Inform Practice Note #17 November 008 (Version 1 - November 008) Securing Supplies of Critical Plant and Materials cidb s Inform Practice notes provide guidance and clarity in achieving client objectives in construction procurement and delivery. Practice notes inform clients and practitioners on how to embrace best practice and how to deal with issues that may arise. They are aligned with, but do not replace regulation. Content 1. Introduction. Risks to be managed 3. Mitigating the identified risks Synopsis: Price increases and the availability of materials are placing particular demands on the tendering and delivery ability of developing contractors as well as on the risk placed on their clients. This practice note identifies the risks to be managed and proposes a number of strategies to mitigate these risks. Practice Note #17 Version 1 November 008 1
1. Introduction The cidb Status Report The Building and Construction Materials Sector; Challenges and Opportunities (undertaken in 007) notes that: Price increases and the availability of materials are placing particular demands on the tendering and delivery ability of developing contractors as well as on the risk placed on their clients. The delivery of construction works on time and within budget is dependent upon the availability and timeous delivery of building and construction materials and plant which are incorporated into the work and at an appropriate price and quality. Such materials and plant may be locally manufactured or produced, or imported. The South African construction industry is currently experiencing high levels of demand, particularly in the delivery of infrastructure which is expected to continue well beyond 010. (Demand for buildings has, however, very recently dropped off due to power supply constraints, spiralling interest rates and the world banking crisis.) The building cost index has in recent years been well above the consumer price index suggesting that there are shortages in supply. Materials that have been particularly sensitive to inflation include cement, steel, aluminium, bitumen and fuel.. Risks to be managed Clause 9.1. of the JBCC Series 000 Principal Building Agreement states that the circumstances for which the contractor is entitled to a revision for the date for practical completion. The inability to obtain materials and goods where the contractor has taken all practical steps to avoid or reduce such delay. Clause 8.4 d) of the FIDIC Conditions of Contract for Construction states that the Contractor shall be entitled to an extension in the Time for Completion.if is or will be delayed by..unforeseen shortages in the availability of. Goods caused by epidemic or Government action. There are two fundamental risks that need to be managed. These are: Risk 1 The non-availability of critical plant and materials that need to be incorporated into the work result in the completion of the construction works being delayed. Risk The provision for price escalation in the contract does not adequately compensate the contractor for the actual increase in the cost of certain high value plant and materials. The consequence of Risk is that the contractors will suffer financial loss, which in the extreme case can lead to: Insolvency of the contractor, or The client paying an unnecessary premium for construction works as a result of risk pricing to address the uncertainty in the price escalation of critical plant and materials. 3. Mitigating the identified risks 3.1 Mitigating Risk 1 Provide contractors with the free issue of critical materials One possible mitigation measure is for the client to procure critical materials and to issue them free of charge to contractors. This response will require the client to timeoulsy procure, store and issue materials to contractors for incorporation into the works. Practice Note #17 Version 1 November 008
The advantage of this measure is that the client will be able to stock pile critical materials ahead of construction and be able to supply contractors with the free issue of materials. Contractors will be able to obtain the required materials as free issue. The disadvantage of this measure is that there will be considerable cost associated with the procurement, storage and handling of the materials. It may also require doubling handling of materials and may increase the transport costs to sites significantly. Furthermore, the client will be at risk for: Any loss of material for whatever cause including theft, fraud, breakages and time related damages e.g. rust; The acceptance and issuing of materials that fail to comply with the required standards; and Compensation to contractors for the late or non-delivery of materials. Allowances for construction wastage and systems to curb shrinkage need to be carefully considered and managed. Place provisional orders for critical materials with materials suppliers Another possible mitigation measure is to place provisional orders for critical materials at an early stage in the project cycle e.g. after a detailed design report has been accepted. Tenderers will be notified of the provisional orders that have been placed so that they can obtain prices from such suppliers. The successful tenderer will then be able to place the final order with the approved supplier. This approach provides suppliers with