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Resolving agency issues in client-contractor relationships1Resolving agency issues in client-contractor relationships:The Merck Innovation CenterChristine Unterhitzenberger, Lancaster University and Dietmar Möller, Merck KGaAABSTRACTThe management of relationships has been acknowledged as a crucial element of projectsuccess. However, agency related issues such as goal conflict, information asymmetry oropportunistic behavior can make this a real challenge. Steven and Mark – programmanagers for One Global Headquarters at Merck – developed their own way on how to dealwith this challenge in a complex and uncertain environment. This case study will provideunique insights into their approach and motivation.KEYWORDS: project management, agency theory, project success, principal agentrelationshipFig.1 Merck Innovation Center and Emmanuel-Merck-Platz in Darmstadt, Germany (reproduced withpermission from Esch (2018))Resolving agency issues in client-contractor relationships2A FACELIFT FOR A 350-YEAR-OLD COMPANYIn 2015, after several large acquisitions transformed its businesses, Merck KGaA1 underwenta re-branding into the single brand Merck. Merck is a diversified pharmaceutical, life sciencesand chemicals group founded in 1668 and ever since headquartered in Darmstadt, Germany.The company employs approximately 52,000 people around the world, with 11,000 in NorthAmerica and about the same number in Germany (Merck, 2019). The company investedUS$ 565m in Capex world-wide in 2015, including a large number of construction projects(Merck, 2016).The new brand was designed to position the organization as an innovative science andtechnology company as prior analysis suggested that its culture had to undergo atransformative change. It was also recognized that architecture, in particular at theheadquarters, conveys a strong message to customers, partners, the community, andemployees and that the architecture needs to represent the transformative change as well.On this basis, the program One Global Headquarters (OGHQ) was initiated in 2014 with theaim of completion by 2018, when the company celebrated its 350-year anniversary. Theprogram consisted of about 90 interdependent construction projects of various sizes, shapesand forms at the headquarters in Darmstadt with a total investment of more than US$ 200m.The program was led by two internal managers – Steven and Mark – who mainly focused onstrategy and governance issues and were supported by a program management team ofinternal and external experts to oversee the high number of projects. External experts werehired in all cases, in which internal resources were considered inadequate or insufficient tostay in control of architectural quality, schedule and budget, all of which were non-negotiable.At the heart of the program was the development of the Innovation Center and the adjacentEmployee Restaurant (Figure 1 and 2), which was described by its architects Henn asfollows (Henn, 2019):“The Innovation Center will be used to cooperate temporarily in interdisciplinaryteams and to communicate both internally and externally. While the newly developedpublic square (…) orientates the company towards the city, the Innovation Centeropens it to the interior. There are three levels which are set back from one another sothat they are to a large extent visually linked. Levels can be changed using archedramps. These connections, like the bridges joining the segments at individual levels,are highly frequented meeting places where the direct exchange of informationamong knowledge holders is encouraged. In passing, building users can be inspiredby the work of their colleagues and prompted to engage in discussions. Differentdemands on the workplaces – concentration, communication, cooperation – findspatial expression in a flowing transition. Team communication takes place in thespacious internal area on each floor. Single-person office cells along the façadeprovide space for activities requiring concentration and intensive thought. Thecompany restaurant is connected to the Innovation Center on several levels. It willassume essential functions on the currently decentralized staff canteens, some of1 Founded in 1668 in Darmstadt, Germany, Merck is the world’s oldest pharmaceutical and chemical company. In the 19thcentury, the success of its export business to the United States led to the establishment of an office in New York in 1887, whichgave rise to the establishment of a separate entity four years later. In 1917, during World War I it was expropriated. Ever since,there are two different, unaffiliated companies that use the name MERCK. Globally, except in the United States and Canada,Merck KGaA, and its affiliates are named simply “Merck”. In the United States and Canada, Merck KGaA uses its firm name“Merck KGaA, Darmstadt, Germany,” and its businesses operate under “EMD Serono” in biopharma, “MilliporeSigma” in lifescience and “EMD Performance Materials” in the materials business. The other company, Merck & Co., Inc., Kenilworth, NJ, USholds the rights in the trademark MERCK in the United States and Canada. All references to the name Merck in this case studyrefer exclusively to the former.Resolving agency issues in client-contractor relationships3which are to be decommissioned. The restaurant will become a meeting place fornumerous employees from the various parts of the site.”Fig. 2 Typical floor space in the Merck Innovation Center (reproduced with permission from Esch(2018))EUROPE’S LEADING CONSTRUCTION MARKETThe context for this case study is Europe’s leading construction market with the continent’slargest building stock: Germany. The construction sector in general is one of the largestcontributors to the world economy and a key industry in most countries. A recent globalsurvey found that the productivity of the sector has by far trailed that of almost all otherindustrial sectors over the past decades, thus offering huge opportunities for improvement(Barbosa et al, 2017). While it was found that low productivity performance in construction isnot uniformly distributed, with big variations between countries and subsectors, there are stillcommon reasons for it. Among those reasons stands the observation, that“Construction is highly fragmented. Contracts have mismatches in risk allocation andrewards, and often inexperienced owners and buyers find it hard to navigate in anopaque marketplace. The result is poor project management and execution,insufficient skills, inadequate design processes, and underinvestment in skillsdevelopment, R&D, and innovation.” (Barbosa et al, 2017, p. 8)The study concludes that market failures and external factors compromise how the industryfunctions and result in low productivity of firms of all sizes. Overall, low labor productivity, asResolving agency issues in client-contractor relationships4well as poor project management can be directly linked to project failures in terms of costoverruns and delays that are often observed in construction projects.The German construction sector is a good representation of this situation. The