Institutional Issues: Procurement

This is the start of a multi-post series, of undecided length, focusing on institutional, managerial, and sociopolitical issues that govern the quality of infrastructure. I expect much of the content to also appear in our upcoming construction costs report, with more examples, but this is a collation of the issues that I think are most pertinent at the current state of our work.

Moreover, in this and many posts in the series, the issues covered affect both price and quality. These are not in conflict: the same institutions that produce low construction costs also produce rigorous quality of infrastructure. The tradeoffs between cost and quality are elsewhere, in some (not all) aspects of engineering and planning.

The common theme of much (but not all) of this runs through procurement. It’s not as exciting as engineering or architecture or timetables – how many railfans write contracts and contracting regulations for fun? – but it’s fundamental to a large fraction of the difference in construction costs between different countries. Some of the subheadings in this post deserve full treatments by themselves later, and thus this writeup is best viewed as an introductory overview of how things tie together.

What is procurement?

Procurement covers all issues of how the state contracts with providers of goods and services. In the case of public transportation, these goods and services may include consulting services, planning, design, engineering, construction services, equipment, materials, and operating concessions. The providers are almost always private-sector, but they can also be public companies in some cases – for example, Milan Metro provides consulting services for other Italian cities and Delhi Metro does for other Indian ones, and state-owned companies like RATP, SNCF/Keolis, and DB/Arriva sometimes bid on private contracts abroad.

The contracting process can be efficient, or it can introduce inefficiencies into the system. In the worst case I know of, that of New York, procurement problems alone can double the cost of a contract, independently of any other issue of engineering, utilities, labor, or management quality. In contrast, low-cost examples lack any such inefficiencies in construction.

The issue of oversight

On the list of services that are procured, some are more commonly contracted out than others. Construction is as far as I can tell always bid out to private-sector competition, including equipment (nobody makes their own trains), materials, and physical construction. Design and engineering may be contracted out to consultants, depending on the system. Planning never is anywhere I know of, except some unusually high-cost American examples in which public-sector planning has been hollowed out.

The best practice from Southern Europe as well as Scandinavia is that planning and oversight always stay with the public sector. Even with highly privatized contracts, there’s active in-house oversight over the entire process.

The issue of competition

It is necessary to ensure there’s healthy competition between contractors. This requires casting as wide a net as possible. This is easier to do in environments where there is already extensive private- and public-sector construction going on: Turkey builds about 1 million dwellings a year and many bridges, highways, and rail lines, and therefore has a thick domestic market. In Turkish law, it is required that every public megaproject procurement get at least three distinct bids, or else it must be rebid. This rule is generally easy to satisfy in the domestic market.

But if the domestic market is not enough, it is necessary to go elsewhere. This is fine – foreign bidders are common where they are allowed to participate, always with local oversight. Turkish contractors in Northern Europe are increasingly common, following all of the local labor laws, often partnering with a domestic firm.

Old boy networks, in which contractors are required to have a preexisting relationship with the client, are destructive. They lead to groupthink and stagnation. A Turkish contractor held an Android in front of me and, describing work in Sweden, said, “If a Swede said it’s an iPhone, the Swedes would accept that it’s an iPhone, but if I did, they’d check, and see it’s an Android.” In Sweden at least the domestic system is functional, but in a high-cost environment, it is critical to look elsewhere and let foreigners outcompete domestic business.

It is even more important to make sure the experience of bidding on public contracts is positive. A competent contractor has a choice of clients, and a nightmare client will soon lose its business. Such a loss is triple. First, the contractor would have done a good job at an affordable price. Second, the negative experience, such as micromanagement or stalling, is likely to increase costs and reduce the quality of work. And third, the loss of any contractor reduces competition. In the United States, we have repeatedly heard this complaint from contractors and their representatives, that they always have to deal with the “agency factor,” where the agency can be the MTA or any other transit agency, making things difficult and leading to higher bids.

