Utility Companies and Construction Spend Management
Construction services are typically a large part of utility company spend. On a national scale, the US Construction Services market reached $1.2 trillion in 2017, comprising 6.5% of the US GDP. Of this spend, Utilities and other organizations that invest in infrastructure spent $238 billion on power distribution systems, highways and streets, sewage and waste disposal, water supply, and conservation & development. These large-scale, capital-intensive projects present many challenges to Utilities when managing their contractors and master contracts.
4 Construction Management Challenges That Confront Utilities:
- Broad Scope: The Scope of the master contract construction work is too broadly defined.
- Confounding Pricing: Time and material (T&M) pricing causes project costs that are difficult to control and analyze.
- Incumbent Relationships: Long-standing and highly intertwined relationships with incumbent contractors can create complacency surrounding project management or value engineering.
- Geographically Widespread: Utilities have large geographical footprints with many operational districts which each have different construction standards and regulations.
These challenges are amplified by the sheer number of small construction projects that Utilities undertake. Big projects worth more than $2 million are rare, so a procurement or engineering department can reasonably source each one through a bidding process. However, Utilities undertake many projects worth less than $2 million, so bidding every project becomes unreasonable. As a solution, Utilities typically employ a reliable/experienced incumbent contractor with good T&M pricing. So what benefit does sourcing bring?
4 Reasons to Source:
- Risk Mitigation: Diversifying the contractor supply base allows utilities to mitigate risk should one supplier fail or grow too strong.
- Testing the Market: Engaging with suppliers through the RFP process unearths new ideas for pricing structures, takes advantage of lower market rates, and builds connections with local suppliers who have a more intimate knowledge of municipal standards and specifications.
- Keep the Incumbent Honest: Inspire healthy competition by sourcing the contract on a regular basis. This encourages the incumbent to engage in best project management practices and opens new cost saving opportunities.
- Smooth Sourcing: Sourcing these contracts is initially complex, but will simplify the sourcing process once contract terms, pricing, and the RFP process is defined.
A helpful, popular option for managing these smaller projects is to engage a master contractor with a contract comprised of defined unit pricing. Similar to a job contract, these agreements define a specific scope and price each work element as a single unit.
4 Reasons to Use a Unit Price Contract:
- Lessens Overhead Requirements: Unit Price contracts are ideal for frequent small- to medium-size construction projects where biding is unnecessary.
- Incentivizes Efficient Performance: Contract unit pricing vs. time and material pricing.
- Unit pricing = pay less, get more -> set price, the faster contractors perform, the more money they make
- T&M = pay more get less -> no set price, the slower contractors perform, the more money they make
- Enhances Scope Definition: Unit pricing allows a more granular definition of the scope of work. Each line item covers a defined piece of work, so the contractors know exactly what is involved.
- Controlled Project Costs: A defined pricing structure controls project costs by allowing both parties to easily produce and share project estimates. Accurate estimates reduce the number of unplanned costs and strengthens the budgeting process.
Utility companies are constantly engaging in small, capital improvement projects, and oftentimes need a way to effectively source and manage the work. Sourcing these engagements will result in cost savings and risk mitigation, while using a unitized contract will allow greater control of your project costs and scope.