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FHWA > Programs > Office of Policy > Office of International Programs  > Contract Administration: Technology and Practice in Europe > Chapter 3

CONTRACTING TECHNIQUES

Alternative contracting techniques used by European transportation agencies could have a tremendous impact on the efficiency and effectiveness of contract administration in the United States. The report discusses these techniques in terms of procurement, contract types, and payment mechanisms. Similar to the U.S. relationship between the State DOTs and the FHWA, the EU Directives establish minimum requirements for procurement, but individual countries can develop unique contracting techniques that fit distinctive needs just as State DOTs do in the United States. Consequently, the contracting techniques documented in this report have the potential to be directly implemented in the United States.

The primary findings of this chapter involve the widespread use of best-value procurement, greater latitude to enter into competitive negotiations, more use of alternative designs in proposals, extensive use of management contracts, long-term contracts tying maintenance to construction, and payment methods that are based on outcomes at the end of the projects rather than payment for work as it is put in place. All of these techniques result in contractors and designers working more closely with the public sector and being given more public trust. Many of the techniques resemble contracting techniques employed in the U.S. private road sector and public building sector, but they have not for the most part been employed in the U.S. public transportation sector.

The United States and Europe share the same traditional method of contracting: the design-bid-build methodology. In the 19th century model developed in the United Kingdom and employed in many European countries, the client procures a professional design team separate from the contractor and awards construction contracts based on low bid. Professionals are employed to supervise the contractor. During the 1980s, a slowdown in development and consequent overcapacity meant that construction bids included low profit margins. This situation led to confrontational behavior, claims specialists, increasingly expensive claims submitted, years to settle, and unacceptable time and cost overruns for clients. An example provided by Yogesh Patel of the British Highways Agency included a project bid at 31 percent less than the engineer's estimate. Claims pending 1 year after construction would have brought compensation of 111 percent over the bid amount. The parties finally settled the claims for 42 percent of the bid amount--11 percent over the original engineer's estimate.

Likewise, in the Netherlands in the mid-1990s, the Dutch were experiencing concerns regarding the lack of innovation, efficiency, and competition. The result was a countermovement toward integrated solutions and project development methodologies such as design-build. This change involved transfer of technical risks to the private sector, giving the private sector greater influence on design and development of larger public works projects, and challenging the private sector to provide innovation both in product and process. The primary goal was to achieve more efficient solutions; a secondary goal was to improve opportunities for Dutch businesses to compete outside of the Netherlands.

Following is a quote from the Construction Industry Research and Information Association (CIRIA) report, Contract Incentivisation Schemes: Lessons from Experience (Richmond-Coggan, D. 2001, p. 39), which summarizes this need for transition away from the traditional procurement methods. "Traditional procurement routes in the public sector may appear to be tortuous and leave little to the imagination in respect of expediting best-value." The report goes on to suggest "a more open style of procurement against the backdrop of public accountability ... The recent challenge to traditional procurement strategies within the public sector by the private finance initiative (PFI) has shown that the constraint on openness can be lifted to encourage the use of incentives within the negotiation process and their inclusion in the contract. Whilst this is an entirely different procurement methodology it has combined the issues of risk and reward within the negotiations and developed more openness in aligning the client and contractor objectives."

All of these issues have influenced the Europeans to turn toward alternative contracting methods. Standard EU regulations (discussed below) and use of alternative contracting methodologies by many different EU members have validated the alternative methodologies, making it easier for EU members wanting to use alternative methodologies to obtain internal legislative approval to proceed.

Innovations in procurement, contracting methods, and payment methods have resulted in an enhanced collaboration with the private sector. The European construction industry is beginning to understand the mutual benefit of long-term relations and managing its supply chain.

The European Parliament and the Council of the European Union have adopted a directive regarding rules to be followed by EU members in procurement of public works contracts and concessions over a specified amount. See Council Directive 93/37/ EEC of June 14, 1993 (http://www.tendersdirect.co.uk/thelaw/ecd9337.asp), as amended by Council Directive 97/52/EC of October 13, 1997 (http://www.bipcontracts.com/directive7.htm). The Commission of the European Communities has proposed certain amendments to the Directive providing for electronic purchasing, expanding the ability to negotiate contracts, providing for framework contracts, clarifying provisions relating to technical specifications for the purpose of encouraging effective competition, strengthening provisions relating to award and selection criteria, simplifying thresholds, and providing a common procurement vocabulary. See http://europa.eu.int/comm/internal_market/en/publproc/general/com275en.pdf. Council Directives are implemented by individual EU member states through appropriate governmental action. For example, the above-cited Directive was implemented into U.K. law by Public Works Contracts Regulations 1995. See http://www.bipcontracts.com/Briefings/Briefings2000/Brief7_00.htm.

