You are on page 1of 31

What’s the Cheapest Way to Keep

Getting You There?

Alternative Project Delivery in the 50


States and a Financial Analysis of
Alternative Project Delivery Systems on
Road Projects

July 2012 Monthly Conference Call for Div. 4 ABA


Construction Forum on the Construction Industry
Kyle Ostergard, Esq.
Alston + Bird LLP
kyle.ostergard@alston.com
213.576.1036
www.alston.com
• Kamran Ghavamifar & Ali Touran, Alternative
Project Delivery Systems: Applications and
Legal Limits in Transportation Projects, 134 J.
of Professional Issues in Engineering
Education and Practice 106 (2008).
• The paper is a snapshot of the legal codes for
the 50 states regarding alternative project
delivery (APD) systems in transportation
projects as of December 2006.

2
What Does Project Delivery
System/Method Mean?
• Term referring to all the contractual relations,
roles and responsibilities of the entities
involved in a project.
• AGC defines as “the comprehensive process of
assigning the contractual responsibilities for
designing and constructing a project. A
delivery method identifies the primary parties
taking contractual responsibility for the
performance of the work.”

3
Design-Bid-Build

• On the one hand, under the Brooks Act (Public


Law 92-582) passed in 1972 and state Little
Brooks Acts, the selection of the designer should
be quality-based.
• On the other hand, the lowest, responsible
responsive bidder performs the construction.
• These two principles led agencies to adopt the
Design-Bid-Build (DBB) delivery system, which
dominated transportation projects until 1996.

4
Design-Build

• In 1996 the Federal Acquisition Reform Act was


passed authorizing the use of Design-Build (DB)
on federal projects.
• The Transportation Equity Act for the 21st
Century allowed state DoT’s to award DB
contracts if the state’s code authorized it.
• The owner chooses a single entity following
completion of conceptual design or preliminary
engineering when performance requirements
established.
5
Design-Build

• The design-builder assumes almost all


responsibility for the detail design and
construction and delivers the final product, which
should fulfill the performance requirements.
• DB is actually the oldest delivery method in the
construction industry – many large cathedrals in
Europe built by master builders, the rough
equivalent to DB contractors.
• Up to the 19th Century, almost all project in US
delivered with form of DB.
6
Design-Build

• States fully authorized DoT’s to use DB: 17.


• States that required extra approval from
outside DoT: 2.
• States had pilot programs or limited number or
cost over period of time: 18.
• DoT’s that had no authority to use DB: 13.

7
Construction Management-at-Risk

• CM-at-Risk (CMR) sometimes referred to as


Construction Manager/General Contractor
(CM/GC).
• Contractor engaged early during the project
design phase to help owner manage duties and
increase the feasibility and constructability of
the design.
• Expected to provide realistic cost estimate
early in project life cycle.
8
Construction Management-at-Risk

• States normally reserve the right to bid


construction if CMR price is not competitive.
• Difference between CMR and CM-Agency
(CMA) is that CMR is obligated to deliver
project with GMP and CMA is the owner’s
agent and adviser and, so long as CMA
performs duties, not responsible for time or
cost overruns.
• CM for fee.
9
Construction Management-at-Risk

• States that authorized CMR: 14.


• States that required extra approval from
outside DoT: 2.
• States with limitations per fiscal year: 3.
• States did not allow DoT or any agencies to
use CMR: 31.

10
Public-Private-Partnership

• P3 also referred to as Public-Private-Initiative


or Comprehensive Development Agreement
• A non-traditional arrangement between the
department and one or more private or public
entities that provides for:

11
Public-Private-Partnership

1. “Acceptance of private contribution to a


transportation system project or service in
exchange for public benefit concerning that
project or service;
2. Sharing of resources and the means of providing
transportation system project or services; or
3. Cooperation in researching, developing, and
implementing transportation system projects or
services.”
– (State Code of Georgia)
12
Public-Private-Partnership

• 2007 U.S. Secretary of Transportation


authorized to use three capital projects as pilot
program with results to be studied.
• Similar to DB in technical aspects, but the
financial aspects has caused apprehension

13
Public-Private-Partnership

• States that have accepted P3: 24.


– Of those 24 states, 4 had some limitations.
• State DoT’s fully authorized to use P3: 19 .
• One (1) state authorized but required outside
approval.
• States that had pilot programs: 4.
• States where not authorized: 26.

