Issues and options for Australian construction
There are many issues that affect construction productivity. Some are long-term, such as innovation, R&D, and education and training systems. Others are structural, like the number of micro and small firms, or institutional, like state based occupational licensing and building codes. However, for the Australian industry by far the most important factor in low productivity growth is the lack of business investment in intellectual and physical capital, the amount of machinery, equipment, buildings, structures, software and R&D, and the skills of the workforce.
The construction industry has been the subject of a number of recent reports from both government and industry, the latest being the Queensland Productivity Commission’s Opportunities to Improve Productivity of the Construction Industry, which followed the NSW Productivity and Equality Commission report Housing Supply Challenges and Policy Options in August 2024 and the Productivity Commission report Housing Construction Productivity: Can We Fix It? in February 2025. This year from industry has come the Committee for Economic Development’s Size matters: Why Construction productivity Is So Weak and the Australian Industry Group’s Australian Home Building in Crisis.
These reports have raised many issues and highlight their wide range. Some issues are well known and there is a broad consensus on both their importance and reform direction, such as training and skills, occupational licensing, and workplace health and safety. Others like collaborative contracting and increasing innovation and R&D are more aspirational. For better or worse, the decision has been made that updates and revisions to the National Construction Code (NCC) will be delayed and less frequent, and the code will be reviewed to make compliance easier. Including issues around government procurement and contracting allowed the Queensland Productivity Commission’s Interim Report to address some important productivity determinants that were not in the other recent reports, which has led to this post.
The issues discussed in this post are in the broad categories of projects, procurement, and complexity. The post first looks at project estimates and reference class forecasting, then argues for separating design and construction. On procurement the topics covered are project sizing and access, industry capacity and BIM mandates. The last two topics are project complexity and collaborative contracting, and using target cost contracts for major projects.
Project Estimates and Reference Class Forecasting
A significant reason for poor decisions on projects is unwarranted optimism about outcomes and the time needed to complete tasks. Planners often underestimate a project’s time, costs, and risks due to size, gestation and time taken to deliver, and overestimate the benefits, particularly for major projects. In some cases there is strategic misrepresentation of costs and benefits, where project promoters produce biased appraisals at the approvals stage. After a project has started there are the risks of escalated commitment and lock-in, scope changes, and conflicting interests.
Project estimates can be improved by using the performance of previous projects to inform those decisions. Clients collecting and using data from previous projects in the evaluation and definition stages of new projects makes for better decisions. Bent Flyvbjerg proposed a system called Reference Class Forecasting that has three steps:
1. Identification of a relevant reference class of past, similar projects;
2. Establishing a probability distribution for the reference class;
3. Comparing the specific project with the reference class distribution [1].
Reference Class Forecasting allows project time and cost estimates to be compared and evaluated against previous similar project outcomes and performance. The data on comparable completed projects provides a range of probable outcomes for a proposed project, with realistic and more accurate time and cost estimates for major projects.
Another example is Independent Project Analysis (IPA), established by Ed Merrow in 1987 for industries like oil and gas, petroleum, minerals and metals, chemicals, power, LNG and pipelines. Depending on the project, between 2,000 and 5,000 data points are collected over the initiation, development and delivery stages. From the IPA database companies can compare their project with other, similar projects, across a wide range of performance indicators. Merrow argues defining and planning a major project should cost 5% of the total, and the cost of not spending that money is much more. Merrow’s projects are mostly private sector resource developments like oil and gas projects, and he notes they have different dynamics to public sector projects [2].
Merrow argues that the owner’s job is to specify the project and the contractor’s job is to deliver the project as specified, on time and on budget. In his view contractual relationships are more tactics than strategy, and cannot address any fundamental weaknesses in the client’s management of the project. While risk can be managed by contracts, it cannot magically be made to disappear with contracts.
Clients are responsible for project shaping and definition, what Merrow calls Front End Loading, which is a necessary prerequisite for creating value. There are three stages of Front End Loading, the first evaluates the business case, the second is scope selection and development, and the third is detailed design. His argument is that there needs to be gates between these stages that prevent less viable projects from getting to authorisation
Separating Design and Construction
Merrow also argues the best form of project delivery is what he calls ‘mixed’: hiring engineering design contractors on a reimbursable contract and construction contractors on a separate fixed price contract. The evidence from the IPA database is that this is the most effective form of project organization, and is basically traditional construction procurement where consultants are appointed to do the design and a competitive tender is held for one or more contractors to execute the works on site against a complete design.
