PROJECT RISK MANAGEMENT THE COMMERCIAL DIMENSION pdf

In a percentage of cases there may be some negotiation of these terms, but frequently not.Conversely the prime contract terms for a project are invariably negotiated,specially drafted an

A SPECIALLY COMMISSIONED REPORT

PROJECT RISK

MANAGEMENT

THE COMMERCIAL DIMENSION

Tim Boyce

A SPECIALLY COMMISSIONED REPORT

PROJECT RISK

MANAGEMENT

THE COMMERCIAL DIMENSION

Tim Boyce

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in 1980 after which he enjoyed appointments with Siemens, British Aerospaceand more recently as commercial director at BAE SYSTEMS His functionalresponsibilities have included contracts, commercial, procurement, estimating,legal, project accounting and the implementation of the European Business Excel-lence Model.

His committee work includes the Chartered Institute of Purchasing and SupplyNational Contracts Management Committee, the CBI Contracts Panel, the CBIDefence Procurement Panel and the CBI/MoD working groups on partneringand incentive contracting He was the CBI observer at the HM Treasury CentralUnit on Purchasing working group on incentivising industry In 1997 he wasinvited by the Director General of the CBI to join the CBI Public Private Partner-ship Forum He has lectured widely in the UK and in the US on business, contractand commercial management

1 TOTAL RISK MANAGEMENT 1

1 The risk – risk scenario 9

2 The bid/no bid decision 9

3 Bidding 16

4 Pricing for risk .19

5 Risk review board .23

6 Making an offer 25

7 The priced list of risks .29

8 The caveats register 30

9 An effective contract .31

10 Negotiation .34

11 Contract launch 35

12 Pointers for project risk management 36

Checklist 36

3 FINANCIAL RISK 38 1 Prime contract financial risk 39

2 The nature of price and the sharing of cost risk .39

3 The client will not pay .43

4 The client cannot pay .46

5 Inflationary cost increases .46

6 Foreign currency fluctuations .48

7 Contract termination .51

8 Financial claims against the prime contractor .53

9 Pointers for project risk management 54

Checklist .55

3 Options 60

4 Sharing the risk 61

5 The commercial engineer .62

6 Setting the baseline .63

7 Requirement creep .64

8 The changing requirement .65

9 The work takes longer than expected .66

10 The never-ending contract .68

11 Failure of performance .69

12 Buyer initiated problems 70

13 Pointers for project risk management 71

Checklist 72

5 TIMEFRAME RISK 74 1 Bidding compliant delivery .75

2 The timeframe obligation 78

3 Time is of the essence .79

4 Consequences of delay 79

5 Liquidated damages .81

6 Force majeure .81

7 Delivery incentives 83

8 Client delay .84

9 Subcontractor delay .86

10 Prime contractor delay 86

11 The threat of termination .88

12 The threat of damages 89

13 Pointers for project risk management 91

Checklist 92

3 Subcontractor lateness 104

4 Subcontractor failure .105

5 Subcontractor work unfit .106

6 Monitoring subcontractors .106

7 Pointers for project risk management 107

Checklist 108

7 PROJECT COMPLETION AND BEYOND 113 1 Life after completion .114

2 Key contractual milestones 114

3 Residual obligations and risks 117

5 Acceptance .118

6 Products rejected .120

7 Title does not pass .121

8 Products lost or damaged in transit .122

9 Failure after delivery/acceptance 122

10 Warranty 123

11 The hand over of technical data to the client .125

12 Third party intellectual property rights .127

13 Account management .129

14 Pointers for project risk management 130

Checklist 131

Section 1

Total risk management

The basis of all business is buying and selling goods or services or a tion of the two The word product is these days used for both goods and services.

combina-A television is a product and a particular type of insurance scheme may bedescribed by the provider as a product For the purposes of this Report the wordproduct will be used in the former sense Products are designed and producedand sold to customers as end items in themselves The characteristics of a productmight include: it is available off-the-shelf; it is produced (hardware) or replicated(software) in quantity with each unit being identical to every other; the design

is driven by the supplier (albeit aimed at specific markets) rather than by anindividual customer; the performance characteristics are well known prior tothe product being made available to customers; its constituent parts are readilyavailable as materials or components

On the other hand there is a particular type of service which is called a project

It commonly comprises the bringing together of many disparate products into

an overall solution The characteristics might include that it is bespoke; it is unique;the design is driven by one customer; performance characteristics can be designedand modelled but not known until the project is complete; its constituent partsmay comprise products which themselves must be specially designed Projectstend to be of large financial size and long timescale Whilst no business enter-prise is without risk, it can be seen quite readily that projects are by their verynature of considerably greater risk than products Management of risk in a projectsenvironment is therefore of considerable importance

Project Risk Management is a well established doctrine supported by many toolsand techniques Risk analysis, risk registers, risk models and active risk manage-ment are all important in seeking that ultimate goal of project management –completion on time, to specification and within budget There is, however,another key distinction between products and projects, the significance of which

is perhaps sometimes overlooked Products tend to be bought or sold subject

to standard terms of contract The buyer or seller, usually whichever is in thestronger position, subjects the transaction to his standard terms In a percentage

of cases there may be some negotiation of these terms, but frequently not.Conversely the prime contract terms for a project are invariably negotiated,specially drafted and often of significant contention before the parties come toagreement Each side may come to the negotiation armed with a preferred set

of terms, some or all of which may be based upon standard terms Each willtry to exploit the strength of its bargaining position to secure its terms butultimately the agreed terms will always be of a bespoke nature, reflecting notonly the outcome of commercial negotiations but in many instances reflectingthe fact that individual standard terms may simply not exist or may be inade-quate for the unique situation of the particular project

