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DEFSEC Media is New Zealand's defence, security and fire B2B/B2G publishing group. Our leading magazines, Line of DefenceNZ Security and Fire NZ are read by key business, government and military decision makers and influencers. This website is the online home of cutting-edge content from each of our titles.

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Contracting strategy in a Mega Project environment

Line of Defence Magazine, Spring 2017

Mega Project: Roy Hill mine in Western AustraliaMega Project: Roy Hill mine in Western Australia

 

Claire Negus, managing director of Primary Delta Consulting, presented on contracting strategy at the recent NZDIA Defence, Industry & National Security Forum. In this exclusive interview, Line of Defence asks her about contracting strategies for high-stakes, big-budget, long-term infrastructure projects.

 

In her previous role as General Manager Commercial at Roy Hill, Claire Negus was responsible for operating assets, contracts and procurement management, organisational risk, financial evaluations and insurances.  With a team of 80 across six locations, Claire had carriage of contracts to the value of AUD 10bn.

Roy Hill is a mega project. Centred on the massive 55 million tonne per annum Roy Hill iron ore mine in the Pilbara region of Western Australia, facilities include a wet processing facility, six accommodation villages (300-2,800 rooms each), power plants, 344km of rail, a two-birth port and an airport.

In the mega project context, managing suppliers and contracts is a high stakes game, and poor decisions up-front can have expensive, dangerous and long-lasting implications. It’s a context, says Claire, in which risk-based approaches to contracting strategy and early supplier engagement are critical.

 

LoD: What will you be talking about in your forum presentation?

CN: My talk will take a risk-based approach from the owner side of the contract and looking at understanding what they want to achieve at a strategic level and understanding what risks that poses in relation to their strategy. The talk will then take them through the process of considering different risk profiles and contract forms. I’ve got about 10 different contract forms and I talk about the different risk profiles of each and how each match one’s strategic objectives and risks.

Ultimately a large portion of contracts is around risk mitigation, so we talk about how you then fit this into your preferred contract format, and we work through ensuring that your contract specifics match your strategy and risk profile. It’s about how to get the right contract strategy and execute it effectively for a mega project.

 

LoD: So, the risk based approach lends itself particularly well to a mega project where the stakes are particularly high?

CN: Theoretically it’s what you should do at any risk level, but the reality is that you’re not going to spend your time and effort on risk where the stakes don’t matter. It comes down to effective use of resources. If you do have a lot to do or a lot to gain, then it’s worth spending the time up front to get it right.

 

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LoD: In New Zealand, projects are not necessarily as large as some you might find in the Australian context, although programmes such as the defence regeneration may throw up large scale projects. How do you see this risk-based approach to contracts relevant in the New Zealand context?

CN: You’ve got two aspects there as I understand it: one is that you get fit for purpose assets and the other is that you have it operated in a sustainable manner to a standard to which the customer is satisfied. Thus, you take your two strategic objectives and then you look at them from a risk perspective – what are the risks associated with each? – and then you take a step back and match it to a contract form.

In that instance, there are some contract forms that will satisfy those strategic objectives, but the customer may also want to look at splitting it up. So, part of what I go through is to talk about what is more important. Is the cost more important or is the quality more important? And if the cost is more important you may want to cost out all the elements.

Let’s say time is not of the essence. You may want to spend a bit more time breaking up the construction portion and have them constructed in such a way that you get either really good cost or really good quality, and then you might then take a different approach to the ongoing operational side of it. What is more important, do we care about time or how much it will cost? Is it about getting the quality exactly right, or are we just happy if our staff are happy. These are the sort of things the customer needs to think about and understand.

 

LoD: Tell us about your experience at Roy Hill and how it has informed your approach?

CN: Whether you’re on the contractor side of the fence or on the customer side you’re probably looking to understand each other best. So, some of my experience comes back to what worked and why did it work and what didn’t work and why, and – more importantly – does this approach make sense?

I talked about what’s most important to you, but the other thing to understand is what’s most important to the parties you want to deal with. One of the things we did at Roy Hill was early contract engagement where we would actually run forums and workshop with potential suppliers in order to understand what they valued and let them know what we valued.

Getting an understanding of who can manage that risk best and who has the best solution also plays into that contracting strategy.

 

LoD: So, with early engagement there is an opportunity for the customer to understand where suppliers sit but also for suppliers to self-assess their own abilities?

CN: Yes, but also to understand what the customer wants, and how can they best service the customer with their skills set. If you understand what the other party is good at and what the other party values then you’re in a better position to (a) win and do the work well, and (b) to make a profit.

Because different parties place different values on things, if you understand what they value you can obviously increase your price in those areas, and if you understand what they want you to do you can either increase your capability and capacity in that area to cater for that and/or if you have the right expertise you can potentially either lower or increase your price depending on how they value that service.

It’s about both parties at that point getting the most out of the relationship. But it comes down to an understanding of who does what best.

 

LoD: There has been a lot of talk recently in New Zealand about early engagement, and clearly Defence has become focused on engaging earlier in recognition that better outcomes can be achieved by engaging at the pre-tender stage. How do you think New Zealand and Australia sit internationally in this regard – are we arriving late to the party or are we leading the charge?

CN: I’m not qualified to assess the New Zealand context, but I think Australia is probably leading the charge. In the Fast Moving Consumer Goods space, one tends to see relational contracts rather than early engagement. Early engagement more speaks to major infrastructure pieces. In the major infrastructure space, Europe is not doing it.

The European competitive advantage is quality and efficiency – they have high quality and their cost of construction is moderately low given the level of quality. Getting something that is fit for purpose or outside the box, however, is very challenging because they’re not interested in early engagement or necessarily understanding what the customer wants.

I’d suggest that the US is not quite where we are yet, but they are more in line with where we’re headed in comparison to Europe.

Whilst scoping from an early contractor engagement perspective is relatively standard globally, actually having open dialogue prior to engaging someone is more unusual.

It’s important to understand the drivers. Over the past ten years Australia hasn’t had great economic growth, with the exception of the mining sector. Outside of the mining sector, growth from a major infrastructure contractor’s perspective has been in the government space. Government projects typically have a fairly well-defined scope prior to going to market, although some states do it better than others.

In the mining sector, when the focus was speed to market, early contractor engagement went out the window. It was all about “how quickly can we get this built, the quality has to be about right, and we don’t care about the cost.” And now that commodity prices are less buoyant there is far more focus on getting quality because that then leads to maintainability issues and longer term operational cost.

In this setting, people take the time to get the early contractor engagement and to really optimise their contracting strategy to make sure they’re getting the right people. They ask questions such as “do I go lump sum for the whole job or do I spend the money up front to have an engineer do quite a bit of due diligence to refine the scope so I have five or six separate portions?”

Portioning means I can likely get more highly skilled people to do it, and I decrease the risk, which means I’m paying less and I should get a better-quality outcome. But if I went lump sum, I’d likely get someone who isn’t that skilled who would charge me a margin to take on the risk, but I should get it faster and at a higher cost.

It comes down to what the drivers of the outcome are at that point in time.

 

LoD: So, in context of New Zealand, the Defence Capability Plan, the Defence Estate Regeneration and various capability projects, there is a deliberate strategy and budgets. For a lean, mean defence force, does this mean that the risk based approach is particularly applicable?

CN: Where you’ve got a large project to take on and something that will be around for some time and present budget impacts for many years, it is particularly important to consider the entire life cycle of the contract and the scope of work up-front, and to spend the time and money getting that right so that you don’t end up with a problem twelve months or twelve years down the track.

 

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