A five-point plan for coping with volatility in a positive way

The first project that I worked on as a trainee QS had a fluctuations clause. For a year, client and contractor faced inflation of 15%-plus across many product categories. We had plenty of issues to resolve, but cost escalation was not one of them because the pain was shared.

The risk transfer worked not only because it distributed the burden of inflation between contractor, client and supply chain, but also because the project team were able to focus on issues that they could control – such as  coordination and change management – rather than things that they couldn’t, like the price of rebar.

According to latest BCIS data, reinforcement and other commodities affected by the Ukraine conflict increased by more than 20% in March 2022 alone. That is more in a month than during that long inflationary year way back in the 1980s. How does the industry deal with this?

No single organisation should be expected to carry all the burden, but making changes to live projects or projects in procurement is much easier said than done

Looked at in the round, no single organisation should be expected to carry all the burden, but making changes to live projects or projects in procurement is much easier said than done. If changes to a contract threaten the viability of an investment or the profitability of a project should the pain be shared?

Furthermore, will that risk shared undermine the security for lenders? Who makes the final call? These questions are being asked on many projects and answers are needed sooner rather than later.

> Arcadis’ International Cost Comparison 2022

As things stand, any solutions that exist are being implemented on a discretionary basis, project-by-project, contract-by-contract. Initial actions, as set out by the CLC in its March 2022 guidance note, focused on understanding the exposure of the supply chain and building project-specific plans based on the status of the project, its risk exposure, and available contractual remedies.

Looking back at the construction sector’s response to covid-19, the value of an industry-wide approach is clear. One industry-wide set of site operating procedures kept construction workers safe and eliminated a potential source of dispute between client, contractor, workforce and the wider public.

A similar response to the Ukraine crisis will be much harder. Measures for projects that are on site or that are in procurement must inevitably be determined with reference to the contractual terms and the effectiveness of the risk transfer in place.

By contrast, for new projects, some clients might consider including provisions for risk sharing measures like fluctuations, but wide adoption will take a long time, even if bodies like the CLC were to recommend them.

In the absence of a mandated industry-wide approach like the site operating procedures, then the next best thing is a consistent approach for clients and their project teams to adopt. As part of the Arcadis International Construction Cost Report, we developed such a five-step approach to encourage clients to think about managing these unfamiliar new circumstances in a consistent way.

In doing so, the five-point plan builds on existing best practice and gives teams the discretion to choose the measures that work for them, rather than introducing completely new ways of working. The key parts of the plan are:

Supply chain resilience: In addition to urgent concerns around financial health and exposure to financial risk beyond the scope of a specific contract, supply chain resilience will increasingly involve navigating the impacts of sanctions, product sourcing and supply-chain disruption.

Project resilience: Project resilience is about the identification and mitigation of showstopper risks, which are multiplying as the impacts of the Ukraine crisis grow. Single points of failure are probably the greatest concern given the extent to which disruption to a complex system like a bathroom pod could trigger wider knock-on impacts.

Project optimisation: Project optimisation should use the energy generated by the crisis to focus even more on opportunities to rationalise design, minimise waste and assure design completeness and quality. These are actions that teams should always focus on, but the added value in the current market is significant.

Team culture: High performing teams can make a difference in the current crisis by collaborating to solve problems. Self-interest will potentially get in the way, and a project culture needs to be built to counter this. Getting the basics right around people care and commercial arrangements is the first step in getting this right.

Project leadership: Leadership matters. The Ukraine war provides ample demonstration of not only how important it is but how important it is to focus on the right issues.

From my perspective, one of the strengths of the approach is that it does not offer a magic bullet to solve the problems now being faced by clients and their teams. The plan needs to be adapted to project circumstances and opportunities.

It will be a long time before European energy markets, steel manufacturing capacity or other critical supply chains return to their pre-war state

Nevertheless, great quality information will support better decisions, doing more with less will save money, and leveraging the problem-solving talent of teams will prepare projects for the challenges ahead, focusing effort on problems over which the project team has some control. These are all well-established approaches that can be glued together by great relationships and great leadership.

Some consequences of the Ukraine war will persist. It will be a long time before European energy markets, steel manufacturing capacity or other critical supply chains return to their pre-war state.

This means that the current “unprecedented” unstable market conditions will become very familiar indeed. To make projects work under these new circumstances, we need to review how we collaborate and share risk from a new perspective. The five-point plan is the first step towards managing that volatility in a positive way.

Simon Rawlinson is a partner at Arcadis and a member of the Construction Leadership Council. Click here for more details from the Arcadis International Construction Costs Report.