Good client-contractor relations

The issue of avoiding being a nightmare client deserves special scrutiny. It is critical for agencies to make sure to be pleasant clients. This includes any of the following principles:

  • Do not change important regulations midway through the project. In Stockholm, the otherwise-good Nya Tunnelbana project has had cost overruns due to new environmental regulations that required disposal of waste rock to the standards of toxic waste, introducing new costs of transportation.
  • Avoid difficult change order process (see below for more details on itemization). It should be everyone against the project, not the agency against the contractors or one contractor against another.
  • Avoid any weird process or requirements. The RFPs should look like what successful international contractors are used to; this has been a recent problem of American rolling stock procurement, which has excessively long RFPs defining what a train is, rather than the most standard documents used in Europe. This rule is especially important for peripheral markets, such as the entire United States – the contractor knows what they’re doing better than you, so you should adapt to them.
  • Require some experience and track record to evaluate a bid, but do not require local experience. A contractor with extensive foreign experience may still be valuable: Israel’s rail electrification went to such a contractor, SEMI, and the results are positive in the sense that the bid was well below expectations and the only problems stem from a nuisance lawsuit launched by a competitor that bid higher and felt entitled to the contract.
  • For a complex contract, the best practice here is to have an in-house team score every proposal for technical merit and make that the primary determinant of the final score, not cost. Across most of the low- and medium-cost examples we have looked at, the technical score is 50-70% of the total and cost 30-50%.
  • Do not micromanage. New York’s lowest bid rules lead to a thick book of regulations that force the bids to be as similar to one another as possible in quantity and type of goods, to the point of telling contractors what materials they are allowed to use. This is bad practice. Oversight should always be done with flexibility and competent in-house engineers working in conversation with the stakeholders and never with a long checklist of rules.

Flexibility

Contracts should permit as much flexibility as practical, to allow contractors to take advantage of circumstances for everyone’s benefits and get around problems. This is especially important for underground construction and for construction in a constrained city, where geotechnical surprises are inevitable.

Most of the English-speaking world, and some parts of the rest (Copenhagen, to some extent Grand Paris Express) interpret flexibility to mean design-build (DB) contracts, in which the same firm is given a large contract to both design a project and then build it. However, DB is not used in the lowest-cost examples I know of, and rarely in medium-cost ones. If design is contracted out, then there are almost always two contracts, in what is called design-bid-build (DBB). Sources in Sweden say they use single build contracts, but they often use consultants for supplementary engineering and thus they are in practice DBB; Italy is DBB; Turkish sources claim to do design-build, but in reality there are two contracts, one for 60% design and another for going to 100% and then doing construction.

The Turkish system is a good example of how to ensure flexibility. Because the construction contractor is responsible for the finalized (but not most) design, it is possible to make little changes as needed based on market or in-the-ground conditions. In Italy and Spain, the DBB system is traditional, but the building contractor is allowed to propose changes and the in-house oversight team will generally approve them; this is also how the more functional American DBB contracts work, typically for small projects such as individual train stations, which are within the oversight capacity of the existing in-house teams.

DBB can be done inflexibly – that is, wrong – and often when this happens, everyone gets a bitter taste and comes out with the impression that DB is superior. If the building contractor has to go through onerous process to vary from the design, or is excessively incentivized to follow the design to the letter, then problems will occur.

One example of inflexibility comes from Norway. Norwegian construction costs are generally low, but the Fornebu Line’s cost is around $200 million/km, which is not as low as some other Nordic lines. Norway uses DBB, but its liability system incentivizes rigidly adhering to the design: any defect in the construction is deemed to be the designer’s fault if the builder followed the design exactly but the builder’s fault if the builder made any variation. This means small changes do not occur, and then the design consultants engage in defensive design, rather than letting the building contractor see later what risks are likely based on meter-scale geology.

Itemization and change orders

Change orders, and defensive design therefor, are a huge source of cost overruns and acrimony. Moreover, because of the risks involved, any cost overruns are transmitted back into the overall budget – that is, every attempt to clamp down on overruns will just increase absolute costs, as bidders demand more money in risk compensation. California is infamous for the way change orders drive up costs. New York only avoids that by imposing large and growing risk on the bidders (including, recently, a counterproductive blacklisting system called disbarment, a misplaced effort by Andrew Cuomo to rein in cost overruns); the bidders respond by bidding much higher.

Instead of the above morass, contracts should be itemized rather than lump-sum. The costs of materials are determined by the global, national, and local markets, and the contractor has little control over them; in fact, one of the examples an American source gave me of functional change orders in a DBB system is that the bench at a train station can be made of wood, metal, or another material, depending on what costs the least when physical construction happens.

