The National Children’s Hospital is just the latest in a long line of public capital projects to suffer from a massive cost overrun. BARRY MCCALL asks what can be done to prevent this happening in future.

The maxim about those who do not learn from history is often attributed to Napoleon or other great historical leaders but it was actually first stated by philosopher George Santayana. And it wasn’t necessarily intended as advice, it was more a lament for humanity’s inability to learn from even the most painful of experiences.

Who knows what the great philosopher would make of Ireland and its public procurement systems? Cost overruns for capital projects has long been a systemic failing. Most observers attribute it to the natural tension between the parties in a system set up to be adversarial.

That’s the kind version. The less charitable one puts it down to a lack of honesty. Not in a corrupt sense but in the way that people often prefer to obfuscate the truth, particularly when politics are involved.

You begin with a public capital programme. Notionally, the projects included are there because of sound, objective reasons – they have undergone rigorous cost benefit and needs analyses and prioritised accordingly. Well, that’s the theory anyway.

The facts of the matter are somewhat less clear cut. Political geography usually trumps benefits and needs when it comes to project prioritisation. A minister’s constituency here, a marginal seat there, a vociferous lobby group in another place. But these projects aren’t included at the expense of other more urgently required pieces of infrastructure – they are added to an already excessively long list.

And that brings us back to quarts and pint pots.

When Taoiseach Leo Varadkar stood up in the Dail earlier this year and complained of “low balling” among contract bidders he should really have considered the mote in the government’s own eye first.

Contractors have to make money, or they wouldn’t stay in business very long and this leads to the claims game. The ink will barely have dried on a contract by the time the contractor is back with a claim for increased costs saying that provision hadn’t been made for any number of things in the specifications on which the tender was based

How do you get €100 billion worth of projects to fit into an €80 billion budget? Simple. You underestimate the cost of all of them by 20 per cent. Or, closer to reality, you underestimate the cost of projects near the bottom of the list very significantly and try to put more realistic prices on the ones which will take place soonest.

Indeed it is not unknown for government departments and others to underestimate the cost of projects in order to get them included on a list.

In one sense, there is not a lot wrong with this. In a system where everyone is doing the same thing there is little point in accuracy as it lowers the prospects of the project making the list. But one thing which should never be underestimated is the cynicism of politicians – it is wise always to take commitments to projects with a start date more than five years away with a very large grain of salt.

Those with long memories will remember not only the number of times Tallaght Hospital was promised but had start dates announced as well. The hospital climbed the priority list with extraordinary rapidity when Dublin South West became a five-seat constituency.

A few more Dail seats along the proposed route of the long promised and much announced Cork to Limerick M20 motorway might do that project the world of good.

So, cost overruns are inherent in a system which, charitably, takes an overly optimistic view of costs in first place. But there are other factors at play as well.

Michele Connolly

According to KPMG partner Michele Connolly the quality of the original cost estimate, regardless of political considerations, often leaves something to be desired. “How good was the process that went into the budget or programme or works plan?” she asks. “Very often it’s been done on the back of an envelope. I’m exaggerating for effect, of course, but quite often the cost estimates are done very early before projects have been speced up and designed in any detail.”

SIMPLE SOLUTION
She offers a relatively simple solution to this issue. “Take a €100 million project, for example. That cost estimate is based on an early and very broad spec. It’s probably too low. There should be a risk premium on top to reflect the early stage. But that doesn’t happen. The price is given as €100 million and then the next few years are spent on recriminations and arguments over cost overruns.”

And then comes the tender process itself. The mantra here is that the lowest tender will not necessarily be awarded the contract. But that is almost invariably the case nevertheless.

Connolly again: “In a lot of cases the tender process is very price focused. They might say price is only 40 per cent and quality is 60 per cent but in the end quality doesn’t outweigh price. This forces people to bid bottom dollar prices. That leaves very little scope to absorb variations if something goes wrong when you put a spade in the ground. They have no choice but to get into the claims culture and look for more money. The State is pushing so much risk onto contractors that it leads to an adversarial claims culture.”

The claims culture she refers to is a kind of cat and mouse game which is probably as old as public procurement. On one side of the equation is the custodian of the public purse looking for the lowest price possible and on the other side is a bunch of contractors bidding against each other for much needed work.

 

The Office of Government Procurement has over two hundred staff working on the goods and services contracts

Tendering is an expensive and time-consuming business and only a fool would go into a process without giving themselves the best chance of winning. That means going in with a bid that is barely profitable or indeed marginally loss-making. This is well known in the industry – the Construction Industry Federation frequently issues warnings in relation to below cost tendering.

The only thing that stops bidders going in with massively loss making tenders is the fact that they would be ruled out as unrealistic.
Contractors have to make money, or they wouldn’t stay in business very long and this leads to the claims game. The ink will barely have dried on a contract by the time the contractor is back with a claim for increased costs saying that provision hadn’t been made for any number of things in the specifications on which the tender was based.

Historically, this was an accepted fact of life. Negotiations took place and a figure was arrived at which both sides deemed acceptable. Various efforts have been made to eradicate the claims culture, but all have failed, mainly because of the nature of the system which places excessive risk with contractors while failing to reward them for taking it.

And this brings us back to the less than honest basis of the system. Both sides enter into the process in the knowledge that the eventual cost will be significantly different to the one originally estimated as well as the one agreed at contract stage. Most charitably, this is unrealistic.

But it is important to be clear. No one is cheating, there is no suggestion of corrupt practices, the people involved are all honest and doing their best. It is the system which needs to be changed.

