Best Sourcing Practices for Construction Services

This article examines how leading global pharmaceutical companies contract construction services. Although the majority of the project owners are aware of how construction services are procured within their respective organizations, most of them lack clarity on how their peer groups procure the same services. Thus, the objective is to provide an overview of the engagement/sourcing practices of peer groups and analyze where the market is heading in the near future. Many large-scale projects are contractually widespread, and few project owners are successful in handling projects with such levels of technical difficulties. Hence, construction services expertise is currently in high demand for project owners.

Key Highlights

This article examines how sourcing practices are procured globally and regionally.

To obtain a wholesome view of construction practices, one must understand the following:

• How are construction services currently procured?

• What are the core elements of construction procurement strategies?

In our globalized world, pharmaceutical companies are always looking to expand their presence overseas. Typically, growing companies with long-term plans must construct new factories as well as office spaces. Once a decision is made regarding expansion/development, relevant category managers begin to seek providers of construction services.

Pharmaceutical Construction Outlook

Global pharmaceutical spending is estimated to be at $158 billion, which is registering a CAGR of 11.2 percent from 2016. The growth in pharmaceutical output is a result of increasing government spending and growing foreign investment in the pharmaceutical sector, with North America leading pharmaceutical construction globally, with maximum concentration; this is primarily due to the large number of pharmaceutical manufacturers in the region. However, Asia is emerging as the leading destination for pharmaceutical production due to the growth in demand for medicines and other drugs in countries such as Singapore, China, Malaysia, and Korea.

Pharmaceutical Construction Spend Outlook – Global (2016 - 2022)

Source: Beroe Analysis

Decision-making Process

There are typically two types of budgets—the expenses and capital budget—for all projects that require demolition.

Maintenance Projects and Small Demolition Works

These projects fall under the expenses budget. The budget is decided well-ahead of the year and each facility manager/site manager will be allocated a budget annually to execute the renovation/maintenance works.

Larger Expansion Projects or Renovations Greater than $1–5 Million (Reactive Maintenance Works)

If the site manager/local team has a requirement, then either the project manager or the regional manager prepares a proposal for the VPs and CFO. Once the proposal is approved, the local team selects contractors, which involves purchasing/supplier management for bidding, and executes the project.

Capex Projects

Capital funds use is planned well-ahead and is usually self-funded by the company. The initial budget planning starts well in advance (three to four years) and a project manager is hired (full-time) either in-house or someone with the required expertise. The project manager manages the project and accounts for the funds allocated. Capex projects are usually open-book contracts since large spend is involved.  

Core Elements of Construction Procurement Strategy

Construction procurement is usually de-centralized with contractors, engineers, and maintenance people.

The procurement strategy team comprises the VP of engineering, regional engineering head, and the project manager/program manager (in-house). Other functions are outsourced.

The selection of the design, and then, the EPCM team is critical to the success of such projects. The team might be same, but due to country regulations, joint ventures are often formed. The selection process must be very structured and objective. User groups will often attempt to push for the selection of certain suppliers. The selection of these entities must be based on their resources, knowledge, and successful completion of projects – not just their prices. The pricing provided throughout this process must be guarded by procurement and executive management.

Once the client initiates the project, the regional/local project team receives the request. The team determines the timeline, functional requirements, and location of the project. It is mandatory for the local project team to estimate project costs based on these requirements. In recent trends, it is mandated to have pre-bids from a list of three to five prequalified suppliers. Selecting a PM/engineer is a cumbersome process since the PM/engineer must spend time explaining the project to each contractor. The request for proposals is usually a five- to fourteen-day process. In addition, the contractor must provide a high-level overview of project execution, including how much funds will be required and when. This is shared with the procurement team and the financial team to manage cash flow. After the estimation, the procurement team reviews the documents based on their evaluations and respective justifications. The procurement team will approve the project and a 10 percent additional cost is given as a cushion to accommodate any uncontrollable risks/cost overruns. For funds thereafter, the engineering team raises a PO and the finance team approves the PO, thereby releasing funds.

Procurement Best Practices – Pharmaceutical Construction

 

Key factors that impact the selection of the delivery method: Supplier availability and supplier market maturity are key factors that influence decision-making. The higher the supplier’s maturity, the easier it is for the project owner to transfer the risk to the contractor, based  on their confidence in the supplier’s past experience and capabilities.

Based on financial/third-party fund availability, the project budget will impact the contract type and payment terms. Standardized/finalized designs can be completely outsourced to third-party vendors. Complex/unclear design requires clear procedures to incorporate changes in budget and rework timelines. When time to market is critical, buyers pay a premium to fast-track projects. A program manager or project superintendent is hired based on the complexity of the project.

