First Pivot Point And Risk - Defining The Construction Project, The Timetable, Cost Budget And Delivery System - Approaches

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October 04, 2018
Author: John Donley
Organization: Donley Construction Consultants

Too often, no one decides the project delivery system. Instead, a default system takes hold with whoever is ostensibly “in charge” – the owner, the designer, the contractor, the end user – imposing a system of project delivery that they are comfortable with, but which may or may not be best suited for the project at hand.

In a military operation, if the goal is to cross a river, chain of command and need for speed, and relatively unlimited budgets dictate a pontoon or other quick temporary bridge, to carry the weight of vehicle loads. That will be designed on the spot or by rote, and carried out by the troops that will then use them. Time – speed – is the driver. Cost, least important; quality in terms of load bearing, critical, but quality in terms of longevity or aesthetic, largely irrelevant. On the other end of the spectrum, development of the Getty Museum in Los Angeles involved ensuring protection of high priced fine art, access to the public and tackling new design challenges such as software to manage window louvers allowing light in for art appreciation but without damaging the paintings, and the need for a mini-tram to bring patrons up a majestic hillside. Security to avoid theft was critical. Getty chose a high end, design build contractor on a cost plus basis. That allowed for design adjustments, technology assessments and interface with the curator’s needs without excessive formal change order processes that would slow the project down. The owner, while price conscious, was already providing a private collection for public use in a charitable manner, so cost was not the driver. Time was not the driver. Quality – quality of construction, quality of art appreciation, and quality of art protection were the drivers. The SF- Oakland Bay Bridge Project is a good example where all three drivers were important, and the public works paradigm of design/bid/build was applied. Quality was critical since the bridge was being replaced to avoid another collapse during an earthquake, which was predicted. Quality in terms of aesthetics were also a high priority, both in terms of State prestige, but in terms of fit with the bridges it meshed with, including the Western suspension portion of the bridge, the City of San Francisco waterfront and skyline, and the Golden Gate Bridge.

Budget was important, as were time, but within contract parameters, those got fought out by claims and changes. In terms of resources, the Contractor and sureties required assembly of an International Joint Venture team to meet the capitalization and cash flow requirements of the multi-billion dollar project. Time was least important, if quality was in question; but time was still important since the project was ticking against a seismic clock of the next big earthquake. In the typical home kitchen or bathroom remodel, quality is less critical than budget, cost, as the new features will be improved over the rest of the existing, untouched house, but still largely “too match” the overall home motif and style. Cost is the usual driver. Time is often frustrating, but if the mortgage is 30 years and no plans to move, is a false idol. The owner may sacrifice design and quality by not hiring an architect and relying on a contractor design build design, even one without much of a sketch, and thereby unwittingly also lose a second quality component – quality metric, since now the contractor as designer also defines whether the quality as contractor meets the design intent.

In a commercial tilt up, seeking to secure rental income in a booming rental market, say in South of Market San Francisco to a high tech company, time to market is the driver. Quality and cost will be on a fungible square foot basis and driven by the anticipated end user’s resources – whether Yahoo and well established, or a startup and bare bones. Time and market forces are the drivers, cost and quality more customized. This would be easily a design build project, but unlikely a cost plus project, since other than finish allowance items, the work scope is predictable and not change order driven.

These are examples of projects with different drivers. No one gets all three drivers. If the owner wants to control cost and quality, time will be controlled by the contractor. If the owner wants time, speed, it will need to decide whether to yield on quality or cost. And so on. Once these drivers are evaluated and prioritized, then the project delivery system can be decided. There are variations, but the main types of project delivery systems are:

Design/Bid/Build. In this traditional approach, the owner controls design (quality) and seeks fixed price bids, on a negotiated or competitive bid process. Bids price the work called for the design. The premise is that, if the project is well designed, and bidders provide prices to the same design, then going with the low bidder ensures lowest cost available in the market for the same quality as the other bidders offering to achieve the same design for a higher price. Usually the contract documents will have price controls such as schedule, time for completion and liquidated damages for delay. So theoretically, the owner controls quality by design, price by bids, and time by schedule requirements and penalties.

