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Corporate Partnership
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Risk Pricing in
Infrastructure Delivery:
Making Procurement
Less Costly

2

Risk Pricing in
Infrastructure Delivery:
Making Procurement
Less Costly

Jonathan Kennedy
Aris Pantelias

University College London,
United Kingdom

Dejan Makovšek

International Transport Forum,
Paris

Klaus Grewe

Independent Consultant,
United Kingdom/Germany

Julian Sindall

Cadenza Transport Consulting Ltd,
United Kingdom

Working Group Paper
2018

The International Transport ForumThe International Transport Forum is an intergovernmental organisation with 59 member countries. It
acts as a think tank for transport policy and organises the Annual Summit of transport ministers. ITF is
the only global body that covers all transport modes. The ITF is politically autonomous andadministratively integrated with the OECD.
The ITF works for transport policies that improve peoples’ lives. Our mission is to foster a deeper
understanding of the role of transport in economic growth, environmental sustainability and social
inclusion and to raise the public profile of transport policy.
The ITF organises global dialogue for better transport. We act as a platform for discussion and prenegotiation of policy issues across all transport modes. We analyse trends, share knowledge andpromote exchange among transport decision-makers and civil society. The ITF’s Annual Summit is theworld’s largest gathering of transport ministers and the leading global platform for dialogue on transport
policy.
The Members of the Forum are: Albania, Armenia, Argentina, Australia, Austria, Azerbaijan, Belarus,
Belgium, Bosnia and Herzegovina, Bulgaria, Canada, Chile, China (People’s Republic of), Croatia, Czech
Republic, Denmark, Estonia, Finland, France, Former Yugoslav Republic of Macedonia, Georgia, Germany,
Greece, Hungary, Iceland, India, Ireland, Israel, Italy, Japan, Kazakhstan, Korea, Latvia, Liechtenstein,
Lithuania, Luxembourg, Malta, Mexico, Republic of Moldova, Montenegro, Morocco, the Netherlands,
New Zealand, Norway, Poland, Portugal, Romania, Russian Federation, Serbia, Slovak Republic, Slovenia,
Spain, Sweden, Switzerland, Turkey, Ukraine, the United Arab Emirates, the United Kingdom and theUnited States.

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www.itf-oecd.org

ITF Discussion Papers
ITF Discussion Papers make economic research, commissioned or carried out in-house at ITF, available toresearchers and practitioners. They describe preliminary results or research in progress by the author(s)and are published to stimulate discussion on a broad range of issues on which the ITF works. Any
findings, interpretations and conclusions expressed herein are those of the authors and do notnecessarily reflect the views of the International Transport Forum or the OECD. Neither the OECD, ITF
nor the authors guarantee the accuracy of any data or other information contained in this publication
and accept no responsibility whatsoever for any consequence of their use. This document and any map
included herein are without prejudice to the status of or sovereignty over any territory, to thedelimitation of international frontiers and boundaries and to the name of any territory, city or area.
Comments on Discussion Papers are welcome.
Cite this work as: Kennedy, J. et. al. (2018), “Risk Pricing in Infrastructure Delivery: Making Procurement
Less Costly”, Discussion Paper, International Transport Forum, Paris.

RISK PRICING IN INFRASTRUCTURE DELIVERY | WORKING GROUP PAPER | ITF

Foreword
Transport infrastructure is a major enabler of economic development. In the drive to refurbish or build
more, governments worldwide have turned to the private capital market to help finance it. The primarynarrative behind this push is that there huge stocks of private capital available, while public financing
capabilities are said to be limited and insufficient.
The almost exclusive vehicle of private investment in transport (and social) infrastructure are
Public-Private Partnerships (PPPs). In the context of PPPs, two important aspects have received little
attention.
First, sufficient attention has not been given to the role of suppliers. The focus of, governments andIntergovernmental Organisations has been on resolving the challenges to private investment from theviewpoint of investors; a key part is reducing uncertainty they face and enabling them to price risk more
efficiently (establishing infrastructure as an asset class).
Yet looking at the investors only gives an incomplete view of the total cost of the risk transferred fromthe public to the private sphere. In PPPs investors transfer some of the major risks they are not
comfortable bearing (e.g. construction risk) to design, construction, maintenance, and operations
contractors.
As investors, suppliers too face uncertainties and can’t price risk efficiently. In such a case, the base costof the initial investment (and of subsequent services) will be much higher than they could be, and notjust the cost of their financing.
Uncertainty arises from the difficulties to accurately estimate the cost of construction, maintenance,
operations, and financing. But it also stems from “unknown unknowns” (the so called Knightian
uncertainty), for instance changes in weather patterns or paradigmatic technological shifts the timing
and impact of which are unclear but will influence what infrastructure is needed and where.
So what can policy makers do to reduce the cost of inefficient risk pricing of suppliers? Where does thisput PPPs? How can public decision makers reconcile long-term uncertainty with private investment ininfrastructure? Who should bear long-term uncertainty in projects, the public or the private sector?
These were some of the guiding questions for a Working Group of 33 international experts convened by
the International Transport Forum (ITF) In September 2016. The group, which assembled renowned
practitioners and academics from areas including private infrastructure finance, incentive regulation, civilengineering, project management and transport policy, examined how to address the problem of
uncertainty in contracts with a view to mobilise more private investment in transport infrastructure. As
uncertainty matters for all contracts, not only those in the context of private investment in (transport)
infrastructure, the Working Group’s findings are relevant for public procurement in general.
The synthesis report of the Working Group was published in June 2018. The report is complemented by aseries of 19 topical papers that provide a more in-depth analysis of the issues. A full list of all Working
Group papers is available in Appendix 2.

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Acknowledgements
The authors are grateful to TENNET TSO (for sharing their risk register), Linda Anderson, Peder Hjersing
from EY Denmark, and representatives from Jan de Nul and BAM PPP UK Ltd for their time and insights insupport of this work.

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Table of contents
Executive summary ................................................................................................................................ 7
Why is risk pricing relevant for infrastructure? .................................................................................... 10
Objectives of the report ................................................................................................................... 11
Structure of the paper ..................................................................................................................... 11
Defining the problem of risk pricing in infrastructure delivery ............................................................ 11
What do we (think we) know about uncertainty and risk pricing in construction? ............................. 14
How the delivery model affects uncertainty ................................................................................... 14
How the procurement process affects uncertainty ........................................................................ 15
How contract design interacts with uncertainty ............................................................................. 16
The contractor’s own understanding of their risk exposure ........................................................... 17
Understanding construction and design risk........................................................................................ 20
Defining construction and design risk ............................................................................................. 20
Sources of construction and design risk .......................................................................................... 21
Common infrastructure delivery models and their implications on risk pricing .................................. 25
Design-Bid-Build (“Traditional delivery”) ......................................................................................... 27
Engineering, procurement and construction (EPC) (as used in PPPs) ............................................ 28“Collaborative” delivery ................................................................................................................... 29
How does information about an infrastructure project’s costs evolve over its life? ........................... 31
Infrastructure’s estimation challenges ............................................................................................ 31
Evolving cost (and time) accuracy ................................................................................................... 33
At what point in the project life-cycle are contractors required to “price” their bids? ................. 35
What challenges do contractors face in trying to price risks for infrastructure projects? ................... 36
Delivery models................................................................................................................................ 36
Financing requirements ................................................................................................................... 38
Information provision ...................................................................................................................... 39
Timing constraints ............................................................................................................................ 40
Risk pricing approaches ................................................................................................................... 41
What can public authorities do to improve risk pricing for contractors? ............................................ 43
Design clarity (and flexibility) ........................................................................................................... 43
Risk identification, allocation and mitigation .................................................................................. 47
Information provision ...................................................................................................................... 51
Delivery models................................................................................................................................ 53
Bid process: Timeframes, criteria and clarity of objectives ............................................................ 54© OECD/ITF 2018

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Case studies in Denmark, Germany and the UK ................................................................................... 56
Bank Station Capacity Upgrade (UK) ............................................................................................... 57
Heathrow Terminal 5 (UK) ............................................................................................................... 63
Fehrmarn Belt Link (“Fixed Link”) (Denmark) .................................................................................. 67
Berlin Hauptbahnhof (Central Station) (Germany) ......................................................................... 71
Notes .................................................................................................................................................... 76
References ........................................................................................................................................... 80
Appendix 1. Construction cost overruns at decision to build and contract level ................................. 89
Appendix 2. Research questions and outputs ...................................................................................... 90

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Executive summary
What we did
This report investigates the impact of uncertainty on risk pricing for infrastructure projects. Risk pricing isvery relevant to infrastructure delivery as it affects the overall cost of projects. If risk premia can be
reduced by making pricing more efficient, significant additional funding capacity can be generated acrossinfrastructure sectors or programmes. At the same time, it is widely accepted that uncertainty is themain driving factor behind inefficient risk pricing. In this context, this paper explores relevant scientific
literature and draws upon input from practitioners to shed light on the sources of uncertainty and theirimpacts on pricing construction and design risks for infrastructure projects. The investigation mainly
touches upon the two most predominant delivery models, Design-Bid-Build (DBB) and Engineer-ProcureConstruct (EPC), but also discusses a few novel ones, namely Early Contractor Involvement (ECI) andAlliancing. Several risk pricing challenges are identified and corresponding recommendations put
forward. Practical examples of reducing uncertainty for contractors in infrastructure construction arehighlighted through four case studies.

What we foundAlthough various relevant methodologies exist in the areas of economics and finance, risk pricing forinfrastructure is not approached with the same methodological rigour nor is it as well understood. Thiscan be attributed to numerous factors, starting from the uniqueness of projects and difficulty oftransferring lessons learnt, to the lack of relevant data, both on the private as well as the public side,which could be used to develop appropriate benchmarks.
Uncertainty in infrastructure project delivery depends on four elements, specifically the delivery model,
the procurement process, the contract design, and the contractors’ own understanding of uncertainty.
All four elements are interrelated and ultimately affect contractors’ perceived uncertainty whenengaging in project risk pricing. The detailed interaction between the first three elements is still not fully
understood and warrants additional research that is outside the scope of this report. It is clear, however,that contractors’ perception of uncertainty depends on how early they get involved in the delivery
process, how long and competitive the procurement process is, and how the contract that underpins thedelivery has been designed. Contract power in particular, which reflects the combined effect of various
characteristics of contract design, interacts with the delivery model and the procurement process togreatly influence risk pricing. Contractors also face methodological issues when pricing risks which add
an additional layer of inefficiency to the process.
The inter-relationship between design and construction has been a key concept in the report, placing
particular emphasis on how design clarity and flexibility relates to the underlying delivery model. A morenuanced truth appears to hold, with uncertainty as a function of design decisions and broader delivery© OECD/ITF 2018

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and procurement processes. Whatever the model, the client still ultimately pays for the risk, so the focus
shifts to how that cost may be minimised.
Finally, findings suggest that infrastructure delivery has not kept pace with the changing nature of
projects (in terms, for example, of size and complexity). Applying set solutions (e.g. fixed-price DBB,
high-powered EPC, etc.) will not necessarily produce good results due to the corresponding changes oncontractors’/bidders’ risk exposure. This new reality seems to suggest the need for more tailored delivery
approaches to achieve risk pricing efficiency.

What we recommend
Matching design
characteristics

clarity(andflexibility)

to

the

deliverymethodusedandproject

Under a Design-Bid-Build delivery model, clients should produce a complete, detailed, fully approved andfully costed design before tender issue and ensure that constructability risks have been considered.
Under Design and Build, Engineer-Procure-Construct or collaborative delivery models, clients should, at aminimum, produce a fully costed Reference Design before tender issue. Under the latter group ofdelivery methods, clients should also maximise (and clearly channel) opportunities for contractor-led
design and innovation where possible with approvals and permitting processes. Regardless of thedelivery method used, however, having clear and unambiguous functional specifications can go a longway in reducing uncertainty for contractors.
Early and continuous focus on risk management (and in particular risk allocation)
Risk allocation principles are well-established but many times not followed. Clients should make sure thatdeviations from first-principles are minimised if unnecessary risk premia are to be avoided. At the sametime joint risk management practices or other improvements in risk management approaches could
provide reasonable solutions in the face of increased project complexity and evolving project risk
profiles. Upfront identification of a project’s risks (and potential mitigants) is also key, assisting to ensure
a proactive rather than reactive risk management approach.
Facilitation of information provision
In the case of information provision “more” is usually better, except when the information provided isunreliable and not well organised. Clients should spend time preparing and organising their virtual data
rooms with as much pertinent and useful information as possible. Although information quality liability
issues will always be present, risk pricing can be greatly improved through more information sharing. At
the same time, data “dumping” should be avoided as it leads to high processing costs and reduces thevalue of useful information which may be lost among outdated or marginally relevant data.
Careful selection of delivery models
There is no “one-size fits all” when it comes to selecting a delivery model for infrastructure. However,procuring authorities are encouraged to adopt models that promote collaborative relationships andincentivise a shared focus on delivery. This may mean deciding between public or private financing, andwhen to engage with the contractor in the process depending, for example, on the degree of complexity
and the innovation required. Different models induce different trade-offs for both clients andcontractors and managing them efficiently requires experience and organisational capabilities on bothsides which should not be underestimated. The various trade-offs that arise from the selection of thedelivery model, the procurement process and the contract design call for an increased and sustained

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focus on cultivating skills and increasing organisational capabilities on the clients’ side. Building andmaintaining capability is particularly important given the evolution of delivery, with projects growing insize and complexity.
Well-prepared procurement processes
A clear tender programme with reasonable bid timeframes and a focus on bid value rather than cost are
just some of the elements that clients need to consider carefully when preparing the procurement
process for a new infrastructure project. When contractors are unclear on or lack confidence in the bid
process, are unrealistically rushed to price and submit their bids, or are pushed to deliver on value while
being disproportionally assessed on cost, the end result is usually inefficient with respect to risk pricing.

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Why is risk pricing relevant for infrastructure?
“Risk pricing” has to do with how much money a counter party (a bidder for a contract, investor, etc.)
demands in order to accept a certain risk in the presence of competition. If the bidder’s understanding of
the expected outcome is limited, the natural response is to avoid or at least reduce the uncertainty.
Contractual features including buffers, hurdles, safety-cushions, and contingencies come into play. The
guiding premise in this paper is that where bidders have greater, more reliable information, it will reduce
uncertainty and lead to a lower cost of risk transfer. This is the fundamental narrative of efficient risk
pricing in financial economics.
Risk pricing in the context of infrastructure investment and financing remains an important topic in theinternational agenda. At the forefront is the consideration of infrastructure as an asset class (OECD,2017). Establishing an asset class involves making data available on historical performance of
homogenous groups (classes) of investment in terms of their risk/return characteristics. This information
helps investors price different investment opportunities more precisely or more efficiently. In effect, by
establishing infrastructure as an asset class, infrastructure investment may be made accessible to agreater range of investors and ultimately also lead to a reduction of the cost of financing.
Solving the challenge for investors, however, is only one part of the problem. Financial investors are
typically not comfortable managing project-related risks (like construction or operation and maintenance[O&M] risks), which are not their core business, and seek to transfer these to other more specialised
counterparties. In Public Private Partnerships (PPPs) for example, which are the dominant mode ofprivate investment in transport, high-powered contracts1 are used to transfer all risk of cost overruns
and schedule delays to a construction contractor. The transfer, due to the multiple enforcement
measures attached to the contract, is so effective that the median construction cost overrun in PPPs is
0% (Blanc-Brude and Makovšek, 2013). Essentially, the contract in all but its name functions as aninsurance policy which is “purchased” when the deal is negotiated.
However, if risk pricing is challenging with respect to infrastructure investment or financing decisions, it
is far more complex and pervasive when it comes to the consideration of the actual works and/or
services to be delivered by construction (and/or O&M) contractors. Unlike the financing domain,
contractors cannot rely on vast databases to estimate ex post performance of different construction or
O&M solutions. Considerable uncertainties are present when projects need to be priced and this leads tosignificant contingencies being factored in. The extent and magnitude of these uncertainties and the way
they are perceived by contractors are of paramount importance to the overall efficiency of risk pricing in
relation to the risk transfer that takes place through the different types of contracts governing thedelivery of the required works and/or services. Available empirical evidence indicates that the overall
cost of motorway projects built through high-powered contracts under PPPs in Europe could be about
20% more costly than under traditional procurement. This difference includes and is on top of expected
cost overruns in both PPPs and traditional procurement (Makovšek and Moszoro, 2017).
In other words, while risk transfer incentivises efficiency in delivery (and operation), this can beoutweighed by contractors’ inefficient risk pricing. In the case of PPPs this means that risks anduncertainties may be overpriced compared to projects delivered under “traditional” delivery models(such as Design-Bid-Build), even when claims and cost overruns applying to the latter are factored in. It
may also mean that the mispricing of risk may sometimes be so high that it may dwarf potential costsavings achieved through the life-cycle perspective used for the design of these projects and their O&M

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planning, which is a basic feature and key perceived benefit of PPPs. However, beyond well-founded
concerns, relevant available empirical evidence is currently limited (Makovšek and Moszoro, 2017).
Uncertainty can also play a significant role in low-powered contract types, which means risk pricing issomething to be considered in all delivery models of infrastructure (i.e. beyond PPPs). Limited available
evidence from traditional road delivery in the US suggests that reducing uncertainty, such as throughinformation provision, leads to lower bids (De Silva et al., 2008; Kosmopoulou et al., 2014). Hence,solutions addressing uncertainty could potentially improve risk pricing, yielding additional delivery
capacity within current funding envelopes.2

Objectives of the report
This report investigates risk pricing in infrastructure delivery with a focus on design and construction risk.
Special consideration is given to sources of uncertainty which may be impacting the pricing of these risks
during the procurement phase. The focus is then placed on how pricing inefficiency can be reduced.
Essentially, it is a question of what government can do to reduce contractor uncertainty (as well as any
resulting opportunistic behaviour), which would flow through to reductions in overall project costs.

Structure of the paper
Sections two through six cover the foundation concepts of this paper based on a thorough review ofexisting literature. The second section expands on the problem definition. Section three elaborates on
our current knowledge about uncertainty and risk pricing in construction. The fourth, fifth and sixth
sections discuss what is construction and design risk, what are the main delivery models the public sector
uses to deliver infrastructure assets, and how understanding about a project’s end costs evolves throughits development, respectively.
Section seven presents practitioner input regarding risk pricing in construction. In particular, it elaborates
on the contractor’s perspective in terms of the challenges faced when pricing risks in detail for major
infrastructure projects.
Section eight takes stock of all preceding concepts and discussions and puts forward a set ofrecommendations on what procuring authorities can do to improve risk pricing efficiency.
The report concludes in section nine with four brief case studies, illustrating how uncertainty forcontractors can be positively or negatively impacted by different delivery approaches.

Defining the problem of risk pricing ininfrastructure delivery
Despite its prominence in infrastructure discourse, risk is not a single well-defined concept. It can bevariously defined as the distinction between reality and possibility, the probability of loss, or thedeviation of actual from expected value (Gallimore et al. 1997; Brookes, 2003; Hartono et al., 2014). It© OECD/ITF 2018

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can also be more technically defined as probability multiplied by consequence (Jaafari, 2001; Baloi andPrice, 2003; Hillson and Hulett, 2004).
Risk can be differentiated from uncertainty on the basis of measurability (Arndt, 2000). A “risk” signifies asituation in which the distribution (probability) of outcomes is known, whereas an “uncertainty”
represents a situation when it is “impossible to form a group of instances, because the situation dealt
with is in a high degree unique” (Knight 1921, p. 233). It may also be that a situation is not unique, butthat we have no prior experience with it. Hence, we may face uncertainty in decision making due to alack of information about ex post performance, or because the outcomes are simply unknowable(Knightian uncertainty).
In practice, concepts of risk and uncertainty are used interchangeably. Their distinction is also fluid
rather than fixed, recognising that as experience, knowledge or measurement capability improves, agiven factor can move from being uncertain to being a probable risk.
One way economics deals with uncertainty is through contract theory. In the context of incomplete
contracts (i.e. the inability to draft a contract for every eventuality and monitor/enforce it in full),
uncertainty may lead to strategic behaviour of either the principal or the agent.3 Closest to the context ofpricing under uncertainty within contract theory are auctions (competitions for the contract) which focus
on strategic bidder behaviour. Several decades of evidence suggest that if uncertainty about the value ofan object procured (or sold) is reduced, this will lead to a lower cost of procurement (Milgrom Weber,
1982; Campbell and Levin, 2000; Goeree and Offerman, 2003).
In finance theory, risk and uncertainty are considered through risk pricing but from a different
perspective. The focus is on how investors (bidders) can build portfolios and price risk to maximise their
payoff given available information. In this context, Markowitz (1952) has put forward the capital asset
pricing model (CAPM) and is considered the father of modern portfolio theory. However, althoughfinance theory (and its practical applications) distinguishes between two different types of risk
(systematic vs non-systematic),4 it does not give great attention to the subject of uncertainty.
The reason financial theory has all but ignored uncertainty is because it has assumed the market will“learn” it away. Uncertainty in finance is effectively assumed to be dissolved by observing past
performance. This can be illustrated by an example of a new market (Figure 1).
When the first pioneering investors make their investments, there is no (or very little) information on
past performance available. The investors coming “after” benefit from the experiences gained by theirpredecessors. As this process continues and there is competition for investment opportunities, more
information is accumulated and variability is reduced to the maximum extent possible. At this stage noinvestor has a significant disadvantage in terms of available information to others and accordingly noabnormal returns can be achieved.
This simplified example outlines some of the main principles of the efficient markets hypothesis (EMH). A
key distinction with the contract/auction theory approach in economics is that it assumes perfectcompetition and focusses only on the risk pricing aspect.
In the context of infrastructure investment and the EMH two important points have been recently raised(Makovšek and Moszoro, 2017).
Firstly, the assumption that the market can fully “learn” away knowable uncertainty is contested forfinancial investors and may be hopelessly overoptimistic in other domains, which can’t rely oncomprehensive series of past performance data.

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Figure 1. How investors on the financial market learn and improve the accuracy of their bets
High returns

Return/Risk+
0%High losses

Secondly, there is a vast body of literature from behavioural economics and psychology demonstratingthat people are risk (and uncertainty) averse. If uncertainty is present in a project, investors (bidders) will
try to avoid it, reduce it, and/or price it in their contingencies.
Unfortunately, major infrastructure delivery is a prime example where bidders accepting a set of risks
through a contract cannot hope to price it against a comprehensive past performance profile.5 The
challenge is two-fold.
Firstly, the process of risk assessment for certain project risks (such as design and construction) may notallow an approach that comes close to that in finance. Reasons behind this may be traced to the poor
record-keeping that characterises large parts of the construction industry, as well as the widely
acknowledged sector-specific opacity and idiosyncrasy which may be related to obtaining a commercial
advantage in a tough and low-margin industry. These issues restrict the use of quantitative techniques
although a range of them has been put forward in the academic construction literature (Bacarini, 2006;
Boussabaine, 2014). Under these circumstances design and construction risks are almost exclusively
priced subjectively, with contractors relying on expert risk workshops; whereby experienced
practitioners make informed guesses about the corresponding probabilities and impacts.
Secondly, governments have not fully pursued nor exploited the possibilities of ex post analysis.
Researchers such as Flyvbjerg (2009) have extensively documented the challenges in terms of data
accessibility due to the unwillingness of authorities to engage in such ex post analysis. Similar issues havealso been raised by the OECD (2017). The same challenges affect all subsequent phases of project
development, limiting our understanding on how, for example, risk allocation decisions drive project
performance. While case studies may be helpful to some extent, getting a view on systematic ex post
performance is indispensable and long overdue.
In light of the above, it is striking that limited empirical understanding exists on how risk pricing isaffected by the characteristics of infrastructure delivery in relation to the existence of uncertainty. In thepresence of a multitude of possible delivery models (e.g. Design-Bid-Build [DBB], Design and Build [DB],
Design Build Operate Maintain [DBOM], etc.), procurement processes (competitive tender vs directaward), contractual payment types (e.g. cost plus, lump-sum, target price, etc.) and contract
enforcement measures (e.g. performance guarantees, liquidated damages, third party guarantees, etc.),
we still do not have sufficient empirical evidence to fully understand their contribution to contracting
outcomes and delivery performance. This knowledge gap is reflected in the contents of this paper whichaims to highlight certain aspects of it related to construction.
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What do we (think we) know about uncertainty
and risk pricing in construction?
Existing evidence related to risk pricing in construction is limited and mostly anecdotal. Nevertheless, it isunderstood that uncertainty comes into play through a number of different elements that pertain to theprocess through which a construction contract is designed and awarded and which ultimately affect thecontractor’s risk exposure. These elements are:

Delivery model, in terms of the stage at which a contractor is engaged, and for what scope ofworks/services (e.g. construct-only, design and construct, etc.). The delivery model also affects
the source of financing used (e.g. public, private, or mixed).6



Procurement process, in terms of the duration7 and the level of competition in the procedure toaward the required works/services, ranging from competitive bidding - with or without anegotiation phase - to direct award.

