House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Written Evidence

Memorandum submitted by the Specialist Engineering Contractors' (SEC) Group

Thank you very much for the opportunity to give written evidence to the inquiry into the UK construction industry.

This industry makes a substantial contribution to the nation's economy. The industry's annual output is in the region of 9% of GDP and total employment in the construction and construction-related activities is 3 million. The UK construction industry delivers the hospitals, schools, homes, workplaces and transport infrastructure for the people of this country.

The Specialist Engineering Contractors' (SEC) Group represents all engineering in construction (other than civil engineering). As such it accounts for over 30% of the construction industry's output. This figure reflects the involvement of engineering contractors in all the processes of construction delivery—design, construction or installation, maintenance and facilities management.

SEC Group brings together the construction industry's premier trade associations:

The Association of Plumbing and Heating Contractors (APHC), British Constructional Steelwork Association (BCSA), Electrical Contractors' Association (ECA), Heating and Ventilating Contractors' Association (HVCA), Lift and Escalator Industry Association (LEIA); and SELECT (Electrical Contractors' Association of Scotland).

These organisations represent a sector comprising over 60,000 companies and a workforce of more than 300,000. SEC Group seeks to raise awareness—amongst clients, professional advisers, government and the industry at large—of the critical importance of specialist engineering expertise within construction industry. Its overall aim is to promote productivity, profitability and best practice throughout the construction process.

PRIORITIES FOR THE INDUSTRY

The industry needs to be consistent in the delivery of best value which is the only way to bring improved profitability for businesses, especially SMEs—which constitute over 85% of the firms in the industry.

We now need firm and concerted action to eradicate adversarial and age-old practices, particularly with regard to payment. This will enable the industry to focus on achieving delivery through established, integrated project teams brought together by a genuine teamworking culture and appointed at the earliest opportunity in the procurement process. This is guaranteed to provide the necessary motivation for firms in the industry to invest in training and new technologies which, in turn, will deliver consistent best value for the customer, improved risk management (especially in relation to health and safety), sustainable outcomes and, consequently, greater profitability for the industry.

Our submission is concerned with the steps that need to be taken to address these issues. Achieving best value is undermined by wasteful and inefficient practices arising from a fragmented delivery process. Numerous reports have highlighted the way forward but now is the time for implementation (see Background Note at Annex 1). This is now essential with the 2012 Olympics on the horizon.

We invite the Trade and Industry Committee to make a number of recommendations which will drive the necessary change. Most of the recommendations relate to public sector procurement authorities as they are now responsible for 40% of the spend on UK construction and, therefore, are in a strong position to drive change in industry practices. However, we would emphasise that change can only come about through partnership between procurers and progressive elements within the industry.

The measures we propose are:

— specific drivers to bring about greater integration in the delivery process (especially making funding of projects conditional upon evidence of integration);

— actions to both facilitate and remove barriers to integration (eg. project bank accounts, project insurance);

— amendments to the Construction Act to improve payment security—especially for SMEs;

— steps to improve corporate competence; and

— a specific proposal for engaging SMEs in the public sector procurement process.

We wish to play a full and active role in the inquiry and would be happy to provide oral evidence.

1. DRIVING CHANGE IN THE PROCUREMENT PROCESS TO BRING ABOUT INTEGRATED DELIVERY

Recommendation 1

progressively

conditional

Common Minimum Standards

Champion

1.C The Audit Commission (and Audit Scotland, the Wales Audit Office, Audit Office Northern Ireland) to insist that evidence of integration and collaborative working be a major part of the best value review process.

1.D Working through the Regional Development Agencies, the DTI should establish a network of independent construction advisors to guide and assist customers on assembling or appointing integrated project teams.

1.1 There are approximately 180 government departments, agencies and non-departmental public bodies. They have subscribed to the Achieving Excellence programme aimed at bringing about better value through shorter construction times, reduced construction costs through waste reduction, and fewer defects. Whilst the NAO has accepted that significant progress has been made, government procurers have not, as yet, "harvested" the added value to be obtained from the early engagement of the supply chain. Such early engagement is a fundamental feature of integrated delivery.

1.2 In 2005 the SEC Group carried out a survey of firms within the specialist engineering sector to establish levels of satisfaction on central government construction projects.2 Only 7% of firms reported that they had been appointed early on the majority of government projects. In view of the fact that specialist engineering firms can, together, contribute as much as 70% of the value of the project, this figure is unacceptably low. Furthermore, 44% of firms reported that they had not been appointed at an early stage on any project whilst a further 36% indicated that they had been appointed early on less than half of their projects. Our view is that this evidence is a stark reminder of the lack of progress in achieving integrated delivery on government projects.

1.3 In the same survey 61% of firms stated that they were not invited to enter into partnering arrangements on any project. A further 29% of firms stated that invitations to enter into partnering arrangements were received on less than half of the projects they were involved in. Again, these figures are unacceptably low and reinforce the fact that government procurers have much work to do to engage with the supply chain.

1.4 The NAO has identified savings of £2.6 billion on public sector projects that can be achieved through good practice including partnering and the early deployment of an integrated project team:3

Departments should involve construction suppliers early on in the design process, where appropriate paying for their time on a fee basis".4

There are, however, other significant benefits to be obtained from an integrated delivery process that involves consultants, project managers and key specialist contractors and manufacturers as part of the design team. It is at the design stage where the delivery team can have the greatest impact in arriving at best value solutions, managing health and safety risks and determining sustainable outcomes for the project.5 If consultants, specialist contractors and manufacturers have had an opportunity to come together to pre-plan and design the project, they are more likely to own the solutions that will secure the necessary outcomes.

1.5 There is evidence that failure to bring the parties together in this way has had an adverse impact on the management of health and safety risks.

before

An integrated design team of consultants, specialist suppliers and project managers is better placed to manage out health and safety risks in the design process such as those associated with unsafe construction methodologies and poor sequencing of work.

