Page 415 - Global Project Management Handbook

20-4 MANAGEMENT OF THE PROJECT-ORIENTED COMPANY

RISK SHARING ON CONTRACTS

Back in the 1980s, the attitude on projects was to dump risk down the contract chain. The
client dumped risk on the contractor, the contractor on the subcontractors, and the sub-
contractors on the material suppliers. The consequence often was that the client took risk
that he or she could do something about reducing and gave it to the contractor, who
would only be able to allow a contingency for it and add a profit margin on that contin-
gency. This would contribute to the competitive project environment and conflict
between client and contractor described earlier. The result was that the project usually
ended up costing more than the target (Fig. 20.1, left). The contractor would argue that
the scope of the project and risk were not perfectly defined and add variations to cover
the unknowns. It was in the contractor’s interest to make the variations as large as possi-
ble to increase his or her profit; the contractor’s objectives were in direct conflict with
those of the owner, which was to achieve the lowest possible price.
In the 1990s, the received wisdom came to be that risk should be assigned to the party
best able to deal with it. This was reflected in the New Engineering Contract published in
the United Kingdom by the Institution of Civil Engineers (1995). This sounded like a nice
idea; each party could take responsibility for risk within its control and work to minimize it.
The problem is that projects are coupled, nonlinear systems. A risk may be primarily within
one party’s control, but as that party tries to reduce the risk, he or she creates a bigger risk
for another party (Fig. 20.2). As the client reduces his or her risk, he or she increases con-
tractor A’s risk; as contractor A reduces his or her risk, he or she increases contractor
B’s; and as contractor B reduces his or her risk, he or she increases the client’s risk.
Although each risk is primarily within one party’s control, the risks are coupled and can-
not be reduced independently. Thus this approach also led to conflict as each different
party separately and independently tried to reduce his or her risk, often having a deleteri-
ous effect on other parties.

Out-turn

Bid
Variations
profit Target Out-turn
Contingency Gain share
Profit
Escalation
Contingency
Escalation

Estimate
Estimate

Fixed price Partnering
FIGURE 20.1 Project out-turn to target.