Contracting system isn’t saving money

Photographs by Mark Morelli

IT SOUNDED LIKE a good idea at the time. Stung by the enormous cost overruns of the Big Dig and other open-spigot public projects, officials on Beacon Hill wanted to put more of the risk associated with excess spending on contractors. They came up with a system in 2004 that seemed to fit the bill. Instead of the usual process of having a building or a public works project designed and then awarding the construction contract to the lowest bidder, the new system called for selecting the contractor up front and then negotiating the construction price as the full scope of the project emerged.

The new approach brought the contractor into the design process at a much earlier stage, offering the chance to work out any conflicts between design and construction early on, a key cause of past overruns and delays in getting work started. The most attractive feature of the new contracting system was a “guaranteed maximum price,” above which any cost overruns would be the responsibility of the contractor and not the public.

Some government agencies say the contracting approach is working, primarily by reducing the length of the construction schedule. But a growing body of evidence suggests the new method is not living up to expectations. The ballooning cost of the Green Line extension to Somerville and Medford is the latest, but not the only, example. A CommonWealth review of 110 state and municipal projects green-lighted by the state Inspector General’s office for the contracting approach indicates costs have nearly doubled from initial estimates. The initial estimated cost of all the projects combined was $5.3 billion, but the tally is now nearly $10 billion and the tab continues to rise with about 40 percent of the buildings still under construction and final costs not tabulated for many more.

Critics of the contracting approach say it has given contractors an incentive to inflate prices to reduce the risk of their responsibility for cost overruns. Others say the contractors allowed to do these types of projects have essentially hijacked the process, and have been able to get away with it because government agencies lack the engineers and managers needed to keep them in line. State law also limits the number of contractors who can do these type of projects to those who have done them before, which restricts competition.

Perhaps the biggest blow to the contracting approach came in early September when the state’s Supreme Judicial Court ruled that a guaranteed maximum price isn’t really guaranteed. The decision, overruling a lower court decision, will probably mean that the state must fork over $5 million more to a subcontractor who spent more than the supposed ceiling price under the guaranteed maximum.

The Baker administration, which has been diving into all sorts of sticky problems in its first year on the job, seems wary of tackling this one even though the governor’s vaunted MBTA reform bill included expanded use of the alternative procurement process. Transportation Secretary Stephanie Pollack is taking a wait-and-see approach in assessing blame for the cost overruns on the Green Line extension. Perhaps more telling, the state’s Division of Capital Asset Management and Maintenance, which deals with contracting procedures across state government on a daily basis, took several months to respond to questions about the contracting procedures and then issued a “no comment.”

Charles Chieppo, who was part of a group inside the Romney administration that pushed for the new contracting approach more than a decade ago, says it hasn’t worked out the way the group planned. “What you’ve ended up with is, instead of more competition, which is the driving force, you’ve ended up with less competition,” says Chieppo, a senior fellow at the Pioneer Institute. “The anecdotal information is it’s not saving money.”

LEARNING THE CODE

Understanding the ins and outs of the controversy first requires knowledge of the jargon spoken in the construction business.

The government’s long-standing approach with public construction is called design-bid-build, which is fairly self-explanatory. The state hires a firm to design the project, then puts the construction work out to bid, and hires a contractor to build it, usually the lowest bidder. Problems inevitably crop up when the contractor discovers flaws in the design, which spur design changes that lead to cost overruns and the potential for a process that can spiral out of control.

In 2004, the Legislature approved a couple of different approaches that call for the contractor to be selected up front. One is called design-build, where the contractor works with the design team right from the start and at some point a guaranteed maximum price is agreed to. This process is mainly used by state agencies and is aimed at public works projects such as roads, bridges, turbines, and garages.

The other approach is called construction manager at-risk — commonly referred to as CM at-risk. The public agency selects a construction manager who works with the designer from the outset of the project or at least very early on in the design stage. Once the design work on a project is 60 percent done, an initial price is agreed upon based on the proposed completed design work. Once the entire design is finished, a guaranteed maximum price is set. The public agency involved in the project is required to have an “owner’s representative,” often a private independent construction expert who serves as a liaison with the contractor.

The CM at-risk approach is limited to projects such as school or public safety buildings with a project cost of more than $5 million. Some state agencies, including the University of Massachusetts Building Authority, the Massachusetts Water Resources Authority, and other independent authorities, are exempted from many of the restrictions.

