CHAPTER 50
Global Infrastructure Projects
A Better Way
The United Nations estimates that the world’s population reached seven billion by the end of 2011. In the last fifty years, humanity more than doubled, surging from three billion in 1959, to four billion in 1974, to five billion in 1987, and to six billion in October 1999.
The United Nations Population Division anticipates eight billion people by 2025; the urban population of developing countries is expected to grow by a million people every five days until 2030. The world economy has almost doubled in size over the past twenty years. This scenario suggests that we should all be very concerned because human demands are huge, although planet earth remains the same size.1
As a consequence of population growth and urbanization, demand for infrastructure and public utilities is increasing, putting pressure on governments, infrastructure assets, and resources. Infrastructure can generally be defined as the set of interconnected structural elements that provide framework supporting the development of a country or region. When problems exist with the performance of infrastructure, the effects can be widespread.
The European Sustainable Investment Forum, Eurosif, a not-for-profit association of institutional investors, financial service providers, academic institutes, research associations, and nongovernmental organizations (NGOs) that represents assets totaling over €1 trillion through its member affiliates, produced an infrastructure report stating that “the major issues affecting the infrastructure sector include a growing population, underfinancing, security, and climate change. As governments struggle to make ends meet, private investors are filling in the gaps for these projects, and the implications for environmental, social, and governance factors on the sector are intensifying.”2 Certainly, private investors will play a key role in the absence of sufficient government financing for these projects if their investments can be allocated in a context with clarity of rules, regulations, and returns.
According to McKinsey’s report “Infrastructure Productivity: How to Save $1 Trillion a Year,” just keeping pace with projected global gross domestic product (GDP) growth will require an estimated $57 trillion in infrastructure investment between now and 2030.2 That’s nearly 60 percent more than the $36 trillion spent over the past eighteen years. The $57 trillion investment required is more than the estimated value of today’s infrastructure.
The report has identified that eliminating waste, improving the selection of projects, streamlining their delivery, and using best practices from around the world would make a decisive difference if scaled up globally to optimize the use of capital. This means that practical steps can boost productivity to achieve critical cost savings. Although not sufficient, this can be a first step to a sector where productivity has been a long-time laggard.
COMMON FEATURES OF INFRASTRUCTURE PROJECTS
Infrastructure projects are important because they transform the physical landscape and contribute to the improvement of social and economic systems where they are located. These investments tend to be long-term and their benefits are felt over many years. These projects are generally characterized by some common features:
Large Capital Requirements
Normally, infrastructure projects require large investments over long gestation periods. An example is the Brazilian Logistics Investment Program, designed on the basis of a strategic partnership with the private sector and focused on the renewal and integration of the Brazilian transportation network. The goal is to meet the growth demands of a country with continental dimensions. In order to facilitate investment projects in infrastructure, which will add around $235 billion in the coming years, the government has enacted a number of tax and bureaucratic benefits.
Sensitive to Political Environment and Policy Changes
Because of their long life cycles, these projects experience many uncertainties and changes including transformations in the regulatory environment and institutional framework. Henisz performed a two-century analysis on the determinants of infrastructure investments in over one hundred countries and concluded that policy makers seeking to attract investment should pay attention to how they structure political institutions, and investors should look carefully at all the governmental pledges that may have an impact on the return of potential investments.
Multiple Stakeholders
It is common for projects to have a great number of stakeholders in multiple sectors related to regulatory and financing agencies, funding institutions, constructors, suppliers, and communities impacted, among others. Part of the conundrum public authorities face is the balancing of multiple interests and objectives and the need to respond to the growing expectations of citizens to have their views heard while ensuring that consultation processes are conducted in an effective fashion.
Complexity in the Planning-to-Implementation Process
Infrastructures are complex collections of interacting components in which change often occurs as a result of learning on the go, making them adaptive systems. What happens to one infrastructure can directly and indirectly impact large geographic regions, and send ripples throughout social economic layers. On top of that, the necessary steps to protect the public interest and tendering procedures add more complexity. Shaping the opportunity and thinking about the regulatory permits and the organizational arrangement may take years. Then there is the planning process that requires more time. The way the planning process is conducted is a great determinant of success or failure. The problem is that governments are enforced for four or five years and normally take a short-term vision inconsistent with the long, long, long-term view required by these investments to get to the authorization stage. The reality produced is that the planning is accelerated and costs escalate during execution.
High Rates of Failures
The uncertainties, complexities, and relationships involved do not contribute to a great number of success stories. Infrastructure projects have presented poor results from their management perspective. Cost and time overruns are very common, and disputes with stakeholders are business as usual. Contributing to this reality are the forgotten lessons. A lot is commented about the importance of determining the lessons learned. The problem is that governments change, contractors move from one opportunity to another, and the lessons that should be learned for future investments are forgotten in the minds of many.