In reality, this paradigm has logic fallacies. One is that each bidder intends the same level of quality to the same design. Some level of subjective “good enough” exists in every contract. A bidder who at home builds antique cars or Garwood boats may always achieve a custom level of quality craftsmanship irrespective of the quality level defined by the specifications. A bidder with a newer, less experienced, less quality motivated crew may not.

Secondly, this approach assumes the design is fixed and has no flaws. Since construction inherently has flaws and corrections, it is overly optimistic to assume there will not be changes. How bidder one and bidder two react to a change in design or conflict may be different. At bid pricing gets skewed when these changes are added in.

A third human factor variable is team chemistry. If the team works poorly, even if the design is good, the product, cost, time and quality may suffer. There is natural resistance to changing contractors (or design team members) midstream, due to increased time and cost from learning curve restarts, but also, because the new contractor or designer will not want to warrant the old design. This model can be inflexible.

On most public projects in California, the design/bid/build project delivery system is required as an element of competitive bidding; so the bids can be fairly compared, the design has to be the same and therefore the design is provided by the public agency. Still, and in response to the pitfalls of this system, many public agencies are leaning toward “Lend Lease” arrangements rather than competitive bidding, if legally supported by their legal counsel as meeting the law, to avoid claims driven, not on time, not on budget, claims laden and quality challenged projects. The lowest bidder in today’s economy may be out of capital just trying to stay alive and unable to ramp up if a problem arises. School District projects are particularly suited to Lend Lease approaches since time – getting done before school and around school, and quality driven by the office of the State Architect for public safety reasons – take priority, and a slow, poor quality contractor can ruin not just a project but thousands of children’s school year (plus parents, administrators, teachers, etc.). Again, this is an area of controversy, but an example where public agencies are tinkering with the design/bid/build delivery approach to better achieve public service goals, and avoid problem child contractors.

Design/Build. In this paradigm or delivery system, the Contractor is also the Designer. This is most likely where the design does not have heightened aesthetic requirements, and is built around function; military base installations being a common example, as well as commercial tilt ups. The design variables are few, and aesthetic requirements secondary if not nonexistent as compared to purely functional issues for user groups.

The design-build approach reduces much of the risk to the owner of changes driven by design changes, precisely because the contractor not owner controls design. There are instances where a design build contractor can still make a differing site condition claim or change order claim, such as if the represented soil conditions are vastly different than what is later encountered, or any retained inspection right by the owner is unreasonably exercised (unfair rejection of acceptable work).

Time and cost are generally also fixed in the bid. Design bid can be competitive bid off a set of general site and design parameters or performance goals.

This approach speeds up the design phase, and reduces the risk of scope and design disputes. It is more turnkey. Conversely, unless the owner selects a construction manager to oversee the contractor, or has in house expertise, the owner may lose control over quality levels intended in the bid documents, because the contractor as designer will design to fit his means and methods, and may not agree with the owner’s different view of intended quality metrics.

A good example of a design/bid construction element is the classic home pool construction. The typical pool contractor will have standardized pool shapes to choose from, and pool mechanical and pump house levels each with a price, not much different than buying a car and adding in features for more cost. The pool contractor will design the pool mechanical equipment, a hidden non-aesthetic item, hire the engineer, get it permitted, and build to a plan he develops and submits. A more high end pool project may involve the owner hiring a landscape architect to define the pool and hardscape, but when it comes down to the pool mechanical design, it will likely be left to the contractor to design/build it.

