Contract Strategies in Challenging Markets

by Teresa Magnus, Magnus & Company

As the construction industry experiences its greatest expansion in a generation, the project owner community is becoming increasingly challenged with achieving positive project results. With straining labor markets and full backlogs, owners turn to their contracting strategies to mitigate risk. Relying on Draconian terms and conditions of the past will not yield the desired results because of the tension and distraction it creates in the project execution team. To improve the outcome of construction projects, we must first change the dynamics of the relationships between the parties. And while team-building activities and mobilization meetings can improve the way project teams function, ultimately it is the contract strategy in general, and the contract documents specifically, that set the tone and pace of the project and determine the opportunity for success.

Contract Strategies and Process

Both the conduct of the owner organization in its approach to the contract strategy and contracting process, and the language of the contract documents, define the relationship among the parties at the inception of the project and for its duration. Focusing the process and the documents on the expected outcomes for the project, communication and issue resolution protocols, and roles and responsibilities for each party will improve the relationships between the parties and yield better results. Too often contracts focus on dispute resolution procedures for the end of a failed project, archaic “notice” obligations, and unrealistic allocation of risk. In addition, many projects have multiple prime contractors and A/E firms, layers of subcontractors, and hundreds of suppliers. With traditional contracts only requiring “cooperation” without necessary process or actual intent to cooperate, there is little chance of actual collaboration within the project team. Owner organizations must focus their process on building relationships with the parties to their agreements and amongst the parties, both through requirements in their documents and in their actions.

Contract Packaging

In challenging markets, contract packaging can increase an owner organization’s control of the work, reduce project risk, increase the pool of qualified contractors, increase access to experienced, frontline supervision, and increase access to skilled craft workers. Breaking large projects, and especially the construction scopes of work, into smaller packages broken down by areas or trades increases the number of qualified contractors for each of those packages. It also gives the owner organization more direct contact with the contractor planning and performing the work. Bringing specialty contractors into the planning process increases knowledge, reduces costs, and improves schedule. In addition, those specialty contractors employ experienced frontline supervisors and craft workers. This process is in contrast to the more traditional approach of packaging everything into a single document with the expectation that all risk is shifted to the large firm, and that the project will have positive results because the selected firm is “too large to fail.” Actually, what this traditional model accomplishes is building the first wall of separation between the owner and its project. With each additional layer of contracting, the owner is moved further from the work. Disconnected from the parties performing the work, the owner becomes less informed and less able to react to changes in the project or negative trends. And unwinding these contract strategies to take back control of the work when failure becomes eminent is nearly impossible and extremely costly.

Changing Dynamics

Contracts should be designed to help the project team remain laser-focused on the construction project and achieve the working dynamics of the team required to be successful. Collaborative agreements are the most successful form of agreement to promote these positive working relationships and address these three main components: fair risk management, the intent to collaborate, and the intent to work efficiently and productively.

The Fair Allocation of Risk

Contracts designed to allocate risk fairly focus on defining the party with the greatest ability to control or mitigate the risk, assigning the risk to that party, and outlining the process for resolution if the risk is realized. Allocation of any and all risk to the contractor (and to subcontractors through flow-down procedures) encourages stacking of contingencies, distracts project leadership, and creates tension among the project team. In contrast, highly functioning teams work together to mitigate or manage risks. PDRI and other project management risk assessment tools will identify, document, and rate risk. Kept at the forefront of routine communication and project management, risks are managed by the team together. There are some risks, however, that cannot be controlled by any of the parties. In these instances, the risk must remain with the owner organization, and managed collaboratively with the project team. Especially under these circumstances, a project team alert to the risks is important. The following are a few standard areas of risk for construction projects:

  • Material Escalation
  • Labor Rate Risk
  • Foreign-Sourced Materials and Equipment
  • Change in Law
  • Schedule Compression

The Intent to Collaborate

Contracts designed with the intent to collaborate comprehensively across the project team create and foster an environment of trust and respect amongst the team members and improve project outcomes. These integrated forms of agreement or collaborative contracts include the owner, architect/engineer, construction manager, contractors, subcontractors, suppliers, vendors, and any other party key to the success of the project under a single agreement. Through the process of developing and signing an integrated form of agreement, the owner signals the intent to collaborate to all parties, and then contractually requires it. In contrast, the tone and approach of the owner organization to a more traditional competitive bidding contracting process may signal something else, and cause project team members to focus more attention and resources on defensive positions, documentation, withholding information, and other counterproductive activity. Under the collaborative agreement, the team functions as one team because the failure or success of one depends on the same for all. The collaborative agreement encourages joint planning and scheduling to improve overall performance of the project schedule. The agreement also outlines joint work processes to improve overall productivity and efficiency, among other benefits. One last highlight from this form of agreement is the “safe harbor” clause on group-made decisions, risks realized during the project, and joint mistakes. The language requires the team to jointly resolve (and absorb the cost of) these project events. And while the language of the agreement obligates the parties to participate in joint planning and work processes, the project management team has generally built a level of trust during the contracting phase that makes them want to collaborate with the project team. That level of trust and commitment to the project among the project management team creates an environment for having a much more successful experience.

The Intent to Work Efficiently and Productively

Contracts designed to promote efficiency and the productivity of the entire project team yield better results in the field and overall. While it may appear obvious that an owner organization expects project teams to be efficient and productive, most traditional contracts contain language quite to the contrary and their projects suffer because of it. At a recent industry event, the president of a global oil company stated that 35 percent of construction costs resulted from material waste, overlap, and mistakes or rework. If that is an indicator of the market, then it is no wonder that the construction industry struggles to achieve stronger productivity results. Language in agreements that requires owner organizations to make timely decisions, foster honesty in sharing known conditions and schedule information, and promote joint planning processes improve the efficiency and productivity from the project management team, through engineering and procurement, and down to the craft in the field. Agreements that limit liability between parties for shared equipment and resources reduce waste and congestion. Project teams that honestly plan and execute work under reasonable schedules and work conditions reduce rework and mistakes. Language that defines roles and responsibilities, especially for shared resources, reduce overlap and rework. Traditional contracts that do not collaboratively address, nor incentivize, the efficiency and productivity of the project team are less successful.

In summary, the challenge of achieving positive results on construction projects in the current marketplace requires owner organizations to assess the dynamics created in their project teams by their traditional approaches to contracting strategies and documents. With strained labor markets and busy contractors, owners turn to their contracting strategies to improve the outcome of construction projects. Changing the dynamics of the relationships between the parties will help the project team remain laser focused on the construction project. Collaborative agreements are the most successful form of agreement to promote these positive working relationships and address these three main components: fair risk management, the intent to collaborate, and the intent to work efficiently and productively. Strong teams, fairly contracted, will yield the strongest results in the field.

Teresa L. Magnus, CPA, JD, is the principal of Magnus & Company, a construction advisory firm committed to improving the experience of the industry by challenging conventional business models through unique thinking, creative solutions, and intelligent execution. Her perspective is based on her 20-plus years of experience in the construction industry serving in roles as the owner, contractor, subcontractor, laborer, and consultant. Magnus will be a featured presenter at SUBExcel 2018, Feb. 28-March 3, in Tempe, Arizona.


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