Interestingly the choice between buyer and seller standard terms in a routineproduct transaction is fraught with danger for the side that concedes, for thesimple reason that standard terms are never generated with fairness or balance

in mind The reason that every transacting organisation has different standardterms for sale and for purchase is that each organisation expects to purchasefrom its suppliers on terms which it would ideally never confer on its customersand vice versa The central reason is that each organisation likes to both buy andsell at zero or minimum risk to itself Standard terms are a means of pushingrisk ‘down’ to suppliers and ‘up’ to customers Everyone in the supply chain hasthe same motive Of course in simple product transactions little attention is givenbecause nobody expects anything to go wrong The product is identified by partnumber or catalogue number, specifications exist, and price and payment arestraightforward The client gets what he is expecting and the supplier gets hismoney The allocation of risk under the contract terms is of no practical interestother than in the very small percentage of cases where things do go wrong.Projects are different It is not so much that the parties expect things to go wrong(if they did, they have no business in proceeding) but that they are aware thatthe risk of difficulty is inherently much higher Not only are there usually morerisks but several of the risks may have a significant probability of arising andthe impact of a risk that materialises may be catastrophic This results in twothings Firstly, each side (preferably jointly) will consider how best to managethe project so that risks do not materialise at all or, if they do, that the impact

is minimised Secondly great attention is given to the negotiation of bespokecontract terms The contract is ultimately the single vehicle by which risks areallocated (or shared) between the parties It is essential that each party knowswhere it stands both before a final decision is made to enter into the contractand afterwards, if risks materialise

A project management plan may ascribe responsibilities between the parties

A risk management plan may purport to allocate individual risks to one party

or the other but the contract must be clear on what these allocations mean from

a legal perspective This is not just a point of technicality For example, if theclient agrees to carry responsibility for a particular risk (which affects the proba-bility of timely completion of the project) and to undertake risk mitigation activities,

where does that leave the prime contractor? Supposing the client neglects toundertake the mitigation (perhaps to save money) and the project runs late, canthe prime contractor charge for his own increased costs? If the project runs latebecause of this failure to mitigate, where does that leave the client? Can he stillterminate the prime contract for default (failure to complete on time) on the part

of the prime contractor? Common sense or a sense of fair play may incline thereader towards one answer or another, but common sense and fair play areunfaithful guides The answer of course is that what happens in the real world

of project management and active risk management cannot be divorced fromthe hard questions of liability and the consequences of doing or not doingsomething

So, the prime contract is the ultimate risk vehicle Pre-contract negotiations willhave established an allocation of risks enshrined in the prime contract The form

of contract may represent a simple allocation of risks – i.e it is a record of whichparty owns each risk and the consequences of that ownership Alternatively,the form of contract may in itself be constructed so as to deal with risk in a waythat encourages client and prime contractor to cooperate in the management

of risk Project risk management is the hands on tool for helping the projecttowards a successful conclusion Putting these things together we are inevitablydrawn to the fact that risk identification must inform the prime contract negoti-ations and the prime contract must inform the management of risk during projectexecution Understanding between project or risk managers (doing the job) andbusiness or commercial managers (doing the prime contract) is therefore essen-tial In fact the combination of project risk management and commercial riskmanagement might be called Total Risk Management:

Figure 1: Total Risk Management

We got paid

We didn’t get sued

We made a profit

TOTAL RISKMANAGEMENT

Happy company

Happy customer

Happy shareholders

If this idea of TRM is to succeed it is first necessary to consider when the ship between project risk management and commercial risk management of aproject really begins The two facets certainly come together at the prime contractnegotiation stage, but in many ways that is already too late There are four keypoints when the coming together must occur:

relation-TRM STAGES THE KEY QUESTION

Bid/no bid decision What is the probability of submitting the winning bid?

Tender preparation What is the probability that the emerging

risks can be contained?

Prime contract negotiation What is the probability of securing a ‘safe’ deal?

Prime contract performance What is the probability of completing the prime contract

on time, to specification and within budget?

The view of total risk can be considered as maturing as these stages come andgo:

Figure 2: Maturing View of Risk

Can we win at

an acceptable risk?

Can we complete the

project to time, budget

and performance?

Bid/no bid

Tender preparation

Contract

Negotiation

Contract performance

An initial view

A considered view

A merging view

An ongoing view

Although there is an overlap between them, the two questions – can we winand can we perform? – are in essence quite different in character A mistakethat is sometimes made is to undertake risk analysis during the bid stage only

in respect of the second question This is to deny to the fundamentally tant first question the benefits of risk analysis and risk management

impor-Consider these issues presented somewhat differently:

Figure 3: Risk Management Transition

In the pre-contract stage two risk management activities should be underway.One looks at the problems associated with preparing an attractive bid on timeand defeating the opposition The other is concerned with predicting whether

or not the project can be completed successfully Naturally if the early work onthe latter question produces a very high probability of failure, then that resultcould have a devastating effect on the desire to bid and bid risk managementwould become superfluous In this diagram it has been convenient to introducethe expression bid risk management but preparing a bid for a project is in factanother project So it would be more accurate to say that the prime contractnegotiation is the transition from one (bidding) project to another (doing) projectand that project risk management in tandem with commercial risk managementare needed in both stages

Can we win?

Bid risk management

Can we perform?

Pre-contract project risk management

CONTRACT NEGOTIATION

Project risk management

Request for

bids received

Bid submitted

Contract awarded

Project completed

There are many other considerations in business risk management frompersonnel recruitment strategy to investment strategy to market orientationstrategy These are outside the scope of this Report which addresses itself tothe commercial aspects of total risk management in a projects environment The

text describes matters from the perspective of a prime contractor undertaking

a project for a client In this context the prime contractor places work with

subcon-tractors Where a very general point is to be made the text adopts the more neutral buyer and seller In places the text refers to penalties The usage is that of the

layman and not the lawyer To a layman a penalty is an unfortunate consequence

of some event Lawyers have a more particular definition that leads to a generalprinciple that penalties are not enforceable in English law contracts The text

refers in places to products This is intended to mean the physical

manifesta-tion of the project as delivered, for example a system or any part thereof which

is handed over to the client

At the end of each Section is a paragraph called Pointers for Project Risk

Manage-ment The purpose of this is to capture the essence of the commercial aspects

that most need to be absorbed into a project risk management perspective EachSection also has an appendix that provides a more detailed checklist of do’sand don’ts to better illuminate how key commercial risks may be dealt with in

a contractual manner

For a much fuller exploration of the commercial aspects of business the reader

may refer to The Commercial Engineer’s Desktop Guide (Hawksmere).

