‘fit for purpose’ contractual relations: determining a theoretical framework for construction...

Pergamon European Journal~fPurchasmg & Supply Management, Vol. 3, No. 3, pp. 127 135, 1997

© 1997 Elsevier Science Ltd All rights reserved. Printed in Great Britain

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'Fit for purpose' contractual relations: determining a theoretical framework for construction projects 1

Andrew Cox and Ian Thompson Centre for Strategy and Procurement Management ( CSPM), University of Birmingham, Birmingham Research Park, Vincent Drive, Birmingham B15 2SQ, UK

Contractual relations encompass the contractual terms within a governing relationship; typically this comprises: the relationship, the risk apportionment, the division of responsibilities and the reimbursement mechanism. In the Western construction industry these have traditionally sur- rounded arms-length/adversarial discrete contracts. Recent moves to foster collaboration have confused the 'end' with the 'means' and thus will not maximize the business objectives. This article considers a range of 'fit-for-purpose' contractual relations which, when appropriate, can be linked with positive measures to foster collaboration. Consequently this effects the risks and responsibilities prescribed in the contract which, when appropriately aligned, will ensure business success. © 1997 Elsevier Science Ltd

Keywords: contractual relations, trust, collaboration, opportunism

There is a growing recognition throughout the world of Purchasing and Supply, that there is no single optimum buyer-supplier relationship and that a 'horses for courses' approach to employ the most 'fit-for-purpose' relationship is required• Thus the understanding is that 'partnership' (however it is defined) is not the panacea of all ills. In fact, as a relationship, the term is virtually meaningless: it has become highly abused by academic and practitioner alike and few know what is meant by it. Furthermore, in the UK, it has confusion with the legal definition of a private business enterprise between two or more joint- equity partners as defined under the Partnership Act 1890. A long-term collaborative arrangement, where buyer and supplier are working toward common goals and mutual benefits, is just one type of relationship within a broad spectrum of relations.

This spectrum has been identified in two contemporary concepts: the ACR-OCR framework (Sako, 1992) and Relational Competence Analysis (Cox, 1996). There are

This article represents an edited version of a paper submitted to the 2nd IFPMM Summer School in Salzburg, Austria (Thompson, 1996) and is based on research currently conducted at the Centre for Strategy and Procurement Management at the University of Birmingham, UK. The work has been facilitated by sponsorship from Railtrack plc and London Underground Limited, ['or which the authors gratefully acknowledge support.

important comparisons between the two concepts, albeit they are derived from different bases and are arguably maintained by different mechanisms. This article examines these relationship frameworks in the context of the construction industry and links them to the contractual arrangements in current practice. It considers what the purposes/ intentions of the parties are together with the function of contractual relations and it discusses the issue and merits of trust.

This article is submitted as a conceptual framework which is in the process of being tested empirically. The authors welcome comments and feedback to the aforementioned address.

Background to contractual relations in the construction industry

Marl Sako observed that

•..While the term 'contract' is prone to a narrowly legalistic interpretation, 'contractual relations' denote both explicitly contractual and some non-contractual but normative elements in all economic transactions (Sako, 1992 p 250).

As such, the constituents of the contract (that is, the division of responsibilities, the method of reimbursement and the apportionment of risk - - Moyses, 1991) can be intrinsically linked to the transactional relationship(s)

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A Cox and I Thompson

between buyer and supplier. In this article the notion of contractual relations shall be based on these four elements: Relationship, Risk, Responsibilities and Reimburse- ment (see Figure 1). It shall be demonstrated that these elements should be inter-linked so strategic alignment with the business goals of the firm is achieved, thus mak- ing them 'fit-for-purpose'.

The concept of 'fitness-for-purpose' has a specific legal derivation where it is recognized that every commodity has a function to serve and in identifying and prescribing that function (or objective), the commodity is said to be 'fit-for-purpose' when that function/objective is fulfilled (Martin, 1983). Thus, in a similar fashion, contractual relations can be considered 'fit-for-purpose' when they achieve their desired intention, as will be discussed later in this article.

Much academic work has been done in the component manufacturing industries (electrical, automotive, inter alia) to produce models of buyer-supplier relations. Examples include Womack et al (1990), Lamming (1993), Hines (1994) and others. These models are limited to use in 'widget' production within controlled (factory) environ- ments where the supply of goods is merely a repeat process off a production/assembly line. Thus these models have very limited application to an industry such as construction where repetition is rare and works are procured typically on a one-off project-by-project basis. Furthermore, they do not consider whether the existing industrial structure is most appropriate, but instead assume it has the optimal configuration for producing the end-consumer's .requirements. Thus these models are unlikely to be appropriate for the construction industry which has been identified as too 'fragmented' (Latham, 1993; Cox and Townsend, 1996).

