Contact: Alan Giles, ext 7712 email: [email protected]

1. Summary

1.1 The main issues relating to the proposal for awarding an additional one year extension to the Highways Term Maintenance Contract (TMC) include:

(i) contract expectations;

(ii) preparation work required for a new contract;

(iii) contract compliance in achieving Key Performance Indicator (KPI) targets;

(iv) outstanding contractual issues;

(v) value for money compared with retendering;

(vi) possible effect upon contractor investment plans;

(vii) possible effect upon proposed changes to working practices; and

(viii) overall consequences of retendering too early.

1.2 This report discusses the implications relating to the above issues with regard to the award of a one year extension to the contract. Some of the issues are difficult to quantify accurately but nevertheless an attempt has been made to assess the advantages and disadvantages of extending the existing contract compared with retendering.

1.3 The conclusion is that the risks and disadvantages of not awarding an extension far outweigh the small potential benefits of cost savings achieved by retendering.

2. Contract Expectations

2.1 Highways Term Maintenance Contract, Instructions for Tendering state:

"The Countywide Term Maintenance Contract shall be for a minimum period of 5 years with three 1 year extensions. These three extensions will be awarded by the Employer, subject to the successful Tenderer demonstrating continual improvement and achieving performance measures including agreed KPIs."

2.2 The Highways Term Maintenance Contract Conditions of Contract state:

"The Contract may be extended by additional periods of 52 weeks subject to agreement between the Employer and Contractor."

2.3 Hence, although the award of one year extensions was not definite, both the contractor and Hampshire County Council client staff at the time of the tender expected the contract to be managed on the basis of the wording in the Instructions for Tendering. The TMC Partnering Board, comprising senior members of Hampshire County Council Network Management Board and Raynesway Construction Southern Limited (RCS), was established to manage and promote the partnering activities of the contract, which in turn should enable more efficient working practices to be identified and implemented. It was the expectation of the Partnering Board that one year extensions would be based upon the contractor demonstrating continual improvement measured through agreed KPIs.

2.4 The investment needed on a contract of this size is very large. The contractor currently employs about 250 staff, many transferred under TUPE from district council employment, there are several million pounds worth of vehicles and plant required and the contractor has to invest in improvements to Hampshire County Council owned depots as well as its own depots and offices. It is considered normal that a Highways TMC of this size would run for a minimum of five years to make that degree of investment (ie a commercial return on the capital employed) worthwhile. Contract durations of up to eight years are not unusual and several authorities now have contract durations of more than 10 years, including extensions.

2.5 The contract presently requires RCS to employ New Forest and Eastleigh highway Direct Labour Organisations for highway work in those districts. This was intended to provide some transitionary protection to the workforce when the district agency arrangements were terminated. It is not intended to require the contractor to continue to employ them during any contract extensions. The possibilities of any contract savings arising from this change will be investigated.

3. Preparation Work Required for a New Contract

3.1 There are several alternative methods available for the letting of large TMCs. At present a Departmental Working Team is looking at options for the Engineering Design support (presently through a contract with Atkins). As yet there is no clear indication of the best way forward for the TMC. Matters that will need to be considered include:

(i) type of contract;

(ii) work items to be included;

(iii) level of partnering;

(iv) duration of the contract;

(v) basis for any possible extension;

(vi) new working methods arising from previous experience; and

(vii) efficiency saving requirements.

3.2 The first three of the above items are mentioned in a report to the Buildings, Land and Procurement Panel in April 2005, called Study of Procurement Options for Professional Services. The report was mainly concerned with the procurement of design services but covered the wider area of procurement of other works as well. The report indicated that current thinking is moving away from the traditional single service provision (ie design service or construction service) and instead looking at the economies of scale efficiency that might be obtained by combining these services. In addition, arrangements for joint procurement with the Highways Agency or some form of public-private partnership should also be considered. In all cases a review of the existing management structure of the Environment Department will also need to be done to see what opportunities there are to best integrate with any new contractual arrangements.

3.3 All these issues will need a period of debate and comparison with current industry practice. The timescales needed to incorporate these major changes are such that it is unlikely that the Environment Department would be in a position to recommend new contractual arrangements starting before 2008 at the earliest.

