The Modern System

 A Short History of Building Procurement: Part 3

By the beginning of the 1800s builders were becoming recognised as an occupation, and as their firms developed they often specialised in certain types construction, such as civil engineering during the boom in railway building later in the century. Others, such as William Cubitt, became developers, building housing to meet demand from the rapid growth of cities. By the middle of the 19^th century large contracting businesses had taken on the form that in many ways we still see today, and procurement and contracting was using the same, or a recognizably similar, system.

There were two key characteristics of this new procurement system. First was the use of detailed drawings and design, completed before the work began. The second was the preparation of cost estimates for the project, on the basis of the design drawings. The two significant outcomes of these characteristics, that became the foundations of the modern system, were the shift to competitive tendering and the growth of the professions.

The construction of Westminster in the 1830s was one of the first buildings to be done with detailed drawings from the architect and a bill of quantities (BQ) with full estimates based on them. Under the system of measure and value costs had been determined on completion by a measurer, originally a tradesman, and over time this became a specialised task. As the new method of procurement and contracting appeared measurers became more important, as prices had to be agreed between the architect, client and builder before work began. Measurers became quantity surveyors.

A series of government commissions on building procurement produced reports that sometimes, but not always, favoured competitive tendering. Nevertheless, as the system became more widespread government departments came round to the idea that it was the best way of obtaining value for money. By the middle of the 19^th century competitive tendering on the basis of design and price specification had become the usual practice.

The new profession of quantity surveying was therefore an essential element in the new system. The procurement method where clients invite tenders on the basis of completed designs made it necessary for the client to know whether the tender prices were reasonable, so every element of the design had to be quantified in terms of materials and labour, and priced. While bills of quantities date back to the middle of the 18^th century, by the close of the century something close to a modern BQ was coming into use. An 1828 parliamentary committee investigating the Office of Works and Public Buildings found the practice had become well-established. So bills of quantities become fundamental to the contracting system in Britain, and later became part of the required contractual documentation. It is worth noting that other European countries did not find the detailed bill as essential.

Not all of the projects using the new system were won through competitive tendering, often contracts were negotiated with firms familiar to the client or architect. In these early days of fixed-price contracting, the idea of competition was controversial. Much of the opposition to the contracting system was really opposition to competitive tendering, rather than to the idea of a single contract with an agreed sum. Competition was believed to lead to lower standards as contractors would bid low to win work and could not possibly match those prices without reducing standards.

It was also feared the contractors would abuse the system through collusion on bid prices or corrupt practices. Fears that have been justified more than once, as too bid rigging, cover pricing, unsuccessful tender fees and market sharing, which were all reported to occur then are sometimes found today. The protection against such practices was initially based on the idea of only employing ‘respectable’ builders, and the idea of respectability was seen as protection against the consequences of competition. Rather than reliance on builders’ respectability the best protection against abuse came to be seen as careful pricing of specifications and close supervision of the work by the architect, or other agent.

One key element of the builder’s respectability was possession of sufficient capital and employees to carry out a job without subcontracting, which was regarded as a dubious practice. Clients wished to avoid subcontracting, so it was often done secretly. The original large contractors employed craftsmen in every trade and were expected to complete most of a project under their own management. However, the advantages of subcontracting led to its widespread adoption by the middle of the 19^th century. The advantages then still exist today, such as flexibility of employment, managing risk and liability, and specialisation, which was important as the development of new materials and new components required new skills (for example patent glazing, iron and steel frames, gas, and later electrical and lighting).

This was also a time a rapid technological innovation and development, both by and for contractors. Satoh has six chapters on 19^th century technical advances in his Building in Britain, covering: stone, wood, bricks, components, pumps and lifting machinery. Like other industries the widespread availability of steam power was transformational in the application of new machinery in the contractors’ workshops, and the use of mechanization on building sites slowly increased. There was also an ongoing transfer of site work into the workshops. For the largest firms these were huge, William Cubitt (contractor brother of property developer Thomas Cubitt) had 25 acres on the Isle of Dogs in 1845, complete with wharves, sawmills, cement kilns, an iron foundry, brickfields, a pottery and so on, linked by an internal railway and employing about 800 men.