Contract design, in terms of the clarity of definition of project objectives and counterparty
responsibilities, risk allocation, payment mechanism (e.g. fixed price, cost-plus, admeasurement,
or incentive payment, etc.), flexibility to accommodate change and incentive mechanisms.8

Contractor’s own understanding of their risk exposure in a particular project, in terms of theinteraction of all the above elements as well as the contractor’s capabilities to understand,assess and price uncertainties and risks. Each element is treated below.

How the delivery model affects uncertainty
The delivery model involves uncertainty through the project design maturity. Involving a contractor
earlier in project execution (e.g. through a DB approach) requires the contractor to “price” at a stage
when the design is not yet fully developed (or approved). While this internalises the risk of design errors
and omissions and ensures single-point responsibility it exposes the contractor to greater cost variability(Figure 2). Hence the attempt to solve one issue introduces a new challenge and, in essence, a trade-off.
Evidence on a contract level is unavailable. However, related evidence (Appendix 1) in terms ofsystematic cost estimation accuracy calculated against different reference points in a project’s
development appears consistent with this identified trade-off. The left-hand side of Figure 3Error!
eference source not found. represents studies assessing cost overruns against the decision to build. Thisis an early point in project development, when a formal decision to build is taken and a detailed design isnormally not yet available. The right-hand side of Figure 3 represents studies comparing cost overruns
against contracts signed when, in most cases, a more advanced design was available.
Beyond the general impression which shows a marked difference between the two data sets, available
studies are insufficiently detailed to allow isolating the effect of design maturity from other influences(e.g. contract types used, project size, contract management rigour, restraint of the procuring authority
to apply scope changes after contract letting, etc.).

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Figure 2. A textbook example of project design maturity and accuracy of cost estimates

Source: Schexnayder et al. (2003).

Figure 3. Systematic cost estimation accuracy at different reference points in the project development
Average

Systematic cost overruns
30
25
20
15
10
5
0

Decisionto build

Contract
value

Source: See the literature review in Appendix 1.

How the procurement process affects uncertainty
The procurement process involves uncertainty in terms of the fairness and transparency of the award
process as well as the time and cost that will need to be invested by prospective contractors up tocontract award. The process itself has direct implications on the level of competition for winning thecontract. In the case of direct award there is effectively no competition but as this is not an acceptable© OECD/ITF 201815

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procurement process for major infrastructure projects in the most advanced economies, its impact onrisk pricing will not be further discussed. In what constitutes a “traditional” public procurement process,9a contract goes to competitive tender following a specific procedure that usually has two phases:a prequalification phase, usually expressed as “Request for Qualification” (RFQ) or PreQualification Questionnaire (PQQ) which can be preceded by a call for “Expressions of Interest”
(EoI)



a tender phase, usually expressed as “Invitation to Tender” (ITT), “Invitation to Bid” (ITB), or“Request for Proposals” (RFP). Variations of the second phase may involve a negotiating phase 10
or competitive dialogue.11

In the face of competition for the contract, contractors not only face the uncertainty of pricing the scopeof works/services, but also the uncertainty of losing to rival bids which will result in unrecoverable
financial costs (bidding costs). Consequently, contractors price losses (or a provision for them) into theiroverheads which, in turn, then get passed onto future tenders. The extent to which this passing costdistorts the overall risk pricing efficiency of (future) tenders is not easy to measure as it is usually a verysmall fraction of the overall project cost.12 This impact becomes even more difficult to observe due tothe effects of competition in inducing other types of strategic contractor behaviour which may have theopposite effect on the pricing of the contract (e.g. “aggressive bidding”).
Related to a contractors’ ability to price risks efficiently is the duration of the procurement process; withthe duration inducing contractors to trade-off near and long-term risk. For example, a longer processthat results in greater design clarity may reduce a contractor’s longer term life-cycle risk andcorresponding contingencies (if their bid is successful). However, it will also increase potentiallynon-recoverable costs incurred by partaking in a prolonged bidding process (near-term risk). In effect,
significant bid extensions may sometimes cause bidders to withdraw13 from the process altogether.
Conversely, the rigour and accuracy of the risk pricing process may suffer if bids are to be delivered
within a very tight period.

How contract design interacts with uncertainty
Contracts are the basis of managing infrastructure projects. Their basic aim is to outline risks associatedwith the project and how they will be allocated and dealt with during the lifetime of the project (Bower,2003). The goal of contract design is to meet the objectives of the procuring authority (client) by taking
advantage of the contractor’s skills. In doing so numerous factors need to be considered such as (Bower,2003):
type and extent of involvement of the procuring authority

flexibility to accommodate changes (or not)

motivation (incentives) to the contractor(s)risk allocation between the counterparties

cash flow characteristics of both procuring authority and contractor(s).

Consequently, contract design refers to defining project objectives, counterparty responsibilities, risk
allocation, payment mechanism, flexibility and incentive mechanisms. The combined effect of thesevarious elements determines so-called contract power. The basic notion behind contract power relates
to how restrictively the initial contract price (or schedule) defines the expected end result for the16© OECD/ITF 2018

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contractor. This translates into how much risk is effectively transferred to the contractor to deliver at aparticular time and for a specific cost.
Under the most common infrastructure delivery model (DBB), less restrictive contract designs allow
contractors to pursue contractual revenues beyond what was initially agreed (Lo et al., 2007). This meansthat contractors, when bidding, may not express their total revenue expectations because theirexperience has taught them they may achieve additional compensation during contract execution. Thismay come from client-initiated scope changes, claims relating to errors and omissions in design
documentation, or other issues not fully defined in the contract (Bajari et al., 2014).
There is a large spectrum of mechanisms and measures that increase the effective transfer of risk to thecontractor, and with that also improve certainty of outcomes. Fixed-price/fixed-date “turn-key”
contracts, at the extreme opposite of less-restrictive contracts, are normally used in project financearrangements such as under a PPP delivery model. These contracts aim to fully insulate project owners(and through them the project’s external financiers) from any variation in end cost and schedule.
Multiple enforcement measures are used to achieve this (e.g. performance bonds, penalty clauses fordelay, full completion guarantees, etc.). Figure 4 shows that this form of contracting effectively serves as
an insurance contract, with median cost overruns of zero (i.e. they are diversifiable), and average cost
overruns of 2.2%.14
Figure 4. Cost performance of construction contracts in project finance projects
Observations
70
60
50
40
30
20
10
0

-55

-50

-45

-40

-35

-30

-25

-20

-15

-10

-5

0
Median

5

10

15

20

25

30

35
40
45
50
Observed cost overruns

Source: Adjusted from Blanc-Brude and Makovšek (2013).

Findings suggest that such high-powered contracts require contractors to express all revenue
expectations upfront (at the bidding stage) and in full. This reflects the very limited opportunities forcontractors to derive additional revenue during contract execution, if and when risks materialize or
uncertainty is resolved and costs become clearer. However, as outlined previously, it has been suggested
that additional costs incurred in such projects through inefficient risk pricing potentially offset thebenefits of other types of anticipated efficiencies (e.g. profit-driven management, life-cycle design
perspective, etc.) (Makovšek and Moszoro, 2017).

The contractor’s own understanding of their risk exposure
The contractor’s own understanding is the cumulative amount of information they have at the time theybid for the project. This will depend on the delivery type (how early they will be involved in the project),© OECD/ITF 201817

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procurement process (how much competition they will face and how long it will take, both of which
affect how much effort they are willing and/or able to invest into discovering information during thebidding process), contract design (how they will be remunerated for the works/services under thecontract, how risks will be allocated and how effective the incentive mechanisms will be, etc.), as well as
their past experience (including past peer signals, experiences and lessons learnt). Although thetheoretical prediction is that making more information available will reduce uncertainty for bidders andlead to better delivery outcomes, there is limited empirical evidence available.
The mechanism behind why this occurs seems to be two-pronged. On one hand, better quality, more
complete and unambiguous information allows bidders to better price their bids, thus enabling more
effective competition (reduction of contingencies for risk/uncertainty) among existing bidders. On theother hand, reduced uncertainty may diminish information asymmetries between incumbent bidders in
the market and new entrants, thus increasing the number of firms bidding - i.e. there is an additional
positive effect from increased competition. These two effects, however, are confounding and difficult toseparate.
Unfortunately, regarding infrastructure, or construction more broadly, few empirical examples exist thatshow how reduced uncertainty impacts the end cost of project delivery (see Box 1).
In summary, whatever the theoretical lens - contract theory or financial theory - less uncertainty is
better. But while the impact of uncertainty in auctions has been studied and considered in different
contexts, research remains embryonic in respect to major project delivery. Consequently, significant
work still has to be done on determining optimal approaches.
What complicates matters in the discussion on risk pricing for infrastructure projects is that the delivery
model, procurement process and contract design are all closely interrelated. For example, the choice ofdelivery model (e.g. DBB, DB, etc.) will inevitably shape the contract design (and power), as well as thedegree and duration of competition. Unfortunately, empirical studies that differentiate between theinfluence of these three elements on risk pricing are currently non-existent, not least because the terms
procurement, delivery and contract design are often used inter-changeably or are conflated.15
Due to this lack of evidence this report does not focus on whether and when the potential benefits ofdifferent delivery models, procurement processes or contract power offset the disbenefits of inefficient
risk (and uncertainty) pricing. These are highly important questions for policy makers and researchers
alike. They are also bigger issues that merit more effort on the side of the government in terms ofmaking adequate data available that would allow their investigation and better understanding. Rather,
the focus of this report is on the fourth and last element of uncertainty and risk pricing, i.e. what
contractors know about and how they perceive the risk and uncertainty inherent in the project. This will
be considered from both a theoretical and a practitioner perspective.

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Box 1. Empirical evidence of uncertainty in infrastructure procurement
In this box three empirical examples are brought forward, where industrial economists studied how a
reduction in uncertainty affects bidders in road projects.
Example 1: Price adjustment policies (Kosmopoulou and Zhou, 2014)

Considerable time may pass between the actual bid submission and contract completion. Especially if
input prices are volatile (e.g. oil), contractors need to be mindful of potential future price variations that
affect the cost of their products (e.g. asphalt). As they cannot do much to control these costs, they are asource of exogenous uncertainty.
In the US, multiple institutions applied pass-through formulas for inputs affected by considerable pricevariability. For example, the Oklahoma Department of Transport (ODOT) applied such a formula forasphalt mixtures (i.e. an oil related input). If the initial price grew by more than 3%, an automatic
corrective payment would be disbursed to the contractor. Between August 2006 and June 2009, ODOT
granted a net payment to firms equal to 5.05% of the value of eligible contracted items, in returnachieving an 11.7% reduction (on average) in the price of winning bids (after the price adjustment
introduction and for the eligible items).
Example 2: The impact of public information on bidding (De Silva et al., 2008)

In this case, ODOT changed its procurement policy to publicise the State’s internal cost estimates during
tendering. This not only involved publishing the total cost estimate for the tender, but also more detailed
information: “The state started revealing its estimate for each component of the project by releasing a
set of individual cost estimates for each quantity of material used and each important task involved. As aresult, this policy change provides detailed information that can reduce substantially the uncertainty
related to common components of the cost. For example, in one case, the state can reveal the cost of
excavation which depends on soil conditions, and in another, the cost of a specific bridge repair which
depends on the extent of the damage” (De Silva et al., 2009). The study compared the winning bids forasphalt pavements and bridge work. Asphalt paving projects are relatively straightforward as the job
descriptions typically specify an area of roadwork to be surfaced, the depth of surfacing required, andthe material to be used. In bridge work, there is more uncertainty. Soil conditions at a site may not be
fully known until excavation work begins and repairs may not be fully understood until some demolition
work is undertaken. The analysis included the State of Oklahoma, where the procurement protocol
changed, and the State of Texas, where it remained the same. In total over 13 000 submitted bids byconstruction firms were analysed over the period 1998–2003. No change was recorded for asphalt
projects, while the average bid for the bridge projects was reduced by 9.6%, with average winning bid
reduced by 9%.
Example 3: Increased entry and bidder survival in the market (De Silva et al., 2009)

Entrants are typically less informed and bid more aggressively than incumbent firms. This bidding
behaviour makes them more susceptible to losses affecting their prospect of survival. Using the data of
the same US State Agency as above (ODOT), the authors investigated whether reduced uncertainty
increased the number of new entrants and their survival prospects in the market. It was found that the
information release eliminated the bidding differential between entrants and incumbents attributed to
information asymmetries. Secondly, the study argued that firms who used to exit the market relatively
soon are now staying 37% longer, while at the median level bidding duration increased by roughly 68%.

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Understanding construction and design risk
“Construction projects are executed in a dynamic environment characterised by uncertainties in budgets,
technology and project delivery systems” (Li et al., 2012). However, whilst it is accepted that
infrastructure involves significant risk, it is less clear what is meant by construction and design risk as
distinct from other project risks. A clearer understanding of these risks and their constituent sources isnecessary for an informed discussion on risk pricing.

Defining construction and design risk
Design and construction are distinct but inter-related phases of a project’s development, with design
effectively setting key construction parameters such as inputs, methods and scope. It follows that design
adequacy has a key bearing on construction outcomes. Similarly, while design and construction risk can
be conceptually delineated, the boundaries between the two are blurred.
Design risk is characterised as risk relating to project planning and approvals, design and scope definition,
contract definition and proposed engineering techniques (Gosh and Jintanapakanont, 2004; Li and Zou,
2008; Roumboutsos and Anagnostopoulos, 2008; Smith et al., 2009; Sastoque et al., 2016). Design risk
can also be more broadly interpreted as comprising risks stemming from the bid process itself, such as
cancellation risk (Sanchez-Cazorla et al., 2016).
Comparatively, construction risk is broadly defined as events or factors occurring during the construction(execution) phase, to the detriment of the project (Faber, 1979; Wang et al., 2004). This distinction isclearly limited, with design risks, such as poor constructability, only materialising during the construction
phase.
Construction risk can be more functionally defined as events or occurrences that influence project
objectives of cost, time and quality. This “iron-triangle”16 conceptualisation finds strong support acrossthe literature (Perry and Hayes, 1985; Akintoye and MacLeod, 1997; Zou et al., 2007; Kasprowicz, 2017).
It also aligns closely with practitioner understanding. A 2014 study of UK contractor risk definitions foundstrong association with notions of cost, profit/loss and time (Hartono et al., 2014). In contrast to moreneutral risk theory, practitioners were also found to perceive risks as solely adverse, indicating loss
aversion.
However, a solely functional conceptualisation of construction and design risk can be considered too
narrow and can lead to a privileging of risks on the basis of their measurability (Froud, 2003; Broadbent
et al., 2008). In practice, construction risk is not limited to events or conditions with numericalcalculability. Examples include community opposition or third-party interface which may be hard toquantify in terms of probability and impact, but remain credible risks for contractors (WEF, 2015; 2016).
In this context, construction and design risk can each be more accurately defined as the probabledeviation of actual from expected project outcomes. The wider the probable deviation in outcomes, thehigher the risk (Clemen and Reilly, 2001). Project outcomes should, in-turn, be viewed from theperspective of overall effectiveness for clients and end-users, rather than through the narrow lens ofcost and time (Li et al., 2012; Thomson et al., 2013).

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Sources of construction and design risk
Assessing key risk sources further aids the understanding of construction and design risk, as distinct fromother project risks. It is important, however, to acknowledge that different project stakeholders will havedifferent perspectives on what constitutes a risk source for construction and design risk. For example,
equity investors and lenders in PPP projects will consider cost and schedule overruns as the source ofconstruction risk. For the construction contractor delivering the project, cost and schedule overruns willbe the result of other sources of risk that are related to various aspects of project execution. Thisdifferentiation becomes clearer below.
Cost and schedule overruns are perceived as foremost risk sources for investors, reflecting theirlikelihood of occurrence and consequence (Flyvbjerg et al., 2002; Flyvbjerg, 2009). In traditional publicdelivery (DBB), overruns are systematic and potentially large (Flyvbjerg et al., 2003; Blanc-Brude and
Makovsek, 2013). In PPPs, their likelihood is reduced, but consequences for contractors can be greater.
As such, overruns are a key focus, as reflected in construction risk ratings, which are determined on thebasis of cost and schedule overrun resilience, alongside complexity, risk allocation, and contractor
experience (Moody’s, 2016).17
However, sources of construction and design risk for project contractors extend well beyond headline
measures of time and cost with a range of specific risk sources identifiable, as outlined in Table 1. While
precise risk profiles will vary in-line with project specifics and differing operating environments, thefollowing risk sources are commonly observed:
client/owner behaviourcommunity

contractual

design (omissions/interface/changes)

economic

environmental (including project environment, stakeholders)

financialforce majeure

political and regulatory (including permits and approvals)



project governance

technical



technological third-party (sub-contractors/suppliers).
In the case of PPP delivery, several risks (e.g. financial, economic, political) extend across the project
life-cycle, but have specific implications in the construction phase. For example, financial risk in theconstruction phase signifies occurrences that impact contractor (or sub-contractor) cash flows orsolvency (Akintoye and MacLeod, 1997). Similarly, political and regulatory risk denotes exogenous
impacts on a contractor’s ability to meet contractual obligations, such as approvals/permit delays, orchanges of law (e.g. immigration law) (Grimsey and Lewis, 2007; WEF, 2015). Contractual risk is a further
life-cycle risk with pronounced implications during construction. This reflects the large number of parties
involved in project execution, and the reliance on contracts to establish and govern relationships
between them (Ward and Chapman, 1991; Peckiene et al., 2013; Sastoque et al., 2016).

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Besides project size, complexity and type, sources of construction and design risk are ultimately
determined by delivery models (e.g. DBB, DB, EPC, DBOM etc.) and contract power (e.g. Turnkey,
cost-share, etc.) (Diab et al., 2017). For example, the bundling of design and construction coupled with
the Turnkey contract (such as an EPC, as used in PPPs) increases the scope of risk and, in turn, potential
price and time variability. This is further compounded when clients place bid emphasis on design
innovation (Barlow and Koberle-Gaiser, 2008).
Client behaviour is a further potential source of risk for contractors (Roumboutsos and Anagnostopoulos,
2008). In traditional project delivery, this risk manifests itself in late stage change orders and anincreased likelihood of dispute. In PPPs, risks stem from the tendency of clients towards maximum risk
transfer, as opposed to allocation on the basis of capability to manage and capacity to bear (Grimsey andLewis, 2005; Chung et al., 2010; Wang, 2015; Pantelias and Roumboutsos, 2015).
As projects grow in size and complexity sources of construction and design risk - and their relative priceimpacts - are also evolving. Increasing complex operating environments, especially for large inner-urban
projects, means a broader spectrum of risks and uncertainties. Rather than technical complexity, sourcesof uncertainty are increasingly exogenous in nature and relationship-based (i.e. community opposition,
third-party interface, etc.). These emergent risks do not neatly fit conventional risk classifications, andsuffer from a lack of consistency across projects in respect to their allocation (Li et al., 2005; Hwang etal., 2013).

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Table 1. Key sources of design and construction risk identified in the scientific literature18
Reference
Diab et al. (2017)

Moody’s (2016)

Study context and methodology
Highways-focused
Practitioner survey (gauging impacts
on contingencies)
PPP-focused
Based on 80+ PPP/PFI ratings

Sastoque et al.
(2016)

PPP-focused
Literature review

Jarkas and Haupt(2015)

Practitioner survey

Hwang et al.
(2013)

PPP-focused
Practitioner survey

Roumboutsos
andAnagnostopoulos(2008)

PPP-focused
Practitioner survey

Li and Zou (2008)

Transport PPP-focused
Practitioner survey© OECD/ITF 2018

Key risk sources
inaccurate design
inadequate constructability reviews
owner/client-initiated changes
design and construction (all technical matters)
geotechnicalindustrial relations
input price risk
protected/endangered species
resources/suppliers/equipment
site contamination
utilities relocation
weather
contractor counterparty risk
cost overruns
material availability
permit approval delays
residual risk
scope variationssite security
time delays
clarity of drawings and technical specifications
contractor’s financial difficulties
delay in consultant responsedelay in payment process by client
errors and omissions in design drawings
frequent change orders by client
late delivery of materials
shortage in technical staff and skilled labour
slow decision-making process by client
unavailability or shortage in specified materials
availability of financeconstruction time delays
inadequate PPP experiencelack of government support
unstable government
application of innovative techniques
contract variation
cost overruns
design deficiency
late design changes
material/labour availability
poor quality workmanshipcapital materialised problem
cost overruns
design deficiencies
excessive design changes/variations
force majeure
inflation volatility
lack of design flexibility
poor quality workmanshipsafety risksite conditions/supporting structures

23

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Reference
Grimsey andLewis (2007)

Study context and methodology
PPP-focused

Ibrahim et al.
(2006)

PPP-focused
Literature review

Creedy (2006)

Highway-focused

Li et al. (2005)

PPP-focused
Literature review

de Lemos et al.
(2004)

PPPs
Risks derived from Lusoponte
bridges concession (Portugal) case
study

24

Key risk sources
approval delays
change in law
design faults
failure to obtain planning approvals
force majeure events
inefficient work practices/resource use
poor co-ordination of parties
quality shortfalls/defects
construction delays
cost overruns
design deficiencies
excessive contract variation
insolvency/default of subcontractors or suppliers
labour/materials
late design changes
poor quality workmanshipunproven engineering techniquesclient project management costs
constructability
contractor risks
deficient documentation (specification and design)design and scope change
environment
insufficient investigation and latent conditions
price escalationright-of-way costs
services relocation
completion delay
construction force majeure
cost overruns
design deficiency/variations
environmental pollution
excessive contract variationinflation and interest rate volatility
land acquisitionmaterials/labour
non-reliance/creditworthiness of local parties
poor geotechnical conditions
poor quality workmanshippublic opposition
third party insolvency/default
unproven engineering techniques
weather
approval delays
design and construction integration
environmental
land/site availability
public agency behaviour (e.g. work additions)
reputational
technical complexity
utility and local authority co-ordination© OECD/ITF 2018

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Reference
Ghosh andJintanapakanont(2004)

Study context and methodology
Practitioner survey, based on the
Chaloem Ratchamongkhon Lineproject (Thailand)

Akintoyeand
MacLeod (1997)

Practitioner survey

Perry and Hayes(1985)

Literature review

Key risk sources
construction delay
delay in solving contractual issues
economic disaster
financial failure of contractor
scope of work definition
unavailability of funds
availability and productivity of labourmaterial shortages and quality
site safetysoil and site conditions
climateextent of change
feasibility of construction methods
industrial relations
interaction of design with construction
new technology
precision and appropriateness of specifications
quality of management and supervisionsafetyCommon infrastructure delivery models and theirimplications on risk pricing
Major infrastructure projects are delivered by governments using a variety of models. These are
generally supported by international standards.19
More specifically, a client’s delivery choice involves determining:the scope of works or services (such as studies) to be delivered (and the bundling or not ofdifferent phases of the delivery process)the procurement process, in terms of the expected level of competition and durationthe contract design through which the delivery of works and services is to be governed andremunerated.

Figure 5 outlines commonly-used delivery models along two (correlated) spectrums: the degree of risk
transfer (to contractors) and the degree of owner (in relation to the contractor) control.
Comparatively, Figure 6 illustrates the typical associations (as observed in the literature) between
delivery models and contract design (power) under the two major means of financing (public vs private),noting that in practice wide variance can occur.
From a principal-agent perspective, the choice of delivery model and contract design is one of incentive
intensity, with different choices giving effect to either low-powered or high-powered incentives(Williamson, 1985; Chang, 2013). It can also be considered a “trade-off” between the time costs incurred
through more detailed planning and design (e.g. DBB), and the incentive costs incurred through risk
transfer (e.g. DB) (Olsen and Osmundsen, 2005).