DELUSIONS OF SUCCESS
Many authors point out that the industry’s capacity to deliver infrastructure projects is not at the right pace. As a result, significant overruns in budgets and schedules are rising in frequency. Flyvbjerg et al, Kain, Pickrell, and Skamris and Flyvbjerg, among others, have come out with such findings.4
Morris and Hough, Gaspar and Leite, and Ganuza attribute cost overruns to technical constraints.5 According to these studies, delays and cost overruns are a result of imperfect estimation techniques on the part of government officials. The list of infrastructure projects funded on overly optimistic forecasts of initial usage is huge. One of the explanations for these flawed forecasts can be that the investment bankers and consultants who put together the deals get most of their fees irrespective of whether or not the forecast patronage materializes after construction. If their clients don’t get the project, they don’t get their hefty bonuses.
Other researchers such as Wachs, Kain, Pickrell, and Flyvbjerg attribute cost overruns to political factors. In order to make projects sellable, politicians understate costs and exaggerate benefits. As shown by Flyvbjerg, artificially low costs, exaggerated benefits, and underestimated risks are common strategies employed by the proposing institution to have a large infrastructure project approved.6
Pricewaterhousecoopers (PWC) stated,
Large construction projects can suffer from many problems, ranging from optimism bias in the original estimate to poor communication to slow decision making. Many owners fail to establish the proper project management structure, monitoring procedures, and risk management processes. As a result, they don’t anticipate unforeseen events and don’t build in the necessary contingency plans. Because of shortcomings in project controls, they often don’t realize the severity of delays and cost overruns until well after a project has foundered.7
Despite the fact that governments, investors, and financial sources use well-known consultants to make projections and estimations, it is very common to have gaps between the the projected future and the emerging reality. Miller and Lessard8 comment on the risks involved related to market forecast, potential difficulties attracting investors, technical risks involving engineering difficulties and their novelty, construction, regulation, operation, and social-acceptability. Risks emerge along the project life cycle in conditions of strong uncertainty, and turbulence makes them very susceptible to crisis. For this reason, risk and crisis management processes must be well thought out.
CHALLENGES AND OPPORTUNITIES
The World Economic Forum (WEF) has analyzed the future of long-term investments and has shown that “in 2009 long-term institutional asset owners owned slightly under half of the world’s professionally managed assets—approximately US$27 trillion out of US$65 trillion. However, constraints on these investors allow roughly 25% of their assets (US$6.5 trillion) to be used for long-term investment.”9 Interestingly enough, this $6.5 trillion is available for direct private equity and venture capital, strategic stakes in public companies, and major infrastructure investments, which means that infrastructure can only attract a fraction of that amount, indicating a huge gap between infrastructure investment demand and the total amount of capital available worldwide.
Governments will need to complement the search for sources of capital with a wide array of other measures. The great challenge is how to increase investors’ interest in infrastructure projects. Traditionally, companies take varied but conventional approaches to infrastructure project organization design based on previous experiences, partnership philosophy, and risk appetite. Most organizations are set up adequately at the outset. However, over time, many of them fail to adapt to how a project’s needs change at different phases, thereby leading to poor governance, control, and management.
The WEF strategic infrastructure report also states that “in such an environment, Public-Private Partnerships (PPPs) can accelerate infrastructure development by tapping the private sector’s financial resources as well as its skills in delivering infrastructure effectively and efficiently on a whole life-cycle cost basis.”10 Despite this need for private sector participation, projects are lacking well-planned commercial and technical feasibility studies, risk allocation, and clarity on the institutional and legal framework.
RELIEVING THE DEADLOCK
A number of international organizations have been studying how to tackle infrastructure issues. Organization for Economic Cooperation and Development (OECD) published the Infrastructure to 2030 report, which recommended finding innovative approaches to finance including public–private partnerships and the investment of pension funds, improving regulatory and institutional framework conditions, reducing the vulnerability of long-term infrastructure planning and implementation to short-term thinking and priority setting, and strengthening governance and strategic planning by ensuring the involvement of a broader range of stakeholders in the process of needs assessment and prioritization.11
A report from the World Energy Forum comments on a “project preparation gap” that includes poor demand forecasts, delayed land acquisition and approvals, and inadequate risk allocation.12 Additionally, if the tender documents are deficient or unclear, the bidders have to generate the required information via due diligence. This process can be costly and wasteful unless the bidder is prepared to tender low amounts, expecting to make high returns through effective claim management.
