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Sub-contracting or Co-contracting: Construction Procurement in Perspective F T EDUM-FOTWE and R MCCAFFER Department of Civil and Building Engineering Loughborough University UK M Z ABD MAJID Department of Structures and Materials Universiti Teknologi Malaysia Malaysia
Abstract The use of subcontract arrangements as part of the overall procurement strategy of the client is widespread within construction. Subcontracts in construction are often implemented in the spirit of adversarial relations that have traditionally characterised procurement in the industry. The paper presents an overview of construction procurement and discusses several macro factors that are influencing business activity in construction, with attendant repercussions for contractor-subcontractor relationships and construction procurement in general. It proposes a co-contracting agenda as a means of engendering the same benefits that partnering has brought to the client -principal contractor relationship. The paper argues that a co-contracting agenda will be essential for achieving the levels of productivity that will be required in the intensifying competition that the industry will face in the future. Keywords: Construction, procurement, subcontract, co-contract, organisational relationship.
INTRODUCTION Over the last two decades the construction industry has been profoundly affected by economic and industrial change as a result of recession, changing markets, impact of new technologies and increasing competition arising from greater regional and global integration. In the context of these harsher operating conditions and the concomitant pressures imposed on companies that undertake business in construction, strategies that were relevant to the industry conditions of the 1960s and 1970s through to the early parts of the 1980s are no longer adequate for sustaining competitiveness. The pre-1990s strategies, which were predominantly growth-oriented, often resulted in rigid organisations and systems that take considerable time to respond to the changes within their business environment. Notably, the growth strategies, driven by large-scale economics and attended by vertical and horizontal integration strategies, have been replaced by new imperatives of the 1990s. Faced by global and regional competition, the larger construction companies have responded by seeking greater flexibility. This trend in the 1990s, which will continue well into the future, involves a flexible response to the business environment and horizontal and vertical disintegration. The adoption of these strategies by construction companies has manifested itself in the disposal for peripheral business units and establishing closer and longer-term relationships with suppliers. These strategies have called for a greater
reliance on outsourcing, externalisation, and subcontracting of several activities of the construction process by main contractors to their small and medium counterparts. The paper examines the changing and emerging procurement strategies in construction against this background. In particular, it identifies and highlights the changes that are bringing about a shift from the traditional subcontractor arrangement to one of co-contracting. This emerging form will feature prominently in the procurement process within construction. Developing appropriate strategies to address such procurement forms will be essential for the future viability of construction companies.
CONSTRUCTION PROCUREMENT IN PERSPECTIVE Construction procurement deals with the arrangements for acquiring construction goods and facilities by clients either as private individuals or corporate establishments or public institutions. Construction procurement from the 1960s has grown from situation whereby all public jobs and most private jobs were offered on just competitive tendering to having various alternatives. Currently there are several forms of procurement in use within the construction industry. The various forms of procurement can be loosely classified under the following four typologies proposed by Harris and McCaffer (1996): separated and cooperative arrangements, management-oriented procurement systems, integrated arrangements and discretionary systems. Figure 1 presents examples of the procurement categories adapted from Harris and McCaffer (1996) and Franks (1998).
• Traditional single stage • Construction Management competitive tendering • Management Contract • Two stage competitive • Design and Management tendering • Variants of the above
• Design and Build/Construct • Design Build and Finance • Package Deal • Turnkey • All-in contracts • Other DBFO variants
• Partnering • Alliancing • Joint venture • Voluntary arrangements
Figure 1: Alternative procurement routes for clients in the construction industry
The primary distinguishing features of all the different procurement systems in Figure 1 can be accounted for by defining three basic characteristics. First, the responsibility for design and construction of the facility, and whether this should be placed on separate organisations or on a single organisation. Second, whether the principal contractor should construct the works or manage the construction process. The third feature hat helps to distinguish between procurement systems is the basis of remuneration for any work done. Examples of the above procurement systems in common use within construction include the traditional competitive tendering arrangement in which the principal contractor tenders for and constructs the works to a design that is previously prepared by the client’s designers. In contrast to the traditional arrangement, design and build procurement places responsibility for both the design as well as the construction on the principal contractor. The principal contractor also constructs the facility. In a management contracting arrangement, the principal contractor is engaged in a management role for the construction process, while other contractors undertake the actual construction in a work package subcontract arrangement. Where such subcontract arrangements are held directly with the client, the procurement system is described as construction management.
