Have you got enough budget for your construction projects?
Singapore’s Building and Construction Authority (BCA) has projected that the total value of construction contracts to be awarded in Singapore in 2019 would range from S$27bn to S$32bn.
Of these, around 60 percent will be in the public sector and major infrastructure projects such as the Cross Island Line, Jurong Lake District development and Changi Airport Terminal 5, will support public sector construction demand of S$16bn to S$20bn per year until 2023.
But major projects, by nature of their scale and complexity, are inherently exposed to a wide range of uncertainty. These include uncertainty related to funding, approvals (regulatory and stakeholder), land acquisition, foreign exchange fluctuations and complex interfaces.
The bigger and more complex projects are, the greater the uncertainty and correspondingly, the greater the risk.
With a large number of projects coming forward in Singapore, more pressure is being put on the supply chain which can trigger cost escalations. It is important to manage budgets well, particularly where public money is involved and there is a wider socio-economic benefit in limiting overspend.
But there is a tried and tested way of mitigating against these risks: a contingency sum, which can be accessed if risks impact.
Up until now, the sector has failed to use contingencies effectively.
Major projects in Singapore have a track record of drawing down all, or worse, spending their contingency and being forced to request more funding.
Assuming each major project in Singapore sets aside a project contingency of 10 percent of construction value, the BCA forecast equates to a total of S$1.6bn to S$2bn worth of contingency per year.
Delivering our projects within this S$2bn contingency, or better yet, releasing some of this will help drive improvements in major project delivery, contractor and supply chain capability and bring about greater value for the Singaporean public through more efficient use of public funds.
So what are some key challenges to setting up a contingency and managing it well in order to maximise its use?
Key contingency challenges
In spite of safeguards introduced by Singapore’s Ministry of Finance, there is still a tendency for budgets to be influenced by optimism bias, especially in the quest to deliver best-in-class, innovative and future-proofed projects, which will enhance Singapore’s global standing and reputation.
Optimism bias is the belief that we are less likely to experience negative events than others and can manifest itself in optimistic schedules, downgrading of likelihood and impacts of risks and setting aside lower contingency and management reserve than required.
You need realistic and accurate cost estimates, supported by pragmatically assessed and quantified risks to provide you with budgets and contingency sums that you can trust and which can withstand scrutiny.
Be clear on the concept of management reserve and its purpose – far too often major projects use a portion of their contingency sums as management reserves, effectively short-changing themselves. The management reserve should be a separate sum set aside for unidentified risks, or ‘unknown unknowns’.
Putting together a robust budget, quantitatively-analysed contingency sum and dedicated management reserve will allow you to put in a well-substantiated funding request.
Your risk strategy
Once you have secured funding, what’s next? Correct project management will enable delivery within budget, and proper use of management reserve will cover the occurrence of any ‘unknown unknowns’.
All that is left is to manage your risks to minimise contingency drawdown – this represents your greatest opportunity to maximise project value.
Deciding your risk strategy is the first step to this. The trend in Singapore is to transfer risk to the contractor – where you get a more predictable outcome, potentially at the expense of obtaining better value for money.
You will need to consider if your project warrants a different approach – whether there is benefit in taking on the risk yourself to protect your reputation, delivery schedule and drive value and project performance.
We are seeing clients becoming increasingly confident in taking on more risks.
Globally, clients are undertaking common logistic arrangements instead of reverting to contract specific logistics.
They’re letting smaller packages and managing the corresponding increased interfaces between contracts instead of letting larger joint-venture packages and undertaking consolidated client-led bulk purchase instead of the default contractor-supplied materials.
New Engineering Contracts
The use of the New Engineering Contract (NEC) contracts is also increasing and it promotes a more collaborative approach, with parties obliged to act with mutual trust and co-operation, and provide clients with the opportunity to adopt a shared risk contracting strategy to drive better results.
The open book nature of this contract and various contract options cater for a range of client risk strategy, and its focus on transparency and early warnings support pro-active and flexible risk and opportunity management.
NEC contracts have been adopted as the default for all public works and consultancy projects in Hong Kong, where it is deemed to promote collaboration to manage and mitigate risks as well as incentivising contracting parties to use innovative construction solutions and cost-saving ideas under the pain-gain share mechanism.
Active risk mitigation
Risk strategy decided, how else can you protect your contingency sum?
The best form of defence is attack. Actively spending money on pre-emptive risk mitigation to minimise or negate the cost of impacted risks and spending money to pursue and realise opportunities will enable you to offset your contingency drawdown.
We also observe increasing maturity in this area. Many clients are identifying long lead-time, single-supplier and bulk procurements early on, which offer opportunities to negotiate preferential rates, secure required quantities and seek ways to diversify and protect the project’s supply chain.
Clients are also increasingly analysing their project schedules to identify opportunities to de-risk or accelerate activities to reduce time-criticality and release pressure on their project’s critical path.
Your decision on where, when and how to spend money in order to save money must be supported by a robust, timely and quantified risk and opportunity management process, which will inform your decision making and enable you to nimbly implement mitigations and realise opportunities.
Effectively managing your project contingency
There is no reason why major projects should be over-spending. Advancement in project management capability, improved governance and technology enablement provides the opportunity to not only meet, but beat your contingency.
You will need to:
- set your budget, contingency and management reserve accurately and realistically
- assess your risk strategy and how confident you are to take on and manage risks
- be pro-active in risk mitigation and opportunity realisation
In return, you will achieve:
- accurate and realistic budgets and funding you can successfully deliver against
- a risk strategy that drives greater value and improved project delivery performance
- effective risk and opportunity management, which enables you to maximise the use of your contingency sum.
If you want to build better assets for the same money, bring about greater value for the Singaporean public and contribute to more efficient use of public funds, you should think about how a pro-active risk and opportunity management approach could work for you.