That is not to say that 'factory' practices do not occur in the construction industry; the whole of the materials supply industry to construction is process manufacturing. Furthermore, McDonalds Restaurants have established a reputation for their unique oft-site modular construction approach which enables on-site establishment times to be

minimized (Cox and Townsend, 1997). Nevertheless, this is an exception to the generalized rule; construction is inherently a site-specific 'project-based' activity.

The degree of fragmentation can be demonstrated in the sheer number of construction firms. Of the 350 000 registered UK companies, over 180 000 are construction companies (Raftery, 1991), of which 95% have 7 employees or less. Yet it is the remaining 5% of construction firms that conduct approximately 70'7,, of the work, by value (DOE, 1996). The industry has extremely low barriers to entry, accepting that anyone with a van or a wheelbarrow may form his own construction firm irrespective of qualifica- tion or competence; similarly any organization may elect to commission construction works and become a 'client' of construction, irrespective of knowledge and/or competence.

Despite this, construction is a large and important sector in most national economies, accounting for between 7% and 10% of the Gross Domestic Product (Winch, 1996). Transaction frequency is generally low, as few clients of construction are able to offer repeat orders for work over a long time horizon. Furthermore, each piece of construction work is site-specific and thus, being unique, the supply chains are invariably bespoke and peculiar to the one-off nature of the work (creating a 'quasi-supply- network'). This creates particular cost inefficiencies for the client as a new learning curve is climbed by the supplier each time. Added to this, there is often a high degree of uncertainty attached to construction activities (especially associated with ground conditions and the unforeseen) and thus they carry large financial risks.

The peculiar nature of construction, as briefly described above, means that contractual relations will be specific to the business needs of this particular industry and a generic 'manufacturing-industry' approach would be too over- generalized and unspecific.

Traditionally contractual relations in the Western construction industry have been conducted at arms- length. This has been compounded by drives of 'Value for

Figure 1

f

Responsibilities

Relationship

Reimbursement

J

The four 'R's of contractual relations

Risk~

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Money' where through competitive tender, the works are procured to the lowest-price supplier with little or no guarantee (or even incentive) of future work. Thus relations have been focused on the short-term (for the duration of the project), with both parties attempting to lever what they can out of the existing contract. The result has been manifested in adversarial arms-length relations with the parties selecting opportunistic behaviour rather than working together.

The evidence to support this is considerable. For example, a recent survey of the top 50 UK contractors revealed that a quarter earned between 10% and 15% of their annual turnovers through contractual claims with clients or suppliers, and a further third earned between 5% and 10% of their turnovers in a similar way (Financial Times, 1995). A conservative estimate of this additional cost is £1200 million per annum, which equates to 2.4% of the UK's national expenditure in construction.

The search for col laborat ion

In response to this increased adversarialism, the search for more collaborative contractual relations has become a contemporary theme in the construction industry. Some recent examples from the UK include:

• The Commitment to Fair Construction Contracts charter (CRT/CIPS, 1995) was based on the hope that should both parties have their top management sign a 'gentleman's agreement' to act 'fairly' within the contract, then opportunism and adversary will cease. Since its launch the charter has received luke-warm support from a few well-meaning clients but there has been very little evidence to suggest any change in behaviour or performance as a result. The concept does not consider addressing the structure of the industry, the business relationships and/or the contracts in use; thus it can only be seen as a token gesture which supports and entrenches the already existing structures.

• There is a relatively new contract developed in the UK for a wide range of construction works called the Engineering and Construction Contract (ICE, 1995). One of its distinctive features is the requirement that the parties ' . . . shall act in a spirit o f mutual trust and co-operation' (clause 10). 2 The contract comprises prescriptive management procedures to define the parties' behavior (i.e. as long as the individuals involved follow the rules they do not have to concern themselves with the outcome). Beyond the certainty of the contract's provisions, the parties are expected to operate in a 'spirit of mutual t r u s t , . . ' , but is this realistic? As has been discussed elsewhere (Cox and Thompson, 1996), what is the legal force of such a term and why is it necessary to explicitly state this requirement? This form