abovementioned study finds it to be almost average-ranking in terms of both construction laborproductivity and its growth. In 2018 the industry’s added value contributed US$ 178bn or5.3% to the German economy (Statistisches Bundesamt, 2019). During the past decade,after a cyclical downturn of the industry, many large national construction firms, whose corecompetence was the efficient execution of large turn-key construction projects, left themarket and their place was taken by medium-sized, often family owned, companiesspecializing in particular trades such as concrete works, façade-works or interior fit out.Architects typically work in small- to medium-sized specialized practices and subcontractengineering design work to specialized engineering firms. Deliverables, their quality and, tosome extent, the fees of architects and engineers are regulated by national legislation.It has been widely argued that contractors, like all other partners in a project, should becomefully involved as early as possible in order to participate in the evolution of the final design bycontributing their knowledge and expertise and become an integrated network partner.However, many public and private clients defer the final investment decision by means oftheir corporate governance until basic design is completed and cost estimates by theconsultants become firmer. Hence, only after the final investment decision is made by theclient, the architect and engineers start to prepare the tendering documents for all trades andprocurement packages in order to avoid sunk costs in case the final investment decision isnegative. Various different procurement models are available, whereas the traditionalcompetitive tendering is still prevalent. More innovative methods like open book contracts arein its infancy in Germany and many clients and contractors do not know how toaccommodate them in their corporate governance and are not familiar with the requiredchanges in behavior and attitude.Many spectacular project failures both in the public as well as in the private sector have beencredited to an adversarial and fragmented project environment based on suboptimalcontractual arrangements that often resulted in claims and litigation. Major customers andpowerful players of the German construction industry have recognized the necessity of bettercollaboration and better contracts with their initiative TeamBuilding under the slogan “For aBetter Collaboration in the Construction Industry”, which was started in 2017 (InitiativeTeambuilding, 2019).ONE GLOBAL HEADQUARTERS – THE MAIN ACTORSAs previously mentioned, the OGHQ program was led by Steven and Mark. Steven is aprogram and project manager with more than 30 years’ experience. He is a chemicalengineer with a PhD by training, however moved into the management of major projectswithin Merck several times during the past 20 years. Since then he has been responsible forR&D, construction and organizational projects ranging from tens to several hundred millionUS$ with the OGHQ program being the largest and most important so far. His backgroundgives him a very good understanding of the client’s organization as well as projectgovernance. Mark is a qualified architect and joined Merck only shortly before the programby direct initiative of Merck’s CEO. He has a long career in the construction industry with vastexperience as architectural lead for a major contractor in Germany. This gives him specificexpertise in architecture as well as in the nuances of the German construction market. Helikes to stress the need for a good start in any project and compares it to a 100m sprint thatResolving agency issues in client-contractor relationships5is always lost, if the runner doesn´t get a good start. This theme became a proverb in theprogram.Steven and Mark are supported by a team of internal and external experts. Within theprogram, Claire is the project manager for the Innovation Center and Employee Restaurant.Claire is a qualified architect, who worked as an independent architect before joining Merck20 years ago. She has been trusted with major and important construction projects since.Based upon her track record, Steven had lobbied hard to have her assigned to the program.Other key players were Peter, the architect’s project leader who had the overall responsibilityfor the design of the buildings as well as the construction management, and John, thestructural engineer, who had to find ways to make Peter’s ambitious design feasible andaffordable while also complying with building regulations. John heads the Berlin office of hisstructural engineering company, which is one of the best in the country with a vastexperience in challenging designs. Peter led many ambitious construction projects for largecorporate clients in Germany and China and is supported by Paul, a civil engineer bytraining, who successfully acted as a construction manager for various projects.Worth mentioning here are also Frank, who is Merck´s procurement manager for theprogram with an engineering background, and Lilian, a civil engineer and quantity surveyor,who is part of a team of external specialists from the project management consultancy Drees& Sommer. She and her team were specifically hired for the program to complement allrequired competences of the program management team.CONCRETE AND STEEL WORKS – BACKGROUNDConsidering the general environment outlined earlier, Steven and Mark were faced with adilemma: they either follow the traditional way of procurement through competitive tendering,which is likely to create the basis for an adversarial environment with all its negativeconsequences, or they use more innovative forms like open book contracts, which aredifficult to accommodate within Merck’s corporate governance and the industry isn’t veryfamiliar with them either. However, they did not want to adopt an only partially suitablesolution and decided to explore new collaborative ways of selecting contractors. They wereconscious of some of the issues often present in client-contractor relationships like goalconflict, information asymmetry, trust or opportunistic behavior and tried to identify ways toovercome these. They assumed that these issues contribute to the adversarial environmentand hence, are inhibitors of project success. As the OGHQ program had very high strategicimportance within Merck, Steven and Mark did not want to risk the project being late, overbudget or of mediocre quality. Based on the procurement of concrete and steel works for theInnovation Center and Employee Restaurant their approach to collaborative procurement isexplained in the following.The tendering package for concrete and steel works was chosen for two reasons: Firstly, theintricate architectural design was highly challenging as it required complicated and fair-facedconcrete surfaces, wide ceiling spreads, and floors resting on very few supporting pillars (seeFigure 3a to d). To build such a complex concrete-cum-steel structure without flaws requiresa tremendously high quality of craftmanship in formwork, ironworks and concrete works,which only few contractors are able to