Pay peanuts, get monkeys

In his article, ‘Psst… don’t tell the client’ in the June issue of CM, Peter Gracia showed that open-book accounting, a fundamental principle of partnering, is open to abuse. A good point, but his solution is misplaced. His call for greater auditing and control will undermine partnering just as much as the abuse of open-book accounting. If you can’t trust the contractor why on earth would you want to work with them?

Why is open-book accounting abused? Is it because contractors are basically unscrupulous? Or, is there anything inherent in our current system of procurement that is encouraging this abuse?

I believe the latter is the case.

There is a fundamental problem in the way that contractors are often selected for partnering projects. It promotes dishonesty and undermines the whole principle of collaborative working.

For example, I know a contractor who is very successful at winning traditional lowest competitive tenders, with a win rate standing at three out of four. This contractor provides excellent value for money within the strategic partnering relationships that it is involved with. Why is this contractor so successful? Because it has excellent control over its cost base, works collaboratively with a supply chain and brings this expertise to bear in both winning competitive tenders and in delivering negotiated partnered projects.

But this same contractor is remarkably unsuccessful at being selected in two-stage tender situations. Why? Because it is honest. Two-stage selection for partnering projects is often based on the lowest cost for prelims, overheads and profits, and the rate it gives for these is never the lowest.

Here’s the nub of the issue. Those giving procurement advice often have not learnt Egan’s fundamental lesson: selecting on lowest cost does not deliver value. Lowest cost mentality still pervades, even if in the realm of profits, prelims and overheads. The figures often defy belief. It is quite common to hear that a project has been let with a combined overhead and profit margin of 7%. Why would anybody want to work with a contractor with such a low overhead and margin? Are they likely to have the expertise to deliver a value-for-money project? How are they going to make any money? The only way is by cheating on the open-book arrangement.

What’s the solution? Asking for figures for prelims, overhead and profits is fine. The mistake is to equate lowest cost on these with value for money.

A combined profit and overhead of 7% is common, but why would you want to work with a contractor like that?

Nicholas Fowler

What does a client want? A project delivered to programme, that achieves both quality requirements and lowest overall cost of ownership. How is this most likely to be achieved? Is it not by appointing a contractor who has the expertise and capability to work in a collaborative manner, understands value engineering, who has developed an integrated supply chain and who has addressed issues of process improvement, waste reduction and site safety?

Does this expertise and approach by a contractor equate with low prelims, overhead and profits? Certainly not. To achieve what the client is looking for, we must invest heavily upfront in the project. This equates to a high level of expenditure in terms of prelims and overhead by the contractor as well as the client.

What does a contractor’s overhead buy us? The expertise of an organisation, its skills in IT, programming, project management, supply chain management, value engineering, logistics, research, quality systems, management development and skills training.

What do the contractor’s prelims buy? A well-managed site, good welfare and safety, proper materials handling and storage. In short, all the things that will drive up productivity and reduce outturn costs.

And finally, what about profit? Contractors need profit to stay in business and to invest to improve constantly the way they deliver the service to their clients.

So if we are serious about making partnering work, let’s start with the way we select our contractors. We need to dismantle this ludicrous approach to contractor selection on the basis of lowest cost of prelims, overhead and profits. Instead it needs to be based on selection by capability. There are plenty of clients using this ‘capability’ approach already. Let’s make it the norm, and not the exception.