2 Note the similarity to Article I of Japan's General Conditions of Construc- tion Contract (1981) which states: 'The Owner and the Contractor shall perform this Contract sincerely through co-operation, good faith and equality '

'Fit for purpose' con tractual relations

of contract suggests that its terms will govern both the relationship and behaviour of the parties. In all other respects the contract is in the arms-length mould and once this contract's honeymoon period has subsided, adversarial arms-length behaviour is likely to predicate. Partnering has gained much popularity, initially in the US and more recently in the UK. Despite this many have struggled to understand what is meant by the term. The UK's National Economic Development Council has been one of the few attempting to define it:

Partnering is a long-term commitment between two or more organizations for the purpose of achieving specific business objectives by maximizing the effectiveness of each participant's resources. The relationship is based on trust, dedication to common goals and an understanding of each other's individual expectations and values (NEDC, 1991, p 5).

More recent work (Bennett and Hayes, 1995) suggests partnering can be carried out either on a serial basis (strategic partnering) or a one-off commodity basis (project partnering); although how this can be seen to constitute a long-term commitment is questionable. Aside of the dif- ficulties of definition, there is still dissonance between the intended relationship and the application of the contractual terms. To simply attend a workshop to improve teamwork and sign-up to a head of agreement to be preferred business partners, without re-engineering all elements of the contractual relations, is mere tokenism. Furthermore, the concept fails to determine how collaboration can be achieved or maintained. It assumes the existing supply chain is the appropriate industry structure to foster collaborative relations and deliver the required performance. Following a major Government/Industry review of the UK construction industry (Latham, 1994), the UK's Department of the Environment set up a number of working parties to address some of the issues raised. Working Group 12 was charged with 'partnering' and recently produced its first draft report which stated that only 30% of such arrangements have worked. The WGI2 Chairman has recently been q u o t e d : ' . . . S o m e firms are just using the term 'partnering' as a marketing tool and others are jumping on the bandwagon . . . ' (Building, 1996). A half-way house of declaring 'collaborative relations' but failing to reflect them in the contractual and management issues is a recipe for failure; maybe this is why so many 'partnering' arrangements have failed to date.

Whereas each of the aforementioned methods is well- intentioned, there is a clear lack of understanding regarding their application as the most appropriate contracting method. Under certain conditions they may be appropriate, but certainly not under all conditions. Confusion exists between the 'means' and the 'end'. The danger is that collaborative relations between buyer and supplier become the objective rather than an optimum vehicle for achieving the performance required for the works.

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Identifying the purpose of contractual relations

Thus, it follows that it is important to consider why there is interest in contractual relations at all, and what it is that is wanted from them. This is an increasingly valid fundamental question as there are trends to begin 'relationship assessment techniques' (Lamming et al, 1995) where the emphasis is upon measuring and maintaining the relationship between buyer and supplier. This needs careful consideration: as already said, the relationship is a means and not an end. The purpose of a relationship is merely to serve the business objectives of the purchase/supply; thus performance is the over-riding criterion.

It is appropriate to 'assess' all the determinants of the performance, and thus if (and only if) the relationship is a determinant of performance then it should be 'assessed', but only as being complementary (along with many other factors) to the overall performance objectives.

Cox (1995a) argued that the raison d'dtre of the [privately-owned] firm is the creation of profit (or a margin) within a particular market structure and that this has been ignored by many in considering supply chain relationships. This needs to be translated through all the core and support functions of the business in such a way as to align activities with this overall intent. Thus a range of contractual relations is required, from which one type will be inherently 'fit-for-purpose' for the supply of goods or services to the firm, based on the particular circumstances of the transaction. Similarly the measures of performance (be they cost, q, uality, quantity, time, security of supply, etc.) should be aligned to the strategic goals of the business. The contractual relations that are 'fit-for-purpose' are those that are optimum to deliver these goals. It also follows that the conditions of contract should be the optimum mechanism required to deliver the business case: furthermore they should be aligned with a fit-for-purpose governing relationship to achieve the business goals of the firm.

Therefore as, in most cases, construction is merely a support function for the firm's business, it is important to maintain the right focus. If construction procurement becomes engineering/architecturally-led it is unlikely to maximize the business objectives of the works; similarly, isolated 'relationship assessment techniques' are insuf- ficient and inappropriate.