deliver. In such a case it is paramount for the project’seventual success, that the bidding contractors do not under-estimate the complexity anddifficulties of the required work and erroneously bid too low or beyond their capabilities.Hence, Steven and Mark concluded that in such a case tendering cannot be conductedbased on price only, but that a collaboration based on trust needs to be developed with thecontractor to manage the complexity of the project. Secondly, requirements the structuralResolving agency issues in client-contractor relationships6design for the tendering documents was based upon, were exacerbated at a late stageduring the procurement phase, rendering several requirements and material take-offs2obsolete in some parts. As the timely laying of foundations was imminent, certain structuraldesign questions relevant to pricing had to be put to rest during the procurement processunder the mutual understanding that they were to be sorted out fairly later on. Steve andMark were confident that their collaborative approach would be able to accommodate thisdifficult situation. Otherwise an incomplete design basis would result in extensive claims oroverpricing due to incalculable risks, which they obviously wanted to avoid.Fig. 3 a and b: Concrete ramps in the MIC during construction and upon completion (reproduced withpermission from Esch (2018))Fig. 3 c and d: View into a stair well during construction and upon completion (reproduced withpermission from Esch (2018))2Material take-offs are used in engineering and construction, and the term refers to a list of materials with quantities and types(such as specific grades of steel) that are required to build a designed structure or item. This list is generated by analysis of ablueprint or other design document.Resolving agency issues in client-contractor relationships7CONCRETE AND STEEL WORKS – PROCUREMENT PROCESSDuring the pre-contract phase Steven, Mark and Claire put a high emphasis on the quickbuild-up of project knowledge with the potential contractors who were about to join thebidding process. Naturally, there is a big information asymmetry about the project and thenature of the task between the principal partners, i.e. client, architect, engineers – who haveworked on the project for months or even years – and the incoming bidders – who are justfamiliarizing themselves with the material provided – which puts the latter at a disadvantage.Steven, Mark and Claire had planned to overcome this information asymmetry through adedicated information exchange including discussions with all bidders on an individual basisthroughout the procurement process, which is summarized in Table 1. This also allowedthem early on to build a collaborative relationship based on trust with the bidders which theyhoped would be carried through to the post-contract award phase of the project. StagetTendering activityBiddersCalendar week20151Request for interest in bidding234 – 122Distribution of original tenderdocuments14133Individual workshops – workshop 1816 – 174(1)Submission of quotes5225Individual workshops – workshop 25236(2)Revision of quotes #15257Amendment of tender documentsbased on new regulatoryrequirements and227 – 298(3)Submission of indicative quote2309Individual risk mitigation workshops– workshop 323010(4)Revision of quotes #223311Contract negotiations13612Contract signed138 Table 1. Procurement process; disturbance symbol ( ) represents changed requirements.Steven, Mark and their team intended to achieve the following objectives with this approach: Build a mutual understanding of technical and qualitative building requirements. Familiarize bidders with the planning content of the previous design work as wellas its limits and challenges. Clarification of technical issues and time schedules for both sides. Preparation of a common basis for realistic and comparable pricing. To become mutually acquainted with the acting persons and creation of a mutualbase of understanding and trust.Claire and Frank identified 23 pre-qualified contractors who they provided with a briefintroduction to the project and asked for an expression of interest for inclusion in the biddingprocess (stage 1). They received 14 positive responses and sent the full tendering packageto these contractors (stage 2). Upon closer inspection of the information provided, sixcontractors decided not to engage in the bidding process any further and the remaining eightwere invited to individual day-long workshops (stage 3). During the workshops (workshop 1),Resolving agency issues in client-contractor relationships880%100%120%140%160%20 25 30relative quoted priceWeek of 2015Bidder ABidder BBidder CBidder DBidder EClaire explained rationale and situation of the project, in particular the challenging time-linethat was given the highest priority by Merck, as well as the organization of the constructionsite; Peter explained building concept and design and presented examples and challenges inmaking the fair-faced concrete surfaces; John explained the structural design concept andPaul and Lilian captured feedback on a previously drafted schedule considering site logisticsand interdependencies with other contractors. After this introduction, technical questions bythe bidders were addressed and discussed extensively.This workshop was specifically designed to establish a good working relationship anddemonstrate the collaborative approach chosen for this project. However, discussions onpricing were completely excluded at this point and the bidders were asked to prepare theirquotes under due consideration of the workshop results.Three bidders refrained from submitting a quote after the workshops, whereas the remainingfive submitted their quotes on time (stage 4). As shown in Figure 4, quoted prices werespread out significantly at this point (t=1) with a variance of more than 50%. After evaluationof the quotes the bidders were invited to another set of individual workshops (workshop 2),which were centered around the results of the Lilian’s and Peter’s check and individual itemsof the quotes, where pricing appeared to be off or inconsistent (stage 5). As a result, the twolowest priced bidders raised their price, whilst the most expensive one lowered his, and thespread in pricing of the now technically comparable quotes had fallen by half (t=2; stage 6).All these intensive discussions also provided interesting insights for Steven, Mark and theirteam into competence and general attitude of the bidder and their representatives, who wereabout to become future partners in the project. This allowed them to draw conclusions on thecontractors’ collaborative approach and how it developed over time, i.e. they could see ifcollaboration is really engrained in the contractors’ thinking and doing or if it is just amarketing approach.Fig. 4 Pre-Contract phase: Development of quoted prices for the concrete and steel works package(normalized with the final contract price = 100%) over the year 2015.t=1 t=2 t=3 t=4Resolving agency issues in client-contractor relationships9Shortly after the project had reached this stage, additional regulatory requirements