14
APD is the Future

• The process of passing legislation for APD


slow at times, but the trend is toward
authorization.
• From 2002-2006, an increase from 30 to 37
states permitting DB.
• The trend serves as reminder to stakeholders
that DBB will become less prevalent.

15
Financial Analysis of APD Road Projects

• Pertti Lahdenperä & Tiina Koppinen,


Financial analysis of road project delivery
systems, 14 J. of Financial Management of
Property and Construction 61 (2009).
• Which PDS should the owner (client) select?
– The various decision making and expert systems
that have been developed are usually qualitative
systems that consider various features of a project.

16
Financial Analysis of APD Road Projects

– Those systems do not, however, indicate actual


cost performance of the PDS’s.
– Further, they focus more on the investment phase
excluding so-called life cycle forms of contract.
– Studies often focus solely on two PDS’s or
variations and/or performance of a certain PDS’s.
• Precludes formulating a general view on cost efficiency
of a number of PDS’s.

17
Financial Analysis of APD Road Projects

• In light of these deficiencies, the goal of the


paper is to examine the cost performance of
different road PDS’s by defining their
indicative, relative cost performances.
• The authors used their earlier study from 2007.
– That study did not include the private-financed
option and financing issues were excluded.
– The cost to the user community was also ignored.

18
Financial Analysis of APD Road Projects

• The paper seeks to address the deficiencies of


the earlier study and focus on the significance
of various financial parameters by means of
sensitivity analyses.

19
The Project Delivery Systems Analyzed

• CM-at fee (CMA); CM-at risk (CMR) excluded


• Design-Bid-Build
• Design-Build
• Design-Build-Operate (DBO)
– Owner arranges financing and pays for the investment in
due time as w/ CM, DBB, and DB.
• Design-Build-Finance-Operate (DBFO)
– Service provider or special purpose vehicle (SPV)
arranges for financing.
20
The Analysis

• Discounted Cash Flow (DCF) method used to


obtain PDSs’ present costs (PC’s).
• Two complementary analyses:
1. Cost to the owner
2. Cost to society
• Finland selected as the application
environment for financial estimates and
accounting constraints.
21
The Analysis

• Taxes excluded
• All work assumed to be out-sourced.

22
Financial Estimates/Assumptions

• Risk-free rate: 4%
• Industry margin (increased borrowing for
private sector above risk-free government
bonds rate): .5%
• Cost escalation/inflation: 2%
• Social opportunity costs: 4% risk-free rate
• Share of equity: 10% of project financing

23
Financial Estimates

• Return on equity: 4% risk premium or beta


under CAPM
– 8% (Risk-free + beta) required rate of return on
equity
• Consulting Fees in DBFO (legal/financial):
.5% of debt raised (which here equals
investment costs)

24
Other Estimates

• 30 year total study period


– Close to the stated economic life cycle of roads.
• Early commissioning advantage: €1 million
monthly cost of delayed commissioning

25
Conclusions

• The results of the financial analysis indicate


“clearly” that DBO is the most efficient in
terms of owner’s costs.
• The private finance of DBFO increases its
costs close to those of DB, but not to the levels
of the two most operationally inefficient --
DBB and CM.

26
Conclusions

• In sum, disregarding the financing component,


the fewer the contracts the client enters into to
purchase an entire road management package,
the more cost efficient the project becomes.
• Consideration of early commissioning
advantage improves the standing of CM the
most, but it is likely to match DB and DBO
only where speed of construction is critical.

27
Conclusions

• Sensitivity analysis
– Changes in estimates do not usually affect the
ranking order of DBB, CM, DB, and DBO since
any alteration affects them much the same.
– The lines representing CM and DBB are not
completely parallel when variations occur in cost
escalation and social opportunity costs due to
differences in speed of construction.

28
Conclusions

– Probably not surprising, but DBFO is affected


differently by most variations in estimates.
– Increases in senior debt to industry, share of
equity, required return on equity, and
concession period all diminish DBFO’s
competitiveness.
• Social opportunity costs, which is related to
the valuation of risk in public-financed PDS’s
seems critical.

29
Conclusions

• Change is not always as dramatic in reality


– Interest rates dealt with as independent factors are
derivative from market rate and thus change in
parallel.

30
Conclusions

• (1) DBO, (2) DB, (3) CM and (4) DBB


• DBFO’s competitive position is not absolutely
clear but seems to be in the middle category
with DB on the basis of the owner’s PC of a 30
year contract.
– Consideration of the early commissioning
advantage makes CM (fastest commissioning)
nearly equal or sometimes better than DBFO,
which increases its superiority over DBB.

31