Nevertheless, despite this, there is little done in the construction industry at present to adequately link the strategic business goals and the out-turning works contracts. Many countries have their own suite of national construction contracts (e.g. the JCT and ICE contracts in the UK, the CCAG and CMP contracts in France or the VOB in Germany) but there is little or no consideration whether these are being appropriately aligned with an optimum relationship to deliver the business goals. This is the subject of on-going research at the CSPM at the University of Birmingham.

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A continuum of relations

This article began by identifying a spectrum of relations supported by two contemporary concepts. In the ACR- OCR framework, Sako (1992) suggested there is a continuum of buyer-supplier contractual relations between the poles of 'arms-length contractual relations' (ACR) and 'obligational contractual relations' (OCR). The ACR is typified by specific discrete (one-off) transactions where there is no commitment between the parties and an absence of 'goodwill trust'. Such relations are often short-term, leveraged arrangements defined by an explicit contract, and as such are typified in the construction industry today. in the event of default the parties are searching for redress of action, usually through remedies of damages, and legal action ensues. In the UK, for example, these type of relations are adequately supported by many discrete forms of contract, such as the ICE contracts (for civil engineering), the JCT contracts (for building) and the IChemE contracts (for plant and process works). The international FIDIC (Federation Internationale des Ingenieurs-Conseils) conditions of contract are similar.

These contracts are designed as reactive mechanisms to apportion responsibility for actions and events as they are, or were, discovered. In the adversarial arms-length relationship, as soon as an event becomes uncertain, there is immediate fall-back to the contract and its risk apportionment (whether specified or not).

The converse, Sako's OCR, is typified by high degrees of interdependence, goodwill trust and reciprocity; as the relations develop over the long-term a high degree of collaboration is induced to the point where no contract is considered necessary. These relations are characterized by an 'invisible handshake' (Okun, 1981), or the 'Chinese Contract' (Handy, 1994), where there is no formal contract just an acknowledgement of a 'gentleman's agreement'. In the event of default parties are quick to make amends and avoid dispute; a spirit of 'trust' prevails. This behavior has been noted in Japanese construction as part of the cultural norm (Levy, 1990 and Levy, 1993) and may suggest why the Japanese General Conditions of Construction Contract is worded as it is. This cultural environment must be con- texturalized with other factors; for example it has been suggested that Japanese public construction works procured this way, costupto 50% more than those procured through the Western-style open tender (Cutts, 1992). Perhaps this is further evidence of the confusion between means and end.

Sako's ACR-OCR Framework describes two extremes, between which she recognized there is a 'continuum' of contractual relations. However in failing to describe any of the interim relations or how one might interpolate between the two extremes, she has posted (in her own words) a 'dichotomous contrast' between ACR and OCR. Indeed in recognizing that the 'switching costs' from one mode of trading to the other are high (Sako, 1992, p.7), the framework can only be viewed as a 'binary model' in support of the two extremities. Furthermore, Sako does not offer any guidance

on how relations within the continuum can be generated or maintained. Although her model offers a good narrative on two contrasting external relationships based on evidence from the electric components industries of Britain and Japan, it is difficult to commend its application any further.

Cox (1996) also suggests a continuum of buyer- supplier relationships which goes further to define the boundary of the firm and a range of outsourced/quasi- vertically integrated relationships (see Figure 2). He suggests that this continuum will be strategically aligned to the competencies of the firm and their degrees of asset specificity (Reve, 1990). This is the theory of Relational Competence Analysis. It considers the total costs of ownership balanced against certain transaction risks to determine a 'fit-for-purpose' relationship with the supply-base. Control over core competencies/activities is advocated and those activities which are complementary or residual are outsourced beyond the boundary of the firm through an appropriate relationship with the external supply base.

This creates a flexible and versatile approach to the procurement of construction works, based on the constitu- ent activities viewed as an appropriate combination of assets and competencies. It has a revolutionary effect on the supply and value chains, where individual organizations begin to compete (and collaborate) on competencies, rather than expecting the existing turgid (cost- producing) structures to be the optimum vehicle by which value is delivered.

The frequency with which projects and their supply networks are required will also effect the approach to supply chain management. A 'portfolio approach' to construction expenditure should be employed (see Figure 3).

