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Wednesday, March 9, 2011

India struggles to find right balance for sharing risk and reward in highway project procurement

New bidding norms for highways on the anvil
Build Operate and Transfer (BOT) (annuity) is one among the two Public-Private Partnership (PPP) modes on which the National Highways Authority of India awards projects. The other is BOT (toll).

Unlike the BOT toll model where the private operator takes the risk of toll collection, the government mitigates the risk of toll income in the annuity model by guaranteeing six monthly payments over the concession period, which normally goes up to 18 years.

The existing Engineering, Procurement and Contract (EPC) model for road highway contracts is being upgraded, to replace the annuity model. In the existing EPC model, a contractor builds the road and all the changes in the design and the cost of input cost is paid by the government. The current model also does not mandate the contractor to maintain the road.

“The current EPC norms make the contractor liable for any defect in the road only for a year after the road is complete, called the defect liability period,” said a senior NHAI official, on condition of anonymity.

The new model, being prepared by the Planning Commission, would have fixed total project costs and specifications.

“The total cost of the EPC projects will be fixed but will be subject to change only if the design is changed at a later period. In this new model, the contractor will also be asked to maintain the road project for five years after which it will be handed over to the National Highways Authority of India (NHAI),” said a government official, who did not want to be identified.

Allocation of risks and rewards in construction work is more art than science, more gazing into crystal balls than predetermined algorithms, because the nature of such work is that many of the issues of construction cannot be known before the work begins. And once you allow a contract price to be changed due to change orders arising from latent issues, you open the door to open-ended cost rises.

To get it as right as possible, the government must have engineers and contract managers of a caliber at least as competent as the contractors, preferably more so. The original specifications must be as comprehensive as technically feasible, contemplating most of the "normal" situations that result in change orders with formulas for price adjustments which reimburse the contractor but do not provide incentive to profit from more and more changes.

Incentive clauses might be included to encourage contractors to overcome changes rather than allow them to become obstacles.

It is a difficult but routine problem that has been around, I suspect, since before the Great Pyramids were constructed. Putting bureaucrats in charge of such matters is a waste of time and money. Hire professionals from accounting, legal and construction backgrounds who will be critical and unyielding in requiring timely contract performance, and most of the cost containment problems will be solved regardless which "model" one chooses.

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