November 9, 2023

Nicholas Tsirogiannis and Danijela Malesevic

The transport infrastructure boom has seen traditional fixed-price and hard risk transfer procurement models fall out of favour, with collaborative delivery models in their various iterations being adopted on numerous major projects and programs of works nationally.

Both public sector principals and contractors have observed several key benefits emerging from use of these collaborative models and it is likely we will continue to see these models adopted on future major projects – in particular, complex linear infrastructure like the electricity transmission infrastructure required to support the energy transition. There are significant parallels between transport infrastructure and transmission infrastructure that lend themselves to the adoption and benefits of collaborative delivery models.

Despite complications inherent in incorporating collaborative models on projects that require private funding, they have nevertheless been adopted on one of the biggest recent transport PPPs.  Given the public sector’s budgetary constraints, we are likely to see more privately financed projects, however the constraints in the construction sector mean it is unlikely that even on these projects the traditional hard risk transfer and fixed price elements will be acceptable to the market and we will instead continue to see incorporation of collaborative elements in the procurement of privately financed projects.

This article sets out the background to the adoption of collaborative contracting, including some of its key benefits, and considers how they can be used to progress delivery of future major infrastructure projects – including those that may require private financing.

From sporadic to extensive use

Over the last decade, collaborative delivery models have featured heavily in the unprecedented pipeline of transport infrastructure projects along the eastern seaboard. The use of alliancing increased significantly, from sporadic adoption (in the transport and water sectors) to now being used extensively to deliver major public transport infrastructure projects like the Level Crossing Removal Project (LXRP) and metropolitan and regional rail infrastructure programs in Victoria.

Spurred on by the adoption of collaborative models in Victoria and on the LXRP in particular, we have seen further innovation in the development and implementation of a new delivery model: the Incentivised Target Cost (ITC) model.

In Victoria, ITC was first developed by Major Road Projects Victoria (MRPV) as the primary delivery model for the delivery of its road program and has been more recently used on the Suburban Rail Loop project (SRL) and, in part, on the PPP component of the North East Link Project (NELP). In NSW, ITC has been used on Sydney Metro upgrades, the Warringah Freeway Upgrade and the Western Harbour Tunnel Project.

Why fixed price contracting fell out of favour

The increased adoption of collaborative delivery models (both alliancing and ITC) has largely been at the expense of the traditional D&C delivery model. The traditional D&C fixed price/fixed time and hard risk transfer approach fell out of favour on linear transport projects for a number of reasons, including:

  • a hard dollar approach was not conducive to brownfields rail projects which have many complex interfaces including with the rail network operator and maintainer of the rail infrastructure;
  • under a hard dollar and traditional risk transfer approach, the State would be left having to enter into (and ultimately assume all risk in) separate interface arrangements with the rail network operator to facilitate the required participation (which is often extensive);
  • on rail projects in Victoria, government wanted the operator as a party to the main contract and to be an active participant in the design, delivery and commissioning of the project;
  • making the operator a participant is seen as the most effective way to deal with this interface and alliancing more easily allows for a multi-party approach;
  • pricing that interface is very challenging for both the government and the contractor;
  • similarly, utilities and ground conditions are two particular risks on linear transport projects more broadly, that are very difficult to price;
  • alliancing had already been successfully used on brownfields rail (Regional Rail Link) and some earlier level crossing removals (2007 to 2012) and was seen as the go-to delivery model in Victoria for rail projects;
  • the open book nature of a collaborative delivery model was much more aligned to the programmatic approach adopted by the LXRP and more recently by MRPV – as it enabled the delivery agency to have full transparency of all costs as they were being incurred, which in turn allows the delivery agency to have detailed understanding on how much an activity or item costs going forward; and
  • general pushback from the market on full risk transfer and fixed price contracting models.

PPP follows the trend

Collaborative contracting has also found its way into the PPP structure. That is probably unsurprising given the significant challenges experienced on brownfields transport projects procured via the PPP model in both Victoria and New South Wales. On those projects, challenges with ground conditions, utilities and cost escalation led to significant claims being made by the D&C contractor. On the NELP in Victoria, following bidder feedback, elements of the ITC model (including a target cost) were introduced into the traditional PPP structure. The project was initially tendered under a traditional PPP model with fixed price contracting which was ultimately amended partway through the procurement process. The procurement process was accordingly extended to allow the bidders to reflect the new model in their bid response. Notwithstanding the delays experienced as a result of this extended process, it does show that government, equity and the financiers are adaptable enough to accommodate market feedback and the change in risk appetite of the contractor market.

Collaborative delivery models are here to stay

While it has taken more than a decade, collaborative delivery models are now finally accepted as an effective delivery model on complex government infrastructure projects. Both industry and government see them as providing a better way to address risk, enhance collaboration, and incorporate innovation, and as a more transparent way of delivering projects through an open book approach to costs. They have also replaced the traditional adversarial environment created by fixed price contracting with a more collaborative working environment that enables joint problem solving instead of a reliance on formal claims and dispute management processes.

Model of choice for electricity transmission infrastructure?