wereissued by the building authority in terms of unexpected explosion events3. Theserequirements had not been known earlier and several parts of the tendering package had tobe re-worked by the planners (stage 7). This was a major issue for Steven and Mark as theywere aware that Merck would not accept any delay of the set completion date due to thecelebrations planned for the company’s 350-year anniversary. Work on foundations had tostart soon, and hence, they decided together with Peter and John that further talks shouldconcentrate on the two most promising bidders – namely Construct (A) and Build (B).Construct and Build were asked for indicative quotes based on some initial information (t=3;stage 8). Afterwards, both were invited to individual risk mitigation meetings in order toexplore the most suitable way forward to minimize negative consequences of the re-design ina collaborative spirit (stage 9). These face-to-face meetings were centered around: Full disclosure of the regulatory situation and their influence on the buildingstructure Request for ideas and optimization potentials with respect to works preparationand sequences in order to accelerate construction. Options to bring materials purchases forward on the basis of draft materialtakeoffs and fair allocation of corresponding risks as well as shift work on site.During the workshop the bidders were also provided with the revised material take-offs andother documents that had changed. Based upon all available information, the final quoteswere submitted by Construct and Build (stage 10). As indicated in Figure 4, the final quoteswere higher than the previous, indicative ones because quantities and qualities of steel andconcrete had increased due to higher design loads (t=4).In parallel, Peter, Lilian, and Paul adjusted the time schedule accordingly under inclusion ofoptimization proposals by the bidders in order to evaluate the consequences on othercontractors. Steven, Mark and their team then evaluated the two quotes with Constructoffering the best value. They visited an example project of Construct and decided to move totechnical contract negotiations with them. During these negotiations they agreed thefollowing: Planned delivery and contract dates Concept for organization and sequence of construction Site organization Contingencies in case of adverse weather conditions Secondary offers for optimizationsOnly after these conditions were fixed, the price was negotiated, as per Merck’s corporategovernance under Frank’s lead, and subsequently the contract signed. These negotiationswere conducted in a constructive atmosphere of mutual respect and fairness. After signingthe contract, Merck offered Construct unilaterally additional bonus payments, if certainmilestones were met. The idea was to motivate them to achieve targets and to demonstrategoodwill and good intentions for further collaboration by offering a bonus which could not beinterpreted as a withheld portion of the earned payment for services. The bonus arrangementgave Claire a lever to directly influence Construct´s management with regard to directing3 For these particular buildings, an additional regulatory requirement was imposed by the local building authorities owing to thefact that the buildings are placed close to chemical plants that pose a potential danger from industrial accidents. One suchscenario required the buildings to withstand blasts of defined strength, which constitutes a highly unusual load case for buildingsin engineering terms and had to be investigated thoroughly by highly specialized expert engineers before the tangibleconsequences for sizing façade and structural work became entirely clear.Resolving agency issues in client-contractor relationships10extra effort towards meeting important and evolving milestones at her discretion, which isotherwise difficult to do under German law.CONCRETE AND STEEL WORKS – EXECUTIONDuring execution of the contract Claire, Lilian and Paul regularly met with Construct´s projectmanagement and monitored the work done on site. Technical and organizational issues werediscussed as were progress, obstructions, safety and order on site, as well as logistics.Solutions to problems were sought jointly, and if unavoidable, intermediate milestones wereadjusted and individual bonus payments offered, whilst keeping the project end date fixed.Additional work requests were regularly negotiated in a mutually fair manner.The contractual work had been delegated to the Construct team who remained fullyresponsible for execution and output. John regularly supervised critical stages of structuralwork and Mark, Claire and Peter checked the critical fair-faced concrete surfaces. Stevenkept loose contact to the senior management team of Construct and got slightly moreinvolved in rare cases of dissent between the two project teams. He chose this approach tokeep both parties focused on work execution, rather than on questions of accountability orindividual contractual interpretations.REFERENCESBarbosa, F., Woetzel, J., Mischke, J., Joao-Ribeirinho, M., Sridhar, M., Parsons, M., Bertram,N. and Brown, S. (2017) Reinventing Construction: a Route to higher Productivity. McKinseyGlobal Institute. (Available at www.mckinsey.com/mgi; accessed: 22. May 2019)Esch, HG (2018) Merck Innovation Center, Wasmuth Verlag, Tübingen.Henn, G. (2019), private communicationMerck (2019) Corporate Responsibility Report. (Available at: https://www.merckgroup.com;accessed 22.05.2019)Merck (2016) Annual Report 2015 (Available at: http://ar2015.merckgroup.com; accessed22.05.2019)Statistisches Bundesamt (2019) Volkswirtschaftliche Gesamtrechnungen –Inlandsproduktsberechnungen. (Available at: https://destatis.de; accessed: 22 May 2019)Initiative Teambuilding (2019) Initative Teambuilding (Available at: https://initiativeteambuilding.de/; accessed: 22. May 2019, German only)ACKNOWLEDGEMENTSThe research team is grateful to all informants of this research who provided support for theadvancement of knowledge. In particular we would like to thank the client, Merck KGaA, theexternal project managers, Drees & Sommer AG, the architects, Henn Architecture and thephotographer, HG Esch.COPYRIGHTSCopyright Photographs ©2018 Hans Georg Esch All Rights Reserved; Contents andcompilations published in this case study are subject to German copyright laws.Reproduction, editing, distribution as well as the use of any kind outside the scope of thecopyright law require a written permission of the authors. Copies of the material arepermitted for private and educational use only. The commercial use of our contents withoutpermission of the authors is prohibited.Resolving agency issues in client-contractor relationships11Resolving agency issues in client-contractor relationships: The Merck Innovation CenterInstructor’s guide for teaching caseABSTRACTThis teaching case focuses on agency issues in project management using a large corporateconstruction project as empirical context. It is mainly focused on the procurement strategyand process of one specific work package through a collaborative approach which aims tobuild trusting