Section 2

Getting to contract

1 The risk – risk scenario

2 The bid/no bid decision

3 Bidding

4 Pricing for risk

5 Risk review board

6 Making an offer

7 The priced list of risks

8 The caveats register

1 The risk – risk scenario

Bidding for a contract involves a twin risk Firstly there is the risk of losing thecompetition and secondly there is the risk of winning it! As has been said beforenow, ‘the good news is that we’ve won the competition, the bad news is thatnow we have got to perform the contract’ In any competition for business there

is the risk that the prize turns out to be a lemon A lemon contract is one that

is more difficult to complete than expected or one that becomes impossible tocomplete at all This is bad news for all the stakeholders The prime contractor’sfinances and reputation will suffer, with potentially disastrous consequences.The client will not get what he wants when he wants it His reputation (as a compe-tent procurer) may also suffer, with knock on consequences The client may sufferadditional cost which may not be recoverable from the prime contractor or anyoneelse The prime contractor’s shareholders will suffer and any end users of theproject (for example in public services) may also lose out

So the decision to bid is not to be undertaken lightly In this Section the process

of moving through evolving bid risk management into a ‘no turning back’ decisionand then on into an effective ‘risk understood’ contract will be explored

2 The bid/no bid decision

Making a decision to bid for a significant prime contract is a major step Oncethe decision has been made the bid gains a momentum and almost a person-ality of its own Once it is thundering along it can be almost impossible to stop.The risk that is taken at this early stage is gambling the cost of bidding againstthe chances of winning The cost of bidding is more than just the money spent.The diversion of resources, the inability to bid for other contracts and the reputa-tion of the prime contractor are all considerations Money spent on one bid meansthat money not being available for bidding for other contracts Bidding soaks

up valuable resources as the prime contractor not un-naturally wishes to putits best people onto bidding for an important new project Many companies do

not have the luxury of maintaining top teams whose task is exclusively bidding.Indeed such dedication may in itself be a risk insofar as bid preparation by peoplenot involved in prime contract execution lacks that vital element of experience,the absence of which either makes the bid of academic interest only to the client

or some key activity or risk is missed in the costing/pricing exercise Thus thebest source and possibly the only source of expertise for the bid team may bethose people engaged on current contact work, where the diversion of key peoplemay introduce additional risk, cost and possibly delay to that work Once thebid is underway it becomes a personal challenge, and rightly so, for the bidmanager to submit the bid no matter what and, of course, to win the primecontract Similarly the prime contractor in its dealings with the client and withpotential subcontractors is keen to show that it can submit an attractive bid.Again, this is rightly so but the point is that once bid preparation is in hand no-one wants to stop it for fear of loss of face, writing off nugatory expenditureand losing the chance of winning This means that the decision to bid in the firstplace must be a good decision

Risk analysis of the prospects of winning and risk analysis of the potential primecontract must begin very early on and be maintained throughout Certainly theprospects of winning can alter as the bid phase proceeds, as more information

or intelligence becomes available News that an arch competitor has a new andunique approach to the particular project, news that an overseas bidder hassupport from his own government in making a subsidised bid, news that theprime contractor has become unpopular with the client all might indicate thatthe prospects of winning have slumped These things do happen and so bidstrategy should be based upon:

Figure 4: Phases of Risk Management

Pre-bid: Predict and prevent

In-bid: React and mitigate

Post-bid: Pro-act and manage

In the examples given it might be possible to predict the possibility of an overseassubsidised bid and prevent it by political lobbying If the prime contractor isrumoured to be unpopular (e.g because of problems on a current contract)then it should react and take extraordinary steps to mitigate whatever theproblem might be before the client develops a mind-set in which the percep-tion of the prime contractor’s alleged poor performance becomes absolutelyfixed If after the bids are submitted, a competitor is discovered to have unexpect-edly offered a novel approach the prime contractor may try spoiling tactics byattempting to rubbish that new product in the client’s eyes by drawing its atten-tion to the unproven and hence high risk nature of that approach.

In the extreme, a continuing risk analysis (of the probability of winning) as bidpreparation proceeds might lead to a conclusion that, where at the outset thechances of winning were estimated at a certain level, the unfolding of eventsand the gaining of intelligence during the bid alters that initial perception:

Figure 5: Progress of confidence in winning

100%

Time 0

Bid confirmation

Bid submitted

Winner announced WORTH BIDDING AXIS

Figure 5 gives a not untypical view of the progress of the confidence level insubmitting the winning bid:

Pre-IFB: Early confidence may be very high because the initial

intelligence is that the prime contractor is the marketleader, has the best record of delivering projects on timeand is competitive on price Confidence may wane as,perhaps, discussions with the client show he is keen toencourage new, innovative solutions to his requirementsthat point to the selection of a different prime contractor

IFB Received: Confidence recovers as it is realised, perhaps, that the

IFB highly matches the prime contractor’s intendedsolution So a decision to bid is made

Post decision to bid: Again confidence wanes as the enormity of the

require-ment, lack of adequate bid preparation time, scarcity

of top people all strike home

Bid submitted: Confidence level is high as the bid team congratulates

itself on completing the bid and getting it submitted ontime

However, the prime contractor should be clear at what level of confidence it isworth bidding If ongoing risk analysis shows the confidence level (the dottedline on figure 5) falling through the Worth Bidding Axis then there should be

a serious re-appraisal of the prospects and if action taken does no stop the rot,

a decision to withdraw should seriously be considered Bid mation points should be built into the bid plan at least as far as two thirds theway through the bidding period After two thirds most of the bidding cost mayhave been incurred and it may be as well to finish the bid even if confidence islow Before the two thirds point the options are greater Indeed it is possible topostulate a Rule of Thirds (figure 6)

re-appraisal/confir-Figure 6: Risk re-assessment – the rule of thirds

In the first period, unless some fundamental, catastrophic event occurs any riskre-assessment would be too uncertain to allow a positive decision to stop thebid It is only really in the middle period when a more objective re-assessment

is possible and while sufficient time and un-spent bid cost remains to make areversal of the bid decision a possibly wise choice

In deciding to bid, the following risks need to be considered and re-assessed

as events unfold

Competitors:

• How do their products compare with ours?

• How do their prices compare with ours?

• What is their delivery performance like?

• Do they offer long term product support?

• What standing/influence do they have with the client?

• What pricing strategy will they follow (e.g ‘loss leading’)?

• Is there a ‘sitting contractor’?

The Requirement:

• How complex?

• Are we familiar with it?

• Can we offer compliancy on technical features?