1.6 The NAO has recently reported that the government is not meeting sustainability targets for the construction and refurbishment of buildings on the government estate. The NAO recommends that:

"Departments and agencies should employ integrated teams to deliver construction and major refurbishment projects. Integrated teams should:

— Comprise department or agency clients, designers, building contractors and specialist suppliers and consultants, all of which should be signed up to the need to deliver sustainability in the project".7

1.7 With all the evidence now pointing to the need for integrated and collaborative delivery, we invite the Trade & Industry Committee to recommend to HM Treasury that, as part of the next Comprehensive Spending Review, it progressively makes funding of government projects conditional upon evidence of compliance with the OGC's Common Minimum Standards (see footnote 3). In his foreword to "Transforming government procurement" the Financial Secretary of the Treasury stated:

"The next Comprehensive Spending Review will put further priority on departments and procurers to exploit the opportunities that are available through innovative procurement methods . . . to ensure that procurement is built on the principles of value for money and sustainability".8

We suggest that this linkage of funding to compliance with CMS should also be extended to those projects that receive government funding and also projects that are funded from lottery monies.

1.8 It has already been agreed, in principle, by both government and industry that funding should be dependent upon there being evidence of integrated delivery.

"Representing 40% of construction orders, the public sector can make a substantial difference to the widespread adoption of Rethinking Construction principles . . . The public sector can be helped to achieve this by:

— linking government funding of construction projects to the application of Rethinking Construction principles . . ."9

1.9 This linking of funding to best practice procurement is not a new concept. The Housing Corporation, which has responsibility for investing public monies in housing associations and other registered social landlords, has made funding of projects conditional upon evidence of best practice, especially partnering. 10

1.10 The NAO has already expressed concern at the absence of such linkage in the case of government projects:

" . . . despite all departments' formal commitment to embedding the principles of Achieving Excellence as a matter of Government policy, public funding for construction is not always conditional or does not contain the right incentives to embed the principles of Achieving Excellence. Funding organisations such as the Housing Corporation, however, in response to escalating demand and the need for increased efficiency, are refining their investment strategies to introduce incentives and conditionality to drive through more efficient and effective construction approaches such as partnering".11

1.11 In addition we are of the firm belief that the Treasury should appoint a "Champion" to bring about the implementation of integrated procurement and delivery. SEC Group has already made this proposal to Ed Balls, Economic Secretary to the Treasury. Such a Champion should be a high profile and authoritative figure with a strong business background and experience of best practice procurement. He/she should be supported by a small team and have responsibility for monitoring progress and overcoming barriers to integration across the public sector.

1.12 Local authorities present a greater challenge. Whilst many authorities have already embraced partnering and collaborative working, others have made very little progress in this regard. We suggest that the Trade & Industry Committee invite the Audit Commission (and its counterparts in Scotland, Wales and Northern Ireland) to issue advice to District Auditors that evidence of integration and collaborative working should be a major factor in the best value review process.

1.13 A vast majority of the construction industry's customers are one-off or occasional customers. Such customers should also have the benefit of integrated and collaborative delivery. The Accelerating Change report recommended that such customers should have access to independent advisors having a similar role to that of independent financial advisors. An advisor could offer help on how construction could address the customer's business needs and also, if necessary, help the customer with bringing together or selecting an integrated project team. This proposal has not been widely implemented and we suggest, therefore, that the Trade & Industry Committee recommends that the DTI take steps to progress it. The DTI has responsibility for the Regional Development Agencies which could be used to establish and support a network of independent construction advisors.

2. ACTIONS TO FACILITATE INTEGRATION

Recommendation 2

2.A All government procurers to introduce project bank accounts where practical and cost effective for all projects commencing in 2008. All local authorities should do the same by 2009.

2.B DTI to contact all government procurers to encourage them to offer at least one project (value between £20-30 million) for piloting project insurance.

2.C All government procurers to insist upon the use of collaborative contracts for the whole delivery team and that lead contractors' bespoke contracts are outlawed.

Government departments . . . eliminate the practice of retentions as soon as possible".

2.1 If projects are to be delivered by integrated project teams working collaboratively, the barriers to achieving this must be removed. The major barriers are:

(i) Traditional payment processes that enable parties to generate positive cash flow at the expense of others along the supply chain, thus undermining trust;

(ii) Policies of insurance that offer protection for the individual party rather than for the team as a whole.

(iii) Project participants having different contracts that are primarily aimed at risk transfer rather than cooperation and teamworking.

(iv) The continuation of the practice of retentions that helps reinforce a lack of trust which is anathema to collaboration.

Moreover integrated teams require an "integrated infrastructure" for delivering their projects; insurance policies, payment systems and contracts must be aligned to underpin the team.

Project Bank Accounts

2.2 The Accelerating Change report recommended that, "payment practices should be reformed to facilitate and enhance collaborative working".12 This theme was taken up by the NAO:

Departments need to provide specialist small and medium sized suppliers with greater certainty that they will be paid on time to reinforce the trust that should exist between all parties for collaborative working to operate effectively. If this trust does not exist in the supply chain then specialist suppliers, who can significantly influence the value for money obtained on a project, will have little incentive to innovate. Considerable losses can also be incurred over payment disputes which will ultimately feed their way back into the costs for the client. The use of a single project account is one way to provide greater certainty of payment to specialist contractors and suppliers further down the supply chain from the main contractor"

2.3 Last year the Secretary of State for the Department of Culture, Media and Sport launched the 2012 Construction Commitments. 14 Although originally aimed at Olympic construction projects, they have been adopted by the government as the agenda for improving procurement on public sector works. The Commitments recommend that, where practicable and cost effective, project bank accounts should be introduced on public sector (and Olympic) projects. The Public Sector Construction Clients' Forum (PSCCF) fully endorses this.

2.4 A working group of the PSCCF has already produced guidance and documentation for establishing project bank accounts. Research carried out by consultants advising the working group revealed that project bank accounts could save up to 2and a half % on project costs. Our own research last year revealed that individual firms could save as much as 5% of their costs where a project bank account is in place. The results of this research were audited by Davis Langdon. 15

2.5 We invite the Trade & Industry Committee to recommend that all government procurers introduce project bank accounts (where practicable and cost effective) on all their projects commencing in 2008. Furthermore, all local authorities should do the same by the beginning of 2009.

