House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Ninth Report

4 Improving economic sustainability

109. Truly sustainable construction should produce the best possible economic, social and environmental outcomes. These facets of the construction process are in fact complementary to each other—not mutually exclusive, as sometimes supposed. For example, a building that minimises its environmental impact through energy efficiency and reducing water wastage will also improve its economic performance by cutting its occupant's running costs. Similarly, a construction process with high health and safety standards is less likely to result in accidents that delay a project's delivery. Chapters 4, 5 and 6 separately consider the economic, social and environmental elements of sustainable construction. We show the linkages between the three dimensions; how they are underpinned by the importance of design; and how in conjunction they can achieve a better outcome for the industry, its workforce, its clients, and society. In this chapter we focus on the economic sustainability of the sector and the primary means of promoting this—through the client and supply chain working together as a team. We then explore in more depth the main characteristics of successful team-working, and the various ways government can do more to foster it.

Recent economic performance

110. The key factors for an economically sustainable end-product are performance against time, cost and design quality. Best value for the client comes when all these are considered together. Constructing Excellence and BERR collect data against these indicators for both private and public sector construction projects to assess performance over time. Table 4 below gives some of the results of their most recent report. Table 4: Construction industry performance on time, cost and client satisfaction

Key performance indicator 2000 2001 2002 2003 2004 2005 2006 2007

Client satisfaction: product
(% scoring 8/10 or better)
73% 72% 73% 78% 80% 83% 84% 82%

Client satisfaction: value-for-money (% scoring 8/10 or better) - 67% 69% 73% 74% 79% 80% 75%

% of projects on cost or better 50% 46% 48% 52% 50% 48% 45% 46%

% of projects on time or better 28% 36% 42% 44% 44% 46% 44% 58%

Source: Constructing Excellence in partnership with BERR, Industry Performance Report, 2007

111. It is not easy to provide an objective overall measure of design quality. However, client satisfaction can give a subjective indication of the industry's performance. Table 4 above shows that, across the industry, client satisfaction has steadily increased in recent years, both in terms of the end-product and whether it represents value-for-money. There has also been a significant increase in the percentage of projects delivered on time, albeit from a very low base. However, performance in terms of cost has barely changed at all—more than half of reported projects went over budget. As the Construction Confederation told us: "The evidence is not brilliant".[167] Overall, the construction industry is getting better at delivering a quality product for the client, and the proportion of projects completed on time has increased, but there still remains significant room for improvement in finishing projects both to time and to budget.

Raising performance through integrated teams and supply chains

112. The construction industry's poor performance is largely a consequence of its highly fragmented structure. The traditional approach has been for the client to appoint an architect to produce a design, which is then tendered to a main contractor who has responsibility for managing construction delivery. The main contractor will then sub-contract the work to specialist contractors who are largely responsible for making the architect's original design a reality. This hierarchical structure often leads to adversarial relationships, with most parties operating in silos, and the transferral of risk along the supply chain.[168] Frequently delays occur because sub-contractors have not had the chance to influence the early design. Disputes and reworking impact on out-turn costs and the quality of the end-product. This puts at risk the improved services or business performance that the project is meant to deliver.

113. Because the construction industry's structure so clearly harms its performance the main thrust of recent efforts to improve it have focused on the need for greater team-working—what the industry refers to as integrated delivery. The Specialist Engineering Contractors' (SEC) Group described integration as "the bringing together of all the processes involved in construction delivery—especially design and construction—into a seamless whole".[169] The client, the main contractor, architects, sub-contractors, structural engineers, etc should work together as a team and share collective responsibility for the delivery of a project. Integrated teams, which are often co-located, should be established at the outset to work together on the design, cost plan and allocation of risk before construction begins. Everyone involved in the project team has a collective interest in ensuring its success. The Construction Confederation cited industry estimates that between 15% and 20% of project costs could be saved as a result of adopting a more integrated approach.[170]

114. Integrated supply chains are able to move from project to project, and apply lessons learnt on one project to the next. This gives firms greater confidence to invest in their capacity, for example, by providing training for their employees or developing new ways of working. As a result, the industry can further improve its performance. However, if they are to survive integrated supply chains need the security of a long-term programme of work. This is one of the main reasons why the development of framework agreements and long-term government expenditure programmes are important to the industry.[171] Without them, it is difficult to hold supply chains together from project to project.