• Not too late

to cut losses

• Bid costmostly spent

• See it through

BID SUBMITTED

Bidding Resources:

• Do we have top team people available to produce the bid?

• Have we got the money to bid?

Partners:

• Do we want to bid in a team?

• If so do we lead?

• Is there enough time to put a teaming agreement in place?

• Can/will team members defect to the opposition?

Subcontractors:

• Do we need any?

• Are they single source?

• Do we have time to get and negotiate formal proposals?

Prime contract Award:

• What validity must we offer?

• How does this fit in with our long term resource plan?

Prime contract:

• Can we or dare we reject or comment on the terms and conditions?

• What risks do they contain?

It can be seen that there are very many things to consider and in terms of thoserisks, which are not associated so much with the process of bidding but more

to do with the potential prime contract, it is essential to have a strategy for dealingwith all such risks The options may be:

Option Principle

1 Ignore the risk and hope it does not materialise

2 Comment on it at the bid stage (i.e draw it to the client’s attention)

3 Remain silent at the bid stage but aim to deal with it at the prime

contract negotiations

4 Remain silent at bid and prime contract negotiation stages but have a

plan to eliminate or transfer the risk once in contract

Ignoring the risk is not an option! Of the other choices the best approach is notalways obvious Commenting on a risk at the bid stage is theoretically the rightthing to do because it exposes the issue early on and shows the client howthoroughly the prime contractor has understood the potential prime contractand the lengths to which it has gone to respond realistically On the other hand

it may count against the prime contractor when the client adjudicates all thebids To eliminate the risk of a caveat against the potential prime contract preju-dicing the adjudication, companies sometimes choose not to mention the issueuntil the process is sufficiently well advanced for prime contract negotiations

to have started The danger here is that a good opportunity may not presentitself or that the client may not entertain new things being introduced at thatstage In this latter situation the risk is that introducing new things may at bestirritate a friendly client or at worst cause him to re-open the competition Thisleaves the final choice which is to say nothing until the prime contract is awardedand underway when raising the issue, with the intent perhaps of re-negotiatingthe prime contract, may meet a stonewall or a penalty of some sort

For example, if a prime contractor considers bidding for a prime contract knowing

or believing it could not complete the project on time it has a number of choices:

Option Principle

1 No bid

2 Offer an alternative schedule

3 Bid to meet the completion date but aim to shift the date in prime

contract negotiations, perhaps by offering something in return

4 Bid to meet the completion date but plan to ‘manage’ the problem away

as opportunities arise during prime contract performance

Option 1 may very well be the right answer if it is known that the client will notunder any circumstances consider alternative dates and if the prime contractor

is convinced that it could not in any circumstances meet the required dates and

if there was no probability at all of things changing during prime contract mance These are big ifs and the circumstances quite unique If any of thesepropositions does not hold true then another option should be preferred Bidding

perfor-an alternative date is ostensibly the right thing to do, but it runs the risk thatthe bid will be ruled out at an early stage of the adjudication However the clientwill no doubt do his own risk assessment on offered completion dates and itmay be that the prime contractor’s preferred but ‘late’ date is of lower risk than

any offered by competitors So this option could turn out to be the best To avoidthe risk of premature elimination it may be that Option 3 is preferred It is driven

by the ‘let’s get to the table’ philosophy but of course runs the risk that the client’srisk analysis will reveal the strategy The final option depends on a hard nosed,some would say pragmatic, approach that major projects almost always entail

a change of scope or direction at some stage and that such events are the besttime to reset the prime contract schedule

3 Bidding

Once the decision to bid is made, it having been decided to risk the cost of bidding,diversion of resources etc against the potential benefits of securing the primecontract, the real risk is that the bid will not be produced in a way that gener-ates an attractive result

Putting a bid together is a project in its own right There is a requirement tomeet and a deadline to achieve The result must be a quality bid, produced withinbudget and delivered on time Like any other project it needs a managementteam (figure 7) and the disciplines that go with it

Figure 7: Bid Management

• Quality

This is a fairly stylised structure but indicates the sort of organisation, functionsand responsibilities that can be involved Its size and constitution will depend

on the scale of the bid but to be successful it will depend upon:

• Having top team experts

• Operating as a tight, effective team

• Being dedicated to the bid

• Having the necessary assets and facilities

• Having the necessary finances available

A half hearted, non-expert, part time, unfunded team will not produce the winningbid! As an absolute minimum the project manager must be retained from thebid phase into the prime contract phase Ideally the commercial and financemanagers should also be common to both phases A successful bid put together

by these key players will be translated into a major risk to project tion if there is little or no continuity of personnel between the bid and the contract.This can then become a resource management problem for the prime contractor

implementa-As has already been said, bid teams need the experience of staff working oncontracts and yet, if successful in a new bid, some of those key staff need to moveonto the new contract to provide that essential continuity

An important task for the bid team is to establish a win strategy so that costand effort can be optimally deployed The win strategy will always be highlyproject-specific but must be based on the best intelligence with regard to:

• Mandatory requirements of the IFB;

• Adjudication procedures;

• Adjudication criteria

Identifying adjudication criteria is not always easy Adjudication criteria tend

to be: formal and published to the bidders; formal but not published; informal(i.e invented once bids are received) or absent If there are no criteria at all thenlobbying could well be the principal if not the single element to the win strategy

If there are formal, published criteria which include relative weightings betweencriteria then a more objective, scientific win strategy can be developed so as toensure that valuable bid time, money and effort are devoted to those aspectswhich will win most points in the adjudication

Another technique for reducing the risk of the bid being unsuccessful is to put

in place a bid review team The review team’s task is not to contribute in anyway to the preparation of the bid but to regularly review the bid during its prepa-

ration from the client’s perspective Its role is not an editorial check of the bid.