Project Insurance

2.6 In order to bring about integration a radical change to insurance arrangements in the industry is needed. Project participants are required to have in place a range of insurance policies including professional indemnity policies, contractors "All Risks" policies and product liability policies. As a result the risks on each project are insured by countless different policies which either overlap or leave vacuums between them. A few years ago research carried out by Reading Construction Forum indicated that £1 billion per annum was wasted on having these myriad policies in place providing cover for the same type of risks.

2.7 All these policies are activated on proof of liability and, therefore, lead to defensive behaviour to avoid liability attaching to the insured party. Insurers become uncomfortable when their insured oversteps their scope of responsibility to cooperate with or support other parties. The process of establishing liability inevitably means that resources are concentrated on determining who is to blame. Griffiths and Armour, one of the largest UK insurance brokers in the UK construction insurance market, have estimated that for every £5 paid out on a policy, £4 is expended on legal fees leaving £1 to address the original problem. The NAO has proposed that departments take action in this area.

[Departments should] . . . seek opportunities to pursue the case for project-wide insurance, not only to reduce costs through bulk buying, but also to align behaviours with the principles of integrated team working".

There is, therefore, a need to have a policy that underwrites the delivery team; the policy would be activated on proof of financial loss rather than on proof of liability.

2.8 On 19 June 2006 the PSCCF agreed that its members should identify suitable projects for piloting "single project financial loss insurance". To date the OGC and the Specialist Engineering Contractors' Group has been funding work on developing a project insurance policy suitable for piloting. However, it is now vital that more government departments nominate projects for piloting project insurance.

The Trade & Industry Committee is invited to recommend that the DTI contacts all government procurers to treat this as a priority and nominate appropriate projects (valued between £20 million and £30 million).

Collaborative Contracts

2.9 The evidence available to the SEC Group suggests that bespoke sub-contracts (or amended standard forms of sub-contract) continue to be used on the majority of government projects. Such contractual arrangements are primarily aimed at passing risk along the supply chain and, therefore, run counter to the Government's aim of achieving a fair allocation of risk on contracts for government works. In our survey in 2005 of engineering contractors working on government projects (as sub-contractors) only 38% of firms indicated that they were content with the contractual terms on offer on the majority of projects.

2.10 All public sector procurers should outlaw the use of lead contractors' bespoke conditions of sub-contract; the suite of contracts adopted by the public sector procurer should be used by the whole supply chain provided that they represent a fair and proportionate allocation of risk and, most importantly, promote collaborative working. The NAO has recommended that public sector procurers use collaborative contracts in order to reinforce teamworking.

Some contracts are still written in the traditional, more adversarial approach and are not suitable for modern collaborative ways of working"

2.11 The Treasury has now proposed that there should be a single coherent framework for contractual arrangements. 18 We agree. Contractual arrangements should be transparent throughout the project and should facilitate dialogue between all parties to determine how project risk should be fairly allocated. It is vital that consultants, specialist contractors and key manufacturers are brought into the same contractual arrangements.

We invite the Trade & Industry Committee to recommend to the OGC that all government procurers are advised to insist upon the use of collaborative contracts throughout the supply chain and that lead contractors' bespoke sub-contracts (or their amendments to standard contracts) are outlawed.

Retentions

2.12 The practice of deducting retentions continues on the majority of public sector projects. Delays and abuse associated with this practice also continues. The Trade and Industry Committee has already conducted an extensive inquiry into the practice of retentions in the construction industry and has described it as "inefficient" and "frequently harmful", especially to SMEs. 19 Some customers of the industry—both in the public and private sectors—have already abandoned the practice (a list is attached at Annex 2). Despite this retentions are often deducted along the supply chain.

2.13 In its second report on retentions the Committee concluded:

It remains our view that government departments should set an example to other public sector construction procurers and the private sector and work to eliminate the practice of retentions as soon as possible . . ."

We strongly urge the Committee to make the end of 2008 the target for all government procurers to phase out the practice of retentions given that they are fully committed to collaborative delivery. It is also necessary that they ensure that the practice is outlawed along the supply chain.

3. REVIEW OF THE CONSTRUCTION ACT

Recommendation 3

In advance of the second consultation on amending Part II of the Housing Grants, Construction & Regeneration Act 1996 (the "Construction Act"), the DTI should include within this consultation amendments to effect the following changes to the payment and adjudication provisions in the Act.

what

when

(ii) All conditional payment provisions to be outlawed.

(iii) Cross-contract set-off clauses to be made ineffective.

(iv) The Act to specify that the statutory right to receive interim payments comes into being at the commencement of the contract.

(v) There should be statutory protection available to the payee in the event of a payer's insolvency.

(vi) A single statutory procedure for all adjudications.

(vii) The jurisdiction of the adjudicator should be widened.

(viii) The Act should make clear that the adjudicator should not have power to award "party and party" costs under any circumstances.

3.1 We have already referred to the lack of payment security as a major barrier to greater collaboration. The Construction Act has a vital role to play in curbing payment abuse and protecting smaller firms. The aim of the Act was made clear by Lord Lucas in the House of Lords debate on Part II of the Housing Grants, Construction & Regeneration Bill on 26 February 1996:

The legislation requires that payment should be defined in terms of amount and date

3.2 At the outset there was strong commitment from Nick Raynsford, the (then) Construction Minister, that the operation of the Act would be monitored and, if necessary, it would be amended.

If there is clear evidence of abuse we shall stop it . . . there is widespread agreement that there must be monitoring

3.3 In his March 2004 Budget Statement the Chancellor of the Exchequer announced a review of the Act in the wake of continuing concerns over "unreasonable delays in payment". The aim of the review was to "identify what improvements can be made". Sir Michael Latham was appointed to carry out the review by the DTI. He reported in September 2004. An initial consultation aimed at obtaining consensus on the issues to be addressed was carried out by the DTI between March and June 2005. A second consultation on draft amendments to the legislation is awaited.

3.4 Many of Sir Michael's recommendations have been diluted with the DTI's preference being for "light-touch" amendments and "shoe-horning" any changes into a Legislative Reform Order. This has tended to override consideration of those necessary changes required to cure weaknesses in the legislation in order to curb abuse.

3.5 Evidence given during the review indicated that payment periods in UK construction have increased from 76 to 88 days since the Act was introduced. Our own 2005 survey of firms involved on government projects indicated that almost 60% of firms (as sub-contractors) experienced payment delays or abuse on the majority of projects.