Integrated Project Management. While this label can mean a lot of things, it generally signifies a risk sharing approach to design, that spreads “design-build” as to specialty mechanical and high end systems beyond the contractor to key specialty subs, as well as the project designer. Hospitals are a good example, where quality and speed are key, cost less so, and avoidance of disputes paramount to retain clientele – busy hospital administrators with low tolerance for litigation. The design professionals develop designs knowing that specialty subcontractors and the design engineer will have high input into the mechanical and electrical systems and redundancy that are needed for a modern hospital. Digital Fabrication and Design Thinking also work towards inclusive involvement in all key participants, since the distinctions between design, build, concept, implementation, quality control, longevity and warranty get blurred as modern technology allows data sharing by electronic 3D drawings, and artificial intelligence, computer based designs, and highly evolved field drawings. In such cases it makes little sense to compartmentalize, when the tools are cutting edge, and quality requirements high, since the specialty subcontractor may be ahead in know-how from the designer, due to both fields being challenged by the rapid availability of new construction and technological tools and delivery methods. Data sharing takes precedence over roles.

This team approach usually requires a high end project with high quality and highly modern quality requirements, complex mechanical and electrical components, electronic 3D design and data sharing, and a small selectively qualified team members used to doing projects together. It is typically assumed that the integration of project management, and hence, some design risk sharing (and construction outcome risk sharing), also means some reduction of adversarial fiscal controls – meaning, cost plus contracts where penalties for time and quality failures are addressed at marginal costs (profit of selected team members) and not reimbursement of out of pocket expense. Otherwise, specialty subs and contractor will not want increased design team meetings or risk if bread and butter cost reimbursement is not guaranteed.

Construction Manager at Risk/Not at Risk. Whether choosing a design/bid/build or design/build approach, the owner may wish to offshore decision-making risk to a professional construction manager. If at risk, that means the Construction manager will sign the contracts with trades (and if a design/build contract, with the design team) and be at profit/loss risk to the owner.

Conversely, the Owner may instead use a Construction Manager as an independent consultant, but still contract directly with the contractor and designer. Then the CM is not at risk and only contract is with the Owner. A debate in ongoing within jurisprudence when a CM at risk, or for that matter, the owner’s design team, might have liability to the contractor in tort even if only in contract with the Owner. A CM and owner should be careful how the prime contract and CM contract are drafted to avoid creating inadvertent “third party beneficiary” rights in favor of the prime contractor or other project participants.

Keep in mind, the rules relating to duty following contract privity go by the wayside when other duties are breached, such as fraud, trademark or patent infringement, or property damage or personal injury claims such as in construction defect cases. A whole set of legal rules pertaining to allocation of indemnity, insurance, and property damage or personal injury rules apply, that are beyond the scope of CM manual, except as pertains to having the right contract language in place to afford later risk managers (your insurer and insurance defense counsel) with maximum risk reduction tools. Those will be discussed in detail in a later chapter.

Fast Track projects. In a fast track project, construction starts before the entire design is complete. Sometimes this is due to a court order, such as a jail expansion, where a foundation contract can be let out to bid and started before the guts of infrastructure and mechanical and computer driven systems are designed. These can be fixed price if the fast track design is broken into parts, or design build, or can be cost plus or T&M.

Multiple Prime Contractor Projects. In very large projects, risk can be spread by multiple prime contractors dividing project scope, or by Joint Ventures. This is attractive to contractors where the project is so large that it exceeds their human and financial capital alone, as well as bonding. For owners, it reduces price by reducing risk and invites better prices in a market where there is growth, decreasing resources and increasing prices. The transcontinental railroad was a project with a team moving West to East and one moving East to West, as a basic example that was more a geographic and logical organization function. The Bay Bridge project had large contractors in JV’s or Teaming to allocate huge cost risks from the cost of the project and QC demands.

Pricing Mechanisms.
Fixed Price. Fixed price or lump sum means a scope of work for a set price, absent change orders.

Note, many contracts have portions that are fixed and portions that have variables, including unit prices or “allowances” which are typically owner selection or finish items; best example, in a home remodel, the kitchen appliances are usually allowances, whether a budget is set based on standard cost of a refrigerator or stove, or even flooring or carpet, and whereby the Owner has selection rights but subject to price increases based on increased material supply costs and increases in installation costs.