Labor costs depend on large-scale factors as well, including market conditions and union agreements. The use of union labor ensures that the wages and benefits of the workers are known in advance and therefore unit costs can be written into the contract easily. Spain essentially turns contracts into cost-plus: costs depend on items as bid and as required by inevitable changes, and there is a fixed profit rate based on a large amount of competition between different construction firms.

The upshot is that itemized costs prevent the need to individually negotiate changes. If difficult ground conditions or unexpected utilities slow down the work, the wages of the workers during the longer construction period are already known. It is especially important to avoid litigation and the threat thereof – questions of engineering should be resolved by engineers, not lawyers.

Here, our results, based on qualitative interviews with industry experts, mirror some quantitative work in economics, including Ryan and Bolotnyy-Vasserman. Itemization reduces risk because it pre-decides some of the disputes that may arise, and therefore the required profit rate to break even net of risk is lower, reducing overall cost.

The impact of bad procurement practices

One of our sources told us that procurement problems add up to a factor of 2 increase in New York construction costs. Five specific problems of roughly equal magnitude were identified:

  • A regulation for minority- and woman-owned businesses (MWB), which none of the pre-qualified contractors in the old boy network is.
  • The MTA factor.
  • Change order risk.
  • Disbarment risk.
  • Profit in a low-competition environment.

MWB and disbarment are New York-specific, but the other three appear US-wide. In California, the change order risk is if anything worse, judging by routine cost overruns coming from change orders. California, moreover, is very rigid whenever a contractor suggests design improvements, as Dragados did for its share of California High-Speed Rail, even while giving contracts to contractors that engage in nuisance change orders like Tutor Perini.

Aligning American procurement practice with best practice is therefore likely to halve construction costs across the board, and substantially reduce equipment costs due to better competition and easier contractor-client relations.

33 comments

  1. numble

    I think you may want to take a deeper look into the actual contracts, which should be obtainable via public records requests, instead of analyzing based on qualitative interviews with middle management that may not be in the weeds on how things actually work.

    MWB is not New York specific. There are so many disadvantaged business enterprise programs run by transit agencies for construction projects that the FTA has its own DBE regulations to regulate how transit agencies implement their DBE programs on federal contracts: https://www.transit.dot.gov/dbe

    Although design-build contracts are advertised as lump sum in news reports and in high-level summaries, the actual bids and contracts already itemize the costs. I would be surprised if any contract was actually a lump sum contract. They are itemized because payments are tied to completion (or percentage completion) of each item. Example from the LA Purple Line Segment 1 contract: https://pbs.twimg.com/media/EkfntUyVcAYE_FX?format=jpg

    This is why change orders that delete items/tasks don’t require negotiation on how much the agency does not need to pay when it decides to remove a task, or for tasks that are related to what’s in the itemized costs. And paying a contractor to sit for X weeks/months while land or utilities are sorted out are not really acrimonious as to what you need to pay the contractor, even though they are very costly.

    • Alon Levy

      I’ll get into it in another post, but, the actual contracts in the US are extremely opaque – too much is subcontracted and therefore invisible to public records.

      DB and lump-sum are not the same thing. New York likes lump sum contracts and has for a while, even before it got the DB bug. They are both bad so I cover their problems, but they are not the same thing.

    • Tunnelvision

      I can assure you that many DB contracts in the US are Lump Sum. As the designer on 3 such projects I can also assure you that I have no idea of the cost breakdown unless I submit a FOIA request. Costs are also usually spread across a Schedule of Values which further complicates cost comparisons as these are values and not costs. Because the risk and contingency has to be carried somehow and no one is going to carry a line item stating risk/contingency as that’s the first thing the owner will delete during negotiations.

      • PS

        I’ll echo that – Indeed on our DB contracts we effectively delete out the measurement and payment sections of our Spec book, so there’s not even a basis for itemization (i.e. determination of what work/materials are included in the item).

        It is a bit of a problem because otherwise the item prices could be a starting point for negotiation on change orders. On the other hand I think you’d have to allow the DB to define and re-define items as part of the proposal which sounds like a rabbit-hole.