3.6 The operation of the provisions in the Act concerning the issue of notices of withholding and the exercise of the right of suspension of the work for non-payment are dependent upon the payee knowing how much he is to be paid. Unfortunately the Act leaves it to the contract to determine the amount due at the date for payment. Most contracts (and sub-contracts) enable the payer to delay payment either by spurious challenges to the payee's claim for payment or by simply ignoring the claim. This means that the payee has to refer the matter to an adjudicator which involves further delay and costs on his part. In the meantime, work has been completed without any reimbursement. 21

3.7 This is the major weakness in the Act. We believe that the Act would benefit greatly from having a statutory payment mechanism that defines what is to be paid and when. The Act, therefore, should include the following:

(i) The payee to have a statutory right to apply for payment.

(ii) The payer to have the right to respond to the application (within, say, 15 days of receipt of the application).

(iii) If the response has a different amount, the payer must identify in detail the reasons for the different amount.

(iv) In the absence of a response (or a properly detailed response), the Act should state that the payee's application for payment becomes the debt. Alternatively, the amount stated in a compliant response should constitute the debt.

(v) The date for payment should be no later than 30 days after receipt of the application.

3.8 The ban on pay-when-paid clauses has been undermined by the use of pay-when-certified clauses so that, for example, a sub-contractor will not get paid until the architect or engineer has issued a certificate under the main contract. A payer can still rely upon a pay-when-paid provision to justify non-payment in the event of the insolvency of a third party payer. Therefore, a main contractor can refuse to pay a sub-contractor in the event that his client has gone into insolvency.

We believe that all provisions making entitlement to payment (or the obligation to discharge payment) conditional upon events or upon the operation of provisions under another contract should be outlawed.

3.9 Sir Michael Latham's review made other recommendations in relation to payment which the DTI appears reluctant to take forward. Cross-contract set-off applies where a payer under Contract A refuses to pay all or part of that due to the payee on the basis that the payee owes him money under Contract B (which is wholly unrelated to Contract A). This practice of cross-contract set-off undermines the need for certainty of payment and invariably leads to disputes. It is our view that the DTI should amend the Act to outlaw such provisions.

3.10 In many instances a substantial percentage of the contract price is expended before commencement of work on site. For example, lift and steelwork contractors expend more than 80% of the value of their contracts prior to starting work on site. Moreover, the initial interim payment does not "kick in" until they have been on site for between 60 and 90 days. The Construction Act provides a statutory right to interim payments but does not indicate when this right arises; it should take effect from commencement of the contract which is usually prior to the start of work on site. Again, this issue was highlighted in Sir Michael Latham's review as worthy of consideration for inclusion in the Act.

The DTI should amend the Act so that the statutory right to receive interim payments arises on the commencement of the contract

3.11 The DTI has refused to act on a recommendation in Sir Michael's review that the Act should give clients the right to pay sub-contractors directly in the event of the insolvency of the main contractor. The vast majority of firms in the industry are more exposed to the risk of insolvencies up the supply chain than firms in other industries. The main reasons are as follows:

(i) there is widespread sub-letting by firms with a meagre asset base;

(ii) SMEs—constituting the largest number of firms in the industry—are not in a position to insist upon payment guarantees; and

(iii) retention of title provisions (the title in goods does not pass until payment has been made) are generally prohibited by standard form contracts (including government contracts).

3.12 Many other jurisdictions provide insolvency protection for construction supply chains. The DTI's objection is that direct payments to sub-contractors are in conflict with the pari passu principle of distribution (all parties to be treated equally in an insolvency). But such principle can be overridden by legislation. For example in section 159 Companies Act 1989 there is an exception to this principle for certain schemes operated by investment clearing houses. These relate to the settlement of debts arising under market contracts in the financial services sector.

3.13 The DTI should amend the Act to allow clients the option of making direct payments to sub-contractors. Alternatively, there could be a statutory right for the payee to insist upon bank guarantees (or similar security) to apply in the event of the payee's insolvency.

3.14 Adjudication was introduced by the Construction Act to provide a quick and inexpensive means of resolving disputes on a temporary basis. It has made a significant difference to the position of SMEs but there is now widespread concern within the industry that adjudication is becoming too costly and, therefore, inaccessible to SMEs. Adjudicators' fees have significantly increased as has the cost of enforcing adjudicators' decisions in the courts. There are many instances of contractual provisions that require parties referring disputes to adjudiation to pay all the legal costs of the other side (irrespective of the outcome of the adjudication). There are, also, examples of referring parties being asked to place large sums of monies in an account as "security for costs".

3.15 Much of the increase in costs has been due to habitual challenges to the jurisdiction of the adjudicator. Furthermore, there is widespread uncertainty caused by the proliferation of bespoke adjudication procedures. It is not always clear whether a bespoke procedure is compliant with the Act and this, in turn, provides further opportunity to frustrate the process of adjudication (ie, should the adjudication be governed by the bespoke procedure or by the fall-back procedure in the Scheme for Construction Contracts?).

3.16 It was recommended in Sir Michael's report that there should be a single adjudication procedure. The New Zealand Construction Contracts Act 2002, for example, imposes a mandatory procedure for all adjudications. The DTI should be invited to amend the Act to provide this. In order to reduce the challenges to the adjudicator's jurisdiction (and, therefore, the costs) the DTI should also be invited to extend the adjudicator's power to rule on certain aspects of his own jurisdiction. In particular, the adjudicator should have the power to decide whether there is a "dispute" and the "scope" of the dispute. To further reduce opportunities for challenging the adjudicators' jurisdiction, the DTI should also be asked to remove the exclusion in the Act relating to process plant.

3.17 A remaining issue relates to the power of the adjudicator to award "party and party" costs allowing the "winning party" to be reimbursed his legal costs by the "losing party". Although the DTI has decided that the adjudicator should not have such power, it has agreed to allow an exception. Following referral of the dispute, the parties should have the right to agree on the adjudicator having this power. We believe that this exception will undermine adjudication. The adjudication process is not a forensic process to decide whether a party is right or wrong. The adjudicator's decision is a holding decision that facilitates the flow of cash. Moreover, the risk of exposure to meeting the other side's legal costs will increase the cost of adjudication overall and, therefore, reduce access by SMEs. In practice SMEs will often be under pressure to agree to give the adjudicator power to award "party and party" costs. The DTI should be requested to abandon this proposal.

