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Clifford Chance

Clifford Chance

Construction Insights

Procurement structures - cracking the code

Individual mistakes in contract drafting or negotiation are always problematic, but normally survivable. By contrast, selecting the wrong overall procurement structure can be catastrophic.

And yet more attention is typically devoted to avoiding the former pitfall than the latter, with the result that inappropriate structures are regularly encountered.

For example sponsors may:

  • focus on the apparent cost and schedule advantages of EPCM/CM vs EPC/D&B without giving due weight to the greater risks retained by the owner and the precautions and resources needed to mitigate them;
  • persevere with a single EPC/D&B structure for a giga-project whose capex exceeds the normal EPC/D&B range, resulting in a loss of control over outcomes which is not offset by recourse or contractor incentives;
  • select early in the project's life specific technology which latently constrains the subsequent selection of key contractors, leading to loss of leverage;
  • hope that gainsharing incentives reduce capex below an unaffordable GMP/G Max, only to find during execution that the contractor prefers compensated risk avoidance to the pursuit of shared savings; and/or
  • perceive the apparent schedule and design continuity benefits of a two-stage EPC/D&B structure more clearly than the real conversion and other leverage challenges which often bedevil such structures.
Why is that?

One answer is that major project sponsors – especially in project financed deals – are sometimes inexperienced in construction procurement.

They are therefore unfamiliar with the full range and features of the available options, disguised as they often are by obscure industry acronyms.

Another is that the procurement team may be subject to market or management pressure to select a structure which subordinates long-term success to short-term expediency. Sponsors may also be vulnerable to advocacy by other parties (e.g. bidders) in favour of structures which serve the interests of those parties more than those of the sponsors. There is nothing inherently wrong with such advocacy – construction is a tough world and its inhabitants are entitled to look out for their own interests – but it is incumbent on sponsors to equip themselves with enough objective knowledge to select the optimum structure, while they have the leverage to secure it.

Once the barriers of terminology have been dismantled, and given access to some external benchmarking data and impartial advice, any reasonably sophisticated project sponsor should be able to make a smart structure selection.