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PROCUREMENT STRATEGY IN
MAJOR INFRASTRUCTURE:
The AS-IS and STEPS
17th May 2023
Dejan Makovšek, PhD
Infrastructure and Public Procurement Division
Public Governance Directorate
With an expert opinion by Andrea Chao LLM
Partner & Lawyer at Bird & Bird LLP
(Amsterdam)
How procurement strategy choices matter for project
outcomes
2
Blanc-Brude & Makovsek (2013):
• Analysed a bank’s database of project finance deals – 75 mega
projects.
• Observed median construction risk is zero, average is 2%. 54/75
projects were exactly on budget.
0
10
20
30
40
50
60
70
-55 -50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50
Observations
Observed cost overruns
Example I: On-budget performance for major EPC
(lump-sum) infra contracts
4
Bolotny & Wasserman (2022):
• 44o small bridge projects empirically analyzed in a structural mathematical
model.
• The result (42% price hike) is the net outcome conceals two effects:
– I) bidders include an increased contingency [the effect increases cost];
– II) less efficient bidders get excluded
Example II: From DBB to lump sum contracts in small
projects
DBB (schedule of rates)
DBB (Lump-sum)
Total cost
Cost overrun
Cost at contract signature
+42%
A few contemplations:
5
Relevant should not be the price mentioned in the contract,
but the price eventually paid:
• A price that is too low may help getting the project
kickstarted internally
• But such price also creates a fundamental flaw in a
project: lack of profit that needs to be recouped – through
whichever means necessary
A few contemplations:
6
When looking at the price eventually paid, also look at:
• Internal costs/shift in focus
• Legal costs
• Social costs (incl. people leaving the sector)
… And your social obligations
A few contemplations:
7
What happens when allocating high level of risk at the market
side, esp. combined with award criteria focussed on lowest
price?
• Bid price increases to deal with this risk allocation
• Considered too risky: no bid
• Hoping for the best: going in eyes closed
What scenario would you prefer?
How do countries make choices about the procurement
strategy?
8
Context - The last thirty years…
• Lean public sector policy lead to reduced
capabilities (e.g. elimination of inhouse design
department at RWS in NL)
• Reduced capabilities => inability to manage
interfaces between contracts.
• Large projects => large contracts
• Large contracts + total risk transfer => low/no
competition.
9
Policymaker’s narrative:
• Complex project suffer cost
overruns – transfer more risk
• DB/EPC contracts transfer
too much risk
• De-risking needed to keep
procuring big contracts
Delivery model assignment for public works projects
and programmes – the global best practice
10
Frame the challenge
What are my objectives
What is the strategy of
my org
Identify … potential delivery models
Control offered?
Innovation potential?
Do I have capability to manage?
Will the market accept?
Who is best placed to manage risk?
Decide packaging
Into how many contracts should my
project be split
Engage the market
Will the market accept our
procurement strategy
Iterate if not digestible
The problems of the existing “state-of-the-art”
• A top-down approach in which defining the objectives/constraints directly identifies
the best delivery model. A self-contained process, which requires no external
evidence.
• The client’s capabilities are taken as a given and not informed by the nature of the
project.
• The packaging decision is made after the delivery model has been selected => one-
size-fits-all risk allocation. Again ignoring the nature of the project.
• The entire sequence of analysis/decision-making process is not grounded in any
empirically tested theory.
11
A few contemplations:
12
Money talks
… but:
- choices have consequences
- all tasks need to be done by someone, and nothing comes
for free
A few contemplations:
13
Quick
Good Cheap
Pick any 2
The approach the OECD is piloting
STEPS - Support Tool for Effective Procurement
Strategy®
14
The value proposition of STEPS
• Based on scientific insights (being “evidence-based” is not
sufficient), i.e. does not legitimize preconceived ideas
• Identifies the right unit of analysis/granularity
• Helps inform structure/capabilities of the client org
• Leads to less costly infra, without loss in innovation or
increase in conflict, compared to existing approaches
15
Breaking down a project into STEPS activities
• STEPS activity =
– economic activity (not detailed technical task)
– technologically bounded (skillsets)
– highest level of firm specialization
16
A B E
R
Market
(suppliers for
activity a, b, …)
A A A A A
B B B B B B
…
E E
R R
1 2 3 4 5 6
…
…
…
Example: Commercial implications of contract
packaging?
17
An activity with
many suppliers
An activity with one
(few) suppliers
Bidder
consortium 1
Bidder
consortium 2
Commercial implications of bargaining power shift
(hold-up)?
18
An activity with no
hold-up
An activity with
hold-up
Why do we assume that major projects are
homogenous in terms of risk and uncertainty?