The goal of the Directive is to ensure that contracts over a certain value are awarded in a competitive, transparent, and nondiscriminatory manner. The EU procurement requirements flow through to local agency contracts for which the State provides more than 50 percent of the funding. Furthermore, all contracts (including those under the specified threshold) are subject to certain requirements set forth in the treaty establishing the European Communities: no discrimination on the grounds of nationality; free movement of goods; a prohibition of quantitative restrictions on imports and exports; and measures having equivalent effect, freedom of establishment, and freedom to provide services. See http://www.ntc.no:8088/01/25/ systm001.pdf for answers to frequently asked questions.

The EU Directive provides for three different types of procurement: Open Procedures allowing all interested contractors to submit tenders; Restricted Procedures whereby only those contractors invited by the contracting authority may submit tenders; and Negotiated Procedures whereby contracting authorities consult contractors of their choice and negotiate the terms of the contract with one or more of them. For negotiated procedures to be used, the agency must make certain findings. The proposed amendment to the Directive would expand the ability to use negotiations. Sole source negotiations are permitted only in limited circumstances.

The British Highways Agency's goal of best-value selection
The British Highways Agency's goal of best-value selection - click here for description

Under both the existing and proposed Directives, award may be based on either lowest price or may be made "to the most economically advantageous tender." Under the proposed amended Directive, complex contracts would have to be awarded on the latter basis. For contracts awarded based on a determination of economic advantage, the contracting authority must state in the contract documents or in the contract notice all the criteria it intends to apply to the award (such as quality, price, technical merit, aesthetic and functional characteristics, environmental characteristics, running costs, cost-effectiveness, after-sales service and technical assistance, delivery date, delivery period, or period of completion). The original Directive stated that the criteria must be listed, "where possible," in descending order of importance. The amendment would require the relative weightings to be disclosed.

PROCUREMENT

Best-Value Selection

The most notable difference between European and U.S. procurement methods is that best value (referred to in the Directive as "most economically advantageous tender") is used in virtually all types of procurements. Best-value selection involves the evaluation of technical and management factors in addition to cost--as opposed to the low-bid selection, which involves only cost comparison of responsive bids from responsible bidders. Although the EU Directive permits low-bid selection, in general it appears that low-bid selection is limited to relatively simple projects. The Europeans have found that best-value selection, using transparent and uniform processes, enhances competition and innovation. In cases of long-term maintenance contract procurements, the business culture and quality are weighted much more significantly than are the price and technical portions of the procurement. There also is widespread use of prequalifications in selections to ensure technical competence in the procurements. The British Highways Agency's overall goal of best value is shown in the figure on page 14 (British Highways Agency 1997).

Although all countries visited employed at least some type of best-value selection, the specific best-value criteria and weighting of these criteria varied from project to project and country to country. For example, Portugal includes best-value factors such as schedule and quality of technical proposal, but qualifications of proposers are reviewed on a pass-fail basis.

The Netherlands has a slightly different approach. For most construction projects, combinations of contractors (consortiums) compete for the contract. Depending on risks for the government, they use a process involving initial shortlisting followed by evaluation of final proposals. The shortlisting is based on evaluation of criteria establishing the contractor's capability of performing the contract, and can include competence, resources (experienced staff, special equipment, process certificates, etc.), experience and achievements, work quality in previous projects, approach to project (if required), and execution plan. Generally, the Netherlands applies the same evaluation criteria to review of the final proposal as for the shortlisting, plus price.

The typical Swedish best-value procurement is comparable to that used by the Netherlands. The Swedes typically employ a 70 percent price weighting with 30 percent weighting of references, schedule, quality assurance system, traffic safety, environmental issues, etc. The Swedes typically do not publish the numerical weights of the evaluation criteria but instead rank the relative importance of each factor. Their legal counsel has determined that this approach meets EU requirements.

In U.K. design-build projects, the first contracts were awarded based on 20 percent quality, 80 percent price. Currently, weighting of 60 percent quality and 40 percent price is more standard, and sometimes quality is given an even higher weight. In some long-term maintenance contracts in the United Kingdom, a weighting of 90 percent has been placed on factors other than price.

The French have a best-value system that most closely resembles the low-bid system. They use an annual prequalification process for certain types of projects. Evaluation criteria are identified in the request for tenders in the order of priority (schedule, quality, price, etc.). Usually price is not the top criterion, but in practice the French Ministry of Transportation stated that the low bidder is selected in 95 percent of the cases. This situation occurs in part because technical proposals typically are not detailed enough to allow selection based only on technical qualifications. It generally takes 2 to 3 weeks to review the bids. Most of the situations involving selection of other than the low bidder are with alternative requests for proposals (RFPs). It usually takes 1-1/2 to 2 months to review proposals when the alternative process is used.