  2. Sassy

    > equipment (nobody makes their own trains)

    There are at least a few:

    * J-TREC is part of JR East Group (formerly part of Tokyu Group as Tokyu Car)

    * Kinki Sharyo is part of Kintetsu Group

    * Nippon Sharyo is part of JR Central Group

    * CR and CRRC are both owned by the Chinese government

    * Also the reverse: Hitachi has an ownership stake in Tokyo Monorail, Nippon Sharyo has an ownership stake in Linimo

    • Anon

      In Seoul for the SR000 series trains, there was a controversy that resulted in the operator being barred from assembling trains.

      I wonder how this applies to socialist countries, where everything is state owned. things might sometimes be structured differently, i’d be curious.

    • Alon Levy

      Sure, but it’s not tightly integrated – JR East buys rolling stock from all of those, for example. CR and CRRC are SOEs but they act like private businesses, in the same way that Airbus is an SOE and so is to some extent Air France but Air France buys planes from both Airbus and Boeing.

    • Sascha Claus

      It was also common in Europe that some tramway operators built their own cars, partially or completely or at times or always or whatever you might imagine.

  3. Sassy

    > Spain essentially turns contracts into cost-plus: costs depend on items as bid and as required by inevitable changes, and there is a fixed profit rate based on a large amount of competition between different construction firms

    It’s interesting that it works well in this case. I’ve often heard of cost-plus in a negative fashion, related to US defense contracting.

  4. Eric2

    “to the point of telling contractors what materials they are allowed to use. This is bad practice.”

    “If design is contracted out, then there are almost always two contracts, in what is called design-bid-build (DBB).”

    Wouldn’t DBB have the issue that the design-contract tells the build-contract what materials to use, just like if the transit authority was telling the builder what materials to use?

    • Alon Levy

      It does, in the more rigid implementations, as in the US when there’s insufficient oversight capacity (but not when it’s sufficient!), or in Norway where the incentives are such that the builders don’t vary. The better implementations are flexible: the building contractors can make small changes, based either on the Turkish des-bid-ign-build breakdown or on itemized change requests made to a well-staffed public oversight team (and Turkey also itemizes ~everything).

      • Tunnelvision

        Turkey itemizes everything because you have cost escalation formulas for every element due to the chronic inflation in the country as a result if the incompetent politicians running the country. When I worked on the Melen water project in the 2000’s the price was changed every month because of this. Maybe its changed but given inflation was at 16% last year I doubt it. It was also a remeasured contract in that each month you calculated what had been constructed and paid for it, and that was that. No earned value or schedule of values, all unit rates. Hong Kong’s remeasured contracts are very similar. These are not popular in the US because heaven forbid you could use the rates as the basis for change order negotiations. and FTA regs require you to have an independent estimate for every change order which means it takes forever to get to the table to negotiate change orders. UK, pre NEC was similar you had a Bill of Quantities that was priced at rates and remeasured.

    • Tunnelvision

      Materials always have to specified or at least the required performance has to be. In the Us you typically can state use X or an approved equal. With X being the baseline performance level needed. To not specify this you open up the door to counterfeit products or substandard products that do not reach the performance you need. That would be ripe for abuse and historically has been.

  5. Frederick

    At least in NY, if the overseeing authority does not micromanage according to the regulations, those officials will also be at risk from litigation. It is not just the contractors who have to bear risk.

  6. Tunnelvision

    Just a note on your comment about NY and the DBE issue. That’s not unique to NY or MTA. Any federally funded project will have M/D/WBE goals. These can vary from 15% to in some cases I have seen 43%. While many of these companies are competent they are only able to contract for a certain value of work to maintain their status. These companies have low overheads as they spend little on marketing or preparing the proposals unlike the primes. The challenge is that as projects get bigger you may have to have multiple subs for similar work due to the annual revenue restrictions. This takes additional management and coordination effort driving up the cost of the projects. These rules apply to both design and construction contracts and obviously design build. But it’s not limited to NY or MTA, this occurs wherever federal money is being spent and even where no fed money is used quite often individual states have similar requirements.

    • Alon Levy

      What I was told is an NY-specific issue is that the few big firms that are pre-qualified to work with the MTA are all run by white men, so the DBE reg forces more complex subcontracting (because apparently contracting outside of the usual old boy network is too hard or something).

