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Can COVID change supply chain management in construction?

8 June: With many construction clients in the dark about the impact of coronavirus on their suppliers, the pandemic may be the catalyst for a more intelligence-led approach to supply chains, spreading risk and cost more equitably.

While many construction projects ground to a halt or operated at a much-reduced capacity during lockdown, site costs continued to accrue. In many projects, there is no contractual obligation for the client to support the main contractor with additional costs, and even where clients do provide such payments it is difficult to know how these are being cascaded down the supply chain (see table below).

Furthermore, while support measures like the UK government’s furlough scheme are in effect, the true impact of lockdown on the construction sector is not known. It won’t be until works are starting to complete onsite that we will get a clearer view - it is likely that there will be high-profile insolvencies.

The lack of transparency across supply chains means many clients cannot be sure of the financial viability of the companies that their projects are reliant upon. “On a typical construction contract, less than 15% of the project is delivered directly by the main contractor,” confirms Adam Sanford, Framework Manager for the Southern Construction Framework (SCF), which supports public sector procurement of construction work in the South of England.

The difficulty is that traditionally there has been little direct relationship between clients and their supply chains. Instead, work has been put up for tender and main contractors bid based on a lump-sum contract. While every construction contract is bespoke, there are two major types: JCT and NEC. While JCT contracts, by default, only allow the main contractor additional time to complete a project, NEC contracts allow both time and money.

Construction contract types and force majeure options

Type Additional time Additional cost Client pays suppliers directly
JCT (traditionally building and construction) Yes No No
NEC (traditionally engineering) Yes Yes No
NEC Option F Yes Yes Yes

Regardless of the contract type, traditionally clients have little oversight of how risk, subcontractors and cashflows are managed when the project is underway. The coronavirus pandemic offers a chance for the sector to revolutionise this approach to supply chain management, according to Sanford.

“The sector needs to invest in new ways of working, but people are reluctant to make investments and without legislation, nothing happens,” he says. “We hope that COVID will be the catalyst for better thinking.”

Flagging up the gaps

Launched more than 10 years ago as part of a government initiative to improve standards in public sector construction projects, SCF manages tenders on behalf of its clients using two-stage open book accounting. This is an integrated team approach that allows the main contractor to bid on an outline scheme and then work with subcontractors to finalise designs and methods before anyone has committed to a final contract.

“Clients buy a service contract from the main contractor, who then builds up all of the subcontractors and supply chain, facilitates design management, assesses risks and plots the best way forward,” Sanford explains. “This gives the client a much richer picture of risk, cost and value.”

This approach allows suppliers to flag up where they see gaps in the specifications, risks or potential improvements, things that might get missed in a traditional tender where the focus is cost. “What you’re not doing is driving the price right down and hiding the issues until later,” says Sanford. “Projects are much more predictable in terms of time and costs because of the preconstruction process.”

In 2019, SCF entered its fourth iteration, in which it is focused on increasing its direct relationship with its supply chain. SCF works with 11 main contractors but knows that there are many hundreds of subcontractors working on its projects.

“We are taking all of the good practice that we’ve spent the last 10 years fine-tuning with the main contractors and are cascading that down into the supply chain,” he says. “We want to increase the resilience of our supply chain by giving more visibility and fair opportunity to all of our subcontractors.”

To do this, SCF is working with Local Supply Chain, an online portal through which suppliers can register become part of the SCF network and bid to work on projects. “When the model is fully operational we can support them by grouping suppliers together to give training, for example, or there might be opportunities to work together to build up materials supply contracts with bigger discounts,” explains Sanford.

Peace of mind through transparency

Additional benefits will include greater transparency. “When we have full take-up, we will then be able to ensure that suppliers aren’t changed after contracts are signed and we’ll be able to monitor performance and behaviour,” confirms Sanford.

This transparency would give SCF’s clients peace of mind in the future as to how the suppliers on their projects are being treated. Some tools already exist that would help achieve the same result, but the sector has been reluctant to make use of them, according to Sanford.

One such option is a project bank account. This is a bank account held by a third party, into which the client makes payments and from which all of the contractors are paid. This provides complete clarity over who is being paid what and when, however, while such accounts have existed for decades very few projects deploy them.

“People are very reluctant to do it because of the extra work and administration,” says Sanford. “In the construction and consultancy industry, there is an acceptance that the main contractors will deal with this work. The reason we’ve been successful in using some of these tools is that we offer a hybrid process where we take on a lot of that extra administration.”

Similarly, in projects where an NEC Option F contract (see table above) has been signed, the client pays the subcontractors directly. “These collaborative, transparent contracts that allow direct relationships between the clients and the supply chain, allow public bodies to be much more equitable in how they deal with sharing losses,” says Sanford. Despite this, Option F contracts are not commonly used in the public sector and are even rarer in private construction projects, where commercial priorities drive decision making.

New approach to risk management

Alongside financial matters, another area of supply chain management highlighted by COVID and which, according to Sanford, needs to change is risk management. Putting global pandemics to one side, the key risk in any construction project is what might be discovered in the ground. Some contracts deal with this as a flat fee, but SCF’s approach is to understand who in the supply chain is holding what risk before the contract is signed.

“As a client, you should have a responsibility to make sure that risk isn’t pushed down to a company that is so small it could be made insolvent by one big problem,” Sanford explains. “Managing risk before you start the contract is a much safer, equitable and ethical way of dealing with it.”

“In a post-COVID world, people are going to be thinking more about how to deal with risk. Buying a lump-sum contract with all the risk bundled up into it and no cost breakdown is much less attractive.”

Another way to more equitably manage risk is to adopt integrated project insurance (IPI), whereby all of those involved in delivering the construction project join together to create a Special Purpose Vehicle under which everything is delivered. This enables the subcontractors to share financial rewards, but also minimise risk through an insurance policy which indemnifies the partners for losses above an agreed threshold.

Similar to project bank accounts or NEC Option F contracts, few projects have tried the IPI approach, but Sanford believes that COVID can provide the construction sector with the impetus to make these types of changes one way or another.

“Clients are increasingly under pressure to be more involved with their supply chain due to poor treatment of suppliers, such as 120-day payment terms, or a domino effect of insolvency as a result of the failure of one main contractor,” he says.

“COVID will either cause clients to think more responsibly about those specialists working on their schemes and they will turn to more transparent, collaborative contracts or a wave of insolvencies will bring the issue to the fore and legislation will force better practice in the industry.”

However it comes about, Sanford is clear that moving to more intelligence-led supply chain management that embraces direct relationships and collaboration with subcontractors will bring massive benefits to construction projects.