Time to challenge the status quo on managing project risk in South Africa
As the COVID-19 crisis continues, businesses across the globe face continued uncertainty. In South Africa’s construction industry, like many others, confidence is low. Capital projects are being deferred, resulting in a cooling in the supply chain – and limited investment in people and material capacity.
To protect the industry, it’s time for a new perspective on the way construction projects are managed. Making small adjustments in five key areas can reduce the commercial risk to project owners, improve cash flow for contractors and suppliers, and make a significant difference to the entire industry.
A new approach to risk management
This is a difficult time for contractors and suppliers in South Africa. Both are struggling to navigate their clients’ ambitions while negotiating from a weak position of reducing profit margins, and rising labour and material costs.
For investors, the continual cooling of the market presents both opportunities and risks. Where projects are going ahead, investors are seeking to take advantage of perceived buying gains in the form of low margins from desperate contractors. However, they still have the same level of risk due to uncertainty in areas such as design, engineering and inflation.
Offloading risk to contractors is not always the best route to take – all the more so in the current climate.
As quantity surveyors on some of the largest projects underway in the continent right now, we have an obligation to the industry to keep contractors and suppliers in a positive cash flow position, away from insolvency, while ensuring investors and asset-owners are not at risk.
Challenge and change current risk management practices
Having a better understanding of the issues of the project creates greater scope for determining which risks to pass on, which to accept, and which to make financial provisions for or mitigate in some other way. Here are some options to consider:
1. Financial modelling of risks
Financial modelling and contingency tracking go a long way to understanding and mitigating risk over the lifespan of the project.
Financial modelling of risks helps determine how much contingency really is needed. As risks are mitigated, the value of the contingency can be reduced to match the level of risk.
2. Procurement strategies
Understanding the investor’s appetite for risk will assist in developing a procurement strategy that aligns with their risk position.
- During the study phase, assess who has the most buying power in the industry, as determined by the investors and contractors involved and the scope of work.
- Identify where it makes sense for investors to free issue equipment to contractors – particularly for large or long-lead items – to assist with cash flow on projects. Although this increases procurement management and governance for the investor, it could also mitigate risks and the effects of exchange rate fluctuations.
- As travel restrictions will affect the procurement of international items, careful consideration should be given to procuring locally, where possible, to minimise delays.
3. Payment terms and guarantees
In this challenging environment, can we as an industry support a 60 or 90-day payment term? There are several options to consider to make payment terms more reasonable for contractors:
- Discuss contract and payment terms in detail before going to tender. This will assist with managing cash flow and balancing risk more fairly between contractors/suppliers and investors/asset owners.
- Build in more frequent payment certifications and shorter payment periods so contractors or suppliers are not subsidising projects on behalf of investors.
- Challenge the necessity of advance payment guarantees and offer other methods of security that could be more useful. These guarantees are costly and not all investors are confident in their ability to mitigate risk and provide the necessary security. A better option may be to cede ownership to the investors so they can ensure the goods themselves and relieve the contractor of this burden.
- Encourage investors/asset owners to provide payment guarantees to contractors/suppliers so they, in turn, can secure funding from banks and keep cash flow positive – which will ultimately benefit the industry as a whole:
- In the private sector, there has been a trend for many years where investors are not providing a payment guarantee to the contractors, but also insisting on receiving a waiver of lien from contractors (which states they won’t hold up the site if they don’t get paid). This puts both the contractor and the project at risk, as it’s more difficult for contractors to secure funding without the guarantee.
- In the public sector, government bonds could be used to protect larger contractors, particularly as we work towards managing ourselves out of a construction industry crisis. This might also be a way for contractors, in turn, to provide comfort to Exempted Micro Enterprises (EMEs) and Qualifying Small Enterprises (QSEs), to protect and grow this sector.
4. Tender and contract process (design and build)
De-risk the project by providing more information and greater detail upfront.
To assist with appointing the right contractors in the first place, and avoid pushing more risk onto the contractor than is necessary (or fair), provide sufficient detail on design requirements and specifications in tender documents. This will help determine whether the lowest bid really is value for money or simply too good to be true because there are so many exclusions.
Go through all clarifications and exclusions so you have a thorough understanding of how these may affect your budget. Deal with all qualifications before appointing a contractor or supplier, and understand the mitigations attached to each qualification. This is particularly important when managing sub-contractors or consultants.
5. Building partnerships
Given that we are all part of the same project, we need to challenge why we hold our cards close to our chest – especially now. Working with contractors as strategic partners has benefits for everyone.
Bring contractors into discussions early so they can understand the pipeline of work.
This will assist them in assessing their capacity and resources and focusing on their strengths and where they have the most buying power. They may be able to approach and price certain proposals differently if they know there is work coming.
Use mechanisms such as a prequalification process to build a rapport with contractors, understand their supply chain and discuss the nuances and sensitivities of funding.
If the contractor body is limited, bring them in early for input on how to build and deliver the project. Create opportunities to work together on a solution that fits the funding and guarantees available, with some flexibility to address any funding issues.
Greater collaboration needed to ensure industry longevity
To guard against the collapse of the construction industry, we need to work together more effectively than in the past.
The opportunity cost of not making changes to the status quo will be felt on both sides of the fence.
The cost to an investor of having to change contractors if they go under comes in the form of terminating contracts, agreeing on amounts still to be paid, wasting time appointing another contractor, and the cost of doing site establishment for a second time. For contractors, there’s a very real danger of going out of business.
Changing the way we set up and run projects to improve the management of project cash flow will help to protect owners, investors and the entire supply chain – and ensure the longevity of the construction industry as we navigate this uncertain and changing environment.