In 1834 the Builders’ Society was formed in London, partly in response to the rise of the labour movement as the influence of the guilds declined with competitive tendering, and by coincidence the same year as the founding of the Royal Institute of British Architects (RIBA). Its main purpose however, according to Satoh (1995: 96), was to hold together builders “who being asked to tender on a specification that did not contain an arbitration clause had all declined. The arbitration clause seems to have indicated what was to be done in the case of controversy between owner and builder.” These arbitration clauses were the source of many disputes and conflicts between contractors and architects, and led eventually to the Conditions of Contract agreement, much later.

Architects strongly favoured traditional contracts for price over contracting in gross, at a fixed sum for the whole project. The reason given by Satoh is “the tedium of preparing the correct drawings and specifications beforehand” (1995: 292) rather than preparing designs and giving directions as the work progressed, as they used to do. However, as conflicts between owners and contractors became more common, and intense, under the new competitive system, architects realized the importance of the role of the project superintendent. With the central role of the architect as client representative becoming established, the RIBA wanted to ensure architects were seen as acting on behalf of their clients. Concerned about potential conflict of interests and protecting clients the RIBA, in 1887, prohibited members from getting involved and profiting from the organisation of building work.

The idea of the contract is to make clear what the obligations of each party has, but no one has ever devised a contract that eliminates all possibility of disputes over interpretation and performance. As the contracting system developed it was the architect who came to determine the conditions under which work was let, and was responsible for resolving disputes. Under the modern system these contracts gave architects a unilateral power to determine payment to contractors, which was sometimes abused to benefit clients, and was the source of bitter complaints from contractors.

In 1870 the terms of a document called the Heads of Conditions of Builders Contracts was agreed between architects (RIBA) and the Builders’ Society This established the basic outline and principles of the standard building contract which could then be varied to particular circumstances, and addressed the concern of builders who felt that previous contracts made no provision for variations in materials prices or the cost of extra work. Bills of quantities were introduced as part of the contract in 1902, after many revisions in the meantime, and this remained the basic form until 1931 when the Joint Contract Tribunal was set up and the standard forms of contract came into use. These are still the basis of the majority of building contracts in the UK today.

As well as the conflicts between architects and builders, there was considerable rivalry between architects and engineers. This began in the early 19^th century as the pace of technological innovation increased and new materials arrived – iron, then steel, followed by reinforced concrete at the end of the century - and mechanical engineering emerged (a British specialization) with the new machines. Architects knew little about these innovations and left them to engineers. By 1800 architecture and engineering were separate professions with separate training. Architects studied with older architects and in schools of architecture, while engineers went to engineering faculties. The antagonism found in the UK between architects and engineers in the early 19^th century was also present in America. Fitch (1973: 126) describes a ‘great schism’ that developed as architects struggled to master the requirements of new forms of building and new materials and the mutual contempt between them and the new profession of engineers.

The disengagement of architects and design from building and construction occurred at a time when engineers were also focusing on design rather than delivery, due to increasing specialisation and differentiation between different types of engineers (such as mechanical, structural, civil, electrical and sewerage). Both architects and engineers neglected estimating, which was left to the new profession of quantity surveyors. Thus each of the construction professions developed their own language, skill sets, and cultures, nevertheless sharing a mutual sense of superiority over builders and contractors.

Moving On

By the end of the 19^th century in the UK there was a fully developed procurement and contracting system with practices well understood by all the parties concerned, and this system continued, with its essential characteristics unchanged, into the 20^th century. Nevertheless, it also continued to generate controversy and conflict, and an increasingly litigious industry.

In the first half of the 20^th century the modern system was refined and further developed. Bowley (1966) outlined four new ways of contracting as characteristic of the period between 1944 and 1960s. First was selective tendering, where only contractors known to be capable are invited to tender. Second were negotiated contracts, often used by local housing authorities to bring the contractor in at an earlier stage. Third was serial contracts, with contractors having successfully completed one project were re-engaged on later ones. Fourth were package deals as they were called then, now more commonly referred to as design and build, used particularly for the mass housing programs with high-rise buildings in the 1960s.

None of these were really new. All of them had been used before in various forms and they have all reappeared, sometimes renamed, at various times, to the present. A proliferation of contract forms continued, as attempts to overcome inadequacies of the traditional system, into an ever expanding variety of contracts and procurement systems to choose from. How effective this has been is a topic in its own right. 

On procurement Bowley (1966: 352) said “It is difficult to see how any system more wasteful of technical knowledge, intellectual ability and practical and organising experience could have been invented.” While it is hard to disagree with the sentiment, this rather seems to overlook the evolution of procurement methods as new versions, and contracts, developed as a response to problems and issues found in existing procedures.

