06 May 2005
The new terminal at Heathrow airport is on track and on budget. Christian Wolmar believes there are vital lessons for the public sector to learn from BAA's decision to shoulder the risks itself
The installation of the roof on the main building of Heathrow's Terminal 5 was successfully completed in March. At 400 x 150 metres, it is the largest single span roof in Europe. Six sections, each weighing 2,500 tonnes, had to be jacked up over a ten-month period.
To minimise any mishaps, BAA, the company that owns the airport, did a £2.4m dummy run in Yorkshire to see if the concept were feasible. But according to Mike Forster, BAA's development and design director, it saved three months' work on the Heathrow site and taught them a lot of technical lessons.
This dry run was typical of BAA's approach to the T5 project – and in particular, to the issue of risk. The scale of the project is enormous. The site is 260 hectares, the size of London's Hyde Park, with 4,500 people working on it. The new terminal building alone will cost £1.2bn and will be able to handle 30 million passengers per year, which would make it the fourth largest airport in Europe. Building it also involves diverting two rivers and constructing link roads and tunnels, at a total cost of £4.2bn.
But rather than taking the conventional approach of trying to pass on risk to myriad contractors, from the outset BAA took the key decision that it would take on all the risk itself. This is in sharp contrast to contracts that are the norm in the public sector. These attempt to pass on the financial consequences of risk to the contractors.
Ironically, this has not stopped costs going through the roof in projects such as the Jubilee Line extension, the Scottish Parliament and the Millennium Dome. Nor has it stopped risk from ultimately reverting to the contracting organisation, along with massive legal claims and counterclaims.
BAA is, of course, a private company; the authority was privatised in 1987. But it remains a highly regulated business that is very vulnerable to cost increases, since its income is essentially fixed. It is determined by five-yearly reviews of landing charges by its regulator, the Civil Aviation Authority, which also allows BAA a set rate of return, which in turn is meant to pay for the T5 investment. The current period lasts until the end of March 2008 – the opening date for the terminal.
'The regulator allows us a certain rate of return. But to satisfy our shareholders, we have to beat that,' says commercial director Matthew Riley. Huge cost overruns or long delays would send its share price plummeting. Hence BAA's radical approach to risk which – if it proves successful – could have widespread implications for big public projects.
The company has, it should be said, had a long time to think about these issues. The public inquiry into the highly controversial project started in May 1995, after two years of preparation, and heard evidence for a staggering four years. The decision to go ahead was eventually announced in November 2001.
BAA has attempted to distance itself from the more recent controversy over last year's aviation white paper which envisages the need for a new runway at Stansted, another of the company's airports.
However, BAA's growth depends on government decisions. Demonstrating that it is efficient by getting T5 built on time and to budget is particularly important for the company, which constantly fears that it will be forced to relinquish control over one of the three London airports it operates.
The team setting up T5 was most concerned to avoid the pitfalls of other projects it studied. The cost of building the Scottish Parliament increased from an unrealistic £40m to £400m. The cost of the West Coast Main Line upgrade also jumped by a similar factor, while the Jubilee Line extension opened two years late and at £1bn more than projected.
Riley says that if T5's performance had been in line with those schemes 'it would have been one to two years late in completing, been 40% above original cost estimates and we would have killed six people'.
BAA found that these projects were not let down by technical incompetence, but by their management and ill-defined parameters. Rather than attempting to define risks in advance, they tended to be dealt with after the event, leading to massive legal claims.
At the heart of the T5 agreement is the concept that while BAA retains the risk, suppliers work as part of an integrated team to mitigate potential risk and achieve the best results. Teams of people from different companies work co-operatively on the endless smaller projects that make up a massive scheme such as this.
Instead of handing over a set amount to each contractor for risk – which often ends up as profit – these project teams are allocated a small contingency fund which, if unspent, is then available for another team. Rather than simply handing over the work, BAA takes an active management role. These teams act as 'virtual companies', responsible for the task and working to the project's overall milestones.
If there is a failure by a contractor – say a ceiling needs to be replaced – then the work is redone with no blame. Riley says: 'If the ceiling has to be done a second time, then the team will pay the cost with no profit margin. If it had to be redone a third time, then the cost would be down to the particular contractor'.