relationships between the principal – the client – and the agent – the contractor.The project faced a multitude of challenges which will be discussed. It will enable students togain an in-depth understanding of agency related issues and to develop the skills to designappropriate procurement strategies considering agency issues in complex projectenvironments.INTENDED AUDIENCEThe intended audience for this case is participants of executive education programs or shortcourses as well as professionals who attend in-house training. Hence, it is assumed thatparticipants who have a certain amount of work experience and who can relate the case totheir experience will use the case. Examples of courses this case is suitable for are moduleson project organization or governance on MSc project management programs, which requireprior work experience or short courses for practitioners, which address topics likecollaborative working, procurement strategies for projects or projectorganization/governance. The case is designed to be one element of 90 minutes to supportthe delivery of the course, but it should not be used as case for the entire course.LEARNING OBJECTIVESAfter analyzing this case, students should be able to:1. Evaluate the presence of agency related issues in client-contractor relationships2. Develop methods to overcome agency related issues in client-contractor relationships3. Operate appropriate procurement strategies for complex projects4. Assess benefits and weaknesses of collaborative approaches in projectsTEACHING STRATEGYCase preparationAs outlined earlier, this case can be used on programs and modules related to postexperience education in project management. Students working on this case should befamiliar with different procurement methods for projects including contracting/outsourcing aswell as project organization and project governance. No detailed knowledge in these areas isrequired, but they should be familiar with the related terms and processes.To prepare the students for this particular case it is recommended that they read thefollowing paper prior to working on the case to provide them with the required theoreticalbackground on agency theory:Resolving agency issues in client-contractor relationships12Bryde, D., Unterhitzenberger, C. and Joby, R. (in press) Resolving agency issues inclient-contractor relationship. Production Planning & ControlFor further information about the project in relation to architecture, photography andinnovation, it is recommended to read the following book as it offers many visual andintellectual insights into the project (in German and English). It is not a requirement to readthis book in order to understand and work with the case.Esch, H. G. (2018) Merck Innovation Center, Wasmuth Verlag, Tübingen.The students should be given the case prior to the teaching session to read in depth, so thatthe time in the classroom can be used for discussions.Teaching methodsThis case enables lecturers/tutors to use a problem-based approach to learning in a smallgroup teaching environment. Due to the nature of the intended audience – executiveeducation and post-experience students – small group teaching is recommended. It will allowthe students to use their knowledge and experience in the small group discussions, to buildon others’ existing work and to think creatively and originally in order to solve the problemthey are presented with. The teaching case and its discussion questions provide the problemfor the students which they are required to solve through these small group discussions.They need to work out themselves how to solve this problem, which enables them to developtransferable skills, improve team working and communication and enhance debating andanalytical skills.Ideally, the use of this case should be structured as follows (duration 90 minutes):10 minutes Re-cap on agency theory and agency-related issues5 minutes Summary of the case by the students2 minutes Forming of small groups (2 – 4 students per group)3 minutes Handing out of discussion questions30 minutes Small group discussions on discussion questions 1 – 1030 minutes Discussion of the answers with the full cohort5 minutes Presentation of the epilog5 minutes Open Q&A around the case and the epilogLITERATURE REVIEW, THEORY AND RECOMMENDED READINGAgency theory has its origins in economics of the 1960s and 1970s where researchersexplored how individuals and groups share risks and how it creates problems when theinvolved parties have different attitudes towards risks (e.g. Arrow, 1971; Wilson, 1968). Itwas then developed further to incorporate issues such as diverging goals of cooperatingparties and division of labor, which created what is now known as the ‘agency-problem’(Jensen and Meckling, 1976). In essence, agency theory focuses on the dyadic relationshipbetween two cooperating parties: the principal, who delegates work to the agent, whoperforms the work, whereas the relationship is defined through a contract (Eisenhardt, 1989).This type of relationship is omnipresent in many multi-organizational projects where a clientResolving agency issues in client-contractor relationships13(the principal) engages external consultants or contractors (the agents) to execute work,usually due to a lack of expertise or resources in-house. It has been recognized as a usefuland realistic theory for exploring cooperative relationships (Eisenhardt, 1989) and has beenapplied as a theoretical lens for project governance research (Turner and Müller, 2003).Agency theory is interested in solving two main problems: the adverse selection problem andthe moral hazard problem. The adverse selection problem refers to the informationasymmetry between the principal and the agent (Akerlof, 1970), as one party usually hasmore or better information than the other party. An example situated in the project context is,that it is often the case that the agent, i.e. the contractor, has significantly more detailedinformation about how the project is performing than the principal, i.e. the client, who mightalso be not in the position to verify the information provided by the agent (Wiseman et al,2012). This can subsequently lead to the moral hazard problem where the agent engages inactions, which put a specific risk on the principal, knowing that the principal will have to incurthe consequences (Eisenhardt, 1989).Common issues related to the adverse selection and the moral hazard problem are (Bryde etal, in press): Goal conflict – Each party will follow their own interests and not act in a way, which ismutually beneficial if the goals of the cooperative relationship are not aligned or notknown. Opportunistic behavior – One of the parties operates in an opportunistic way, i.e. theyexploit a situation by aiming to maximize their economic self-interest accepting thatthis might lead to the loss of a partner. Information asymmetry – The principal and the agent do not have access to the sameinformation and/or are not willing to share their information. Trust – The two parties trust each other if they have a firm belief in the reliability, truthand ability of each other. Principal-agent