Each of the segments will have different intervening

'Fit for purpose" contractual relations

variables and drivers. For example, public sector clients have considerably more restraints to operate in than private sector clients. This includes annuality of expenditure budgets, financial probity drives and regulated procurement legislation, inter alia. The 'hybrid' column refers to organizations with mixed ownership and/or conflicting business drivers (this could include privately owned utili- ties operating under regulated legislation). Similarly 'externally funded' clients have to contend with a combination of internal drivers (from their own businesses) and external drivers (from the funding agency's business). This category includes clients such as privately-financed consortia, non-governmental organizations, the voluntary sector and some property development/housing associa- tions.

The portfolio approach helps consider the regularity and strategic importance of the construction activities to the overall business drivers and thus influences the elec- tion of 'fit-for-purpose' contractual relations. Many construction clients are one-off purchasers and therefore are unable to benefit from offering suppliers repeated workloads in return for preferential supply. However over a longer time horizon, regular clients can form framework agreements for series of projects ('serial expenditure') and/or more integrated supply for 'process' expenditure of repeat orders. Each segment has different drivers and therefore different procurement solutions will be optimal, from which it follows that it necessary to determine individually specific 'fit-for-purpose' contracting strategies and supply relationships.

It should be noted that there are some parallels between the continua of contractual relations offered by Cox and Sako, albeit they are derived from very different bases and

Figure 2

LOW ASSET SPECIFICITY

ADVERSARIAI. r LEVERAGE

RESIDUAl., COMPETENCIES

EXTERNAL CONTRACTS INTERNAL

MEDIUM ASSET SPECIFICITY l tlGll ASSET SPECIFICITY

PREFERRED I SUeelJER ]

SINGLE SOURCING

STRATEGIC ALLIANCES

NETWORK [ SOURCING

COMPLEMENTARY COMPETENCIES CORE COMPETENCIES

LOW HIGH

I It RELATIVE DEGREE OF STRATEGIC IMPORTANCE TO CORE COMPETENCIES

A step-ladder of external and internal contractual relationships (Source: adapted from Cox, 1996)

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One-off Project

Private Sector Public Sector

Clients: Clients:

Expenditure:

Serial Projects

Expenditure:

Process

Expenditure:

A Cox and 1 Thompson

Public/Private

'Hybrid' Clients:

Externally funded

clients/consortia:

Figure 3 A 'Portfolio' approach to construction procurement

thus to take the comparison too far would be inappropriate as the authors were writing with different objectives. However, a similarity can be drawn between Sako's ACR and Cox's adversarial leverage relations, and possibly between elements of Sako's OCR and those found further up the step-ladder of Cox's continuum.

There is little debate concerning the nature of adversarial relations in construction, and it is supported by considerable evidence within the industry at present. However non-adversarial collaborative relations are rarer and there is considerably more debate given to how the conditions in which trust and/or collaboration can be nurtured and opportunism restrained whilst maintaining a focus on performance. Therefore, in these relationships, it is necessary to determine to what extent collaboration and/or trust can be established and opportunism curbed in order to deliver the business case with greatest efficacy.

Trust and opportunism - - can either be controlled?

It has been established that there is little or no trust in the arms-length leveraged contractual relations, leaving the parties vulnerable to the risks of opportunism. The consequences are potentially increased adversarialism and productivity losses. The maxim: caveat emptor ('let the buyer beware') prevails.

Conversely, Sako argues, that OCR are embedded in a sense of mutual trust, generated out of a state of interdependence between buyer and supplier. Thus, because of this, opportunism is curbed. Sako noted that in Japan, this is policed through the cultural traditions of boycotts, loss of reputation and murachahibu (ostracism) in the event of default. It is however questionable that these deterrents would be effective in the European/American construction industries. Furthermore it is unlikely that trading partners would be willing to voluntarily place themselves in a position of dependency and there is little evidence to suggest this is the case. Although trust may be volunteered and reciprocated, there is the risk that it can be revoked on an equally voluntary basis, potentially leav-

ing one party in a position of dependency and vulner- ability. Thus it is unlikely that trust (based on dependency) will be volunteered in such a deep-rooted traditionally adversarial culture as that of the construction industry. Furthermore because of the risk of revocation, volunteered trust cannot be advocated.

It is perhaps because of the lack of trust offered between client and contractor, that the UK's Engineering and Construction Contract has explicitly drafted the contractual term regarding mutual trust and co-operation. There has been much scepticism regarding the validity of such a clause (Cornes, 1996 and Lewis, 1996). To help address this specific issue the CSPM conducted a survey of 163 top UK construction clients in June 1996. The response rate was 37% representing an annual expenditure of approximately £8 billion (which is 16% of the UK's industry). To the question: Do you agree that mutual trust and co-operation cannot be enforced? 90%, of the respondents answered that they did. Interestingly only 5% respondents were fully satisfied with the existing standard forms of contract and yet 100% were still using them!