Public procurement processes and rules for construction contracts are much more complicated than they need to be

SECURE VALUE
The public servants running procurement competitions are keenly aware of the need to secure value for money, according to Dr Peter Brennan, managing director of tender manager service specialist Bid Services. “They are incredibly protective of the taxpayer’s dollar”, he says. “If they do a business case for a €100 million project, they will pull it if the cost goes to €115 million and can’t be justified.”

But that still leaves the question of what to do about the broken system.

Shane MacSweeney, head of government and infrastructure with EY, stresses that the benefits of public capital projects have to be taken into consideration before reform is contemplated. “It is important to reaffirm the huge economic benefits that flow from delivering infrastructural assets”, he says. “Whether it’s a hospital, school, rood or a runway, it’s about stitching together the economy. The National Development Plan sets that out to 2040.”

He worked in Australia for eight years before returning to Ireland two years ago. He has also worked on projects in South East Asia and the Middle East. “I’ve seen what worked and what didn’t. You have to see it in the context of the massive economic benefits delivered. You are always going to have challenges with major projects. This is not unique to Ireland. What is crucially important is not to throw the baby out with the bathwater.”

 

COLLABORATION
But how can we do it better? “We need to broaden our choice of procurement routes”, he says. “Globally, the system has evolved into a much more collaborative approach. It’s not adversarial which you get in Ireland. The adversarial relationship between public and private sectors results in the variation game being played.”
The collaborative relationship he refers to is known as alliancing. “The government and private sector get into bed together and co-develop the design, sensibly share risks, and sensibly share pain and gain. They both work together to design out risk. It’s used a lot in Canada and Australia for water and transport projects. In the UK it’s used for water and is coming into transport now. They are using it for their Smart Motorway programme, for example. In Ireland, we have a couple of small examples in Transport Infrastructure Ireland where has successfully used it. There are some examples in Irish Water for smaller projects as well. It is now being mooted for Metrolink. That will be a massive example.”

EARLY INVOLVEMENT
The system has the virtue of early contractor involvement. “It gets the contractor into it earlier and has proved exceptionally successful. I worked on a rail project in Australia which came on time and within budget.”

It’s not necessarily suitable for absolutely everything, of course. “It’s best used for big large complex projects where risk is difficult to define.”

“One of the other major challenges is market capacity”, MacSweeney adds. “The volume of construction workers is not there. We can either take a risk on contractors who are not fully road tested or we can attract foreign contractors. In terms of delivering the pipeline ahead we need to promote Ireland inc in Europe and globally from a construction perspective. Other sectors go on trade missions. We do it for agri and so on very successfully. We should do a roadshow across Europe and globally. We should point to the project tracker for the next 10 years – it’s €116 billion. Worth of projects and we can’t deliver it by ourselves. There is an opportunity for overseas contractors. We can show a pipeline of activity that the industry can identify as an investment opportunity.”

This is not an entirely new concept. “We did it successfully in the early 2000s successfully for eight public private partnership projects. We need to go out to the market to bring the most sophisticated players into country.”

Peter Brennan points out that there is nothing technically wrong with the way major works contracts are awarded at the moment. “A bid is scored on different aspects and the contractor with the highest score wins. That is nearly always the contractor with the lowest price. That’s fair enough, they are the rules. But they don’t necessarily deliver the best value for money.”

He also believes in a form of alliancing. He argues that every project over a certain size, €5 million perhaps, should be subject to a different approach with a rigorous risk assessment and business assessment carried out before it ever goes to tender. The process he suggests is a competitive procedure with negotiation.

“You shortlist two or three tenderers for a contract like a bundle of schools worth an estimated €100 million”, he explains. “You then enter into a dialogue with the tenderers and their design and technical teams and negotiate over a period of two, three, four or even five months. You find out what the contractors can do, you talk about the design, the site, and various other aspects of the project. At the end you get a best and final offer. You get an agreed appreciation and understanding of what’s involved and an alignment of the parties’ requirements. That way you get best value for money.”

“There is a very strong argument that the competitive procedure with negotiation will produce much better results”, he adds. “It might delay a project slightly at the early stages but will deliver much greater cost certainty and value for money in the long run.”
It will also rule out the prospect of appointing a contractor who can’t do what the client needs. “They will drop out during the negotiations if the job is too much or too risky for them.”

Increased resources are also required for the procurement of works contracts. “Works contracts are three or four times more complicated to procure than goods and services”, Brennan points out. “The Office of Government Procurement has over two hundred staff working on the goods and services contracts and they do an exceptionally good job. But there is only a handful on the works side. They are seriously under-resourced. What’s there is excellent, but they could do with another 30 or 40 staff.”

“Public procurement processes and rules for construction contracts are much more complicated than they need to be and, in some cases, might not even be compliant with EU rules”, he adds. “They need to be overhauled.”

There are better ways to procure projects, the question is if there is the political will to adopt them. The government has committed to ensuring that all major projects will have to have a business case made for them before proceeding. This is a start but won’t address the cost overruns on its own. The procurement system itself must change.

GOOD REPUTATION
Notwithstanding that, Ireland does have a good reputation when it comes to the delivery of the projects themselves. “It’s not that we are very bad in Ireland at doing these projects”, says Michele Connolly. “Globally we are seen as very good. Where we are poor is at balancing risk with pricing. Other jurisdictions set up infrastructure delivery authorities. This takes the politics out of it. They leave it up to the professionals to tell the government what to build for the good of the economy. Projects are prioritised on the basis of bang for buck and on the basis of need.”

We have shown that this can work in Ireland with Transport Infrastructure Ireland and, despite its unfortunate experience with charges, Irish Water. Maybe it’s time to hand the National Development Programme over to an independent body which will employ best practice procurement processes and take the politics out of it.

Barry McCall

Posted by Barry McCall