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Time for network contracts to evolve

3 February 2010

Ofwat has published its final price determination, and to no-one's surprise it is calling for improved standards of service and an overall reduction in charges.
At the same time, most water companies are re-bidding their capital projects contracts together with their network maintenance contracts. How many companies have ensured that Ofwat's expectations for AMP5 are reflected in their network contract objectives?
Most network contracts operate on a schedule of rates basis. This is fine for enabling procurement to prepare a document for pricing work, but how can operations order a particular job from a schedule of rates when, with the failed asset underground, they don't know what work is required?
Operations finds it difficult enough to achieve budgetary targets, particularly with demands for increased levels of service. The "last quarter" syndrome, where operational budget overspend leads to a moratorium on contracted work in the last three months of the financial year, is commonplace in many water companies.
There has to be a better way: a contract structure that facilitates year-on-year cost efficiencies while rewarding the contractor for continually improving standards of service. The contract structure must focus on resources (which can account for as much as 70 per cent of overall contract costs) and productivity. It must also cover capital maintenance and risk allocation, as well as regulatory targets.
Return needs to follow risk: the more risk the contractor carries, the greater the return to which he is entitled. Most importantly, this return must far outweigh the profit to be made from merely achieving target cost. However, not all risk can be passed out to the contractor, especially where large, unexpected failures occur. These events must be clearly defined and quantified, with financial compensation provided to adjust the contractor's financial target.
It is imperative that financial rewards go hand in hand with achievement of performance targets. These targets should be made up of a combination of input measures through a Service Level Agreement, and output measures linked to regulatory objectives. Achievement of performance targets must be met in full before any reward mechanism is triggered. There is little point in financial benefits being delivered at the expense of operational performance.
The contractor must be capable of controlling the performance measures, and where others adversely influence a performance measure, the contractor must be compensated. Targets must be achievable and, in the case of regulatory measures, must be adjusted if necessary to reflect the impact of others working on the network outside the control of the contractor.
The use of NEC contracts for capital projects over the past 15 years has led to major change in the management of capital projects in the utilities. NEC has recently developed a Term Service Contract (TSC), which has been applied in the maintenance environment. One water company has adopted a TSC on its water supply and sewerage networks and it has led to dramatic improvements in productivity, costs and regulatory performance.
Contracts of this nature require a contract manager to work closely with the operational budget holders and the contractor. The contract manager's role is to ensure effective management of the risk register, approval of compensation against defined criteria and provision of relevant contract performance data at all levels for both the water firm and the contractor.
Companies and contractors must implement a common meeting framework, from depot through to executive level. These meetings need to move away from griping about problems and focus instead on performance improvement. The benefits cannot be overstated: year-on-year cost savings combined with significant improvements in the achievement of regulatory targets.
It is time procurement and operations sat down together and restructured their network contracts. Efficiency can be achieved only through better planning, overhead reduction, and a "right first time" approach to problem solving. This is the only way that water companies can hope to meet the challenges of AMP5.
Mike Levery, MCL Consultancy
Source: Disconnector

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