U.S. Parallel: Best-Value Selection

The United States is beginning to employ best-value selection, but primarily in design-build contracts where there is opportunity for innovation and minimal design is provided by the transportation agency. FHWA's draft design-build rules state that no less than 50 percent of the selection be based on price. In practice, price is most often the highest weighted factor. As in Europe, the methods for combining price and qualifications and the weighting of the technical factors vary from agency to agency. The NCHRP has completed one study of best-value procurement (NCHRP Report 451 - Report Guidelines for Warranty, Multi-Parameter, and Best-Value Contracting 2001) and, at the time of this report, has begun a second study to provide guidance for U.S. highway agencies in procedures for best-value selection.

Best-value selection has the potential to provide for the selection of higher quality contractors while lowering costs by rewarding technical innovations. Best-value procedures also have the potential to create a less adversarial and claims-oriented industry by developing a higher level of trust between the public and private sectors. Employment of a best-value selection system also will create accountability for past performance, as it can be incorporated into the selection criteria for future projects.

Confidential Discussions of Alternative Designs and Alternative Bids

Ministries of transportation visited use confidential discussions of alternative designs much more readily than in the United States They advised the scan team that this practice has resulted in an increase in design and construction innovation. The competitive proposal and negotiation process benefits the government since it requires the contractors to be both innovative and cost-conscious. The EU process is generally acceptable to contractors, thus promoting competition. Specifically, the minimum EU standards promote relative uniformity of the procurement process throughout the EU and make it easier for contractors to compete all around the EU. The negotiation process enables contractors to benefit from innovations they propose without concern that their ideas will be shared with competitors.

In the United States, the standard low-bid procurement process does not allow contractors to incorporate alternative concepts in their bids, although design-build procurements often include such opportunities. For traditional contracts, a bidder's innovative ideas would be submitted only as proposed changes after contract award through some form of value engineering process. There is often a shared savings clause in the contract to create an incentive for the contractors to submit cost-savings ideas. The scan team observed numerous examples of contractor-initiated changes being integrated into the procurement process. These changes can be referred to as "alternative proposals," with the innovation and competitive pricing occurring during the procurement process, not after award. This process leads to better pricing on alternative designs, but it also requires longer bid review times.

A primary barrier for alternative contractor proposals in the United States is our inability or unwillingness to hold confidential discussions with proposers during the procurement period. The U.S. process only allows discussions during a competitive bidding process to clarify existing plans. Typically, any information shared with one bidder must be shared with all of the bidders. Procuring agencies are not allowed to discuss possible innovative proposals with only one team. Because teams do not want to have their alternative concepts shared with other teams, they are unwilling to ask questions about alternative proposals until after the contract has been awarded. This process results in less value to the owner. Some of the European agencies visited allow confidential discussions of innovative ideas during the procurement process and have subsequently experienced increased innovation and more competitive pricing. The new high-speed rail link from Amsterdam to the border of Belgium, discussed in the following section, provides an excellent example of confidential discussions during the procurement period for a design-build project.

The Netherlands High-Speed Line South

High-speed rail is linking the Netherlands to other countries in the EU. The new High-Speed Line South is running between the Skidmore airport and Rotterdam. Part of the line runs through the Green Heart of the Netherlands, an area designated by the government for noncommercial use. This area is so important to the public that the government decided to run the high-speed rail in a bored tunnel under the area rather than disrupt its pristine nature during and after construction.

The bore tunnel selection included a prequalification phase using a request for qualifications (RFQ). Eight contractors responded to the RFQ, and the government shortlisted the teams down to five contractors to develop designs and bids. The bidding phase involved reviewing 10 bids, 2 proposals from each of the 5 bidders. Three of these 10 proposals were then chosen for competitive negotiations.

The final winning proposer's design had very little resemblance to the government's original design. The original design involved a shorter, two-bore tunnel with connections between the bores. The winning firm proposed an extremely large, one-bore tunnel that was actually longer than what the original design required. The result was a longer and safer tunnel that met the needs of the owner better than the original design.

The key to the success of this procurement was that the government agency was able to entertain design alternatives during construction that it did not share with all other bidders. The winning proposer had the ability to find out whether the government would entertain the idea of a one-bore tunnel, before spending the money to explore the idea with the tunnel boring machine vendor. The proposer had confidence that this information would not be distributed to other teams during the procurement process, thereby negating its competitive advantage. Note, however, that the government only commented on the feasibility of the alternative design solution during the procurement. It did not actually approve the new design until all bids were submitted.