115. Integrated teams and supply chains were at the heart of both the Latham and Egan reviews of the industry, and are a key part of the good practice guidance promulgated by Constructing Excellence, the industry's Strategic Forum, and the Office of Government Commerce. The 2002 Egan report, Accelerating Change, set an ambitious target for 20% of construction activity by value to be conducted by integrated teams and supply chains by 2004, and 50% by 2007. That has not been achieved. On using 2006 survey data, the Construction Products Association (CPA) estimate that roughly 20% of projects use integrated project teams, where the client's team and the contractor's team work together, and no more than 15% use integrated supply chains.[172] However, collecting data to assess performance is not straightforward. The extent to which teams or supply chains are seen as integrated often depends on the perspective of those involved. The SEC Group told us clients working together with just their main contractor and designers may consider themselves an integrated team. From the perspective of sub-contractors, who are frequently excluded from such arrangements, no more than 5% of projects are integrated.[173]

116. Whatever the actual figure, the Strategic Forum noted that while "more integrated working is taking place … there is no hiding from the fact that we have not moved anything like as quickly as the Accelerating Change report intended or we would have liked".[174] The National Specialist Contractors' Council (NSCC) attributed this lack of progress to a "lack of engagement by clients and main contractors".[175] This is all the more disappointing given the savings that integrated delivery could realise. The National Audit Office's 2005 report estimated that such collaborative working, in conjunction with the application of other industry good practice, could generate savings of roughly £2.6 billion per annum for the public sector.[176]

117. The industry's main umbrella bodies remain committed to the promotion of integrated working. They have agreed new, although slightly less ambitious, targets for various parts of the sector—clients, consultants, main contractors, specialist contractors, and product manufacturers and suppliers—to be engaged in integrated supply chains on 30% of construction projects, and for 40% of their work to be conducted through integrated project teams by 2012. The Strategic Forum has also agreed an action plan of activities to engage with the industry to help it meet the targets. Best practice in integration and procurement is also one of the six themes of the new Construction Commitments.

118. The fragmentation of the construction industry has contributed to its poor performance on delivery to time and cost. Integrated working not only improves value for the client, but also allows time for firms in the supply chain to develop business relationships with each other, creating an environment that encourages investment in capacity and innovation. Despite the potential benefits for all involved, progress in adopting integrated working has been slow. We welcome the new targets for the period 2008 to 2012. We are encouraged that the industry bodies have recognised their responsibility. The Government should also play its part through, for example, effective framework arrangements; engagement with the industry on its long-term construction programmes; and departments' compliance with the Common Minimum Standards.

Early engagement with the supply chain

119. Many of the industry bodies we spoke to said that early engagement of the supply chain was a fundamental feature of integrated working which ultimately benefits clients.[177] Traditionally, construction projects have followed a sequential process of design, specification, and procurement. However, this approach tends to preclude manufacturers and specialist contractors from offering expert advice at an early stage.[178] Integrated working, which involves the supply chain early on in projects, generates efficiencies in both the design and construction stages.[179] The whole team is able to influence the planning of the project, its design, and the management of risks and costs. Issues which might have arisen further down the line, leading to costly re-working of the initial design, can be addressed at the outset. In so doing, early engagement promotes a more realistic costing and bidding process.[180]

120. In spite of the advantages, the SEC Group told us the public sector had a poor record of engaging the supply chain early. A survey of its members found that only 7% had been appointed early on in the majority of government projects they had worked on. 44% of firms stated that they had not been appointed at an early stage for any project. This is surprising given that the SEC Group estimate specialist engineering firms contribute as much as 70% of projects' value.[181] It is also disappointing given the prevalence of framework arrangements in the public sector, which are supposed to support the development of integrated teams. Overall, government is not doing enough as client to engage with the supply chain early on—a key feature of integrated working. As a result, the public sector is missing out on efficiencies that would deliver a cheaper and better quality end-product.

Maximising whole-life value

121. The selection of teams on the basis of 'whole-life value', rather than 'lowest price' is key to integrated working.[182] Whole-life value involves the maximisation of benefits and minimisation of costs over a project's lifetime. Initial construction costs are a small element of the total lifetime cost of the built environment.[183] The Commission for Architecture and the Built Environment (CABE) told us that "over quite a short life of a building, you will quickly spend more running it, operating it, maintaining it, consuming energy in it, and so on than you will in its first creation".[184] Similarly, decisions made at the design stage can have massive effects on the benefits drawn from a project over its lifetime. In a workplace this may include raised productivity for its occupants or, say, for a hospital, better health outcomes for its users. By taking account of the lifecycle of the built environment, a consideration of whole-life value can also contribute to achieving social and environmental sustainability. As CABE told us: "It would change quite fundamentally what we build and probably how we build it".[185]