Finally, there is an approach called construction manager-general contractor, which was approved by the Legislature in 2012 as a pilot program specifically for the Green Line extension. Under that program, the MBTA hires a contractor, a designer, and an independent cost estimator. The three parties each develop cost estimates as the design advances. Once design is completed, the MBTA and the contractor agree on a guaranteed maximum price. By law, if the contractor’s estimate is greater than 110 percent of the independent cost estimator’s, as is the case with the Green Line extension, the MBTA can try to bargain the price down or, if unable to reach an agreement, put the contract back out to bid under the traditional lowest-bidder method. In that scenario, the original construction manager-general contractor — in the case of the Green Line, White Skansa Kiewit Joint Venture — is prohibited from entering into the bidding.

In 2010, the cost of the Green Line extension was estimated at $953 million, but by January of this year the tab had risen to nearly $2 billion. T officials secured $1 billion from the federal government for the project, ensuring the state could keep its cost close to the original projections. But in May, when White Skansa Kiewit submitted a cost estimate to build the first phase of the project, the price was more than double what T officials had penciled in. The cost of the extension’s later phases also spiraled upward, making the price for the entire project between $700 million to $1 billion higher than originally estimated.

MBTA and state transportation officials told the T’s Fiscal and Management Control Board that one of the disadvantages of the new contracting process is that the contractor, on the hook for any cost overruns, has an incentive to inflate the price. “Possible reasons for higher than expected bids include…CM/GC ‘padding’ costs with high ratio of management to craft staff, due in part to avoid costs above guaranteed maximum price,” officials wrote in a presentation to the board.

The recent renovations at Logan Airport’s Terminal B, which used the CM at-risk approach, also came in far above the initial estimate. Targeted for $92.5 million, the project’s cost was initially reduced to $82 million but then ballooned to $143 million even after some elements were eliminated. A spokesman for Massport says the changes that increased cost came at the request of airlines and Transportation Security Administration officials, which he says will be recovered from federal reimbursements and increased baggage fee revenues.

Among those items cut were expanded ticketing and security checkpoint areas that were eliminated from the original design at the request of the contractor to save money, according to a Boston-based architect familiar with the project who asked not to be identified. The architect says the changes compromised the project. “When it is crowded, the concourse is almost impassable,” the architect says. “There is not enough queuing and space at the new security checkpoint.  A new checkpoint should not be too crowded on day one.”

CM at-risk is the most commonly used contracting method because, in part, state lawmakers gave municipalities an incentive to use it in building new schools. Each community that uses CM at-risk receives an extra point from the state on its reimbursement rate, which ranges from 31 to 80 percent of the cost of a project. Depending on the size of a school project, an extra point is worth anywhere from hundreds of thousands to millions of dollars.

Newton North High School, built using the CM at-risk process, saw its cost skyrocket from $109 million when it was first proposed in 2003 to nearly $200 million by the time it was completed in 2010. It is the most expensive school ever built in the state.

At the same time, Quincy built a new high school using CM at-risk and saw the $126 million project come in about $7 million over the guaranteed maximum price despite a four-inch stack of change orders that cut out many amenities to save money.

When it came time to build Quincy’s new Central Middle School, officials opted to go back to the old lowest-bid procedure, which they say saved money because they used what is termed a “model school design.” Model schools are buildings that have been constructed in other communities that can be used as a template and reduce costs because all the bugs are already worked out. James Timmins, Quincy’s city solicitor, who dealt with both projects, said the city opted for the traditional method on the advice of the school building authority.

“We were going to get very competitive bids using design-bid-build so there was little benefit derived out of going CM at-risk,” he says.

In fact, a study by the Associated Builders and Contractors of Massachusetts, a group of nonunion construction firms, found that in 2009-2010 communities that built schools using the lowest-bidder method had nearly four times the savings of projects that used CM at-risk. Of the 12 projects using CM at-risk, the final cost came in 5 percent below the estimated price. For the 18 school projects that went to the lowest bidder, the average savings was 21 percent.

“I think the name is part of the attraction for communities,” says Greg Beeman, ABC’s president and CEO. “When you look at the numbers, though, it’s kind of hard to come to the conclusion that communities are less at risk than communities who use the traditional model.”

Beeman says part of the problem is the small pool of contractors eligible to do CM at-risk jobs. State law requires that only contractors who have prior experience with the construction approach can compete for projects, which excludes a broader pool of contractors who have built schools as lowest bidder but have not been able to get their foot in the door for CM at-risk projects. All of the companies qualified to do CM at-risk work are union firms, Beeman says.

“One of the ideas of the law was to create an opportunity to get more private sector contractors in the public market,” says Beeman. “As it turned out, it’s really a method where the playing field is only a handful of contractors. It’s one of the unintended consequences. They gobbled up the early experience and that handful of companies became the only contractors who built a school with the CM at-risk model and now they’re the only ones who can be hired for them. It’s a Catch-22.”

