Alliance Contracts

in Australia

Brain Noble

Director Operational Asset Management

Main Roads Western Australia

4th November 2010

Alliance Contracts in Australia

• Australia’s first Alliance was in the oil industry in mid

1990’s.

• First used in the water industry during late 1990’s.

• First road construction alliance is 2000.

• Main Roads Western Australia first Alliance in 2003.

• Main Roads has awarded 8 Construction Alliances

and varied two maintenance contracts into Alliances.

• Our future road maintenance/management strategy

is based upon this type of contracting.

Alliances were developed from a strained

Contracting Environment

Project Alliance Definition

A Project Alliance is where an owner and one or

more service providers (designer, constructor,

supplier) work as an integrated team to deliver a

specific project under a contractual framework

where their commercial interests are aligned to the

actual project outcomes.

In an Alliance, the Parties:

─ Assume collective responsibility.

─ Take collective ownership of all risks.

─ Share in the “pain” or “gain”.

Alliance Contracting is Not Partnering

Partnering can be considered a “Band-aid” solution -

it does not address the contract issues:

• Partnering partners tell each other that they will

act reasonably and fairly.

• But when things go wrong, they often regress to

traditional litigious ways.

• Project Alliance partners work together because

compensation (financial success) is tied to overall

success of project outcomes.

• While Partnering can be effective in getting

people to work together in difficult situations, it

does not address the actual issues (i.e.

uncertainty, complexity of the work) that are

making the situation difficult in the first place.

Alliance Contract Principles

• All parties either win or all parties lose.

• Equitable sharing of risk and reward.

• All parties have an equal say.

• All decisions must be “best-for-project”.

• No-blame culture.

• No recourse to litigation.

• All commercial transactions are fully open-

book.

• Encouragement of innovative thinking with a

commitment to achieve outstanding outcomes.

• Open and honest communication (no hidden

agendas).

• Visible and unconditional support from top

management levels of each party.

• Governed by joint body (Alliance Leadership

Team) where decisions must be unanimous.

• Day-to-day management by seamless

integrated project team (“Best for Project”).

• Resolve issues within the Alliance with no

recourse to litigation.

Payment

Uses 3 part approach.

Part 1: Actual project costs.

Part 2: Margin (profit + corporate overhead).

Part 3: Margin Incentivisation (Gain/pain sharing).

What are the Benefits?

• Creates an environment that drives high

performance.

• Achieves commercial objectives of all parties.

• Joint responsibility for managing risk.

• Realistic target price.

• Synergy driven outcomes.

• High performance and innovation.

• Helps build capability of all parties.

Risk Sharing vs Risk Transfer

• Traditional approach to contracting.

─ Transfer as much risk as possible.

─ Can be successful for non complex, certain,

well defined projects.

• When a traditional approach may not be most

suitable option.

─ Complex, unpredictable risks.

─ Tight timeframes.

─ Not well defined details.

─ High likelihood of scope changes.

─ Complex interfaces.

─ Difficult stakeholder issues.

─ Complex external threats.

• When faced with these factors, project

outcomes are more likely to be achieved with

collective responsibility.

Typical Alliance Structure

Alliance Leadership Team

Alliance Management Team

– Headed by Alliance Manager

Project Team

Alliance Leadership Team Responsibilities

Alliance Leadership Team

• Create an inspiring vision

• Establish principles & set challenging objectives

• Approve performance targets

• Set policy & delegations

• Approve Alliance Management Plan

• Appoint the Alliance Management Team members

• Champion the vision, principles & objectives

• High level support / stakeholder interface

• Harness best resources

• Monitor team performance

• Resolve conflict within the Alliance Leadership Team

Alliance Management Team

Responsibilities

Alliance Management Team

•Deliver outcomes to meet / exceed objectives

•Appoint / empower wider team

•Day to day management of the project

•Provide effective leadership to the wider team

•Measure / forecast / report performance to AB

•Take appropriate corrective action

Procurement stages for an Alliance

Contract

3 phase process

1. Selection of Partners.

2. Interim Alliance.

3. Full Alliance.

Selectionof PreferredProponent

CommercialDiscussions

Are Key

Issues

Agreed?

Interim Alliance Period

IsThe Target Outturn

CostAgreed?

Walk Away

Alliance Agreement

Yes

No

Yes

No

Selection Interim Full Alliance

All parties have the right towalk away up to this point

Only owner has the right to terminateFor convenience from this point

1ST Phase

Selection of partner(s)

The most important step for the owner to

achieve a successful Alliance is to choose the

right partner.