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Precise approaches (and the risk allocation they give effect to) vary by project, based on size, complexity,
and type. Choice of financing will also generally determine the scope of works to be delivered by acontractor (i.e. the scope of risk transfer) and the requisite contract power. For example, in a PPP,
contractors are customarily engaged on an EPC basis, requiring them to price a bundled scope of works
through a lump-sum “Turnkey” contract. This wide scope and use of high-powered incentives reflects
grantor expectations as well as the strict lender requirements inherent to non-recourse finance (and highleverage) (Blanc Brude et al., 2009).
Figure 5. Commonly-used infrastructure delivery models

Figure 6. Delivery models and contract powers under public and private infrastructure financing

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When publicly financed, delivery models and contract designs tend to be more varied, depending on: anowner’s desired level of control; an owner’s risk tolerance and desire for price certainty; project time
constraints; required degree of innovation; and, above all, the degree of certainty/uncertainty in projectrequirements (Turner and Simister, 2001; Merrow, 2011; Tadelis, 2012). For example, a lump-sum
contract is generally preferred when requirements are well-defined and clients want price certainty,
whereas cost reimbursable contracts are preferred when conditions are uncertain or requirements areless clear-cut.
It follows that delivery models and contract powers, assuming a competitive tender process, areforemost determinants of a contractor’s risk exposure and, in-turn, risk pricing premiums. For any
project, contractors must identify, and where possible quantify, all relevant risks and their mitigants orcontrols (Park, 1979). This is undertaken in the context of project idiosyncrasies, precedent limitations,scope uncertainties, and potential deficiencies in internal systems and data collection, with implications
for pricing efficiency (Paek et al., 1993; Pinsent Masons, 2017; and Makovšek and Moszoro, 2017).
The remainder of this section outlines two commonly-used but divergent delivery models; Design Bid
Build (DBB) (“traditional delivery”) and Engineer Procure Construct (EPC) (the predominant form ofcontractor engagement in PPPs). This will include an assessment of risk implications for clients andcontractors from the perspective of scientific literature. Emergent “collaborative” models are also briefly
discussed. Findings are summarised in Table 2.

Design-Bid-Build (“Traditional delivery”)
The term “traditional delivery” is synonymous with the Design-Bid-Build (DBB) model, the predominant
form of contractor engagement in public infrastructure, and in particular transport (NBS, 2012; Park andKwak, 2017).
At its core, DBB sees the functional separation of design from construction, with design undertaken
in-house or outsourced, and contractors engaged only once it is complete (or mostly complete).
Contractors are typically engaged on a lump sum or guaranteed maximum price basis meaning clientslook to competition to discover efficient costs, and to contain risk premiums. While third-party
designers/architects bear risks of design negligence, the DBB model sees clients retain full design risk
with contractors provided warranties as to its sufficiency (DBIA, 2015). For clients, this exposure extends
beyond design omissions or errors to include constructability, maintainability and fit-for-purpose risks. As
such, the DBB model represents a trade-off with clients retaining greater risk in exchange for greater
control over design and, through input-specification, construction methods.
However, the resulting functional separation of design from construction has implications, with thepotential to create a “gap” between these two liabilities. In particular, when the two are separated “eachcontractor is liable in so far as it can be shown that the failure of a building at a junction or interface
between packages was their responsibility rather than that of the other work package contractor”(Chang and Ive, 2007, p. 682). Sometimes this separation is even more complicated20 thus increasing thedifficulty in managing the liabilities that result from the various interfaces.
From a transaction cost economics (TCE) perspective, this liability gap can also increase client exposure
to hold-up. Hold-up is ever-present in infrastructure, reflecting such factors as asset specificity, sunkcosts, imperfect visibility, and broader political drivers (e.g. reputational consequences of delay).
However, it can be more pronounced in DBB due to the higher incidence of ex post changes and, in turn,the increased scope for opportunistic pricing (Winch, 1989). Indeed, ex post changes and resultant cost

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overruns in traditional procurement can be considered systematic (Rowland, 1981; Bordat et al., 2004;
Creedy, 2006; Cantarelli et al., 2012; Makovšek, 2014). Their extent is also influenced by contract power,with low-powered contracts (i.e. cost-plus) better motivating contractors to accommodate ex postchanges but serving as a weaker incentive to minimise overall costs (Tadelis, 2012).
In the context of competition, functional separation (and resulting liability gaps) also expose clients tostrategic bidding by contractors, with adverse selection risks (Hart and Holmstrom, 1987). In particular,
competition can lead bidders to strategically assess weaknesses in specifications, with the intention ofrecovering low bid costs through ex-post change orders once they are in a single-source position(Crowley and Hancher, 1995; Williams et al., 1999; Bajari et al., 2014; Park and Hoon, 2017). A recent US
study of 312 road projects estimated that strategic bidding increases contractor margins by an averageof 3-4% (Jung et al., 2016). While strategic behaviour is not limited to DBB models (Medda, 2006; Qu andLoosemore, 2014) it is more likely due to the greater likelihood of design errors and omissions, andopportunity for contractors to pursue revenue beyond the initial contract value.
By extension, contractor risk exposure under DBB is relatively contained. Direct risks include delivery
against a pre-specified design, minimising cost and time variability. Empirical evidence supports this, with
ex ante construction costs (on average) lower for DBB than bundled contracts, such as those used in a
PPP (Blanc-Brude et al., 2006; 2009). However, this does not mean DBB is risk-free from a contractor
perspective. If tendered on a fixed (or guaranteed maximum) price basis, contractors will bear the risksof labour and materials cost volatility and availability. Contractors are also exposed to in-direct designrisks, such as an increased likelihood (and costs) of dispute. These risks are compounded by the lack of ex
ante opportunities for contractors to influence design. However, as outlined, these risks should beconsidered in the context of the increased opportunities that exist in DBB delivery for contractors to
pursue revenues beyond ex ante contract value.

Engineering, procurement and construction (EPC) (as used in PPPs)
Delivering projects on a fixed price and date certainty (‘Turnkey’) EPC basis is a common method ofcontractor engagement and the predominant method in privately-financed projects.21 Whereas DBB isdefined by its functional separation, EPC is defined by its integrated “bundling” of design andconstruction project phases, and reliance on high-powered contracts and associated enforcement
measures (e.g. company guarantees). As such, an EPC method can be considered a trade-off between
the minimisation of liability gaps (inherent in DBB), and the level of risk premium charged by a contractor(Weitzman, 1980).
Central to an EPC approach is the principle of single point responsibility for in time and on budget
delivery (HM Treasury, 2010; Delmon, 2011; Chang, 2013). In a PPP, this is achieved through the transfer
of design and construction risks from a procuring authority to a special purpose vehicle (SPV) (alsoreferred to as project company) and, in-turn, from the SPV to a contractor (or construction joint venture[CJV] if more than one) through an EPC agreement on a “back-to-back basis”, i.e. contractual terms andhence risks are passed down the supply chain. The contractor is additionally bound by direct agreementswith the public grantor and lenders. Sub-contractors and suppliers are wrapped by the lead contractor,
minimising interface risks and further preserving single party responsibility for grantors, lenders and the
SPV (HM Treasury, 2006; Shen et al., 2006). Contracts are underpinned by extensive enforcement
measures (Gatti, 2013) with the guiding principle that non-fault parties (e.g. lenders or grantors) will be“made whole” for any losses incurred (Dentons, 2017). Very limited exclusions apply, such as, forexample, risks relating to unforeseen ground conditions, change orders, or political force majeure28© OECD/ITF 2018

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events. Contractor liabilities may also be capped in very large projects, reflecting balance sheet
constraints and insurance limitations.
This bundling of risks and use of high-powered incentives reflects grantor expectations and strict lender
requirements. Grantors and financiers (equity sponsors and lenders) each want to ensure that
contractors exert maximum effort in meeting their contractual obligations (Iossa and Martimort, 2009).
For lenders, an additional goal is preserving the SPV as an empty “shell”, with minimal residual risk
(Arndt, 2000; Demirag et al., 2012). Contracts and associated enforcement measures serve to maximise
these incentives, while the use of output (rather than input) specification serves to maximise acontractor’s latitude to deliver whatever is required, in contrast to DBB, where contractors deliver on an“as drawn” basis.
In this context, it can be expected that contractors will internalise higher levels of risk relative to DBB, asevidenced by higher average construction costs observed in PPPs (Blanc-Brude et al., 2009). Thisobserved cost discrepancy suggests that risk pricing impacts from project phase bundling and use ofhigh-powered contracts can exceed the benefits stemming from stronger incentives to perform and acontractor’s greater influence over design. As outlined previously, this likely reflects the more limited
opportunities in a Turnkey contract to pursue revenues beyond initial contract value, with contractors
forced to fully price revenue expectations ex ante.
From a client perspective, this risk premium is an exchange for fewer retained risks (e.g. design) andgreater time and budget certainty. But whilst this model has been proven effective to the point of
resembling an insurance (i.e. median cost overruns in PPPs are low), its pricing is not necessarily efficient.
Contractor risk premiums are assumed by clients to be contained by competition and a negotiatedapproach to risk allocation (Li et al., 2005). Empirical evidence, however, finds that PPP construction
costs are, on average, higher than traditional public delivery, even when average cost overruns in
traditional public delivery are taken into account (Blanc-Brude et al., 2009; Makovšek and Moszoro,2017). A lack of evidence that PPP construction is of superior quality, or has been based on life-cycle
optimisation, adds further weight to the suspicion that risk pricing in turnkey contracts may beinefficient. This inefficiency may be attributed to a range of factors, including: failure to consider upside
gains (loss aversion); lender risk aversion; client tendencies towards maximum risk transfer; an
imbalance of negotiating power; and estimation error (Arndt, 2000; Grimsey and Lewis, 2002; Zou et al.,2008; Chung et al., 2010; Hartono et al., 2014; Roumboutsos and Pantelias, 2017) among others.

“Collaborative” delivery
A trend towards more collaborative (hybrid) forms of contractor engagement can be observed acrossinfrastructure markets, with an increasing number of governments issuing collaborative contracting
guidelines. At its core, this form of contracting seeks to facilitate joint project definition and risk
identification through earlier and deeper engagement of contractors. This recognises the decreasing
opportunity (and increasing cost) of changes, such as those to design, over the project life-cycle (Edkins
et al., 2013; Morris, 2013; WEF, 2016).
Precise approaches vary in the extent to which they utilise conventional risk/reward incentives andcompetition-based price discovery. For example, early contractor involvement (ECI) relies on fixed pricecompetition and allocation of construction risk to a single contractor, while alliancing seeks to“hard wire” collaboration through shared goal development and target costing, and joint governancestructures, with competition largely focused on capability rather than cost. Alliancing also constitutes amore fundamental departure from conventional single-point responsibility.
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As such, collaborative contracting should be understood as a broad categorisation, encompassing a
range of models with differing degrees of risk transfer and differing levels of competition. ECI andalliancing, the two most common models, are outlined in further detail below.
Early contractor involvement (ECI) is typically used in highly uncertain conditions or when considerable
innovation is required (Mosey, 2009). While variations can be observed,22 ECI typically involves a
two-stage process:Stage one: typically, two or more contractors are engaged (on a non-price basis) to work with aclient and designer to develop a preliminary design and risk-adjusted price. Payment is fee forservice, with fees typically less than 50% of contractor costs.

Stage two: a single contractor proceeds to construction phase, typically under a DB delivery
model, and lump-sum contract.

By involving contractors at an earlier stage in a project’s development, and enabling designers to be
novated to contractors at the start of construction, ECI aims to minimise design omission andconstructability risks associated with DBB delivery. At the same time, ECI aims to provide clients withgreater control over design and construction methods than is possible under bundled delivery, such as
EPC. More effective risk management is cited as a further justification with perceived benefits stemmingfrom joint risk identification. Limited available evidence suggests ECI can deliver time savings relative to
DBB delivery, where conditions are complex or uncertain (Li et al., 2015). A UK Highways Agency study
on the use of ECI for five road schemes found it reduced project preparation time by 30-40%, by enabling
aspects of development to be carried out simultaneously rather than consecutively (Nichols, 2007).
However, it is unclear whether ECI compounds or mitigates pricing challenges observed in conventionaldelivery. For example, while ECI can assist in minimising constructability issues and ensuringfit-for-purpose, this comes at the (potential) cost of reduced competitive tension. Delays and transaction
costs incurred when a client does not proceed with a pre-engaged contractor may also increase
exposure to hold-up. Challenges also exist in incentivising contractors to share their innovations ahead of
the formal (construction) tender.
For contractors, earlier engagement should serve to reduce uncertainty, with greater access to
information and greater clarity on client objectives. Similarly, the opportunity to influence design should
minimise liability gap-related dispute risks. However, it is unclear whether this translates into reduced
risk contingencies, with contractors ultimately still required to price a bundled scope of work in thecontext of a time-bound bid process.
Alliancing is another commonly-used form of collaborative engagement (Pinsent Masons, 2017). It seesclients and contractors jointly prepare a project scope and target cost, underpinned by a sharedrisk/reward mechanism. Parties are bound by open-book accounting, no blame/no disputes policies, andunanimous decision making. Project functions, transcending planning, design and construction, aretypically integrated through a joint project management board.
Where conditions are highly uncertain or complex, Alliancing has been suggested to generate cost andtime savings over traditional public delivery (NAO, 2005; Clifton and Duffield, 2006; Victorian
Government, 2009). However, concerns also exist about its capability to deliver on project objectives
given its limited risk transfer and low-powered incentives, which translate into a (relatively) weak
incentive to minimise production costs (Davies, 2008; Boukendour and Hughes, 2014). For clients, risks
also stem from the joint development of target costs, with contractors potentially incentivised to inflatetargets (in order to maximise margins by beating them). More broadly, concerns exist as to whether risk

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can be meaningfully shared, given that contractor exposure is capped while client exposure remains
open-ended (Austroads, 2014).
For contractors, delivery through an Alliance should represent a relatively low-risk proposition withdesign and construction risks shared between multiple parties. On the other hand, contractors are
exposed to risks (e.g. cost growth or time delays) over which they have only a much more limited degreeof direct control. This is compounded by “no dispute” clauses which translate to an absence of avenues
for legal redress in events of fault.

How does information about an infrastructure
project’s costs evolve over its life?
Infrastructure’s estimation challenges
Cost estimation is integral in infrastructure, both in informing initial investment and financing decisions,and in providing a basis for competitive tendering and delivery accountability.
It follows that costing inaccuracies have significant and compounding consequences for clients and their
suppliers (Akintoye, 2000; Welde et al., 2014). Indeed, Hicks (1992, p. 545) observes: “Without an
accurate cost estimate, nothing short of an act of god can be done to prevent a loss, regardless ofmanagement competence, financial strength of the contractor, or know how”. For public clients, these
impacts extend beyond near-term service provision to wider budgetary and political considerations. For
contractors, over-estimation can result in an unsuccessful bid, while under-estimation can meansignificant losses (“winner’s curse”); particularly in the context of low industry margins (European
Commission, 2016; EY, 2017).
Estimation in the context of construction is difficult as every project is unique in the sense that it has
never been built in that environment before. Besides project complexity and idiosyncrasy, costing issubjected to political-economic and psychological influences and biases, including strategic
misrepresentation, optimism bias and lock-in (Flyvbjerg et al., 2002; Flyvbjerg, 2008; Cantarelli, et al.,2010; Cantarelli, et al., 2012; Welde et al., 2014; Boussabaine, 2014). While these influences tend to be
more pronounced in certain sectors (e.g. rail) than in others (e.g. roads) they are ultimately evident
across all infrastructure sectors.
For contractors, inadequate knowledge (such as a lack of knowledge regarding site condition), time
constraints, poor tender documentation and variability in subcontractor pricing23 (i.e. difficulties
estimating the costs of subcontractor replacement) represent further constraints (Carr, 1989; Akinci andFischer, 1998; Akintoye, 2000; Akintoye and Fitzgerald, 2000). For clients, a reliance on historical pricedata (if available), which systematically underestimates contractor revenue expectations, is a further
challenge (Makovšek, 2014).

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Table 2. Commonly-used delivery models
Broad structure

Implications for client

Implications forcontractor(s)Cost/time
performance

DBB(“traditionaldelivery”)

Design and construction
separately and sequentiallytendered to the private sector
Design either undertaken inhouse, or outsourced (forlarger projects)
Contractors engaged on basisof complete design (inputspecified), with clientsproviding a design warranty
Contracts predominantly fixedprice, but cost plus (unit price)or hybrid forms (e.g. surety
bonds) are also used if
conditions are uncertain

Ability to retain close control overdesign and delivery methods
Clients directly and fully exposed todesign risk including maintainability,
fit-for-purpose and constructability
Weak incentives for contractors toagree late stage changes at true cost
(if fixed price), or to minimise project
costs (if cost-plus/unit price)
Potential for high monitoring costs, inensuring quality is maintained
Heightened risk of strategic underbidding (“low-balling”), as well as expost hold-up
On-time and on-budget delivery
highly dependent on design adequacy
Sequential procurement can mean
longer pre-implementation
timeframes (time costs)

Reduced cost and time
variability (risk), given
delivery is against a
pre-specified design –but still exposed todelivery risk (materials
and labour) if fixed priceInability to influence
design ex-ante creates
in-direct design risks,such as likelihood oflegal dispute
Inherent adversarial
relationship between
parties

Systematic latestage scopechanges anddesign omissions
On-time/budget
delivery is poor,
with systematic
cost overruns

EPC (ascommonlyused in PPPs)

Contractor engaged (by SPV if a
PPP) on fixed cost and datecertain (“turnkey”) basis
Contractor performanceassured through extensive
security/support package (e.g.
liquidated damages) andperformance-based payment
schemeEnables more extensive risk transfer,including complete transfer of designand construction (and associatedconstructability, maintainability andfit-for-purpose risks)Serves as a “high-powered” incentive,
maximising efficiency
Difficulties in specifying desired
outputs/outcomes
Lender due diligence means greater
scrutiny of project costings, andcloser monitoring of delivery
performanceContractors require greater profit
margins, reflecting their greater risk
exposure – with studies suggesting acirca 20% premium relative to lessrestrictive contracts
Relies on client ability to specify
requirements ex ante, with ex postchanges in scope likely to result insignificant costs
Degree of risk transfer (and liabilities)
may serve to limit competition insome cases

Bundling translates intoa more complex
estimation task, andsignificantly increased
cost/time variability (i.e.
risk exposure)
Facilitates early
contractor input, andgives contractors control
over design - assisting
identification of
trade-offs between
design and construction
decisionsContractor subjected to(far greater) scrutiny oflenders
Clients’ use ofhigh-powered incentives(and output
specification) reduces
contractor’s
administrative burden,
and provides greater
flexibility in approach

Strong record of
on-time/budget
delivery, withlow average cost
overruns
Evidence of
inefficient risk
premiums (withconstruction
costs in PPPs, on
average, higher
than traditional
procurement)

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Table 2. Commonly-used delivery models (continued)
Broad structure

Implications for client

Implications forcontractor(s)Cost/time
performance

ECI

Typically involves a two-stage
process, with clients engaging alimited pool of contractors towork alongside designers,
followed by a competed DB
stage (with designers novatedinto the contractor)
Mostly used where conditions
are highly uncertain or when
considerable innovation isrequired

Facilitates upfront consideration of
constructability – minimising design
emission and interface issues, whilst
preserving client control
Facilitates greater contractor input tocost (and time) estimation
Reduces pre-implementation
timeframes, relative to a DBB
approachPotential reduction in (effective)competition given delays andtransaction costs, should client
decide to open bidding to the wider
marketDisincentive for contractors to share
full efficiencies (innovations) in theearly stages due to subsequent
competitive trigger (i.e. stage two)

Lengthier period of
involvement meansincreased bid costs(which could prove
unrecoverable ifcontractor is
unsuccessful at stage
two; thoughcompetition is less)
Risks of pricing abundled scope of works(i.e. design completionand construction)
remain due to stage twotender

A study on theuse of ECI for UK
highwaysprojects foundup to 50%
shorter
construction
times, relative toa DBB approach
Remains unclear
whether ittranslates into
reducedcontractor risk
contingencies

Alliancing

Clients and selected
contractors jointly prepare
project scope and target cost;and agree a shared risk/reward
mechanism (cost incentive)
Parties are bound by
open-book accounting, noblame/no dispute policy andunanimous decision making
Project functions –transcending planning, designand construction – areintegrated through a joint
project management board
Mostly used where conditions
are highly uncertain and/or
complex

Minimises conflicts/disputes between
parties
Difficulties incentivising contractors
to reveal efficient target costs
Limitations to the extent of(meaningful) risk share, given
contractor exposure is capped whileclient exposure remains open-ended
Value for Money highly dependent onclient capability

Limited avenues forlegal redress, owing to“no dispute” clausesmeans uncertainty

Improves
non-cost
outcomes, andenables earlier
project
commencement
relative to DBB
approaches
Remains unclear
whether ittranslates into
reducedcontractor risk
contingencies

Evolving cost (and time) accuracy
Costing accuracy is not static but rather evolves over the project life-cycle. A sample of Dutch transport
projects found that cost overruns were four to five times larger when early stage estimates were used asa reference point, compared with estimates at the formal “decision to build” stage (Cantarelli et al.,2010). Figure 7 illustrates this evolving accuracy as information improves over time. Information
improvement denotes relevance rather than volume, recognising the diminishing utility of precise
information (Samset and Holst Volden, 2016).
More specifically, cost (and time) accuracy improves in-line with scope and design definition (Cowie,
1987; Zeitoun and Oberlender, 1993: Akinci and Fischer, 1998). This reflects the bearing that design andscope certainty have on material quantity and price, schedule variability and reluctance bysub-contractors and suppliers to agree to fixed price terms (Paek, 1994).
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Figure 7. Evolving estimation accuracy over the project life-cycle* Under ECI models, contractors do not price (for construction) until the second stage, which commences once a
design is well-developed (typically stage two comprises a restricted D&B tender)
Source: Adapted by authors from Samset (2008); Samset and Volden (2016)

Table 3 compares estimation accuracy at three distinct stages of a project’s development (Peurifoy andOberlender, 1989). Additional related studies are included in the Appendix. While proving a positive
correlation between cost accuracy and project definition, studies also demonstrate a degree of residual
cost inaccuracy, even at contract value stage (i.e. post design). In other words, at no point (at least in
traditional public delivery) do pre-construction cost estimates become completely accurate. What
proportion of this “residual” cost inaccuracy reflects (ex ante) estimation error, as opposed to (ex post)
client-initiated scope changes or opportunistic pricing by contractors remains unclear (Cowie, 1987;
Akinci and Fischer, 1998; Lo et al., 2007). As outlined, systematic estimation error is not evident in PPPs
from the perspective of an SPV (or grantor), though precise estimation accuracy from a contractor
perspective remains unknown (Blanc-Brude and Makovšek, 2013).
Table 3. A comparison of actual and estimated costs pre- and post-design
Conceptual stage estimates(%)

Post completion of initialdesign stage estimates (%)

Post completion of final
design stage estimates (%)

Lower bound

-10

-5

-3

Upper bound

+40

+25

10

Range (between bounds)

50

30

13

Source: Peurifoy and Oberlender (1989).

