Guide to Capital Projects Contract Negotiations – when in the Employer/Owner shoes

All capital projects are executed through written contracts that bind both the owner and the contractor to certain terms and conditions, and performance requirements. The whole process of contractor selection is generally defined as the Contract Procurement/Tendering Phase of a capital project. Contract negotiation is one of the final stages when the employer selects the preferred bidder(s) and then selects the final contractor.

Negotiation skills play a key role in ensuring that optimal values are realized out of the Contract Procurement/Tendering process. To be a good negotiator, you need to understand both the art and the science of negotiation. The art of negotiation is all about understanding people and building relationships. The science of negotiation is all about understanding the numbers and the game theory behind the negotiation.

Capital project contract negotiations are more complex than simple business negotiations for one, they are both distributive negotiation (where there is a fixed pie to be divided between the parties) and integrative negotiation (where the parties are trying to create value), at the same time. Secondly, this negotiation must strictly follow the procurement and governance policies of the organization.

Over two decades of my capital project experience, I have been part of various teams engaged in contract negotiations ranging from small subcontracts to large general contractor selection, and claims.?This article summarizes some of my learnings and experiences.?

1. DO A THOROUGH HOMEWORK

The overall objective of the Contract Procurement/Tendering process is to maximize the project outcome by selecting the 'best suited' contractor. The boundaries of the term ‘best suited' depends on many factors such as:

• Lowest Financial Bid criteria
• Technical Competency
• Financial Capability
• Synergies between employer and contractor organizations, and many more

It is important that your organization's leadership and procurement team agrees and decides the 'best suited' criteria in the very early stages of Contract Procurement/ Tendering. This will form the basis for potential contractors’ selection at the Request for Qualification (RFQ) stage, Technical Scoring framework, and eventually provide guidance during contract negotiations. The big mantra when defining 'best suited' criteria is to - Look at the big picture – what are your goals and objectives of the project, as well as the overall business case under which the project is being governed.

Then based on the above 'best suited' criteria you need to do further preparations, which can be summarized under topics:

1.1 Tender Check Estimate and Negotiation Baseline Cost

Prior to bid receipt, you must ensure that your Tender Check Estimate is ready and properly validated through an estimate review process. The overall Tender Check Estimate must be in form of a Bill of Quantities (BOQ)/Schedule of Values/Cost Centers mirroring the same as in the bid documents. At the time of preparing and reviewing the Tender Check Estimate, you must ensure those cost elements which are included due to special/additional contract conditions such as preliminary items like employer office facilities are considered in the Tender Check Estimate.

Similarly depending upon the time gap between Tender Check Estimate preparation dates and Bid Submission dates, an increase in base labor and materials prices are considered using the appropriate inflation formula.

1.2 Prepare your BATNA and ZOPA

BATNA and ZOPA are two important negotiation tools. In any negotiation, it is important to understand your BATNA and ZOPA.

BATNA stands for "Best Alternative to a Negotiated Agreement". It is the option you will take if you are unable to reach an agreement in the negotiation in the first place. BATNA can be used as a negotiating tool. If you have a strong BATNA, you may be able to use it to your advantage. For example, if one bidder is interested to get the project as his resources are idle, however, his quote is higher, you may be able to use this to your advantage.

ZOPA stands for 'Zone of Potential Agreement'. It is the range within which an agreement can be reached. BATNA and ZOPA are important because they set the limits of the negotiation. They help you to understand what you are willing to accept and what you are not willing to accept. It also helps you to understand the other side's bottom line. If you know the other side's ZOPA, you may be able to make them an offer they can't refuse.

1.3 Are your Scenario Options Ready

When you have your Tender Check Estimate, BATNA, and ZOPA ready, it is time to develop various scenarios. Such scenarios can be prioritized based on their value outcomes. It is also important to identify when a given scenario shall kick in. Your scenario options must follow the basic principle of mutual gains, which means that it is important to generate a variety of possible solutions to the negotiation bottlenecks and then work together to find the one that is best for both sides. It is often helpful to use brainstorming techniques to generate a variety of possible solutions.

It is important to remember that BATNA and ZOPA are not static. They can change during the course of a negotiation. For this reason, it is important to keep them in mind during the negotiation and be prepared to adjust your own position and scenario options, if necessary.

2. STRATEGIC MINDSET AND SMALL SPECIALIST TEAM

Like any other endeavor, negotiation success too depends on the competency of the team behind it. You need to form a very small cross-functional team comprising of:?

• Lead Negotiator
• Cost Specialist
• Contract Specialist
• Design/construction

The team members must have specialized skills such as data analysis, presentation, and interpretation.

It is important that you and your team have a strategic mindset, and such a mindset is aligned to the overall organizational business strategy. My three general negotiation strategy clues are as below:?