19
Procurement strategy solution for project X
20
DBB with schedule of rates
A collaborative delivery
model
DB contract
Persistent post-contract
uncertainties causing
hold-up risk
Competition failure risk
Hold-up risk
Procurement failures
21
Contract
signature
Pre-contract failures
• Competition failure
(Too few bidders)
• Hold-up
• Inadequate risk allocation
(e.g. one size fits all
commercial arrangement)
Post-contract failures
A few contemplations:
22
Hold up - during the tender (or even before)
- Level of competition available?
- Further limiting competition by:
- Work packages – too large
- Tender requirements – too many, too harsh
- Risk allocation – too harsh
A few contemplations:
23
Hold up after the tender
- A construction project is a moving train
- Stopping takes a long time
- Getting of while moving is dangerous
- Restarting takes a long time
- Once the project has started, there is a shift in balance
A few contemplations:
24
Risk of hold up for future projects is influenced by decisions
made on a current project
- Promoting new market parties to arise?
- Sticking to the usual suspects?
- One project approach, or framework approach?
What are your tender requirements driving?
25
The end result of a complete procurement strategy
Bidder selection
Incentive power
(competition vs
collaboration)
(scientific& enshrined in legislation)
(scientific)
Steps in a procurement strategy How a decision is made
Contract scoping (scientific)
(scientific)
Make-or-buy
The delivery
model
Delivery
entity
(capabilities
organisation,
leadership,
…)
Iteration of
solutions
Repository of post contract
procurement failures from all
projects (the red dots)
Market structure -
capabilities data
(the red dots)
Towards a holistic risk management framework as
well as STEPS Digitalisation
Using AI to predict procurement
failures…
Category managers checking
supply chain
STEPS
(the commercial
implications)
Standard Initial
detailed risk analysis
(the tech. reasons)
Execution of
procurement
strategy
Other risk dimensions
(OECD/UCL/MBS)
Affecting risk and therefore
management strategy
26
Planning/
appraisal
and value
distribution
THANK YOU
DEJAN.MAKOVSEK@OECD.ORG
& GUEST COMMENTATOR
ANDREA.CHAO@TWOBIRDS.COM
27
Where does procurement strategy fit when compared
to standard project risk management?
28
Risk identification
…technical failures, third
party interfaces, permit
issues…
Risk mitigation
…build contingency for
technical failure, get
permit…
Commercial/contracting
implications
…opportunism of suppliers
in contracts, changes in
their bargaining power…
STEPS
Steps and main cognitive lenses behind the STEPS
(Support Tool for Effective Procurement Strategies)
29
Theory applied to issue/decision in step
in Tool
Theory Leading scholar examples
Step 1.
Project activity break-down
Division of Labour/ Specialisation Adam Smith
Transaction Costs Economics Oliver Williamson (Nobel Prize 2009)
Step 2.
Project Specific-or-Network Analysis
Economics of Scale Adam Smith
Step 3.
Activity analysis
Uses theories listed under steps 4-6 to inform the economic characteristics of activities, making the
analysis in those steps possible
Step 4.
What Capabilities do I need in-house
(Make-or-Buy Analysis)
Transaction Costs Economics Oliver Williamson (Nobel Prize 2009)
Transaction Costs Economics Ronald Coase (Nobel Prize 1991)
Resource-Based Theory (competence and capabilities) Jay Barney
Step 5.
Into how many contracts should I package
(Activity bundling analysis)
Economies of Scope John Panzar and Robert Willig
Transaction Costs Economics Oliver Williamson (Nobel Prize 2009)
Resource-Based Theory (competence and capabilities) Jay Barney
Step 6.
Competition or collaboration? What payment
mechanism?
(Exchange Relationship Analysis)
Transaction Costs Economics Oliver Williamson (Nobel Prize 2009)
Principal-Agent Theory (contract theory)
Oliver Hart & Bengt Holmström (Nobel Prize
2016), Michael C. Jensen & William Meckling
Resource-Based Theory (competence and capabilities) Jay Barney
Example III: Similar result in major contracts (EIB
Motorways)
30
• Construction risk: risk premium in 57 DB/EPC (in a PPP) road
contracts ~20% above ex-post risk in 101 DBB contracts (LCC does
not explain diff.); based on Blanc-Brude et al 2009.
DBB
Public-Private Partnership (DB/OM)
Total cost
Cost overrun
Cost at contract signature
24%
Source: Makovšek & Moszoro 2018.
What the existing approach boils down to…
• The procurement strategy is a methodology to legitimise
preconceived ideas about project objectives.
• It is not a method that would inform trade-offs, possibly
leading to an adjustment of the project objectives or the
approach how to achieve them.
• The result can be a bias towards larger contracts, one-size-
fits-all risk allocation ... and much more expensive infra.