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At what point in the project life-cycle are contractors required to“price” their bids?
It has been established that cost accuracy evolves over a project’s life in-line with information provisionand project definition. By extension, the point at which contractors are required to “price” a given scopeof works (and the contractual basis on which they do so) is critical in determining how much uncertainty
they face and, in-turn, required contingencies or premiums.
As illustrated in Figure 7, different delivery models engage contractors at different points in the life-cycleand for different periods of time. As such, they also determine when a contractor is required to price ascope of works. For example, where a contractor is engaged under a DBB model they typically price theirbids only once design has been completed by the client and/or its design partner, meaning uncertainty islower and cost accuracy is higher when final bids are submitted. Input specifications, which are common
under the DBB model, should further simplify a contractor’s pricing task.
Comparatively, under bundled delivery models, such as DB, contractors are engaged sooner in the
project lifecycle, when information is more limited and uncertainty is greater. However, the precise point
at which a contractor submits a final bid (i.e. price) varies depending on several factors. For one, it
depends on the client’s desired level of control over design. Where a client wishes to retain control, it
may develop the design to a point of completion (or near-completion), before providing it to bidders fortheir review and pricing (and then transfer). Alternatively, where a client wishes to maximise private
innovation it may require bidders to price earlier, such on the basis of a preliminary design. Final bids
may be preceded by a period of competitive dialogue, so that pricing occurs after bidders have had an
opportunity to “test” key design and construction methods with the client.
Under an EPC model, as used in PPPs, contractors are engaged early in the project life-cycle, typically on
the basis of higher-level output specifications. Indeed, the PPIAF’s (2016) PPP Certification Guide states:“The procuring authority does not normally provide significantly detailed design, technical information,or even technical information that is warranted. In practice, this means that as soon as the tender
requirements are well known, the private party must start from scratch in obtaining its own technicalinformation”.24 In effect, bidders develop their design (and broader technical solution) incrementally
between the request for proposal (RFP) and tender submission stages. Definitive technical solutions areusually developed only once the contract is awarded (i.e. contractors price works on the basis of an
incomplete design) (PPIAF, 2016). As such, contractors’ pricing task is significantly more complex, withgreater cost (and time) variability. Estimation is further complicated by the use of output (what the
project should do) as opposed to input (how it should be built) specifications, though the trade-off is that
contractors enjoy greater control over design and construction methods.
For both DB and EPC, the degree of design completeness at the point when bids are priced is further
shaped by bid assessment criteria and specifically by a client’s minimum information requirements.
Bidders will typically develop a design to a point that meets a client’s minimum information
requirements (and to assist with its own risk assessment) but will be cautious not to over-specify, inorder to preserve capacity to amend design post award. Minimum (design) requirements can vary by
project, reflecting such factors as: client preference; project complexity; and the extent to which bid
assessment is based on meeting performance requirements versus pricing specified inputs.
Finally, under a typical ECI approach, contractors are engaged as design commences, but are notrequired to price design and construction until later in the project life-cycle. Under this delivery model
pricing typically takes place when design has been (jointly) developed to a point of completion or nearcompletion.

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What challenges do contractors face in trying toprice risks for infrastructure projects?
Contractors engaged in major projects face significant challenges in pricing risks, with implications forprice efficiency and, in-turn, overall construction costs. This part of the report deals with thesechallenges as identified through practical experiences of industry practitioners.
At a high level there is consensus that risk pricing, especially when needed to be done in detail, is
impacted particularly by the “bid context”, comprising such inter-related factors as:delivery models (i.e. bundled or unbundled scope of works, contract power, risk allocation, etc.)financing requirements

information provision (volume, changeability and reliability)timing constraints.

Each of these factors contributes to greater levels of uncertainty. All else being equal, a contractor facing
greater uncertainty will build-in greater contingencies into their fee relative to a contractor facing morecertain conditions.
At the same time, practitioners stress that projects nowadays are less challenged by technical orenvironmental construction risks such as ground condition risk, adverse weather conditions or poor
execution resulting in sub-standard quality and delays. Contractors are aware of these risks and are able
to mitigate or avoid them to a reasonable extent. For example, ground conditions can be investigatedvery thoroughly, the construction site can be protected from heavy rainfall, and contractors can control
the execution to a very high standard.25
Projects appear to be mostly challenged by non-technical risks such as incomplete design specifications
from the client or outstanding approvals and permits (especially when design and construction are taking
place in parallel) resulting in massive delays. Such approvals and permits could only be granted if a design
demonstrates that all regulations and conditions are matched.
Additionally, contractors face methodological challenges in identifying, prioritising, quantifying andpricing risks in detail. In particular, and noting variance across industry, contractors tend to rely on
individual or team experience rather than objective data and scientific processes to identify and pricerisk, in-turn, increasing the likelihood of subjective bias.
In an effort to summarise the multiple challenges that affect risk pricing for contractors, these have beengrouped into the following categories: delivery models, financing requirements, information provision,
timing constraints and methodological issues. Each of these categories is outlined in further detail below.

Delivery models
As mentioned earlier, a client’s choice of how a project will be delivered, both in terms of the scope ofworks (e.g. bundled or unbundled) and contracting mechanism used (e.g. turnkey, cost-reimbursable,etc.), has a key bearing on a contractor’s risk pricing task.

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For example, in traditional public delivery risks stem from the inherently adversarial relationshipbetween parties and an associated “claim and counter-claim” mentality. The more that design
responsibility is retained by the client, the greater the likelihood of future legal dispute between theclient and contractor. As outlined earlier in this report, this reflects the fact that whilst contractors are
insulated from direct design risk under a traditional delivery model, they remain indirectly exposed dueto the greater likelihood of omissions and hence dispute. This residual uncertainty must ultimately bereflected in contractor contingencies.
Additionally, contractors often sign contracts transferring most of the risks from the client to themselves,
only to proceed to challenge each one of them, aiming to re-transfer them, to reduce their own cost of
mitigation, or to avoid them altogether. Many projects are challenged by such legal actions right fromthe beginning, identifying gaps in the contract where the client still has to provide information, decisions
or preparatory works.
These dispute-related risks aren’t unique to traditional delivery, they can also occur in bundled delivery,such as EPC; however, their likelihood is reduced by the greater level of risk transfer and the use ofhigh-powered contracts. On the other hand, bundled delivery and high-powered contracts, by theirnature, increase uncertainty for contractors owing to the associated increase in price and time volatility.
This can be compounded further when clients seek to maximise risk transfer. Effectively contractors mayneed to accept many risks over which they have limited control.
Furthermore, although turnkey (fixed-price/fixed-date) contracts have an excellent on-time and onbudget performance, it remains a challenge for a contractor to calculate the risk transferred within thecontract for three main reasons:
1. The objectives of the client and the contractor may be different regarding risk transfer. In
effect, the objective of a client may tend to be the transfer of as many risks as possible.
Conversely, the objective of a contractor is that they may want to avoid as many risks as
possible. The client is expecting a product as well-built and fit-for-purpose as possible, in timeand on budget. A contractor wants to deliver something simple and quick, to make a profit. It isalways helpful to remember that while transferring a lot of risks may lead to a much higher
price for the client, the underestimation of their probability and impact could lead thecontractor to bankruptcy.
2. The transfer of risks the contractor can’t manage. Many risks a client wants to transfer can’t befully mitigated or handled by the contractor. A contractor can usually fully handle technicalconstruction risks. However, risks related to delayed and/or missing approvals, or interfaces
with third parties, can only be controlled to a limited extent. In many countries third-party
agreements and approval requests can only be signed off by the client itself. To sign off arequest, the client must check the relevant content due to the ensuing legal responsibility. To
undertake these checks qualified staff is needed and in their absence (or limited capacity)
projects end up in a deadlock. The contractor may be contractually responsible to achievethese approvals but cannot control any relevant delays which are a risk to the project.
Contractors are aware of these risks but are not able to quantify them accurately. As a result,they either add a significant contingency to the bid price, or try to offload these risks by legallychallenging the contract from the beginning.
3. The number of detailed risks impacting milestones and completion dates in conjunction withhigh costs foreseen for any related deadline extension. Effectively, common risk management
practices are usually able to identify the obvious risks, like ground risks, financing, politicaldecisions etc. However, major projects nowadays can handle these known risks very
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successfully. Projects are impacted by small unidentified risks many times resulting in years ofdelays and overspent budgets. An example is provided in Box 2.
Other standard forms of contract, such as the New Engineering Contract (NEC) in the UK, seek tominimise liability gaps and disputes through encouragement of a partnering approach, the use of plain
language in the contract, and a dispute resolution process that enables the contract to continue even as
disputes are resolved. It seeks to create the environment for fair treatment of disputes and align theinterests of both the client and the contractor in delivering the project.
Box 2. German energy project – ecological and third-party interface risks26
The project, valued at circa EUR 500 million, involved construction of a 50-kilometre, high-voltage powerline, a section of which was to be constructed underground.
Initial risk analysis identified two broad risks pertaining to that section of the pipeline – groundconditions (“swampy” ground) as well as third-party interface; specifically, the need to engage andnegotiate with multiple landlords as well as transport and utility infrastructure providers. It wasperceived that both risks were easy to mitigate. For example, further ground analysis would enable thecontractor to tailor its construction approach to suit the site conditions, while third-party interface risks
could be mitigated by building-in sufficient negotiation time into the delivery schedule.
However, more detailed analysis undertaken at the early design phase revealed 86 specific risks, anumber of which were related to ecological requirements in major project planning approvals(“Planfeststellungsbeschluss”). One such requirement related to the felling of trees and the migration ofa bat colony to an alternative nearby habitat; a process which could only be undertaken between themonths of November and February (due to bat nesting season). As a requirement of planning approval,
this process needed to take place one year before construction could commence. Its successful (andtimely) completion also relied on third parties, who for example negotiated access to land.
In effect, a (relatively) small project component, due to its long implementation timeframe and bearing
on planning approval, could result in significant risk for a contractor. More specifically, a contractor
would have to commence the process of habitat relocation two years ahead of construction, despite
client expectations that construction would start within months of contract award. Uncertainty is further
compounded by the reliance on third parties.
This highlights how relatively small (non-technical) project components, if not foreseen and addressed
upfront by clients, can translate into significant cost and time variability for a contractor.

Financing requirements
In the case of privately-financed projects, strict lender requirements can present further challenges forcontractors in pricing risks within constrained bid timeframes.
Privately-financed projects are highly leveraged, with debt typically averaging between 80–90% (EIB,2010). By extension, lenders require extensive contractual commitments (and collateral) fromcontractors. This is based on the lender’s own view of construction (and design) risk, and a contractor’scapabilities, with leverage and spread set accordingly. This assessment is influenced by the advice of theLenders’ Technical Advisor (LTA), who is typically procured by the bidding contractor but reports to thecontractor’s lenders (and ratings agencies if bond financed). In order to inform this risk pricing exercise

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RISK PRICING IN INFRASTRUCTURE DELIVERY | WORKING GROUP PAPER | ITF(and ahead of any final approval of funds), bidders must develop designs and construction cost estimatesto a sufficient degree of certainty. This represents a significant governance and timing constraint within
an already highly congested bid programme.
Although clients must ensure contractors are exposed to meaningful levels of liability, this can have a“knock-on” effect on lenders and their requirements, increasing contractor risk premiums as aconsequence. This is particularly the case where clients demand unlimited liability without first assessing
the benefits of increased liabilities (e.g. stronger incentives to perform) relative to costs (i.e. impact on acontractor in relation to their lenders).

Information provision
The sheer volume of information that must be processed by contractors, and that information’s
diminishing utility, in an evolving bid process, is a key source of uncertainty and, in-turn, contributes torisk premiums.
Bidders must process large quantities of information with a team that is typically mobilising as other bids
reach completion and resources become available. Information is also changing, for example throughprotracted clarification questions or updated studies, which may cause bidders to delay certain decisions
until there is greater clarity. In this context, the availability and relevance of information represents a key
cause of uncertainty for bidders with the potential for information to be overlooked or considered toolate to be useful.
This in turn translates into an increased dependence on client-sourced information. However, the extent
to which bidders can rely on information provided by clients (and their third-party advisors) is often
limited. For example, a client may carry out ground investigations for a referenced design using a
reputable organisation but provide it to bidders for “information only” purposes (i.e. on the basis thatthe client bears no responsibility if it proves incorrect). In this case, bidders will look at the quality of thereport and reputation of the supplier in order to form a view on its reliability; with this reflected incontingency levels. Additionally, clients may have legitimate reasons for limiting their accountability for
information provided. For example:
1. The client may not have the expertise themselves to know whether the report is sufficient andaccurate.
2. The client’s supplier may not be willing to bear the risk of very large claims for work given the(relatively) small value of their contract.
3. The client may consider that in accepting liability for the information, it is also opening itself up
to potentially costly claims.
4. The client would prefer to keep the project at arm’s length once awarded and avoid gettingcaught up in ongoing discussions about information it provided at the tender stage.
Additionally, bidders may face an “information imbalance” relative to clients. Indeed, it can be argued
that risk pricing premiums do not always stem from a lack of information (i.e. project uncertainty), butfrom information disparity between clients and bidders and the associated risk of opportunistic
behaviour by the dominant party.
It is clear that, at the start of a bid a client knows (or should know) a lot more about the project than thebidder, who has a constrained timeframe within which to become familiar with the project and its© OECD/ITF 201839

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constraints and a reduced opportunity to gather primary evidence (e.g. limited access to land fortesting).
However, information imbalances between clients and bidders are not necessarily fixed for the life of the
project. Entrenched imbalances reverse once construction commences due to a contractor’s superior
technical knowledge gained through construction activities. Information asymmetry may also occur in acontractor’s favour, such as when a contractor has unique technical or design knowledge, resulting in a
price premium.
In summary, information in the bid process can be considered a trade-off. On the one hand, clients must
avoid the liability gaps and risk-shifting that can occur when they retain too much accountability for
information provision. On the other-hand, insufficient information or overly limited assurances serve toincrease contractor uncertainty, with bidders required to take a view on information accuracy andaccommodate this in risk contingencies with premiums ultimately passed through to clients via a bidder’s
final contract price.

Timing constraints
Timing constraints are a further key challenge for contractors in pricing risk. This applies both when bid
processes are too short and when they are subject to unscheduled delays or uncertainty about theirtimely completion.
As a general principle, a longer bid timeframe translates into lower levels of uncertainty for bidders (andreduced risk allowances). It follows that time constraints increase uncertainty, due to the reduced
opportunity to gather accurate information and, if under a bundled delivery model, to refine designs. It
can also impact the depth of quantitative risk analysis that can be undertaken.
Conversely, uncertainty also increases when bid processes are unexpectedly prolonged or subject to thethreat of discontinuation. Indeed, bidders will typically set an upfront bid budget which they may be
unwilling or unable (for internal governance reasons) to extend, with significant extensions likely to seebidders reconsider their involvement. If a project is temporarily paused, there is a risk that thecontractor’s bid team members are moved to other projects from which it may be difficult to extract
them if a bid process re-starts. The consequential loss of knowledge and momentum can lead to a
reduction in the quality of bid and loss of confidence in the client, increasing risk to the bidder.
Delays, particularly at the award stage of a project, also introduce risks relating to environmental andplanning approvals. For example, a delay of several weeks can trigger delays of six months (or more) toenvironmental surveys or construction activities, forcing a reprioritisation of construction activities atbest and overall programme delay at worst. The extent to which the impact of these approvals andpermits become detrimental to the contractor is related to contract design and in particular risk
allocation, as mentioned previously.
Ultimately, if a contractor is able to gain confidence that the client team is well managed and is likely todeliver on its own programme, it allows the contractor to take a more optimistic view of the potential forsignificant delays (or of a client’s capacity to navigate these risks in an efficient way) thus moderating therelevant contingencies.

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Risk pricing approaches
Risk pricing is also subject to challenges which can be considered endogenous in their nature, i.e.
challenges inherent to the process of risk identification and estimation. Box 3 outlines a typical risk
pricing approach noting that in practice approaches vary by contractor and project. In particular,
challenges stem from the reliance on individual or team experience and their biases, as well as on
deficiencies in harnessing and properly interpreting historical data.
Box 3. How are risks priced in practice?
In the first instance, contractors identify the full range of relevant risks, typically with the use of a risk
checklist or matrix, and with risks categorised along lines such as:27•

construction risk (e.g. utility company delays, labour disputes, changes by the State, poor quality
control)•default risk (e.g. termination)•

design risk (e.g. approvals and consents)•

external risk (e.g. changes in standards)•

force majeure risk (e.g. weather, catastrophic events, major political events)•

other market risk (e.g. interest rates, currency fluctuations, inflation, refinancing)•performance risk (e.g. scope creep, system expansion, third-party claims)•

political risk (e.g. public-sector budget cycles, change in law, change in taxation)•site risk (e.g. access risks, permit risks, environmental constraints, latent defects)•

strategic risk (e.g. changes in ownership, conflict of interest).

A common approach is to then allocate risks a relative value (e.g. on a scale of 1-5) for probability as wellas consequence; with consequence assessed through the lens of cost, time and quality (measured indifferent ways dependent on the project), as well as impacts on: environment; reputation; safety andsecurity; stakeholders and partners; client activities, etc.
On this basis, risks are allocated a total value (i.e. “probability x consequence”), which can either bemeasured at an individual risk level, group/classification level or in aggregate across the project.
Typically, contractors will compare values pre- and post-mitigation, with the latter incorporating changes
made to reduce a risk’s probability or consequence (or both). In developing a mitigated score, acontractor must trade the cost of the mitigation with the anticipated reduction in risk. Thus, the baseprice becomes more expensive even as post-mitigation risk may be reduced.
The allocation of ranges and treatment of the scores often varies between organisations and projects, sothat direct comparison of one organisation’s risk evaluation or even another project within the sameorganisation is unreliable at best or misleading at worst. Bidders usually collate their risk information torun a Monte Carlo simulation analysis in order to derive a confidence range for the risk allowance andhence give a price and probability for the selected risk allowance. One contractor interviewed for thisreport cited an example where the Monte Carlo analysis yielded a risk allowance of 1-2%, which was
rejected by the Directors as too low and was overridden by a higher subjectively-based amount reflecting
a more “normal” allowance.

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Example: Risk assessment for a North European highway construction project

Figure 8 shows risk scores from the assessment of a contractor’s risk register during the tender phase ofa highway project. Each risk identified has been scored on a scale of 0 to 5 for chance (likelihood),
finance, time, safety and quality categories, before and after mitigations. Aggregate scores in eachcategory are shown below, with the change achieved by mitigation contained in the third table.
Figure 8. Change in risk score through mitigations
Pre-mitigation
Score
Chance Finance Time Safety Quality Sum
5
6
6
23
2
2 39
4
22
3
9
1
1 36
3
34
17
22
0
3 76
2
60
57
33
2
7 159
1
14
45
38
0
2 99
0
0
8
11
131
121 271
Sum non-zeros
136
128 1255
15 409Post-mitigation score
Score
Chance Finance Time Safety Quality Sum
5
0
2
2
0
2
6
4
1
0
0
0
0
1
3
1
4
2
0
0
7
2
5
0
1
1
0
7
1
129
3
3
2
2 139
0
0
127 128133
132 520
Sum non-zeros
136
9
8
3
4 160

Change
Score
5
4
3
2
1
0
Sum non-zeros

Chance Finance Time Safety Quality Sum-6-4 -21
-2
0 -33
-21
-3
-9
-1
-1 -35-33-13 -20
0-3 -69-55-57 -32-1-7 -152115-42 -3520 40
0119 1172
11 2490-119 -117-2-11 -249

This example shows that mitigation was able to bring the chance of almost all events to a score of 1 (i.e.
very unlikely), and the severity scores for most categories to zero. This results in a more manageable
number of risks with a chance category of 2 or more, provided that the mitigations identified are actuallyprovided. However, as outlined, mitigations can themselves represent a cost, which will be reflected in
the overall bid price.

Unconscious bias is one challenge, particularly where a given risk (or its assessment and/or mitigation) is
beyond the direct experience of a team (HSE, 1999; Creedy, 2006). Conversely, the same holds when ateam or individual has direct experience which impedes an objective assessment. Bias can also stemfrom the language used to define a risk (Tversky and Kahneman, 1981).
A lack of consistency in approach is a further challenge. With methodologies and risk scoring varying
between projects, senior management can lack an objective basis on which to compare risks and identify
potential similarities or errors between projects. To a large extent, this reflects the difficulty incomparing projects and the associated lack of (objective) statistical data. Even two highway projects
within the same country may vary greatly in terms of scale, topography, technical challenges,
environmental constraints, contractual terms and other contextual issues.
Reliance on assessment methods that use interval levels of measurement (e.g. 1 to 5) is a further factor.
While such conventional methodologies can assist risk prioritisation, they are limited in their capacity todetermine relative degrees of risk (Leitch, 2010). For example, a given risk that scores twice as highly as
another within a limited range (e.g. 1 to 5) may in fact be several multiples greater in terms of its actual
impact. These methodologies can also draw attention away from important but middle-ranking risks. For
example, a low probability but high impact risk, e.g. a risk allocated 1 (for probability) x 5 (forconsequence) scores 5 and will be given a lower priority in a matrix where other risks score twice as
highly (e.g. 3 x 4 = 12), despite its potentially catastrophic consequence.
Methodological risk pricing limitations also reflect the realities of the bid process. Contractors, working
under time constraints and with access to limited (and potentially evolving) objective data, must
calculate the likelihood and consequence of a multitude of risks identified. Similarly, assessment
methods are simplified to fit within timing constraints, increasing reliance on individual experience. As aresult, opportunities to reduce uncertainty (and contingencies) through more comprehensive
assessment and data collection are foregone.

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What can public authorities do to improve risk
pricing for contractors?
Risk pricing is far from an exact science, and is subject to varying endogenous and exogenous influences.
However, this does not preclude the need or opportunity for efficiency gains.
By returning to first-principles this paper has demonstrated that the accuracy and efficiency of risk
pricing is a function of uncertainty. The greater the uncertainty the greater a contractor’s demands in theform of buffers, safety-cushions and contingencies. It follows that if clients are to bring down risk
premiums, they must reduce uncertainty. The pertinent question is how uncertainty can be reduced
without creating risks of adverse selection or moral hazard.
Drawing on practitioner input, this section outlines tangible suggestions that clients could follow to
reduce uncertainty in a bid context. Specific recommendations are grouped along five themes which
follow the timeline of project implementation:•

design clarity (and flexibility)•

risk identification, allocation and mitigation•

information provision•delivery models•

bid process (timeframes, criteria and clarity of objectives).

In particular, a recurring finding is the opportunity – through the use of a reference design – to address
design-related uncertainties, without prohibiting bidder-led design and delivery method optimisation.
Reflecting on the findings of preceding sections, the need for clients to evolve their delivery approaches
to reflect the growing complexity of major projects is a further common theme.

Design clarity (and flexibility)
Design clarity, design flexibility and contractor innovation do not necessarily negate each other. Rather,clients can provide contractors with greater design clarity, thus reducing uncertainty, whilst preserving
scope for private innovation through the provision of different degrees of flexibility.
It is important to acknowledge, however, that not all clients are looking for and/or are mature enough tohandle design flexibility and/or innovation, as well as not all delivery models are conducive to facilitating(and managing) relevant opportunities. In that sense recommendations on design clarity and flexibility
must become conditional in order to become more specific.
Under a DBB delivery model clients should produce a complete, detailed, fully
approved and fully costed design before tender issue.

Under DBB delivery the client, more often than not, is not looking for design innovation and/or does nothave the capabilities to engage in a delivery model that can handle design flexibility and/or would enable
design innovation from the contractor’s side. Instead, the procuring authority simply wants to contract
the construction of a rather simple asset where design innovation is not a project objective. In this case

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the client should make sure that the design that goes to tender has been “de-risked” as much as
possible, by elaborating all necessary design details and obtaining prior approvals/permits, to avoid
future claims by bidders after contract award. The client should, nevertheless, be prepared for claims
resulting from problems arising from the mandated design (such as unforeseen ground conditions orother). Under such circumstances contractors can focus on pricing their bids under design certainty andwithout having to worry about obtaining approvals/permits.28 At the same time the client can use its own
full cost estimate of its design as a benchmark, either by releasing it to contractors during the tender
process and guiding their bids, or by using it internally as a comparator for the evaluation of bids
received.
Under DB and EPC (PPP) delivery models clients should, at a minimum, produce afully costed reference design before tender issue.