Its task is to shake the bid and ask the fundamental question, is it any good?The characteristics of the review team are:

• Members must be senior to the bid team members so as to commandrespect and exercise authority;

• Disciplines must mirror the disciplines of the client’s adjudication team;

• Members must know the client and have the experience to putthemselves in the client’s shoes;

• Members must have the time and commitment to read and absorb allthe bid invitation material and not just ‘float around’ being clever butdisruptive;

• Members must be hard nosed and willing to sack members of the bidteam or to tell the bid team to tear it up and start again

The review team has two principal questions to answer Firstly it must ensurethat the bid is attractive in terms of presentation, content, substance and intel-ligibility It is often the case that bids, certainly the major ones, are comprised

of contributions from a wide range and number of sources possibly includingsubcontractors or teaming partners The result can be incoherent and look asthough it has been thrown together, even down to relatively minor points such

as paper size (EU and US use different standard sizes for example) and characterstyle/font size of typescript The red team must aim to ensure that the end result

is pleasing to the eye and is reader friendly Again, this is more than a proof read.The essential question is: does this bid have the look and feel of a serious andprofessional offer from a prime contractor competent to undertake the project?The second purpose is to ensure that the bid responds to the questions set bythe IFB Bid invitations frequently specify the required structure of bids (e.g.number of volumes, content of each, number of copies with and without priceinformation), documents to be provided (e.g plans and specifications), responses

to be given (e.g compliancy matrices) and options to be offered Bid teams canget carried away doing their own thing It is the task of the review team to dragthe bid team back onto the right path The aim is not simply to verify that thebid is technically competent and well presented The aim is to confirm that the

bid is answering the right question.

4 Pricing for risk

Assuming then that a final, irrevocable decision to bid has been made andassuming that the pre-contract project risk analysis is well established then amost pressing question arises as to what allowances should be made in the price

to cover perceived project risks Theoretically if the price is high enough theprime contractor will take any and all risks However, clients do not have unlim-ited funds, competition does not permit generous covering of risk within theprice and in any event a primary obligation of the prime contractor is to protectthe shareholders’ interests and that militates against ‘unintelligent’ acceptance

of untenable or high impact/high probability risks

If the level of risk is significant and the nature of the principal risks is such thatthey lend themselves to mitigation and elimination through joint action betweenprime contractor and client, then a form of contract that is based upon cost-risk sharing may be preferred (see Section 3) In such a contract all risks areeffectively shared because the immediate risks of performing the contract (e.g.technical and timeframe risks) have, it could be said, no more than a cost impact

if they arise Thus if costs are shared, risk is shared and there is a mutual tive to cooperative active project risk management The remote or consequentialrisk of performing the contract (e.g a third party claim against prime contractor

incen-or client) is not so easily shared, but must still be considered

If cost-risk sharing is in operation the degree of provision to build into the schemestill needs to be assessed and discussed, but by both sides However, for thepurposes of this Section it is assumed that cost-risk sharing does not apply and

it is for the prime contractor alone to determine how to cover risk with regard

to prices to be offered This is called pricing for risk Some provisions may be

included in the cost base or added as percentages or amounts to cost or added

as percentages or amounts to price For these purposes all will be referred to

as pricing for risk The primary aim is to keep risk provisions out of the price

as any unnecessary allowances merely make the price uncompetitive To reiterate,

it is better to get to the negotiating table with a low price and a game plan toimprove the position than to take the safe route of fully pricing for all risk andbeing immediately eliminated from the competition on the basis of high prices

Thus, using the project risk register, it should be possible to eliminate certaincategories of risk insofar as pricing is concerned:

Category Risk description

1 Risks that can be passed to the client under the prime contract

2 Risks that can be passed to subcontractors under the terms of purchase

orders and subcontracts

3 Risks that can be covered by insurance

4 Risks that, ostensibly, the prime contractor will carry but for which

feasible plans exist to shed the risks if and when they should materialise

These categories cause very many risks to be excluded from pricing Category

1 risks include such things as inflation risk which can be passed to the client byincluding a variation-of-price clause (see Section 3) Category 2 risks may, forexample, include eliminating exchange rate risk by paying overseas suppliers

in Sterling In Category 3 insurance may cover costs of delay caused by fire.Liability for lateness in Category 4 might be later transferred to the client byshowing that delay was caused by his acts or omissions

Finally attention should be turned to those risks that remain It is sometimeshelpful to split these into two main headings:

Risk Allowances: Events certain to occur but to an uncertain extent

Risk Contingency: Events which are uncertain to occur.

Provisions for both may be included in pricing Whatever the type of risk, analysis

of impact and probability should be carried out and thought given to the ship of risk to price (figure 8) Pricing for risk is an essential part of bid preparation

relation-Figure 8: Impact and Probability

Figure 8 shows that many risks are best ignored in so far as pricing is concerned

No risk should be completely ignored but, other than in a cost-risk sharing scheme(see Section 3), there is no point covering all the risks by provision in the price.Not only would this produce an uncompetitive price but some risks are not appro-priate for treatment by pricing provision The risk of the prime contract beingcancelled for the convenience of the client is a serious financial risk but there

is little point in putting something in the price for it as, if the prime contract iscancelled, the price will never be paid as such

High impact, high probability risks can be ignored because if the impact is high,having a notional value of, say, five times the prime contract price, then there

is absolutely no purpose in including 5% or 10% in the price Such risks canonly be treated in one of two ways Firstly by having a plan to avoid or shedthe risk if it arises Secondly by deciding not to bid in the first place! High impact,low probability risks can more safely be ignored Again there is little purpose

in putting a nominal risk provision in the price against a high impact risk which

is actually not expected to arise The strategy should be to ignore it in pricingbut keep it under constant review in risk management to ensure it does not materi-alise High probability, low impact risks on the other hand demand a provision

IGNORE ITIGNORE IT

in the price, but if the impact is very low it is unlikely to be noticeable in theswings and roundabouts of prime contract performance Almost by definition,low probability, low impact risks need not have a pricing provision made forthem.