122. Despite the acknowledged benefits of a whole-life approach to construction appraisal and procurement, many clients have yet to apply it. The Building Services Research and Information Association (BSRIA) told us that there has been a trend away from procurement on a lowest price basis in recent years, but that "price still remains the dominant criterion in 64% of cases".[186] There are several reasons for this. First there is a simple lack of understanding by clients of what whole-life value means and how they can benefit from such an approach.[187] Second, without an integrated team or supply chain, it is difficult for everyone involved in a project to define at the outset what will provide best value for the client.[188] Third, clients frequently face pressure to bring down the upfront costs of a project because of budget constraints.[189] They are not rewarded for purchasing a more expensive solution that would actually give better whole-life value. Finally, those in charge of procuring a project are unlikely to be responsible for its eventual running costs. This also creates an incentive for clients to focus on minimising the capital expenditure of a new building, rather than taking account of its operating costs as well.[190]

123. Government and the industry are promoting awareness among clients of the importance of whole-life value when developing projects. On the industry's side, Constructing Excellence is undertaking research on the relative ratio of construction cost to business value, to improve the evidence base in support of whole-life project appraisal.[191] Elsewhere, the Construction Industry Council has led the creation of the Design Quality Indicator (DQI), an online tool, launched in 2003, for evaluating the design of buildings. There are several versions of the DQI, which procurers of buildings can apply according to the different phases of the project. First, there is a 'brief' version, which aims to clarify the client's priorities and ambitions for a project. This is followed by a 'mid-design' version, which allows the client and design team to assess whether their initial aspirations have been met and for them to make adjustments. There are then 'ready for occupation' and 'in use' versions, which clients can apply later down the line. The aim of the process, which around 800 projects have now used, is to provide a more objective assessment of what can provide best value for the client.[192] A variation of it has now been developed for schools.

124. At the time of its launch, the Strategic Forum had set a target for 50% of publicly-funded and PFI projects with a value in excess of £1 million to be using the DQI, or a variant of it. The Construction Products Association told us, however, that although considerable progress has been made, it has been difficult to measure performance. It did note that in 2007 around 90% of new schools costing more than £1 million were using the process.[193] As part of the new industry targets for 2012, the Strategic Forum has set a slightly less ambitious target for a 10% year-on-year increase in the proportion of civic, housing and education projects using the DQI.

125. Government, too, has made some progress in encouraging a whole-life approach to procurement. It has been a key part of the OGC's Achieving Excellence in Construction initiative. The Private Finance Initiative (PFI) is also meant to encourage decision-making on the basis of whole-life value, because suppliers have responsibility for both the initial construction and the subsequent operation of a project, be it a hospital, a prison or a school. This creates an incentive for them to minimise costs over the building's lifetime. The CBI told us PFI has led to a reduction in construction times by 40% and cost savings of more than 20%. Survey evidence of all 500 operational PFI schemes shows 72% reported 'good' or 'very good' performance in the service levels achieved by the contractor.[194]

126. HM Treasury's Green Book, which provides guidance on the investment appraisal for all public procurement, states that departments should take whole-life value into account when making investment decisions.[195] To this end, the OGC has recently published a supplement to the Green Book looking specifically at whole-life value in construction. The achievement of improved whole-life value by encouraging uptake of the new Construction Commitments is also an overarching objective of BERR's Strategy for Sustainable Construction. However, BERR's memorandum to the Committee acknowledges that: "Ultimately, as well as value-for-money assessments, each department needs to take account of what is affordable within its overall budget". BERR also told us that applying a whole-life value approach is challenging and that its success is dependent on the use of "high calibre people with the appropriate skills". The OGC is trying to address this issue through the reinvigoration of the Government Procurement Service, which we discussed in Chapter 2.[196]

127. A whole-life value approach to construction procurement seeks to maximise the benefits and minimise the costs of a project across its life-cycle. It requires an integrated project team able to develop a design that creates best value for the client. However, it also requires clients to have the skills and long-term perspective to make investment decisions which are not based on short-term price. Government has made progress in encouraging a whole-life approach in the public sector, but in the words of the Minister: "There is a good deal more to do".[197] We welcome the emphasis placed on whole-life value in BERR's Strategy for Sustainable Construction. We also welcome the publication of the OGC's supplement to the Green Book on whole-life appraisal in construction, which the Office should now seek to embed in procurement practice across government. It should support this by ensuring clients have the information to accurately quantify whole-life costs and benefits. Finally, the Government should make it mandatory for all public sector projects with a value in excess of £1 million to use a structured mechanism for assessing their design, such as the Design Quality Indicator.

Commercial arrangements to manage risk

128. Integrated team working can allow risk to be managed more effectively. The construction industry's traditional way of working has been for contractors and their supply chains to adopt an approach to contracting and insurance that allocates risk disproportionately, and promotes adversarial relationships between firms. Because risks are not effectively managed, they are more likely to come to fruition, and so the client ultimately suffers. Constructing Excellence told us that "the public sector needs to understand and manage risk better".[198] It can do this by both changing the way it contracts with the industry, and by adopting a different approach to insurance.