4. ESTABLISHING CORPORATE COMPETENCE

Recommendation 4

core criteria

technical competence and financial standing

core criteria

all

compliant

all

compliant with the core criteria

competence

competent persons

4.1 In "Rethinking Construction" in 1998, Sir John Egan made the following highly critical observation:

The City regards construction as a business that is unpredictable, competitive only on price not quality, with too few barriers for entry for poor performers. With few exceptions, investors cannot identify brands among companies to which they can attach future value

4.2 Sir John's own discussions with City analysts concluded that there was a need for "effective barriers to entry in the construction industry". This would result in stable and predictable margins which would, in turn, attract greater investment. Over the longer term this should result in a healthier industry that invests more in training, skills and R&D.

4.3 In "Constructing the Team" in 1994, Sir Michael Latham proposed that public sector procurers should only select firms from one national database and that members of the supply chain should also be selected from such database. This was to be developed from existing government databases which listed consultants and contractors. As a result Constructionline was introduced—as a joint venture between DTI and Capita—but it was not adopted by the government and local authorities as the only database. Furthermore, Constructionline has a major disadvantage in that it does not verify technical proficiency.

4.4 "Competence" involves objective proof that an organisation is technically proficient to deliver the services it provides, is sufficiently resourced to provide such services, is of sound financial standing and has procedures in place for promoting health and safety. The proof is usually provided by objective demonstration of compliance with relevant standards.

4.5 There is now an overriding need to be able to readily identify organisations that are competent. Government procurers are committed to "employing those who offer the best overall quality service".22 Successful teamworking is predicated upon the notion of competence.

All firms and their workforce within integrated teams should be fully qualified and competent

4.6 In addition, if we are to have a sustainable industry—from a social and economic perspective—it is essential that public sector procurers engage firms that have demonstrated their competence through investing in the future by training and up-skilling their workforces. Corporate competence should also embrace evidence of investment in sustainable technologies and processes (eg. renewable energy technologies) and of practices that have led to waste reduction.

4.7 There has been a lack of decisive action in developing a widely-accepted means of qualifying firms in construction as "competent". This had led to a plethora of vetting processes, approval procedures and pre-qualification schemes operated by myriad private sector providers.

4.8 Regulatory requirements have also subscribed to this state of affairs. Over the years a large number of statutory schemes and procedures (as well as non-statutory schemes) have been introduced with the aim of improving standards. But their effect has been to significantly increase the industry's overheads without any discernible rise in standards. For example, a firm may have to qualify under one or more "competent persons" schemes (Building Regulations), be a registered installer with CORGI (Gas Regulations), qualify as an "approved" plumber (Water Regulations) and be a "competent contractor" (Construction, Design and Management Regulations) CDM Regulations.

4.9 This could be in addition to obtaining the TrustMark badge (a government scheme for licensing firms as competent for domestic works), being approved by Constructionline and satisfying a variety of other licensing and qualification requirements. SMEs report that they have to pre-qualify under 30 (or more) different schemes in order to obtain work. There is often little to show for this overhead; firms are not assured of greater market share despite being able to demonstrate that they are technically competent, well-resourced and have a good health and safety record. Moreover, there is no evidence that all this activity has helped in the delivery of value for money.

4.10 The industry has made substantial strides in putting its own house in order. SEC Group's member associations have introduced registration and qualification schemes for their member firms. These often involve independent auditing and inspection to ensure compliance with the required standards.

What is the way forward?

4.11 The solution is to be found in developing a means of recognising membership of a registration or licensing scheme as a reliable indicator of competence. The first stage should be the development of a core set of criteria for recognising such schemes. Once a scheme is "badged" as "compliant" with the core criteria, this would obviate the need for a firm to qualify under another scheme that is similarly "badged". In other words the criteria would provide a means of mutual recognition of schemes aimed at establishing the competence of member firms.

4.12 Insofar as health and safety is concerned a model set of core criteria now exists within the Approved Code of Practice published in April 2007 to accompany the 2007 CDM Regulations. If a registration or qualification scheme (or an individual firm) complies with the core criteria—which assesses basic health and safety capabilities—this will provide evidence that a firm in membership of the relevant scheme (prima facie) satisfies the general requirement of competence under the CDM Regulations.

4.13 Our proposal, therefore, is that—in collaboration with the industry—the OGC should develop core criteria in relation to technical proficiency and financial standing for recognising membership of registration/licensing/qualification schemes (and also for recognising firms not in membership of such schemes) as a reliable indicator of competence. The Department for Communities and Local Government may wish to be involved because of their responsibilities for local government.

4.14 Once the core criteria have been developed, it is suggested that the Trade & Industry Committee recommends that the OGC and DCLG (following a suitable lead-in time for the industry to become compliant with the criteria) advise all procurers of public sector works—including supply chain members—only to select firms in membership of schemes of qualification that are badged as complying with the core criteria (or, alternatively, individual firms that have demonstrated compliance with the core criteria).

4.15 It is also suggested that the Trade & Industry Committee recommend that, all procurers (including supply chain members) of all new public sector works commencing in 2009 will only select firms that have (either individually or as a member of a qualification scheme) complied with the core criteria in the Approved Code of Practice issued under the 2007 CDM Regulations. It is necessary that the Government makes an announcement to this effect as soon as possible to enable the industry to have sufficient time to become compliant.

4.16 A remaining problem exists with the Building Regulations and, indeed, related regulations. Throughout the Building Regulations and other related regulations (eg Fire Regs, Water Regs) there are various requirements relating to competence. These are often inconsistent and illogical; some requirements are discretionary whilst others are mandatory. Furthermore, the Building Regulations have introduced "competent persons" schemes as a means of encouraging greater self-regulation. Whilst these schemes (rightly) acknowledge that the industry possesses the necessary expertise and experience to determine whether standards are being adhered to, they have been developed piecemeal. Consequently they constitute yet more "pathways" for demonstrating competence.