      • Tunnelvision

        The primes or General Contractor’s are run by whoever runs them. By definition the D/M/W/V BE has to be owned by a Disadvantaged/Minority/Woman/Veteran as per the Federal/State definitions/regulations. The MTA for example has a very comprehensive list of approved entities as you can only use the approved ones. The biggest challenge is the revenue cap which means you may have to use more than 1 for specific elements of work, which means additional coordination and management efforts for the Prime.

        • john

          Sounds like the answer to this issue is to amend the regulation and lift the revenue cap (that, and break the old-boy network).

  7. Henry Miller

    How do you evaluate technical score? Everything else I feel like I understand and could do myself, but I have no clue how you evaluate technical score.

  8. Reedman Bassoon

    What should be done when there is only one bidder?

    From a 2018 Tutor Perini conference call:

    I keep saying it, but the truth is in the pudding. We have now got three straight
    large projects for the MTA, a $1,400 million tunnel and a $1 billion for a station.
    Three straight contracts the total $3 billion for the LAMTA,
    $1,400 million job in Newark where we are the only bidder.

    And as I advised our owners, if you don’t make these contracts far more contractor
    friendly you are not going to get bids even including us.

    • Henry Miller

      You need to figure out why it is contractor unfriendly. Odds are the person who said that quote has a large list, start there.

      Lacking the above, split the contracts into smaller ones that smaller companies can bid on. Or for contracts of that size you find qualified companies that can do the work and offer a couple million to prepare a bid – for billion dollar contracts it should take millions just to prepare a bid so it is no wonder nobody wants to risk that much investment that may not pay off.

      But start asking those who should be bidding why they don’t.

    • Tunnelvision

      Except for the MTA projects there were other bidders as I was involved with the procurement of them and distinctly remember negotiating with more than 1 bidder for all the contract except for the original CM019 contract for caverns and tunnels for which Dragados/Judlau was the sole bidder. MTA procurement rules allow negotiated contracts to proceed even if there is only a single bidder. Cannot speak for LAMTA.

  9. Sarapen

    Hello, this is completely unrelated to the subject of this post, but I thought you might be interested in this article about Indonesia’s high speed rail project:

    http://averyreview.com/issues/54/the-storm-blowing-from-paradise-weathering-china-s-belt-and-road-initiative

    It’s mostly about the political context of the project, but it also covers quite a bit of technical information and even presents stuff from Chinese and Bahasa Indonesian sources. I must state that the language of the article is perhaps more literary than most STEM types are used to, but I thought it was an interesting read.

    • Alon Levy

      Oh God, Southeast Asia is so bad at this.

      The literary language is interesting just as a way of comparing what is normal and what isn’t. The use of state power to control flooding is completely normal – and far from some colonial imposition, Holland became an economic superpower after it had done it domestically, building up indigenous expertise going back to the Middle Ages. The same is true of rail construction, and it’s telling that the article speaks of late capitalism while lumping it together with the developmental state model of Sukarno, a model that wasn’t even particularly state-capitalist in the Japanese sense (Sukarno was overthrown by a more pro-American government that proceeded to commit genocide). It gives off the impression of calling everything late capitalism or neoliberalism, including social spending, unions, environmental protection, etc.

      But what’s not normal is the total reliance on foreign expertise. A couple climate zones to the north, South Korea imported Japanese engineering principles, but then built infrastructure domestically – and the KTX rolling stock isn’t even Shinkansen but a TGV derivative. Taiwan did buy Shinkansen, after it correctly judged the 700T a better offer than the Eurotrain. Did the lines go through forest? I imagine they did. But it doesn’t matter, because half of South Korea’s population lives in the built-up area of Seoul, and Taiwan is almost as centralized. Rural tradition is nice for tourism; for regular day-to-day life, it’s awful and the people embedded in it run to the city, often immigrating illegally.

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  12. MFS

    The M/WBE procurement requirements (mostly applies to a % of the total contract, not necessarily the prime contractors), are not a NY-specific thing. Most states have them. Tunnelvision above has it correct. If it’s helpful I can talk to you offline about how these work generally in NYC & NYS although not specifically in the MTA capital context.

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