Unbundling design and construction for major projects has a number of advantages. Breaking a project into smaller, sequential contracts spreads the cost out over time, and does not incur interest costs on finance for design work. It makes quality control easier and more effective, by being focused on each stage, an important risk management tool. Completion of design and documentation before tendering significantly reduces contractor risk and therefore total project cost.
Design and construction of major projects should be contracted separately to spread the cost over time and reduce project costs and risks. As far as possible, design and documentation should be complete or nearly complete before tendering. The success or failure of the great majority of projects is determined during definition, planning and development.
Project Sizing and Access
Competition can be limited for major construction projects, for several reasons: procurement costs can be excessive; high technical complexity is sometimes an important factor; and for contractors outside the first tier access to finance for large projects can be difficult. Projects can benefit from economies of scale and scope, but large contracts restrict competition if potential bidders are constrained by technical skills and other resources.
Therefore, dividing a large project into a number of smaller contracts is an important policy decision. Having the design complete before tendering facilitates the division of a large project into sub-projects, for example a road or highway project can be done as stages that link up on completion. This creates opportunities for local contractors, particularly in regional areas. Increased competition for work contains costs as well.
Where possible, a major project should be broken into sub-projects to reduce barriers to entry for tenderers, create opportunities for local contractors and suppliers, and increase competition. This can also reduce project costs by removing a layer of management on projects where a large contractor wins the work then subcontracts it out to smaller local contractors, but charges a project management fee.
Industry Capacity
There are significant capacity constraints in construction, as the experience of cost increases and schedule slippage with major projects in Australia shows. Industry capacity is the limit on production, a theoretical maximum of what can be produced in a single period. In some cases this is straightforward, based on the installed capacity of machinery, plant and equipment, adjusted for the utilization rate and maintenance requirements, that produce a set amount day after day, week after week. Construction is not like this, it is geographically dispersed and brings together many suppliers at many sites. Shipbuilding for example brings together many suppliers at a few sites, automobile manufacturing has a small number of specialist suppliers, often co-located.
Separating design and construction allows sequencing of major projects. As the design work is completed a project can be added to a pipeline of projects and released for tender when conditions are appropriate, or when other projects are approaching completion. Suppliers and contractors can use the pipeline of projects to build capacity in the knowledge that there will be ongoing opportunities for their staff and equipment, reducing the set-up costs incurred by re-establishing project teams.
Construction is much more labour intensive than industries it is typically compared to such as manufacturing or mining. This makes the number of people employed one of the key constraints on construction industry capacity. As well as a pipeline of work, developing industry capacity is a long-term strategy based on providing training and skills, improving management practices, and support for SMEs.
Construction industry capacity and productivity will be improved by increased investment in the capital stock. Traditional policy instruments to increase investment are tax incentives like instant write-offs, accelerated depreciation, and financial incentives like production subsidies, grants and loan guarantees. Business investment can also be promoted by development of industry technology strategies, revising public procurement methods, and advanced market commitments for products like prefabricated buildings and services like digital twins. Investment in physical and intellectual assets is essential for building industry capacity and upgrading technology.
BIM Mandates
BIM mandates are important because the use of BIM unlocks the potential of digital construction and affects all suppliers of materials, products and services. The ISO 19650 standards for BIM and digital twins provide a framework for creating, managing and sharing data on built assets, establishing consensus on what is to be done and how. There is evidence from surveys that BIM increases efficiency, reduces rework, and improves productivity and workload capacity [4]. In Australia, the Queensland Department of State Development and Infrastructure has had a BIM mandate for public projects over $50 million since 2019.
The experience of overseas jurisdictions with BIM mandates is that BIM use increases over time. The UK is a good example. There has been a significant increase in the use of BIM in the UK since 2011 when a BIM mandate for public construction was introduced. In 2018 a BIM Framework based on ISO 19650 provided a roadmap for firms and clients, and the government developed clauses in construction contracts covering contentious issues such as intellectual property and data ownership. The UK is now a leading user of BIM, along with other early movers with BIM mandates like Singapore and Norway.