2.1. Separate the people from the problem

Separating the people from the problem means that it is important to remember that the other side is not the enemy. The problem is the enemy. It is important to maintain a constructive relationship with the other side, even as you work to find a solution to the problem.

2.2. Focus on interests, not positions

It means that it is important to understand what the other side wants, and why they want it. It is not enough to simply know what they are asking for. It is also important to understand their underlying interests. Once you understand their interests, you can begin to look for creative solutions that meet both sides' needs.

2.3. Always be driven by objectives

Insisting on using objective criteria, means that it is important to agree on a set of objective criteria that will be used to evaluate the possible solutions. This will help to ensure that the final solution is fair and equitable. This means that you have your Scenario Options ready all the time and your Small Specialist Team works around these options.

3. MANAGE YOUR OWN AND THE TEAM BIASES

The negotiation team should always avoid cognitive biases, especially anchoring, confirmation bias, and the sunk cost fallacy. These biases can lead negotiators to place too much importance on certain information, to search for information that confirms their preexisting beliefs, or to persist in a course of action even when it is no longer rational to do so. Recognizing these biases can help negotiators avoid them and improve their negotiation outcomes. Training in negotiation and decision-making can help negotiators further improve their performance by reducing the impact of cognitive biases. Few quick to manage these biases follow as under:

4.1. Managing Anchoring Bias

Anchoring bias is a cognitive bias that describes the human tendency to rely too heavily on the first piece of information offered (the "anchor") when making decisions. For example, the negotiation team starts to interpret bid numbers without reviewing the cost breakdowns and without comparing them with the Negotiation Baselines.?

To manage anchoring bias during negotiation, it is important to be aware of its existence and to try to consider all relevant information when making decisions. It is also helpful to encourage the other party to provide a range of options and to consider multiple anchors when making decisions.

4.2. Managing Confirmation Bias

Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one's preexisting beliefs or hypotheses.

In a negotiation, confirmation bias can lead to anchoring, where one party fixates on an initial offer and refuses to budge. To avoid this, negotiators should be aware of their own confirmation bias and make an effort to consider all information objectively. They should also encourage the other party to do the same by openly sharing all relevant information and inviting questions.

4.3. Managing Sunk Cost Fallacy

The sunk cost fallacy is a cognitive bias that leads people to continue investing in something as long as they have invested so much in the past, regardless of whether or not it is rational to do so. The sunk cost fallacy can lead to suboptimal decision-making and negotiation outcomes and can cause the negotiation team to hold on to losing investments for too long.

To avoid the sunk cost fallacy, the negotiation team should focus on the future and on the potential benefits of a decision, rather than on the past. If re-tendering seems to the best outcome, so be it - you should not shy away from such failed negotiation outcome, and keep re-tendering in your scenario list.

5. ALLOW SUFFICIENT TIME

Contract Procurement/Tendering Phase may require three to twelve months starting from bid document preparation to issuance to the letter of award depending upon the size and complexity of the project. You should ensure that sufficient time is allowed for the Contract Procurement/Tendering Phase - especially for negotiations.

Compressing negation duration may lead to an "Agreement Trap". It is a situation the negotiation team tends to agree to a deal that is inferior to your BATNA, or the best alternative to a negotiated agreement, due to lack of time.

To ensure that you well manage time during the Contract Procurement/ Tendering Phase, you need to develop a detailed Tender Schedule. Such Tender Schedule should include activities such as Bid document Preparation, Prequalification, Tender Document Preparation, Bid Submission Time, Bid Analysis, board approvals and issuance of Letter of Award etc. The main benefit of a detailed Tender Schedule is that it provides a clear and concise roadmap for the procurement/negotiation team to follow. By outlining all of the tasks that need to be completed during the Procurement/ Tendering Phase, and when they need to be completed, the Tender Schedule ensures that the Procurement/Negotiation team is aware of their responsibilities and knows exactly what needs to be done.?

Additionally, a well-designed Tender Schedule can help to improve communication between the other stakeholders – such as the company board, finance, HR, and other business function, so when the contractor comes on board, peripherals tasks are complete and works at the site can commence without any hindrance.

6. BE CAREFUL, IT IS THE START OF THE STORY NOT THE END

Unlike other business negotiations, where negotiation closes with a done deal. Capital project negotiation finishes with the start of the construction phase. Therefore, it is mandatory that you do not lose sight of how actions taken during the negotiation stage may have an impact on the project delivery stage. This is especially important for organizations where procurement and delivery are separate departments without cohesive cross-functional relations.

At last, you need to document negotiated changes made to bid documents and the clarification made during the bidding phase - in design, contract condition properly etc. Such change should then be made in the bid document to eventually become the final signed contract document.