Unit Price. Paving, pile driving, and other measurable linear foot or square foot items are often priced by unit price based on an estimated quantity at bid. This is often fair since it allows comparison of bids for selection of bidder, while avoiding time consuming negotiations over whether an increase in quantity is a change or not. The price escalator or descalator is built in to the contract. Note, that under State of California Department of Transportation and Greenbook, increases or decreased of more than 25% allow repricing, on the view that the unit price has both a mobilization and economies of scale factor built in, so if quantities shrink, the unit price would go up, and if quantities increase, the incremental increased cost to the contractor goes down since the mobilization costs are built into the price.

Time & Materials – “T&M”. Time and Materials means, materials and subcontracts are billed at cost plus a stated mark up for contractor profit and overhead; and Time is based on agreed hourly rates based on the trade and person involved (i.e., laborer, carpenter, senior carpenter, foreman, superintendent). T&M is somewhat common in residential construction but it has problems, mainly in keeping track and making sure the contract format and the billing format match. Homeowners often assume T&M is the same as Cost plus, and that the labor does not have a markup built in. Contractors sometimes get confused on their mark ups and can overbill if not careful. One example: if there is a change order clause that subcontracts are billed at cost plus 15%, but the contractor uses a labor pool for labor, is the labor pool a subcontractor billed at cost plus 15%, or labor at unit rates? What about offsite time, inefficiencies and the like. A contractor using this format should be clear.

Cost Plus Fee With or Without a Guaranteed Maximum Price. AIA contract forms provide for either a fixed fee, or a Cost plus Fee basis, and then, with or without a Maximum price. There are pro’s and con’s with this format. One, the contractor bills his actual cost, plus a percentage mark up as fee. That means the contractor must display his costs to the owner, something some contractors are loathe to do or consider proprietary. But, it takes much of the bid gamble of a fixed price contract out of the mix; if the contractor’s costs exceed his estimate, he is still paid his cost and his fee. This also can reduce the inefficiency of negotiating change orders and the fact such midstream negotiations often can slow down the project, or inject disputes where none should exist.

This format is well suited for high end residential construction, and high end commercial where the Owner has not completed his final design concept at time of obtaining a permit set of construction drawings. Many finish details can wait and be developed concurrently with a longer project; this leads to more speed since work on foundation and basic framing can start in advance of all finish details. In most projects of this type, even if not designated design/build, the contractor, owner, scheduler, and a cost estimator or CM are regularly meeting to assess when finish item decisions need to be made to avoid disruption, and what products have what prices at set times and lead delivery times, to make many real time choices. Where all decisions have effective turn arounds, this can be a win-win. If the Owner is indecisive, or Architect an inadequate sounding board or programmer, the project can slow with too many decisions made too late, or worse, each stage of the work becoming akin to a mock up, with redo of work to basically design in the field after the fact.

An owner wanting involvement in design and design evolution may prefer this approach and take the risk that his costs may be more open ended.

Often the owner, and lender, will insist on cost controls including a guaranteed maximum price. Contractors will push back and state the GMP is only as to stated starting scope, and demand the owner acknowledge the plans are not yet complete. This then would require change orders to adjust the GMP and time schedule, somewhat defeating the purpose of the Cost Plus format, and re-introducing the risk of change order processes getting in the way of progress, or team chemistry.

Usually, Cost Plus Fee will not work with a Construction Loan, as the Lender wants a cap on its risk. The lender will require a GMP, or even an addendum that despite the Cost plus fee agreement with the Owner, the Lender’s exposure to the Contractor for stop notices for unpaid work are fixed and capped to the loan amount.

Costs Segregation Tools. Where a contractor uses a GMP, it is advised that a new bank account be established for each project, to isolate costs, and avoiding accounting issues; and an early sit down with the owner and any lender on how costs are presented. Too often, the parties do not appreciate the cost presentation in the early billings, until there is a later dispute, and then argue the format did not follow the contract. The Contractor, CM, Owner, Lender and Design team can avoid this by making the first billing a test run and subject to approval.

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