In the current financial market turmoil, capital project investments have moved into the spotlight. And the need for capital projects to meet or exceed their expected return on investment has never been more critical. As the tightness in the financial sector plays out, the re-emergence of inflation risks related to labor, equipment, material and the cost of money will increase. These risks make project completion and cost control a critical necessity. Any extension of the project duration or growth in cost can have a devastating effect on a business’ financial position.
The method of construction contracting and risk mitigation must change based on this new market reality. The concept of shifting construction risk to construction firms may seem a prudent risk management approach. This approach has been used for many years through the process of lump sum biding, requiring insurance bonds, and imposing liquidated damage contract clauses.
In this new market reality construction companies are less likely to except these approaches as they present an unacceptable risk to the construction company. As a business, construction companies simply are not capitalized to the level required to cover large monetary awards, nor do they have the ability to obtain large enough insurance or performance bonds to support the end users business risks.
It is also highly possible that the age of lump sum bidding will continue to decline to become the exception verses the norm. Mixtures of contracting methods will be used in the future. The lump sum contracting method will be used with well-defined project scopes of work or with specialized subcontractors. Less defined project scopes of work will lend themselves to cost-plus, time and material, unit pricing or alternatives such as earned value contracting may see broader acceptance. As the project scope becomes better defined it is possible to convert these contract strategies to lump sum.
Fostering an environment that facilitates a clear dialogue between the business owners and the construction companies will be the best strategy in this difficult market. Proper due diligence related to business strategies and establishing clear expectations as to the final outcome of a capital project will be critical. An inclusive rather than adversarial project development approach, where contractors are invited to provide input for the overall success of the capital project, will be the order of the day.