Conclusion

This history of building procurement has focused on England and its development in London, because that is where many of the major projects were built. These developments are widely relevant today because England shaped much of modern language, laws, institutions, and governance. Competitive tendering, enforceable contracts, subcontracting, surveying and measurement of costs with a BQ are now widespread, but these all came with the modern system that was developed in the UK. Other countries have different histories, especially the US and elsewhere in Europe, but the modern system of procurement and English common law is the foundation on which they are built.

What this short history shows is how, over a period of 200 years, a system of procurement and contracting based on measurement and specification, replaced the older systems of direct employment of craftsmen at day rates and measure and value. As this new system was developed and maintained it had great continuity, and is an important element in understanding how difficult innovation in procurement actually is. The surprisingly few fundamental changes seen since the modern system of procurement came into widespread use in the early 19^th century does not mean there have been no changes. What the history shows is that procurement methods evolve slowly, in response to problems and issues with the methods in use and to changes in both the organization of work and the structure of society.

Despite being constantly criticised and modified around the edges, procurement at the end of the 20^th century is still found have serious issues and be in need of radical change. Inquiries in many countries (such as the UK, Australia, Singapore, Hong Kong, Japan, Holland) came to the conclusion that deficiencies in procurement should be remedied, often by government intervention and/or contractual reform. In one view:

It is like a game. There are rewards and penalties, rules and roles. Some cheat, or at least take advantage, where others wouldn’t. Some play the game straight and true, others are always looking for an angle to make another dollar or two. Or three. Contracts describe what is to be provided under what conditions. Some people put the contract in a desk drawer and forget about it, others use it as a means of extracting increased payments. The contract sets the rules but it is the individual who decides how play will be conducted. (Morris 2013: 176).

These comments echo those made in the mid-nineteenth century. Satoh closes his book with a series of quotes from opponents of the modern system (1995: 297-99). These include: poor quality work due to low price bidding, or subcontracting; builders undercutting each other to win work; the lack of provision for variations in fixed price contracts; unjustified claims by contractors; arbitrary decisions by superintendents and architects; non-payment by clients; and collusion between contractors. To address these issues the contracting system incorporated increasingly detailed drawings and specifications, and a schedule of prices was often attached for claims and variations. The unilateral nature of the contract led to the drafting of the Conditions of Contract, which were revised over time.

In many ways, in procurement and contracting in the building and construction industry, the more things change the more they appear to stay the same. This may, however, not be true of the 21^st century.

This is part 3 of a three part series, the preceding parts are on Pre-Modern Building Procurement and The Great Transition. A pdf of the full document is here.

The Great Transition

 A Short History of Building Procurement: Part 2

Until the 17^th century building had typically been done by craftsmen working directly for a client. Well into the 18^th century clients would sometimes buy the materials and pay for labour only, in other cases the craftsmen would supply their own material and agree to a price for the whole job beforehand or work on a value and measure basis. However, by the end of the 1700s the measure and value method was being replaced by contracting with one person to undertake a project for an agreed price, although still disliked by both tradesmen and employers. In the 19^th century procurement through contracting became the norm, and it has remained with us since.

From the late 1780s there were regulations requiring British government departments to use the contract in gross, but this was generally ignored. Administrators in the Office of Works and Public Buildings were typically against contracting for a fixed sum as well as contracting for the whole project, and they carried on in the old way of employing separate trades until a reorganization in 1832 forced a transition from separate contracting with unit prices to general contracting for a lump sum (Satoh 1995:37).

Satoh (1995, citing Cooney 1955) describes four types of building firms found during the 18^th and 19^th centuries. The first were master craftsmen, employing journeymen and apprentices and working with their own trade (the traditional medieval system). The second were master craftsmen who contracted for a whole building but then contracted with other master craftsmen for work outside his own trade. This was largely a barter system known as ‘blood for blood’, however this form of co-operative contracting had largely disappeared by the middle of the 1800s.

The third type of firm were builders, often architects, who completed buildings by contracting with master craftsmen in each trade. During this transition from direct labour to a contracting system in Satoh’s description: “The architect as the agent of the building owner assumed the undifferentiated duties of designer and supervisor on the one hand and construction manager on the other” (1995: 16). These architect-contractors on large projects were a passing phenomenon, although they continued to do minor works throughout the 19^th century.