COLLABORATIVE CONTRACTS

129. The legal framework for contracts can affect the way in which parties behave. If integrated supply chains are to function effectively, they need to be supported by contractual arrangements which ensure risk is owned and shared by the entire project team.[199] They should also be transparent and non-adversarial in style. The Institution of Civil Engineers' NEC3 Engineering and Construction Contract has set the benchmark in this area. First introduced in 1993 as the New Engineering Contract (NEC), it is a family of contracts written in plain English and designed to foster partnership between employers, designers, contractors and project managers.[200] Other forms of standard contract such as the Project Partnering Contract (PPC 2000) and the JCT Constructing Excellence (JCT CE) Contract adopt a similar approach, with the encouragement of collaboration being at their heart.

130. Both the National Audit Office and the Office of Government Commerce have recommended the use of collaborative contracts by public sector construction clients.[201] However, evidence we received suggested their use is far from universal. The Specialist Engineering Contractors' (SEC) Group highlighted Network Rail and the Building Schools for the Future programme as examples where traditional contractual arrangements, which pass risk along the supply chain, are still in place.[202] More generally the SEC Group criticised the public sector for having in place a "vast array" of "unnecessarily complicated and lengthy" construction contracts for different procurement methods and buildings. The Group argued that the proliferation of different contract forms with varying risk/reward mechanisms added substantially to the cost of bidding for government construction work.[203]

131. A related issue raised by the SEC Group, the Heating and Ventilating Contractors' Association (HVCA) and the Confederation of Construction Specialists was the use of bespoke rather than standard form contracts by main contractors.[204] They argued that such bespoke contracts tend to use the industry's traditional approach of passing risk down the supply chain. This often occurs despite the fact that the contract between the client and the main contractor itself reflects a fair apportionment of risk. For example, even though the client and main contractor may use the NEC3 Engineering and Construction Contract, the main contractor is not obliged to reciprocate the same arrangements with their supply chain unless the client tells them to do so. The SEC Group cited evidence from 2005 that only 38% of firms were content with the contractual terms on offer on the majority of projects. Arguably such arrangements are not conducive to the development of integrated supply chains.[205]

132. Integrated team-working needs to be underpinned by contracts that foster collaborative rather than adversarial relationships between clients, their contractors and their sub-contractors. Unfortunately the industry does not seem able to do this for itself. As a result clients must take the lead. There are useful standard contract forms such as the NEC3 Engineering and Construction Contract, recommended by the Office of Government Commerce for all public sector construction projects. Despite this, a large proportion of government construction is still let using a variety of traditional contractual arrangements. Led by the OGC, departments should work towards the use of collaborative contracts as a matter of course, and ensure they are adopted throughout their supply chains.

PROJECT INSURANCE

133. Traditionally, insurance arrangements in the construction industry have aimed to protect the individual rather than the team.[206] Project participants are frequently required to have a number of different insurance policies, including professional indemnities policies and product liability policies. As a result, any one construction project may be covered by a plethora of different and potentially overlapping policies. The SEC Group cited evidence from the Reading Construction Forum that around £1 billion is wasted every year on insurance cover that provides for the same types of risk.[207] Constructing Excellence also told us that insurance is a problem, "with redundant layers of consultant, contractor and supplier cover which often do not protect the client anyway".[208] Furthermore, because these insurance policies are activated on proof of liability, this can lead to defensive behaviour on the part of contractors and sub-contractors. The process of apportioning blame is also costly and can swallow up the bulk of what is paid out on a policy.[209]

134. One innovative approach has been the development of Integrated Project Insurance (IPI), where the client has one insurance policy that covers the entire integrated team—client, contractors and sub-contractors. The whole project is insured against a target budget that has been agreed by the insurer and the project team. The insurer covers financial loss incurred above the target budget, subject to any agreed deductible, which is shared between all members of the team. Correspondingly, any benefits from out-performing the target budget are also shared among the project team. This aligns the interests of all members of the team to help ensure the project is a success.

135. BAA used a form of IPI on its recent Heathrow Terminal 5 programme. Its application there was cited to us as an underpinning factor in the Terminal's construction on time and on budget.[210] However, Constructing Excellence told us the concept "needs some learning from demonstration projects before it can be promoted with confidence".[211] The SEC Group told us a number of brokers and insurance companies are interested in supporting such pilots.[212] In turn, the Minister responsible for construction said a health service project managed by NHS Estates was currently piloting the concept to see if it could be more widely applied for the public sector.[213]

136. Integrated Project Insurance provides single cover for the entire project team, and could foster integrated working by encouraging the collective ownership of a project's target budget. It is an emerging concept, but one that could deliver benefits for all members of the project team. We encourage the OGC to set a target for the approach to be piloted across a range of departmental construction projects so it can be properly evaluated.