relationships are often characterized by ahigh level of mistrust. Verification of contractor performance – The principal does not have any means ofverifying the contractor’s performance and hence, cannot validate if the informationprovided is correct or not and if the project is on track or not. Concealment of negative outcomes – One of the parties withholds or suppressesnegative outcomes of their work. Either the principal or the agent do not shareproblems and failure and do not give the other party the opportunity to contribute tothe rectification.These issues are all inter-related and cannot be isolated from each other, as e.g. informationasymmetry can lead to mistrust and opportunistic behavior or goal conflict can lead toopportunistic behavior or concealment of negative outcomes. Many principals, i.e. clients,attempt to solve these problems through contractual arrangements, incentives or theappropriate governance, which should reduce the agency problems (Joslin and Müller,2016). Agency theory differentiates between two types of contracts (Florical and Lampel,1998): the outcome-based contract, of which a fixed-price contract is a typical example, andthe behavior-based contract, of which a fee-for-service contract is a typical example. Agencytheory argues, that the agent will be more likely to act in the interest of the principal if thecontract is outcome-based as the reward for both depends on the same actions and hence,the goal conflict and likelihood of opportunistic behavior are reduced (Eisenhardt, 1989).However, if appropriate information systems are in place, which put the principal in theposition to verify the contractor’s performance and behavior, behavior-based contracts canbe appropriate (ibid). Next to the type of contract, the contractual completeness is anotherfactor, which can contribute to the reduction of agency-related issues, whereas contractualResolving agency issues in client-contractor relationships14completeness relates to the extent the contract is fit for purpose (Handley and Benton Jr,2009).This teaching case sheds light on some important aspects of agency theory includingagency-related issues and their potential resolutions – especially during the procurementprocess – for a large-scale construction project.Recommended readingEisenhardt, K. (1989) Agency theory: An assessment and review. Academy of ManagementReview, 14(1), pp. 57-74ReferencesAkerlof, G.A. (1970) The Market for” Lemons”: Quality Uncertainty and the MarketMechanism. The Quarterly Journal of Economics, 84(3), pp. 488-500Arrow, K. (1971) Essays in the theory of risk bearing. Markham, Chicago.Bryde, D., Unterhitzenberger, C. and Joby, R. (in press) Resolving agency issues in clientcontractor relationship. Production Planning & ControlEisenhardt, K. (1989) Agency theory: An assessment and review. Academy of ManagementReview, 14(1), pp. 57-74Florical, S. and Lampel, J. (1998) Innovative contractual structures for inter-organizationalsystems. International Journal of Technology Management, 16(1), pp. 193-206Handley, S.M. and Benton Jr., W.C. (2009) Unlocking the business outsourcing processmodel. Journal of Operations Management, 27(5), pp. 1540-1556Jensen, M., and Meckling, W. (1976) Theory of the firm: Managerial behavior, agency costs,and ownership structure. Journal of Financial Economics, 3, pp. 305-360Joslin, R. and Müller, R. (2016) The relationship between project governance and projectsuccess. International Journal of Project Management, 34(4), pp. 613-626Turner, J.R. and Müller, R. (2003) On the nature of the project as a temporary organization.International Journal of Project Management, 21 (1), pp. 1–7Wilson, R. (1968) On the theory of syndicates. Econometrica, 36, pp. 119-132Wiseman, R.M., Cuevas-Rodríguez, G. and Gomez-Mejia, L.R. (2012) Towards a socialtheory of agency. Journal of Management Studies, 49 (1), pp. 202–222DISCUSSION QUESTIONS1. Which agency related issues can you identify in the case?2. How were the different issues addressed by Steven and Mark?3. Do you think the way Steven and Mark addressed the agency related issues wasappropriate and effective? Why?4. Can you relate mechanisms to resolve agency related issues in this case to some ofthe mechanisms identified in the CURED framework (see Bryde et al, in press)? Whatdoes this tell us about Steven’s and Mark’s approach?Resolving agency issues in client-contractor relationships155. Steven and Mark decided to develop their own collaborative way of procuringconcrete and steel works. Do you think their model should be recommended forreplication for other projects? Why?6. Due to the introduction of additional requirements by the building authorities a majordisruption of the procurement process occurred. Do you think Steven’s and Mark’sstrategy to postpone this issue post-contract award is suitable? Why?7. Post-contract award the client offered bonus payments to Construct. Why did theychoose to spend extra money if they are not contractually obliged to do so? Do youthink it paid off?8. Bryde et al (in press) point to another area, where agency problems arise, namely inthe allocation of benefits and risks in uncertain situations. Which instance in the casestudy addresses this particular concern of Steven and Mark? Did they adopt a valueor a risk sharing perspective? Why?9. Would you have done anything differently to Steven and Mark? Why?10. In your opinion, is it likely that Steven’s and Mark’s approach contributes to thesuccess/failure of the project? Why?ANSWERS TO DISCUSSION QUESTIONS1. Which agency related issues can you identify in the case?Agency issues emerge due to the phenomena of adverse selection and moral hazard.Adverse selection relates to the information imbalance between the agent – in our case thebidders – and the principal – in our case Merck as the client and the consultants – mainlyduring the pre-contractual procurement process; whereas moral hazard relates to situationswhere the principal has difficulties directing the agents actions because they areunobservable or cannot be contractually agreed and hence, occurs in the post-contractphase. Our case is situated during the pre-contractual procurement process, so the focus ison the adverse selection problem and more specifically on the following issues: Degree of goal conflict – It is highlighted in the text that “many spectacular projectfailures both in the public as well as in the private sector have been credited to anadversarial and fragmented project environment based on suboptimal contractualarrangements that often resulted in claims and in litigation”. This is related to thedegree of goal conflict as an adversarial environment often develops when theinvolved parties have opposing or non-aligned goals. This can typically occur in twodifferent situations: a) when contractors are either predominantly interested inmaximizing their own profit and hence, do not necessarily act in the interest of theproject/client or when the contractor representative follows his/her own agenda interms of e.g. building a promotion case; and b) when clients are not interested in asustainable and fair