Under these delivery models, the client is usually looking to harness the innovation capabilities of themarket for a more complex asset and/or has the capability to manage the interaction with bidders undera more elaborate delivery model. In these cases, balancing design certainty versus flexibility and bidder
innovation can take place through the development of a reference design in accordance with the
project’s functional requirements. This process can also assist clients to better understand the viability ofthe objectives they are setting. The reference design should be approved by the system operator, or
their representative, to ensure that it is acceptable to them and to give contractors confidence there isan accepted fall-back design solution.
The reference design can provide flexibility to bidders by being detailed in some areas and not in others
depending on planning conditions, project complexity or any areas the client has particular interests in.
The client should set a bid timeframe that enables bidders to evaluate it and identify opportunities tofurther improve it, potentially by also considering a “competitive dialogue” phase ahead of final bid
submission. Bidders can then be allowed to change, replace, and/or take specific parts of the reference
design as they see fit, as long as it is clear that they also take responsibility for the design sections which
they did themselves or amended.
Talking bidders through the reference design, so that they understand the objectives and key influencesin developing a complete solution, can deliver further benefits.29 In particular, this provides contractors
the opportunity to ask questions, in confidence if necessary, about why alternate designs were not
adopted and whether the client had considered different approaches. This can save contractors time bysteering them away from ideas that have been considered and rejected for valid reasons, but can also
allow them to test more innovative solutions with the client team before committing to them.
The reference design should be fully costed by the client and the cost estimate shared with allparticipating bidders. While the cost estimate will only correspond to the level of detail of the solution
contained in the reference design (which will not be complete), it can still help bidders price their own
solutions with relative certainty when it comes to meeting the project’s functional specifications. At thesame time, it will enable bidders to identify opportunities to realise efficiencies/savings within project
objectives by differentiating themselves on price or design efficiency based on any amendments they
have made. Additionally, clients will be able to determine where any additional costs (in final bids) stemfrom by comparing bidders’ final submitted designs to the reference design during the evaluation
process. However, a guiding principle should be for the reference design to help identify the best overallvalue that meets the project’s functional requirements and not to fix the cost by inventing a target price.
In cases where a DB or EPC (PPP) delivery model has been selected without the client having thenecessary capabilities to manage the interaction with the bidders, then bidders can be uncertain as to44© OECD/ITF 2018

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what status a reference design holds and the extent to which it may be altered. They need tounderstand what degrees of freedom are available and what would be considered an improvement or
degradation in the design. If they do not understand these principles, bidders may blindly adopt thedesign and build in unhealthy risk premia leading to an increased price. Similarly, they will miss theopportunity to introduce improvements and innovation.
Having the right capabilities on the client’s side to manage the process in terms of tender timeframe,interaction with bidders, etc. is a pre-condition in order to engage in DB or EPC (PPP) delivery. If theclient does not have these capabilities the recommendation is to avoid these delivery models altogether
and fall back on DBB delivery and its corresponding recommendations.
Under collaborative delivery models (e.g. ECI) clients should produce a fully
costed reference design before engaging with the private sector.

Producing a reference design under the case of collaborative delivery models (e.g. ECI) is still a pertinent
recommendation. Although in such models the final design solution to be tendered will be the output ofcollaboration between the client and the bidders, having an initial reference design on the client’s side
can help frame the discussion and avoid wasting time exploring solutions that do not meet the client’s
functional requirements. It can also provide a benchmark for the cost of the final solution in relation towhere the discussion started from and thus help rationalise from a cost perspective the final design to betendered.
In DB, EPC (PPP) and collaborative delivery methods, clients should maximise(and clearly channel) opportunities for contractor-led design and innovation, if
these lie within project objective.

If pursuing innovative solutions from the market is within a client’s objectives, then the set-up of the
project must be such that maximises related opportunities. While there may be situations where design
is heavily constrained by standards, or other land, property, environmental and legal (among other)
restrictions, this is unlikely to affect all of the design. Therefore, any available degrees of freedom should
be reflected in the reference design, which should address the minimum requirements to achieve
approvals but need not be optimised, leaving room for bidders to do so. In effect, a reference design canin this case reduce uncertainty whilst enabling (and better channelling) contractor innovation.30
Transparent scoring of reference design components (for the purposes of bid assessment) can assist inachieving these goals. For example, a specific reference design feature for which a client is seeking
improvements can be scored lower if retained in a final bid (e.g. 5 out of 10), while a feature a client
wishes retained (or which is considered integral to planning approval) will be scored higher to lessen
bidders’ incentive to explore alternatives.
Ultimately, this recognises that design innovation is not “broad-brush”, but rather should aim to leverage
the comparative advantages that bidders have over each other.
Similarly, there may be specific elements of a project that require an advanced level of design in order tosecure necessary approvals. By taking a reference design through the approvals process, but building insufficient design flexibility by agreement with the permitting authority, clients can reduce contractor
approvals uncertainty whilst preserving scope for contractor optimisation. This approach is practicallyillustrated in the UK tunnels case in Box 4.
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the bidder’s own risk. Clients may invite all bidders to contribute to the commissioning of surveys andwill share the findings with all bid teams - however this may undermine a bidder’s willingness to propose
investigations that give away their ideas.
Box 4. Reference Design in a UK tunnel project
The client team prepared a reference design for a twin-bore tunnel that needed to follow an ‘S-shape’ inplan due to various geographical constraints.
The reference design was taken through the statutory planning process with generous limits of deviationin key areas along the route so that contractors had flexibility in their alignment and the positioning of
emergency intervention shafts at surface level.
In other areas, the client team determined that due to additional constraints the limits of deviation
would have to be much closer to the proposed reference design alignment. This approach allowed
bidders to adopt different tactics in their designs but all were viable within the planning approval granted
to the scheme.
On other schemes where the client attempted to optimise the alignment and minimise limits of deviation
unnecessarily, the contractor has either been restricted to a sub-optimal solution, or has had to seek
additional permits and purchase more land in a weak negotiating position.

Clients should develop clear functional specifications
Clients should set out in clear and measurable terms what functionality the project is to achieve, thus
adding clarity to its design. This is likely to include a mix of mandatory (“must have”), targeted (“should
have”) and desirable (“could have”) requirements depending on the degree of allowable flexibility.
For example, rather than specifying that a contractor produce a four-storey building in a specific location,
the client could express the objectives as accommodating up to “P” people to a minimum
accommodation quality standard “S” within a plot boundary defined and not obstructing the statutory
sight lines between viewpoints “VA” and “VB”. This output-specified approach gives the contractor
freedom (flexibility) to solve the problem in a variety of ways, but equally it requires the clientorganisation to think carefully about what it really wants to achieve.
It is also valuable for clients to consider the requirements at each stage of the lifecycle, rather thansimply the first day of operations. Requirements may vary for each of the infrastructure lifecycle stages
shown (specific projects may have other operational situations also):

46•

construction•

testing and commissioning•

normal operations•

special operations (major events, environmentally difficult conditions such as high winds,
flooding, etc.)•

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replacement of major assets•

decommissioning.

Defining functional requirements and identifying the means to verify and validate solutions against themis consistent with a classic systems engineering approach and provides a framework for appraisingalternate tenders. It also reduces the fundamental risk that the project fails to achieve its objectives.

Risk identification, allocation and mitigation
Clients should follow established risk allocation principles

In defining which risks a contractor should bear, a key objective should be minimising the overall cost ofrisk, rather than maximising incentives through risk transfer.
Cost efficiency is best achieved by following established risk allocation principles, i.e. on the basis of aparty’s capability to manage and capacity to bear (Ward et al., 1991; World Bank, 1997; Pantelias andRoumboutsos, 2015). The reasons are intuitive: a party best able to manage a risk has the greatest
opportunity to reduce the likelihood of occurrence, while a party able to bear a risk can best cope with
its impact should it eventuate. In effect, allocation in line with these principles serves to minimise thetotal cost of risk and bid costs. By extension, where clients transfer risks to a contractor over which acontractor does not have sufficient control, this will result in a premium. This can also be consideredthrough the lens of incentives. When allocation creates little or no incentive for positive behaviours - orworse, encourages negative behaviours - it is better for the client to retain that risk themselves.
In this context, benefits stand to be realised through a more bespoke approach to risk allocation, andgreater consideration of the costs versus benefits of risk transfer.
As a practical example, greater consideration should be given to the retention of permit risk, for instanceby ensuring that necessary permits are in place prior to the award of a contract, and - subject to permit
expiry dates - prior to the tender process. This would serve to reduce the risk of the contractor suffering
delays after project award and incurring penalties for events that may in reality be outside of their fullcontrol. It also recognises that permit-issuing authorities often lack the resources to respond to multiple
bidder enquiries.
Clearly, certain permits will be dependent on the detail of a contractor’s design, in which caseresponsibility should remain with the contractor. However, clients may still have a role to play in
reducing the contractor’s risk. For example, it may be possible for the client to arrange talks between thepermit authority and the contractor(s) or otherwise to work with the authority to determine the boundsof design acceptability so that all contractors understand the likely conditions of any permits, reducing(but not removing) the risk of rejection.
Clients should consider the benefits of joint risk management

Development of a joint risk register, where all parties involved in the project map their risks against
potential mitigations and their costs, may provide significant benefits. In particular, this process can
assist to identify which party is able to mitigate or manage a given risk at the lowest possible price,
thereby lowering the combined cost of risk across a project. Relatedly, this can help inform clients as to
the risks for which it is in their interests to mitigate ahead of the tendering process (i.e. risks the client
can control or bear at lower cost). An example of the use of a risk register is presented in Box 5.

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The caveat of this approach is that it assumes that no one party is able to engage in opportunistic
behaviour due to its position in the market or other factors. In short, it requires a project environment
where all parties are equally invested and willing to share critical information.
Requiring contractors - perhaps through tender requirements - to more systematically identify, quantify
and explain factors driving up risk premiums, may also assist efficient allocation, with clients better able
to see cost drivers, negotiate changes and identify potential mitigations. However, as outlined, before
additional tender requirements are placed on contractors, clients should fully assess their cost
implications versus their expected benefits.
Box 5. An excerpt from a risk register for a EUR 500 million power line project
A well laid out risk register presents potential events in a structured and a manageable way. Hitting the“sweet spot” in its structure without becoming too high level or too granular requires ex ante and ex
post experience. The example below captures one line in a risk register consisting of 243 risks.

The baseline estimate of risks identified in this particular project (i.e. the cost should they all occur) was
about EUR 30 million; approximately 6% of the total budget. The probability-adjusted risk budget was
about EUR 13 million or 3% of the total project budget. Provided all the key risks were identified thisproject was not particularly “risky”. Given the evidence presented on decision making under uncertainty,
the outputs of risk registers are not included in bids at their face value. Any such exercise involves asubstantial amount of guessing and ultimately it is the contractor’s management board that has todecide how much faith they have in these estimates.

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Clients should evolve their risk management approach to reflect the growing
complexity and evolving risk profile of major project delivery

A recurring theme of this paper has been the increasing complexity of the major project environment,
and evolving risk profile from a contractor perspective. This shift brings into question the validity of
traditional project and risk management approaches.
For contractors, uncertainty increasingly stems from third-party (including community) interface orapprovals, rather than the conventional technical considerations of delivery. In other words, premiums
are being driven up by risks which may seem small in isolation, but which are closely inter-linked andhave significant domino-like effects.
It follows that in order to target uncertainty at its source client risk management approaches must also
evolve. Specifically, clients must look beyond the major risk categories (e.g. design) and increase theirattention to the finer details. This will require a more granular and bespoke approach to risk
identification and allocation, and a greater upfront focus on the mitigations that can be put in placeahead of construction, and potentially ahead of tender commencement. Such a risk management
approach is outlined in Box 6 and could provide a solution to some of the challenges discussed in thispaper, especially when it comes to increasing the client’s ability to identify small but highly impactfulrisks.
Box 6. Baseline report: A detailed risk management approach from Germany
As stated earlier in this report, major projects are not only impacted by well-known risks, such as groundconditions or construction failures. These are risks that can be identified in the early design stages andeffective mitigation methods can be put in place in case they materialise. Once mitigated thecorresponding risk cost can be easily allocated between the counterparties.
Major projects nowadays are impacted by “small” risks, such as missing approvals and permits, ordifficulties in accessing small pieces of land. Although the headline cost of these tasks and their possible
mitigation measures are often tiny, their impact to the project can be commensurate to the impact ofwell-known major risks. “Small” risks, if and when they appear, may delay a project in the same way that
big risks do, resulting in the same additional overhead costs (for example a major project may often have
overhead costs for 500 or more staff per year) and/or incurring any relevant penalties. To identify these“small” risks a more detailed risk management approach is necessary.
The approach presented below has been designed and implemented in public projects in Germany. It
follows common risk management processes but is far more detailed than average.
In terms of a general overview, the proposed approach is based on the use of a (so-called) Baseline
Report (BR).31 The BR is developed in the early stages of project development. It aims to identify all thetasks that need to be undertaken within a project and provide their descriptions in as much detail as
possible. As the project design evolves from its initial conceptual form to more advanced stages, the BR
is updated to reflect changes or clarifications to originally defined tasks. This development and updating
continues all the way until the project reaches the procurement stage at which point the BR is locked-in.
When it comes to risk management, the BR is used to identify any risk or action that is relevant to any ofthe project tasks based on a sequence of five steps:
1. Similar to common risk workshops, the first step is to identify risks. However, risk identification
does not focus just on the most common ones and/or the ones based on the experience of the
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have been reviewed. As a result, the client, from the very early design stages of the project, canbe confident that a very high proportion of possible risks have been identified. These risk
workshops are held under the attendance of the entire project team (many times divided in
sub-teams) thus minimising and mitigating one of the biggest project risks, i.e. the lack ofappropriate information transfer and communication within a project team that often has ahundred people or more.
2. Similar to the first step, the entire team will identify possible mitigation actions for each risk
within each project task. This process transforms the project from having a reactive risk
identification status to having in a proactive risk mitigation status.
3. Estimate the related risk costs per task, but more importantly, the possible costs arising frommitigation actions.
4. Define the probability of occurrence of each risk within its task.
5. Calculate the overall project risk budget with the use of Monte Carlo simulation.
The immediate benefit of the BR approach is that each task will have its own risk description and, if
necessary, the calculated mitigation budget in case a risk materialises.
Furthermore, to maintain risk awareness it is recommended to report the outcomes of these risk
workshops during each design stage, all the way until procurement, once discussions have started withpotential bidders. However, the workshop that takes place immediately before the start of project
procurement is the most important one. During its course the project team will not only identify andmitigate risks, but will also identify which risks can realistically be allocated to a contractor.
A final point for maintaining this proactive risk awareness culture within a project team is theestablishment of a strict governance regime for all project phases (i.e. design, procurement,
construction, commissioning, etc.). This takes the form of a recurring monthly meeting where
attendance is compulsory for every member of the project team. During these meetings the project risk
register will be filtered for any new risks that may have emerged through the evolution of design but also
for any task where risks may materialise within the next three-month period (this future outlook period
may be different for different risks). Any filtered task and risk will be discussed and mitigation actions
agreed. In case of already developed mitigation actions, these may be modified if necessary by using acontrolled change order process without losing sight, however, of the initially estimated mitigation costs
embedded in the overall risk budget.
Overall, through the implementation of such a detailed approach the client can have reasonablecertainty that before procurement:50

Most of the risks will be identified.



Mitigation methods will be in place.

Defined risk costs will be allocated to counterparties.



Uncertainty will be reduced very significantly, with any remaining uncertainty being reflected in
the client’s contingency but not in the contractor’s risk pricing.



Risks have been allocated to the party best able to manage them and/or to bear them.

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Information provision
Clients should facilitate information provision

As a general principle, clients should prepare and provide as much contextual information as possible
before a tender process begins.
The political and economic imperative to deliver a project as soon as possible creates a natural tension
between project advancement and appropriate preparations. Nevertheless, careful consideration of theinformation required before inviting contractors to tender is likely to result in a smoother procurement
process and a better price.32
Relatedly, it may be desirable to engage with potential contractors at an early stage, perhaps at an“Industry Open Day”, to outline the project and proposed delivery approach, and to seek feedback on
information requirements. It is to be expected that there will be difference of opinions but reachingconsensus may also be possible. It may be valuable to share some early ideas or information withpotential bidders even in advance of this meeting to give maximum opportunity for informed input.
Information that contractors will typically wish to have available with tender documents include:

design informationoreference design (fully costed) if under a DB, EPC (PPP) or collaborative delivery models

ocomplete design (fully costed and approved) if under a DBB delivery modelcomplete list of approvals, obligations and permits which have to be fulfilled during construction,
subdivided in client’s responsibilities and Contractor’s support or the other way around

counter-party responsibilitiesclient risk register (fully costed)

topographical surveys (and aerial LIDAR/photogrammetry survey sufficient to form a 3D Building
Information Modelling (BIM) model if possible)

ground investigations of suitable detail to facilitate outline design and pricing



pollution identification

unexploded ordnance (explosives)buried obstaclesutilities surveys

environmental statement/initial studies including significant historical events, such as flooding
recordsrecord drawings/structural assessment data of any significant structures that the scheme isdependent on.

There will be other requirements reflecting the specifics of each project, but a basic principle is to
identify the information that either requires specialist access, would take a bidder a long time to obtain,
or is likely to be needed by all bidders regardless of their chosen solution.
To this end, information provision can be considered an effective (and efficient) means of reducing
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for heavy traffic. Ordinarily, a contractor might demand a premium due to the difficulty in pricing traffic
disruption risk. Public sector clients are likely to have more accurate information on traffic flows which, if
shared with bidders, would enable more accurate risk pricing.
A further salient point is organising and signposting any information to be shared ahead of its releaserather than “dumping” it all in a virtual data room. A major frustration of contractors during the bidding
phase is sorting out useful from non-useful information under constrained time frames. While organising
the information to be released requires the commitment of ex ante additional resources on the clientside, the resulting benefits could be multiple: starting from the client itself realising and mitigating any
significant data gaps, to facilitating more efficient use of information by bidders and supporting moreaccurate risk pricing.
Clients should, where prudent, facilitate improved data reliance

Improving data reliance for contractors is an obvious opportunity to improve pricing efficiency. For
clients, this recognises that large premiums stemming from data-related risks are ultimately passed onby contractors in their final bid price.
As outlined, it may not be practicable (nor sensible) for clients to bear full liability for all data provided,
given that much of it will have been provided by third parties, and has the potential to create future
liability gaps. On the other hand, clients generally have greater control over data procurement, and agreater capacity to identify competent people or organisations to procure, manage and deliver
information for use by bidders. Clients may also have a greater capacity to bear risks relating to data
deficiencies.
Information may be provided with clear caveats as to its validity and use, in order to limit spurious claim
opportunities. Contractors should also be incentivised to declare any omissions, contradictions, or otherfailings they identify at the earliest possible point. The client’s advisors or suppliers should also bearreasonable liability but cannot be expected to carry the full impact of a major claim or they refuse toprovide the services. The due diligence process required to achieve this is broadly similar to that which
all bidders would ordinarily have to undertake, but within a more constrained timeframe and withpotentially less access to key sites. Where necessary, the client may wish to take out insurance against
potential claims.
Risk-share may be another option, whereby a contractor bears the first part of any claim up to a
pre-declared limit, after which the risk is shared with a client. This could be used for the risk ofcatastrophic events (if not covered by force majeure) such as major collapse of legacy infrastructure or
significant changes not under anyone’s control that would lead to very high contingency costs if thecontractor were made to bear all of the risk. This should strike a balance between avoiding spurious
claims and containing large risk premiums.
Both the public and private sectors should improve consistent data harnessing
and application

It is not possible for all events to be definitively assessed for statistical patterns, however, there is clear
scope to improve risk pricing methodologies and, relatedly, to better harness and apply historical data.
This will serve to strengthen the scientific basis underpinning risk analysis, as well as instil greater
objectivity in pricing decisions.
While governments have a leading role to play in this regard, responsibility also extends beyond
government to include clients and their industry organisations.
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Delivery models
Clients should adopt delivery models that promote collaborative relationships andincentivise a shared focus on delivery

Predominant forms of infrastructure delivery (e.g. DBB and EPC) are inherently adversarial in their nature
with risks of dispute between parties. This reflects both the large number of parties involved and relianceon (incomplete) contracts to govern relationships between them.
New delivery models such as ECI and Alliancing have not been tested widely enough to enable a
consistent understanding of their true benefits and pitfalls, but the recent development and launch of
ISO 44001 reflects the wider shift towards collaborative approaches that align the behaviours andprocesses of all parties for the benefit of the project rather than any one organisation.
The consideration of the delivery model and the contract design that underpin the delivery of a projectneed to be considered in the context of project characteristics and other contextual implementation
parameters, such as the capability of the procuring authority, the maturity and strength of the local
construction industry, etc. It is only when all these parameters have been considered, that appropriate
models can be put in place that will promote positive interactions between the various parties andenhance the efficiency of project delivery, risk pricing included.
As an example, over the last 20 years, the UK has developed the NEC suite of contracts, now in its fourth
edition, based on partnering principles.33 Although PPP contracts are likely to require a more bespoke
approach, the philosophy has been tried and tested worldwide with positive outcomes on contract
performance and project delivery. Notable examples of major projects in the UK delivered through thismethod are the 2012 London Olympic facilities and the Crossrail project. The caveat is that the
combination of the delivery model and contractual design for these projects were successful because of
the characteristics of the projects, the capabilities of the corresponding procuring authorities, and thematurity of the UK construction industry. Similar projects in different countries may have required adifferent delivery model and contract design to be successful.
Clients should possess or have access to the necessary capabilities required forthe successful life-cycle management of infrastructure projects

Literature review, as well as practitioner input, stresses the importance of client capabilities in delivering
successful projects. These capabilities are related to the client’s ability to define project objectives(including whether design innovation is one of them or not), understand the trade-offs of risk allocation,
select the appropriate delivery model, design and manage the procurement process, and manage all
relevant contracts until the end of the project’s life-cycle. In the face of evolving project complexity andrisk profiles, such capabilities are important not only at the front end of the project but also at the backend when contract renegotiations may become necessary.
Developing these capabilities is neither easy nor cheap. First and foremost, skilled and experienced
professionals are in high demand in the industry and would require remuneration packages that arecompetitive in the market. Whereas private sector clients can afford to pay competitive salaries, public
sector clients may be restricted by pay-caps, thus limiting their attractiveness as a potential employer for
highly experienced professionals.
Secondly, justifying the cost of an internal team (inclusive of continuing training requirements) depends
on the volume and intensity of work that the client is facing. A long-term pipeline of large projects may
justify the development of a competent team in-house. A more limited outlook may not.

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A way around these constraints has been to depend on external advisors who can complement internallyexisting capabilities on the client’s side. However, even this approach is not always failsafe as external
advisors’ maximum remuneration could still be capped thus limiting the range of experience that can be
hired. Another difficulty is that advisors may move on to different clients after the completion of a
project thus requiring constant replacement, which takes time and may lead to different levels of
support as their skills may vary.
An interesting approach, seen in Denmark (but also elsewhere),34 involves the development of acorporate entity which becomes the client and which is separate to the sponsor of the project which isstill the public sector. Under such a corporate structure pay-caps may no longer be applicable thus
enabling the recruitment of highly skilled internal teams that can manage the delivery of big, complex
projects very effectively and efficiently.
Overall, possessing the necessary capabilities is of paramount importance in delivering successfulprojects. In the absence of such capabilities clients should aim to avoid complex delivery models (e.g. DB,
EPC or ECI) and aim to follow recommendations for implementing simpler ones, such as DBB.