Fair payment

137. Integrated working can only succeed if there is a culture of fair payment throughout the construction sector. The hierarchical structure of most industry supply chains means that payment tends to flow from the client to the main contractor, who then pays the project's sub-contractors, who in turn pay their own sub-contractors. Both the main industry umbrella bodies representing sub-contractors—the National Specialist Contractors' Council (NSCC) and the SEC Group—told us there remains a "deep-seated culture among main contractors of delaying, reducing or simply avoiding payment to their sub-contractors".[214] At worst, poor payment practice can lead to firms' insolvencies. In this section we consider current payment practices in the construction industry, and particularly the issue of retentions. We then look at the various ways in which the Government has sought to address the issue in recent times, including by amending the Construction Act, and what further work it can do.

RETENTIONS

138. Retention is a contractual mechanism, whereby a proportion of all payments made to a main contractor is held back by the client until expiry of the defects liability period of the main contract. This is usually about 12 months after the completion of the project. The practice tends to be mirrored down the supply chain, with the main contractor holding a retention against its sub-contractors. The sum held is usually around 3-5%. As a rule, half the retention is paid to the sub-contractor upon completion of their work on a project. The other half is paid on receipt of the final certificate or 'making good defects' certificate.[215] The practice is common throughout the construction industry. A recent survey by the NSCC estimated the total amount currently held in retention against its members at about £950 million.[216] The SEC Group estimate a total of £3 billion is held across the industry at any one time.[217]

139. For many clients, retentions may provide a means of protecting themselves against a poor quality end-product. However, the HVCA told us: "Retentions do not promote quality; this is achieved through rigorous qualification and inspection procedure and engendering positive relationships".[218] For infrequent clients, though, it is easy to see why they use retentions as a means of insurance. This is less the case for frequent clients, where there is always the option of withholding future work. The SEC Group told us a particular concern was the practice of many local authorities withholding retentions, not as a means of protecting themselves against poor quality service, but to use the money for other purposes or just to earn interest.[219]

140. Retentions are a major concern for sub-contractors, and particularly for small businesses. The NSCC noted that sub-contractors involved at the very early stages of a project often have to wait years before the retention is paid.[220] Even then, more often than not, it is not paid automatically. Rather sub-contractors have to pursue payment themselves. In some instances companies have reported up to 20% of their turnover being tied up in retentions.[221] This has major implications for firms' ability to invest. The SEC Group cited evidence of how firms might otherwise have used retention monies: 20% said they would invest in more training; 14% said they would employ more operatives; 13% stated they would invest in IT; and 10% would invest in new equipment and tools.[222] Furthermore, only about a quarter of contractors are ever requested to return and rectify defects—the main rationale for holding a retention in the first place.[223]

141. Overall, retentions can undermine efforts to create integrated supply chains by promoting a lack of trust between firms. The practice is also divisive because main contractors tend not to deduct retentions from other team members such as consultants and manufacturers.[224] Our predecessor Committee looked specifically at this issue over five years ago. Its Report concluded that retention "is an out-dated practice that should not be necessary in a modern, productive industry which delivers a high quality product".[225] In a follow-up Report the Committee concluded that "departments should set an example to other public sector procurers and the private sector and work to eliminate the practice of retention as soon as possible".[226] Indeed, government has other means by which it can protect itself against poor quality end-products. For example, framework arrangements, which we considered in Chapter 2, effectively managed can provide an incentive for firms to make good any defects or else be denied further work.

142. A number of large companies, such as Sainsbury's, BT and Yorkshire Water, have already stopped holding retentions. However, as the construction industry's largest client, the public sector is in a powerful position to instil the culture change necessary to phase out retentions entirely. Some parts have already done so, including the Highways Agency and Defence Estates and a smattering of local councils. Yet, there remains room for considerable progress. Even where government departments have a policy of no retention, this is often not enforced down the supply chain. This enables the main contractor to earn interest on the monies held against its sub-contractors.[227] Overall, the Building Services Research and Information Association (BSRIA) highlighted survey evidence stating that just 7% of building services contractors reported satisfaction scores of eight or more out of ten with respect to retentions. 37% gave the lowest score possible.[228] This suggests the sector has not made a great deal of progress during the intervening years since we last considered this issue.

143. The practice of holding a retention against contractors as an insurance against defects undermines efforts to promote team-working and integrated supply chains in the construction industry. It also damages the cash-flow of smaller sub-contractors and reduces investment in training and innovation. Government has other means by which it can ensure the sector delivers good quality projects, for example where it has long-term framework arrangements in place. Given that the practice is at odds with the Government's promotion of integrated working through the Common Minimum Standards and the Construction Commitments, we urge it to require all parts of the public sector to end retentions as soon as possible.