With the establishment of the Royal Institute of British Architects in 1834 the distinction between builders and architects was made clear and became widely accepted by the profession. One consequence of this was the rise of merchant builders, who had access to both materials (their form of business) and capital. Some of these were speculative developers and some became large scale contractors.

Type four firms were the master builders, who permanently employed their workers and were responsible for the whole project, often but not always won through a competitive tender. These firms were the original general contractors, and from the early 1800s contracting for the whole project at a fixed sum became widely adopted, first in the private sector with the public sector following the trend. Some of the London-based firms doing major projects became very large, employing several thousand men each by mid-century.

Clark (1992) describes the disappearance of the craftsmen builder in London over the last two decades of the 18^th century, and how, by the early part of the 19^th century, the new system of contracting was well-established. This new contracting system, with one firm doing the work for a fixed price, was opposed by many clients, architects, tradesmen, and small contractors. There were also problems of fraud and business failure associated with fixed price contracting. These objections are familiar today, and, many of the comments Clark reports are still found in the succession of UK industry reports from Bamwell to Egan (1998) nearly 200 years later (see Murray and Langford 2011 on all these reports).

The most bitter opposition, which continued throughout the 19^th century, came from tradesmen and other building workers. The competitive system was fatal for the guilds and their long-standing traditions and practices. Opposition to general contracting was driven by a combination of increasing use of machinery, both on-site and in the workshop, and the increase in the length of the working day to around 12 hours. Indeed, at the close of the 19^th century the early trade unionists were still arguing about craft rights and opposing building work done with contracting by one person or firm.

The smaller contractors, master craftsmen and small builders, also opposed the new system because they often lost money by bidding too low for contracts. Many of these became employees of the large contractors, a significant loss of social status. Despite the opposition, the new procurement system spread rapidly during the early years of the 19^th century and became a normal way of doing business. By the 1830s both private and public clients had come to believe the system was the best way to contain costs within estimates and to get value for money. These remain the primary concern of clients to this day.

The story of the building of the New Palace of Westminster (the British Houses of Parliament) in the mid-nineteenth century is instructive. As told by Kingsford (1973), the project used new engineering techniques and machinery, the skills of hundreds of traditional craftsmen and a huge work force managed by some of the largest contractors. The project started in 1837 and was expected to take six years and cost £700,000, but actually took almost 30 years and cost over £2 million, well over £500 million or $1.2 billion in today’s money. (This story was repeated, with variations, in the building of the new Australian Parliament House in the 1980s and the Scottish Parliament (Holyrood) in the 2000s.)

In the building of Westminster there were disputes between the architect who won the design competition, Charles Barry, and pretty much everyone else involved, starting before construction began. There were arguments over the initial design, over the estimates and the architect’s fees, there were disputes over contract prices and supply problems with the materials. The designer of the heating and ventilation system fell out with Barry and the two became enemies. The masons went on strike for 30 weeks after a foreman swore at them.

The project was carried out through a series of contracts awarded through competitive tender or by recommendation by Barry. The first two contracts were let by the government department in charge. The third contract was put out for tender to eight firms recommended by Barry, and was won by a firm (Grissell and Peto) who were then given the following four contracts by negotiation without further competition.

In the third contract the prices were set by the builder and agreed to by the architect, however in the fourth contract prices were determined by the government department and set lower than prices arrived at through competition. The contractor later renegotiated a new set of prices, as these were profitless contracts otherwise. The contracts had detailed specifications on all aspects of the work and were priced in a form recognizably similar to a modern bill of quantities. The work of each trade was specified separately.

During the 19^th century general contractors, often winning projects in competitive tenders, became responsible for organising projects and employing workers. While there were recognizable elements of the old system still in use in the 19^th century, the building industry was becoming a complex and confusing conglomeration of businesses and individuals. Many of these characteristics of the industry, as the example of the building of Westminster shows, are still part of the building and construction industry today. The same can be said for issues in procurement and contracting.

This is part 2 of a three part series. Part 1 was Pre-Modern Building Procurement and Part 3 is The Modern System. A pdf of the full document is here.

Do Projects Have Internal Markets?

Projects As Micro-Markets

Can an individual project contain within it an internal, though temporary market? The definition of a market found in a standard economics text is “any arrangement in which the interaction of buyers and sellers determines the price and quantity of goods and services exchanged”. By this criteria the act of procurement, which is purchasing goods and services, is indeed a market transaction.