Bid process: Timeframes, criteria and clarity of objectives
Clients should set out, and follow, a clear tender programme

In recognition of the duration and dependencies of key tasks, client teams should run the tender as aproject in its own right, with built-in contingency and project management measures to ensure adequate
resourcing, proper planning and deliverability to budget and time.
A professional approach to the tender management process also increases the credibility of the clientwith bidders. More broadly, it sets a high standard for overall management of the contract delivery
phase, reducing risk from all parties’ perspectives.
Clients should ensure bid timeframes correspond to the delivery model used

Clients need to carefully consider the experience of their own organisation and that of other publicbodies in procuring projects of similar scale and complexity before committing to a programme of work.
The choice of the underlying delivery model will be critical in determining whether longer or shorter
timeframes would be necessary.
In particular, depending on the model used, fuller upfront consideration is needed of the time involved
in data-sourcing, such as environmental surveys (which can be seasonally constrained), and statutory
planning or permit processes (which can be subject to mandatory consultation periods).
Relatedly, delivery schedules should reflect the time required to negotiate with relevant third-parties,
such as landowners or utility companies who may need to grant access to land or assets.
Sufficient time to consider and evaluate provided designs also needs to be factored in. Especially in cases
where bidders are expected to modify and improve initially provided design solutions, a lack of time maylead to higher risk premiums when it comes to meeting functional requirements and achieving client
objectives.
Additionally, where clients are asking for committed bids in the context of an EPC (PPP) delivery model,
they should recognise that lenders are only willing to hold their financing quotes for a few months, so
protracted bid evaluation, negotiation and award processes can put this commitment at risk.
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Clients should minimise ambiguity in tender financial requirements

Clients need to set out clear project and tender financial requirements, so that bidders understand what
is required of them from an early stage.
This is particularly the case for formulae affecting the financial models of bidders, such as priceindexation. It can be time-consuming and introduce risks of hidden model error where clients makefrequent changes to their financial formulae or the architecture of the model.
It is sometimes appropriate for the client to develop their own model for bidders to complete, but clear
rules are required on what amendments are acceptable. Such models should have checks built-in thatbidders and evaluation teams can use to ensure they have completed the model appropriately.
Clients should consider in detail the cost, time and risk implications of bid
requirements

In bid processes clients need to more precisely weigh the additional tender requirements that are placedon contractors against the benefit that these requirements provide.
For example, a tendency exists for clients to require bidders to include significant design or assessment
work for issues of relatively small consequence, with associated risks of distracting parties from moresignificant issues. This is illustrated in the UK rail project case in Box 7. The risk is that client-side experts
specify a high level of detail in the tender to satisfy their curiosity, but in doing so require a level ofbidder effort disproportionately greater than the reward bidders can gain in the scoring mechanism.
Greater balance between the true value of information to the client and the level of detail required in
the tender would lead to more efficient tenders.
Requirements relating to contractor liabilities are a further example. Clients must more fully consider the
trade-off between liabilities (risk) and financing impacts, recognising that unlimited liability contractual
obligations may significantly impact a contractor in relation to their lenders, for little additional benefit(by way of increased incentive). A more nuanced approach, such as tailoring limits by project phase, may
achieve a more efficient balance between incentives and cost.
Box 7. Disparity in bid effort against bid reward
One example of spurious detail is a rail project in the UK where the bidder was required to provide routedesigns, power demand models and journey time analysis to a relatively advanced level of design
confidence. This amounted to several person-years of activity during the bid phase, consuming aconsiderable proportion of the bid budget but was worth less than 5% of the bid marks available.
Clients should provide clarity on the trade-off between “value” and “cost” in bid
assessment

A lack of clarity on the trade-off between value (i.e. client and user benefits) and cost (i.e. funds required
to deliver it) can increase bidder uncertainty and reduce innovation. For example, a client mayemphasise their desire for innovation and quality outcomes in tender documentation, but then basetheir award decision overwhelmingly on the lowest cost, undermining the ability of bidders to achieve
the former objective.
Greater upfront clarity on this trade-off, as the client perceives it, can reduce uncertainty for bidders
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be the inclusion of “what if scenarios”, providing bidders with clarity on how much extra the client may
be prepared to pay for a better-quality proposal.
A fully costed and risk-assessed Reference Design can assist clients to understand what the expected
range of costs is likely to be, and hence where the major influences on cost (and risk) are, even if thisinformation is not shared with bidders. These can, in-turn, assist clients in identifying ways to encouragebidder innovation and reduce their risk. It is to be expected that this Reference Design assessment will
have a wider degree of estimating tolerance than bidders would be comfortable with, but it will informthe client’s decision on the relationship between cost and value.
The UK has recently begun to use competitive dialogue (CD) contracting methods, which facilitate
greater input from contractors in the development of the final terms of the tender. In particular, bidders
can discuss their ideas and provide feedback on draft tender documentation, prior to the final tenders
being issued, thus reducing the risk of tender documents including features that make them unbiddable
or discourage innovation.
However, in cases where clients are uninformed, CD has the potential to further compound the lack ofclarity and increase complexity in tender documentation. As such, if pursuing a CD approach, clients willneed to productively harness input during the process and come to a clear decision at the end of it.
Competitive dialogue also has the potential to lead to a lengthier and hence more expensive bid processthat adds to contractor overheads.

Case studies from Denmark, Germany and the UK
The four case studies below illustrate differing approaches to dealing with risk and uncertainty. From theoutset, it should be noted that analysis lens is strictly focused on the question of how a project dealt with
contractor uncertainty (i.e. how risk pricing was positively/negatively impacted), and does not extend toan assessment of the overall economic viability or success of these projects. Further, while each of thecase studies can be broadly characterised as a “mega project”, observations and derived learnings can beconsidered relevant to major projects of smaller size, which in aggregate account for the bulk of public
sector infrastructure investment.
In terms of the cases discussed, the Bank Station Capacity Upgrade (BSCU) (UK) and Fehmarnbelt Link(“Fixed Link”) (Denmark) projects each illustrate the potential to reduce risk (and ex ante construction
costs) through competitive dialogue. More broadly, both demonstrate that collaboration andcompetition are not mutually exclusive but rather complementary means to the same end (risk pricing
efficiency). Comparatively, Heathrow’s T5 (UK) project highlights that a partnering approach and greaterrisk retention by clients can significantly reduce bidder uncertainty, whilst containing flow-on risks ofadverse selection and moral hazard. In these three projects, success (i.e. risk pricing efficiency) also
depended on the depth of client capabilities, with well-resourced procuring entities and well-organised
tender processes.
In contrast, the Berlin Hauptbahnhof (Central Station) (Germany) project highlights the negative
implications – in terms of cost and schedule impacts – when contractors are required to price their bids

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on the basis of an incomplete (and untested) design. It also demonstrates the challenges created whenplanning and tendering timeframes do not reflect a project’s actual scale and complexity.

Bank Station Capacity Upgrade (UK)The Bank Station Capacity Upgrade (BSCU) saw London Underground Limited (LU) adopt a pioneering
delivery approach termed “Innovative Contractor Engagement” (ICE). ICE led to a 10% (GBP 61 million)
reduction in (ex ante) project costs relative to the “Base Case” (LU, 2014), though actual savings will not
be known until project completion (estimated at 2022). Reduced uncertainty was not the only
contributor to these lower costs, however it was a key factor.
ICE also achieved an increase in overall “value”35 over the client’s “Base Case” (LU, 2014).36
This case study looks in detail at how LU was able to reduce bidder uncertainty (with a corresponding
positive impact on risk pricing), at the same time as maximising innovation.
Project overview

Bank Station is the fourth busiest station on the London Underground network, accommodating nearly
100 000 passengers during the morning peak (LU, 2014). The BSCU increases Bank’s capacity by 40%, at
the same time providing a speedier interchange between lines. The project comprises construction of:a (600-metre) Northern Line southbound tunnel and platform (the existing southbound tunnel
will be converted into a pedestrian concourse)a ticket halla station entrance (on Cannon Street), with escalator and lift (“no step”) accessinternal passenger connections between the Northern Line, the Docklands Light Railway (DLR)
and the Central Line.

The project is highly complex, reflecting such factors as: technical complexity; third-party (e.g. utility)interface; age of existing assets; and the need for the station (one of the network’s busiest) to remain
operational throughout construction.
The BSCU contract was awarded to Dragados SA in July 2013, at an estimated final cost (EFC) of
GBP 564 million and estimated completion date of 2021.37
As of December 2017, over half of the project’s budget (GBP 322 million) had been expended, withtunnelling works underway and foundation works for the new ticket hall and non-public areas of thestation already complete. Main excavation works started in October 2017.
What is Innovative Contractor Engagement (ICE)?

In contrast to past projects, LU procured the BSCU using an ICE delivery method. At its core, ICE isfounded on the principle that value must be built in to a project as early as possible; recognising that
opportunities to add value diminish (and costs increase) over time (Miller and Lessard, 2000; Edkins etal., 2013; Morris, 2013). More specifically, the ICE approach taken in the BSCU project comprised three
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1. The first stage (“Prequalification”) saw four contractors short-listed on the basis of a (non-price)
pre-qualification survey.
2. The second stage (“Dialogue”) saw the short-listed contractors engage separately (andconfidentially) with LU on its base business case (including base design).
3. The third stage (“Formal Tender”) saw LU issue a partial invitation to tender (ITT) based on a“requirements specification” and provision of a base (RIBA D38) design, with bids assessed on thevalue they provided beyond the client’s business case.
At the same time, LU pushed-back applications for Transport and Works Act Order (TWAO) approval until
after a contractor had been selected. This represented an effective reversal in sequencing relative to aconventional DB delivery model, by extension, enabling designs submitted for planning approval toreflect “market-tested” innovations (LU, 2014). A more detailed breakdown of ICE stages and timeframes
is outlined in Figure 9.
Figure 9. ICE implementation stages and timeframes

Source: LU (2014).

How did ICE reduce uncertainty whilst increasing innovation?

The concept of ICE was driven first and foremost by a perceived need to increase supplier innovation.
Indeed, LU (2014) stated that ICE was built on the back of earlier project learnings, which saw innovation
constrained by planning consents, with planning applications typically lodged ahead of final tender. But
while innovation was the primary motivator, reduced uncertainty (for bidders and the project more
broadly) emerged as a key benefit. The pertinent question is how ICE was able to increase design
innovation whilst simultaneously reducing bidder uncertainty (and positively impacting risk pricing).

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This can be explained by the following complementary factors:


upfront mitigation by the client of risks perceived to be beyond bidder control, in particular landpurchase and site access

a longer preparation timeframe, enabling the client to refine its base design and giving bidders
time to engage with the client and resolve issues ahead of formal tendera strong focus on information provision, with bidders provided with the base business case(including “base design” and fully-costed risk register)39clarity on client objectives, expressed through a “specification requirements”.

These factors will be outlined in detail below.
Upfront risk mitigation (by client)

Recognising the innovation constraints (and uncertainty) resulting from risks that are beyond a bidder’scontrol, LU took steps to identify and mitigate these risks ahead of final tender.
For example, LU sought to mitigate risks associated with land acquisition and third-party (e.g landlord)interface. This involved Transport for London’s (TfL) Board signing-off on a “whole of block” construction
footprint before formal bidder engagement, despite the client’s base design assuming a smaller
street-level footprint (TfL, 2014). By extension, this mitigated a key risk (and innovation constraint) for
bidders, who had the latitude to conceive vertical transportation (i.e. street access) solutions utilisingeither the “base case” solution (i.e. limited land purchase), or a new solution requiring more extensive
land acquisition. LU also shared the cost breakdown for a “whole block” solution upfront, enablingbidders to factor these costs into their bid, rather than develop separate estimates.
In short, by mitigating key risks upfront, specifically land purchase and third-party risks, bidders could
focus on technical solutions rather than on associated risks (and pricing).
A longer procurement timeframe, with extensive bidder engagement ahead of final tender

As this report has outlined, short bid timeframes are a key potential source of uncertainty, by limiting theability of bidders to refine designs (and delivery methods) and test underpinning assumptions; in turn,increasing the likelihood of estimation error.
BSCU addressed this by lengthening the procurement process, which included a six-month period for
bidders to engage in confidential dialogue on their proposed solutions, ahead of formal tender. As LU(2014) explained, “The key objective of the dialogue stage was to help the bidders understand the basescheme and LU’s requirements so that they could effectively derive their innovations and be ready torespond with those innovations in the ITT phase”.
Engaging on a confidential basis also meant that bidders better incentivised to share their ideas, without
the risk of intellectual property (IP) being lost to competitors. This addressed a key limitation of
conventional “collaborative” contracting approaches such as ECI, which can see bidders hold back on
sharing innovations until the start of the formal tender process, or later.
Figure 10 compares key milestones (and timeframes) under LU’s base case scenario (i.e. conventionaldelivery) and its actual delivery under ICE. This shows that while construction commenced later, theconstruction period itself was shorter, inferring that the time spent in early stage development and thelength of construction are negatively correlated. It further suggests that uncertainty may cause bidders© OECD/ITF 2018

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to “build in” considerable schedule contingency when upfront opportunities to refine design andconstruction methods are curtailed.
Figure 10. Comparison of base case with ICE

Source: LU (2014).

Strong focus on information provision, including a “base design”

A lack of objective information has been identified by this report as a key source of uncertainty; andcontributing factor to bidders’ reliance on (subjective) individual or team experience rather than(objective) scientific assessment.
ICE sought to mitigate this through a stronger emphasis on client (and third-party advisor) information,
which LU described as “unprecedented” in its degree (LU, 2014, p. 31). This involved sharing – on an
equal basis – all project documentation that defined LU’s base case, including the business case, costplan, base design and (costed) risk register.
Through the dialogue stage bidders were also encouraged to request meetings or lodge technical queries
with the client and its advisors. 150 meetings and 350 requests for information (RFIs) were handled
during the dialogue stage (LU, 2014).
In particular, the provision of a base design and corresponding (fully-costed) risk register served toreduce design uncertainty for bidders, at the same time channelling innovation towards those aspects ofdesign (and construction) for which bidders could “value-add”.
Success in this particular case stemmed from the provision of a considered but preliminary (RIBA D)
design “for information” rather than compliance purposes. This reduced bidders’ design risk (e.g.
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it. For example, the winning bidder developed an alternative tunnel design which reduced risk associatedwith ground movement, a key project risk.
As LU (2014) explain, “The Project scored the Base Case as a reference for the evaluation of bidder
responses at 5 out of 10 for each of the eleven criteria. However, there was no requirement for bidders
to price the Base Case design.” In short, contractors weren’t bidding against a reference design, they
were bidding their own design against client requirements. Table 4 illustrates the practical impact of thisapproach, with bidders proposing variations to the base design for certain features, while mirroring it forothers.
Table 4. Comparison of (short-listed) ICE bids with the client’s base caseFeatureBase case

Bidder 1

Bidder 2

Winning scheme

Bidder 4

Ticket hall

Ground Level
access from
10 King William
Street andCannon Street.

Ground Level
access from
10 King William
Street.

Ground level
access from
10 King William
Street withcolonnade to
Cannon Street.

Ground level
access from
Cannon Street
adjacent toNicholas Lane.

Ground level accessfrom Cannon Street
and Abchurch Lane.

Restricted to
10 King William
Street footprint.
PRM access

Use main lifts toNorthern Linethen single
17-person lift to
DLR Level

Restricted to 10
King William
Street footprint.
1 x 40-person lift
to Northern
Line/DLR
2 x 40-person lift
to Northern Line

Whole site
footprint.

Whole site footprint.

Whole site
footprint.

1 x 21-person lift
to Northern Line1 x 17-person lift
to Northern Line4 x 40-person lifts toNorthern Line1 x 21-person lift
to DLR1 x 17-person lift
to Northern Lineand DLR1 x 17-person lift from
Northern Line to DLR

1 x 17-person liftfrom NorthernLine to DLR

1 x refurbishedexisting lift

Access to NL

4 x 40-personlifts

3 x 40-person
lifts

2 banks of
3 escalators

2 banks of
3 escalators

4 x 40-person lifts

Access from NL to
DLR

2 escalators inbored pile wall;
2 stairs

3 escalators

As base case

3 escalators inbarrel; no stair

3 escalators

Access from NL to
CL

Bypass tunnel
linked to
Triplication;
2 then 3 new
escalators,
Central Linebarrel in square
works

Similar to Basecase,
2 escalators,
barrel into
Central Line insquare works

Similar to Basecase, 2 escalators
SCL with
temporary
construction
audit.

Direct tunnel
with moving
walkway andtriple escalator

Similar to Base case
except barrel into
Central Line and SCL.

Source: TfL (2014).

Clarity of client objectives

Clarity of client objectives and, relatedly, clarity on the precise trade-off between benefits and costs (thesum being “value”) further assisted to reduce bidder uncertainty.
Client objectives were codified in specification requirements, and further clarified to bidders through thedialogue stage. This clarity (and consistency) was also maintained in bid evaluation criteria.

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Collectively, these mechanisms served to communicate a consistent message to the market about what
the buyer wanted to buy, and how the market’s offer would be valued (LU, 2014).
Key learnings from the BSCU project case study
Opportunities exist to engage more effectively with bidders ahead of final tender, whilst
maintaining competitive tension

Using ICE in this case captured the benefits of “collaborative” delivery (specifically, earlier and moredetailed dialogue with bidders), whilst preserving the competitive tension of a conventional Design-Build(DB) model. By extension, it enabled the co-creation of a project solution without the disincentives
inherent in normative collaborative contracting.
This can be traced to several differences under ICE relative to standard collaborative contracting, such as
ECI. For example, while the intended outcome of early engagement under ECI is the co-development of acompliant design (which then forms the basis of an ensuing competitive tender), ICE saw the client
engage with bidders (confidentially) to test their own designs (and broader delivery) ideas, with nocross-pollination prior to contract award. As such, the pre-formal tender phase under ICE can be termeda dialogue rather than a collaboration.
Furthermore, competitive tendering, rather than joint risk identification and costing, represents theprimary price (and efficiency) discovery mechanism under ICE. By extension, ICE does not expose clientsto (potential) gaming risks or the disincentive to share innovations that can be observed under otherforms of collaborative contracting.
In summary, ICE mitigates several weaknesses inherent in an ECI approach, whilst preserving the benefitsof supplier engagement (Institute of Civil Engineers, 2015).
Design is a foremost source of contractor uncertainty and, as such, represents an effective
lever for clients looking to reduce risk premiums

Balancing design clarity with design flexibility is a foremost objective of an ICE approach. Specifically,
through the development of a base design and set of functional requirements, clients were able toreduce design (and broader scope) uncertainty whilst channelling design (and construction method)
innovation.
In the BSCU project the base design represented the culmination of several earlier concepts, developedby the client over a number of years. This provided bidders with greater certainty as to the design’s
constructability and fit-for-purpose but did not preclude scope for further enhancement. Indeed, LU(2014) state that the base “had not been fully developed into a workable design that fully met the
project requirements. This was addressed by going to the market via an Innovative Contractor
Engagement process”.
Ultimately, the approach taken in the BSCU resulted in bidders identifying further opportunities tode-risk the design. These opportunities would have been overlooked had bidders been focused solely oncompliance with a pre-set design.
Greater information provision can reduce uncertainty, however too much (or poorly
organised) information can be detrimental

A stronger emphasis on information provision, coupled with extensive dialogue, was a further defining
feature of ICE. However, this benefit is qualified, with the BSCU project also highlighting the negative
impact of too much information. Indeed, LU (2014, p. 32) observes that in some respects “…the62© OECD/ITF 2018

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significant quantity of documents provided was detrimental to the bidders’ progress”. This confirms thereport’s earlier assertion that information provision is more about quality and accuracy, than volume.
Innovative delivery methods require wider changes to a client’s management processes andprocedures – a delivery risk if capabilities are lacking

The use of ICE in the BSCU project delivered risk pricing benefits over a conventional DB model.
However, this does not mean ICE is beneficial for every project, or client.
In their ex post review of BSCU, LU acknowledges that the use of an untried delivery model required theconcurrent development of new management processes and procedures. It further cautioned: “Doing
this on a major project such as Bank presented a significant delivery risk to the project and brought
considerable reputational risk to LU. Thus, it would have to develop specific processes and procedures
for managing these risks.” (LU, 2014, p. 14)
As such, the adoption of ICE must be considered on a case-by-case basis, and in the context of a
procuring agency’s broader capabilities and processes. In particular, clients should be aware that ICE
requires significant resources, puts significant demand on senior project members, and requires a clear
over-arching strategic resource plan (LU, 2014). Critically, it also relies on strict adherence toconfidentiality and impartiality provisions (which can be major risks).

Heathrow Terminal 5 (UK)In procuring a major new terminal (T5) and associated infrastructure Heathrow Airport’s (private) owner,
British Airport Authority (BAA), opted for a delivery model founded on the principles of risk retention and“partnering”. This approach materially reduced the risk for bidders and, in turn, reduced risk premiums.
While in theory the degree of risk retention by BAA exposed it to potential adverse selection and moral
hazard risks in practice these did not eventuate, with T5 delivered on budget and with only minor
construction delays (House of Commons Transport Committee, 2008).40
This case-study explores how T5’s delivery approach positively impacted risk pricing, whilst meaningfully
incentivising contractors towards efficient delivery.
Project overview

In 2001, BAA announced the procurement of a new terminal, T5, which would increase Heathrow’s
annual passenger throughput from 67 million to 95 million people. Construction was expected to last five
years, at an estimated cost of USD 8.5 billion (2003 prices) (Davies et al., 2009). Specifically, the project
involved construction of:

two large terminal buildingsan air traffic control towerroad and railway transportation links



13 km of bored tunnels



airfield infrastructure

a 4 000-space multi-storey car parka hotel.

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Works were broken into four main streams (buildings, rail and tunnels, infrastructure and systems), andfurther subdivided into 16 major projects and 147 sub-projects. T5 also involved an incredibly complex
supply-chain, comprising 80 first-tier, and as many as 15 000 fifth-tier suppliers (Davies et al., 2009).
A collaborative delivery model

BAA opted to procure T5 using a “partnering” delivery model. This comprised:full risk retention by the client, with risks subsequently insured

use of cost plus defined margin (cost reimbursable) contracts41

codification of objectives, accountabilities and processes in a shared project agreementcreation of integrated (i.e. client and contractor) and co-located project teams.

In particular, BAA’s chosen delivery model reflected the findings of earlier research, which suggested two
common causes of cost and schedule overruns: a lack of collaboration between parties; and reluctanceby clients to retain risks. As Davies et al. (2009, p.115) observe, this collective evidence base led BAA toconclude that transferring such large degrees of risk to the contractor “offered no real protection for theclient”.
In this context, BAA’s delivery model for T5 was based on the collaborative identification of key risks anddelivery solutions (low-powered incentives), rather than extensive risk transfer and use of fixed pricecontracts (high-powered incentives).
A codified agreement, signed by all parties, and the creation of integrated and co-located project teams,
aimed to translate these principles into practice (Gil and Ward, 2011).
How was uncertainty reduced?

Recognising T5’s complexity, specifically technological (and wider systems) risks and reliance on a clusterof diverse facilities, risk reduction was an early and enduring client focus. For BAA, the degree of risk
involved can be illustrated by comparing the project size (USD 8.5 billion) with its (then) USD 14 billion
market capitalisation (Davies et al., 2009). In particular, risks were reduced through the following
mechanisms:
long planning and design lead times



greater risk retention by the clientclarity of objectives (as well as responsibilities and accountabilities)

testing of technologies, broader systems and construction components.

Each of these aspects will be outlined in further detail below.
Long planning and (pre-tender) design lead times

The capability to reduce risk was undoubtedly aided by T5’s lengthy planning and design phase which
extended 15 years from planning commencement to the decision to proceed. To a degree, this length
was non-negotiable given T5’s function and local and environmental impacts, with the project subject toover 700 planning conditions. Equally, it can be considered a deliberative approach by the client, as
evidenced by the lengthy period between project approval and construction commencement.

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BAA also undertook extensive investigations into mega project delivery, including a two-year systematic
benchmarking study of major UK construction projects over USD 2 billion undertaken in the preceding
10 years, and every international airport opened over the preceding 15 years.
A long planning and design phase allowed BAA (and its contractors) to refine designs and construction
methods, recognising that the challenges created by insufficient investment or clarity in design can rarely
be undone during the construction phase (Davies et al., 2009).
Tailored delivery method with greater risk retention by the client

Reflecting its belief that clients ultimately bear the risk in major project delivery, BAA opted to retain all
major risks and to take out (single) project-wide insurance covering loss or damage to property, injury,
death and professional indemnity (NAO, 2005; Basu et al., 2010). In short, BAA undertook to de-risk andregulate the project environment.
More specifically, BAA pooled the risk contingency from each major component of the project, whichthen enabled risk contingency to be allocated to where it was needed. This provided BAA with greater
control over the financial implications of risk at an overall project level, and thus tighter overall budget
control (OECD, 2015).
By extension, contractor risks were significantly reduced, with direct exposure limited to the attainmentof pre-agreed margins. This in turn enabled contractors to focus on technical delivery, rather than on risk
pricing and mitigation.
Clarity of client objectives

Upfront and ongoing clarity of objectives, as well as responsibilities and accountabilities, formed afurther key feature of T5’s delivery model, reflecting its reliance on goal-alignment and partnering rather
than high-powered incentives.
Clarity was provided through a shared project agreement (Brady and Davies, 2010). This was a legal
document outlining the “processes” (i.e. reporting lines, responsibilities, and accountabilities) to be used
(Davies et al., 2009).
The NAO (2005, p. 6) further clarifies that the agreement did not specify the exact work to be required,but rather formed “a commitment from the partner and a statement of capability, capacity and scope tobe provided from the partner organisations”. Clarity was further assisted by the establishment ofintegrated (and co-located) project teams.
Testing of technologies, broader systems and construction components before application

A strict “trial and testing regime” formed a key pillar of T5’s delivery approach and an effective risk
reduction mechanism, particularly for the construction phase.
A policy to only use established technologies and components assisted to reduce risks across the
supply-chain. This involved “proving” a new technology, such as by applying it to one of BAA’s smaller
airports, before applying it to T5.
This also extended to components used in the construction phase, with suppliers manufacturing parts –and practicing their installation – off site. An estimated 70% of mechanical and electrical engineering
components were manufactured off site (Brady and Davies, 2010).
As an example, the terminal’s roof (spanning more than 150 metres) was pre-erected off-site to enable
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these risks a risk mitigation plan was developed, enabling faster construction on site. This was estimatedto have reduced the roof installation timeframe by more than three months, offsetting previous delays(NAO, 2005).
However, the rigor observed during the design and construction phase was not maintained during asset
handover. Indeed, Brady and Davies (2010, p. 156) observe: “The trial and testing regime adopted by BA
and BAA once the building had passed into the operational phase in September 2007 contrasted strongly
with the testing regime used in the construction phase when off-site testing of components andsub-assemblies was insisted on prior to acceptance”. This led to significant operational challenges when
T5 opened.
How was opportunistic pricing mitigated?

