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Top 8 ways contractors lose money on construction projects.
More often than not, a construction project is fraught with hidden costs. These unforeseen costs may be lurking due to various causes such as, without limitation, an incomplete design, inadequacy of the design and inaccuracies in the information provided to the Contractor during tender, biased specifications containing veiled sole-source suppliers and manufacturers, indecisiveness and delayed decisions by the Employer, unrealistic construction durations, unreasonable site inspections in pursuit of higher standards of performance, the Engineer’s insistence on absolute completion as opposed to the required substantial completion, and an adversarial working relationship with the Engineer and the Employer.
Increased costs usually result in delays in the time for performance and, consequently, further unforeseen additional costs to the Contractor. Hidden costs flourish particularly when the encounter between the contracting parties is an initial one. While it may be difficult to anticipate these hidden costs during tender, and even more difficult to estimate through objective criteria, it is beneficial for the Contractor to acknowledge these costs so they can be managed when they do arise.
Construction is an industry with inherent risks, with projects involving long term commitments in a fast changing environment. While a risk may be made invisible, it does not disappear. No construction project has ever been built exactly in accordance with the original drawings and specifications. The actual cost of building a project will always be at variance with its estimate. A Contractor’s costs associated with traditional recognized risks are exacerbated by further hidden costs that usually jeopardize timely completion of the Works. The costs that will be described in this article are difficult to evaluate by a Contractor in an objective manner during the bidding stage. Therefore, allowance for these costs can be provided for simply in the form of a contingency as a percentage of the overall cost of construction.
The causes and examples of hidden cost in this article are by no means isolated incidents. Indeed, with the prevailing financial crisis, particularly in the real estate sector, these causes of hidden costs are on the increase.
1. Incomplete design.
Either due to pressure from the Employer to float the tender, incompleteness of the design notwithstanding, or due to the Employer’s uncertainty on various matters that affect the design, finalization of the design is often delayed after the contract has been awarded and well into the construction process.
The design eventually evolves through a series of submittals and repeated resubmittals by the Contractor of shop drawings, material and equipment. Piecemeal approval of engineering submittals becomes the norm, and delays accompanied by abortive engineering ensue.
Often, limited design budgets and time constraints dictate less attention to critical construction detail. Some construction details drawn on paper are difficult, and at times impossible, to build. Additional costs associated with revised construction detail are often denied by Employers, particularly on a fixed-fee contract.
2. Sufficiency of tender.
It has long been established that the responsibility of the Employer is not overcome by the usual boilerplate, and often unconscionable, clauses requiring the Contractor to visit and inspect the site, to examine the contract drawings and specifications and to inform themselves of the requirements of the Works. Under a design-bid-build contract, the Employer impliedly warrants the accuracy of the information, drawings and specifications. The second implied warranty the Employer undertakes is that the drawings and specifications are suitable for their intended use. It is not unusual that an Employer shies away from responsibility for these warranties and the additional accompanying costs culminating in claims and counterclaims.
On a closely related matter: decennial liability is prevalent under the vast majority of civil codes in the Middle East. The Contractor is held jointly responsible with the Engineer for failures arising from defects in the design. While this is not a hidden cost in the true sense, the cost of verifying the design is rarely, if ever, considered by the Contractor in its tender price. Indeed, to safeguard against this risk, the Contractor would have to make due allowance for verification of the entire design – nothing short of this would do. The responsibility for remedial measures in the event of either partial or total collapse could be astronomical.
3. Biased specifications.
The Engineer’s designation of a sole specific product in the specifications is usually avoided, or in some instances not legally permissible, to avoid what might appear to be favoritism for that product. The provision of “approved equal” is also frequently incorporated into the specifications. This approach also ensures adequate competition.
No one product is exactly equal to another. However, there may be an equivalent product. It is not unusual that specifications inconspicuously require sole-source suppliers or manufacturers. Vast amount of time and expense is incurred by the Contractor in the form of submittals and re-submittals of Goods by manufacturers considered to be just as good as or possibly even better than those specified. The provision “approved equal” often turns out to be illusionary with the consequence that a Contractor is compelled to utilize a product at a higher cost than that budgeted. On the other extreme, it may be a relief for contractors to note that the rejection by the Engineer of one of two manufacturers specified in the contract specifications has been construed by the court as a Variation.
4. Indecisiveness and delayed decisions by the Employer.
While the majority of causes of delays are usually attributed to either the Contractor or the Engineer, the actions or inactions of the Employer have a severe impact upon the progress of the Works. These decisions can vary greatly ranging from the choice of material and equipment to, in the extreme, a radical change in the function of the entire Works, the latter being instigated by changes in market demand. Employers must be fully aware of their obligations and must be willing to take responsibility.
