Risk sharing v risk allocation

The most significant difference between traditional contracting methods and alliance contracting is that in alliancing, all project risk management and outcomes are collectively shared by the Participants. In more traditional methods of risk allocation, specific risks are allocated to Participants who are individually responsible for best managing the risk and bearing the risk outcome. This concept of collective risk sharing provides the foundation for the characteristics that underpin alliance contracting including collaboration, making best-for-project decisions and innovation. If substantial and significant risk is allocated to individual Participants, then it may not be an alliance and those characteristics may not be necessarily required or appropriate.

Sharing management and consequences of risks

Historically, most alliances have been delivered on the basis of a 50:50 sharing of risks (and opportunities) and a capped downside for NOPs. This means that although risks may have been jointly managed by the Participants, potential financial consequences were not equally shared.

Figure 2.1: Historical Risk or Reward Models - Cap on NOPs' Painshare

An alliance contract works very differently to a traditional contract

Traditional contracts are founded on the traditional role of buyer and seller. The buyer wants an asset delivered at fair cost or better and the seller wants to deliver the asset for a fair return or better. The buyer describes its requirements and terms, often in the form of an Request for Tender and the seller proposes a solution, terms and price to deliver that requirement, in the form of a Tender response. This means that both parties build their own risk assessment into their price and stand to win or lose if the risk outcome is higher or lower than predicted for each of them. The resulting contract encompasses both the requirement and the offer and allows variations to these to be made as the work progresses, as per the agreed risk allocation model and Commercial Framework.

This approach works well where the project has few unknowns and the outcome is predictable. Whilst the buyer and seller are aligned on delivering the project, the buyer's motivation is to minimise the cost and the seller's motivation is to maximise the profit. The only moderator to this behaviour is the parties' desire to maintain a sustainable position (i.e. they will be concerned about reputation and staying in business) beyond the life of this project.

Where projects are more complex, with more unknowns, and the parties have less ability to confidently predict the outcome using traditional contracting, the parties will allow for higher levels of risk which will mean a higher tendered price, and/or they will have significant variations as the work progresses. This can lead to highly complex risk-allocation models and commercial frameworks with significant time and effort spent negotiating variations to the original agreement. Resolving these variations can be time consuming and costly.

Alliance contracting provides an alternative approach where the buyer and seller collaborate to develop the requirements and the proposal, combining their knowledge and experience to address the complexities and unknowns, with an objective of increasing their shared confidence in the outcome. They share exposure to the project outcome, which forms the basis of the Commercial Framework. The buyer and seller are aligned as minimising actual cost to the buyer and increasing profit to the seller. Time otherwise spent negotiating variations under a traditional contract becomes time spent finding the best solution to resolve issues and problems through the life of the project. The time and energy of the leadership team is spent on value-adding activities rather than contractual disputes; solving the overall project outcome is the objective and this aligns to each party's individual commercial objectives.