The report proposes four areas to be addressed: (1) managing a rigorous project preparation process by effectively setting up the project team and leadership, designing the project governance structure and project management, and securing the required preparation funding; (2) conducting a robust and high-quality technical, commercial, legal, and environmental feasibility study with proactive stakeholder management; (3) structuring a balanced risk allocation and regulation with the adoption of a life-cycle–oriented model aligned with policy objectives to ensure a successful long-term partnership between the public and the private sectors; and (4) creating a conducive enabling environment by establishing a solid legal framework with independent regulators and dispute resolution forums and enforcing transparency to enhance public, private, and societal readiness.
Considering the views from these two global institutions, we suggest starting with some critical issues to solve the deadlock.
Opportunity Framing
Opportunity framing is the process by which the essential attributes of a potential infrastructure project are evaluated. Information needs to be collected, forecasts produced, and the value created allocated to the various stakeholders in order to make it sustainable.
Javernick-Will and Scott13 identified three pillars that must be understood in the shaping of a project: regulative knowledge that includes the rules of formal governance structures and legal processes within a given society; normative knowledge that specifies how things should be done, including adopting socially accepted practices and processes and fulfilling expectations for roles; and cultural-cognitive knowledge that includes common beliefs, shared conceptions, and meanings. Whereas normative knowledge is morally governed and regulative knowledge is legally sanctioned, cultural cognitive behavior occurs because of cultural beliefs and perceptions.
Merrow14 states that the one requirement for a successful megaproject is the need to assess and then shape the opportunity into a framework that will allow the project to be managed. Five steps are considered in the shaping process. The first one is the context, including the physical location, the history of prior projects in the area, the political and institutional environment, the regulatory climate, the local content requirements, cultural considerations, the labor availability, and quality. The second step is assessing the potential value of the project. If the value to be created cannot be understood, the risk of losing control is high. This value needs to be linked to the project ambition, the benefits to be delivered, and the future state resulting from the transformation. The third step is assessing the comparative advantage and the purpose of the project. Answering why the project is fundamentally better than alternatives gives convincing reasons to execute it. The fourth step is identifying and understanding the stakeholders. Identifying stakeholders early can guide the opportunity framing. The final step is thinking about partners, investors, and sources of financing.
Stakeholder Engagement
The effect of infrastructure projects on economies is influenced by the involvement of governments, communities, and regulators. A sustainable development mindset for people, the environment, and communities, and a positive attitude to keep teams motivated and to deal with setbacks over extended periods are particularly important. The combination of all these factors takes the stakeholder challenge to an entirely new level.
As early as possible, the stakeholders must know what the planned project entails. The decision makers must clearly explain the project ambition, and the possibilities and limitations they face in a realistic and understandable way. Stakeholders must be actively prepared for changes. It is vital to avoid surprises. Negative impacts communicated openly can cause short-term annoyance but generate trust in the long-term. A continual constructive dialogue may not avoid opposition but offers the opportunity to share knowledge and exchange perspectives that may result in fewer barriers to the achievement of the expected benefits.
A sensitive issue on stakeholder management is the suppliers’ network. There is a need to carefully select suppliers and consider their compliance with issues such as human rights, work conditions, environment, and corruption fighting. A good starting point on these issues is the United Nations global compact.
Effective stakeholder engagement is an increasingly critical factor in ensuring successful delivery of infrastructure projects. Disputes, poor stakeholder relations, and disgruntled community groups can cause significant delays and impact the project.
Risk Management
Infrastructure projects are inherently rife with risks, suggesting that they must be viewed from a full life-cycle perspective. The complex multilayered dimensions involved associated with the existing interdependencies make it difficult to determine the possible risks. Identifying, understanding, and analyzing such interdependencies are significant challenges. Affecting all areas of daily life such as electric power, natural gas and petroleum production and distribution, telecommunications, transportation, and water supply, the degree to which the infrastructures are coupled, or linked, strongly influences their operational characteristics
The risks involved include the technical, economic, business, social/political, legal/regulatory, public policy, health and safety, and security concerns that affect infrastructure operations. It is therefore essential to have a robust risk-based governance approach so that the leadership team can sense risks and take decisive action in a timely manner.
Governance and Assurance
Governance can be understood as the art of deciding how to decide. It is a process of understanding project decisions across multiple organizational layers, organizations, and institutions. In contrast, the assurance process guarantees throughout the entire life cycle all the required compliances and adherence to the adopted methodological approaches. There are three assurance mechanisms that have proven particularly effective. The first is stage gate reviews. Stage gate reviews are points at which a project is reviewed and a decision is made on whether to move forward, to recycle, or to stop a project.
The second assurance mechanism is independent reviews, which involve external parties. It is always important to bring different perspectives to a project as a form of enhancing value creation and bringing new ideas and experiences to the project team.