31
Take this slide out and just deliver orally? –
Question Bjorn can ask

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Procurement strategy in major infrastructure: The AS-IS and STEPS - D. Makovšek, OECD Public Governance Directorate

  • 1. PROCUREMENT STRATEGY IN MAJOR INFRASTRUCTURE: The AS-IS and STEPS 17th May 2023 Dejan Makovšek, PhD Infrastructure and Public Procurement Division Public Governance Directorate With an expert opinion by Andrea Chao LLM Partner & Lawyer at Bird & Bird LLP (Amsterdam)
  • 2. How procurement strategy choices matter for project outcomes 2
  • 3. Blanc-Brude & Makovsek (2013): • Analysed a bank’s database of project finance deals – 75 mega projects. • Observed median construction risk is zero, average is 2%. 54/75 projects were exactly on budget. 0 10 20 30 40 50 60 70 -55 -50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 Observations Observed cost overruns Example I: On-budget performance for major EPC (lump-sum) infra contracts
  • 4. 4 Bolotny & Wasserman (2022): • 44o small bridge projects empirically analyzed in a structural mathematical model. • The result (42% price hike) is the net outcome conceals two effects: – I) bidders include an increased contingency [the effect increases cost]; – II) less efficient bidders get excluded Example II: From DBB to lump sum contracts in small projects DBB (schedule of rates) DBB (Lump-sum) Total cost Cost overrun Cost at contract signature +42%
  • 5. A few contemplations: 5 Relevant should not be the price mentioned in the contract, but the price eventually paid: • A price that is too low may help getting the project kickstarted internally • But such price also creates a fundamental flaw in a project: lack of profit that needs to be recouped – through whichever means necessary
  • 6. A few contemplations: 6 When looking at the price eventually paid, also look at: • Internal costs/shift in focus • Legal costs • Social costs (incl. people leaving the sector) … And your social obligations
  • 7. A few contemplations: 7 What happens when allocating high level of risk at the market side, esp. combined with award criteria focussed on lowest price? • Bid price increases to deal with this risk allocation • Considered too risky: no bid • Hoping for the best: going in eyes closed What scenario would you prefer?
  • 8. How do countries make choices about the procurement strategy? 8
  • 9. Context - The last thirty years… • Lean public sector policy lead to reduced capabilities (e.g. elimination of inhouse design department at RWS in NL) • Reduced capabilities => inability to manage interfaces between contracts. • Large projects => large contracts • Large contracts + total risk transfer => low/no competition. 9 Policymaker’s narrative: • Complex project suffer cost overruns – transfer more risk • DB/EPC contracts transfer too much risk • De-risking needed to keep procuring big contracts
  • 10. Delivery model assignment for public works projects and programmes – the global best practice 10 Frame the challenge What are my objectives What is the strategy of my org Identify … potential delivery models Control offered? Innovation potential? Do I have capability to manage? Will the market accept? Who is best placed to manage risk? Decide packaging Into how many contracts should my project be split Engage the market Will the market accept our procurement strategy Iterate if not digestible
  • 11. The problems of the existing “state-of-the-art” • A top-down approach in which defining the objectives/constraints directly identifies the best delivery model. A self-contained process, which requires no external evidence. • The client’s capabilities are taken as a given and not informed by the nature of the project. • The packaging decision is made after the delivery model has been selected => one- size-fits-all risk allocation. Again ignoring the nature of the project. • The entire sequence of analysis/decision-making process is not grounded in any empirically tested theory. 11
  • 12. A few contemplations: 12 Money talks … but: - choices have consequences - all tasks need to be done by someone, and nothing comes for free
  • 14. The approach the OECD is piloting STEPS - Support Tool for Effective Procurement Strategy® 14
  • 15. The value proposition of STEPS • Based on scientific insights (being “evidence-based” is not sufficient), i.e. does not legitimize preconceived ideas • Identifies the right unit of analysis/granularity • Helps inform structure/capabilities of the client org • Leads to less costly infra, without loss in innovation or increase in conflict, compared to existing approaches 15
  • 16. Breaking down a project into STEPS activities • STEPS activity = – economic activity (not detailed technical task) – technologically bounded (skillsets) – highest level of firm specialization 16 A B E R Market (suppliers for activity a, b, …) A A A A A B B B B B B … E E R R 1 2 3 4 5 6 … … …
  • 17. Example: Commercial implications of contract packaging? 17 An activity with many suppliers An activity with one (few) suppliers Bidder consortium 1 Bidder consortium 2
  • 18. Commercial implications of bargaining power shift (hold-up)? 18 An activity with no hold-up An activity with hold-up
  • 19. Why do we assume that major projects are homogenous in terms of risk and uncertainty? 19
  • 20. Procurement strategy solution for project X 20 DBB with schedule of rates A collaborative delivery model DB contract Persistent post-contract uncertainties causing hold-up risk Competition failure risk Hold-up risk
  • 21. Procurement failures 21 Contract signature Pre-contract failures • Competition failure (Too few bidders) • Hold-up • Inadequate risk allocation (e.g. one size fits all commercial arrangement) Post-contract failures
  • 22. A few contemplations: 22 Hold up - during the tender (or even before) - Level of competition available? - Further limiting competition by: - Work packages – too large - Tender requirements – too many, too harsh - Risk allocation – too harsh
  • 23. A few contemplations: 23 Hold up after the tender - A construction project is a moving train - Stopping takes a long time - Getting of while moving is dangerous - Restarting takes a long time - Once the project has started, there is a shift in balance
  • 24. A few contemplations: 24 Risk of hold up for future projects is influenced by decisions made on a current project - Promoting new market parties to arise? - Sticking to the usual suspects? - One project approach, or framework approach? What are your tender requirements driving?
