Meeting the challenge of competition through collaboration
The Australian defence sector has its largest forward works pipeline of construction work in its history. In delivering that pipeline, the Department of Defence is in competition with other sectors in an environment characterised by high levels of escalation, disrupted supply chains, increased industry insolvencies and a lack of industry capacity. But more collaboration and innovation are required to remain competitive in a sellers’ market.
Defence construction, like in other sectors, has been impacted by a range of external factors including the global pandemic, the conflict in Ukraine and government led stimulus activity. These have created the perfect storm of decreased supply and increased demand and have resulted in significant escalation in building costs which is affecting cash-flow and driving an increased number of insolvencies. Understandably, the construction industry is looking to reduce risk and is becoming more selective when choosing clients and when signing contracts.
The booming pipeline of construction work means that industry providers have increased choice in what is a sellers’ market.
The defence sector’s forecast increase in work on its estate and the reliance on the estate as a Fundamental Input to Capability (FIC) means that the sector needs to develop an approach to making working on the Defence Estate an attractive proposition in what is a highly competitive market.
To achieve that aim, increased collaboration, and a different approach by all stakeholders in the defence sector is required. Some of the areas where improved collaboration will assist the sector in becoming a client of choice include, appropriate allocation of risk, a common understanding of supply chain risks, a different approach to contracting and a more trusting and transparent project culture.
Understanding and allocation of risk
The approach of pushing risk, via the contract, to the consultants and contractors is inappropriate in a volatile market as not all the risks traditionally passed to industry can be managed by industry. An understanding of risk and appropriate risk allocation can be achieved through:
- Initial analysis of the supply chain to understand the market. This supply chain analysis needs to be ongoing throughout the project lifecycle
- Understanding of the drivers for each stakeholder. This drives a common understanding of the project vision, individual stakeholder issues and a productive project culture
- Common understanding of stakeholder views to provide context for ongoing risk reviews. This includes incorporation of risk appetite. Collaboration and transparency are key enablers for this
- Understanding of the key components of the project and how they impact project outcomes. This will provide insight into how risks should be allocated and mitigated and can provide flexibility in delivery schedule to reduce supply chain risk.
Supply chain analysis and constraints mapping
During initial project planning, an in-depth analysis of the supply chain needs to be conducted. This analysis needs to consider local market conditions and importantly, include a review of the impacts of work in other sectors. Knowing and challenging when an estate sustainment project can commence and must be completed, or when initial and final operating capability of a capability project must be achieved will provide some of the framework for this analysis. Key outcomes of early supply chain analysis include:
- Understanding and challenging project drivers
- An understanding of procurement options and timing for approaches to market
- Identification of projects that are happening in the region including scope and relevant key commodities and materials
- Insight of workforce availability
- Understanding what other sectors are doing in terms of contracting models to make the Department of Defence a client of choice in a competitive market.
Facilities and infrastructure design play the leading role in cost and fitness for purpose of any project. With the cost and availability of materials and equipment affecting the affordability and capability effectiveness of many projects, there is an acute need to develop design solutions that are efficient and effective to meet client needs and budget.
More importance needs to be placed on improved performance definition in design briefs. This will emphasise the need for efficient design that considers the specification of material and equipment against supply chain capability and capacity.
As design is the predominant cost on any project, improvement in design philosophy and practice that considers the supply chain, and the regional market more broadly will achieve increased outcomes in affordability and fitness for purpose.
The increased number of insolvencies are not restricted to a single contracting model but in the current market, fixed priced contracts at all levels of the project bring risk to both the buyer and the seller. The increased use of early contractor involvement (ECI) contracting has improved the understanding of construction risk; however, the volatility of the market poses significant risk that results in inflated lump sum pricing or a loss of margin when the risk eventuates. Several state government agencies have implemented rise and fall clauses in their contracts (Western Australia backdated these clauses) which reduces risk for contractors.
Thinking beyond construction contracts, the use of provisional sums for design investigations should be considered as the cost of these investigations is increasing through currently unbound escalation. This escalation introduces the possibility of incomplete investigations which may result in poor design, including overdesign, with the alternative being reduced margin for the designer. A provisional sum approach, with clear direction on its use, reduces this risk through proper risk allocation and sharing.
To provide certainty to clients and providers the use of cost-plus contracts should be investigated. This will require deeper levels of trust and transparency along with an agreed (and reasonable) margin and open book accounting, however, the benefits in terms of contractor certainty and reduced risk to project quality are significant.
The importance of cashflow cannot be overstated. Cash is king, but poor cash flow is one of the underlying causes of business insolvency.
Implementing milestone payments that provide reasonable cashflow is not only good for providers, both contractors and consultants, but it reduces the risk of significant gaps between projected and actual cash flow for the Commonwealth when schedule is not met. Furthermore, reducing the time between milestone payments will result in lower pricing as suppliers will not have to absorb costs between milestones. Developing more equitable approaches to payment including milestones for the partial completion of deliverables is an option open to the Commonwealth as is the proposing of alternative payment regimes by suppliers.
Control and monitoring of on-site behaviours
Volatility in the market not only threatens time, cost and quality, it can increase the risk of workplace health and safety (WHS) issues. To manage these risks, closer monitoring of all site behaviours is required. This includes reviewing schedule performance, reassessing delivery timescales, ongoing audits and credit checks of the supply chain along with insisting on leading and lagging key performance indicators for WHS to identify possible issues before they result in lost time injuries or worse.
Transparency and collaboration
Many of the suggestions outlined above will only be possible if a more transparent and collaborative approach is taken by all stakeholders. Key measures include:
- Early and ongoing engagement with the supply chain including identification of options for a more diverse supply chain to reduce exposure risk
- More openness around budget and project objectives done within an information security framework
- Articulating stakeholder drivers and developing a common understanding of these across the project team
- The use of ECI, or at the least requiring buildability advice to be part of the design process. ECI contractors will also provide deeper engagement with, and understanding of, the supply chain.
What are the benefits?
The benefits of the approach discussed above are important when working in a highly competitive and volatile market, however, many of the benefits will be enduring, they include:
- Improved quality by providing contractors and consultants the means to deliver projects in a volatile market while maintaining reasonable profit margins. These quality outcomes will drive improved handover takeover and whole of life results.
- More competitiveness for the Department of Defence as a client. This is important in the current market where suppliers have an abundance of choice, however, it will continue to benefit the Department of Defence when in a cooler market, through increased choice of ‘defence capable’ providers.
- Safer worksites by reducing the temptation to cut corners to maintain margin.
- A strong, engaged, and sustainable defence construction industry to continue to provide support to the Department of Defence.
- A better culture and mindset that acknowledges that the current situation requires an approach that is more than dollars and projects.
The Defence Estate is a key enabler of the Department of Defence outcomes and delivering an effective estate requires an engaged defence construction industry. In these times of increased demand, market volatility and a challenging geopolitical situation, a highly collaborative approach characterised by transparency and trust is required.