In the UK BIM maturity levels are defined as:
· No BIM: Information generated manually by hand;
· Level 0: 2D Computer-Aided Design (CAD) and no or minimal collaboration;
· Level 1: 2D CAD for documentation and 3D CAD for specific elements;
· Level 2: Collaborative 3D CAD models with a Common Data Environment, this is required for UK public projects;
· Level 3: Shared 3D cloud-based model of the project, with the team working collaboratively in real-time.
Industry has a collective action problem because the cost of adopting a new technology is significant and skills are typically in short supply. Firms will invest in BIM if they believe that they will profit by it, but legitimately fear future technical progress could make today's investments unprofitable as change makes today’s technologies obsolete. Paradoxically, when innovation and technological progress is rapid, uncertainty can hold back investment by firms because there may be a better, cheaper technology available tomorrow. Why invest today if there will be a competing technology that is half the price in a few years’ time?
Therefore, BIM mandates from government and private sector clients are needed to promote BIM use. For small and medium size firms the initial software and training costs are a barrier to adopting BIM. There should be grants and subsidies to provide financial support to get SMEs to level 2 BIM, with a limit of 50% of these costs.
Complexity and Collaborative Contracting
Contractual relationships are more tactics than strategy, and cannot address any fundamental weaknesses in the client’s management of the project. While risk can be managed by contracts, it cannot magically be made to disappear. An important point on final costs is that a fixed price contract for a project is a floor, not a ceiling. Contractors will allow for the extra risk a poorly documented tender involves, and have a range of contractual provisions available to make claims and cover cost increases during delivery.
Simple or standardised projects are low risk with minimal technical requirements. These commodity-type projects have well-known structural features and components, their design and location do not present any particular challenges and the construction methods and project management requirements are not exceptional in any way. Examples are car parks and some industrial and commercial buildings. These projects can be accurately estimated, precisely documented and have little uncertainty about what is to be produced and how it is to be done, and should be awarded through competitive tendering on a fixed-price contract.
Figure 1. Project characteristics and contracts
Complicated and complex projects are challenging, each in its own specific way, because of the many characteristics that can cause complexity, such as design, materials, technology, location or site issues, logistics, non-traditional project organisation, or significant coordination and integration issues. Complicated projects require significant development and will benefit from early contractor involvement or have to be well documented before tendering.
Complex projects require more collaborative implementation with early involvement by designers, contractors and suppliers. These have significant uncertainty about their final form, and should be awarded through negotiation with some form of cost-plus or incentive contract. It may also be advantageous to look for innovative ideas or design options, so for these projects an incremental approach allows contractors and suppliers the opportunity for input during the development of the design.
Traditional forms of project organisation and procurement are designed for delivering well documented commodity projects and making repetitive decisions in a stable, predictable environment. By contrast, complicated and complex projects are not fully documented and have significant uncertainty about their final form, and should be awarded through negotiation with a qualified supplier on some form of cost-plus or incentive contract. What will be an appropriate procurement strategy for a simple project will be inappropriate for more complicated or complex projects.
Target Cost Contracts
A target cost contract (TCC) is an incentive-based procurement strategy that rewards a contractor for savings, using an agreement on cost with an incentive fee. The three components of a TCC are the design, with reimbursable cost with an agreed margin, a lump sum amount as an incentive for the contractor to reduce construction cost below the agreed estimate, and a compensation mechanism for major design changes (not design evolution).
Under a TCC, the actual cost of completing the project is compared to an agreed target cost. If the actual cost exceeds the target cost, some of the cost overrun will be borne by the contractor, known as the ‘painshare’, and the rest by the client following an agreed formula. Conversely, if the actual cost is lower than the target cost, then the contractor will share the savings with the client, known as the ‘gainshare’. This painshare/gainshare mechanism is intended to align the interests of contractors and clients, and is the distinguishing feature of these contracts.
Claims under a TCC can be difficult to manage if there are changes in the target cost. These can be cost reductions due to contractor input (through design revisions for example) and cost increases due to client design changes. The challenge is to preserve the incentives while resolving disagreements about the extent and effect of target cost changes.
While incentives might be an effective way to reduce cost, improve project delivery and increase productivity on major projects, the actual operation of the painshare/gainshare mechanism is not straightforward. The sharing formula can vary from simple to complex systems of benefit and risk sharing, and can involve more than one supplier.