The foregoing material on pricing for risk has made one implicit assumption.This is that the cost of the job is the subject of sound cost estimates to whichprovisions are then added, or not added as the case may be, in relation to identi-fied risks which may later arise, the impact and probability of which have beenanalysed However, it is possible that this stable basis may be unstable if thebasic cost estimates are wrong, either because of poor estimating or becausethe job was not understood at the time it was priced There is little comfort inhaving done a brilliant analysis of future risks as a result of which 12.75% riskprovision was included in the price if the basic costs were underestimated by500%! Needless to say a comprehensive understanding of the prospective jobbacked up by quality estimating is an essential pre-requisite to pricing

5 Risk review board

In many companies when a bid is approved for submission many people areinvolved in ‘signing it off’ but sometimes the approval procedure is excessivelyconcentrated on the price Such procedures should make it clear that each functionwithin the prime contractor is signing for something slightly different Thesefunctions and their responsibilities can be many and varied:

Function Primary approves the bid in respect of

Project Manager The entire requirement is understood

Plans and resources exist to discharge the prime contractTechnical Manager The technical aspects are understood

Production Manager The manufacturing requirements are within the prime

contractor’s capability and capacityEstimating Manager The requirement has been fully analysed and estimated ‘bottom

up’ using appropriate estimating methodsProgramme Manager Detail plans exist to show the prime contract can be completed

on timeFinance Manager That cost estimates and prices have been formulated in accor-

dance with approved rates and factorsContracts Manager That the terms and conditions have been reviewed and

commented upon in line with prime contractor policyQuality Manager That the quality requirements are consistent with prime

contractor approvals

In addition, those functions which will provide resources in the performance

of the prime contract should:

• Confirm that resources and their facilities exist or will be brought line as the prime contract demands

on-• Contribute to the cost estimating process and confirm that their sibilities can be discharged within the costs allowed

respon-• Identify any capital expenditure or other investment necessary for theperformance of the prime contract

The whole bid should be reviewed and authorised with perhaps the final signoff occurring at a ‘bid approval’ or ‘tender vet’ meeting However, such proce-dures make the implicit assumption that each function has identified and dealt,

in some way or another, with any risks which are associated with their area ofresponsibility This type of approach is inadequate as it fails to give risk the neces-sary exposure in the review-and-approve part of the process The procedureshould require the establishment of a Risk Review Board whose tasks are:

• To review, modify if necessary and approve the Pre-Contract RiskAnalysis;

• To interrogate the bid team or the prime contractor functions listedabove on the identification of risks in their respective areas and themitigation plans;

• To ensure that all risks are owned by an individual.

• To make the final decision that the risks having been identified analysedand mitigation planned result in a net total risk that is acceptable tothe prime contractor

These heady responsibilities demand that the Risk Review Board is comprised

of senior managers representing the broad perspectives of the prime contractor’sinterests In particular the fourth responsibility listed above is most onerous.Companies are in business to make a profit in return for taking a risk, but thatdoes not mean that a prime contractor is in business to take any risk no matterhow great, no matter how dire the potential consequences Therefore the finaldecision to proceed or not with the bid must rest with the Risk Review Boardun-swayed by the bidding costs incurred, the momentum and wishes of the bidteam or the possible reaction of the client if a bid fails to appear

Of course the risk-risk scenario demands that initial bid/no bid decisions aremade only in relation to those projects where there is an acceptable probability

of winning, combined with anticipation that the resultant potential prime contractwill be good business Thus the risk-reassessment undertaken during the bidshould not only continue to question the probability of winning but, as the pre-contract risk analysis develops, it should also continue to question theattractiveness of that potential prime contract No-one will thank the bid teamfor developing a position where there is a 99% probability of winning the greatestlemon in business history Thus in the normal course of events, bids coming

to the Risk Review Board for sanction will be approved but nevertheless inperforming its duties as Grand High Risk Inquisitor the Risk Review Board willhave made an invaluable contribution to the bidding process

6 Making an offer

Having seen preparation of the bid through to its completion and approval surelythere can be no risks associated just with putting the offer on the table? Well,there are eight areas of possible risk:

of signing the offer However, in regular dealings with particular clients it is goodpractice for the prime contractor to ensure that the client does know which ofits representatives is entitle to sign offers Furthermore, in the extreme, there

is no requirement for offers to be signed by a person provided it is clear thatthe prime contractor is making an offer albeit that some clients will demandsigned offers The corollary of making it clear that an offer is indeed an offer(i.e capable of acceptance in the legal sense) is to make sure that communica-

tions with the client which are not offers should be clearly so identified Letters

or other documentation conveying information, outline proposals, indications

of cost, budgetary estimates etc should be phrased so that it is clear that no offer

is being made Oral communications should be similarly safeguarded

When an offer is made it is wise to express a validity period This is the periodwithin which the offer can be accepted so as to create a prime contract Unlessthere is a tender bond, or some valuable consideration for holding the offeropen for the stated validity then the offer can be withdrawn or amended bythe offering party at any time, although to do this during the adjudication ofcompetitive tenders can be risky unless the client has called for revised proposals

or otherwise allowed adjustments to be made In any event an offer is tively cancelled if a counter offer is made, such as the client making an offer

effec-of prime contract which is different in some way to the prime contractor’s effec-offer.The risks in offering a validity period of any significant length are principallytwo fold Firstly that new information will emerge which would cause the primecontractor to wish seriously to re-consider its willingness to bid either in absoluteterms or on the basis of the prices or other terms presently on the table Secondlythere is the problem that the validity required is longer than that offered bythe prime contractor’s subcontractors This risk should have been identified,assessed and allowed for as appropriate in the pricing exercise but it is never-theless a good example of the need for careful consideration in offering particularvalidity periods

By the time that the offer is submitted to the client all negotiations with majorsubcontractors should ideally have been completed both as to price and termsbut with the proviso that further negotiations may be necessary as negotiationsevolve with the client Ideally those completed negotiations will have producedterms and conditions agreed with subcontractors which are no less onerousthan those required by the client or those upon which the prime contractor expects

to settle with the client The phrase ‘no less onerous’ is important because it sents the minimum position in terms of holding subcontractors on ‘back-to-back’terms with the client’s potential prime contract For example if the client wantstwelve months warranty then subcontractors should be required to give twelvemonths warranty However, whilst this is strictly back-to-back and no moreonerous it leaves the prime contractor with the risk of failure of a subcontractoritem which is just outside the subcontractor’s warranty but still within the client’swarranty, because of the dwell time between prime contractor receipt and onwardhanding over to the client Hence the prime contractor should seek, say, fifteenmonths warranty from the subcontractors so as to eliminate its risk in this area.Thus the prime contractor can legitimately seek ostensibly more onerous termsfrom its subcontractors However, the real risk at the point of making the offer

repre-to the client is that those ideals (subcontracrepre-tor negotiations complete, no lessonerous terms) may not have been achieved At that stage, actual or anticipatedmismatches should have been taken into account either in pricing or inresponding to the clients intended terms Nevertheless the risks should be recog-nised and negotiations with subcontractors continued after the offer has beenmade in order to eliminate or reduce those risks A danger here is that havingfailed to achieve the ideals, subcontractors’ bargaining positions are strength-ened if they know that the prime contractor’s bid has been submitted

Misrepresentations are those inducements to the client to enter into a primecontract which are deliberate or innocent misrepresentations of factual infor-mation In the extreme the remedy is recession of the prime contract and liabilityfor damages plus the possibility of criminal proceedings if the misrepresenta-tion was fraudulent Thus great care must be exercised when saying and doingthings which are intended to persuade the client to place the prime contractwith the prime contractor.