U.S. Parallel

Various U.S. agencies have specifically asked proposers for alternative technical concepts, usually in the context of design-build projects. Such an approach was used for the Transportation Expansion (T-Rex) project, a multimodal project jointly undertaken by the Colorado DOT and the Regional Transportation District that included 19.1 miles of new double-tracked light rail transit and 16.6 miles of highway improvements. The prequalified teams submitted a total of 44 alternative configuration concepts for the T-Rex project. The agencies accepted approximately half of the proposals, and conducted three 6-hour workshops with each team to discuss the concepts. Although no formal analysis has been conducted regarding the benefits of this process, the agencies believe that the alternatives resulted in significant savings of both time and money.

CONTRACT TYPES

The scan team observed numerous contract types and delivery structures on the tour. The United States is currently employing a number of these techniques, but the scan revealed new techniques that have merit for implementation in the United States. This section specifically discusses those contracts that are not currently being used in the United States. Design-build, design-build variations, and concessions are introduced below, but are discussed in more depth in Chapter 4: Design-Build and Chapter 7: Concessions.

Contracts Similar to U.S. Methods

Contracts not Currently Used in U.S.

  • Design-Build
  • Design-Build-Maintain
  • Design-Build-Operate-Maintain
  • Concessions
  • Framework Contracts
  • Managing Agent Contracting (MAC)
  • Private Finance MAC
  • Integrated Supply Chain Management

All of the contracts listed above promote methods of creating more partnership between the public and private sectors. European contracts have evolved toward placing more public trust and responsibility in the private sector. The contract types discussed in this report provide examples of how some European countries are reallocating contractual risk to leverage the efficiency of the private sector.

Design-Build

The design-build contract involves one contract for both the design and construction. The traditional method of contracting separates design and construction to create a system of checks and balances for quality and price. Although this separation creates checks and balances, it also can create a long delivery period and may result in an overdesigned project and an adversarial and claims-oriented environment. Design-build contracts speed the delivery of projects and promote more constructability and innovation.

European highways agencies have used design-build contracts to a much greater extent than U.S. agencies. Design-build requires a higher level of trust and cooperation between the public sector and industry than does the traditional method. As mentioned throughout this report, the public European highways community has a much closer relationship to the private sector than does the U.S. Specific lessons learned about design-build in Europe are discussed in Chapter 4: Design-Build.

Design-Build-Maintain and Design-Build-Operate-Maintain

The extension of a design-build contract to a design-build-maintain (DBM) or a design-build-operate-maintain (DBOM) contract is becoming prevalent in Europe. Adding maintenance or operation and maintenance has numerous advantages. The primary advantage is that these contracts create a lifecycle responsibility for the design-builder. The same company that designs and constructs the highway is also responsible for maintaining quality over a period of years. This situation provides an incentive to deliver better quality in the initial design and construction of the project because the design-builder will be responsible for additional maintenance and repair costs if the initial quality is inadequate. DBM and DBOM contracts are discussed in more detail in Chapter 4: Design-Build.

Concessions

The French national highway system is almost exclusively operated by concessionaires. Interestingly, only one of France's concessionaires is privately held; the remainder are limited liability companies owned by central and regional government bodies. Portugal is the most aggressive employer of concessions. Portugal has integrated the use of concessions into its long-term planning and anticipates expansion of its concession contracts from 431 km in 1991 to 2,269 km in 2006. Although the United States has limited experience with real toll concessions, European agencies have significantly more experience with other variations of concessions. The intricacies and implications of concessions are discussed in Chapter 7: Concessions.

Framework Contracts

The framework program was implemented in the United Kingdom in 1999. The framework contract is an arrangement that allows a purchaser to package its procurement requirements and select one or several suppliers to meet specific task(s) or order(s) over a period of time. The purchaser and suppliers establish terms on which purchases will be made at the outset, but do not set precise quantities.

Frameworks can be applied to supply, works, and professional service activities, but they are best suited to orders of a similar nature, where demand is likely to materialize in a regular or programmed manner over an extended period.

Frameworks enable purchasers to place orders, or "call-off" services, with or without secondary competition--substantially speeding procurement. As noted above, the proposed new EU Directive specifically permits such agreements.

Carillion, a framework contractor in Kettering, England, hosted the scan team. Carillion is responsible for the long-term maintenance of a section of highway on the national motorway. Carillion performs all maintenance (landscape, stripping, inspections, etc.) on the highway and is the sole source for improvements on small construction projects. Carillion has a 5-year contract to perform maintenance and small construction contracts; it also can compete in the open marketplace on larger construction projects. Some of this work is self-performed by Carillion and some is done through its supply chain.