4.17 Although the Building Regulations are currently under review by the DCLG, we suggest that the Trade & Industry Committee invites the DCLG (and other interested parties) to work with the industry in:

harmonising and rationalising, where possible, the requirements relating to "competence" within the Building Regulations and related regulations; and in

developing a single identifiable badge for "competent persons

4.18 At some point in the future it may become possible for firms that have satisfied the core criteria referred to in paragraphs 4.13 of this submission to comply (to some degree) with the requirements in the competent persons schemes and other requirements relating to competence in the Building Regulations and other regulations. This is certainly the vision and, if realised, it will help erect barriers to entry to the industry which will, in turn, allow firms to compete on a level playing field. It will enable firms to be more efficient through investing in training and new technologies that will help deliver best value for the public sector. But, at present the plethora of vetting processes in the industry is imposing a substantial burden on all firms. The immediate priority is rationalisation.

5. ENGAGING SMES ON PUBLIC SECTOR WORKS

Recommendation 5

Annex 3

5.1 The vast majority of firms in the industry are SMEs. They are often responsible for delivering the bulk of design, construction and maintenance works whilst, at the same time, they are having to bear a disproportionate amount of risk and low profit margins. Their problems are exacerbated by poor payment practices such as retentions and the risk of insolvencies along the supply chain.

5.2 In Improving Public Services through better construction the NAO acknowledged that these problems constituted major barriers to SMEs becoming fully engaged on public sector projects and to the delivery of their full potential. Over four years ago the Better Regulation Task Force and the Small Business Council carried out a joint review of access by SMEs to public sector contracts. 24 The overall conclusion of the review was that the public sector must take a more active role in ensuring that good practice in relation to the commercial treatment of SMEs becomes common practice.

5.3 This review made clear that SMEs were in an advantageous position to help public sector procurers achieve best value since they often provided innovative solutions and products, better customer care and were capable of greater flexibility in responding to the changing needs of their customers. Public sector procurers should be monitoring the treatment of SMEs so that barriers are removed to enable them to become fully engaged in the procurement process.

5.4 To that end and, as a first step, we invite the Trade & Industry Committee to recommend that the OGC (and its counterparts in Scotland, Wales, Northern Ireland) endorse the draft Best Practice SME Charter attached at Annex 3. Following such endorsement they should be invited to take the necessary steps to ensure that the Charter is adopted and implemented by all procurers of public sector works. Further, its use should be monitored and it should be understood that non-compliance with the Charter could result in a failure to obtain public sector works contracts in the future.

Annex 1

BACKGROUND NOTE

A.1.1 Most commentators would accept that the industry of 2007 is much improved compared with the industry of 1994 when Sir Michael Latham's report, "Constructing the Team" was published. The context for the report was, however, a recession-hit industry in which commercial conflict—largely involving the abuse of firms in the supply chain by large contracting organisations—had reached its nadir.

A.1.2 In responding to the question: "What has been the most significant change over the last 13 years since Sir Michael's report?", the majority of contracting firms would refer to Part 2 Housing Grants, Construction and Regeneration Act 1996 (generally referred to as the "Construction Act"). The Act was, of course, the progeny of the Latham Report. The (limited) abolition of pay when paid clauses, the statutory right of suspension of work for non-payment and adjudication have helped curb the worst excesses of contractual and payment abuse. The Act has weaknesses and these have been exploited. As a result, and against a background of continuing payment delays, the Chancellor of the Exchequer announced a review of the Act in his March 2004 Budget Statement. We discuss the review in this submission.

A.1.3 Whilst the Act applied a break to internecine strife, the delivery process in the industry continues to be fragmented with hierarchical and sequential appointments of firms with three or four layers of sub-contracting not being uncommon. Over 85% of the value of the industry's output is delivered by a supply chain comprising specialist contractors, suppliers and manufacturers. But the supply chain has little influence over procurement decisions, design solutions and cost plans and it is these that will determine whether or not the finished product represents value for money. This, alone, represents the major fault line in the UK construction industry.

A.1.4 Not surprisingly, this was the fundamental issue addressed in Sir John Egan's report, "Rethinking Construction" in 1998:

The most successful enterprises do not fragment their operations—they work back from the customers' needs and focus on the product and the value it delivers to the customer. The process and production team are then integrated to deliver value to the customer efficiently and eliminate waste in all its forms

The key word in this quotation is "integrated". According to the concise Oxford Dictionary "integration" means, "combine, or be combined, to form a whole", "bring, or come, into equal participation in an institution or body".

A.1.5 The implications for the construction industry of Sir John's report would be far-reaching:

To summarise, . . . we are not inviting UK construction to look at what it does already and to do it better; we are asking the industry and government to join with the major clients to do it entirely differently. What we are proposing is a radical change in the way we build. We wish to see, within five years, a construction industry deliver its products to its customers in the same way as the best consumer-led manufacturing and services industries. To achieve the dramatic increases in efficiency and quality that are both possible and necessary we must all rethink construction".

A.1.6 The future is, therefore, a more collaborative approach to delivery that would transcend traditional demarcation lines and myriad interfaces in order to provide holistic solutions to the customer. Rethinking Construction was fully endorsed by the government and reflected in "Achieving Excellence" launched by Alan Milburn, the (then) Chief Secretary to the Treasury, in March 1999. Achieving Excellence was a three year programme (subsequently extended to five years) with targets for securing substantial improvements in quality, cost and time in reducing the average period taken between the start of the procurement process and the award of contract. These were to be achieved through teamworking arrangements between procurers and suppliers to maximise integration of the delivery process. Millburn's message was:

If you like, the Government is deliberately putting itself under the spotlight and what is more we are determined to drive through change . .

A.1.7 Whilst public sector procurers, private sector customers and many firms in the industry were committed to the "Egan agenda", achieving long-lasting change has been slow and patchy. Partnering and teamworking arrangements have often appeared to be "skin deep" or have excluded the supply chain.

Partnering is where a group of contractors get in to bed together—the trouble is the main contractor usually has all the bed clothes!"2

It appears to be very difficult to get out of the habit of using the supply chain as a repository for all the risks associated with construction—especially design risks arising from deficiencies in the original designs.