3.4 A timetable and resource estimate for the workload in preparing a new TMC is being prepared. Costs are estimated at £120,000 and staff resources estimated at 12 people for four months, spread over about a 15 month period. This represents the workload in the actual preparation of the contract document itself, including the bills of quantities, which will follow once the best method of procurement has been agreed. The small numbers of staff presently managing the contract will obviously be involved but they cannot stop work on the day-to-day management in order to devote themselves full-time to the preparation of a new contract and additional staff will need to be seconded from elsewhere.

4. Contract Compliance in Achieving Key Performance Indicator Targets

4.1 Although Performance Indicators had been in use for some years in the previous two TMCs using RCS, they had been used more to identify local problem areas and not comprehensively to help raise standards. In addition the quality of the information supplied by both RCS and Hampshire County Council was sometimes poor. Hence one of the first tasks in the running of the present contract was to agree a comprehensive set of Performance Indicators and to establish a base level of performance against which improvement could be measured.

4.2 Performance Indicators were set up in the first year of the TMC (2002/03), often based on existing ones, hence providing a degree of continuity and building on the previous experience in data collection. Sufficient data had become available by the middle of the second year of the contract (2003/04) to measure performance. An assessment at the end of the second year of the contract established that the contractor had met the required performance improvement targets (Appendix 1).

4.3 Experience gained in the second year of the contract enabled the method of calculation of performance improvement to be refined to better demonstrate continual improvement over the course of a whole year for year 3 of the contract (2004/05). Although the method of calculation of the targets is a little more complicated, the end result is a better indication of overall improvement. An assessment carried out for year 3 of the contract shows that the contractor has continued to maintain a steady improvement in performance (Appendix 2).

4.4 The graph in Appendix 2A shows: (A) the performance for 2003/04; (B) the performance for comparable items in 2004/05; and (C) the performance for all items (including a number of new ones) for 2004/05. In (B) and (C) the contractor has maintained a steady improvement. Appendix 2B shows the background information to this graph.

4.5 The graph in Appendix 2C demonstrates that performance is measured against a minimum acceptable level (approximately 70%) again showing the high standards achieved.

5. Outstanding Contractual Issues

5.1 Over the first three years of the contract a number of technical, financial and contractual issues have arisen between the contractor and client which have needed to be resolved (see confidential Appendix 4). The technical issues generally relate to clarification as to how or when work is to be done. These issues are generally dealt with by operational staff and agreed between the parties.

5.2 Financial issues usually relate to measurements of quantities or the agreement of rates for new work items. Negotiations can sometimes be quite complex but the issues are generally dealt with by the Client Contract Management and Quantity Surveying staff and agreed between the parties.

5.3 Contractual issues often tend to be more complex and may require specialist legal advice, for example where the wording in the contract is considered ambiguous, with the possibility of alternative interpretations leading to a potential dispute between the parties. Recent issues relate to the Variation of Price Clause (VoP) and Rebate relating to Annual Value of Works. Hampshire County Council, following legal advice, has put its position to RCS and an understanding has now been reached on those issues. The figures given in confidential Appendix 4 represent the current estimates for the items concerned.

5.4 So far, since the start of the contract in May 2002, just under £100 million has been spent through the TMC. It is worth noting that in past years for a contract of this size, contractual claims from the contractor of up to 10% would not be unusual. For this contract, of the 14 main contractual issues dealt with so far (listed in confidential Appendix 4), these have resulted in additional payments to the contractor of just over £200,000 and rebates paid back to the County Council by the contractor of just over £560,000.

6. Value for Money Compared with Retendering

6.1 One of the major issues associated with the consideration of a one year extension is whether lower contract prices can be achieved by retendering. The chart in Appendix 3 shows the Tender Price Index for the past few years. This indicates the way in which tender prices have changed since the date the contract was awarded. Tender prices will follow the current economic situation in the industry and will rise and fall depending on circumstances. It is necessary to estimate the likely trend based on past performance and an assessment of factors that will affect future prices. Annual contract price changes in the TMC are more predictable (eg dependent upon inflation, value of contract, etc) but are nevertheless still estimates.

6.2 The Tender Price Index chart shows a low point in the third quarter of 2004 and then a steady rise over the beginning of 2005. This trend is expected to continue to the end of 2007. This does not take into account any impact arising from the recent decision to host the 2012 Olympics. The stepped line shows the current TMC expected increases which reflects annual adjustments for increases in Retail Price Index (RPI) and materials costs, less an efficiency deduction. A comparison of the two lines shows the relationship is expected to remain about the same.

