CH2M Hill Takes the Bite out of Risk Management
CH2M Hill is an international engineering company that serves municipal governments in the areas of water and wastewater management, energy, telecommunications, environment and nuclear management, transportation, industrial facilities, and a host of umbrella services. To say that CH2M Hill is adept at managing risks is like saying monkeys are adept at climbing trees. Neither could survive if they weren’t.
So how does such a thriving company with contracts all over the world approach liability when negotiating with a potential client? And what are the elements that determine how risk should be addressed in the service agreement?
The Risk Profile
Doug Herbst is CH2M Hill’s vice president of business development. When discussing client indemnification against liability, he talks about different “risk profiles” and “risk postures.” The type of contract (design/build/operate or just contract operations), length of contract (three to five years or 10 to 20 years) and the amount of time allowed to make a proposal are just some of the variables that can affect the risk profile.
“One big area is what we call uncontrollable circumstances. If you’re looking at a DBO, there’s a whole bunch more uncontrollable circumstances that are associated with the project than if it was just a contract operations,” Herbst says. He cites as an example encountering archeological artifacts or hazardous waste while putting in a pipeline for a water treatment plant and how these unforeseen circumstances impact liability. Herbst says an outsourcer can protect itself from such circumstances with a waiver of special indirect or consequential damages. “It’s a big component of the overall liability. If the client is not willing to give you that waiver, that impacts your liability.”
On the government outsourcing side, the instruments of indemnification are corporate guarantees, bonds, and letters of credit. On the private sector side, preliminary information is a huge asset. If it’s a design/build project, is there enough time for preliminary soils work or inspection of existing information that may indicate a potential for hazardous waste? Does an existing utility have a gas line that bisects the proposed construction site?
Belt and Suspenders
While some government outsourcing analysts say corporate guarantees are the indemnification instrument of choice right now, Herbst says other methods of liability protection—bonds and letters of credit—get plenty of use as well. “There are some transactions where they want the belt and suspenders,” Herbst says. “They want the guarantees, the bonds and the letter of credit. It’s a question of what both parties are willing to negotiate to make it work.”
Just as the client seeks to get the best protection against loss, outsourcers like CH2M Hill must protect themselves from liability by practicing sound risk management. This means making sure the project fits their profile of a good business opportunity. In the case of CH2M Hill, sound engineering practices can provide a hedge against uncontrollable circumstances, coupled with information gathered during the bidding period. Of course all this would affect price. The more you risk, the higher the price. “If you sense there are a lot of uncertainties because you didn’t have the time to get reliable information, you may have a lot of contingency in a particular line item,” Herbst emphasizes. “And that’s one of the ways you manage the risk. The more information you have, hopefully that contingency amount goes down. It’s a balancing act as to how much risk you can take in a competitive environment and what’s the price of the risk.”
Saving a Bundle
In public-private outsourcing agreements, the parties involved determine the point that risk and liability will be addressed. Some municipalities require that liability be addressed in the bid. Others select a vendor based on lowest price and then negotiate the terms of liability. In the former method, the buyer looks at the bidding vendors’ price and risk profiles, and then chooses the one with the best value. In the latter scenario, price takes precedence; risk is discussed later. Depending on the risk negotiations, the price will then ratchet up or down.
According to Herbst, one way to streamline the cost of risk is through bundling. In his experience, the traditional way of providing services to the public sector is very compartmentalized. For instance, an engineering firm may win the bid to design a water treatment plant. A construction company may contract to build the facility. Another service provider may be contracted to operate and maintain the plant. And still another company may be hired to finance the project. Several contracts with several different risk packages. In the alternative service delivery, a municipality would bundle the discrete elements—design, build, operate (DBO) and, in rare instances, financing. In this way, a government enjoys not only a time and cost savings, but also passes on all of the risks it would assume in a traditional approach to the provider. Herbst gives an example: “A designer designs two pipes meeting up in a field. You go out and see the pipes don’t line up. There’s finger pointing, who’s at fault, who’s really paying for that. There are a lot of change orders that the government winds up being liable for.” But in a DBO, where one firm is responsible for everything, there is no issue to be resolved if your plans show that two pipes should meet and in reality they don’t. You have bundled a lot of the elements of the project, where you give full responsibility for design, construction and operation and maintenance to one service provider. In this way the client is almost always getting a better risk profile than it would in a traditional service delivery.
Companies like CH2M Hill thrive not only because they are cost effective and competent in their service delivery to clients but also because they take the proper approach to managing the risks that are inherent in every project they accept.
Lessons from the Outsourcing Primer:
- An outsourcer’s ability to construct a risk profile depends on how much information it can gather during the bid process.
- Successful risk management requires including contingencies for uncontrollable circumstances in the service agreement.
- Alternative service deliveries can reduce the client’s risk because they can bundle all the discrete elements of a project under the responsibility of one vendor.