As this report has outlined, low-powered incentives can expose clients to opportunistic pricing risks, withbidders potentially over-estimating target costs (ex ante) in order to under-shoot and recover higher
margins (ex post). However, in T5’s case, opportunistic pricing is not readily evidenced. This can be
explained by several steps that BAA took to set target costs and incentivise or monitor supplierperformance.
For example, BAA utilised cost information from its other projects, validated independently, to set target
cost levels. It also mandated transparent ‘open-book’ pricing, which involved looking in detail at a
supplier’s internal cost structures. This closer scrutiny was accepted by contractors as ‘a trade-off’ for
BAA’s retention of risks. Once target prices had been set, suppliers were incentivised ex post to achieve
lower out-turn costs.
BAA also exerted greater control over primary contractor engagement of sub-contractors, with aparticular focus on minimising sub-contractor default risk. This extended to the production of
sub-contractor contracting templates.
Where possible, BAA also sought to utilise competition. This involved competitive procurement ofconstruction components, as well as building in capacity for approval timeframe extensions in order tomaximise negotiating power (NAO, 2005).
Key learnings

While T5 was a private-for-private project, several learnings can be derived with relevance for public
procuring authorities.
Low-powered contracts can deliver on “iron triangle” objectives, under the right conditions

Remarkably for a project of such size and complexity, T5 achieved its cost, time and quality targets. As
such, it demonstrated that contractor risk exposure can be reduced (or in this case largely removed)
without trading-off cost and time discipline, or giving effect to adverse selection or moral hazard. BAA
was able to retain risks but still incentivise performance through goal alignment, use of target cost plus
margin contracts, and strict performance monitoring.
Risk mitigation should be an early and continuous focus across the project life-cycle (i.e. it
does stop once construction starts)

T5 highlights the benefits of a well-considered view of risk allocation where the client’s starting position
isn’t to maximise risk transfer. In T5’s case, major risks were mitigated before contractors were formallyengaged, enabling them to focus on (and to innovative around) technical aspects of delivery.
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T5 further highlights that risk reduction doesn’t stop when construction commences. On the contrary,risk mitigation extends across the project life-cycle including (and indeed extending beyond) the
construction phase. For example, BAA put in place policies to mitigate technological and component risks
which served to reduce overall risk during construction.
Innovative delivery depends heavily on client (and contractor) capability for their successT5’s success was highly contextual. It benefited from a well-resourced and experienced client andsophisticated project management systems. Being a flagship project, contractors were likely also
motivated by reputational implications of failure.
As such, wider application of T5’s delivery model (i.e. full retention of risk by the client and reliance on apartnering model) should be considered only where mature and relevant client and contractor
capabilities exist.

Fehrmarn Belt Link (“Fixed Link”) (Denmark)The procurement of Denmark’s flagship Fehmarn Belt (“Fixed Link”) project, a road and rail tunnel
connecting Denmark and Germany, can be characterised by its lengthy planning and tendering phase,
extensive (competitive) dialogue and systematic approach to risk allocation.
More broadly, the delivery approach highlights the benefits of strengthened client-side capabilities, andwell-organised project planning and tendering processes. Combined, these factors saw the client(Femern A/S) achieve significant reductions in construction costs over the course of the bid process;indicating lower bidder risk premiums.42 Construction reserves were also set at levels well below
established benchmarks; suggesting the client achieved comparably lower levels of uncertainty inretained (construction) risks.43 By extension, this project provides an illustrative example of the steps
that clients may take to reduce uncertainty in the bid process. This case-study explores these steps infurther detail.
Project overview

At an estimated cost of DKK 62.1 billion (circa EUR 8.3 billion) (2015 prices)44 the Fixed Link involves
construction of an 18-kilometre immersed road and rail tunnel between Rødbyhavn on the Danish islandof Lolland and the German island of Fehmarn. Specifically, the tunnel will comprise a four-lane motorway
and two electrified rail tracks. Tunnel components will be manufactured at a purpose-built production
facility located at Rødbyhavn.
Once complete, the Fixed Link will enable commute times between Denmark and Germany of ten
minutes by car and seven minutes by train; with the tunnel representing the longest of its type globally(Femern A/S, 2018).
As a cross-border project, the Fixed Link’s operating environment is highly complex, with a range ofapprovals required in both Denmark and Germany. While parliamentary approval has been granted inboth countries, planning approval has yet to be secured in Germany’s case; with approval by the State
Company for Road Construction and Transport of Schleswig-Holstein (LBV) expected later this year.

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Delivery model

The Fixed Link’s delivery model can be characterised as one founded on the twin principles of“collaboration” and “competition”. In particular, the client was able to utilise the collaborative benefitsof joint risk identification and extended dialogue whilst maximising competition – and use ofhigh-powered incentives (fixed price contracts) – to drive cost efficiencies. Specific features of thedelivery approach included:
long preliminary planning and tendering phases, with over a decade between the completion offeasibility studies and commencement of the formal bid process – and a 3.5 year period between
the start and end of the bid process45

establishment of a sole-purpose and commercially-focused project delivery authority (Femern
A/S) well in advance of tender commencement

extensive dialogue with bidders between initial and final bid submissionuse of fixed price contracts for the bulk of construction works (Femern A/S, 2018).

The Fixed Link is publicly-financed using a State Guarantee Model, with (guaranteed) loans amortised
through user charges over a period of 36 years. As a priority project within the trans-European network,
the project has received EUR 589 million in EU funding (Femern A/S, 2018).
How was uncertainty reduced?

The delivery approach outlined above reduced bid phase (and overall project) uncertainty in several
inter-related ways.
Strong client capability (and end-to-end project involvement)

In 2009, the Danish Government appointed Femern A/S, a subsidiary of the state-owned company Sundand Bælt Holding A/S, to progress preparatory works for the Fixed Link; with Femern A/S’ oversight of
construction subsequently legislated by Parliament in 2015.
By establishing a standalone delivery authority early in the project’s development, and tasking it with
end-to-end project oversight (i.e. inception to execution), the Government ensured a continuity of
project knowledge and accumulation of expertise.
As a state-owned subsidiary, the client also enjoyed greater commercial discipline, a fact illustrated by its
independent (and commercially experienced) board. The resulting high standard of project management
and tendering likely assisted to build credibility and, in turn, improve bidder risk perceptions. Confidence
was likely also drawn from the client’s greater independence from central government (and insulationfrom short-term political influences).
Ultimately, this governance structure recognised that uncertainty (for bidders) is influenced not just bytechnical and wider operating environment complexities but by the strength of client capabilities and theprofessionalism of the tender process. In the Fixed Link’s case, bidder confidence in the client (andproject) was especially important given cross-border approvals risks and likely commencement delays, aswell as strenuous environmental considerations.

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Long planning and tendering timeframes

A lengthy planning phase further reduced uncertainty, by affording opportunities for technical revisionand risk assessment and mitigation. However, it should be noted that timeframes were not entirely
deliberate, and in part reflect delays in securing planning approvals.46
Planning for a fixed link began as early as 1992, with the Danish and German governments jointly
agreeing to commission feasibility studies (Ferment A/S, 2018). Over following decades technical andfinancial assessments were undertaken, culminating in 2015 with the Danish Parliament approving the
fixed link in its current form (including environmental approval) and authorising Femern A/S withconstruction of the link.
This considered project planning approach enabled the precise technical solution and physical alignment
to be optimised; including supplanting an original bridge solution with an immersed tunnel. By extension,
determining the optimal technical solution before tender commencement meant that bidders did notneed to bid multiple technical alternatives.
This considered approach also continued into the formal bid process, which was extended toaccommodate a competitive dialogue phase with bidders following the receipt of initial bids. This phasewill be outlined in further detail below.
Extended contractor dialogue

With initial construction bids significantly higher than anticipated Femern A/S engaged in extensive
dialogue with bidders (within a competitive dialogue framework).47 One such change to result from thedialogue process was an extension of the construction schedule. Indeed, a post dialogue phase financial
assessment by the client stated: “…subsequent dialogue with the contractors indicated that the earlier
assumption of a 6.5 year construction period was ambitious and in itself a contributory factor to the highcost of the bids. As a major element of reducing the bid prices, the construction period was therefore
extended to 8.5 years” (Femern A/S, 2016b, p. 2).
This, in-turn, enabled more cost-effective construction methods (Femern A/S, 2016a). Specifically, itenabled both sides to identify, discuss and price a large number of technical and legal improvement
measures, such as a reduction in tunnel element production costs, or enabling contractors to plandifferent stages of the construction period more flexibly.
At the same time, the dialogue phase led Femern A/S to increase its construction reserves in order tobetter reflect the potential for approvals delays; with tunnel construction reserves increased fromDKK 3.7 billion to DKK 7.3 billion (Femern A/S, 2016a).48
While precise data on contractor risk pricing isn’t available, changes facilitated by the dialogue phaselikely saw a reduction in risk premiums. More broadly, competitive dialogue enabled the client to identify
trade-offs which would increase overall cost effectiveness. This is evidenced by the achievement of“significantly lower” bids relative to pre-dialogue phase bids, with construction budgets reduced by
DKK 2.5 billion (EUR 335 million) (Femern A/S, 2016a).
Table 5 illustrates this trade-off, showing a reduction in overall construction budgets (under both 2018and 2020 construction commencement scenarios). It should be noted that these savings were achieved
without changing the basic functionality of the tunnel designs.

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Table 5. Construction budgets, pre and post dialogue phase (2015 prices, DKK)
Basis in the Construction Act,
February 2015

Financial analysis, February
2016, on commencement ofconstruction at the beginningof 2018 and opening in mid2026

Financial analysis, February
2016, on commencement ofconstruction at the beginningof 2020 and opening in mid2028

Baseline budget

1.4 billion

44.9 billion

45.3 billion

Reserves

3.7 billion

7.3 billion

7.3 billion

Overall construction budget,
coast-to-coast section

55.1 billion

52.2 billion

52.6 billion

Baseline budget

7.3 billion

7.3 billion

7.3 billion

Reserves

2.2 billion

2.2 billion

2.2 billion

Overall construction budget,
Danish land works

9.5 billion

9.5 billion

9.5 billion

Repayment time

39 years

36 years

36 years

The coast-to-coast section

Danish land works

Note: February 2015 budget represents pre-dialogue phase.
Source: Femern A/S (2016a).

Methodical risk allocation

Contractor uncertainty was further reduced through a methodical approach to risk allocation. In largepart, this was non-negotiable given project realities; particularly environmental factors, weather eventsand the uncertainties associated with cross-border project planning approvals. This saw several risks
relating to factors considered beyond the contractor’s control – or factors for which contractors had only
limited control – either retained by the client, or shared. For example, contractor exposure to adverse
weather events or geo-technical risks was dealt with through the use of reference conditions andassociated compensation packages.
This flexible approach was continued through the dialogue phase; with adjustments to risk allocation
between initial and revised (post-dialogue phase) bids accounting for between 10 -15% of the reductionin the construction budget over this period (Femern A/S, 2016a). This was also reflected by the increasein the client’s construction reserves. More broadly, the client – through methodical risk allocation andthe use of competitive dialogue – was able to build a common understanding of risk.
Key learnings

The delivery of the Fixed Link undoubtedly benefited from a knowledge bank built up from recent former
cross-border projects, specifically the “Great Belt” (Storebælt) (completed in 1998) and “Øresund
Bridge” (completed in 2000). By harnessing and applying learnings, the Fixed Link’s delivery authority,
Femern A/S, was able to reduce contractor risk premiums (as reflected by the reduction in construction
costs over the course of the bid process), as well as overall project risk (as reflected in the client’s low
construction reserves). The opportunity now exists to capture and apply learnings from the Fixed Link tofuture projects, as outlined below.

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Where practicable, the establishment of sole-purpose project delivery authorities can assist
to centralise expertise, instil commercial discipline and increase credibility with bidders

For appropriate projects, such as large mega projects or programmes, the establishment of sole-purpose
delivery authorities can assist to centralise and grow expertise (i.e. beyond the public sector), at thesame time building credibility amongst bidders. This approach has been adopted for several recent major
projects, including Crossrail (UK) and WestConnex (Australia).
In the case of the Fixed Link the early establishment of a sole-purpose delivery authority ensured an“end-to-end” project owner, with Femern A/S overseeing all phases of the life-cycle from preliminary
planning to project handover. This ensured a bank of project knowledge and expertise, and assisted tobuild credibility in the project development (and tender) process.
Collaborative engagement and competitive tension are (potentially) complementary rather
than mutually exclusive means to drive pricing efficiency – but depend on client capability

Conventional categorisation of project delivery models infers that clients face a choice between
collaborative price discovery, or a reliance on (typically adversarial) competitive tendering. For example,
Alliance contracting would personify the former, whilst a lowest price DB tender would represent thelater.
In the case of the Fixed Link, the client was able to utilise both approaches; with an extended dialogue
phase facilitating efficiencies that were unlikely to have eventuated under a competitive tender alone.
This dialogue phase was followed by a competitive tender process on fixed-price terms. In effect, it wasboth collaborative and competitive.
This approach does however rely heavily on client capability and a willingness of bidders to remain in an
expensive bid process for longer. As such, it is likely more applicable for large projects procured bywell-resourced and experienced clients.
Extended planning and tendering timeframes can deliver significant efficiencies (not justcosts)

Project development can be considered a trade-off between the (opportunity) cost of delayedcompletion, and the efficiencies derived from solution refinement. Conventionally, approaches havevalued minimising costs (of delay) over maximising benefits (from contract refinement).
The Fixed Link project has demonstrated that an extended project planning and tendering process candeliver significant savings; stemming from the greater opportunity to refine technical solutions andbetter identify, assess and price key risks.
While a direct comparison of realised savings versus the opportunity costs incurred by a delayed projectcompletion was not undertaken (and therefore net impacts cannot be deduced), this case study
highlights the need for governments to more fully consider this trade-off.

Berlin Hauptbahnhof (Central Station) (Germany)
Following a decade of construction, the “Berlin Hauptbahnhof” (Central Station) officially opened in May
2006, becoming Europe’s largest rail interchange.
The station formed the centrepiece of a post-reunification overhaul of Berlin’s passenger rail network.
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the project suffering from a short lead time, incomplete design (and resultant significant scope changes)
and failure to identify and mitigate key risks ahead of formal tender. Although precise empirical evidence
is not available, it can be assumed that these factors were reflected in bid prices, which likely included
significant risk premiums.
Contractors ultimately overcome several key risks eventuating, however not without consequence; withthe project incurring delays and cost overruns (Muller and Becker, 2015).This case-study considers thesefailings and their implications for contractor risk pricing.
Project overview

The Berlin Hauptbahnhof project involved the replacement of an existing local station (Lehrter Bahnhof)with a major interchange connecting local (subway and light rail) regional and long-distance rail links.
More specifically, the project involved construction of a new central station spanning five levels (totalling
70 000m² of floor space including 15 000m² of commercial space), with a capacity to service 1 500 trains
daily (DB, 2006). In addition, the project involved constructing a mix of cut and cover and sunken
pre-fabricated tunnels.
Reflecting its large scale and extensive use of tunnelling the project was highly complex. Complexities
included: interface with historical sites; proximity to the Spree river and associated sandy soil and highwater table; and innovative architectural design which entailed extensive structural interdependencies(Grewe et al., 2005). The need to keep local (S-Bahn) services operating throughout the construction
period posed a further challenge.
The project was jointly procured by the DB Network Company, the DB Station and Service, the Senate
Administration for Urban Development, and the Berlin Transport Corporation (BVG). Construction wasundertaken by the Arge Lehrter Bahnhof consortium.
The new station, alongside several related road and rail projects, comprised the “mushroom concept”(Pilzkonzept), a major overhaul of Berlin’s transport network.
How did the delivery approach impact risk pricing?

While a degree of uncertainty is unavoidable in mega projects it is also true that uncertainty is a functionof the delivery approach. In this case, uncertainty stemmed from the (relatively) short preliminary
planning and tender phase. This led to:a failure to complete and test the viability of preliminary designs ahead of tendering

a failure to properly identify, cost and mitigate key risks upfront, meaning contractors priced
their bids on the basis of significant unknowns



an overall reactive (post tender) rather than pre-emptive (pre-tender) risk management
approach.

This section will outline these key factors in greater detail.
Short preliminary planning and bid timeframes

Owing to wider geopolitical factors the new central station (and associated tunnel projects) wascommenced after a relatively short preliminary planning phase. Construction contracts were awarded
and construction commenced four years after ratification of the broader “mushroom concept” (Muller

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and Becker, 2010). The need for works to be completed ahead of Federal offices relocating back to Berlin
was an influencing factor in this regard.
Short timeframes can also be traced to the broader approval process, which jointly considered thevarious (and divergent) project components of the mushroom concept. Indeed, Peters (2010, p. 97)
observes “the package-deal-type joint approval procedure and the subsequently executed investments
created strong path dependencies and de facto 'points of no return’...”. While this criticism is aimed atperceived shortfalls in economic appraisal it can also be levelled at the approach to project planning andtendering; with all structural analysis and detailed design work commencing post contract award (Greweet al., 2005).
Further, as outlined in Figure 11, the short project planning and bid timeframes – and associated scopechanges – resulted in full design approval only being granted long after construction commenced. Whilecontractors were not directly liable for securing overall design and environmental approvals, they would
have faced significant in-direct risk.
Figure 11. Delivery milestones and cost estimates

Source: DB (2004); Grewe et al. (2005); Muller and Becker (2015).

A failure to complete design - and test innovative design concepts - ahead of formal tender

While contractors were engaged on a Design-Build (DB) basis their latitude to alter designs was inhibited;with designs restricted by architectural specifications and planning approval considerations. By
extension, contractor flexibility was mostly restricted to construction methods. A pre-set design can
assist to reduce bidder uncertainty particularly in relation to planning approval risks; however, thisrequires that the design is complete and that its implementation has been robustly tested. In this case,
implementation was a secondary consideration, with the result that contractors were bound to an
incomplete design, and one involving significant constructability challenges.
This failure to complete designs and to consider “buildability” ahead of formal tender was compoundedby the degree of innovation required in building techniques, “many of which had never been tested
before” (Muller and Becker, 2015, p. 6). For example, bridges (bearing high-speed rail track) were to be© OECD/ITF 201873

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supported by newly-constructed tunnels; an engineering feat that lacked precedent in a heavy rail
context (Grewe et al., 2005). The degree of engineering innovation (and lack of existing standards)
involved significant cost and time, with contractors having to engage outside experts (e.g. universities).
In effect, contractors had to innovative as they went.
The station’s innovative roof provides a further example, with the final roofing solution a significant
revision on initial designs; resulting in prolonged legal disputes and (successful) claims against the clientby the project architect (Muller and Becker, 2015).
At the same time, the capacity of project teams to revise design solutions during construction were
hampered by planning and project approvals; with modifications needing to conform with previously
approved designs or entailing lengthy reconsideration by relevant authorities such as the Federal Railway
Office (FRO). This proved challenging when late stage attempts were made to contain costs and delivery
timeframes, with solutions having to consider legal and co-ordination implications as well as cost or timesavings (Muller and Becker, 2015).
More broadly, the failure to complete the design before formal tendering (and before constructioncommencement) meant contractors could only react to rather than pre-empt design and associatedconstructability risks; as evidenced by the number of ex post iterative changes.
A failure to identify and mitigate risks upfront

A failure to properly identify, assess and (where prudent) mitigate key risks upfront was a further causeof uncertainty. This included a failure to provide contractors with a detailed (and costed) risk register. As
a result, contractors had to rely on their own risk identification and analysis, which was clearly limited ina time-bound (three month) bid process.
Groundwater risks serve to illustrate this point. Given the close proximity to the river Spree, groundwater
risks in tunnel construction were both highly probable and impactful. While this was broadly identified inproject documentation, meaningful steps were not taken by the client to assess and (if prudent) tomitigate this risk upfront. Risk assessment was instead passed to contractors. With groundwater risks
eventuating shortly after construction commenced it can be assumed that such eventualities were
anticipated and reflected in bids. More broadly, as with design, the approach to risk management in thiscase meant contractors were largely reacting to risks eventuating during construction rather thanpre-empting them.
Key learnings

The Berlin Hauptbahnhof (and associated tunnel projects) was in certain respects unique; born out of awider vision for a reunified Berlin. These geopolitical factors were important influences on the delivery
approach, particularly the shortened planning and tendering phase (Peters, 2010). This unique context
does not however preclude the opportunity to derive learnings, as outlined below.
The transfer of an incomplete and untested design creates significant uncertainty,
particularly when clients pursue highly innovative solutions

This case illustrates the importance of minimising design-related uncertainties, with bidders effectively
pricing an incomplete and largely untested architectural vision. At the same time, contractors’ capacity
to adjust designs and delivery methods was limited; both ex ante (due to the need to conform to design
specifications) and ex post (due to a time-consuming approvals process). The design of bridge support
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buildability whilst at the same time needing to conform to specified architectural designs (Grewe et al.,2005). In effect, the client transferred design completion risk to contractors whilst limiting their capacity
to influence it. Resulting uncertainties relating to design omissions and poor constructability were likely
factored in to bids. These could have been avoided by completing the design ahead of the formal tender
but providing contractors with meaningful (upfront) opportunities to shape it.
Upfront risk reduction – whether direct (e.g. retention) or indirect (e.g. aiding contractors
to assess and price risks) – can deliver significant efficiencies

All else being equal, the earlier a risk is identified and assessed the greater the opportunity (and thelower the cost) of managing it. In this case, key risks were not sufficiently investigated ahead of theformal tender process, with contractors having to develop their own risk registers. For example, detailed
analysis of ground conditions only occurred immediately prior to construction, with contractors
innovating around risks such as groundwater impacts on construction as those risks eventuated;
resulting in significant delays (Muller and Becker, 2015). By extension, bidders were required to price on
the basis of significant unknowns.
Upfront risk evaluation and sharing of information with contractors would have helped to lessen these
uncertainties; particularly such factors as site conditions and groundwater impacts. More broadly, thecompletion of the design and, on this basis the mitigation of planning and environmental approvals risks,
would have further reduced uncertainty.
Market willingness should not be confused with its capacity to better manage and bear riskThis project also highlights the need for clients to better understand the adverse influence ofcompetition and time-limited bid processes on contractors’ capacity to accurately price risk; with
contractors in this case provided a submission term of three months followed by a further three monthsof negotiations (Grewe et al., 2005).
Despite incomplete designs, lack of upfront risk analysis and a short bid timeframe, contractors still bid
the project; later incurring delays and costs when risks eventuated. While a direct comparison of risk
premiums in this and like projects is not possible, it is probable that bidders factored in the greater
likelihood of cost overruns and delays relating to design and constructability unknowns. By extension, thecost of managing risks was likely higher than a scenario where risks had been identified, assessed and(where prudent) mitigated upfront. Mitigation does not infer risk retention. In this case, assisting
contractors to gauge probability and impact would have led to more accurate pricing and more efficient
risk management.