THE 'FAIR PAYMENT' CHARTER

144. In 2007 the Office of Government Commerce (OGC) published its Guide to best 'Fair Payment' practices—the outcome of one of the working groups of its Public Sector Construction Clients' Forum. A key part of the Guide is the setting out of a 'Fair Payment' Charter, which commits clients, main contractors and their sub-contractors to greater transparency; more efficient payment processes; and payment periods not exceeding 30 days. The Charter also states that any arrangements for not holding retentions should be replicated throughout the supply chain. This should help address the problem of main contractors holding retentions against their sub-contractors even though their clients do not hold retentions against them.

145. Central Government construction clients have been expected to adopt the principles of the Guide and the Charter since January 2008. BERR told us the OGC is currently putting in place processes to measure clients' compliance.[229] The Minister responsible for construction also told us that if "people […] come across examples of agencies in the public sector not complying with best practice I would like to know about it, and I would be very happy to take action in response".[230]

146. We welcome the introduction of the 'Fair Payment' Charter. The OGC should ensure all central government construction clients have affirmed their adoption of the Charter by the end of 2009. The Office should then aim for all local authorities to have signed up to it by the end of 2010. The OGC's monitoring of implementation should ensure that clients are adopting the principles of the Charter throughout the construction supply chain, and not simply between themselves and their main contractors. Where construction firms believe their client is not abiding by the principles of the Charter, we urge them to make representations to the Minister and to the OGC.

PROJECT BANK ACCOUNTS

147. The OGC's Guide to best 'Fair Payment' practices and the National Audit Office's 2005 report Improving Public Services through better construction both recommended the use of project bank accounts by public sector clients. Here, the client sets up an account at the outset of a project and agrees an interim payment schedule for the main contractor and the supply chain in the normal way, which is then passed to the bank operating the account. When the client deposits money into the account, it is simultaneously transferred to the contractor and the supply chain in accordance with the schedule. Because all members of the team involved in a project are paid at the same time, rather than cash being cascaded down from the main contractor, the time taken for the supply chain to receive payment is reduced. The Guide estimates that the use of project bank accounts could cut the length of the payment cycle by 18 days compared to traditional arrangements.

148. The surety and transparency of cash flow brought by a project bank account can help facilitate integrated working. Sub-contractors no longer have to price in the risk of late or no payment. The process also decreases financing charges across the supply chain and reduces the impact that the insolvency of a firm may have on those it owes money. The SEC Group cited a survey of its members, which found 65% thought their costs would be reduced through the use of project bank accounts. The majority of respondents believed their costs would reduce by up to 5%.[231] Both Barclays and Bank of Scotland have now begun to offer project bank accounts for construction customers, which BERR described as "welcome progress".[232] However, the National Specialist Contractors' Council (NSCC) told us an issue still to resolve is that the industry has not yet demonstrated to clients how such accounts can help them better manage their projects.[233] Indeed, because they are a fairly new financial product, there is still a relatively low level of awareness amongst infrequent construction clients that project bank accounts are available.[234]

149. Both the Office of Government Commerce and the National Audit Office have endorsed the use of project bank accounts as a means of improving payment practices and facilitating integrated working. Central government procurers should now start to make use of project bank accounts, where practicable and cost-effective. The OGC should monitor take-up and evaluate the benefits.

AMENDING THE CONSTRUCTION ACT

150. In recent times, the most significant action by government to improve payment practices in the construction industry was the passing of the Housing Grants, Construction and Regeneration Act 1996. Part 2 of the Act, generally referred to as the Construction Act sought to ensure prompt cash flow through construction supply chains and to encourage the swift resolution of disputes. On the first of these, the Act sets out a payment framework that:

introduces the right to instalment, stage or periodic payments;

requires the construction contract to have an adequate mechanism for determining what will become due and when;

requires the payer to give the payee early communication of what is to be paid;

provides that the payer may not withhold monies unless they have communicated in a notice the amount they intend to withhold from the sum due, and the grounds for doing so;

provides that the payee may suspend performance when the amount due is not paid by the final date for payment; and

prohibits contractual terms which make payment dependent upon the payer being paid.[235]

151. The overall aim is to provide sub-contractors with "fairer, quicker, and simpler mechanisms to ensure certainty of payment".[236] The Act also requires adjudication procedures to be set out in construction contracts. This gives any party to a construction contract the right to have a dispute resolved by an adjudicator. Their decision is binding on the parties until the dispute is finally decided by arbitration, litigation or agreement. The process is meant to be quicker and more cost-effective than legal proceedings or arbitration.