The following is a list of essential characteristics of a framework agreement as specified in the "Procurement Guidance Strategy Note" of the British Highways Agency's (HA) Works Framework Contract, Issue 2, Revision 0:

  • The Terms and Conditions contained within the new model contract forms have a number of differences from contracts used for single procurement actions. They provide for a longer-term and closer relationship between the Highways Agency and its supplier than that traditionally employed. This is to allow a process of continuous improvement to bear fruit. Typically works frameworks should be a minimum of 5 years duration. [Note, however, that the proposed EU Directive would limit the duration to a maximum of 3 years except under exceptional circumstances where a longer term is justified.]
  • To achieve best-value through the use of a framework great clarity of its purpose is required. This includes clarity of the specification, the type of supplier required as well as clarity of the documentation. That is, five years is a long time if things are going wrong or one has the "wrong" supplier. The need to demonstrate continuous improvement, and the mechanism to deliver it, must be clearly defined.
  • Unlike single procurement actions the quantum, timing and logistics for each procurement action planned under the framework is not likely to be known at the outset. Yet price competition remains important. A balance must be struck between burdensome pricing requirements and having sufficient price data to allow fair and competitive prices to be paid during the life of the framework. The importance of adopting consistent approaches to frameworks (i.e., the models) and use of benchmarking processes on performance and costs should not be overlooked. It is a key element of the control process and a main driver for continuous improvement.
  • In addition the fundamental payment mechanism for a framework should be considered carefully. In pursuing best-value, requirements for price certainty may be relaxed within a framework contract, as there is the incentive of a continuous income stream if the supplier demonstrates quality and value, i.e., if they do this job well there will be another to follow. There are many payment mechanisms that can be used for frameworks but in deciding which one to use a risk assessment should be made and the method that is likely to attract the smallest risk premium from the supplier should be selected.
  • For a starting point, the HA has decided to adopt a target cost payment mechanism for its Model Framework works contract as this offers control with cost openness and an opportunity to deliver continuous improvement.
  • Frameworks should not be entered into lightly. To get value out of them the Highways Agency must be offering a consistent workload of similar activity for a medium to long-term. Care should also be taken that we do not overstate what we can deliver. There must be sufficient demand for a framework and that demand must extend over a number of years for value to be achieved. Much of the value for money will come from the efficiencies of the process and the efficiency gains that repetition brings.
  • In order for the HA to deliver the required consistency of workflow it may be necessary to have a framework contract extend over a region (not just an area) or even nationally. At the same time the impact on the supplier market must be considered in order to maintain competition and a commercially sustainable market into the future.
  • The mechanism for placing orders must be considered carefully. If one supplier is used control is straightforward. However, with multiple suppliers one person needs to manage the framework as a whole and the mechanism for distribution of work amongst the suppliers should be established and explained to them in advance of the tender process. The HA Model Framework Operational Guidance Notes include a suitable method and suggests that a Framework Board be established to manage the process.

Framework contracts have been found to offer flexibility, speed of delivery, quality and reliability of supply or service, and value for money. However, agencies must be able to demonstrate that best value is being achieved at the outset and throughout the long relationship with the supplier. This outcome can only be achieved through demonstration of continuous improvement.

U.S. Parallel - Indefinite Delivery/Indefinite Quantity Contract

A U.S. parallel to the framework contract is the Indefinite Delivery/Indefinite Quantity (ID/IQ) contract used by the Federal government. ID/IQ contracts have been used for some time by the Department of Defense for the procurement of military equipment and have recently been employed for design and construction of capital facilities. A small number of contractors (typically three to five) are placed under contract for a 1- to 5-year term to deliver equipment such as artillery or vehicles. An indefinite-quantity contract provides for an indefinite quantity, within stated limits, of supplies or services during a fixed period. The government places orders for individual requirements. Quantity limits may be stated as number of units or as dollar values. Recently, government agencies have begun to procure design and construction services more frequently under ID/IQ contracts. Renovations of aging military bases and expansions where the quantity of work is not well defined have shown particular value. ID/IQ contracts may be very well suited for much of the routine maintenance on U.S. highways where the description of work can be clearly defined, but the quantity of work may vary depending on use, weather, or other circumstances. This type of work may include stripping, resurfacing, etc. For more information on ID/IQ contracts, consult the Federal Acquisitions Regulations Subpart 16.5 - Indefinite-Delivery Contracts.

Managing Agent Contracts and Private Finance Managing Agent Contracts

The managing agent contract (MAC) was first employed in the United Kingdom in 1996, and 24 contracts were in place in 1999. The managing agent is responsible for carrying out all design work, asset inspections, network maintenance management, and supervision of the term maintenance contractors. The term maintenance contractors are responsible for all routine, cyclical, and winter maintenance and small capital maintenance and improvement works.

The Highways Agency's role in this type of arrangement does not resemble that of a traditional U.S. State Highway Agency (SHA), but that of a network operator that strategically manages the network. Its role is to procure services, not to provide them. As discussed in the previous section on best-value selection, it is utilizing quality criteria and not just price. The Highways Agency defines the performance outcomes that it is seeking and then audits and regulates the MACs to ensure quality.

