Australia: Driving Success and Efficiencies in Services Contracts

Last Updated: 27 April 2013
Article by Suzy Cairney
Most Read Contributor in Australia, August 2019

In these days of lower commodity prices and high Government debt, infrastructure development for new projects in the ports, airports, water and rail sectors has slowed dramatically. In light of the resulting increase in capacity constraints, asset owners, operators and users are focusing instead on finding new ways of squeezing greater efficiencies and more value out of the assets they already have.

Most infrastructure players have good relationships with a wide range of suppliers and service providers in their industry. Changing your contracting approach to these organisations (even under your existing contractual arrangements) can achieve savings, and help you to squeeze more value out of your business, while still retaining those valuable relationships.

You might decide to outsource discrete parts of your operation (to help you focus on your core skills), refresh existing outsourced services arrangements, adjust your maintenance and supply agreements, or perhaps even to outsource the operation and maintenance of the entire asset.

Many businesses are engaging consultants to review their existing operations and see what can be done more efficiently.

Whatever type of service agreement you might want to investigate, there are certain things that are common to all, and it is important to get these right. They include:

Defining Services

When you want someone to perform a service for you, you need to agree on exactly what it is they are to do. Failure to define the services accurately means that you may be paying for a service that you do not need, or you may not be getting a service that you need. Problems in this area are common. For example, an operator under an operation and maintenance agreement in respect of a water asset was obliged under the agreement to rectify defects in that asset. The asset had been built by a third party, and then handed over to the operator. The operation and maintenance contract said that if the contractor failed to rectify a defect within a specific time during the relevant defects liability period, the owner could ask the operator to fix it and the operator would be paid to do so. However, it subsequently became clear that the asset owner expected the operator actively to go out and look for defects in the assets it was responsible for. Given the size of the asset, this was a major additional obligation. The parties resolved the issue through the variations process, but if the issue had been fleshed out before the agreement was signed, a considerable amount of cost and time could have been avoided.

Build in communications

Successful projects (construction or operations) are built on successful relationships. While many projects go well without documentation because the people on the ground make them work, you can give your project a better chance of success by setting up the right communication forums and lines. It may simply be a case of writing down what you are already doing, or anticipating what a new project might need. For example, a terminal operator at a port wanted to get more information about future volumes that might be coming to the port from a particular customer, so that it could decide whether to fund further investment in equipment. The agreement between them included the usual clauses regarding forecast volumes, covered by a fairly standard confidentiality clause, but went no further. Despite the parties' good relationship, the operator could not persuade the customer to provide more information. However, when the contract came up for renewal, the operator proposed a more detailed communications plan, including regular meetings, a team to oversee day to day issues, more frequent reporting by the operator, a more detailed confidentiality clause, and a balanced and commercial disputes process. This gave the customer the comfort it needed to commit to provide the information the operator had been seeking.

Manage your deal

Services contracts are not like other contracts. They are in many ways living documents that have to be managed by both parties, ideally working together. A miner had previously been running its own rail operations on the basis that this gave it a greater degree of control over this crucial aspect of its business. For many reasons, it decided that this was no longer feasible, and looked for a third party operator. It found a candidate and signed a contract with them. Despite the centrality of the rail operation to the miner's business, it got busy with other things, people moved on, and the contract was left to run itself. When the new operator failed to perform, the miner sought to impose the penalties it was entitled to impose under the contract. However, the operator argued successfully that it could not do so, as it had altered the contract by its conduct in failing to impose those penalties earlier. If the contract had been managed from the start, the outcome might have been very different.

Build in flexibility

Services contracts can last for long periods, (10 years or more) and of course things change. They should always include variation clauses so that additional services within the scope of the original agreement can be carried out, and the payments for them are agreed. Further, more balanced variation clauses tend in our experience to produce better results in services contracts, especially where long term relationships are involved. The agreement should be predicated upon payment of a fair price for a reasonable level of service. There was a variation clause in a maintenance agreement for baggage handling equipment at an airport, but it only allowed the principal to direct variations. There was no process for the service provider to claim certain instructions as variations. As such, the clause was very one sided. After a lengthy period of trying to comply with various instructions from the principal that the service provider regarded as clear variations, the service provider decided to terminate the contract. While there was a clear failure of relationship in this case, a more balanced variation clause may have allowed the parties to continue working together.

Set standards

They say carrots work better than sticks, and sometimes performance can be improved by setting (or resetting) reasonably achievable key performance indicators. These of course need to be SMART (specific to the job, measureable, achievable, relevant and time based). Coupled with a reward for meeting or exceeding these KPIs (with or without a penalty for failing to achieve them) this can be a very successful method of improving performance. On the flit side, however, if a reasonable balance is not struck with these KPIs a problematic contract may result.

For example, in waste water treatment plants, and certain recycled water assets, which are located near housing, ensuring that any noxious smells are avoided or dealt can be usually fundamental to ensuring that the social licence to operate continues. Operators of course should be obliged to abide by the terms of any environmental approvals, but KPIs designed to eliminate smells altogether should be regarded with caution.

Of course, implementing some of these measures may come at a cost, where you have an established contractual relationship and the other party does not wish to change it. You may need to negotiate or renegotiate with contractors, consultants and suppliers, and perhaps to offer them something extra. However, it is possible that cost savings may be significant, and if productivity is improved, you may win twice.

There are other contractual levers that can be pulled to achieve more. A more detailed discussion of these issues will be held during Holding Redlich's outsourcing seminar series which will be running during 2013. Please visit our website at www.holdingredlich.com for more information.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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