152. Although the Act significantly improved payment and dispute resolution procedures in the construction industry, the SEC Group, and others told us firms' interpretation of it quickly brought to light a number of weaknesses in its provisions. These include the fact that contracts can still be drafted to enable the payer to delay payment by making spurious challenges to a payment claim, or just by ignoring the claim and forcing the payee to go to adjudication. In addition, although the Act requires the payer to notify the payee of the amount they intend to pay, there is no sanction for failure to give notice, and, in practice, it is rarely given. Furthermore, in response to the ban on 'pay when paid' clauses, firms have tended to use 'pay when certified' or 'pay what is certified' provisions instead. Weaknesses in the adjudication process have also become apparent. Challenges to the adjudicator's jurisdiction have increased the cost of adjudication, while bespoke procedures inserted into contracts have increased the process's complexity. In addition, these procedures often impose upon a party an obligation to meet the other side's legal costs.[237]

153. Since 2004, the Construction Act has been subject to review and a consultation, outlining a number of proposals. The Department held a second consultation in 2007. Over summer 2008 BERR will conduct what it hopes will be a final technical consultation on the specific clauses it intends to insert into the Act. These include:

Removing requirements for the construction contract to be in writing. This will allow more disputes to be referred to adjudication, and will remove the potential for one of the parties to challenge the adjudicator's jurisdiction on the grounds that the entire contract is not in writing;
Introduction of a statutory framework for the costs of adjudication. This will make ineffective any contractual clause on the allocation of the adjudication costs;
Removal of restrictions about which party can issue a payment notice. Whether it is the payer, payee or a third party will be a matter for the parties to agree in their contract;
Introduction of a 'fall back' provision, so that if the payer fails to issue a payment notice, the payee is able to do so;
Prohibition of 'pay when certified' clauses. This should create greater clarity on when payments become due and what the sum due is;
Clarification that the payer must always submit a withholding notice to the payee when they intend to pay less than the sum due, except in cases of insolvency; and
Improvement of the right of a party to suspend performance under a construction contract where they have not been paid.[238]

154. The Minister responsible for construction told us that "by and large the Construction Act has done a good job […] and that is the general view across the industry".[239] The changes the Department wishes to make are aimed at improving cash flow and encouraging the resolution of disputes by adjudication. However, the Minister also said that the industry has to "find a consensual way forward".[240] The process has taken so long primarily because it has been difficult to reach an industry-wide consensus. Indeed, just before the 2007 consultation the Construction Confederation and others told us that (with the exception of improvements to the adjudication provisions) given the existence now of the 'Fair Payment' Charter, further changes to the Act on payment practices were unnecessary.[241] On the other hand, the SEC Group and the HVCA felt the Government's current proposals did not go far enough.[242] The Department's intention is to 'piggy-back' the amendments on the forthcoming Community Empowerment, Housing and Economic Regeneration Bill, which the Government plans to introduce during the 2008-09 Session. This would mean the clauses could be on the statute book by autumn 2009. However, this is dependent on the feedback BERR receives from its consultation on the draft clauses, as well as progress with the Bill on which the Department is 'piggy-backing'. The fact that the Bill is being sponsored by a different department poses an additional risk factor.

155. The Construction Act provides the legal foundations for successful team-working. However, it is widely accepted that it still has some weaknesses. After years of consultation the Government has developed proposals, which it believes will address many of the industry's concerns, particularly those of sub-contractors. They appear to strike a sensible balance between the interests of main contractors and sub-contractors. BERR's aim now should be to ensure the amendments fulfil the policy objectives the Department has set out, and do not leave room for exploitation. It is vital that the next Session's opportunity to reform the legislation is taken.

Measuring performance

156. Integrated working give teams an incentive to evaluate their performance in terms of how they have met the client's original objectives, and learnt lessons for the future. This process, often referred to as post-occupancy evaluation (POE) is essential for teams working together on repeat projects.[243] POE involves the in-depth analysis of how well a new or refurbished building is performing; how it is affecting those who use it; and how it meets the operational needs of its occupants.[244] It should take place at the time when the main contractor hands over a building to the client, and over subsequent years to assess whether the original investment case for the building has been met and what might have been done differently.[245]

157. Generally, the design and construction team has little incentive to spend time handing over a new building to its new occupant because at that stage their contractual obligations are minimal. Where a building contains a high level of innovative content, the client is often poorly placed to make those innovations work because the construction team has not briefed them on how to do so.[246] The Building Services Research and Information Association (BSRIA) note that if buildings do not function as intended from the outset, this can undermine their performance over their lifetime—"teething problems can become long-term chronic shortcomings".[247] Hence, it recommends setting aside a proportion of the contract value—between 0.25% and 1%—to carry out a 'soft landing' handover.