The private financing managing agent contract (PFMAC) is an extension of the MAC concept in which the managing agent also provides financing for the capital and cyclical cost of the MAC agreement. The PFMAC is then paid for its services through a number of performance-based payment systems. MACs and PFMACs are discussed in greater detail in Chapter 5: Performance Contracting.

Integrated Supply Chain Management

A developing new contracting technique in Europe is integrated supply chain (ISC) management. This contract extends the use of managing agent and framework contracts to incorporate long-term strategic alliances with the suppliers of material and labor. The motivation for using ISC contracts is that approximately 80 percent of the cost of any manufactured product is in the supplier's labor and materials. Therefore, key suppliers should be selected for their ability to deliver excellent work at a competitive cost. The supply chain must be capable of contributing new ideas, products, and processes. The suppliers also should be managed so that any waste and inefficiency are continuously identified and driven out. Models of traditional, single source, and ISC delivery methods are shown below.

Traditional, single source, and integrated supply chain contract models (adapted from CIRIA presentation) - click here for description

Traditional, single source, and integrated supply chain contract models (adapted from CIRIA presentation).

The ISC methodology extends the sole source concept of the design-build, MAC, or concession contract by forming a strategic partnership with the prime contractor to manage key suppliers. The ISC concept leverages the fact that 80 percent of project costs are generated through materials and labor. Long-term contracts are formed with the key suppliers who can in turn become involved with the projects at their earliest inception. The designers, manufacturers, and subcontractors are involved in writing performance requirements, value management, and value engineering. The key suppliers also are much more involved in defining the needs of the users, operators, and maintenance personnel.

ISC contracts are new to the design and construction industry, but they are actually modeled after best practices in the manufacturing, automotive, and industrial sectors. Two examples of these best practices come from Shell U.K. and Rolls Royce. After oil prices collapsed in 1986 and again in 1992, Shell U.K.'s North Sea oilrigs were producing oil at a higher cost than it could be sold. The traditional rig design involved complex specifications that were developed and imposed by the operator with no reference to the supply chain. The specifications were requiring nonstandard materials and processes with inequitable contracts. The solution was to move to an output specification (no detailed specifications) and allow suppliers to propose optimal solutions. Shell U.K. and the suppliers developed the projects through mutual interest using nonadversarial techniques. They did this by taking the most economical bid, incentivizing the contracts, and capping the supplier's risk. Shell U.K.'s result was a 30 percent reduction in cost realized in 3 years.

Rolls Royce achieved a similar 30 percent reduction in the cost of producing three engine test cells that were critical to remain competitive. One of the keys to achieving this reduction was to abandon the competitive tender process and replace it with a target-pricing concept for the supplier. In essence, the target price was agreed upon early in the project and Rolls Royce shared the pain and gain of achieving the target price with the suppliers. Using an ISC concept in lieu of the traditional competitive tendering process led to savings in in-house costs, optimal designs, and removal of uncertainty of final price. Target pricing is discussed in the next section.

Although ISC contracts are not yet in full-scale practice in Europe, the United Kingdom is moving in that direction. The term maintenance contractor agreement in the U.K.'s MAC and PFMAC contract uses many ISC attributes. These contracts include long-term maintenance agreements with maintenance operators. The Highways Agency takes the role of a network operator and not a provider of services. The term maintenance contractor agreement aspect of the MAC is discussed in more detail in Chapter 5: Performance Contracting.

PAYMENT MECHANISMS

Alternative procurement methods and contracts require nontraditional payment mechanisms to optimize their benefits. The biggest difference from the traditional payment methods is that payments are not based on units of work completed, but on availability of the product at the end of the project. The private-sector providers are required to carry much more of the costs during and after construction. They are then paid on the basis of milestones, availability (i.e., number of lanes open), quality of performance (i.e., smoothness), and/or safety (a reduction in the number of crashes, measured against a baseline). In concession contracts, payments are evolving toward a purely performance-based method.

Since the majority of contracting techniques found on this scan and documented in this report involve design-build or concessions, there is little discussion regarding the traditional unit price contracts. The host countries did not even discuss the variations of unit price contract, such as cost-plus-time bidding and lane rental concepts invented in the United Kingdom in the late 1980s. These techniques have taken a smaller role between the agencies and the design-builders and concessionaires. However, design-builders and concessionaires may use unit price or work order subcontracts depending on the scope of work for the subcontract.

