At the start of every building project there is an assumption of a low performance outcome.
In the UK and North America retentions or holdbacks are routinely applied by clients and large contractors. In plain language, money is held back (held hostage) at varying percentages (2% to 10%) from each progress payment. If you do a good job and are lucky, 50% of the retention is returned on project completion and then the remaining 50% is returned at the end of the warranty period. Many times there is a long and expensive struggle to get the retention monies paid out. This is a nasty system where large firms dominate smaller firms in the supply chain. It is a bit like the play ground bully taking 10% of everyones lunch money then deciding when and who gets it back after lunch.
How has it come to this? Well, the construction industry has itself to blame, clients must have such low confidence in outcomes or why would they need retentions? The other question is, why do clients work with firms they have such low confidence in? Bottom line, clients have an assumption of low performance and use retentions to:
- Manage project risk
- Enforce quality outcomes
- Improve project cashflows i.e. pay late
So what is wrong with retentions? Well IMHO they:
- Impair firms cashflows
- Cost firms time and resources to manage and chase payments
- Create unnecessary financial pressure
- Large clients and GC’s use them to bully sub-contractors, suppliers and specialists
- They are really an “interest free loan” to whomever retains the money
- They are basically low class and unfair
Ironically, all the above incentivize low performance!
What are the alternatives? Interestingly P3 is an alternative, it takes the client out of the retention system as risks are passed 100% onto the DBFM company. However only very large, well capitalized companies can play this game and the DBFM supply chain are still frequently victims of the retention system. Some alternatives consist of:
- Project trust accounts managed by an independent certifier (PQS)
- Performance bonds
- Clients drastically reduce their supply chain and partner directly with all its constituents
- Specialist firms form associations and provide performance guaranties
- Clients abolish retentions to demonstrate trust
My favourite solutions in order are:
- Remove all retentions from small projects of say, under $10m
- Clients contractually require GC’s/MC’s not to pass on retentions to anyone in their supply or sub-contract chain
GC’s/MC’s are the big boys with the main client relationship so they should shoulder the risks and be responsible for high quality outcomes. Removing retentions would help prevent minimum compliance, sub-economic bidding and encourage partnerships within the GC/MC supply chain.
It should also be noted that most GC’s/MC’s are not actually construction firms, they do not employ bricklayers, carpenters, plumbers etc they sub-contract them in from other firms. They are really management accountants who are “conductors of the construction orchestra” passing all the risk down the supply chain and using retentions among other tools, to enforce compliance. Interestingly in the UK, one major client concluded the GC/MC was not really adding value and employed all the sub-contractors, sub-trades and specialists directly to build a skyscraper. Maybe this practice will spread.
This negative loop of assuming low performance has to be broken for the industry to evolve. Clients should take the lead by rewarding good performance with fair payment terms and not working at all with poor performers no matter how low their bids appear to be.