The world’s infrastructure gap is growing. It’s estimated by the Global Infrastructure Outlook to be in excess of $15 trillion, driven by growing populations, change in demand, and the need to replace aged existing assets for both public and private clients.
Hospitals, for example, have a wide net of stakeholders who rely on the infrastructure, and potential failure has life or death implications. The investment requirements are set to increase further with the global transition towards targeting net-zero emissions. According to McKinsey research, to achieve net zero by 2050, organisations will need to increase investments into low-emissions capital stock by $3.5 trillion per year. The majority of this increase will need to focus on meeting the growing demand for electricity caused by this transition, while simultaneously decarbonising existing power generation and transmission infrastructure.
New Zealand infrastructure investment challenges
New Zealand is facing similar challenges, with $210 billion required to fund the future needs of population growth and climate change (Treasury’s 2022 Investment Statement). Electricity generation capacity will need to increase by 170% to meet net-zero carbon goals, and $12.5 billion of local and central government infrastructure is vulnerable to sea level rises. To meet these challenges, New Zealand will have to increase infrastructure investment to nearly 10% of GDP versus the current 5.5%. This presents significant challenges in terms of government funding, procuring and delivering successful projects in a climate of increased global investment. This analysis will concentrate on one element of the puzzle – procurement.
Pressure ramps up along with cost
The New Zealand market is facing significant pressure delivering the current construction workload with global capacity issues which are further exacerbated by the country’s remote location and COVID-19 controls. The market is facing volatility – the cost to build has likely peaked at approximately 10% per annum in 2022 – with some trades increasing in excess of 50% in a year. With cost increases continuing, contractors are unwilling to provide fixed prices to clients. The government is facing up to a growing infrastructure gap –delivering highly complex, high-risk projects in a climate of volatile costs and capacity constraints.
The relationship alliance model of delivery for infrastructure
The response by clients in the infrastructure sector has been to procure through relationship-style arrangements designed to share risks and rewards. This has been implemented on single major projects as an Alliance Model, and across a long-term programme of works as an Enterprise Model. This approach creates a project team built on shared priorities and values, where decisions are made based on what’s best for the programme rather than the company. In addition, the relationship approach and clear signalling of upcoming work enables contractors to plan and invest for the long term, building the capability and capacity to deliver better outcomes. Apart from typical construction priorities, this model may also include Environmental, Social and Governance targets such as carbon reduction, social procurement and stakeholder engagement. Where managed effectively, these are clearly defined objectives by which to measure success.
The need for a good faith approach
A central principle of the Alliance Model is an approach based on trust and good faith which aims to resolve differences without blame or dispute. This means that the relationships between parties is critical to the success of the model. Partners should work hard to maintain a positive culture with a collective approach to decision making. The challenge for projects in a volatile market is to retain key individuals while staff churn is occurring. This can result in significant salaries being passed onto the client in a bid to retain bonded individuals.
Open-book cost management
From a commercial perspective, a critical element of the relationship model is determining the pricing of the works in an open-book manner. This requires rigorous cost management, reviewing rates and margins with an accounting approach. This involves a level of scrutiny and transparency that’s significantly higher than traditionally procured projects. The client’s cost management team needs to be involved early in setting expectations and agreements with respective parties. There is a steep learning curve for contractors unfamiliar with sharing commercially sensitive information and this can extend throughout the supply chain.
Determining costs up front to balance pain and gain for all project stakeholders
As New Zealand’s largest independent QS business, RLB has found that the relationship-style arrangement is becoming the norm for major infrastructure procurement delivering major road and rail infrastructure and urgent drought resilience. It has also been used for accelerated public realm works to revitalise Auckland’s waterfront in time for the prestigious sailing regatta – the America’s Cup. A major challenge is finding the target out-turn cost used to determine the pain/gain share arrangement on a basis that reflects the true risk to the project. It is critical to develop a robust parallel estimation process to provide an independent view, and to have a mechanism in place to resolve disparities of opinion. A target out-turn cost which is unrealistically high or low can lead to poor value outcomes.
The pipeline of infrastructure projects appears strong, with heightened demand currently expected to insulate the infrastructure sector from the anticipated wider market downturn. Market softening should result in reduced volatility due to the relief on resource and supply challenges. The benefit of the open-book process will be increased competitiveness in the market as present day pricing is achieved. In addition, the relationship approach should give contractors and suppliers the confidence to continue investing during a period of uncertainty. As infrastructure demand grows to meet existing demands and new decarbonisation and climate adaptation priorities, the industry needs to adapt to succeed. The relationship-based approach helps provide confidence, flexibility and rigour in delivery while upskilling the wider industry.