The Employer, who often has a more diverse background than the Contractor and Engineer combined, is the party least knowledgeable of the design and construction process. Proactive management by the Employer, by either an independent construction manager or in-house qualified personnel that match the competence of others involved is essential. Rapid decision-making is crucial to uninterrupted construction.
5. Unrealistic construction durations.
Construction projects are always wanted “yesterday”. Project durations are usually assumed either on the basis of the Employer’s whims or on unfounded recommendations devoid of an objective assessment of the time needed for execution. In instances, the shortened duration is a consequence of an attempt to recoup delays in the design process and to maintain the confidence of the project financers. The tender period is usually too short to verify the reasonableness of the Time for Completion specified in the contract. A proper and detailed construction schedule developed after award and subsequent planning and programming methodologies will be tailored to meet the original time targets rather than establishing an objective assessment of durations. Costly acceleration measures to avoid Liquidated Damages usually become necessary. As a rule, additional costs from loss of productivity accompany acceleration measures. Frequently, in the haste of accelerated completion, the Contractor is involved in considerable rework. Despite the fact that numerous studies have been conducted on rework, there is still no industry-wide standard for measuring and classifying rework as it occurs in the field and an accurate assessment of the costs involved is difficult to estimate.
6. Unreasonable site inspections.
The Engineer’s right to inspect and test is very broad, but should not be without limits. The inspection process can have a dramatic effect on the Contractor’s profitability. Excessive supervision and inspection adhering strictly to the written word in the specifications without consideration of the site conditions is counterproductive. Wherever workmanship is required, the obligation to exercise reasonable skill and care will set the minimum standard required of builders in the absence of some expressly or impliedly stipulated standard.
Ascertaining the spacing of reinforcing bars to surgical accuracy by tape measurement, correct number of bars notwithstanding, verifying the verticality of reinforcing bars with a spirit level, inspection of a block wall that has been accepted and certified for payment prior to the application of plaster coat, variance in internal measurements of a ceramic tile clad toilet wall by a few millimeters – are all examples that are accompanied by delays and additional hidden costs to the Contractor. Arbitrary, overzealous and capricious inspections result in work not required under the contract and delays in the Time for Completion. Work to the reasonable satisfaction of the Engineer imposes an extremely wide ranging obligation upon the Contractor. However, it must be recognized that stringent inspections standards and tests may be considered improper and, in the extreme, may be considered a Constructive Change.
7. Absolute completion versus substantial completion.
There is no bright line guidance as to when the Works can be considered substantially, or practically, complete. Cases involving the extreme are all over the landscape and vary with the facts of each project. It appears that a contract administrator may certify practical completion notwithstanding that there are trivial defects or omissions in the works, but should not do so where there are any patent defects which go beyond what is merely trivial.
In spite of occupation by the Employer, it is not unusual that the Engineer protracts the issue of a Substantial Completion Certificate alleging the Works are not substantially complete due to trivial outstanding works. The absence of a Substantial Completion Certificate necessitates the Contractor’s extended presence on site, prolongation of its insurance policies, protracted protection of the Works as responsibility has not been passed on to the Employer, delays in the issue of the final payment certificate and significant delays in the release of retention monies and continuation of other liabilities.
8. Adversarial working relationship.
The difficulties inherent in building projects frequently cause the expectations of the contracting parties, which are often strangers to each other, to go unfulfilled. Trust is considered to be a vital ingredient in the management and delivery of construction projects. The goodwill and trust that prevails at contract signature usually rapidly evaporates soon after commencement of the project. Claims and counterclaims proliferate with the consequence that working relationships between the parties deteriorate. Expectations of cooperation turn into conflict. Admittedly, it is difficult to quantify the cost of the consequence of an acrimonious work relationship, but this is usually reflected in strict enforcement of the contract requirements to the printed words, under-certification of the completed Works, exhausting the whole period provided to the Employer prior to release of payment to the Contractor. In general, discretion of the Engineer is exercised in an unfavorable manner.
Claims that have not been recognized are resolved by time-consuming, management-distracting, stressful and costly formal litigation.
Notwithstanding the causes for the hidden costs appearing in this article, an honest assignment of responsibility is indispensable. Parties should strive for collaborative relationships rather than purely contractual ones. It may well be that the vast majority of causes of hidden costs is attributed to the lack of the all-important element of trust between all the stakeholders that usually turns expectations of cooperation into conflict. In the ever increasingly competitive construction industry, pricing of all hidden costs may result in a non-competitive tender. There should be no compromise on quality in an attempt to absorb hidden costs. Finally, there may well be supporting counter-arguments to the views expressed in this article, but it is hoped that this article will create biases, not only reinforce prevailing ones.