6.3 It is extremely difficult to ascertain what Hampshire County Council would end up paying if it went out to tender again, compared with current contract rates, because of the many influences which affect tender prices. Quality of service, not just rates, are an important consideration. The TMC tender was assessed on a combination of both price (80%) and quality (20%). RCS was the second lowest tender but won overall by demonstrating its ability to provide the required quality standards for the contract.

7. Possible Effect Upon Contractor Investment Plans

7.1 This issue relates to the effect upon contractor confidence if a contract extension is not granted, especially regarding the contractor pulling back from investing in new plants, depots and IT systems. This is obviously an issue for all similar contracts as they approach the end of their contract period. Experience is rather limited for both Contractor and Client organisations due to the relative infancy of these longer duration Highways TMCs. Failure to award the extension is likely to have a negative effect on

contractor confidence and is likely to limit future investment. Some examples of contractors investment in plant and depot facilities are given in confidential Appendix 5. If there is a termination of the contract in May 2007 then the contractor's investment plans are likely to be reviewed.

8. Possible Effect Upon Proposed Changes to Working Practices

8.1 The partnership approach to the contract has provided for the Partnership Board and the production of a Joint Business Plan. The Joint Business Plan contains proposals for staff from both organisations to look jointly at ways of dealing with issues such as PR, specific operational efficiencies, innovation and recycling. Many of the issues listed in the Business Plan are still being investigated or developed and will probably require at least a year or so after implementation for any changes to settle down and efficiency savings to be fully quantified.

8.2 One of the major initiatives arising from the Joint Business Plan is the setting up of a number of Construction Lean Improvement Programmes (CLIP). This is a national programme supported by Government, to encourage more efficient working practices in the construction industry. It builds on work done by groups such as Movement for Innovation and Sustaining Construction. The CLIP programme for the TMC is jointly funded by Department for Trade and Industry and is a pathfinder in its field, being the only national scheme involving highway maintenance.

8.3 The CLIP analysis techniques are particularly suited to many of the highway maintenance operations, which involve a mixture of input from both client and contractor's staff, again with opportunities to identify and eliminate duplication and put in place more efficient ways of working. The methods require the detailed analysis of the various tasks undertaken to deliver a particular service (eg Winter Maintenance); a look at the times taken for each of the individual tasks and then consideration of better ways to achieve the desired end results.

8.4 The use of the CLIP technique in the Street Lighting Contract has resulted in some fairly radical and innovative changes to working practices with considerable opportunities for efficiency savings. The experience gained will be taken into account both in the preparation of a new Street Lighting Contract and help inform contract preparation for the next TMC.

8.5 Initiatives such as Sustainable Construction have been a major driver for this contract. The contract already included provision for innovative techniques such as Infra-red Patching (allowing for in-situ repairs instead of excavation and replacement of blacktop). The development of Foamix (using excavated blacktop in new blacktop production) during the present contract has reduced the waste going to landfill and helped achieve the County Council's PSA Waste Reduction target. There have been major depot improvements to facilitate these changes and more are required, many of which will not be possible without the necessary cooperation and investment by the contractor.

8.6 Failure to award the one year extension will curtail several of these initiatives and have a detrimental effect upon the incorporation of such changes within the next contract. This would not necessarily be due to the contractor's withdrawal of cooperation but simply through lack of time to properly investigate the issues, plan the improvements, implement trials within the current contract and then build on the knowledge gained by way of new working methods in the next contract. Many of the issues being looked at by the CLIP groups are complex (eg delivery of the Emergency Call Out Service) with the need to study the present working methods and collect data over a complete annual cycle before analysis can even start.

9. Overall Consequences of Retendering Now

9.1 If a one year extension is not granted, a new contract will need to begin on 1 May 2007. This will require a start on contract document preparation by Christmas 2005. Within that timescale it is unlikely that a new form of contract could be prepared and hence the use of the existing form of contract, with relatively little variation, is likely. Although this contract has been reasonably successful up until now, it would be a pity to lose the opportunity to introduce something more innovative.

9.2 There would be a lack of experience with regard to some of the trials that may be proposed from the CLIP working groups and Joint Business Plan initiatives. In fact some of the ideas may not be implemented at all during the life of the present contract and have to wait until the new contract. Again a lost opportunity to start the new contract with streamlined working practices gained from experience in the current contract.