Sourcing Factor	Engagement with Local/Regional/Global Suppliers	Comments
Contracting bundled suppliers	In regions like Asia-Pacific, local and regional players engage with clients; this, in turn, acts as a barrier for new entrants.	Larger E&C firms can provide engineering, project control, and construction services as a portfolio to clients. Cost reduction and increment in purchasing power
Contracting bundled suppliers/multiple suppliers	Regional suppliers	Projects of all categories can be addressed by engaging with multiple suppliers, and it helps to have a set of pre-qualified suppliers in place for any required region over 3–5 years.
Contracting bundled suppliers/multiple suppliers	Many foreign entrants (global suppliers) have entered emerging economies. High competition in the industry means the small- to medium-scale building contractors must work together on certain projects to improve their ability to compete with larger firms.	A preferred supplier method can be adopted, wherein a set of 5–8 service providers are selected, and every time a project is planned, a bidding process can be initiated only among the preferred partners.
Multiple suppliers	Regional and local suppliers	Projects of all categories can be addressed by engaging with multiple suppliers, and it helps to have a set of pre-qualified suppliers in place for any required region over 3–5 years.
Contracting bundled suppliers/multiple suppliers	Prefers regional suppliers	Strong knowledge and exposure to the local environment act as a key element in forecasting industry trends. Continued engagements with various contractors and suppliers provide additional cost benefits.

 

Choosing Lump Sum/Fixed Fee or GMP Pricing Models over Other Pricing Models

Contractor CM or design + CM:  This is the case when CM is combined with other services such as engineering, architecture, and design. This system is often adopted when project spend is within $50 million to $250 million and when design is critical, hence requiring the design team to be separate. In this method, one firm handles the entire design and engineering functions. This method is adopted largely in developed markets. The time scale is generally within 1–2 years.

CM as part of PM: This method is chosen when design and engineering must be engaged by multiple parties—a separate architect, structural and civil works team, and mechanical, electrical, piping (MEP) team. CM as part of PM is used when the owner/client has low in-house expertise and no prior knowledge in the region or in working with the contractor. This is widely adopted in developing regions.

Exclusive CM:  This is undertaken when project spend is considerably high (above $100 million for a single project), or when numerous similar projects under execution (portfolio) have a higher collective project spend, or for multiple locations within the same region.

EPCM – This is adopted when the project is difficult or involves multiple parties, or multiple smaller projects for fast-track execution. EPCM is used when an in-house team cannot maintain a project when the project scale with respect to industry of operation exceeds the capability of the internal team. 

EPCM is preferred by mining, oil and gas, and pharmaceutical buyers because the construction standards for these industries are highly regulated and they fall in the high-spend category.

Conclusion

Procurement/sourcing strategies can be chosen based on the availability of in-house expertise, a relevant contractor pool, and assets. Procurement decisions are made based on cost, quality, timing, and ultimate functionality. For in-house expertise, an average-sized project of medium design and engineering complication requires a team of at least ten members on site. After gauging in-house expertise, the delivery method should be selected. Since contracting scenarios vary, design, project management firms, and contractors are offering their services across different geographies. Companies can gain control of contractors’ expertise based on the requirements of their projects. Most companies fail to closely examine the contractors they have worked with. Companies’ portfolios should be checked for any addition of services. By grouping similar assets, project owners can find collaborations that are specific to the asset type.

Trends indicate that buyers have collaborated with a preferred set of suppliers across multiple regions for different projects; most companies have started to bundle their project portfolio with the contractors they have worked with.

 

 

References

• https://www.constructiondive.com/news/integrated-project-delivery-a-new-way-of-thinking-with-potential-to-reva/412760/

• https://www.aci-na.org/static/entransit/delivery_methods.pdf

• https://www.navigant.com/-/media/www/site/insights/construction/2017/anownersguidetoprojectdelivery.pdf

• http://www.riversideunified.org/UserFiles/Servers/Server_580721/File/Riverside%20Unified%20School%20District/Board%20of%20Education/Board%20Subcommittees/Operations%20Board%20Subcommittee/Project%20Delivery%20Methods_REV-1-%2010-28-16.pdf

• https://www.gilbaneco.com/assets/Delivery-Methods-Summary-Matrix.pdf

• file:///S:/2018/September/Bayer%20-%20Brazil/Delivery-Methods-Summary-Matrix.pdf