A market for a single project is created by the client as they go through the procurement process, regardless of the particular system or method of procurement followed. The client is the buyer of a bundle of goods and services from the contractor/s bidding or negotiating for the project, and their interaction on the scope (quantity) and price of the project is resolved when the agreement or contract is exchanged. In particular, the extent of market power held, gained or lost by participants as the procurement process goes through the stages of pre-bid, tender, final bid and negotiation, or some variation of those stages, is an important factor.

A distinction can be made between the market for a project, typically one of many similar types of projects, and the market for the supply of the bundle of goods and services required to deliver that specific project. Such a market is created by a project manager or lead contractor as they organize the work and subcontract the various specialized tasks. This could be called a micro-market, and it establishes within the project an internal market.

If procurement of a project creates an identifiable, though temporary, micro-market for goods and services, what are the distinctive characteristics of such a market? Clearly it is not like a conventional market described in a textbook. The characteristics of markets are the number of buyers and sellers, the distinctiveness and substitutability of products, forms of competition, barriers to entry and concentration ratio, and the information and mobility of customers. These market characteristics do not, however, neatly carry over to industries with extensive subcontracting, such as building and construction, for three reasons.

The first reason is there is only one buyer, and in such a market with a single buyer it is possible to gain market power through bargaining with potential suppliers. Bargaining power is found in the bilateral negotiations over terms and conditions of supply between trading partners. In a bargaining framework buyer power is the ability to extract surplus from a supplier, typically through individually negotiated discounts. However, because this bargaining power cannot be exercised when suppliers are competitive, it is a countervailing power and thus its use is constrained by circumstances.

Buyer power is the bargaining strength a buyer has with suppliers with whom it trades, where its bargaining strength depends on its ability to credibly threaten to impose an opportunity cost if it is not granted a concession. The traditional economic treatment of bargaining power uses the concept of outside options available to buyers and sellers. The Australian Competition and Consumer Commission describes these as “the outside option is the best option that either the seller or buyer can achieve if they walk away from the negotiations.” Strong outside options for a buyer, or weak outside options for a seller, will be a major source of buyer power in a bilateral bargaining framework.

The second reason is that subcontractors are typically not engaged in a single transaction, as in the market-based trades of instant exchange and settlement envisaged in economics textbooks. The relationship between a large corporation and its subcontractors is typically more durable and intensive than a market relationship. This idea of ‘relational contracting’ has firms developing long-term ties with contractors, often with a degree of mutual understanding and trust that are not typical of market transactions. Instead of using the market, the firm will rely on a trusted supplier, especially when their relationship involves shared knowledge and learning.

Third, there are ‘hybrid’ concepts, where relations between a head contractor and the subcontractors are stable and continuous over fairly long periods of time and only infrequently established through competitive bidding. A form of-integration that largely makes the concept of relational exchange redundant. The hybrid concept does not survive the reality of contractual obligations, however. While there may be relational aspects to the organization of production/projects between firms, the legal distinction between firms, markets and other arrangements remains real, and the legal status of the firm has not been undermined. Conceptual boundaries are not contractual boundaries, and this distinction should not be ignored.

A different approach to these long-term or continuous relationships is the idea that a project creates an internal, temporary, micro-market for the goods and services supplied by subcontractors. This temporary micro-market, or internal project market, comes into formal existence after the procurement process has been completed, a contract signed and the project become a defined, deliverable building or structure (although there seems to be no good reason why this idea could not be applied to any type of project, such as software or equipment development).

In fact, all this takes us back to Ronald Coase’s original 1937 paper ‘The nature of the firm’. Coase was the first to argue that markets and firms are alternative governance structures for economic transactions. Importantly, the firm is a distinct legal entity, a ‘legal person’ that enters into written or unwritten contracts. He argued the firm is an organisation, rather than just a production function, and separated the market from the firm with the ‘price mechanism’ on one hand and its ‘supersession’ on the other.

For Coase the alternative to the firm was the coordination of self-employed individual producers by the market, each being his or her ‘own master’. In the case of subcontracting, this extended organization still coordinates production, but within the temporary market created by the project. Like any other type of market this internal, temporary micro-market created by a project will have a range of characteristics and dynamics.

The basic proposition behind this line of reasoning is the idea that project procurement is a mechanism for creating an internal market. If this is the case, we can utilise the elements of industry structure, competitive analysis and so on, that have traditionally been applied at the firm level, to better understand projects and their governance.