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Notes

1 Contract power refers to how restrictively the initial contract price (or schedule) defines the expected end result for thecontractor. It effectively translates into how much risk is transferred to the contractor to deliver a project at a particular timeand for a specific cost. More details on contract power as a characteristic of contract design are presented later in this report.
2 To provide an idea of the order of magnitude of aggregate cost reductions, in 2010 EU 27 countries invested on average about
1% of their GDP on transport infrastructure alone. Much of this was allocated to major infrastructure projects (2010 was thelatest year with a full dataset for EU27 in the OECD/ITF database).
3 For example, the “hold up problem” has been treated in a substantial body of literature (two earlier examples are Williamson[1979] and Rogerson [1992]). A “hold up” example, where the principal is the loser, can be demonstrated through the case of a
procurement authority that enters a 20-year PPP contract for a new motorway. The investment is funded by the taxpayers(there is no tolling) and the PPP payment mechanism is availability-based. Due to a rapid deterioration of the country’s
macroeconomic conditions it is decided that tolling should be introduced. However, the state has not foreseen this scenario andno relevant provisions exist in the PPP contract. The introduction of tolling gantries on the highway infrastructure invades thecontractual rights of the private PPP partner. A contract renegotiation is thus required. The State does not have time for a
prolonged renegotiation and the bargaining power is on the private partner’s side. The State is in a “hold up” situation.
4 Non-systematic risks are those which are randomly distributed around zero. If, for example, cost overruns on projects wererandomly distributed around zero (building on-budget), then by pooling many projects together the errors of underspend andoverspend would cancel out and the risk on any individual project would be irrelevant. An example of a systematic risk on theother hand is the correlation between a national economy’s macroeconomic conditions and traffic on roads. No matter how
large a portfolio of road projects in a single economy, this risk will not be diversified away. On a theoretical level the diversifiable(non-systematic) risk is irrelevant and the key issue for the investors is the systematic risk.
5 How bidders value different sources of information is a relatively recent subject in literature on experimental economics(Brocas et al., 2015).
6 Depending on the source of financing of the project (i.e. public, private or mixed) there are typically variations to thecontractual risk transfer that takes place for the different works/services (e.g. private co-financing models such as PPP may push
for additional risk transfer to the contractor during the construction stage). This may result in the use of construction contracts
with different characteristics which are captured by contract design.
7 For example, if a bidder has four to six months to complete the bid, it may take two to three months to establish the bid teamafter they are shortlisted; then one to two months for the team to understand the project and its risks in more detail. This often
leaves bidders with less than a month to calculate costs and price all relevant risks.
8 Incentive mechanisms may exist for both the contractor and the procuring authority (client). Regarding the former, thesemechanisms aim to secure required performance, e.g. by including payment incentives or enforcement measures (e.g.
liquidated damages for delays, performance guarantees, construction completion guarantee, etc.). Regarding the latter, thesemechanisms aim to motivate the procuring authority to supply the necessary data in good amount and quality and to provide
support to the contractor (Bower, 2003).
9 Public procurement can fall under three main procedure types: open, selective and limited procedure (Yescombe, 2007). The
most commonly used is a selective procedure which is referred to in this report as “traditional” public procurement.
10 In this case the second phase is usually expressed as “Invitation to Negotiate” (ITN).
11 In this case the second phase is usually expressed as “Invitation to Competitive Dialogue” (ICD).
12 For example, a tender for a EUR 500 million project may cost a company approximately EUR 1 million.
13 Withdrawals from a bidding process can happen for many reasons. While increased bidding costs may be one of them, it is
not the most common factor. Bidders withdraw predominantly because there are too many bidders or (perceived) morequalified bidders participating in the process, and/or they because they lack the resources to bid on “equal” terms. Anothercommon reason is that too many risks are transferred by the client to the contractor, which make their perceived future risk
exposure unsustainable.

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14 Of the 75 projects, 54 projects were built exactly on cost, three cost significantly less (which suggests the procuring authority
reduced the project scope) and 17 had a cost overrun greater than 1%. Six of these had a full completion guarantee (whichmeans that next to the original contractor a third party was guaranteeing on-time/on-cost delivery). There is insufficient detailavailable to understand to what extent the projects with cost overruns have had scope changes by the procuring authority.
15 Inconsistent terminology of delivery models is evident across the literature, with “Design-Build”, “Integrated” and “Turnkey”
used interchangeably. Delivery models (e.g. DBB) and contract/payment types (e.g. fixed price) are also conflated. This reportdistinguishes between delivery models (i.e. whether a contractor is engaged in a bundled scope of works or not), procurement
process (i.e. awarding a contract with or without competition) and contract design (i.e. payment mechanism, high or low
powered risk transfer, etc.).
16 In project management, the “iron triangle” refers to the project objectives of cost, time and quality, with these objectives
forming an interrelated trade-off mechanism (Marques et al., 2011).
17 Relative weightings attached to these five indicators are as follows: risk allocation (5%); project complexity (25%); consortium
experience/readiness (25%); resilience to cost overruns (20%); and resilience to schedule overrun (25%) (Moody’s, 2016).
However, it is important to note that such assessments which are inherent in credit rating methodologies are not the outcomeof exact science. The above weightings are, to a great extent, based on expert judgment rather than statistical analysis.
18 It is important to note that when assessing risk sources for construction and design risks, some studies take the perspectiveof investors while others the perspective of contractors. In that sense certain risk sources presented in Table 1 may beconsidered as “sources” by some stakeholders but may considered as “results” of more granular risk sources by others. An
example is cost overruns which is a risk source of construction risk for investors but is the result of other risk sources forconstruction contractors.
19 For example, contracts may follow various international standard templates such as the New Engineering Contract (NEC),
Joint Contracts Tribunal (JCT), and International Federation of Consulting Engineers (FIDIC), among others.
20 In many projects there is three-point separation between design and construction. The client produces an early design whichis then outsourced to produce a contracted design. The final design is then undertaken by the construction contractor which
also executes the works.
21 A PPP involves the bundling, through a long-term contract (typically 20-30 years), of the financing, construction and/or
management of infrastructure and related services (Grimsey and Lewis, 2002; UK Treasury, 2008; Chung et al., 2010). Morespecifically, a PPP involves private sector participation as financier, designer, builder and operator (HM Treasury, 2012; Pantelias
and Roumboutsos, 2015; Loosemore and Cheung, 2015). Rather than inputs, clients specify requirements in terms of outputs(and increasingly outcomes), which are typically expressed in terms of quality and quantity (Burger and Hawkesworth, 2011).
Compensation is paid over the contract life, either by the procuring authority through a monthly unitary payment, or directly byusers (or through a combination of the two), in which case charging schemes are clearly defined ex ante and strictly regulated.
22 ECI application is highly varied across and within countries, with precise approaches differing with respect to: the point at
which a contractor is engaged; the scope for which a contractor is engaged; the degree of bid competition; and the contractual
basis on which a contractor is engaged (e.g. lump sum, schedule of rates etc.).
23 Variability in subcontractor pricing refers to the difficulties that primary contractors face in accurately estimating cost
impacts should a subcontractor be unable to deliver as agreed (given typically capped liability limits), or where a subcontractor
chooses to rescind a contract (due to contractual default by the primary contractor). This is further compounded by: large
differences in subcontractor prices even for the same scope of work or product; the large number of individual contracts/costs
that must be considered by the primary contractor in a short space of time; as well as the large (aggregate) impact of
subcontracts on overall construction costs.
24 The PPIAF Guide (2016) further clarifies that procuring authorities may provide full PPP project designs or construction
requirements. In such circumstances, the private party will not normally assume any risk relating to the accuracy of the provided
requirements unless it has the opportunity to review the final design and to propose design variations and changes of standards.
25 Despite great improvements in the way these technical risks can be identified, analysed, and mitigated (or avoided), projects
cannot be 100% failsafe with respect to them. For example, although ground investigation can be done very thoroughly,site-related risks cannot be fully eliminated, as seen in the case of the Berlin Hauptbahnhof project (see case study details).
26 Disclaimer: The authors of the report do not criticise the continuous ecological functionality measures in any way. They arenecessary to protect the environment and in no way do they hinder projects. The project under consideration merely had totake care of them and handle the corresponding demands.

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27 The full range and classifications of risk will ultimately depend on the scope of work for which a contractor is engaged. For
example, in a PPP, contractors may face operational and maintenance risk (if also responsible for O&M), or revenue risk (if theyhold an equity stake), however these fall outside the scope of this report.
28 It is acknowledged that the provision of a complete, detailed, fully-costed and fully approved design requires significant
resources and expertise on the client’s side. Realising that such resources are not always available to achieve the “ideal”
standard of this recommendation, providing a complete design (even if not fully approved or fully costed) becomes theminimum acceptable requirement. Going to tender under DBB delivery based on an incomplete design is not an acceptable
practice and should be avoided.
29 The client has a responsibility to make sure that all bidders in the tender process get exactly the same information in order toavoid complaints about due process. Talking bidders through the reference design can be challenging depending on the numberof bidders participating. This can be done at different levels at different stages of the tender process. For example, during
Prequalification it would be perfectly reasonable to give a presentation to all bidders at the same time. During the final tenderstage, clients may have to do this in bilateral discussions with every participating bidder.
30 It should be noted that different countries have different discretionary cultures when it comes to the process behind permits
and approvals and the relevant degrees of freedom that can be allowed with respect to contractor innovation. While in somecountries (e.g. the UK) the permitting authorities may allow some flexibility, in others (e.g. Germany) the culture is morenormative and allowing deviations from already obtained approvals and permits becomes challenging.
31 The Baseline Report (BR) is a text file describing all tasks and obligations of the project. Tasks which contain any sort ofactivity or action are transferred into a similar looking document, the (so called) “Baseline Tracker” (BT). The BT is a spreadsheet
file used to track any changes, differences and developments against the baseline information and tasks. The BT also contains
the project’s risk register which is simply a set of columns within the overall spreadsheet.
32 As an example, in Germany the recommendation from the Government (Reformkommission Grossprojekte) is that the client
has the duty to deliver complete information about the project.
33 The contract needs to clearly articulate the allocation of risk and the mechanism by which changes may be made. It also
needs to provide commercial incentives to deliver the project efficiently, in time and on budget. A common approach is throughpain/gain share terms that link to delivery at a target cost by a target date, but these must fairly represent the balance of risk
and reward to provide useful incentivisation.
34 In the UK the Infrastructure and Project Authority is a public agency, but is not limited to public servant pay caps to attract
highly capable staff.

35 LU derived “Value” from a combination of “cost savings”, “improved benefits” and a “reduction of dis-benefits” (e.g.
blockade) (LU, 2014).
36 As the project is still under construction, the above benefits should be considered tentative rather than definitive. Actual
benefits will not be known until the project reaches completion.
37 TfL’s most recent (December 2017) EFC for the project is GBP 642 million (with a 2022 completion date). This incorporates
additional works not included in the contracted scope. TfL further states “the programme view is that working through theschedule and opportunities will largely mitigate this pressure” (TfL, 2017).
38 The Royal Institute of British Architects (RIBA) has developed the “RIBA Plan of Work” which organises the process of briefing,
designing, constructing and operating building projects into stages and details the tasks and outputs required at each stage. A“Work Stage D: Design Development” corresponds to “RIBA Plan of Work 2007” which contained 11 stages (A-L) and entailed
the following (www.ribaplanofwork.com): Development of concept design to include structural and building services systems, updated outline specifications andcost plan.
 Completion of Project Brief.
 Application for detailed planning permission.
In the most updated version of the “RIBA Plan of Work” (2013), the process is broken down to eight stages (0-7) where former“Work Stage D - Design Development” and part of “Work Stage E - Technical Design” are now part of “Work Stage 3 – Developed
Design”.
39 All relevant documents were provided in soft as well as hard copy so that bidders could understand how cost, schedule andrisk were built up, with all calculations being visible.

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40 While T5’s operational phase is not the focus of this case-study, it should be acknowledged that significant operational
challenges were experienced in T5’s first few months of operations. A House of Commons Transport Committee Inquiry (2008)
identified two sources of failure: insufficient communication between BAA and British Airways (T5’s primary client and systems
operator); and poor staff training and systems testing. The Committee (2008, p. 3) did however acknowledge that the project
was delivered “on time and within budget”.
41 Repayment mechanisms varied but were typically based on evidence of costs incurred (receipts, wage slips, etc.), or on
pre-agreed rates for specified activities (NAO, 2005).
42 Between initial and final bids, the tunnel construction budget was reduced by DKK 2.9 billion (circa EUR 400 million), wholly
derived from cost reductions in coast-to-coast construction (Femern A/S, 2016a)
43 The Fixed Link has total reserves of DKK 9.5 billion (Femern A/S, 2016a); which accounts for circa 18% of the total
construction budget (when reserves are not included). According to Schjær-Jacobsen (2017, p. 129), the Danish Ministry ofTransport’s “standard for experience-based correction supplement is 30% of the base budget”.
44 Costs (which assume a 2020 construction commencement) comprise DKK 52.6 billion for the coast-to-coast section plus
DKK 9.5 billion for Danish land works, inclusive of reserves (Femern A/S, 2016a).
45 Initial feasibility studies were completed in 1999, with Femern A/S initiating pre-qualification in October 2012 and signing
contracts for tunnel construction in May 2016 (Femern A/S, 2018).
46 The Fixed Link was originally expected to be inaugurated by 2018, with a revised expectation of 2028 (State Treaty, 2008;
Femern A/S, 2016).
47 Priced provisional bids of 22 December 2014 were approximately DKK 8.9 billion higher than assumed in initial construction
estimates (Femern A/S, 2016a).
48 Land works reserves were kept constant at DKK 2.2 billion (Femern A/S, 2016a).

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Appendix 1. Construction cost overruns at decision
to build and contract level
SourceReference
estimate

Project typeTime period*

Obs.

Average Cost
overrun (%)

Area

Cantarelli et al.2012b,
Flyvbjerg et al. 2003

Decision to
build

Roads

1927-2009

278

21.2

NW Europe

39

25.3

Cantarelli et al. 2012a

Decision to
build

Roads

37

18.9

15

21.7

Makovšek et al. 2012

Decision to
build

Roads

1995-2007

36

19.19

Slovenia

Lundberg et al. 2011

Decision to
build

Roads

1997–2009

102

21.2

SwedenLee et al. 2008

Decision to
build

Roads

1985-2005

138

11.0

South Korea

Welde et. al. 2017

Decision to
build

Roads

2006 -

30

2.0

NorwayOdeck 2014

Decision to
build

Roads

1993-2007

1045

10.0

NorwayEllis et al., 2007

Contract
value

Roads and bridges

1998–2006

1908

9.36

USA, Florida

Bordat et al. 2004

Contract
value

Roads

1996-2001

599

5.6

USA, Indiana

Bhargava et al .2010

Contract
value

Roads

1995-2001

1862

4.1

USA, Indiana

Hintze and Selstead
1991

Contract
value

Roads

1985–89

110

9.2

USA,
Washington

Love et al. 2015 andLove et. al 2009 andLove et al. 2014

Contract
value

Roads

N/A

44

12.5

Australia

Verweij 2015

Contract
value

Roads

-2014

36

22.4

The Netherlands

ITF 2018

Contract
value

Roads and bridges

2008-1628

9.3

Slovakia© OECD/ITF 2018

Bridges, tunnels
1980-2009

Bridges, tunnels

Netherlands

89

RISK PRICING IN INFRASTRUCTURE DELIVERY | WORKING GROUP PAPER | ITF

Appendix 2. Research questions and outputs
Introduction: Getting the basics right
What are the economic characteristics of infrastructure?
What is infrastructure and what are operations? What are
the models of private participation in infrastructure andthrough which significant private investment actually takes
place?

Makovšek, D. (2018), “What is Private
Investment in Transport Infrastructureand Why is it Difficult?”, Working
Group Paper, International Transport
Forum, Paris (forthcoming).

Can private investment improve productive efficiency?
Makovšek, D. (2018), “The Role of
Improve project selection? Close the infrastructure funding Private Investment in Transport
gap? Have other positive effects when it is private?
Infrastructure”, Working Group Paper,

International Transport Forum, Paris(forthcoming).
What have the private investment trends in transport Mistura, F. (2018), “Quantifying
infrastructure been over the last 20 years? How much Private and Foreign Investment inof that was foreign private investment?
Transport Infrastructure”, Working
Group Paper, International Transport
Forum, Paris (forthcoming).
Defining the challenge: How uncertainty in contracts matters
How does uncertainty affect risk pricing? Beyond
investors, do suppliers in PPPs also have issues withrisk pricing? How does its transfer to the private
sector affect competition? What does uncertainty
mean for the public vs. private cost of financing?

Makovšek, D. and Moszoro, M. (2018),“Risk pricing inefficiency in public–
private partnerships”, Transport
Reviews, 38(3), 298-321.

Is uncertainty also an issue in long-term
services/operations contracts?

Beck et al. (2018), “Uncertainty inLong-term Service Contracts:
Franchising Rail Transport
Operations”, Working Group Paper,
International Transport Forum, Paris(forthcoming).

What is the competition for large transport
infrastructure projects in the EU Market? Is there adifference between traditional procurement and
PPPs?

Roumboutsos, A. (2018),” Competition
for Infrastructure Projects: Traditional
Procurement and PPPs in Europe”,
Working Group Paper, International
Transport Forum, Paris (forthcoming).

90© OECD/ITF 2018

RISK PRICING IN INFRASTRUCTURE DELIVERY | WORKING GROUP PAPER | ITF

Addressing uncertainty for suppliers: the construction phase as example
Adversarial vs. collaborative procurement – iscollaborative contracting the future?

Eriksson et al. (2018), “Collaborative
Infrastructure Procurement in Sweden
and the Netherlands”, Working Group
Paper, International Transport Forum,
Paris (forthcoming).

What lessons in dealing with risk and uncertainty
were learnt in Danish mega projects from Storebaelt
to Femernbaelt?

Vincentsen, L. and Andersson, K. S.
(2018), “Risk Allocation in MegaProjects in Denmark”, Working Group
Paper, International Transport Forum,
Paris (forthcoming).

What can governments do in the short run to reduce
inefficient pricing of risk by construction contractors?

Kennedy et al. (2018), “Risk Pricing in
Infrastructure Delivery: Making
Procurement Less Costly”, Working
Group Paper, International Transport
Forum, Paris (forthcoming).

Addressing uncertainty in long-term contracts in the absence of continuous pressure for
efficiency
What is the public sector organisational Holm, K.V. and Nielsen, T.H. (2018),
counterfactual on which private investment should “The Danish State Guarantee Modelseek to improve?
for Infrastructure Investment”,
Working Group Paper, International
Transport Forum, Paris (forthcoming).
Partial fixes to the Private-Public Partnership approach
How would an organisational structure consisting of
PPPs come close to a network-wide management
approach? What benefits would it yield?

Vasallo, J. (2018), “Public-Private
Partnerships in Transport: Unbundling
Prices from User Charges”, Working
Group Paper, International Transport
Forum, Paris (forthcoming).

Should the public or the private side bear the cost of
long-term uncertainty? How could we design a PPP
contract to avoid hold-up due to incomplete
contracts?

Engel et al., (2018), “Dealing with the
Obsolescence of Transport
Infrastructure in Public-Private
Partnerships”, Working Group Paper,
International Transport Forum, Paris(forthcoming).

© OECD/ITF 201891

RISK PRICING IN INFRASTRUCTURE DELIVERY | WORKING GROUP PAPER | ITF

Long-term strategic approach
How do the PPP and regulated utility model (RAB)
compare in terms of efficiency incentives?

Makovšek, D. and D. Veryard (2016),“The Regulatory Asset Base andProject Finance Models”, International
Transport Forum Discussion Papers,
No. 2016/01, Paris.

What basic considerations underlie the choice
between a PPP and RAB approach?

Hasselgren, B. (2018), “Risk allocationin Public-Private Partnerships and theRegulatory Asset Base Model”,
Working Group Paper, International
Transport Forum, Paris (forthcoming).

Which are the preconditions a country would need to Alchin, S. (2018), “A Corporatised
take to establish a RAB model on a motorway
Delivery Model for the Australian Road
network? Is user-charging a must?
Network”, Working Group Paper,
International Transport Forum, Paris(forthcoming).
From the investors’ point of view, does a RAB need to Francis, R. and Elliot, D. (2018),
be fully reliant on user-charging?
“Infrastructure Funding: Does it
Matter Where the Money Comes
From?”, Working Group Paper,
International Transport Forum, Paris(forthcoming).
Incentive regulation can also yield perverse
incentives. Can the capex bias be managed?

Smith et al. (2018), “Capex Bias andAdverse Incentives in Incentive
Regulation: Issues and Solutions”,
Working Group Paper, International
Transport Forum, Paris (forthcoming).

Does it make sense to pursue hybrid solutions
between PPP and RAB?

Zhivov, N. (2018), “The Thames
Tideway Tunnel: A Hybrid Approach to
Infrastructure Delivery”, Working
Group Paper, International Transport
Forum, Paris (forthcoming).

92© OECD/ITF 2018

RISK PRICING IN INFRASTRUCTURE DELIVERY | WORKING GROUP PAPER | ITF

Uncertainty and private investment mobilisation in transport infrastructure
What lessons can we draw from recent attempts tomobilise private investment in infrastructure in theaftermath of the global financial crisis?

Makovšek, D. (2018), “Mobilising
Private Investment in Infrastructure:
Investment De-Risking andUncertainty”, Working Group Paper,
International Transport Forum, Paris(forthcoming).

Synthesis

ITF (2018), Private Investment inTransport Infrastructure: Dealing with
Uncertainty in Contracts, Research
Report, International Transport Forum,
Paris© OECD/ITF 2018

93

CPB

CPB

CPB

Private Investment inTransport Infrastructure
Dealing with Uncertainty
in Contracts

The Role of Private
Investment in Transport
Infrastructure

Risk Pricing in
Infrastructure Delivery:
Making Procurement Less
CostlyCorporate Partnership
Board

Risk Pricing in
Infrastructure Delivery
Making Procurement
Less Costly

Corporate Partnership
Board

4

2

This report examines how the public
sector could make infrastructure
projects less costly by reducing
the uncertainty for bidders during
procurement. The analysis focuses on
Public-Private Partnerships but many
lessons apply to public procurementin general. The paper is part of aseries of 19 papers and a synthesis
report produced by the International
Transport Forum’s Working Groupon Private Investment in Transport
Infrastructure.

6

CPB

CPB

CPB

Dealing with the
Obsolescence of Transport
Infrastructure in PublicPrivate Partnerships

Risk Allocation in
Mega-Projects in Denmark

Risk allocation in PublicPrivate Partnerships andthe Regulatory Asset Base
Model

Corporate Partnership
Board

Corporate Partnership
Board

8

Corporate Partnership
Board

10

12

CPB

CPB

CPB

The Thames Tideway
Tunnel: A Hybrid Approach
to Infrastructure Delivery

The Danish State Guarantee
Model for Infrastructure
Investment

Infrastructure Funding:
Does it Matter Where theMoney Comes From?

Corporate Partnership
Board

Corporate Partnership
Board

Corporate Partnership
Board

16

14

18

CPB

CPB

CPB

Public-Private Partnerships
in Transport: Unbundling
Prices from User Charges

A Corporatised Delivery
Model for the AustralianRoad Network

Collaborative Infrastructure
Procurement in Sweden and
the Netherlands

Corporate Partnership
Board

Corporate Partnership
Board

Corporate Partnership
Board

22

20

24

CPB

CPB

CPB

Competition for
Infrastructure Projects:
Traditional Procurement
and PPPs in Europe

Capex Bias and Adverse
Incentives in Incentive
Regulation: Issues andSolutions

Uncertainty in Long-term
Service Contracts:
Franchising Rail Transport
Operations

Corporate Partnership
Board

Corporate Partnership
Board

Corporate Partnership
Board

28

26

30

CPB

CPB

CPB

Quantifying Private andForeign Investment inTransport Infrastructure

What is Private Investment
in Transport Infrastructureand Why is it Difficult?

Mobilising Private
Investment in Infrastructure:
Investment De-Risking
and Uncertainty

Corporate Partnership
Board

Corporate Partnership
Board

32

1

Corporate Partnership
Board

Corporate Partnership
Board

34

36