PROJECT MANAGEMENT: Mega-Building Risks

We assume that most of the mega-engineering projects being done around the world are in good managerial hands. These billion-dollar enterprises are so big and involve so many major banks, corporate backers and private sector experts, surely they cannot fail.

A professor from the University of Quebec at Montreal has written a book on managing large engineering projects that suggests otherwise, and which should raise eyebrows in the construction world. Authors Roger Miller, ing. and his co-author Donald R. Lessard document an international research project they launched in 1995 to find out what factors make a huge infrastructure project a success or a failure. Astonishingly they found that nearly 40 per cent of the projects performed badly.

The book, The Strategic Management of Large Engineering Projects: Shaping Institutions, Risks, and Governance, was published last year by MIT Press. Besides being Hydro-Qubec/CAE Professor of Technology Management at UQAM, Miller is with SECOR, a management consulting firm he founded 30 years ago in Montreal. Donald R. Lessard is Deputy Dean at the Sloan School of Management at MIT. The research was conducted by IMEC (International Program in the Management of Engineering and Construction), an organization Miller initiated, and which enlists 10 academics and industry specialists from Canada, the U.S., United Kingdom and Norway. The researchers analyzed 60 large engineering works in both developing and developed countries done by the private sector. The projects are wide-ranging — covering everything from the Boston Harbour clean-up, to a subway in Ankara, Turkey, a hydro dam on the Caroni River in Venezuela and the construction of offshore oil platforms off Norway.

Canadian Consulting Engineer interviewed Mr. Miller about the book and his research in early July.

CCE: Tell us about your research and what you were trying to discover.

Miller: The project started in late 1994 and it took us a year to gather the funds. Our first sponsor was a French firm: Cofiroute, which is a builder of roads and freeways. They are the operator of the Confederation Bridge in P.E.I. The Project Management Institute was another early supporter. From there, we got SNC-Lavalin and Hydro-Qubec, and then Ontario Hydro and government agencies like NSERC and Industry Canada. SNC-Lavalin is the only consulting engineer involved.

The question was: What is it that makes some engineering projects very successful, and others fail? We said let’s go out into the field and look at 20 projects. For each project we met the sponsor or sponsors, the bankers, the investment advisors, the regulators, the engineers.

In using the term “sponsor,” do you mean the project owner or developer?

We took the point of view of the companies who are sponsoring the projects, who develop projects to own and operate them. They are doing it to make money, of course. But they take the risk. For example, in Confederation Bridge, the sponsor was GTM International as well as a Dutch firm, plus a third small Canadian firm.

Taking the risk as in losing money on a project?

The risk as in finding the money, getting the project approved, building the project, and then making money over time. Having met these people, we could build a conceptual model because by then we knew what caused success. But since we wanted to have credibility we raised our sample to 60: four projects in Canada, 15 in the States, about 20 in Europe, 10 in Latin America, and 11 in Asia.

For each project we wrote a narrative document. Then we asked the sponsors to rate their projects on a number of dimensions. We also asked them to identify what major risks they saw when they began these projects, and the strategies they used to handle them. So we had both narratives and ratings. Because we had so much data we could build a logistical regression model. We were confident because the model predicted the project performance we had observed in 87% of our cases.

Were you surprised by the failure rate among the projects? I understand close to 40% of them performed really badly.

Yes I was amazed because we selected projects that were finished. I was completely dumbfounded at the downward spiral in some projects. These events are not always reported in the newspaper.

Were they in Canada?

No, no. The ones in Canada were all very successful projects.

Downward spiral — on what measure?

Efficiency and effectiveness. Efficiency has to do with questions like: Did we build on time and within budget? Is the installation working? Effectiveness relates to questions like: Is the project socially acceptable? Is it meeting socio-political objectives? Is it meeting demand objectives? Is it performing adequately from a financial point of view? From an ecological perspective?

When there is a downward spiral, the project remains built. The sponsors lose all their investment, the bankers lose lots of money, and eventually the project is being operated by somebody else. One of the downspiralling projects was in Europe. After a short time in operation the government took over. A project that we saw in the United States was a complete failure. The bankers lost $400 million.

So when you say a project fell on a downward spiral you mean financially. You don’t mean in terms of how well it operates from an engineering point of view?

