Contingency Costs: Enemy of Owners’ Budgets

Recently I attended a forum conducted by the Economic Alliance Port Houston regarding procurement practices for large energy and petrochemical projects.  Although aimed at the construction of process plants, the presenters and panelists offered up a lot of good thinking that applies as well to commercial buildings. 

Among the “headlines” I took away from the conference are the following.  First, the methods of delivering projects has shifted from lump sum contracts toward cost-plus agreements.  The principal reasons are the difficulty of precisely identifying project scope early in a project’s life; and, on account of this difficulty, the large amount of funds which must be held in the Owner’s “risk portfolio.” 

In other words, a lot of money must be set aside for contingencies, and money held in reserve cannot be allocated elsewhere. 

The implications for commercial buildings are considerable: monies which are needed for Owners’ maintenance or program needs cannot be spent until spending for the large capital project is resolved.  For non-profits, fund-raising goals must either exceed need, or the scope of the capital project must be cut arbitrarily.  Since lump sum contracting increases risk in terms of cost, schedule, and subcontract performance, a lot of money must be kept around “just in case.” 

Second, project management for a large company on the ship channel focuses on ways to reduce the cost which must be allocated to contingency, and the principal means to do this is through assembling an effective team.  Key to this is incentivizing “behavior” that achieves the desired results, rather than trying to incentivize the results themselves.  In commercial building projects this might translate into incentives for maintaining key personnel throughout the project.  Or a pre-agreement regarding the allocation of risks, which reduces “games playing” and other behaviors that create in-the-moment disputes which threaten schedules and performance.

Finally, innovation and cost efficiencies are driven by competition.  One of the panelists noted how clients tend to select firms with whom they are familiar, and who they know to be reliable.  While admitting there is nothing inherently wrong with this, new ideas and better value will not be achieved this way.  A certain amount of opening up to new players is necessary to advance the trade.  The earlier in the scope definition and design process that new ideas can be introduced, the better.

While the scale of projects that the industrial players on the ship channel undertake is considerably larger than those on smaller and less complex projects, all participants in the building process can nevertheless learn and improve their own methods by applying the lessons learned.

Greg Turner, AIA, LEED AP, MBA, APF
Architect, MBA, and Professional Futurist Greg Turner can work with you to augment your organization’s strategic direction and financial performance, through his focus on the relationships between external environmental conditions and internal strategic development.