On the other hand, representations are those inducements which are factuallycorrect and which the client is entitled to believe that he can rely upon even thoughthe prime contractor may not have intended those inducements to form part

of his offer or of the consequent prime contract If the client took into accountsuch inducements in making his decision to award the prime contract then hecan expect them to be implied into the prime contract even though express termsare absent Representations can be made quite unintentionally and the risk can

be high of undertaking a greater obligation than was intended Although clientsare expected reasonably to distinguish between material which is merely adver-tising puffery and that which is intended to create a binding obligation, the divisionbetween puffery and real intent can be unclear particularly in matters of technicaldetail In the bidding and adjudication process it is common for clients to seekclarifications from bidders as to the detail or ambiguities in their individual offers.Answers given can be the simple clarification sought or they can possibly createadditional obligations either because a simple, brief answer establishes a broaderobligation than that conveyed by the detail of the original technical proposal

or because the prime contractor chooses to take advantage of the request forclarification by ‘improving’ its bid (indeed it may be that was exactly what theclient was seeking) Similarly so when the client allows bidders to summarisetheir offers by giving a presentation of their bids followed by a question andanswer session This is usually a golden opportunity for the prime contractor

to really sell its offer and yet in enthusiastic, ‘don’t worry, we can do it’ tation-speak representations really can accidentally be made

presen-The risk of accidental representations can be avoided by including in the primecontract an ‘entire agreement’ or ‘complete agreement’ clause which details all

of the documents which together constitute the whole agreement between theparties The parties can therefore decide whether the prime contract is made

up only of those prime contract documents prepared by the client as a formaloffer of contract or whether the agreement can incorporate by reference earliermaterial such as the prime contractor’s bid, written clarifications, third partyspecifications and standards Thus by expressly stating what is in the agreement,anything else is automatically excluded including representations (such as those

conveyed by presentation visual material, hand-outs etc) which could otherwise

be implied into the prime contract The use of entire agreement clauses to excludewhat otherwise would have been implied terms is subject to a reasonable test.Preceding the entire agreement clause, the prime contract should have the primecontractor providing an ‘entire offer’ statement within its bid For example thebid may be submitted under a covering letter highlighting the key benefits ofthe offer written in marketing terms rather than those of the lawyer The offermay be bound in several volumes of which one is an executive summary thepurpose of which again is to focus on the main advantages of awarding the primecontract to the prime contractor In either case it should be decided whethersuch summaries are part of the formal offer in the strictest sense They certainlyare part of the proposal but are they intended to be part of the resultant primecontract? Sometimes the client may ask for information (e.g an analysis of prices,predicted life cycle costs) which is helpful in bid adjudication but which is definitelynot intended (by the prime contractor at least) to be part of the prime contract.The discipline of providing an entire offer statement helps the prime contractor

to be clear what exactly it is offering and what it is not

Finally there are the issues of the language and applicable law of the primecontract In any international contract the contract should state the officiallanguage of the contract All contracts should state the applicable law underwhich the prime contract is created and to which it will be performed (thesecan be different, one law for formation and one for performance and possibly

a third for arbitration) If the language is other than English there is a risk ofambiguity arising in the translation The converse is true for the non-Englishspeaking client of course but since English has become the standard language

of commerce, business and industry English is preferable If the law is otherthan English Law or Scots Law there is introduced much uncertainty as foreignlaws can be markedly different from the UK varieties in terms of implied obliga-tions and duties Thus the English language and a UK law should be stated as

a premise for the bid

7 The priced list of risks

The foregoing shows that the simple act of making an offer can be fraught withrisks Nevertheless as the bid goes onto the table it represents, amongst otherthings, a particular set of proposed risk allocations between prime contractorand client However there is nothing to prevent, and much to commend, theprime contractor offering options in terms of allocation of risk Most risks have

a value to a buyer (how much would he pay not to carry a risk) and a value to

a seller (how much would he reduce his price to avoid a risk) These values arevariable in themselves and may not naturally coincide between prime contractorand client For example the prime contractor may be prepared to reduce its price

by 5% in exchange for the client carrying the risk of inflation-driven cost increases.The client may be prepared to pay 10% more not to carry that risk Clearly there

is room to negotiate! Such variation in the valuation of particular risks may reflect

no more than a differing perception of the probability and impact of the risks

It may reflect the fact that one side may be better able, or is logically the moreappropriate, to carry the risk

Emerging from these considerations is the idea that the prime contractor couldput forward a priced list of risks as options for the client to consider All compa-nies are used to offering options that would have the effect of altering the cost,scale, performance and timescale of the project but the concept of offering riskoptions is one that should be given some thought The risk options can be offeredwith the bid or during prime contract negotiations whichever appears theoptimum strategy in the given circumstances Not only does this approach dofull justice to the principle of using the prime contract as a risk allocation vehiclebut it would also assist in post contract dispute resolution For example, if post-delivery liabilities (express warranty, implied warranty, Sale of Goods Act impliedundertaking) can be shown to have been discussed in detail pre-contract withthe client, who took some financial or other valuable advantage in return foreliminating such liabilities, the prime contractor has a strong and clear case fordefending any later action by the client in the event of a post-delivery problem