The use of discretionary arrangements in construction is a direct response to a growing demand and interest shown in engendering the benefits of team working within the construction procurement process. Partnering particularly relies on such principles, which call for a high degree of confidence and trust, as well as commitment by all parties involved in the process to defined mutual benefits. The procurement systems described above all rely on one or more subcontract arrangements outlined below. Subcontract arrangements between the principal and subcontractors and on the initiative of the principal contractor, as is the case of domestic subcontractors. • • • •
Subcontract arrangements between the principal and subcontractors and on the initiative of the client, as in the case of nominated subcontractors for specialist work. Subcontract arrangements between the client and subcontractor. Subcontract arrangements between subcontractors and sub-subcontractors on the initiative of the principal contractor. Subcontract arrangements between subcontractors and sub-subcontractors on the initiative of the subcontractor.
The widespread use of subcontract arrangements in construction is a result of the nature and structure of the construction industry. The industry’s workload is highly diversified by type, size, function, form and method of production, and materials used. The execution of the works equally requires the services of many different trades and specialists. Since it is economically unsound for contractors to retain all the trades and specialisation of the industry, construction companies undertake only part of the full range of operations required. Companies of a relatively smaller size perform work that is not undertaken by the principal contractor as well as those of a specialist nature, through a sub-contract arrangement. The use of such subcontract arrangements enable the larger construction companies to maintain greater flexibility and to cope with the high variations in orders often associated with the industry (Hillebrandt and Cannon, 1990; Flanagan, 1995). For example, Thoburn and Takashima (1992) provide evidence of a growth in the use subcontract arrangements by UK firms in their attempt to develop greater flexibility to both competition and other market conditions. As a result, the construction industry is dominated by a large number of small companies that provide subcontract services to their larger counterparts. Hillebrandt and Cannon (1990) argued that in spite of many changes that had affected the industry from the early 1970s, the structure of the industry had remained largely unaltered.
THE CHANGING FORM OF PROCUREMENT IN CONSTRUCTION The last decade of the 20th Century has presented significant changes for the way industry conducts business and particularly so for construction (Gomes-Casseres, 1996). There are a number of strategic factors that have come together to give rise to such unprecedented change affecting the construction industry. This section of the paper will give attention to some of these factors and how they are impacting and influencing the parties involved in the construction process. The relevance of the behaviour of these parties not only affects the degree of competition within construction, but is also contributing to defining a new agenda in construction procurement.
Changing clients and requirements Construction clients are exposed to the same economic conditions as the contractors within the industry. Recent economic changes as a result of global economic downturns exposed these clients to cuts in development budgets, who, in turn, translated the impact of such cuts to the construction industry. In some cases, it meant a withdrawal from developments already commenced. As a result, construction clients have become astute in their requirement of value for money. The demand of value for money implies that construction companies need to attain unprecedented levels of productivity so as to continue to win orders.
Improving construction productivity The construction industry witnessed considerable improvement in its productivity as a result of several initiatives and the deployment of concepts such as lean construction, benchmarking, and total quality management. The outcome of these productivity increases is reflected in the following benefits to the contractor: • • • •
improved product quality- thus minimising re-working increased output reduced accidents increased motivation.
