Overview of alliance contracting

The alliance contracting model, widely used in the UK and Australia to plan and deliver large complex infrastructure programs, is gaining traction amongst Canadian project developers and owners. Traditional Engineering, Procurement and Construction (EPC) and/or Design/Build fixed price contracting strategies have historically lacked incentives to promote owner – contractor collaboration, and commercial interests have often been misaligned due to excessive risk transfer to private contractors, leading to project claims and disputes. Alliance contracts bring innovation and collaboration between the contract parties to the forefront during the procurement process where target outturn cost and performance targets are set for the joint (integrated) owner-contractor project team. Establishing these shared targets helps increase commercial alignment and avoid contractual disputes. In an alliance, risk sharing amongst project delivery team members is achieved via a risk-reward framework (frequently referred to as "pain/gain" mechanism) included in the alliance agreement that applies to all alliance participant organizations.

In many successful alliance projects, the owner and the private vendors and contractors work in the same project office space through planning and execution which promotes collaboration and innovation through teamwork. The parties also typically agree to deliver the project under an "open book" collaborative environment that allows all parties access to actual project costs and records on a real time basis. In essence, the project enterprise resource plannning (ERP) and project management information system (PMIS) become available to all participants and the "one source of truth" for project information for both owner and contractors.

In such a collaborative approach, both the owner and contractor teams work as an integrated project management team to develop, define, and deliver the project jointly, applying innovation broadly to reduce project costs and improve performance.

Lessons learned on global projects

In working with owners around the world, our infrastructure team have captured some key lessons learned for successful alliance contracting.

As a first step, the owner should develop a clear understanding of the project objectives and what is of value for the project. To achieve this, the owner should consider the development of an owner's Value for Money (VfM) Statement, which sets out what is of value to the owner, and acts as a blueprint for the alliance partners to understand what is of value for the project. Based on this VfM statement, the owner and its alliance partners can then develop a mutually agreeable set of performance targets for cost, schedule, quality, environmental controls, and other non-financial goals such as stakeholder engagement or sustainability objectives. These targets are incorporated into a broad commercial framework that includes a risk/reward regime. A project performance pool of funds is established as part of the owners' budget and allows for the owner to compensate contractors for achieving or beating the specified targets.

The risk/reward regime should be designed so that all parties are incentivized to deliver the project at a cost that is lower than the Target Outturn Cost (TOC).

Contractors typically generate profit from two sources:

  • The fixed "fee" percentage (representing margin and overhead costs) charged on top of actual costs incurred, and
  • The gain share if the project is ultimately delivered at a cost lower than the TOC. The key lesson learned is that the latter (the gain share) needs to be larger and matter more to the contractors/non-owner participants (NOPs) than the fee they charge the owner.

If this balance is not achieved and NOPs are more concerned about the fee that they charge than about the potential gain share, they may "chase revenue", attempting to maximize actual costs (and therefore maximizing their fee), as opposed to delivering "best-for-project" outcomes.

One of the problems with traditional fixed price contracts is the lack of transparency and visibility by the owner into project cost, as actual contractor costs are not reported to the owner, and in many cases these costs are not fully auditable. Our experience is that owners who engage in alliance delivery models have a better line of sight into project cost and performance data than owners who engage in more traditional delivery models, and therefore have a better ability to forecast future performance and understand whether a certain risk or level of risk is likely to materialize.

An added benefit of alliances is that owners can develop significant commercial expertise and help reduce cost of the project by working with contractors in tasks traditionally reserved for contractors, such as estimating the cost or schedule impacts of changes and producing budget forecasts. Alliances do require upfront training, particularly where individuals are used to working mostly on projects delivered under traditional fixed price contracts, where contractor costs are not openly shared with the owner's team. The owner should clearly communicate and demonstrate the "open book" culture and behavior that is expected in the alliance team. Alliance contract management training should be undertaken and refreshed at regular intervals throughout the project lifecycle.

There are two primary roles of an owner in an alliance. First, the role of the owner as a client, and second, the role of the owner as an alliance participant. It is important for the owner to separate and delineate these roles. From a governance perspective, the role of the client should be to provide oversight and communicate with the alliance team via the Alliance Leadership Team (ALT). The ALT is comprised of members of the partnering organizations and is the project board that approves the decisions of the Project Director, often referred to as the Alliance Manager (AM). The ALT or alliance board would function in a similar manner as a traditional private sector joint venture project board, with the key difference being that the joint venture now includes key owner executives. Discussions at the board level become more diverse, and frequently include consideration of topics such as project funding, operational issues, or asset management requirements, where the owner's expertise can be leveraged.

It is key that the owner in its role as a participant be deeply involved in managing the project both in the ALT and via staff deployed by the owner into the alliance team on the project. The owner should embed staff into the alliance project team in all key project team functions (construction, engineering, quality, safety, environment, commercial, and project services) and exert its influence and control from within the alliance, participating in the day-to-day decision-making process. It is not unusual to see an owner deploy up to 30 to 40% of the total project management headcount. However, in its role as a client organization (outside of the alliance), the owner should avoid micromanaging the project and should remain a lean organization that delegates day to day decision making to the ALT and the AM, providing the ALT and the AM with the necessary independence and autonomy to drive efficient processes and decision making to deliver "best for project" outcomes.

From a procurement standpoint, when selecting NOPs, the owner must have a clear understanding of what outcomes, skills, and capabilities it needs from the alliance and the NOPs. The owner should select NOPs based on the unique expertise and capabilities they bring to the alliance. These capabilities should both complement the owner's own capabilities, and also align with the needs of the project.

In our experience, the NOP selection process can generally take anywhere from 12 to 18 months. It is an in-depth process that involves a time commitment from the owner. This commitment should not be perceived as a cost – it is an investment in a lower outturn cost and a more successful project overall.

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