NO GUARANTEES

One of the biggest setbacks for the alternative contracting method was a SJC decision that said the guaranteed maximum price isn’t really guaranteed. The court ruled in a case filed by Gilbane Construction, which was hired to build a 320-bed state psychiatric hospital in Worcester. One of Gilbane’s subcontractors, Coghlin Electrical, submitted a bill for an additional $5 million because the walls and ceilings in the building lacked sufficient space to accommodate electrical wiring.

Gilbane initially rejected the invoice, but later submitted it to the state’s Division of Capital Asset Management and Maintenance, claiming the extra work was caused by a faulty design approved by the agency. State officials refused to pay the invoice and Gilbane, which was being sued for payment by Coghlin, sued the state, saying the initial design was faulty. DCAMM argued Gilbane was liable because the company was fully aware of the original design when it agreed to a guaranteed maximum price on the project and could have made the changes then.

Last fall, Worcester Superior Court Judge Brian Davis sided with the state, dismissing Gilbane’s claim because he felt the risk of delays and extra cost were the responsibility of the contractor. “As implied in its name, a [CM at-risk] contract shifts most of the design review, management responsibility, and financial risk associated with the underlying public construction project — including the risk of cost overruns within the original project scope — to the designated ‘construction manager’ in return for a ‘guaranteed maximum price,’” Davis wrote.

Court transcripts indicate Davis and Gilbane attorney John DiNicola engaged in an interesting exchange on whether DCAMM was responsible for a “change in scope” on the project, which would have been the financial responsibility of the government.

“It was always expected there would be walls, for example, right?” Davis asked.

“Yes,” DiNicola replied.

“And ceilings?” Davis asked.

“There was a design change in the wall framing,” DiNicola responded.

“True,” said Davis. “But there was always an expectation that there would be walls?”

“Yes, I don’t think you can have a building without walls,” said DiNicola. “I would agree with that statement.”

“Great,” said Davis. “So no change in scope because they had walls, and no change in scope because they had ceilings on top of the walls.”

But in September, the SJC, which took the case directly on appeal because of the public policy implications, vacated Davis’s ruling and remanded the case back to him for trial on Gilbane’s claims against the state. The SJC ruled that there is an “implied warranty” from the state for cost overruns despite agreement on a guaranteed maximum price.

In a decision written by Chief Justice Ralph Gants, the SJC acknowledged that public agencies bore the risk under the old lowest-bidder method because they oversaw the design and approved the final drawings that then went out to bid. But the justices said that even though the CM at-risk was involved in the process early in the design phase and has input, it is still up to the public owner to get designs right.

“As significant as these differences in relationship are, we are not persuaded that the relationships are so different that no implied warranty of the designer’s plans and specifications should apply in construction management at-risk contracts…and that the [CM at-risk] should bear all the additional costs caused by design defects,” Gants wrote.

NO GOOD DATA

A fierce debate on construction policy is now taking place behind the scenes on Beacon Hill, but the discussions are hampered by a lack of data. Since 2005, more than 75 schools have been built using the CM at-risk method, state records show. But while more than half of those projects have been completed, the final reconciliation of costs is still not done. In Belmont, for instance, the $39 million Wellington Elementary School was opened in 2011 but the final costs still have not been submitted, according to state records.

The Legislature authorized the Inspector General’s office to perform a review five years after the law was enacted. But that 2009 report, the only one performed by the state, was thin on conclusions because few projects had been completed by then.

The MBTA is also supposed to file a report every two years on the construction approach being used on the Green Line extension project. The first report was due last year, but it was merely a summation of what the intent of the contracting method was and explanation of what the benefits could be. The report also includes a recap of the selection process, which shows White Skansa Kiewit was ranked second in technical score and qualifications of the three finalists, and, incredibly, won the contract with its price proposal, which did not ask for an estimated maximum price as intended by the law but rather was focused on overhead costs and profit margins.

The law also required the administration to file a report with the Legislature and the Inspector General when the first $100 million on the project was expended, detailing the results to date and certifying the use of the process going forward. So far, the MBTA has awarded more than $206 million in contracts but no reports have been filed to certify the method, according to a spokesman for the Inspector General.

Supporters say CM at-risk and its cousins were never intended to be seen as cost savers, their value instead lying in the streamlined process, cost-certainty, and a better-built product. Joel Lewin, head of the construction law division at the firm Hinckley, Allen & Snyder LLP, which represents several of the certified CM at-risk firms, including Suffolk Construction and Gilbane, says a dollars-and-cents analysis won’t yield a clear picture of which construction approach is a better use of public money.