  • 25. 25 The end result of a complete procurement strategy Bidder selection Incentive power (competition vs collaboration) (scientific& enshrined in legislation) (scientific) Steps in a procurement strategy How a decision is made Contract scoping (scientific) (scientific) Make-or-buy The delivery model
  • 26. Delivery entity (capabilities organisation, leadership, …) Iteration of solutions Repository of post contract procurement failures from all projects (the red dots) Market structure - capabilities data (the red dots) Towards a holistic risk management framework as well as STEPS Digitalisation Using AI to predict procurement failures… Category managers checking supply chain STEPS (the commercial implications) Standard Initial detailed risk analysis (the tech. reasons) Execution of procurement strategy Other risk dimensions (OECD/UCL/MBS) Affecting risk and therefore management strategy 26 Planning/ appraisal and value distribution
  • 27. THANK YOU DEJAN.MAKOVSEK@OECD.ORG & GUEST COMMENTATOR ANDREA.CHAO@TWOBIRDS.COM 27
  • 28. Where does procurement strategy fit when compared to standard project risk management? 28 Risk identification …technical failures, third party interfaces, permit issues… Risk mitigation …build contingency for technical failure, get permit… Commercial/contracting implications …opportunism of suppliers in contracts, changes in their bargaining power… STEPS
  • 29. Steps and main cognitive lenses behind the STEPS (Support Tool for Effective Procurement Strategies) 29 Theory applied to issue/decision in step in Tool Theory Leading scholar examples Step 1. Project activity break-down Division of Labour/ Specialisation Adam Smith Transaction Costs Economics Oliver Williamson (Nobel Prize 2009) Step 2. Project Specific-or-Network Analysis Economics of Scale Adam Smith Step 3. Activity analysis Uses theories listed under steps 4-6 to inform the economic characteristics of activities, making the analysis in those steps possible Step 4. What Capabilities do I need in-house (Make-or-Buy Analysis) Transaction Costs Economics Oliver Williamson (Nobel Prize 2009) Transaction Costs Economics Ronald Coase (Nobel Prize 1991) Resource-Based Theory (competence and capabilities) Jay Barney Step 5. Into how many contracts should I package (Activity bundling analysis) Economies of Scope John Panzar and Robert Willig Transaction Costs Economics Oliver Williamson (Nobel Prize 2009) Resource-Based Theory (competence and capabilities) Jay Barney Step 6. Competition or collaboration? What payment mechanism? (Exchange Relationship Analysis) Transaction Costs Economics Oliver Williamson (Nobel Prize 2009) Principal-Agent Theory (contract theory) Oliver Hart & Bengt Holmström (Nobel Prize 2016), Michael C. Jensen & William Meckling Resource-Based Theory (competence and capabilities) Jay Barney
  • 30. Example III: Similar result in major contracts (EIB Motorways) 30 • Construction risk: risk premium in 57 DB/EPC (in a PPP) road contracts ~20% above ex-post risk in 101 DBB contracts (LCC does not explain diff.); based on Blanc-Brude et al 2009. DBB Public-Private Partnership (DB/OM) Total cost Cost overrun Cost at contract signature 24% Source: Makovšek & Moszoro 2018.
  • 31. What the existing approach boils down to… • The procurement strategy is a methodology to legitimise preconceived ideas about project objectives. • It is not a method that would inform trade-offs, possibly leading to an adjustment of the project objectives or the approach how to achieve them. • The result can be a bias towards larger contracts, one-size- fits-all risk allocation ... and much more expensive infra. 31 Take this slide out and just deliver orally? – Question Bjorn can ask