10. Impact Assessments

10.1 An impact assessment of the service will be undertaken when a new contract is re-let as a standard part of the equalities submission.

11. Conclusions

11.1 Given the performance under the contract, further investment expected and improved initiatives under way, the only reason not to grant an extension would be if retendering now was expected to achieve significant cost savings.

11.2 Retendering early poses a risk. There may be a chance to enter into another five year contract at lower prices than would be achievable if the current contract was continued. However, there is also the chance that tender prices would not be significantly lower, particularly with the quality elements likely to be required. On top of this, many issues identified as potential efficiency savings in the current contract would not have been fully implemented or trialled. This would result in not being able to incorporate the new working practices into the next contract. At worst the wait would be until the beginning of the contract after next to implement proposed changes. Unfortunately many of these issues are difficult to

quantify but the current Tender Index does not indicate such a significant drop in tender prices that would make retendering a worthwhile risk to take.

Recommendation

That a one year extension be granted on the Highways Term Maintenance Contract.

454Rpt/AG

APPENDIX 2C

TERM MAINTENANCE CONTRACT KEY PERFORMANCE INDICATORS FOR 2004/05

APPENDIX 3

TENDER INDEX COMPARISONS WITH TMC VOP CHANGES

Construction price and cost indices - Term Maintenance Contracts

The request was made to look at Construction Price and Cost indices to try and predict tender prices over the new few years and the effects against the Highways Term Maintenance Contract currently undertaken by RCS. The objective was to try and determine if, in purely net cost terms, it was worthwhile extending the RCS Contract.

Any exercise of this nature is to a certain extent subjective - because prediction of future prices is fraught with many problems and is based upon current assumptions - but by careful analysis of the available data, trends may be established that can aid and give objective rational to such predictions.

Four indices were chosen that it was felt could assist the exercise.

Civil Engineering Cost Index

This is a series of Cost Indices constructed from elements of labour material and plant complied by Davis Langdon and Everest (Chartered Quantity Surveyors) on a quarterly basis. The purpose of the index is to determine input costs of basic components that contractors have to pay to undertake work. Although useful in estimating and determining trends in costs - the index does not take into account discounts or other private deals between trading companies. This makes the absolute index value inaccurate.

Retail Price Index

Published monthly by HMSO on behalf of the Government, this index is constructed from a comprehensive basket of everyday elements (milk, bread, rents, fuels, etc) and aggregated into a single index as a headline benchmark. It does not specifically relate to construction works but gives an indication of prices generally. It does however relate to the RCS Contract because variation of prices are calculated using RPI - X and capped. Therefore the comparison between RPI and RCS variation of price is interesting.

Road Construction Tender Price Index

Published by the Department of Trade and Industry (DTI), this index is probably the most useful for this exercise. It is published quarterly and is an aggregate of the level of tender prices received by local authorities specifically for highways contracts including maintenance works. Indeed Hampshire County Council submits regular data to the DTI for inclusion within the index.

RCS Variation of Price

The fourth set of data is not strictly an index but represents the relative movement of prices caused by operation of the TMC variation of price clause. This is based on an agreed 3.6% increase at the beginning of 2003/04 (contract year 2) and a 2.5% increase per year thereafter, in line with the VoP formula in the contract. The 1%

rebate for annual works valued more than £30 million is not included, since this might not apply in every year of the contract. So far the rebate has been agreed partially for Year 2 (2003/04) and fully for Year 3 (2004/05).

Construction of the Data

The four indices chosen are at differing levels as shown on the attached graph. They have all been base dated back to Quarter 4 2001 to an index of 100. This relates to December 2001 which was the return date of the Highways Term Maintenance tenders.

In addition, the base data indices have been statistically trended. This has the effect of smoothing changes and allow future trend lines to be predicted.

All indices, except for RCS VoP, are the latest published index up until Quarter 4 2004. The RCS index represents the correct increases paid to RCS from Quarter 2 2003 until Quarter 1 2006. From Quarter 2 2006 until the end of the five year contract it is assumed that RCS will receive the capped 2.5% increase.

CE cost index, RPI and RC tender price indices are all estimated from Quarter 1 2005. The estimation has been made using a projection of the previous trend forwards but with realistic forecasts in mind. Merchant Bank ABN Amro and Davis Langdon and Everest both predict construction market downturns throughout 2006 and 2007. This will continue to depress tender prices even though cost pressure continues.

Keith Gale