At the government levels in France, Portugal and the United Kingdom, there has been a major shift away from provider of services to network operations manager, and the payment methods reflect this shift. The Netherlands still maintains a much more traditional role and, much like the United States, has only begun to experiment with the operator role. For traditional contracts, Rijkswaterstaat (RWS; the national government department in charge of infrastructure, including roads) uses units of work, however, its standardized units of work may be very detailed. It provides separate payments for delivery, compaction, and curing of materials and even adjustments for terrain. Product-oriented contracts may provide for similar line items; however, the pay items are focused on the individual products.

Milestone Progress Payments

Alternative contracting techniques often require a contract award with less than 100 percent complete designs. This fact makes unit price payment information unavailable at the time of award. Numerous European agencies have turned to milestone payments to overcome this problem. Milestone payments involve larger payments based on the completion of certain major work items. This method has been used successfully in the U.S. building industry for years. The primary barrier to milestone-payment methods in the highway sector is that it requires the contractor to carry a large financial burden in between milestone payments. Since the European highways agencies are using more private financing, this is not a significant barrier.

On design-build projects, the British Highways Agency will generally monitor the design-builder's performance to verify that certain milestones have been achieved, or audit its records if payment is based on invoiced costs. On DBM contracts in the Netherlands, payment may be based on the completion of certain construction stages or milestones. During the maintenance phase, RWS makes a fixed lump-sum payment every 3 to 6 months if the desired performance criteria are achieved. This payment method also is used on performance contracts.

The Netherlands also is paying by percent-complete formula on the Westerschelde Tunnel profiled in Chapter 6: Alternative Financing, and is very pleased with this payment procedure. Payments are made based on a percentage of progress. The contractor provides the owner with a percentage-based determination of completion every 2 weeks. The owner spends a minimum amount of time verifying progress; however, a detailed audit of the work performed is done four times per year. RWS pays the contractor within 14 days of invoice. It should be noted that the project controls for this project are using the latest information technology to achieve the short payment time and to organize the audit structure.

Payment by Availability

Payment by availability means that the owner pays for a highway on the basis of the amount of time that the highway is open to traffic. This method is a radical change from the traditional payment for completed work by unit costs. The contractor, design-builder, or concessionaire is responsible for carrying all of the costs during construction and operation and gets paid only if the lanes stay open to traffic over an agreed upon period of time. The goal of this payment method is to reward the private sector for decreasing congestion and make it responsible for the entire project lifecycle from design through construction and maintenance.

Of the five European countries visited, the British Highways Agency is the most advanced in this payment method. As noted previously, the British agency has been going through an evolutionary process over the past 10 years. Although the cost-plus-time bidding and lane rental concepts were invented in the United Kingdom in the late 1980s, these techniques are no longer used. The agency also went through an evaluation period for design-build and design-build-finance-operate (DBFO) utilizing shadow tolls. The administrators at the agency now believe that the future contract forms that will be most economical will include payment by availability.

Over the past few years, the shadow toll contracting method has fallen out of favor with some administrators at the British Highways Agency. Opponents of shadow tolls claim that this practice actually increases traffic growth and is contrary to the overall goals of the transportation plan. For this reason, the agency has developed a modified contract and payment method for future DBFO contracts called active management payment mechanism (AMPM). Both shadow tolls and AMPM methods are discussed in Chapter 6: Alternative Financing.

The agency intends to rely on the congestion management provision in the AMPM method as a replacement for the shadow tolls concept. Under this new concept, the contractor's payment is based on the availability of lanes during the construction and operational period. A weekly payment will be made that is proportional to the expected level of traffic flow. This traffic flow will be based on target speeds and expected traffic volumes (in passenger car units/hour as a percentage of capacity). Adjustments will be provided for different time periods of the day and different geometric sections. In theory, this provision will provide the DBFO firm with a large contractual incentive to schedule construction and maintenance operations to minimize inconvenience to the traveling public. In addition, the DBFO firm will have an incentive to manage the traffic operations and improve the flow of traffic through the work zone. Such an incentive may encourage the firm to actively manage the work area by providing additional incident-clearing facilities, emergency towing vehicles, emergency pull-off areas, and other techniques to facilitate the flow of traffic.

The Netherlands is attempting a similar payment method. On the N31 design-build-finance-maintain contract, the progress payments are based on the availability of newly completed roadway sections. Even though the project is privately financed, RWS made the decision to make partial payments when roadway sections are open to traffic instead of waiting until the entire project is open to traffic. This system is intended to incentivize the builder to make the road available sooner, but share the risk for the entire project equitably.

Target Pricing

All of the European countries visited use some form of target pricing with incentives and disincentives. This concept is not unlike the U.S. construction-manager-at-risk concept, and also is the approach commonly used for private-sector design-build in the United States. During the design development process, the owner establishes a target price, and the contractor will produce a design based on the project criteria, with reference to the target price. A guaranteed maximum price will be negotiated with the contractor when the design reaches a point where risks can be assessed accurately. Cost-sharing provisions, like value engineering provisions found in current U.S. contracts, are used to incentivize contractors to optimize design and construction costs. A model of target pricing is provided in the figure on the next page.