158. The features of a 'soft landing' should include fine-tuning of the building to iron out any defects, as well as professional aftercare by the designers during the first year of occupancy, for example through energy-use assessment and occupant surveys. As yet, the approach has only been used once for a pilot project at the University of Cambridge. Its benefits there included greater clarity during the briefing and early design stages that reduced re-working by the design team; more effective building readiness; and better feedback to the designers and constructors to improve future buildings.[248] BSRIA told us there is not yet a full methodology that defines the procedures for carrying out a 'soft landing'. It is currently working with the Usable Buildings Trust to develop a toolkit for wider adoption by the construction industry.

159. At present relatively little public sector construction output is subject to any form of post-occupancy evaluation. Tools such as the online Design Quality Indicator (DQI), discussed earlier in this Chapter can assist firms and their clients to assess the quality of their buildings. However, they are not yet used as standard. Where they are, the results have been worrying. The Commission for Architecture and the Built Environment (CABE) has a service level agreement with Partnership for Schools to evaluate the performance of new secondary schools.[249] In 2006 it published results for 52 schools in which it categorised 50% as 'mediocre' or 'poor', 29% as 'partially good', 15% as 'good' and just 4% as 'excellent'. Most of those schools scoring highest had been built in the last year of the study, suggesting that construction teams were applying lessons learnt from earlier projects. Last year CABE also published findings from a national housing audit in which it found 82% of new housing built over the last five years failed to measure up on design quality, with 29% of developments being so poor they should not have received planning permission.[250] Results such as these emphasise the importance of evaluating buildings after completion and using this information to inform future construction work.

160. Post-occupancy evaluation is not a new concept. Indeed, the DTI carried out a number of POE studies in the late 1990s and one of the Achieving Excellence in Construction guides focuses specifically on project evaluation. The OGC's Common Minimum Standards also recommend use of the DQI to evaluate project success. However, CABE, Constructing Excellence and others argued that government needs to invest more in monitoring and evaluating the performance of existing and completed buildings in order to provide a feedback loop between project teams and clients.[251] To this end, CABE recommended the development of a 'comprehensive living database' to inform the way in which buildings are designed, constructed and operated. In response, the OGC told us POE would be mandated from April 2008 for all central government clients, through its Property Benchmarking Service, which has been in development since 2006.[252] The initial pilot saw the introduction of a standardised framework for measuring the performance of the government estate against a range of indicators, including workplace productivity and environmental sustainability. The OGC has also set up a database to track performance annually and draw comparisons across departments.

161. Integrated working should give teams an incentive to evaluate their performance and apply lessons learnt to future projects. Greater use of post-occupancy evaluation (POE) has the potential to benefit construction teams, their clients, and future clients through increased use of evidence-based design. We welcome the OGC's decision to mandate POE for central government departments, building on its initial pilot project, although we note that the work is mainly focused on office buildings. Once established, the scheme should be extended to cover all parts of the public sector as soon as possible to collect information on a range of different types of building. We hope the OGC and the industry will be able to use the information gathered to inform the construction of future public sector buildings.

162. Overall, integrated team working can provide the way out of the vicious cycle of adversarial relationships and poor performance that have characterised the construction industry for so long. This Chapter has outlined a number of ways in which this can be facilitated. However, it requires a culture change by all the sector's participants—clients, contractors and sub-contractors. As the single largest construction client, government should be taking the lead in tackling that challenge.

167 Q 49 (Construction Confederation) Back

168 Ev 333, para 1.5 (Specialist Engineering Contractors' Group) Back

169 Ev 334, para 1.9 (Specialist Engineering Contractors' Group) Back

170 Ev 209, para 19 (Construction Confederation, Construction Industry Council and Construction Products Association) Back

171 We discuss these in Chapters 2 and 3. Back

172 Ev 219, Annex (Construction Confederation, Construction Industry Council and Construction Products Association) Back

173 Q 335 (Specialist Engineering Contractors' Group) Back

174 Ev 218 (Construction Confederation, Construction Industry Council and Construction Products Association) Back

175 Ev 290, para 4.B.c (National Specialist Contractors' Council) Back

176 National Audit Office, Improving Public Services through better construction, HC 364-I, Session 2004-05, March 2005 Back

177 Q 32 (Construction Industry Council); Ev 224, para 22 (Constructing Excellence), Ev 290, para 4.B.d (National Specialist Contractors' Council) and Ev 318, para 1.1 (Specialist Engineering Contractors' Group) Back

178 Ev 254, para 6 (Federation of Environmental Trade Associations) Back