Phillips Schroeder Surety Limited is one of the UK's leading independent surety brokers and manage various bonds which cover over £3 billion of live construction projects at any time. We have a front row seat to the delivery of some very large construction projects, plenty go to to plan but quite often these are blighted by long delays, shortages in materials and labour, finance issues, sub-contractor insolvencies and other issues. Margins in construction are extremely tight and one would only need to visit companies house and download a few sets of accounts to note that most projects are delivered very close to cost and most contractors will lose money on a couple of projects each year.
The Empire State Building. It is an iconic building known the world over and for good reason. Not only is it an elegant structure; the project completed 17% under budget and several weeks before its scheduled opening in 1931. This led me to ask how, in an age of limited capital movement and nascent technology, were the project leaders able to construct one of the world’s most famous skyscrapers within budget and on time? All the more so given the Government’s recent U-turn on elements of HS2 that continues to haemorrhage cash and drag on (a blog post for another day) despite an abundance of capital, knowledge and technology. Luckily, Danish economic geographer Bent Flyvbjerg was forthcoming with answers in How Big Things Get Done (shortlisted for FT Business Book of the Year 2023).
The Issues
Flyvbjerg collated data from over 16,000 megaprojects (projects with budgets in excess of USD$1bn that share pattern outcomes with smaller-scale projects) across the globe and found that the overwhelming majority completed over budget and with delays. In fact, Flyvbjerg found that amazingly only 8.5% of those projects delivered within budget and on time. This is very bad news for contractors with the delays often leading to liquidated ascertained damages (LADS) and additional premiums on the performance bond, both of which erode profit margins.
Further to this shocking statistic, when a project goes wrong, it is likely to go disastrously wrong. The mean cost overrun of a major building project is 62%, and the distribution of that risk is fat-tailed. In other words, project outcomes do not follow the statistician’s favoured bellwether curve pattern in hovering around that mean, so costs can spiral out of control.
It is due to our rush to commit to a project that leads to such poor performance, opined Flyvbjerg. In our rush to proceed, we cast aside thorough analysis of the undertaking. But why, given just how dramatic the outcomes can be, do we have a predilection for this sort of behaviour?
(i) Psychology
We are predisposed to “optimism bias”. We are a deeply optimistic species and this is welcome, as projects require a “can-do” attitude. But this often leads a company to bite off more than it can chew. In an effort to bolster the portfolio with a big project win, a company’s unchecked optimism manifests itself in unrealistic forecasts, poorly defined goals and disregard for whether it has the ability to carry out the project in the first place. This is why Flyvbjerg is at pains to highlight that projects do not go wrong so much as they start wrong.
(ii) Power
As projects grow in either value or strategic importance, power dynamics form. Executives start to exert pressure on winning ambitious projects, which leads to drastic action that often takes the form of strategic misrepresentation. In other words, the tendency to deliberately distort information for strategic purposes. This is when superficial planning bites because it glosses over major challenges and encourages inaccurate estimates in an effort to win that prized project (which is one of the many acts that eventually caught up with Carillion). Again, this kneecaps the successful delivery of a project before it even begins, as those leading it will never be able to meet the metrics that would deem the project “successful”.
The Fix
Flyvbjerg’s solution? Speed up by slowing down and recognise that your project is “one of those”.
(i) “Think slow, act fast”
Even before the first shovel was in the ground, the Empire State Building was finished entirely on paper. The architects rigorously tested the designs and took their time in doing so until they were entirely satisfied with the planning process so as to empower a swift and smooth delivery. They knew how many rivets and bolts were needed. How many windows. How many blocks of limestone. How many tons of aluminium, steel, concrete and mortar and they insisted on leveraging proven technologies whilst utilising off-site production, (bearing semblance to modular practices today) so that 34th Street was more of an assembly line than a construction site. All this combined to minimise unexpected shocks and complexity. The result being that instead of building one 102-storey building, the team built 102 one-storey buildings through a highly iterative process and did so at blistering speed and within budget. In the modern age of detailed contractual documentation, it would also be very wise to carefully consider which party takes the risk when it comes to delays, how much are the LADs, could the contractor obtain an EOT with costs in the event that something occurs which is outside of the contractor's control. The contractual process is as important as the actual construction process.
(ii) “One of those”
Stop viewing your project as unique. Otherwise known as “uniqueness bias” – kick it into the grass. How? Defer to the experience and knowledge of those who have come before you by using “Reference Class Forecasting” (“RCF”). RCF prevents a company from viewing the project at hand as its own special undertaking but, instead, as one that is part of a broader class of projects (as “one of those”). RCF is an anchor-and-adjustment mechanism. Use data from your class of projects (housebuilding, road, rail etc.) – about cost, geography and time – to establish the anchor. And adjust, only if absolutely justified, to account for any specificities within your project (such as a rare material or highly specialised construction activity). Why is RCF so effective? It is not so much an estimate as it is a figure arrived at via experience-based, real-world outcomes. Or, put another way, the forecast prevents psychology and power from creeping in.
How can the surety market help?
Remember the biases referenced throughout this blog post? Well, the surety market has certain processes that they will follow before providing terms to bond a project. Sureties stress test a contractor’s capacity, capital and character, which make sure that a contractor isn't attempting a project which is doomed to fail from the start. If the contractor is able to secure a performance bond then this also provides the employer with an additional layer of comfort that the contractor is likely to be able to deliver a project on time and within budget. This also increases the contractors likelihood of winning a tender as a surety bond enhances creditworthiness by guaranteeing to pay damages on behalf of the contractor, up to 10% of the contract value.
If you require assistance with performance bonds and/or retention bonds for your next project, or would like to learn more, we would be delighted to assist. Please contact Henry Baird on 07901043444 or via henry.baird@pssurety.co.uk.