Essentially, it is a no-blame culture aimed at getting the best results through co-operation, rather than the conventional adversarial approach.
Assuming the risk does not mean that BAA just lets the contractors do what they want. Quite the opposite. Because BAA takes on the risk, it has to ensure that its suppliers and contractors provide services to the highest possible standard, says Riley. 'The agreement is predicated on best practice. That's the minimum standard.' However, he accepts it is not always easy to define what that is in reality.
There is also no main contractor, which is unheard of for a project of this size. It is a very open process, with the suppliers' books available to BAA: a very different relationship than in many public sector projects where firms hide behind 'commercial confidentiality'.
A further benefit of co-operation is that it gives suppliers opportunities to work together to reduce costs. Riley cites the example of electrical switchgear which would normally have cost about £22m, but ended up at £15m because there was one client, rather than several.
The 41 first-tier suppliers have signed the agreement, but BAA also expects second and lower-tier suppliers to work in a similar co-operative way.
The new approach to risk had an early test. Because of the wet winter in 2002/03, the ground preparation got badly behind schedule, which could have meant a two-year delay. With other suppliers waiting to go on site, the consequential claims would have been huge.
But the fact that BAA had assumed the risk, together with the co-operative approach, meant that over the next seven to eight months the delay was clawed back, and there have been no legal claims.
There have also been several threats of industrial action, including one in April, but so far these have been resolved. However, the potential for action, by skilled workers such as electricians, remains a high risk. Similar disputes arose frequently in the latter stages of the Jubilee Line extension's construction, which also had a definite deadline for completion.
Local authorities and other public bodies have tried to get around the issue of risk through complex private finance and public-private partnership arrangements. A prominent example is the way the London Underground refurbishment has been contracted out to two infrastructure companies, Metronet and Tube Lines. Projects are undertaken by the firms for London Underground – which is publicly owned – but the interface between the two is a constant source of acrimony.
The original idea was, in a way, the same as with T5. Conventional contracts had led to massive cost overruns, so the idea was it would be better to hand over the management of the project to private companies, which would be best suited to deal with the workflow.
But under the Tube PPP, the contractors have a vested interest, as with conventional contracts, in doing as little work as possible, knowing they will still receive a guaranteed income. Moreover, the process has exacerbated the blame culture, with claims and counterclaims flying back and forth. Of course, the PPP contracts are supposed to be performance-based but it has proved impossible to calibrate the performance in relation to the real cost for the contractors.
There have been a series of engineering overruns that have delayed passengers, clearly demonstrating that the penalties to contractors are not a sufficient deterrent. Although, notionally, the risk has been passed to contractors, in effect it always lands up with London Underground, which is seen by the public as being responsible for delays anyway.
The advantage of the BAA contract is that there is no pretence that the risk has been passed on and, consequently, the suppliers charge less.
BAA's approach is, in a way, the antithesis of the Private Finance Initiative. Instead of trying to buy in expertise and assuming that the contractors will bear risks, which are often ill-defined, it accepts that ultimately its own reputation is at stake and that therefore it might as well assume the risk. There is the not inconsiderable advantage that, so far, there has been no recourse to lawyers with any of the suppliers.
There are, then, major lessons to be learnt from the T5 project for the public sector. BAA itself has also found it a learning process. Riley admits that the company underestimated the number of managers that would be needed: 'A couple of years ago, we had just 60 people out on the site working with the various contractors to ensure that everything was progressing smoothly. Now we have three times that number, and it may well still not be enough.'
In terms of safety, the approach has undoubtedly proved effective, with no one killed on the site, a good record for such a large project. In terms of progress and finance, the project, which is 55% complete, remains, according to Riley, 'on time and on budget'.
It is due to open at 4am on March 31, 2008 – a time and date recorded by a countdown clock in the project team's reception area. If it succeeds, the T5 agreement might become the norm for major projects. If, however, it does not meet this target, the new model might have proved to be a mirage.
Christian Wolmar is author of On the wrong line — how ideology and incompetence wrecked Britain's railways, due to be published in July