On May 3, 2023, the Toronto Construction Association held Members’ Day. To kick off the day, the TCA invited Howard Krupat, Partner with DLA Piper, to moderate a panel of industry professionals, which included: Jennifer Burstein of Collecdev, Tim Theodosiou of Modern Niagara, and Corebuild’s General Counsel, Paul Dipede. Angela Gismondi of the Daily Commercial News extracted some of the key themes discussed from the panel in her article, dated May 9th, 2023.
During the presentation, the panel members discussed the various risks that tend to arise during the procurement phase of a project. This article will elaborate on Ms. Gismondi’s article as well as some of the high-level issues discussed.
i. Procurement Risk Impacted by Market Volatility
Certain economic consequences emerged during and after the years of the COVID-19 pandemic, which resulted in tremendous volatility in the cost of raw material commodities. Lumber prices as well as various metals rose sharply from 2020 to 2022. At the start of 2023, prices in lumber and steel have begun to normalize, however, the impacts of the volatility over the last few years are still affecting all construction procurements.
Intense volatility in the pricing of commodities has resulted in massively increased indices included in quotations for labour and materials costs. Increased price quotations of subcontractors, suppliers and manufacturers is commensurate with the steep increases in raw material commodities over the last few years, which has resulted in increased overall construction costs.
Companies that locked in pricing through lump sum contracts in or around 2020 and 2021 felt the most significant impact of the volatile market, as these companies would have priced in pre-pandemic material costs and then may have had no choice but to lock into increased pricing from their material suppliers at a much higher rate than when that company locked in their price at the time of tender.
Subcontractors and general contractors have had to adapt to market conditions. Risk in volatile commodities is now more often than not priced in as a higher-priced contingency, which has ultimately resulted in higher construction costs. As market volatility normalizes, it is likely that construction costs will follow suit.
ii. Procurement Risk Can be Mitigated by Choice of Contract
Market volatility has caused owners and developers in the public and private sectors to scrutinize which prime contract is most suitable depending on the procurement undertaken. Typically, over the past few decades, lump sum contracts have been most common for public and private owners alike. Lump sum contracts were always traditionally more appealing because owners and developers would take advantage of attaining cost certainty and the reallocation of project risk down to the general contractor.
However, over the last few years, the industry has been seeing a shift in this philosophy. In the public sector, capital cost budgets that might have obtained approval from council or a board many months to years before the tender closes are coming in way over budget through competitive tender processes. This is a result of market volatility over the past few years and increased pricing of risk by the general contractor and subcontractors. Unfortunately, many over-budget procurements have been canceled and not re-tendered until months to years later.
In larger construction projects, a project design is never truly flawless, so without input from your construction contractor regarding construction coordination and material selection during the design stage, there are often design flaws that cause project delays during the project that could have been mitigated much earlier in the design process with additional input from the construction contractor.
A shift toward implementation of construction management contracts and other integrated project development contracts is now much more common, whereby tendering for subcontracts are tiered, which allows non-early works subcontractors to lock in pricing further into the construction project. Unfortunately for owners and developers, this method takes away from the cost certainty of a lump sum tendering process, however, it allows the construction manager to work collaboratively with the owner/developer and their architect(s) to achieve cost-savings in construction methods and alternative products during the design phase. Having your construction manager or general contractor involved prior to issued-for-construction drawings can help to reduce the number of project changes and maintain projected project budgets.
Lately, the benefits of a construction management model appear to be outweighing those in a traditional lump sum format. As members of the construction pyramid put more emphasis on a more collaborative philosophy, design and construction become more efficient and less costly once the project is complete. The private sector has implemented construction management models much more frequently over the past few years, however, it appears that the public sector is catching up. More prequalification packages are being issued whereby public owners are bringing their contractors to the table during the preconstruction/design phase. As construction procurements put more of a focus on collaboration as opposed to an emphasis of risk allocation, construction will be more efficient, cause fewer delays, and will ultimately end up less costly.
iii. Supply Chain Delays
Supply chain delays in today’s economy are becoming far too common. As companies were forced to work remotely or altogether shut down due to pandemic-related delays, Canada’s economy was impacted significantly. The pandemic brought on increased cost of freight, increased cost of raw materials in other countries, and a complete halting of international trade altogether. The foregoing caused significant supply chain issues that are still being seen today.
The construction industry has had to adapt. Contractual clauses are being introduced to mitigate escalation in material costs as well as force majeure impacts resulting from the pandemic, however, most contracts were already executed during the period of time that these issues became present during a construction project. As a result, owners, contractors, subcontractors, suppliers, and manufacturers had to find commercial (as opposed to legal) solutions to overcome supply chain delays, material shortages, and price escalations.
From a legal standpoint, once the contract is executed, there is not much that can be done to mitigate the cost impact of supply chain delays, however, contracting parties are finding ways to overcome these legal challenges. One of the most common workarounds is that owners are now identifying long lead items earlier in the project and are ordering said materials or products ahead of time. This allows the owner to lock into pricing earlier in the procurement and mitigate risk of delayed shipments. Another common workaround is where materials are already locked in by a subcontractor, the subcontractor coordinates with the general contractor or construction manager to store a long lead item on the site (or arrange for localized off-site storage) so as to ensure the product/equipment is on site and included in the construction cost ahead of time. The consequence of implementing such construction coordination solutions benefits all parties. For example, the owner is satisfied that their product/equipment arrives earlier and is not the cause of a delay, and at the same time, the subcontractor will be able to progressively invoice for the work so as to increase cash flow, which ultimately leads to more productivity.
In summary, subcontractors, contractors, and owners have had to adopt more collaborative approaches to the completion of construction projects. Collaboration during the procurement of construction avoids project delays and additional costs. To facilitate collaboration, the appropriate form of contract must be established, and once established, market conditions can be analyzed and subcontractors, contractors, and owners adjust procurement risk allocations in order to complete the construction project more efficiently.