8 The caveats register

From the point at which the invitation for bids is received through to the moment

at which the prime contract is signed, the very many people involved in bid ration and in the planning of prime contract execution regularly identify issuesassociated with the potential prime contract Some of these issues may be soimportant that they must be identified at the time of bidding Some may be lesscritical and can be left until prime contract negotiations Some may be minorissues to do with the terms and conditions Others may be fundamental premisesupon which the price has been formulated All these assumptions, exclusions,premises, understandings, dependencies etc can collectively be referred to ascaveats and should be put into a register (figure 9)

prepa-Serial Caveat Source Resolution Price Impact Action

Figure 9: Caveats Register

The register should be brought into being on the first day of the bid tion and it should be the receptacle for all thoughts, ideas, concerns that are atall to do with the potential prime contract In many instances the pre-contractrisk analysis and caveats register can be merged into a single document whichshould be kept up to date throughout the period of bid preparation and primecontract negotiation

prepara-Once prime contract negotiations have commenced it may be decided to produce

a version of the register to table with the client as a basis for structured sions on risk allocation

discus-As well as providing the essential function of recording all the identified caveatsthe greatest purpose of the register is to keep each caveat ‘open’ until somethingpositive has been done to resolve it In principle there are only seven possibleresolutions:

1 OBE – Overtaken by Events because…

2 Risk carried by client – expressly by prime contract clause…

3 Risk carried by client – impliedly because…

4 Risk carried by prime contractor – expressly by prime contract clause…

5 Risk carried by prime contractor – impliedly because…

6 Prime contractor risk but covered by insurance – see policy clause …

7 Prime contractor risk but conveyed to third party – see subcontractclause…

In particular categories 4 and 5 force the prime contractor to keep in mind pricing for risk Categories 6 and 7 force the person negotiating the prime contract to

be mindful of and interactive with other business functions such as insurancemanagement and purchasing

is no requirement either for signatures or for the prime contract to be in writing.However, written, signed contracts serve to eliminate the risk of uncertainty both

as to the intent of the parties to make their prime contract and as to the detail

if later a question of understanding or interpretation were to arise

Both parties will want their prime contract to be effective and there are fourmain risks to achieving this:

• Improper Formation

• Uncertainty

• Mistake

• Frustration

To be properly formed a contract must satisfy the legal requirements of valuableconsideration; offer and acceptance; mutual intent to create legal relations;capacity of the parties to make contracts; legality and possibility In businesscontracts the only one of these that usually gives a problem is offer and accept-ance Although Lord Denning made attempts to soften the rule, the law stilldemands a clear offer met with an unequivocal acceptance for a contract to havebeen formed The Battle of the Forms1is one example where a complete offerand acceptance can be difficult to determine Another area of difficulty is whereone side ‘accepts’ the other’s offer ‘subject to the following’ This strictly speaking

is a counter offer and no contract is created (unless the counter offer is met with

an unequivocal acceptance) and yet the parties proceed as though there were

a contract Indeed if the ‘contract’ is eventually performed (seller delivers andbuyer pays) then a contract will indeed have existed and if there is then a dispute

it would, in the ultimate, be for the courts to deduce the applicable terms This

is not a satisfactory situation If the uncertainty is to be avoided the parties muststrive at the outset to ensure that there is an entire agreement reflecting a genuineoffer and acceptance

Another facet of offer and acceptance is the method of acceptance The generalrule is that acceptance must be communicated, but with the exception of accept-ance under the postal rule, which allows acceptance to have occurred when acommunication of acceptance is put into the post, whether or not the other sideever actually receives the communication Even today cases come before thecourts on the question of the postal rule To avoid this problem the offering partyshould include in his offer an explicit, written statement that a contract has only

come into being upon his receiving a written, unequivocal acceptance from the

other side

The word uncertainty has already been used here in the sense of an entire standing as to terms not being achieved As has been mentioned this would notnecessarily affect the existence of the contract A court would have to imply

under-‘missing’ terms or to arbitrate between conflicting terms, but only in so far asthe original intent of the parties can be deduced by the court However, if theuncertainty is so great that a court cannot find any evidence of a common under-standing then the entire ‘contract’ can be made void for uncertainty To avoidthis risk the parties should go to great lengths to ensure that the agreement isnot only complete but also clear and unambiguous

1 Where the parties proceed with the ‘contract’ without achieving a clear instant of unequivocal acceptance but ‘exchange blows’ in passing paperwork – quotation, purchase order, delivery note etc – in which seller and buyer each in turn refers to its own standard conditions

The final possible risks to the effectiveness of the contract are mistake and tion In both cases a court could set the contract aside A mistake in this sense

frustra-is something fundamental (such as the exfrustra-istence of the goods) in which the partieswere in error at the time the contract was made A frustrating event is an occur-rence (such as the destruction of unique goods) which happens after the contractwas made which so fundamentally alters the position as to have been entirelyoutside the imagination of the parties when the contract was made Fulsomediscussion, checking, examination prior to contract should remove the risk ofmistake Frustration is theoretically a risk which is impossible to prevent sincethe intervention of something completely unforeseeable can not be dealt with

in advance However, in business contracts virtually all risks can be foreseenand dealt with in the contract and a contract voided on the grounds of frustra-tion is a rare event Incidentally the law does not recognise that a contract can

be set aside for mistake or frustration because one side made a bad bargain Ifthe buyer mistakenly orders the wrong thing that is just hard luck for him Ifthe seller finds that he cannot complete the contract within his budget that isjust hard luck for him

These things are all important in avoiding these risks to properly form a contractwhich is complete and certain And yet in the dynamics of the real business world

a buyer may issue a Letter of Intent (LOI) or an Instruction to Proceed (ITP).Although an LOI may increase the confidence of the seller that the buyer is going

to proceed, the seller nevertheless goes ahead at his own risk if he starts worksolely on the basis of an LOI An ITP can be more useful if it is so drafted to be

an offer of contract albeit that it conveys only the key terms such as a summary

of the work, timeframe for performance, price (or method by which price will

be agreed) and payment If the ITP is capable of acceptance then acceptancewill constitute a contract although there is then a risk that the parties will neverconclude complete terms Certainly the risk to the buyer is that once the seller

is working against an accepted ITP there is little incentive for the seller to agreeunfavourable terms which the buyer later seeks to introduce, especially sinceITPs tend to be used in cases of urgency leaving the balance of bargaining advan-tage with the seller

The last point to note is that a contract need not be effective upon signature

It is permissible to include a condition precedent, the non-satisfaction of whichwould cause the contract to fail to come into existence The most commonexample is a condition which requires that the seller shall have received thebuyer’s advance payment before the contract shall come into effect To startwork prior to the satisfaction of a condition precedent is to proceed at the risk

of loss of the cost incurred and the effort deployed being wasted if the tion is not then satisfied