longer lead times. However, its use is very restricted as it can only work where there is only a sole supplier e.g. a particular type of face brick manufactured produced by a specific brick yard. It is an inappropriate response where there are numerous suppliers of materials that comply with the required specifications. Procure critical materials in terms of a transversal contract A transversal contract is, in terms of current public sector procurement arrangements, a contract with one or more suppliers over a period, used by more than one department or public body, to provide goods at agreed prices. This type of contract allows one department to issue a contract and allows other departments and public bodies to satisfy their procurement needs by ordering goods in terms of the contract and paying the supplier for goods purchased in terms of the contract. This type of contract may be modified so that one or more contracts for the supply of critical materials is placed by the client and contractors may order and pay for materials used on specified client contracts in terms of this contract. Suppliers could be contracted to provide guaranteed quantities of materials over a Practice Note #17 Version 1 November 008 3
FIDIC Conditions of Contract for Construction Materials things of all kinds (other than Plant) intended to form or forming part of the Permanent Works Plant the apparatus, machinery and vehicles intended to form or forming part of the Permanent Works. NEC3 Engineering and Construction Contract Plant and Materials items intended to be included in the works Equipment items provided by the Contractor and used by him to Provide the Works and which the Works Information does not require him to include in the Works. Regulations issued in terms of the Public Finance Management Act, 1999, and the Municipal Finance Management Act, 000, require that organs of state establish supply chain management units which contain six elements including demand management. Demand lies at the beginning of the supply chain. The major activities associated with identifying the demand are to establish requirements and to determine needs. The objective of demand management is to ensure that the resources required to support the strategic objectives are delivered at the correct time, at the right place and at the right location, and that the quantity and quality will satisfy needs. An advance payment is a sum of money paid by a client to a contractor after the contract is signed but before substantial construction work starts. An advance payment is effectively an interest free loan offered by the client against a guarantee provided by the contractor. It is repaid by deductions from payment certificates. (See inform practice note #16: Advance payments) three year period. This approach would secure the supply of materials without requiring the client to handle or store such material. Procure critical plant and components ahead of the construction works Critical items of plant or components of the works that have long lead times or which need to be imported should be identified very early in the project. These items should be procured in advance of the award of the construction works contracts. The timing of the delivery of the strategically sourced items needs, however to coincide with the construction programme, unless temporary storage arrangements are made for such items. Provide industry with short and medium term forecasts of materials and plant requirements The availability of reliable information is one of the preconditions for business to be informed of the future demand. This allows industry to gear their production for the demand. Clients need to review the nature of the work associated with their short and medium term expenditure projections and to identify the likely quantum and timing of critical materials and plant. This information needs to be made available to the relevant materials and plant supply chains. Regular forecasts of requirements and interactions with these supply chains will enable industry to either gear up their production to meet the demand or to import the required materials or plant or components thereof. Standardise specifications for materials The range of construction materials available in the market is ever increasing. For example the draft SANS 001-DP, Construction works Part DP: Medium pressure pipelines, requires pipes to be manufactured in accordance with one of 14 different standards. A rationalisation and standardisation in materials used by clients and the communication of these requirements to industry will allow industry to focus on providing that which the client requires. 3. Mitigating Risk Make provision for advance payments to contractors The provision of an advanced payment will allow the contractor to purchase critical materials or plant as soon as possible after the Practice Note #17 Version 1 November 008 4
