7 ways to make shared risks, rewards sustainable in the AEC

by DOANH DO, Researcher, Lean Construction, Paramount Decisions | Dec 10, 2015

Around the world, shared risk and reward contracts are becoming more prevalent. In the U.S., there are several forms of agreements for construction projects, including Sutter Health’s Integrated Form of Agreement (IFOA); the ConsensusDocs 300; and American Institute of Architects (AIA) contracts. All have provisions for sharing the profit and the losses of a construction project among the owner, contractor, architect, specialty trade contractors, and other service providers.

The contracts are designed to support Integrated Project Delivery (IPD) and Target Value Design (TVD).

In Europe and Australia, a similar trend has been taking place under the name “Project Alliancing”. The goals of those shared-risk-and-reward contracts are to:

(1) Better align the business models of AEC service providers with the objectives of the owner;
(2) Promote early involvement and collaboration;
(3) Remove barriers of communication;
(4) Promote innovation;
(5) Reduce the likelihood of cost overruns; and...
(6) Minimize change orders and unnecessary litigation.

Research has shown that projects with shared risk and reward provisions that also utilized IPD and TVD have delivered products with superior quality, schedule, and cost performance relative to the industry norm. In the U.S., data on TVD and IPD show that these projects are delivered 15% to 20% below market price, and with fewer incidents of project cost overruns.

There are, however, some problems with shared risks and rewards that need to be resolved. Anecdotal evidence from TVD and IPD projects in the U.S. showed that 15% of these projects resulted in the team depleting the profit and and contingency pool, thus earning zero profit for their work. The goal of this blog post is discuss how we can make shared risk and reward a more sustainable business practice within our industry.

SHARing RISKS, REWARDS sustainably

For shared risk and reward to remain a viable project delivery option, it must be sustainable. That means that owners get value for their money and that at-risk service providers make an acceptable profit. Here are seven ways to reduce the probability of project failure:

1. Align the objectives of the entire project team, owner included, to delivering value to the owner while enabling AEC service providers to earn a fair profit.

The owner must commit to the economic success of its service providers, and likewise service providers must commit to the delivery of customer value. Only projects that achieve both value delivery and economic profit are truly successful;

2. Anchor target cost based on the business case of the owner.

A project needs to be viewed as a business investment for the owner. The role of the service providers is to assess the feasibility of the project based on the market cost and what the owner can afford to pay (allowable cost). If the gap between the market cost and the owner’s allowable is too large during the validation process, then service providers must be prepared to abandon the project or accept the risk of working for free. For this to work, the owner must share its allowable cost and business case with the project team;

3. Clearly identify the scope that is at risk and the scope to be performed for a fixed price.

It is a misconception that shared risk and reward work has 100% of the project at risk. Typically, 80% to 90% of the work is performed by the at-risk service providers with the remainder being done by external members at a fixed price. For the members inside the risk pool, it is important to document the scope of work that is part of the risk pool. If the scope of the at-risk work changes, then the target cost should also be updated to reflect the change. Certain types of owner's changes are included in the risk pool and certain types of owner's changes are not. It is important to clearly define this boundary so that unnecessary disputes do not occur in the middle of the project;

4. Involve the right people at the ‘earliest responsible moment’ to maximize their positive impact on design and constructability.

Engage the craft workers/supervisors who will actually build the project to get their inputs during the design phase to avoid non-constructible design. Owner representatives on the project should also have decision-making authority to avoid problems that occur from untimely decisions;

5. Have owner and risk pool members decide which firms and people to include in the risk pool.

Shared risk and reward requires a high level of trust, transparency, and a working culture that is different from traditional Lump Sum, and Guaranteed Maximum Price (GMP) projects. Not all individuals and companies are the right fit for such contracts. So the project team needs to be highly selective of the companies and individuals to include in the risk pool. Additionally, parties that require a high degree of coordination and have major impact on the project's success should be in the risk pool;

6. Maintain shared governance throughout project execution.

Shared risk and reward requires shared governance. The profit and losses of each firm is tied to the success of the project and can be adversely affected by the actions of any uncooperative party. As a result, all companies inside the risk pool must have adequate representation and share in managing the project. It is not just the architect or contractor who has to manage the success of the project;

7. Use transparent productivity and financial measuring systems.

Shared risk and reward projects need a new set of transparent key performance indicators (KPIs) that typically do not exist on Lump Sum or GMP projects. At any time in the project, the at-risk pool members must know the financial position of the team (expected profits, cash spent to-date, burndown rates, and future expenditures, etc.) so that they can take proactive actions to ensure successful project delivery. During the construction phase, the team needs to share its manpower curves, productivity rates, schedules, lessons learned, etc., so that everyone can be on the same page, and so that individual actions can be in alignment with the objectives of the entire project team.

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Based in San Francisco, the author is a tech entrepreneur and lean construction researcher. He holds an undergraduate degree in civil engineering from UC-Irvine, and an M.S. in civil engineering from Cal-Berkeley, where he also earned a management of technology (MOT) certificate. Do has experience researching and consulting on large, complex lean construction projects that range in value from $10 million to over $1 billion. He is currently a co-founder of Paramount Decisions and an editor of the Lean Construction Blog, where this article first appeared. To contact him, click here.

ADDITIONAL SOURCES

1. Zimina, D., Ballard, G., & Pasquire, C. (2012). Target value design: using collaboration and a lean approach to reduce construction cost. Construction Management and Economics, 30(5), 383-398.

2. Do, D., Chen, C., Ballard, G., & Tommelein, I. D., 2014. Target Value Design as a Method for Controlling Project Cost Overrun. International Group for Lean Construction.

3. Ballard, G. , Dilsworth, B. , Do, D. , Low, W. , Mobley, J. , Phillips, P. , Reed, D. , Sargent, Z. , Tillmann, P. & Wood, N. 2015, 'How to Make Shared Risk and Reward Sustainable' In:, Seppänen, O., González, V.A. & Arroyo, P., 23rd Annual Conference of the International Group for Lean Construction. Perth, Australia, 29-31 Jul 2015. pp 257-266