The third assurance mechanism is front-end planning. This is the process of developing a detailed project definition so that the owner can evaluate the risks involved, and allocate resources in such a way that the chances of success are enhanced. The Construction Industry Institute indicates that projects that effectively implement front-end planning can improve their performance 10 percent with respect to costs, 7 percent with respect to schedule, and 5 percent with respect to change orders. One common issue is that owners can argue that they are spending a lot of money during the planning phase, forgetting that if they don’t do so they may be cultivating the seeds of failure and have higher costs at the end.
Governance and assurance processes must be in place in order to support infrastructure shaping, planning, execution, and operations. Although governance and assurance approaches do not guarantee success, they can significantly increase the probability of success.
CONCLUSION
Clearly there is a need to find better ways for planning, financing, governing, and executing infrastructure projects, taking into account their various impacts and the interests of the multiple stakeholders involved.
Good infrastructure project planning requires upfront investment in opportunity framing, early stakeholder management, formalized risk management, and governance and assurance to ensure that the project can progress without facing major hurdles. Since infrastructure projects are engines of value creation and transformation, changes are normal and expected. However, poor application of these processes will increase the chances of failure in project delivery. Companies and institutions involved in infrastructure should invest in ensuring that the issues cited in this chapter are considered.
Using a local newspaper as a source, find a story involving an infrastructure project that faces some of the issues outlined in this chapter. Apply the solutions suggested here as a “thought experiment.” How might the outcomes have been different?
REFERENCES
1 Joel Cohen, Seven Billion, New York Times, October 23, 2011, www.nytimes.com/2011/10/24/opinion/seven-billion.html?_r=0; and Robert Engelman, “What a population of seven billion means for the planet,” The Guardian, July 18, 2011, www.guardian.co.uk/environment/2011/jul/18/population-7-billion-planet.
2 Eurosif, Infrastructure Sector Report, http://www.eurosif.org/research/sector-reports/infrastructure.
3 McKinsey, “Infrastructure productivity: how to save US$ 1 trillion a year,” McKinsey Insights and Publications, January 2013, www.mckinsey.com/insights/engineering_construction/infrastructure_productivity.
4 B. Flyvbjerg, M.K.S. Holm, and S.L. Buhl, “What causes cost overrun in transport infrastructure projects?” Transport Reviews 24, No. 1 (2004), pp. 3–18; J.F. Kain, “Deception in Dallas: strategic misrepresentation in rail transit promotion and evaluation,” Journal of the American Planning Association 56, No. 2 (1990), pp. 184–196; D.H. Pickrell, Urban Rail Transit Projects: Forecast Versus Actual Ridership and Cost (Washington, DC: U.S. Department of Transportation, 1990); M.K. Skamris and B. Flyvbjerg, “Inaccuracy of traffic forecasts and cost estimates on large transport projects,” Transport Policy 4, No. 3 (1997), pp. 141–146.
5 J.-J. Ganuza, “Competition and cost overruns in procurement,” International Journal of Industrial Organization 55, No. 4 (2007), pp. 633–660; V. Gaspar and A. Leite, “Selection bias induced cost overruns,” International Journal of Industrial Organization 8, No. 3 (1989), pp. 443–467; P.W.G. Morris and G.H. Hough, The Anatomy of Major Projects: A Study of the Reality of Project Management (New York: John Wiley and Sons, 1987).
6 M. Wachs, “When planners lie with numbers,” Journal of the American Planning Association 55, No. 4 (1989), pp. 476–479; Kain, 1990: Pickrell, 1990; Flyvbjerg et al, 2004.
7 pricewaterhousecoopers, Correcting the Course of Capital Projects. (London: PWC, 2013), p. 2, www.pwc.com/en_GX/gx/scapital-projects-infrastructure/assets/pwc-correcting-the-course-of-capital-projects-v3-pdf.pdf.
8 R. Miller & D. Lessard, The Strategic Management of Large Engineering Projects (Cambridge, MA: MIT Press, 2000), pp. 75–92.
9 World Economic Forum, Strategic Infrastructure: Steps to Prepare and Accelerate Public-Private Partnerships (Geneva: World Economic Forum, 2013).
10 Ibid.
11 OECD, Infrastructure to 2030: Main Findings and Policy Recommendations (Paris: OECD, 2007), www.iva.se/upload/Verksamhet/Projekt/Forskning%20Innovation/Bibliotek/OECD_long.pdf.
12 World Energy Forum, The Future of Term-Investing. 2011, http://www3.weforum.org/docs/WEF_FutureLongTermInvesting_Report_2011.pdf.
13 Amy Javernick-Will and W.R. Scott, “Who Needs to Know What? Institutional Knowledge and International Projects,” Working Paper, Collaborative for Research on Global Projects, Stanford University, 2009.
14 Edward Merrow, Industrial Megaprojects (Hoboken, NJ: John Wiley, 2012).