Legal: incentivising innovation

What is innovation?

Innovation has never been more relevant to the construction industry. The government’s Transforming Infrastructure Performance programme is intended to drive the adoption of modern methods of construction through the power of public spending, in the hope of imitating the transformative productivity gains enjoyed by the oil and automotive industries. In the private sector, the £10m ConstrucTech accelerator fund has been recently launched to help tech start-ups get to market in the construction industry.

Many of the activities identified by the government, including the adoption of digital and manufacturing technologies, the transition to new collaborative business models, and better integrated supply chain management practices, will require a significant change in behaviour by an industry still wedded to traditional methods and forms of contracting. 

The most recent NBS National Construction Contracts and Law Report 2018 found that the overwhelming majority of construction projects are still procured on the basis of a fixed-price traditional or design and build contract following a single-stage tender process. 

Given that these standard forms of contract are intended for use on a wide range of projects, it is perhaps unsurprising that the innovation clauses are relatively bland 

 Once these contracts are signed, there is little incentive for the employer and contractor to collaborate, as reducing the cost of delivery under a fixed-price contract will only benefit the contractor. Indeed, the employer may limit the opportunity for the contractor to carry out value engineering by insisting on detailed employer’s requirements intended to thwart any attempt to downgrade quality. 

Innovation clauses

Some standard form contracts do include clauses that attempt to more closely align the employer’s and contractor’s interests. For example, JCT contracts include an optional “cost savings and value improvements” clause, whereby the contractor is “encouraged” to propose design changes that may benefit the employer. If the employer wishes to implement a proposed change, the parties are required to “negotiate” the share of the financial benefit to be paid to the contractor.

While the intention is admirable, gently encouraging the contractor to innovate, without promising a predefined share of the benefit, may have relatively little effect on behaviour. In contrast, the FIDIC Red Book includes a more prescriptive value engineering clause that promises the contractor a 50% share of any reduction in the contract price (once any consequent reduction in the quality of the works has been taken into account). This may provide a more attractive incentive to innovate, although it is curious that FIDIC only recognises capital benefits and does not consider potential improvements to lifecycle costs. 

Given that these standard forms of contract are intended for use on a wide range of projects, it is perhaps unsurprising that the innovation clauses are relatively bland. 

More interesting and powerful bespoke incentives can be created to suit particular projects or frameworks. For example, the parties can be encouraged to collaborate to improve specific aspects of performance – such as targeting a reduction in waste or increased efficiency – and be rewarded for savings over the lifespan of the asset. The parties may also wish to deal with the risks associated with innovation (such as any delay to completion) and the ownership of any new intellectual property. 

Generally speaking, the potential for innovation increases in proportion to the size and complexity of a project.

The effectiveness of innovation clauses can also be increased if these clauses are replicated down the supply chain by the contractor, as the biggest opportunities for innovation often lie with specialist subcontractors.

Engaging contractors and subcontractors at an early stage can also increase the likelihood of real innovation, as there will be a greater opportunity to implement fundamental design changes. Research by the Centre for Construction Law at King’s College London has demonstrated that two-stage open-book procurement and supply chain collaboration can facilitate early incorporation of innovation and early evaluation of more sustainable materials and working methods.

Another option is to include target price mechanisms, such as the NEC4 Option C. Under this contract, the employer and contractor benefit from an agreed share of any savings if the actual price is less than the target price. They also suffer an agreed share of the pain if the target price is exceeded. 

Conclusion

Generic value engineering clauses are often included in construction contracts but are unlikely to have a significant influence on behaviour unless there is a genuine commercial benefit for both parties to innovate. 

As technological advances continue to provide new opportunities for modernisation in construction techniques, there is likely to be an increasing interest in properly incentivising innovation. As a consequence, more sophisticated innovation clauses may well become commonplace. After all, there is even scope for innovation when drafting contracts.