relationship with their contractors, but either aim to deploy theproject with minimal budget and effort disregarding the impact this might have on thecontractors or also follow their personal interests like securing a bonus for achievingcertain not-project related KPIs. Degree of opportunistic behavior – This can also be observed in the adversarial andfragmented project environment as it relates to the maximization of economic selfinterest in particular when a situation occurs which can be exploited. This is often thecase when one party is in a difficult situation and requires support and the other partytries to get the most out of the situation for themselves, e.g. if the project is delayed,but the client requires a certain completion date, the contractor might overpriceacceleration measures and hence exploit the client.Resolving agency issues in client-contractor relationships16 Degree of information asymmetry – Our case focuses strongly on the degree ofinformation asymmetry during the procurement process which is a crucial projectstage in terms of information asymmetry. It is emphasized that there is big informationasymmetry at the beginning of the procurement process as the client, architect,engineers and consultants have worked on the project for many months or evenyears and hence are very familiar with the project. They have developed the project,went through multiple iterations, they know why decision were made in a certain wayand what the potential problems with the project are at that point of time. The biddershowever, who are asked to submit a price for delivering the project, know basicallynothing about the project. They have a limited set of information in the form of briefingdocuments and later on the tender package. During the workshops they are providedwith further in-depth information. Level of trust – Steven’s and Mark’s intention is to build a collaboration with thecontractor which is built on trust. They allow time in the procurement process to get toknow the different bidders and to give the bidders the opportunity to get to knowthem. They also communicate openly and honestly, allow for questions and treat thebidders with respect. Level of concealment of negative outcomes – As our case is positioned during theprocurement phase the project outcomes of the contractor are limited. However, thereis a major incident on the client side – the change of requirements by the buildingauthority – which shows how Steve and Mark handle a negative event during theproject. They communicate the incident openly to the bidders and share all theinformation they have available at that point in time.2. How were the different issues addressed by Steven and Mark?Steven and Mark tried to close the pre-contractual information in-balance with theircontractor as quickly as possible through an intense process involving several workshopswith a number of bidders. More specifically they undertook the following actions: Degree of goal conflict – They communicated openly and honestly with the bidders onwhat the client’s and their personal goal with the project is, why this goal is in placeand what they plan to achieve with the project. This was clearly addressed in theworkshops in order to avoid a high degree of goal conflict emerging during the postcontract phase. Degree of opportunistic behavior – Again, Steven and Mark were open and honestwith their bidders during the workshops and explained their intentions for the project.Through this process they could investigate how the different bidders reacted to andbehaved in various situations and find out if they have a tendency to exploit a weakerposition or not. Degree of information asymmetry – The minimization of information asymmetry wasat the core of Steven’s and Mark’s actions. Through the carefully preparedprocurement process with various briefings and workshops they were able to bringthe bidders up to speed very quickly and demonstrated their openness to make allinformation they had available to the bidder. The process of building up knowledge forthe bidders and hence, minimizing information asymmetry is shown in Figure 5.Resolving agency issues in client-contractor relationships17Fig. 5. Schematic account of build-up of project knowledge on behalf of the bidders duringthe pre-contract phase in order to reduce information asymmetry Level of trust – Trust can only be built over time. In the absence of a long-standingrelationship with any of the bidders, Steven and Mark invested time during the precontractual phase to get to know the bidders and to give the bidders an opportunity toget to know them. Again, this enabled them to observe the bidders and make ajudgement if they can potentially work trustfully with them in the future. Level of concealment of negative outcomes – Steven and Mark openly admitted inthe midst of the procurement process, that new requirements from the buildingauthorities meant a major change to some of the structural elements of the building.This could have potentially been exploited by one or more bidders, but as Steven andMark approached it in a collaborative way by – again – sharing all the informationthey had and communicating openly about the challenge, they found support from thebidders. They did not neglect the problem and they did not try to force the bidders toprovide a price for a – at this point in time – undefined work which the bidders wouldbe hold accountable to later on. This showed the bidders that the client does not havethe intention to exploit a situation, but to work collaboratively on issues that occurduring the project.For Steven and Mark, the additional effort and cost of having this multi-stage procurementprocess with various workshops were seen as a necessary, but valuable investment. Itallowed them to build trust in the absence of a long-standing relationship and thus mitigatethe risks emanating from the moral hazard problem in the post-contractual phase. They alsowanted to make sure, that the selected contractor was the best fit in terms of competenciesand behavior.3. Do you think the way Steven and Mark addressed the agency related issues wasappropriate and effective? Why?This should be an open discussion amongst the participants. They might contribute variouspoints of view and justifications which we are unable to comprehensively cover here. Insummary, we suggest that Steven’s and Mark’s way to address the agency issues wasappropriate because in the end they led to a successful project. This can be judged on thefollowing facts: Foundation work started on time.Resolving agency issues in client-contractor relationships18 Concrete and steel works were completed in a timely fashion and with high quality. Construct was motivated through incentives and actively engaged in resolving day-today problems on site in order to meet the client´s intermediate milestones.Steven and Mark had demonstrated in the pre-contractual phase, that uncertainties andproblems were shared openly and solutions were not sought at the expense of Construct.Reciprocal behavior was evident in the post-contractual phase, which was supported byClaire and her team, who