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.
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.