With the success of collaborative delivery models in the transport infrastructure boom, it is natural to  ask – should they be the model of choice for the next wave of major infrastructure projects – electricity transmission infrastructure? There are many reasons to support an affirmative answer to that question including the following parallels with transport infrastructure:

  • Transmission projects are linear projects covering several kilometres like road and rail. This means issues that will be live include ground conditions, extensive utilities interface and interaction with multiple stakeholders. Contractors are unlikely to assume the risk on these issues and will look to share those risks with owners or look for the owner to take those risks.
  • The contractor market is unlikely to support a move away from collaborative contracting given the challenges experienced on fixed price projects in the transport infrastructure sector. Also, in a market where there are likely to be more projects than contractors, the contractor market will have the upper hand when comes to risk transfer and the basis on which they are engaged.
  • Given that there will be multiple projects of a similar nature (eg, transmission infrastructure), open book contracting is likely to be better value for money for the procurer (and in the case of transmission projects, for the consumers that will ultimately be funding these projects) and will allow the procurer to get a clear and detailed understanding of project costs. As is the case for LXRP, it will also allow the procurer to have up to date accurate information of project costs as they are incurred and, by having that information, make it much easier to estimate what future projects/packages should cost.
  • Given the scale of the energy infrastructure that will need to be procured, it is likely that procuring entities will need to adopt a programmatic approach to ensure there is sufficient capacity in the designer and contractor market and innovations and lessons learnt on one project are adopted on a program wide basis. This is the approach that the LXRP has successfully adopted since 2017 to procure and deliver the 110 level crossing removals (using Program Alliances) and rail upgrades and, more recently, by MRPV.
  • Cost escalation will continue to be an issue for projects and may, in fact, be exacerbated as more energy transition projects are procured and commence delivery. During the ramp up phase of the transport infrastructure boom, contractors were prepared to incorporate escalation into their pricing or target outturn cost on alliances and assume or share that risk. However, as the cost of labour and materials began to soar, that wasn’t a risk that they were prepared to assume or even share with the State. On fixed price contracts, that was problematic as there was no mechanism to deal with the issue – it was simply a contractor risk. This meant that contractors were faced with either making losses on these projects or trying to find ways to recover increased costs due to escalation from owners notwithstanding they contractually assumed that risk.  On projects where relationship contracting models were used, the open book and reimbursable cost nature of those arrangements allowed the owner to see in detail the effect of escalation and make adjustments to the target outturn cost where appropriate – which benefitted both the owner and contractor.  The open book nature of collaborative delivery models allows both parties to make an appropriate allowance in a transparent manner and then deal with escalation over and above the allowance (whether as a shared or owner risk) in a more reasonable and fair manner for both parties compared to a fixed price arrangement.

Can they be used if there is private financing?

Notwithstanding their popularity and the strong market sentiment towards them, there is potentially an obstacle to adoption of collaborative delivery models on certain projects going forward. The majority of projects (except for NELP) that have adopted collaborative delivery models have been publicly funded and have not involved private financing – eg, in Victoria, LXRP, MRPV projects and SRL. However, given the landscape has significantly changed since the start of the transport infrastructure boom with significantly less public funds available for projects going forward, government projects are likely to have to look for alternative sources of funding.

The most obvious source of funding for government projects is private financing using the traditional PPP structure. Traditionally, privately financed projects have only involved fixed price contracts at the D&C level and financiers have made that a non-negotiable requirement. However, the first sign of movement on that front was on NELP where the underlying D&C contract was a cost reimbursable arrangement with a target cost. Under that arrangement, if the target cost is exceeded, all parties (including the State) share the pain of the cost overrun. While it is difficult to know with certainty what convinced the financiers to agree to a move away from a fixed priced arrangement, the fact that the State underwrote a significant portion of the cost overruns is very likely the feature that got the financiers over the line. In effect, it partially capped the potential exposure of the financiers, albeit in a different way than a fixed price arrangement would.

Blueprint for the future – public sector projects and beyond

It is likely that NELP will provide a blueprint for government and the private sector in tackling risk allocation where private financing is required (especially under a PPP structure). As on NELP, the government (or, in the case of privately developed projects, the owner/developer) will ultimately need to take the risk on a (potentially significant) portion of any cost overruns. To some degree government already does this with other delivery models. For example, on a fixed price arrangement, it is common for government to include in its project budget a contingency amount over and above the contract price for variations, claims and other additional costs that arise on a project. While some may argue that government carries too much of the cost risk under the NELP arrangement, the fact that cost overruns will be shared between the State and the private sector up to the agreed amount should provide more than enough incentive for all sides to make sure that the target cost is as accurate as possible and the risk of large cost blowouts is significantly reduced. The approach adopted on NELP will hopefully keep the PPP model up to date with market requirements and, at the same time, ensure that industry retains the benefits of a collaborative delivery model as we go into the next infrastructure boom.

Of course, the above potential obstacles do not apply to private sector projects if they are financed from a balance sheet, for example by 100% equity developers – a few of which we are seeing entering the Australian market with significant future investment in planning. Where there are significant risks that are difficult to quantify or price, or the market is simply not prepared to accept a hard risk transfer model, or the developer is seeking to avoid paying a premium for the wrapping of all risks, a collaborative delivery model such as ITC may be the most appropriate delivery model. However, the lesson learnt from the transport infrastructure boom is that for collaborative delivery models to be effective an active and sophisticated client is required, in particular to develop and agree a target outturn cost, to review and understand the downstream arrangements and to assess the claims for reimbursable costs on a monthly basis – as well as being active in the delivery phase. This requires an upfront investment in resources by an owner but has proved extremely beneficial for government on the large transport infrastructure projects along the eastern seaboard. This means that for 100% equity developers with a significant investment pipeline, an upfront investment in its internal capabilities could yield benefits across its entire program of works by adoption of more collaborative delivery models – not dissimilar to the public sector’s approach to recent major programs of works.

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