A.1.8 This lack of progress was acknowledged by the Government in 2001 when it established the Strategic Forum for Construction under the chairmanship of Sir John Egan. Its remit was to consider specific measures to implement a more integrated delivery process. The outcome was the Accelerating Change report:3

It is generally accepted that, at present, the number of projects delivered by integrated teams is less than 10%. This report looks forward to the time when the industry can offer a full integrated service to their clients, which will deliver predicted results in all areas

The Accelerating Change report was endorsed by the government and all sections of the industry.

The report set a target of 50% of construction projects (by value) to be undertaken by integrated teams and supply chains by the end of 2007.

A.1.9 In May 2006 the DTI funded an Integration Workshop attended by 80 leading practitioners from all sectors of the industry. The Workshop was invited to consider whether the industry would achieve this target. The Workshop report stated:

The industry is nowhere near meeting the 50% target by end 2007

A.1.10 This conclusion had already been anticipated by the NAO in 2005:

While good progress has been made towards collaborative working, departments and agencies have yet to establish fully integrated supply chain teams and to realise all the benefits of improved investment in capacity and innovation

The NAO added:

There are, however, practical barriers to full integration. In particular, the failure on the part of many clients and main contractors to operate fair payment practices for their specialist suppliers. Where specialist suppliers do not have certainty that they will be paid fairly and in a timely manner they have little incentive to invest in capacity or to innovate

A.1.11 All too often there are the costly reminders of the results of fragmented delivery and lack of teamworking—the British Library, Scottish Parliament and Wembley—to name a few. But, with the construction industry responsible for almost 9% of GDP, there are macro implications. Traditional procurement and delivery, exemplified by myriad interfaces, a lack of communication and engagement with the supply chain, inappropriate risk allocation and contractual conflict, all this is wasteful and inefficient.

A.1.12 There is much duplication. For example, each member of the project delivery team will have its own insurance policies that cover the same type of risks as those taken out by other members of the delivery team. Transactional costs are substantial with several levels of tendering, numerous contracts and a variety of payment verification/authorisation procedures. All this substantially increases the overheads of each firm involved and, thus, depresses profitability. High overheads mean fewer resources are available for training, investment in new technology, innovation and R&D.

A.1.13 In a report to the Office of Government Commerce last year, Deloitte concluded that poor procurement practices depress capacity in the industry. This is of particular concern at a time when the industry is entering a period of activity that, in relative terms, is unparalleled since Victorian times.

Risk/reward dynamics in procurement are of major importance to the industry's capacity. Any actions that override the principles of best practice or attempts to shift unacceptable risks onto suppliers could be counter productive and reduce the ability of the public sector to procure in the construction market

A.1.14 Deloitte concludes that productivity and efficiency in UK construction are below average when compared to foreign construction industries or other UK industries. In particular, the productivity of SMEs is substantially reduced because they bear the burden of unfair commercial practices especially inappropriate risk allocation:

Evidence suggests that small firm productivity is a key contributor to the overall productivity gap. This is especially important to the UK given the long and often inefficient supply-chains in construction: many small firms contribute to key elements of major projects

Poor productivity is often the result of low investment. A DTI/Experian report in 2004 suggests that UK construction productivity falls short of equivalent US levels.9

A.1.15 A recent pilot study carried out for the European Commission compared construction costs in a number of EU Member States. 10 The highest ranking countries included Belgium, Germany and the Scandinavian countries. The UK was one of the lowest ranking countries. The highest ranking countries benefited from most or all of the following factors:

— Extensive industrialisation of the process.

— Limited scale of sub-contacting.

— A well-developed, lean construction management.

— Single point of responsibility for design and construction.

— A well paid, well trained and industrious workforce.

The evidence obtained from this Pilot Study tends to point towards a more integrated delivery process in the highest ranking countries which, as a consequence, are more efficient which, then, enables greater investment in training and innovation.

Annex 2

LIST OF ORGANISATIONS NOT USING RETENTIONS [As of March 2007]

Annex 3

A BEST PRACTICE SME CHARTER FOR PUBLIC SECTOR CONSTRUCTION PROCUREMENT

THE AIMS OF THE CHARTER

A.3.1 This Charter sets out best practice principles on procurement and contracts to encourage the involvement of SMEs on public sector works. It is intended to be applied along the supply chain from the public sector client to sub-contractors (unless the Charter indicates that a certain requirement(s) applies to a particular party).

A.3.2 Lead contractors and their supply chains will be expected to endorse the Charter as a pre-qualification requirement prior to undertaking public sector works contracts. It is intended that compliance with the Charter will:

— help deliver best value in construction procurement to the public sector;

— improve the capacity of SMEs in the construction industry; and

— improve profit margins for SMEs engaged on public sector works.

PRE-QUALIFICATION

A.3.3 Wherever possible and subject to the Public Sector Contracts Regulations 2006 procurers will seek to use local contractors.

A.3.4 Procurers will seek to use contractors registered with reputable schemes of qualification that verify technical competence, health and safety performance and financial standing.

A.3.5 Contractors who are registered with reputable schemes of qualification would automatically qualify for all public sector works contracts unless there are requirements that are highly specific to the nature or type of work involved.

A.3.6 Procurers will use standard pre-qualification documentation developed by the Office of Government Commerce (OGC).

SELECTION AND APPOINTMENT

A.3.7 Partnering or collaborative working arrangements will be inclusive of the supply chain.

A.3.8 Contractors should be appointed as early as possible in the procurement process, preferably as part of the design team (in which case they should be paid a fee for their design input).

A.3.9 Bids should always be assessed on best value (embracing whole life performance and sustainable solutions) rather than on lowest price; the best value criteria together with the respective weightings should be available to all tenderers.

A.3.10 Lead contractors and sub-contractors should list members of their supply chains when tendering and such lists should be adhered to.

A.3.11 When bidding all contractors should provide evidence of their payment performance in respect of their supply chains.

MONITORING QUALITY & PERFORMANCE

A.3.12 Public sector clients will seek to institute mid-project and post-project reviews of performance to provide feedback to the whole supply chain that will include progress against Key Performance Indicators thereby promoting continuous improvement.

A.3.13 Suppliers will work together as a team to manage out defects as work progresses.

CONTRACTS

A.3.14 The suites of contracts used by the public sector client will be adopted (unamended) by the supply chain provided they achieve a fair and proportionate allocation of risk.

