unless quality requirements and provisions for confirming performance of the services are clearly documented
• it may be difficult to demonstrate the real relative cost benefits
• the agency loses some control of operation of the asset and possibly service quality
• the agency loses control of the interfaces with other government services
• if the project fails financially, the agency will be required to provide the services through alternative means
• changes to legislation and government policy can affect the project, and are more likely to occur due to the long contract period involved.