Target-pricing model (adapted from CIRIA presentation) - click here for description
Target-pricing model (adapted from CIRIA presentation).

The target-pricing model has been employed in the U.S. building market for years, and good contract examples are available from the American Institute of Architects, the Associated General Contractors Association, the U.S. General Services Administration, and many others. The fundamental premise lies in setting an early target cost from engineering estimates, then capping the owner's risk through a guaranteed maximum price at some percentage above the estimate and incentivizing contractors to minimize costs by offering shared incentives for savings below the target price. The major barrier that exists in the U.S. highway sector is that the target-pricing system requires reliable conceptual cost estimates early in the project and an open book accounting structure throughout the project lifecycle. These two significant hurdles in the U.S. transportation market are less burdensome in Europe given the closer relationship between European agencies and the private sector (utilizing open book systems in many instances). Open records laws may present an additional barrier in the United States. The private sector guards its secrets carefully from competitors and may believe that information shared with public agencies will somehow become public.

Incentives and Disincentives

Incentive and disincentive methods were embedded into many of the projects involving long-term maintenance structures that were presented to the scan team. The transference of finance, safety, and maintenance responsibilities to the private sector results in intensive auditing from the owner to ensure peak performance. These audits, in turn, can provide measurable metrics that translate into incentive and disincentive schemes. Two primary examples of incentives and disincentives come from the incentive plan for safety and quality management in the British Highways Agency's AMPM contract discussed above and the penalty plan for The Netherlands quality system being used on long-term maintenance methods.

The safety management payment feature provides a contractual incentive if the concessionaire achieves a better than average safety record in comparison with accident rates on similar roads. The service management provision provides a contractual incentive (1 to 2 percent of the DBFO firm's annual revenue) if certain quality goals identified in the firm's management plan are attained. The safety and quality management methods for the AMPM system are discussed in more detail in Chapter 5: Performance Contracting.

In the Netherlands, bonuses are sometimes used to reward contractors for above-average work if no deductions were made for work below a certain quality standard. Although direct contractual incentives for quality and contract time are not provided, the RWS utilizes other contractual measures to ensure quality in construction and a minimum of construction time. The RWS uses a yellow-card/red-card system to control design, construction, and operations quality during the life of the contract. Similar to the yellow-card/red-card system in the game of soccer, the contractor's performance is monitored on a program basis to ensure that it is operating in accordance with its approved QA/QC plan. If a significant deviation is detected, the RWS will issue a yellow card to warn the concessionaire of substandard performance. A second yellow card may follow. Payment reductions may be associated with each yellow card on the basis of the issue involved. In a serious situation, a red card may be issued, which would result in cessation of the work and, ultimately, termination of the contract and possibly a removal of the firm's prequalification rating.

It also should be noted that a significant early completion incentive is inherent in the toll concession concept. Until new construction is open to traffic, the concessionaire will not receive a payment in the form of real tolls or shadow toll payments from the owner. Again, the contract structure incentivizes the concessionaire to consider the whole lifecycle of the highway, which will lead to a competitive balancing of lifecycle maintenance costs and early completion gains.

SUMMARY

The European highway community employs a wide range of contracting techniques. All of the alternative contracting techniques described in this chapter require a higher level of trust and teamwork between U.S. highway agencies and contractors than currently exists. The level of partnership witnessed in Europe came through slow change from the traditional contracting systems, and all of the problems have not been solved. If the United States wishes to benefit from the efficiencies observed in European highway contracting, it must be willing to take strides toward alternative contracting methods and transition from established contracting techniques to more open and transparent methods.

As discussed in this chapter, the European highway community is benefiting from widespread use of best-value procurement, greater latitude to enter into competitive negotiations, more use of alternative designs in proposals, extensive use of management contracts, long-term contracts tying maintenance to construction, and payment methods that are based on outcomes at the end of the projects rather than payment for work as it is put in place. The U.S. highway agencies can directly apply these findings to many of their existing contracting schemes. The scan team recommends that the following tools be explored in the United States as a means to speed the delivery of our infrastructure and increase the quality of construction and maintenance:

  • Use best-value award techniques in the selection wherever it is shown that value can be added through quality or innovation.
  • Explore techniques to fairly and equitably employ confidential negotiations and discussions of alternative proposals to capitalize on the creativity and innovation of the private sector.
  • Use management contracting on repetitive work where project characteristics display a potential to save construction and procurement costs.
  • Explore ISC contracts to capitalize on the efficiencies documented in the manufacturing sectors.
  • Test payments by milestones and payments by availability as ways to tie quality performance to payment structures.
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