Selection Criteria

Non Cost

• Technical, financial, and management capacity.

• Understanding of and commitment to the Alliance

way of doing business.

• Preliminary ideas on innovations and execution

strategies plus the potential to deliver outstanding

design and construction outcomes.

• Willingness to commit to the project objectives and

pursue “breakthrough” outcomes.

• Ability to work with the owner’s personnel in a high-

performance team.

Selection

Commercial (Cost) Considerations

• Agree on the primary commercial

arrangements.

• Ensure that no fundamental “roadblocks” are

left to emerge during Interim Alliance phase.

• Audit the financial records and costing

structures of the prospective non-owner

participants to assist in agreeing the “Margin”

(corporate overhead & profit).

Selection

• Corporate overhead can usually be easily

established based on the audit.

• Profit can be harder to determine. It should take

into account:

─ Actual past profit.

─ Current corporate expectations and actual trend.

─ Difference between the audited project figures

and the prospective Alliance project – such as

risk profiles, nature of work, etc.

Selection

2ND Phase

Interim Alliance Agreement

• Develop Target Outturn Cost (TOC) and Time

Schedule.

• Value management / value engineering.

• Risk & opportunity workshops.

• Planning & design.

• Systems and procedures development.

• Alliance team development.

Interim ISA Payment

• Non Owner Participant’s (NOP)

reimbursement is usually limited to actual

costs.

• If the parties enter into Alliance Agreement,

the NOPs receive a margin on Interim Alliance

Phase work.

• If the parties don’t enter a Alliance Agreement,

then payment of the margin to NOPs is based

on reasons they didn’t enter into the

Agreement.

Interim

Target Outturn Cost (TOC)

• Jointly developed during the Interim Alliance by the

parties.

• First real test of the new Alliance.

• TOC is the key to the payment model:

─ Used to determine the gain/pain portion payable to

each non-owner participant.

─ Used as the target against which the actual cost

will be compared to determine the extent of under /

overrun that is to be shared amongst the Alliance

parties.

Interim

─ TOC is not an estimate of the full cost of the

project to the owner.

─ The TOC does not include any pain/gain

payments.

Interim

Apparent conflict between owner pushing for a

low TOC while the non-owner parties pushing

for a high TOC.

Several factors counteract this conflict:

• Transparency: TOC is developed jointly on a

full open book collaborative basis. Nothing

can be hidden.

• If TOC is too high, the project may not proceed

(not in the best interest of any party).

Interim

• If TOC can not be agreed, non-owner parties

may not receive any margin for Interim work

accomplished.

• Potential for damage to reputation and future

business relationships if owner feels non-

owner parties conspired to inflate the TOC.

Interim

3rd Phase

Alliance

Delivery of Services

Payment Structure

Full Alliance

Direct P

roject C

osts

Pro

ject-specific

overh

eads

Co

rp.

o’head

sP

rofit Part 2

(Margin)

Part 1(Costs)

Part 2 is at risk

under the Part 3

risk/reward

arrangements

Part 1 costs are guaranteed

irrespective of the

outcome of the Part 3

risk/reward arrangements

• Part 1: (Reimbursement of project costs)

Guiding principles:

• Each party is paid actual costs incurred on the

project, including costs associated with rework.

• Payment under part 1 must not include any

hidden corporate overheads or profit.

• All project transactions and costs are open book

and subject to audit.

NOP’s are guaranteed part 1 costs.

Full Alliance

• Part 2: (Margin = corporate overhead + agreed

profit).

─ Margin is set before entering into the Interim

Alliance Phase.

─ Generally a fixed lump sum as a % of TOC.

─ Margin is not subject to adjustment regardless of

the actual costs expended.

─ Margin is only adjusted in case of a Scope

Variation (usually very few under an Alliance).

Selection Interim Full Alliance

• Part 3: (Sharing of pain and gain)

─ Intended to ensure that the NOP’s assume an

equitable share of the gain / pain along with

the owner where the actual performance is

better / worse than agreed targets.

─ Guiding principles:

• gain / pain should be linked to outcomes that

add to (or detract from) the value to the owner.

Full Alliance

• All possible project outcomes must result in

win / win or lose / lose (i.e. everyone wins or

everyone loses together).

• Performance that is better than the agreed

targets lead to superior returns for NOP’s and

performance that is less than the agreed

targets leads to lower returns for NOPs.

