Costs: beyond the 'blowout' to improved outcomes

The media loves a 'cost blowout'.

The phrase is often used when talking about increased costs in public infrastructure. It generates outrage and criticism. That's not a surprise. Public infrastructure sit at the intersection of taxpayer funds and public services.

But what is a 'cost blowout'? Put simply, it means the actual costs exceed the expected costs. And what does that really mean for the government and builders?

1. Additional government costs

There are no true 'fixed time; fixed price' contracts in Australia. Public infrastructure is delivered under contracts where both time and cost can increase in certain circumstances.

By way of simple illustration:

• Scope?- if the Government changes the scope, this may impact the time and the price. That is easy to understand. If a the government wants more beds in a hospital, then this is going to require changes to the design and that may result in additional costs (at least the cost of the additional beds) and may take longer than originally estimated to build.
• Changed circumstances - assuming the scope stays the same, there may be other circumstances that result in the party delivering the project being entitled to more time or more money under the contract. Again, it is easy to understand why this would be the case where the government prevented the party delivering the project from progressing the work (such as by denying them access to the site). Or for an event - such as a flood - where the impact can't be controlled or accurately estimated in advance.

The contract price does not allow for these circumstances. If they arise, additional time and cost may be payable by the government. It's important to remember that additional time also results in additional costs as people are working for longer, insurance is required for longer, money is borrowed for longer etc.

These are additional costs, but the negative connotations associated with the phrase "cost blowout" seem misplaced when thinking about these additional costs.

2. Additional builder costs

In this context, the 'fixed time; fixed price' element refers to the risks that the private sector (predominantly builders) take in delivering public infrastructure under contracts in Australia.

Again, by way of illustration:

• Labour Costs?- if the cost of labour (or the amount of labour required) exceeds estimates, this is a cost that is absorbed by the builder. The price will factor in an allowance for escalation during the build, but if the actual costs differ then that will fall to the builder.
• Material Costs - if the cost of materials (or the amount of materials required) exceeds estimates, then this is also to the builder's account. Again, some escalation may be allowed for, but a global shortage of timber or the collapse of a local steel works are risks that may ultimately increase the builder's costs but not the cost of the project to government.

The contract price is assumed to allow for these circumstances. If they arise, the "project cost" which is ultimately met by government does not increase. However, the builder's actual costs do, so margins are squeezed and eventually builders will be complaining about a profitless boom.

3. Project Announcements

In light of the above variability, it seems odd that project announcements still talk to fixed times and fixed prices. This sets up the narrative that any increase in actual costs from the contract price is a failure, gauge or concession. That does not reflect the contractual reality.

The media and the public should be aware that the government (sensibly) retains some risks and may (rightly) need to provide additional time or meet additional costs if those risk eventuate.

4. Improving Outcomes

Given the prospect of increased costs to government or reduced profits to the construction sector, there is a need to improve the efficiency and effectiveness of the market.

Some ideas to consider include:

• Pipeline - coordinate the pipeline to spread the demand for skills and materials and minimise concentration risk. That means a broader range of projects, in a broader range of geographies seeking broader benefits for a broader range of people.? It also means building a meaningful pipeline for Tier 2 and Tier 3 contractors.
• Skills and Capacity - given the increasing size of the pipeline, there is a need to invest in the skills and capacity needed to deliver it. Better teams deliver better outcomes for everyone.
• Project Definition - more time needs to be spent upfront to better understand individual projects. How do they fit into the broader pipeline, what outcomes might they deliver and what are the particular risks. Slow is smooth and smooth is fast. Spend the energy to set the project up for success - measure twice; cut once.
• Risk Allocation - the risk allocation should reflect the project and its particular risks. Selective use of "standard from" and "market" as reasons not to engage with the realities of the particular project is counterproductive (as is reopening standard positions unnecessarily).
• Procurement - there needs to be a rethinking of the balance between probity and pragmatism. The best value offer may not be the cheapest. It should be possible to assess competing options without taking a large number of bidders all the way through the procurement process - it is inefficient and compounds capacity issues.
• Market Challenges - recognise and collaborate on current market challenges. It may be a difficult insurance market, difficulty in bringing expertise into the country or a disruption in a particular supply market. Acknowledge and engage on the realities.

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