Ah, from an engineering point of view, projects usually perform well. The downward spirals come from socio-political challenges, from contract disagreements, or from issues of probity. It is easier to perform well on the efficiency measures, which are cost, delivery, and so on, than it is on the effectiveness measures, which are profitability, satisfying the market, surviving.

What caused failure and what caused success?

We found failure is most often associated with turbulence that is impossible to predict. There is exogenous turbulence or endogenous turbulence. For an example of endogenous turbulence, one of the sponsors in a project goes bankrupt; that creates havoc. An example of exogenous turbulence would be where the assumptions turn out to be false as construction is proceeding. For example, in a dam project the data suggests that the maximum flow a river can ever reach is 60,000 cubic metres per second, and it turns out that the statistics are not valid and the flow is closer to 80,000 cubic metres per second. Then you are caught in an unbelievable crisis.

In looking at what caused success, we found that the country in which you operate has to have institutional structures that you can anchor your project into. Not all countries are equal in this respect. You may have a regulatory framework that helps guarantee your income. Or there may be procedures for handling labour issues so that you are not stuck with strikes during construction. The legal structures may or may not protect your property rights or [uphold] your partners’ obligations.

Norway provides an example of a well thought-out institutional structure. Even if you are the project sponsor, you have to have partners, and most of the time one of those partners is a Norwegian firm that is very close to the government. (The company used to be Statoil, but now I’m not sure if Statoil has been privatized or not.) Second, you have to present a plan of operation to the National Assembly. This kind of framework makes projects very successful.

You need institutional structures to anchor projects because, based on our sample, it takes on average 13 years before you can really figure out how much revenue is coming. Something like the PFI (Private Finance Initiative) in England is very good. The British government commits itself. I don’t think the bankers will be afraid of the British government reneging on its obligations — even though Henry VIII did!

Another important factor to predict success is the quality of the sponsors. We found there were three types of sponsor in our sample: network operators, concessionaire-developers and entrepreneurs. A network operator is a large geographically dispersed sponsor such as a utility that has many projects and lots of r
evenues from them. These guys have stability so they can plan things.

Concessionaire-developers are engineering firms that have turned themselves into sponsors of their own projects. One of these, Cofiroute, owns maybe 2,000 kilometres of freeways and it is very successful. But that’s because there is an implicit partnership between construction companies and the French government that has been going on for almost 35 years.

In Canada I think we would question the fairness of that type of arrangement where there is such a close relationship between a private company and the government.

This is the price of our ideas. Fairness may lead us, for example, to prefer competitive bidding, but it is more expensive and less innovative. Bidding supposes that designs have been made. You get the lowest price on a choice [of design] that may be much less innovative than in design-build contracts.

Here is a very good example of the need for quality in the institutional structures. How can you make things clear enough that the issues of fairness and probity are solved? If you can’t solve that issue then you cannot make deals and are obliged to go to competitive bidding and pay more.

We found that 60 per cent of the projects done by concessionaire-developers were successful, whereas 75 per cent of the projects done by network operators were successful.

The third type of sponsor in our sample (about 15%) were ad hoc alliances of sponsors — construction firms, entrepreneurs. Half of them were failures. It is easy to see why. The sponsors are hungry for work, but they get into a project without knowing that it is going to take 10 to 12 years before money will flow and they go belly-up.

Being able to undertake risk analyses, being able to support the front end, is important. The front end costs involve shaping the expenditures needed to get approvals from regulators and stakeholders before you make financial commitments, before you begin detailed engineering and building. On the easy projects these front end costs would be 3-5% of overall costs, but with complex ones they can go up to 30%-40%.

You say the number of these large engineering projects is exploding.

Yes, because we need more and more physical infrastructure, roads, etc. This need is growing all over the world because countries are trying to catch up with the West. I contacted a firm called Conway Data and in 1999 they provided me with a list of over 1,500 projects around the world at a size of greater than $1 billion.

Your recearch results were for large engineering projects. What about for smaller projects?

With smaller projects, maybe the importance of the institutional structure is not going to be as high. With smaller projects what is important is more likely to be strategic decisions, risk analysis.

What do you hope will be the result of your research?

It is good for training people, and eventually will be useful for consulting. It is also a very good tool for talking to governments, because instead of fighting ideological battles, we can start from a base. Governments have a stake in making the private sector succeed. If they don’t, then they will have to build the projects and it’s going to be more expensive. They have to create the conditions such that the private sector will not fail.