Full Alliance

• Part 3: (Sharing of pain and gain)

Full Alliance

Ta

rget O

uttu

rn C

ost

Overrun

Underrun

50% 50%

Owner NOP’s50% 50%

Owner NOP’s

Managing “Change”

As a general principle, the parties collectively

assume all risks associated with the delivery of

the project, regardless of:

• Whether or not those risks are within the

control of the parties.

Full Alliance

• Whether or not they have considered them in

advance.

• Whether they could reasonably have been

foreseen or not.

Therefore, situations that would be treated as

“variations” under a traditional contract are not

variations under the Alliance – rather they are

just part of the delivery of the project.

Full Alliance

Issues / Downsides?

Potential Downsides:

• Perception of lack of certainty in cost outcome

for the owner.

• Requires significant involvement and

commitment of owner personnel and senior

management to support process.

• Requires significant cultural shift – away from

traditional adversarial approach to one of

integration, collaboration and high

performance teamwork.

• Substantial costs to establish the alliance and

develop and maintain the alliance culture.

• For government projects it raises probity

issues that need to be managed carefully.

• Parties need to waive legal rights that they

would normally pursue in the event that things

go wrong.

Reasons for Poor Outcomes

• Expecting benefits without investing effort.

• Selection of an inappropriate team.

• Not addressing value for money concerns.

• Under estimating the commitment required by

the parties’ senior representatives and

experienced staff.

• Parties may be tempted to make unilateral

decisions.

• Attempting to transfer risks to other parties.

• Relying upon legal recourse.

Characteristics of high performing alliances

• A single cohesive team without any “us and them”

attitudes.

• High performance culture amongst the team

characterized by:

─ Clear understanding of purpose/mission of Alliance.

─ Unequivocal commitment to meet or exceed

demanding objectives.

─ Willingness to commit to targets without knowing

how they can be achieved.

─ People who mean what they say, and do what they

say they will do.

─ Individuals who are willing to accept

responsibility for their actions.

─ Open and effective communication.

─ Successes are acknowledged and celebrated.

─ Very close collaboration between designers and

constructors – collaboration that never stops,

right up to final completion.

─ All energy focused on optimizing project

outcomes – no time at all wasted on position

protecting or case building.

─ Very fast “integrated” decision-making.

Benefits for Non-owner Parties

• Potential for good returns within acceptable

limits of risk.

• Enhancement of reputation leading to

increased prospects of repeat and referred

work.

• Strengthening of relationship with owner and

the other parties (forming the basis for

possible future Alliances).

• Greater insights into project delivery from an

owner perspective, enabling constructors and

designers to better understand and service

their clients.

• Increased job satisfaction for staff with

associated benefits to overall organizational

culture.

• Significant increase in communication and

general project management skills.

Key steps to insure success

• Owner must have a good understanding of the

principles underlying Alliancing and why it has

succeeded on other projects.

• Select the “right” partners using appropriate

criteria.

• Ensure that all key stakeholders are committed

to achieving or exceeding the project

objectives.

Outcomes of Alliance Contracts in

Australia

• RMIT University have studied 217 Australian

Alliance Contracts from 1996 to 2006.

Industry Number of Alliances

water 81

road 62

rail 27

oil, gas & energy 25

Defence, mining & ports 6 in each area

building 4

The number of Alliances in Australia

Time Number

1996 / 1997 5

1998 / 1999 11

2000/ 2001 14

2002 / 2003 28

2004 / 2005 35

2006 / 2007 87

20008/2009 37

Value and Number of Australian Alliances

(1996 – 2008)

Value $A millions Number

0 to 50 58

51 to 100 40

101 to 250 58

251 to 500 30

501 to 750 12

751 to 1000 7

1001 to 1500 2

1501 to 2000 7

2001 to 3000 + 3

30 Government Alliance Contracts

Final Costs Vs Target Outturn Costs;

─ 83% less than TOC,

─ range 1%-29% variance from TOC.

─ 17%greater than TOC,

─ range 3%-6% of TOC.

─ 37% under planned duration,

─ range 0.5 to 18 months.

─ 20% exceeded planned duration,

─ range 0.5 to 6 months.

i. Project Alliancing Practiticoner’s Guide

Victorian Department of Treasury and Finance

www.dtf.vic.gov.au/projectalliancing

ii. Project Alliancing Activities in Australasia 2008

Alliance Association of Australiasia

www.alliancingassociation.org

iii. Introduction to Project Alliancing

Presentation to Institution of Engineers, Australia

August 2000, Brisbane Australia

by Jim Ross.