PAYMENT

A.3.15 All payments will be discharged within a period not exceeding 30 days from the date on which payment becomes due.

A.3.16 Public sector clients will announce targets for phasing out the practice of retentions and, where they do not use retentions, this policy will be followed through the supply chain.

A.3.17 Where retentions are deducted they shall be ring-fenced for the whole supply chain in a trust account.

A.3.18 Where a contractor deducts retentions from members of his supply chain he must offer mutuality of security such as a payment bond.

A.3.19 Public sector clients to put in place project bank accounts unless it is demonstrated that they would not be cost effective to set up.

A.3.20 All final accounts will be agreed within a period of 30 days commencing from completion of the contract.

NON-COMPLIANCE WITH THIS CHARTER

A.3.21 Complaints concerning non-compliance with this Charter may be made by clients or by individual firms or by a trade association acting on a firm's behalf.

A.3.22 In the event that a complaint is not resolved between the relevant parties it may be submitted to the OGC to be considered in accordance with the suppliers' complaints procedure.

A.3.23 The OGC will report to the relevant parties (and the public sector client if the client is not a relevant party) on whether there has been a failure to comply with the Charter.

A.3.24 The OGC will produce an annual report on the extent of compliance with the Charter.

A.3.25 Repeated non-compliance with this Charter by a client could affect future funding of projects instigated by that client.

A.3.26 Repeated non-compliance by a contracting firm could affect its future selection for public sector works.

NOTE: References to the OGC include its counterparts in the rest of the UK; the Scottish Executive, Welsh Assembly Government and the Northern Ireland Procurement Directorate.

Annex 4

FOOTNOTE REFERENCES IN THE SUBMISSION

1. The Common Minimum Standards (CMS) are a list of key minimum procurement standards that are mandatory across central government (including departments, executive agencies and the non-departmental public bodies for which they are responsible). The first and "General Standard" refers to adherence to the OGC's "Achieving Excellence in Construction" initiative. This has as its overall theme the procurement of integrated project teams involving all the key suppliers at the outset.

2. The report (based upon the survey) is available on SEC Group's website at www.secgroup.org.uk

3. Box 2, pages 6-7, NAO Report "Improving Public Services through better construction", 15 March 2005.

4. Page 13, NAO Report "Improving Public Services through better construction", 15 March 2005

5. An example of the potential savings is given in case example 17 on page 22 of the NAO Report, "Improving Public Services through better construction". "The [Environment] Agency considers it obtained a better engineering solution [through early involvement of specialist engineering contractors] that will last up to 20 years longer than the initial design, which also has significant environmental benefits at a saving of £1,120,000 (12%) on the construction cost of the original solution. The contractors and consultants considered that without the early joint working approach the solution and savings would otherwise not have been identified".

6. From a consultation document issued by the Built Environment and Transport Foresight Panel, published by DTI in 2000. This has been reinforced by recent research in 2003. Loughborough University and the University of Manchester Institute of Science and Technology produced a report for HSE entitled "Causal Factors in Construction Accidents". The report evaluates research that was based upon an analysis of 100 construction accidents. The report concluded: "It was judged that up to half of the 100 accidents could have been mitigated through a design change . . ."

7. Page 29, Building for the future: Sustainable construction and refurbishment on the government estate. 20 April 2007.

8. "Transforming government procurement" was a white paper published by HM Treasury in January 2007.

9. Para 4.10, Accelerating Change launched by Sir John Egan, September 2002 (see Annex 1).

10. The Housing Corporation is a non-departmental public body that comes within the remit of the Department for Communities and Local Government.

11. Para 2.29 "Improving Public Services through better construction", 15 March 2005.

12. Para 5.23.

13. Para 3.33 "Improving Public Services through better construction", 15 March 2005. Case example 19 on page 23 of the NAO's Report is a an illustration of the operation of a project bank account. Payments for each member of the delivery team are retained in a safe receptacle and paid out directly to each team member. Payments do not have to "travel" through many hands thus removing the incentive to hold onto the cash. A project bank account helps to reinforce the team ethic.

14. Available at www.strategicforum.org.uk

15. The results are available at www.secgroup.org.uk

16. Para. 3.23 "Improving Public Services through better construction", 15 March 2005.

17. Para 3.25 "Improving Public Services through better construction", 15 March 2005.

18. Box 2.2, Transforming government procurement, January 2007.

19. Trade & Industry Committee Second Report of Session 2002-03 "The use of retentions in the UK construction industry". A second report, "Retaining retentions?" was published on 17 September 2003—Fifteenth Report of Session 2002-03.

20. Speaking in the House of Commons Standing Committee debate on the Scheme for Construction Contracts in February 1998.

21. Further uncertainty has been caused by the first House of Lords case on the Act—Melville Dundas (in receivership) v Wimpey. The judgments were handed down on 25 April 2007. A 3-2 majority of the House has cast doubt on the status of withholding notices issued under s 111. It appears that there could now be circumstances in which failure to issue a withholding notice does not prevent the payer from denying payment.

22. Constructing the Best Government Client, The Government Construction Clients' Panel, 1998.

23. Para 5.17, Accelerating Change, September 2002.

24. The review published in May 2003 was titled: "Government: Supporter and Customer" and is available at www.brtf.gov.uk/taskforce/reports/smeprocurement.pdf

FOOTNOTE REFERENCES IN THE BACKGROUND NOTE

1. Para 17, Rethinking Construction.

2. A specialist contractor quoted in "Unlocking Specialist Potential" published by Reading University in 1998.

3. Launched by Sir John Egan in September 2002. Available at www.strategicforum.org.uk

4. Para 5.1.

5. Para 2.40, Improving Public Services through better construction, 15 March 2005.

6. Supra at para 2.41.

7. Para 5.12, 2005-15: Construction Demand/Capacity Study, June 2006.

8. Supra at para. 5.9.

9. DTI/Experian, (2004) Measuring the Competitiveness of the UK Construction Industry, Volume II.

10. EU Pilot Study benchmarking construction costs (use of resources) in the Member States (March 2006) by Bernard Williams Associates—Access to the full report is available at www.bwa.uk.net/eucon or on request to Bernard Williams on 0208 460 1111.

May 2007



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