How to prevent claims and maximize project value?
Are you familiar with the Nash equilibrium? In game theory, that is the situation where no player has an incentive to deviate from their chosen strategy given his opponent's choice. This can teach us something about construction claims. We can find traces of game theory in different shapes and forms and throughout the lifetime of a project. One example is where different contractors tendering for the same project are incentivized to submit low bids (and thus take more risk) because they assume that their competitors are submitting low as well (a must-read on low bids https://afitac.com/2018/04/30/world-bank-abnormally-low-bids/ ). This puts them into a Nash equilibrium which is sub-optimal for the contractors as a group. Another example can be found during execution where a contractor is threatened by LDs for late completion. Conversely, this incentivizes the contractor to claim additional costs from the employer and maybe exaggerate them a bit.
A Nash equilibrium is usually sub-optimal for the ‘players’ as a group. This means value is destroyed by not reaching the maximal potential value for all parties together. We should aim to avoid this and jointly try to reach the equilibrium where maximal value is created for all parties involved. This is called the Pareto optimum.
Let it be clear: contractors and employers entrenching themselves by sending claims back and forth will not benefit from the full value potential of a project. It is Proove’s mission to create maximum value for project organizations. We turn this mission into action and help our partners reach Pareto efficiency. We help them to join forces with their partners and collaboratively avoid the Nash-trap and rise to Pareto! Continue reading to find out how.
Why are excessive claims destroying value?
Claims can of course have a contractual (or legal) basis. When one party asks to be compensated for a valid reason and the requested amounts are genuine, there is nothing wrong. When the required substantiation is provided (sometimes after a few ‘rounds’), we observe that parties find agreement reasonably fast.
On the other hand, claims with a contractual basis, but in excess of incurred costs are more troublesome. Often, they arise from low bidding prices or poorly planned work. The immediate effect is loss of trust and willingness to cooperate. Parties will entrench themselves, keep information behind, keep double books and schedules and jeopardize project success by doing so. Other claim-associated costs harming the outcome of a project include:
- The time the management and project team spend on dealing with claims
- Additional legal costs (certainly after escalation)
- Costs for hiring experts of all sorts
Also, costs associated with reputational damage should be considered. All these costs reduce the value of the project for all parties involved.
Luckily, some parties realize this. Measures to reduce the negative impact on project success exist. They require you to actively manage 3 fronts simultaneously:
- Investing in Project Controls;
- Investing in Contract Management;
- Creating an atmosphere of trust, necessary to effectively manage the project.
Nobody said it would be easy!
We consider project controls as a collection of techniques and tools necessary to make the project predictable. You don’t want to surprise yourself, nor the other party: budgets should be made with care, costs controlled adequately, and schedules should be developed and maintained according to best practices. Risks and uncertainties should be understood and used to approach scheduling and budgets in a probabilistic way. As a contractor, you must be able to show the employer that your plan is robust: an occurrence of a risk can be dealt with, without jeopardizing milestones or budgets.
What you should consider regarding project controls:
- All this requires early investments in project controls: starting to set up systems and develop procedures only when execution is about to start or has already started, is a recipe for disaster. Those early investments are easily compensated by avoiding the damage that would arise later on from inadequate systems.
- The systems you set up should allow you to share the right information at the right time with the right people.
- These systems should also be aligned with your project management strategy
- Not all parties have the same maturity in the field of project controls. We have however seen tremendous maturity increases when one party (often the employer, but not always) encourages the other to step up their game. This resonates throughout the companies participating in such projects and we see lasting results. This is most noticeable in scheduling best practices, probabilistic approaches with substantiated cost and time buffers, and the inclusion of time-related costs. The correct understanding and use of techniques, such as earned value management, increase predictability and, when communicated correctly, help to establish positive relationships between the contracting parties.
- Finally, integration between different project controls’ domains is a crucial step towards mature project controls and towards building trust.
Contract management and administration
Aspects of the contract that foster cooperation
Traditional (construction) contracts are too often a source of conflict. They try to capture every eventuality and are used to corner the other contracting party. They lack incentives to cooperate.
