1. © HighGrade 2009 Reprinted from HighGrade April 6 - 12, 2009 www.highgrade.net
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C O N T R A C T I N G W W W . H I G H G R A D E . N E T
The contracting conundrum
David Noort*, 6 April 2009
MINE owners have been vacillating over the owner mining
versus contracting decision since the emergence of contract
mining as a strategy alternative in the 1970s. The pendulum
used to oscillate regularly. Despite this, the Australian mining
industry developed into a force to be reckoned with
internationally. Now the pendulum seems stuck in middle
ground, the clock of progress has stopped and the contracting
industry is running out of time.
The clock seems to have stopped with the advent of ‘alliancing’.
In the 80s and 90s traditional mining contracts (in my opinion)
offered the low cost solution. The traditional contracting model
forces mining companies to measure and mitigate or allocate
project risks to the party best placed to control these risks, over
the predetermined contract term. (Parallel this with SMART directives - specific, measurable,
actionable, relevant and time bound).
The introduction of the alliancing model in the mining industry in the 90s caused much
excitement. It was designed as a model of last resort to allow parties in ultra complex and
high risk environments to mitigate risks cooperatively and share the impact of risks/
opportunities equally under an ‘all for one, one for all’ approach. No longer did mining
companies have to undergo the long and expensive upfront process of measuring, controlling
and allocating risks and suffer the inevitable arguments over standby, dayworks or variation
claims when they got it wrong. Just form an alliance and ‘Bob’s your uncle’, no hassles.
However, this initial exuberance is morphing into frustration and suspicion with many clients I
deal with openly blaming alliance contract strategies for the cost inflation the industry has
seen in the past five years. Contractors on the other hand continue to promote alliances
because such contracts are low risk for them.
Partly to blame is the lack of understanding as to the extent of input cost growth and
performance decline that has been happening across the board. Since 2002, total movement
unit costs in the openpit gold mining sector in Australia grew 16% annually as compared to
7% in Africa, 9% for South America and 11% for North America. Undersupply of skilled labour
in Australia is no doubt a contributing factor, but if you start compounding 16% cost growth,
you also quickly start to understand the magnitude of the problem.
I believe the mine owners are right. There is a fundamental problem in the industry but they
are partly to blame. The problem is twofold:
• Few in the mining industry know what an alliance is and how hard it is to do well.
• There exists a broadly held misconception that alliances will neutralise the effects of
an inability to plan.

2. © HighGrade 2009 Reprinted from HighGrade April 6 - 12, 2009 www.highgrade.net
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The reality is that there is no such thing as low-cost mining in an environment of high risk.
Applying a traditional contract when you are not sure what you are doing or where you are
going will surely result in a contractor having a field day with its scope variation clauses.
However, the harsh reality is that if a project has not been measured to the extent that you
can plan effectively, there is no contracting model panacea, only a bitter pill to swallow.
Suffice to say I do not know of one mining company that has delivered a mining project under
the banner of alliance which remotely reflects the form of contract delivery that emerged from
the construction industry under that name. The misuse of alliancing and relaxed application of
the term (let’s face it, it sounds good) has resulted in the model becoming much maligned. In
reality, alliances in the mining industry are generally watered down forms of cost
reimbursable, performance incentive (CRPI) contracts or the nemesis of the industry – cost-
plus contracts.
The litmus test for an alliance is the equal pain-gain sharing philosophy. (To avoid doubt,
‘equal’ means that for a dollar of overrun, the contractor should pay 50c and the client 50c,
and vice versa for underrun).
The problem is that in a mining operation, you are not building a skyscraper or bridge where
quantities can be preset down to the teaspoonth and therefore a cost over/underrun has to be
attributable to either variation of efficiencies or risk/opportunities realised. The significant
changes to quantities in mining makes it very difficult to map back a dollar in cost overrun to
the changes in building blocks of activities and efficiencies that caused it.
If mining companies could measure their activities at the level required (generally they can’t),
tools such as cost driver trees can be used to map the effect of changes in quantities on target
cost estimates (budgets). You can also use these trees to replace the budget benchmark with
other forms of benchmarking to ensure you measure the efficiency of your contractor over
time against industry trends, but this is problematic as no two mines are the same. Besides,
that is why mining clients often use contractors - so they can set their activity costs
competitively and not have to maintain systems and monitor performance at a level other
than “did you give me the tonnes and grade in the schedule?”.
The project risks are generally so high and margins so thin in mining contracting that
contractors will never accept being held accountable for costs such as additional capital
development to access an orebody which is not where it was thought to be. And clients would
never agree to pay the margins that reflect the magnitude of that risk.
Therefore, to cope with this issue mining companies casually discard the target cost estimate
benchmark and equal pain-gain sharing principle. However, in doing so they have also
discarded any hope of delivering their project cost effectively. Above all, you will always need
an effective upfront process to measure and control risks and a system to be able to measure
performance and reward your people/ contractors for what they can control, holding them
accountable for performance commitments they make. And that applies for an alliance,
traditional contract or owner mining, only how you do it changes.
At a macro level, the alliancing model forces contractors to becoming more client-like,
forsaking their focus on preventing cost “creep”, their key source of competitive advantage.
Mining companies naively expect that because they use contractors they don’t have to
measure the drivers of their performance. But, the reality here is that when you are paying for
inefficiency, if you don’t or can’t measure drivers of performance you will pay the
consequences dearly. Because what you don’t measure you can’t control.
*David Noort is a director of Momentum Partners, an Australia wide management
consulting firm founded in Western Australia.