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HS2 – A change in contractor risk allocation

28 January 2020
The latest National Audit Office report on HS2 reveals the consequence, in terms of increased project costs, of the excessive allocation of risk to contractors and the resultant procurement changes now enacted to maintain engagement with the industry. 

The proposed HS2 rail project is consistently in the news headlines, mainly based upon the frequent increase of the forecast cost. Some interesting facts have been revealed from the publication this month of a National Audit Office report "High Speed Two: A progress update", which can be found here.

Whilst the report covers many interesting aspects of the issues and challenges of delivering a major UK infrastructure project this article reflects on the change in approach to the allocation of risk to contractors.

Last year it was welcome news to hear the procurement of the HS2 Birmingham station had been halted due to the lack of appetite from the tendering contractors based upon an unfair risk allocation towards the contractors. The result has been the redesign of the contractor procurement to enable re-engagement with the industry based upon a more balanced risk allocation.

What was so unfair about HS2's procurement?

The plan was for the engagement joint venture contractors to deliver fewer and larger contracts. The advantages were anticipated to be:

  • Economies of scale
  • Reallocation of the risk of integrating the work of many different contractors

The contractors were going to be reimbursed on the basis of a target cost, the original construction industry intent of this cost reimbursement mechanism being to promote collaboration between employers and contractors. This was enabled by sharing savings made below a target cost and conversely contributing to any costs exceeding the target, thereby incentivising all parties to deliver the project within the target cost. 

A typical equitable industry standard target cost arrangement would be a "pain/gain" agreement where when the final project cost is +/- 10% of the target cost, the pain or gain being equally shared by the employer and contractor. The +/- percentage provides a cap for the contractor limiting both the pain and the gain.

Coming back to HS2 its procurement proposal utilised a target cost but allocated the contractors the risk of 60% of any cost increases above a target price. There is no mention of any cap. Thus contractors would face unbalanced unlimited liability for project cost increases.

A simple summary of the HS2 proposed procurement was the packaging of huge contracts requiring the engagement of the largest contractors via joint ventures with an allocation of the risk for cost overruns 60% towards the contractors.

Then Carillion happened. Both the Government and major contractors woke up to realise the consequence of this unbalanced and unfair procurement.

Contractors on existing HS2 contracts, where the design was being progressed but no target cost had been set, understandably adopted a more risk-averse approach to designs and estimates. As such the designs were more conservative, less efficient and additionally cost risk was being included to offset the financial risks of undertaking the works. The original intent of procurement utilising a target to promote collaboration between employer and contractor for the benefit of the project had been corrupted through the unfair imposition of risk on the contractors.

So, what are the proposed procurement changes?

  • Removal of target costs: HS2 will be responsible for funding increases above a project estimated cost.
  • Percentage fee reimbursement: Contractors will be reimbursed on the basis of a fee percentage of the project cost. This fee will be subject to performance indicators on cost and programme.
  • Incentivisation: Any contractor fee lost due to poor performance against an indictor can be 'clawed back' to incentivise contractor improvement. Also the contractor will be eligible for a share of any contingency remaining should the project be delivered within the estimate.

This must represent a welcome change in procurement approach from Government removing business threatening risk from contractors and allowing them to positively engage with incentivised project delivery.  

To do this requires HS2 to increase its capability to manage these revised commercial arrangements. 

The remaining disappointment is there is no change in the procurement approach of fewer, larger contracts restricting the ability of the whole contracting supply chain to directly participate in HS2. If only the report had also recommended an increase in HS2's capability to manage more contractors.