As an aside, the reason for this apparent dissonance between satisfaction and application probably lies in the industry's general preference for standard forms of contract; in theory these 'optimize' the balance of risk between the parties and, because the whole industry is familiar with their contents, the transaction costs associated with re-drafting and familiarization with new contracts are removed. However when their contents are analysed, the standard forms of contract are nothing more than instru- ments used by the parties to seek strict liability and attach blame to events as they occur (Thompson and Anderson, 1997). Nevertheless, the industry's hands are tied to the standard forms and their traditional methods of contracting, even though they do not deliver satisfactory results. These methods, when linked with the prevailing adversarial culture and fragmented structure lead the parties away from 'trust' towards self-seeking interest ('opportunism').

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If, as is suggested, trust cannot be enforced and should not be volunteered, it therefore remains questionable whether trust is an essential element of contractual relations, however collaborative (or obligational) they may be. A distinction could be made between explicit trust (that needs to be voiced, prescribed and thereafter complied with, as in the Engineering and Construction Contract) and implicit trust (that is inherently believed to exist when collaborating with a trading partner, but remains unvoiced).

It is noted that Cox does not refer to trust in the theory of Relational Competence. Indeed if control is maintained over the strategic assets (or core competencies) of the firm's business, as he advocates, then it is arguable whether trust is a requisite of contractual relations at all. The key question is whether sufficient control of opportunism can be achieved in order to allow collaboration to be fostered and maintained. In the following, it is suggested that, in the absence of trust, collaboration can be facilitated either through trading power or through incentives.

The former suggestion is the 'big stick' approach where one party attempts to create a position upon which the other is dependent and use this to gain advantage. Having created the position of supremacy, leverage is applied to ensure the requirements of the business are fulfilled. Traditionally the Purchasing Manager of the client's firm (or professional equivalent, such as engineer, architect, etc.) has aspired to this role, but it should be remembered that buyers' dependency on suppliers is equally possible (especially in single-sourced markets).

In construction this is likely to be within certain areas of specialism or technological expertise; in particular many architectural finishes can be single-sourced, similarly pre- tender 'nomination' of sub-contractors is an easy method of ensuring dependency on suppliers.

'Fit for purpose' conlractual relations

Although this type of behaviour endeavours to achieve the required performance outcomes, the duration of the leverage will only be as long or short as the position of dependency. In 1513, Niccolo Machiavelli observed:

• . . a wise prince must devise ways by which his citizens are always and in all circumstances dependent on him and on his authority; and then they will always be faithful to him (Machiavelli, 1513).

Similarly, to follow this approach, the prudent trader must continue to devise ways by which his trading partners are dependent on him and the business he offers•

One method of conceptualizing the trade-offof buyer- supplier power is the 'Product Portfolio Matrix' which considers the market difficulty set against the size of expenditure. The problem with this is that, when applied to construction, the client's expenditure is inevitably large and yet it is usually one-off. A better consideration of expenditure would be a function of the relative magnitude combined with the J?equency of the contract/expenditure. Thus whether considering the dyadic relationship between client and main contractor (when the magnitude of expenditure is large, but so are the turnovers of the parties), or whether considering smaller contracts further upstream in the supply-base (where the majority of transactions are with smaller firms and/or individuals, as previously noted), the balance of power between buyer and supplier remains a relative issue.

This trade-offof buyer-supplier power can be conceptual- ized in Figure 4, where there are all sorts of axes which could be used (as in the aforementioned Product Portfolio Matrix example, inter alia).

Supplier's No

relationship Dependency

with buyer:

Dependence

SUPPLIER

POWER

EQUAL POWER:

SAKO'S TRUST?

NO POWER:

INCENTIVES?

BUYER'S

POWER

Dependence No Dependency

Figure 4 The trade-off of buyer-supplier power

Buyer's relationship with supplier

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Although there may be several ways in which dependency can be engineered, it is suggested that in the majority of cases, this is less likely to occur and hence a 'power' approach to generating collaboration is unlikely to be sustained in the present construction market. This places the majority of transactions in the top right- hand box of the Figure 4. Thus the prudent client must devise other ways of encouraging collaboration.