Luckily, an evolution towards more collaborative approaches exists: some modern contract forms (think of Integrated Project Delivery or IPD approach with NEC 3/4 as an example) focus on collaboration and pain/gain sharing. This can create strong incentives for both parties to amicably settle disputes and stay away from aggressive claims.
The following aspects of contracts contribute to creating a collaborative environment:
- Low complexity: use understandable/plain language and avoid excessive references between clauses.
- Avoidance of ambiguity and contradictions.
- Fair risk allocation: Risks should be allocated to the party best placed to manage the risk and this should be explicitly agreed upon. Unfair allocation of risks increases the probability of disputes when the risk occurs.
- Clear definitions of the parties’ duties and responsibilities.
- Clarity on acceptance and approvals: It should be clear when documents, reports, schedules and parts of the works are accepted or approved. All parties should understand the basis for measuring progress.
- When options are foreseen in the contract, the latest date for deciding should be agreed and clearly established in the contract and schedule.
- The payments should follow the progress of the works (e.g. milestone payments) and the process should be clear.
Aspects of your organization that foster cooperation
Let me start this paragraph with my favorite advice: read the contract! Not only the contract manager should do this, but everyone involved in the management of the project: doc controllers, site managers, planners, cost controllers, … We all should know the contract and what it means for our job.
Here is what you should do with your team and project set-up:
- Focus on what, when, and how to submit. Special attention is needed to submit notices timely and avoid time bars.
- Invest early in contract administration, just like in project controls: involve the right professionals from the beginning and give them the right tools.
- Only accept high standards and quality. It might take a few revisions to get there!
- Be critical of all colleagues’ output quality. Keep emphasizing the importance of factual and complete data, e.g. in daily reports.
- Strictly follow contractual procedures. Avoid, for example, acting on verbal instructions where a written Engineer’s instruction is required.
- For the employer: Ensure timely access to site and provide timely and adequate information, approvals and decisions.
- Suitability of the contractors: are the contractors experienced, large and mature enough to manage and deliver the project? If not, it will be a scary ride.
- Anticipate these aspects early in the project’s lifetime! Negligence or errors in those early stages have exponential impacts later on in the project (e.g. errors in design, unclear scope definitions or inaccurate pricing). Also, unfair risk allocation (maybe already in the tender phase) can have a large impact later on.
Contractors and employers entrenching themselves by sending claims back and forth will not benefit from the full value potential of a project. It is Proove’s mission to create maximum value for project organizations.
Atmosphere of trust
As mentioned above, an IPD-approach to the contract will facilitate a collaborative environment. However, merely choosing a contract supporting this, isn’t sufficient. It is hard work. It takes relentless commitment to establish an atmosphere of trust in which all parties together can reach Pareto efficiency.
Here are some tips to get started:
- Foster a culture of transparency and open communication. The earlier a (potential) problem is noticed and communicated, the more likely its impact will be mitigated. Early warning mechanisms are foreseen in contracts like FIDIC and NEC contracts.
- Communicate face-to-face (or face-to-screen in these Covid-days) during meetings with a solution-oriented mindset.
- Avoid threatening with claims and never talk about penalties. Reasonable liquidated damages should never be considered penalties, but merely fair compensations for actual damage.
- When there is ground for a claim, also discuss it during meetings. These are useful to clarify the basis of the claim and more productive than sending letters and emails back and forth. If it comes to a dispute, never give up trying to settle amicably! Arbitration and litigation are the absolute pinnacles of value destruction.
- Give formal change management the attention it deserves. Make the teams understand its importance. Change is the most important driver for claims and everything should be based on facts instead of on opinions and interpretations. Avoid implementing a change without prior agreement on its consequences (on time, costs and performances).
To successfully pursue Proove’s mission to maximize value for our clients, we deliberately talk more about claim prevention than claim management. Value can only be maximized (attaining Pareto efficiency) if parties operate collaboratively and leave behind the more traditional claim mindset. The project management should focus on 3 fronts: Project Controls, Contract Management and creating an atmosphere of trust. We should invest in all 3 at an early stage. At Proove, we strive towards implementing word-class project controls systems that support this approach and try to lead by example.