GCC 004 makes provision for the increasing or decreasing of payment certificates in terms of a Contract Price Adjustment Factor calculated according to the formula and the conditions set out in the Contract Price Adjustment Schedule. Clause 46.3, however, allows the tenderer to identify special materials during the tender stage and to have the contract price adjusted should the price of such material change. The tender provides the following data in Part of the Contract Data: Type of special material Unit Rate or price The price of each special material specified in the Contact Data is increased or decreased by the difference between the price or rate entered in the Contract Data and the price actually paid by the contractor multiplied by the quantity of materials in question. Modify the standard provisions along using wording along the following lines: The Price Adjustment Factor is not applied to the special materials identified by the Contractor in Part of the Contract Data which are increased or decreased by the net amount of any documented variation incurred after the base date on the basis set out in such data. Add the following to Part Data provided by the Contractor or the Contract Data. The variation in cost of special materials is: Special material (describe including units of measurement e.g. steel reinforcing in tons.) Basis for variation e.g. Producer Price Index for selected materials for..as published in the Statistical News Release P014.1, Table 1 of Statistics South Africa, in which case state PPI table 1 for XXX where XXX is the Type of material listed in the first column, or price for base month ex factory, excluding transport, labour or any other costs. award of the contract. This minimises risk pricing to cover the potential under recovery of costs associated with construction materials that escalate in cost at a rate above the price adjustment provisions of the contract. It also places contractors in a strong bargaining position as they have the cash flow to purchase the materials or plant early in the contract and thereby fix the price. Provide flexibility in the provisions for price adjustment Most of the forms of contract contain provisions for price adjustment to make allowances for increases or decreases in the costs of labour, equipment, fuel, plant and materials that occur during the currency of the contract, using a price adjustment formula. Most often the client specifies the formula. This works well where there is a reasonable correlation between actual increases in costs and the price adjustment made in terms of the formula. Tenderers will have to risk price for certain materials where the specified price adjustment formula is likely to result in an under recovery of costs. This can be avoided if tenderers are permitted to identify special materials in their tender submissions and to propose a means of being compensated for the rise or fall in prices associated with such materials. This transfers the risk to the client and removes the tenderer s risk pricing. This approach will necessitate the amending of the standard provisions of contracts other than GCC 004. Make provision for payment of the critical imported materials and plant in foreign currency The local forms of contract, namely GCC 004 and the JBCC PBA don t make provision for payment of items and activities in multiple currencies. The NEC ECC3 and FIDIC, which are international forms of contract, do make provision for payment in multiple currencies should a client elect to do so. Practice Note #17 Version 1 November 008 5
Forward cover is an arrangement to buy or sell a foreign currency at an agreed rate at a future date. It is taken out by: Importers when the Rand is expected to weaken, a development that would increase the size of their bill if the transaction was not covered forward. It is taken out by exporters when the rand is expected to strengthen, an event that would reduce the value of their Rand earnings if not covered forward. Accordingly, tenderers have to carry the risk of currency price fluctuations where employers elect not to make payments in multiple currencies and either risk price it or price for forward cover1 to ensure price certainty and include the cost of such cover in their tender price. The payment in multiple currencies mitigates the contractor s risk relating to fluctuations in foreign currencies. The client, however, assumes this risk and would need to take out forward cover to ensure price certainty. Pretoria Head Office +7 1 48 700/+7 86 100 cidb Gauteng Provincial Office Pretoria 0861 48 cidbgp@cidb.org.za Western Cape Provincial Office Cape Town 0861 97 cidbwc@cidb.org.za Clauses for payment in multiple currencies should be drafted for use with the local forms of contract. Make provision for forward cover An alternative to payments in foreign currency is to require that the contractor take out forward cover on the imported content as a condition of contract and that tenderers price for such cover in their tenders. This ensures the tenderers compete for work on an equitable basis. Eastern Cape Provincial Office Bisho 0861 37 cidbec@cidb.org.za Northern Cape Provincial Office Kimberley 053 861 9631 cidbnc@cidb.org.za Free State Provincial Office Bloemfontein 0861 377 cidbfs@cidb.org.za KwaZulu-Natal Provincial Office Durban 0861 596 cidbkzn@cidb.org.za Limpopo Provincial Office Polokwane 0861 765 cidblimpopo@cidb.org.za Mpumalanga Provincial Office Nelspruit (Mbombela) 0861 678 cidbmpumalanga@cidb.org.za North West Provincial Office Mahikeng 0861 43 cidbnw@cidb.org.za Anonymous Fraud Line 0800 11 43 Call Centre: 0860 103 353 email: cidb@cidb.org.za www.cidb.org.za BM 1934 10/013 Practice Note #17 Version 1 November 008 6