On the money

Chris Gage tells water companies to proactively control what their capital projects cost.

Trying to quantify the level of risk on a complex project or a major programme is always difficult. “Open book” contracts – off-the-shelf procurement contracts based on a pre-agreed framework – have helped project managers identify, quantify, share and manage risk, but they are not foolproof.
Offering to pay a contractor a fee plus their costs to build your next power plant or manage your maintenance contract is inherently risky. Specifically, there is an incentive for contractors to inflate costs to maximise revenue. Target cost contracts mitigate these risks, but they are only as good as the data used to set the target price.
Utilities need cost assurance, but how do they get it? Checking through piles of invoices, purchase orders and journals may be straightforward for small projects, but assuring projects costing tens of millions is a different proposition. A deeper understanding of the supply chain’s cost collection systems and an ability to mine large quantities of cost data are essential.
Utilities’ early efforts at cost assurance were crude and imprecise. Faced with a bewildering mass of financial transactions running into many thousands of lines of data, the natural reaction was to sample a few of them for verification: follow through some of the invoices, double check a selection of timesheets, cross-reference some purchase orders, throw some mud at the contractor and see what sticks.
Since then, the industry has slowly progressed. It has used cost verification, an approach that employs specialist audit software to analyse huge volumes of data and draw out potential anomalies. But little thought is given to the impact on the relationship between the client and contractor, or the root causes of the anomalies.
Utilities then progressed to use reactive cost assurance. This goes beyond the process of checking costs and takes steps to resolve the root causes of underlying issues. But there is an element of closing the door after the horse has bolted. Reactive reviews occur after a problem has already been identified and usually at a time when the relationship between client and contractor is tense. Data quality can be poor and at this point it is too late to start collecting better information. Faced with difficulty in properly demonstrating cost, the burden of proof can in practice shift from what should be reimbursed to what should not.
So is there a better way? In a project’s initial phase the focus is on delivery, and rightly so. But often financial systems and processes are not given the attention they deserve, which often results in opaque accounting and overpayments. Cost assurance should be proactive. Why not get experts from accountancy, IT, commercial and contractual disciplines together to shape the information that is collected, the controls put in place and prevent overpayments occurring in the first place?
This proactive approach has worked well with a number of our clients. For example, the systems and processes of one contractor we have worked with did not meet the requirements of the client’s target cost contract, despite having very good internal cost controls. But by inserting a balanced team of experts to face down a range of issues before they arose, we were able to increase confidence in the costs, prevent overpayments and preserve a collaborative working environment.
Proactive cost assurance has wider benefits too. For example, if a water company has a clear understanding of its cost base, it can deliver a more accurate business plan at price determination. In practice, because many capital costs are incurred by water companies’ supply chains rather than directly, the quality of cost collection is not always what it should be. Hence different water companies submit widely varying costings for the same activity.
To be blunt, the water industry is some way behind the curve when it comes to using cost intelligence to drive decision-making. Google bases its entire business model on data, and Tesco gathers and structures customer purchasing data so it can draw valuable insight from it for planning and decision-making.
By engaging with its supply chain from the outset using proactive cost assurance, the water industry could work with suppliers and contractors to assure cost and define how costs are reported so they fit with price review requirements. Then the industry might catch up with the rest of the business world.
Chris Gage, head of cost assurance at Turner & Townsend.

This article first appeared in Utility Week’s print edition of 17 February 2012.
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