Because the agreement and the painshare/gainshare mechanism is between the client and the contractor and typically does not include designers, subcontractors and other suppliers. This is a weakness in these contracts, as the contractor can attempt to shift risks down the supply chain to maximise their profit.
Rather than the client sharing the gain from improved performance, this share could be used to provide an incentive through the supply chain, and thus allow subcontractors and suppliers to benefit as an incentive to increase their productivity.
Target cost contracts can be used to provide incentives to reduce cost, improve project delivery and increase productivity on major projects. However, significant investment in planning, estimating, and preparing detailed designs is required. The potential of BIM and digital twins to improve project design documents is a factor. With the digitisation of design there are more opportunities for target costing and performance-based contracts.
Conclusion
Delivery of construction projects is a vexed topic, particularly for large and/or complex projects. It brings together a range of economic, social and political issues for which there are no definitive answers, and thus poses challenges in decision-making and governance not found in procurement of many other projects and services. These are further compounded by the long time horizon of built assets and associated return on investment or value for money aspects of many large projects.
It is well known that the future is uncertain, where uncertainty is an unmeasurable or truly unknown outcome, often unique. Major construction projects are typically selected under conditions of uncertainty, not risk (which is identifiable and measurable) for three main reasons: costs and benefits are many years into the future; the projects are often large enough to change their economic environment, hence generate unintended consequences; and stakeholder action creates a dynamic context with the possibility of escalation of commitment driven by post hoc justification of earlier decisions.
A great deal is already known about the requirements for successful projects, based on the performance of projects over the last two decades and the many studies and reports that have been done on those projects. Better use of data from previous projects in the evaluation and definition stages of new projects and a more empirical approach by clients in collecting and using data is necessary if better decisions are to be made. This is what Reference Class Forecasting does.
The procurement strategies and implementation processes used by clients can be improved. Contracts manage risk, but ultimately clients are responsible for their projects, and specification, design and documentation should be completed, as far as possible, before going to tender or before work begins. Sequencing of major projects’ design allows input from contractors and suppliers and creates a pipeline of work. Major projects should be broken into sub-projects where possible, to reduce barriers to entry for tenderers, create opportunities for local contractors and suppliers, and increase competition.
BIM mandates are important because the use of BIM unlocks the potential of digital construction. The ISO 19650 standards for BIM and digital twins provide a framework for creating, managing and sharing data, and the experience of overseas jurisdictions with BIM mandates is that BIM use increases over time. Industry has a collective action problem because the cost of adopting a new technology is significant and skills are typically in short supply. Therefore, BIM mandates from government and private sector clients are needed to promote BIM use, which will also increase industry capacity.
While there are many straightforward projects being built, using conventional materials and well-known techniques, there are also many larger, more complex projects. Simple and standardised commodity projects are well documented with little uncertainty about what is to be produced and done, and should be awarded through competitive tendering on a fixed-price contract.
By contrast, complicated and complex projects are not fully documented and will have significant uncertainty about their final form. Complicated projects are often better done on a cost-plus basis. Incentives are an effective way to reduce cost and increase productivity, and target cost contracts should be considered for complex projects that require more collaborative implementation and early involvement by designers, contractors and suppliers.
[1] See Flyvbjerg, B., Bruzelius, N. and Rothengatter, W. 2003. Megaprojects and Risk: An Anatomy of Ambition, Cambridge, Cambridge University Press. A more recent and less academic book is Bent Flyvbjerg and Dan Gardner, 2023. How Big Things Get Done: The Surprising factors Behind Every Successful Project, From Home Renovations to Space Exploration. New York, Currency Press. From that book, in Flyvbjerg’s database of 16,000 projects 91.5% go over time and budget. The risk of a project going disastrously wrong (not 10%, but 100% or 400% or more over budget) is surprisingly high.
[2] Merrow. E.W. 2011. Industrial Megaprojects: Concepts, Strategies and Practices for Success, Hoboken, N.J.: Wiley. Second edn. 2024.
[3] Bajari, P. and Tadelis, S. 2006. Incentives and award procedures: Competitive tendering versus negotiations in procurement, in Dimitri, N., Piga, G. and Spagnolo, G. (Eds.) Handbook of Procurement, Cambridge UK: Cambridge University Press, 121-139.