These potential benefits are passed on to the client as faster delivery times at a reduced cost and to a better quality for the products they procure. While it can be argued that there is still room for improvement in productivity within construction, the present levels of productivity attained in some economies such as the UK, Japan, and the USA, leave very little room for significant cost reduction in the actual construction operations. The ability of a construction contractor to achieve further productivity gains therefore lie in the effective alignment of all the parties involved in the construction process, and particularly so for the subcontractors it engages (Headley and Griffith, 1997).
Changing business in construction Two decades ago it could be said that the fundamental business purpose of every construction contractor is to convert materials into a finished product. The industry since then has moved on from this scenario to a situation whereby some construction contractors only facilitate the process to one in which some contractors essentially provide managerial services. Effective construction is therefore hinged upon designing and implementing an integrated and systematic project organisation that consistently delivers a superior quality product and service at the best price and within the right time (Underhill, 1996). Construction contractors not only need to deliver these quality products and services – they must consistently do this with fewer resources if their clients are to receive the best possible value for money.
Widening economic and industry markets The world is changing rapidly with markets turning global as information becomes a worldwide commodity and protectionism retreats in the face of deregulation and enlightened self-interest. Until the close of the 1980s and the beginning of the 1990s the construction industry’s traditional markets had remained largely a domestic one. Within the European Union, there are signs a gradual shift away from this traditional domestic-oriented market for construction as contractors explore options for improving their orders within an enlarged single market. The situation is not different for the ASEAN region and other trade blocs (Thoburn and Takashima, 1992). For those large construction contractors that venture outside their traditional markets, there is the need for forming local partnerships to take advantage of local knowledge and expertise, as well as minimise the high cost associated with labour transfers. The construction markets that will result from these enlarged trade blocs into the next century will require increased capacity in order to ensure competitive advantage. Equally the industry's employers are likely to develop capacities that will give them greater negotiating power. As a consequence, client organisations will be more discerning and are likely to demand higher quality and greater risk avoidance. The requirements of this emerging enlarged market for construction and its attendant competitive forces demand a new approach to procurement for managing the project supply chain. Construction companies will have to pursue collaborative and co-operative arrangements not only to secure their long-term survival, but also to achieve a greater alignment between their organisations and the subcontractors they engage.
As a consequence of operating in such enlarged markets and also due to the current trend of increasing globalisation, smaller firms in construction are now exposed to greater competition. Once immune from overseas threats, these smaller construction companies now have to face up to accelerating domestic client demands as well as the reality of a new crop of competitors worldwide.
Electronic communication and IT The impact of IT on the construction process has been considerable, although Thorpe et. al. (1998) argue that construction is yet to receive the full benefit of the information revolution. The widespread availability and use of IT is enabling many a small firm in construction to take on projects which until recent times had been the domain of only the large construction organisations. Many of these smaller companies can convert the latest knowledge to their needs, thus accelerating their ability to compete directly with their larger counterparts. The increasing access to technology by smaller construction companies, along with the continuing lower costs due in part to their small capacity, is changing the competitive market in ways yet to be fully grasped. Technology and trade have traditionally been the main forces for change in the world economy. In recent years, new technologies, particularly information technologies, have intensified the pressure for change on industry structures and processes, and facilitated the development of global markets. Many new technologies are now applied widely and quickly, even in sectors previously regarded as low-tech. In many developed economies, these technologies have helped such sectors including construction to avoid decline, and are transforming these sectors into global competitors. Current use of IT in construction, however, has facilitated virtual proximity for different business units of a construction company that are geographically dispersed, enabling what has become commonly known as electronic commerce. This has given rise to increasing use of tele-working in construction. Equally, the internet has eliminated any sense of geographical isolation or safety for construction companies. The possibilities with electronic communication with regard to the processes of construction are endless. Its impact on procurement within construction is likely to be considerable. This includes electronic bidding and negotiation for projects, and thus opening up a different way for doing business in construction. The need for synchronised communication systems to facilitate such electronic transactions cannot be overemphasised. This calls for a closer partnership approach for organisations engaged along the supply chain beyond existing practice.