CM at-risk “gives the owner the opportunity to take advantage of the input and expertise of a contractor prior to the start of construction,” says Lewin. “That’s invaluable. You can’t take a survey of what final cost is and be able to compare them apples to apples with CM at-risk. I think that’s impossible. No two schools are exactly the same at the end of the day. You can’t compare the original bid price on a project with the final cost. There are changes in design, unexpected decisions, changes made by the owner [public agency]. No two projects are exactly like.”

Massport says the ability to work collaboratively with the contractor from the outset helps reduce the construction timeline by months, if not years, and brings about price stability. “We find CM@risk helpful in many cases because the time to completion is much faster than design-bid-build [the traditional method],” Massport director of communication Matthew Brelis says in an email. “That is exceedingly helpful in the dynamic environment in which we operate with airline mergers, growth, and consolidation. All of that stimulates the economy and fosters economic growth… If it was design-bid-build, it would not yet be open and we do not believe there would have been a difference in cost.”

Jack McCarthy, executive director of the state School Building Authority, says CM at-risk isn’t chosen for its cost-savings. “It’s easier to manage [a project] because there’s less people to deal with,” says McCarthy, who worked at the Inspector General’s office when the CM at-risk law was first passed and when the office issued its five-year report on the new contracting approach in 2009. “One of the reasons you do CM at-risk is for something unexpected. It’s the things you don’t know that drive up the cost.”

Transportation Secretary Stephanie Pollack says the T is in the process of determining if any contracting method can salvage the Green Line extension. Pollack says the initial cost estimates were formulated when the project design was 60 percent complete, as required by law. By the time the final drawings were done, she says, a more precise price estimate was possible. Pollack says the hired designers on the project, as well as the independent cost estimator, came up with divergent estimates as well.

“We’re still in the diagnostic phase in understanding why this bid has come in so high,” Pollack says. She says officials are trying to determine if the contracting method affected the price or if other factors are to blame. “This method was not only chosen but specifically authorized by the Legislature to have it move along faster. There is no guarantee if we went out to bid that we would actually save any money,” she says.

Some early supporters of the alternative contracting approaches say they are sound in concept, but faulty in practice because public agencies lack the in-house expertise needed to make them work. Chieppo, who was part of the Romney team pushing for the changes a decade ago, says there is nothing underhanded going on.

“The owners on these cases, they’re not doing anything criminal or anything nefarious,” he says. “They’re just not particularly sophisticated at what they’re doing. They’re not having to sharpen their pencils.”

Gregory Sullivan was the Inspector General when that office did the legislatively mandated review of the CM at-risk process in 2009. While his report praised the approach as pumping new life into the state’s construction process with cost-certainty and on-time delivery, he has since modified his view because, he says, the lack of public employees with construction expertise means private contractors can take advantage of the system.

“CM at-risk can be very good when run by bona fide public construction agencies, but is vulnerable to abuse at places like the MBTA where the work of professional engineers and architects can be effectively disregarded,” says Sullivan, now a research director at the Pioneer Institute.

Former governor Michael Dukakis, a strong transportation advocate, says state agencies have let go their in-house experts in construction, design, and planning, placing the agencies at the mercy of outside vendors who look at state government through the prism of private industry.

“Where’s the Frank Kevilles at the T?” Dukakis asks, invoking the name of a legendary official who rode herd over the Red Line extension to Alewife and other transit projects in the late 1970s and early 80s. “There’s no one like Frank Keville anymore who knows what’s what.”

But there is growing concern that the system itself doesn’t work. The Boston-area architect who is critical of the contracting approaches says CM at-risk, in particular, has made for costly projects that don’t always result in better products. The architect says part of the failure of the law is including contractors in any portion of design because their expertise is in construction and their goal is profit. He says few, if any, have the training or expertise to gauge what is the best approach and what is needed for safety when it comes to design.

Pointing to the Massport Terminal B renovation as an example, he says many contractors will push to reduce and exclude segments of a design as well as substitute cheaper materials in order to maintain their profit margin with the guaranteed maximum price.

“Typically the CM will want to strip the building down and remove expensive materials,” he says. “They often go too far and hold projects hostage after their award and say that if these items or these areas do not get cut, they cannot guarantee the final price even though these items were included in their good-faith estimates when they were awarded the project.”

The architect says a return to the traditional lowest-bid method would be best for taxpayers, noting his profession would not necessarily be affected by either approach. “This delivery method is another bogus approach that leaves the taxpayer totally vulnerable,” he says of the CM at-risk model. “When you sign a contractor up based on qualifications and on conceptual drawings, they own the contract. When the final drawings are available, the contractor has no competition and can name their price. This is completely ridiculous and utter foolishness for the taxpayers.”