The alternative to forcing collaboration by power is to attempt to foster it by incentive. Given the appropriate incentives, a coincidence of interest is formed and the trading partners will collaborate. Thus the need for a discrete contract can be obviated as in MacNeil's theory of Relational Contracting (MacNeil, 1978 and MacNeil, 1985) which suggests that the expectation of future business would determine collaborative (non-opportunistic) behaviour. This is akin to the element of reciprocity in Sako's OCR, however here there is an element of collaboration (irrespective of trust) that is beyond the confines of a contract, such that the relations are sufficient to ensure the works are conducted as desired.

Thus opportunism is curbed as the supplier is given the incentive of future work. But is this sufficient? Furthermore, a key question arising from this is: how does the buyer prevent a dependency on that supplier building up? These are questions that are currently being considered in research at the CSPM.

Linking up the contractual relations

Having accepted that a Relational Competence approach to the procurement of construction works will yield an appropriate model for the selection of fit-for-purpose relationships, the principal questions that follow sur- round how the contractual elements are tied in to this model. As noted earlier, these elements concern:

• the management of risks; • the division of responsibilities; and • the method of reimbursement.

Through adopting the relational contracting approach, the regular client that is able to offer repeat custom to a contractor who is eager for work (i.e. in the 'serial' or 'process' segments of Figure 3), can be assured full security in knowing that its demand will be satisfactorily sup- plied, promptly and to its exact requirements. Similarly the supplier will be eager to work in such a way to ensure the client wants to continue offering the regular workload. If properly applied, using the Relational Competence method described above, the buyer will not be able to obtain cheaper goods or services elsewhere and, in effect, it has procured a management service (in the supplier) which is working to ensure this. In return, the supplier can take comfort that, while satisfying the client, it can guarantee its revenue stream and furthermore ensure a reasonable profit.

It follows that (in circumstances of regular demand) this approach would have a consequent ia l effect

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throughout the supply chain, as the subsequent supplier in each tier has the opportunity to respond to the conditions and exchange preferential supply for a guaranteed stream of income. Furthermore, given that the construction industry has a reputation for one of the highest incidences of insolvency, this preferred supplier approach will help alleviate the commercial risks associated with bankruptcy.

As discussed, this approach helps to curb opportunistic behaviour and reduces the need to seek strict liability within the apportionment of risk. Risk sharing and the division of responsibilities based on competence to conduct critical tasks and control strategic assets will ensue. This will also assist in addressing the design-build/traditional contracting methods debate. Single-point responsibility (as in design-build contracts) is generally accepted good practice which at all times should be encouraged. However if, in the examination of supplier roles, certain tasks requir- ing different (non-complementary) competencies are identified, then the roles of designer and constructor should be separated. This is a form of value chain analysis (Cox, 1995b) which considers the totality of the supply chain in order to engineer added-value tasks and processes while discarding the non-value-added activities.

As a final point, the method of reimbursement, rather than being a complex mechanism given to justifying the employment of quantity surveyors, should merely be a reflection of the elements of the construction works, the division of responsibilities and the apportionment of risks. Where the risk of the unknown is greater (as in the uncertainty of unforeseen ground conditions, inter alia) the level of detail in the reimbursement structure will be greater, which will allow for greater control on changes as the uncertainties are discovered. In situations where there is absolute certainty in the works, a milestone payment/ lump sum system is more appropriate.

Conclusions

This article has reviewed contractual relations in the construction industry, and some of the recent attempts to introduce collaboration between buyer and supplier. It has asserted the fact that the client's relationship with its supplier is a means towards an end, and not the end itself. The objective of the contractual relations is to deliver the business case for the construction works and support the overall business intent of the firm. Thus the 'fit-for- purpose' contractual relations are those which provide this delivery optimally.

A continuum of relations has been identified with Sako's ACR-OCR Framework describing the two extremes of the range (albeit as a 'dichotomous contract'). Cox's Relational Competence provides a clearer understanding of how external relationships should be selected and man- aged by providing control over the core competencies of each activity. It has been argued that trust cannot be enforced and should not be volunteered, and thus the only means of fostering collaboration is either through unequal power-relationships, or by incentivising the supplier(s).

'Fit f o r purpose' contractual relations

U sing the Relational Competence approach as a theoretical model, the contractual elements of risk apportionment and division of responsibilities should be developed on a competency basis. This, then, provides a framework for contractual relations in the construction industry, which is not only fit for the purpose of constructing the works, but is also designed to ensure business success is achieved.

References

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