What Can We Do About Soaring Transactional Costs?

What Can We Do About Soaring Transactional Costs?

Forty percent of all project funds are wasted on transactional costs. That’s too much.

In an important editorial posted earlier this month, Construction Industry Institute (CII) director and leader of the OS2.0 project, Stephen Mulva, warned that the capital projects industry is in a fiscal “death spiral” and that EPC companies need to stop managing projects “like a caveman with a checkbook.” It was a clarion call to industry leaders and capital project leaders, buttressed with a long list of troubling statistics.

The most jaw-dropping of those figures is the fact that 40 percent of the cost of creating a new capital asset is currently wasted on transactional costs.

“It’s not a sustainable model,” Mulva says. “We have to employ the best business, financial, and accounting concepts, and we’ve got to do it now.” In the editorial, he suggests that the solution is for EPC companies to create alternative financial products and services, and that is certainly one option. There is a complementary powerful solution: platform technology.

To understand why, we need to define what transactional costs are. Simply put, they’re the costs associated with the exchange of goods or services, including the payments to banks and brokers, search fees as well as service fees to process these transactions. In the context of capital projects, transactional costs include financial fees, legal fees, dispute resolution costs along with logistics and communications costs. It also includes foundational project work like the cost of sourcing quotes, cost and schedule benchmarking, assurance reviews — these are called informational costs.

The total sum of transactional costs across the capital construction industry remains ambiguous, but we do know the figure is extraordinarily high: for instance, a 2009 National Research Council report suggests that dispute resolution cost, alone, is responsible for draining between $4 Billion and $12 Billion from U.S. capital construction budgets every year.

The economy of an industry is prosperous and efficient when transactional costs are under control.  Sadly, in capital projects, transactional costs thrive due to both lack of integration and to contractual & operational frictions between the multitude of stakeholders involved in the project lifecycle.

We believe we have what it takes to help change that for good: technology.

 

How can technology enable seamless integration and reduce transactional costs?

We believe platform technology is the integration enabler and that we should lead in making it happen before outsiders to our industry do it for us, on their own terms. 

In an in-depth report last year, a team of McKinsey experts examined the role of technology in shaping the modern industry. They conclude, in part, that digitization is driving a “radical reordering traditional industry boundaries,” leaving whole sectors ripe for disruption. The economic spoils, they say, will go to those who embrace powerful new technologies.

“The ongoing digital revolution, which has been reducing frictional, transactional costs for years, has accelerated recently with tremendous increases in electronic data, the ubiquity of mobile interfaces, and the growing power of artificial intelligence,” they write.

“Together, these forces are reshaping customer expectations and creating the potential for virtually every sector with a distribution component to have its borders redrawn or redefined.”

As for many other industries, platform technology has increased trust between the customer and the vendor on many levels. It has played the role of the independent, powerful, cost effective infrastructure to support the most efficient transactions and value creation. For capital projects, platform technology can also streamline work processes and related transactions by connecting project stakeholders, and centralizing contractual needs. It can also enhance multi-stakeholder collaboration in a powerful way by eliminating the need for the “middlemen.”

 

Why is construction slow at embracing technology?

EPC companies and capital project Owners have been slow to adopt the kind of transformative technologies that can effectively reduce or eliminate transactional costs. Why?

First, our industry has serious flaws in its approach to technology business models and to its mechanisms to fund innovation.  In fact, the mechanisms our industry has established for creating, testing, learning and innovating are irremediably paralyzed by bureaucracy and ineffective use of resources. 

Our industry is also clogged with middlemen who soak up disproportionate amounts of capital construction costs by providing integrative knowledge that companies can access far more efficiently with intelligent, secure, data-driven technologies. That’s applicable to physical processes like procurement, as well as office processes such as quality and assurance reviews.

For instance, millions of dollars are wasted on the traditional stage-gate assurance reviews that can be replaced in part — and sometimes entirely — with integrated checklists powered by machine learning and artificial intelligence. Countless hours are spent checking email, hunting down documents, and collecting the data and insights required to make procurement and engineering decisions — all of this can be easily and efficiently organized and integrated into the cloud.

These are only a few examples and there is a better way. The technology that can solve all of these problems already exists; what we need is the framework to link all the pieces together and build the interoperable ecosystems that drive efficiencies.  What we need is the willingness to innovate, be an early adopter and embrace the success of other industries. 

To paraphrase an old American proverb: To the early adopter will go the spoils.

Many would say that our industry has never been “an early adopter”, some would say “innovation is not even part of our DNA and culture”. I believe, to survive, both Owner and EPC companies need to be willing to embrace transformative technologies.

In the immortal words of Eric Clapton: Everybody, we ought to change sometime!

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