Extract from The Strategic Management of Large Engineering Projects: Shaping Institutions, Risks, and GovernanceBy Roger Miller and Donald R. Lessard, with participation of Serghei Floricel and the IMEC Research Group. Published by the Massachusetts Institute of Technology, 2000. Republished courtesy MIT Press. From Chapter 6, “Building Governability into Project Structures,” by Roger Miller and Serghei Floricel

The tendency of projects to disintegrate

The most striking phenomenon observed by IMEC was the tendency of projects facing turbulence to enter spirals of disintegration. Events combined with strategic inaction to trigger feedback processes that sponsors try to stop, but in the absence of solid governance and without the capacity to face difficulties, disintegration ensues.

South Trunk (a fictitious name) is an independent power project built to burn waste coal from a nearby pile. The project performed very poorly, experiencing repeated difficulties in the coal- and ash-handling systems. Participants started blaming each other: the owner blamed the turnkey contractor for incompetence; the contractor, in turn, blamed the owner for delivering coal not as specified in the turnkey contract. The operator also blamed the coal-pile owner for not meeting fuel specifications. South Trunk’s technical problems resulted from planning errors, but mostly from misallocation of risk and responsibility about the testing of waste coal. Moreover, the coal-pile owner had an exclusive noncancelable contract with no incentive to blend the coal.

All managers interviewed agreed that a surprising reversal in coal prices killed the project; technical difficulties became merely a pretext. The unexpected downward trend, which made the project, as it was structured, essentially unprofitable in perspective, had not been predicted in spite of the fact that both the owner and the bank had used simulations, forecasts, prognosticators, and other methods. The project did not survive this surprise because the lack of cohesion in its organizational system precluded joint problem solving: the “blame game,” formalism, and “positioning for arbitration” overtook all participants.

The turnkey contractor asked the owner to pay for changes that were, it claimed, imposed by the fuel nonconformity. The owner, a small entrepreneurial company, turned to the bank for an additional loan: the latter, in turn, wanted substantial changes to finish the project. The owner refused and threatened to declare bankruptcy. The bank agreed to purchase the project and revive it. Thereupon, the turnkey contractor asked the bank to pay for the changes. The bank refused and told the contractor to leave the site; the latter, in turn, put a lien on the project. The bank finally sold the project to the client utility for 25 per cent of the original cost; the utility operated the project for one year and shut it down, arguing that it did not need the additional capacity.

The Tunnel Project (also a fictitious name) was hailed as a novel approach to solving urban traffic congestion and rejuvenating decaying parts of a large town. The innovative aspect of the project lay in its being a partnership among a regional government, two large EPC (engineering, procurement and construction) firms, and a group of banks. It became a privately financed concession after negotiations had produced what was believed to be a low-cost, effective solution. Front-end expenditures made by the regional government for access roads, embankments, and so forth made it possible for the project to operate as a concession: tolls paid for loans and promised to make the equity investment profitable.

Immediately after the tunnel opened, opposition by motorists to tolls and forced entrance points triggered challenges that could not be stopped, especially when it became public knowledge that the concessionaire was asking the regional government to increase its contribution. With the decision by the concessionaire to raise tolls because of cost overruns, public outcries emerged. Opponents of the project, who had reluctantly accepted it, suddenly realized that the public purse would have to pay to ensure “private profits.” The head of the regional government then declared that tolls would be reduced and concessionaires would have to face up to their business risks.

The concessionaires then filed a suit against the regional government, claiming that unexpected geological conditions not specified in the contract had been found. As each successive group denied responsibility over a seven-year period, the project went from euphoria to a degenerative nightmare. Every bulwark that could have stopped this process of disintegration gave way in the face of difficulties. After the concession was cancelled by the courts, the regional government assumed resp
onsibility for the project and hired a firm to operate the tunnel. The original private sponsors and banks were left with stranded equity investments and loans. Yet, the project served a need and thus could be restarted with new owners.

In the face of difficulties, participants have a tendency to leave projects and minimize losses, perhaps at the expense of other participants. The inability to counter centrifugal forces leads to failure. Reflecting back with private sponsors on the probable influences at work, it appears that failures occurred because unsuspected risks manifested themselves radically and strategies to deal with them were either absent or ineffective. Only the presence of governance capacity in project structure can provide some protection.

Efficiency and effectiveness of projects in the IMEC sample (%)