Changing structure and form of the construction enterprise According to Thorpe et. al. (1998), both academia and industry practitioners in recent years have suggested that the way companies organise themselves, do business, and undertake projects is inherently flawed. As a result, traditional models of hierarchy, standardised procedures, functions, responsibility centres and performance measures for both the construction companies and projects have all come under scrutiny. So nothing short of organisational transformation has been advocated. Contemporary corporate activity such as downsizing, out-sourcing, de-layering, and re-engineering have found frequent use in the management of both the company and projects within construction (Thorpe et. al., 1998). The resulting lean organisations have to rely on greater collaboration to achieve project and corporate goals, and have given rise to a growing trend in subcontracting and outsourcing (Gomes-Casseres, 1996). In many construction companies, management structures are becoming flatter, with a greater focus on customer needs and on team working, including partnership with other firms. Firms are increasingly contracting out non-core functions to smaller external firms. Networks of operations, involving strategic alliances, are coming together.
CONSTRUCTION PROCUREMENT AND THE FUTURE Partnering and other close organisational relationships have yielded considerable benefit to the clientprincipal contractor relationship. These benefits will be mirrored in contractor-subcontractor transactions within the construction procurement process as contractors explore options for achieving further productivity improvements. The viability of the large construction companies has become inextricably tied to the efficient performance of their smaller counterparts. It is imperative that these two categories of companies involved in the supply chain of the construction process should seek greater alignment of their organisations. Such a development takes on added urgency given the rate of growth in the number of small enterprises within the construction industry. For example, within the UK, 60% of construction jobs are in businesses with fewer than 10 employees, and there are now 1.2 million more small firms than in 1979 (DTI, 1995). The role and relationship of the various players of the industry’s value-creating chain will have to be reexamined to define new inter-linkages that facilitate the interest of all the participants in the industry. A cocontracting agenda where close association between major construction companies and smaller companies will provide one option for achieving the flexibility and capacities required for attaining the required to deal with present and future competitiveness. For the construction industry, this can best be achieved through a co-contracting agenda between the principal contractor and the subcontractors it relates to within the supply chain.
CO-CONTRACTING: AN OPTION FOR FURTHER COMPETITIVENESS A co-contracting agenda involves effective alignment of management systems, operational processes, and information systems, to achieve harmonisation in procurement strategy such that the boundaries between different firms at various stages of the supply chain becomes blurred without reaching the point of actual merger (Cole et al., 1997; Gomes-Casseres, 1996). A co-contracting agenda is therefore a relationship between two firms that engenders an atmosphere of equal partners in which each partner’s interests are taken care of (Smitka, 1991). For larger construction companies, achieving a good position in the international market is a matter of necessity. The only way the large companies can continue to succeed in an increasingly competitive world after considerable productivity gains in operational processes is to focus on such organisational relationships and interfaces. Within the UK, the ethos of such a co-contracting agenda is reflected in the various industry reports that focus on options for improving productivity within the construction industry (Technology Foresight, 1995; Latham, 1994; Egan, 1998). Naturally, such cocontracting arrangements have been taking place within the construction and manufacturing industries, albeit in an isolated fashion. Based on the advantages that have attended these limited uses of cocontracting, it is only logical to conclude that a widespread use of this arrangement will enhance the competitiveness of companies within construction industry. Its use within the construction procurement process should contribute to achieving the objectives of both Egan (1998) and Latham (1994).
SUMMARY Subcontract arrangements within construction are employed in all the different procurement strategies in use. The widespread use of the subcontract in construction implies that any improvements achieved in this business transaction can yield considerable benefits to the industry. The paper has discussed several factors that have influenced operational improvements within construction. It has suggested that the next avenue for productivity gains within the industry lie in managing the relationships between companies that form the supply chain of the construction process. The use of co-contracting as an alternative to subcontracting is presented as one way forward for achieving further improvements in construction procurement.
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