remained constantly involved and engaged in day-to-dayoperations of Construct, without interfering or micro-managing.4. Can you relate mechanisms to resolve agency related issues in this case to some of themechanisms identified in the CURED framework (see Bryde et al, in press)? What doesthis tell us about Steven’s and Mark’s approach?The mechanisms to resolve agency issues identified in the CURED framework are Contract,Understanding, Resources, Education and Delegation. These mechanisms were used bySteven and Mark as follows: Contract – Steven and Mark very consciously ensured contractual completeness interms of fit for purpose and employed formal and informal mechanisms to do so. Theydecided that the voluntary bonus is not a formal element of the contract, but aninformal instrument for Claire to manage the progress of work. Understanding – Steven and Mark have the goal to develop a shared understandingwith the contractor right from the outset of the project. They utilize the briefingdocuments, but also the specifically designed workshops during the procurementprocess to create this shared understanding between the principal and the agent.They also put a strong emphasis on communicating adequately, openly and honestlywith bidders/contractors to ensure that the shared understanding is not onlydeveloped, but also maintained throughout the project. Resources – Steven and Mark were aware of the importance of appropriateresources for the project. They recognized that they do not have the expertise orcapacity required for certain aspects of the project and ensured that they employexternal experts wherever necessary. Furthermore, they wanted the bidders tounderstand the project in-depth before submitting the final quote to ensure they hadthe appropriate resources in place as well. This was important as they wanted toprevent the project from suffering due to insufficient funding of one of its keycontractors. Education – Steven, Mark and their team did not conduct or incorporate any formaltraining. Nevertheless, some form of informal training or education took place duringthe initial workshops as they enabled the participants to gain an understanding ofways of working, critical issues in the project and relationships amongst the differentparties involved. Delegation – Steven and Mark delegated the execution of the concrete and steelworks to Construct. They had to trust Construct to execute the work as specified asthey were only able to keep a control certain aspects of the work themselves. Theyeven delegated some of the control to internal and external experts like Claire, Lilian,Paul or John who again could not control every single aspect of the work, but actedmore as quality assurance while allowing Construct to actually do their job.This shows that Steven and Mark utilized most of the measures to resolve agency relatedissues which subsequently enabled them to deliver a successful project.Resolving agency issues in client-contractor relationships195. Steven and Mark decided to develop their own collaborative way of procuring concreteand steel works. Do you think their model should be recommended for replication forother projects? Why?This should be an open discussion amongst the participants. They might contribute variouspoints of view and justifications which we are unable to cover comprehensively here. Overall,we suggest that this model can be transferred to the procurement of other work packagesand indeed, should be replicated for other projects. A reason for this is that issues related toagency theory are not project or industry specific – they are present in any type of projectand in any industry as suggested by Bryde et al (in press). The model employed by Stevenand Mark can and should therefore be adopted by other projects in order to set thefoundations for a collaborative and trustful way of working on the project and – mostimportantly – completing it successfully. Depending on the industry and volume of the tenderpackage, the process might require adaption and/or modification in terms of number ofworkshops, bidders involved and timeframe, but we are convinced that the processdeveloped by Steven and Mark offers a good and valuable guidance for other work packagesor projects and we expect that the same benefits can be realized in other work packages andprojects. Indeed, all major tender packages in the OGHQ program followed the lead ofconcrete and steel works and it proofed successful for the other work packages as well.However, the additional effort and cost need to be considered. We suggest that they arewarranted in those cases, where agency theory clearly indicates risks that need to becontrolled by the principal. In certain other institutional settings, were trust among actorsplays no role, projects may also be conducted at arms-length.6. Due to the introduction of additional requirements by the building authorities a majordisruption of the procurement process occurred. Do you think Steven’s and Mark’sstrategy to postpone this issue post-contract award is suitable? Why?This should be an open discussion amongst the participants. They might contribute variouspoints of view and justifications which we are unable to cover comprehensively here. Wesuggest, that Steven’s and Mark’s approach to postpone the issue post-contract wassuitable, especially against the background that they wanted to build a collaborative andtrustful relationship with the contractor. They demonstrated through their behavior precontract, that they were willing to discuss and resolve all open issues in a collaborative andfair manner. Through their intensive pre-contract discussions with all bidders, the team couldform an educated opinion about the bidders’ behavior and likely response to issues andeventually selected Construct as the best fit. Furthermore, the laying of foundations wasimminent according to the original schedule and further delays would endanger thecompletion date in an unacceptable way.7. Post-contract award the client offered bonus payments to Construct. Why did theychoose to spend extra money if they are not contractually obliged to do so? Do you thinkit paid off?Steven and Mark offered the bonus to Construct post-contract in order to clearly separatethis voluntary award from all contractual obligations. Their thoughts behind this were, thatConstruct would view it as a real bonus award, that was fairly paid out in case of successand not paid if the milestones were not achieved. They hoped that in the case of nonpayment due to missing the milestone, Construct would not view it as reduced income.Resolving agency issues in client-contractor relationships20Therefore there was only “gain” and no “pain” in this arrangement4. Claire, the projectmanager, could allocate the bonus payments at her discretion for intermediate milestoneswithout getting into contractual negotiations or conflict with Construct or German contractlaw.8. Bryde et al (in press) point to another area, where agency problems arise, namely in theallocation of benefits and risks in uncertain situations. Which instance in the case studyaddresses this particular concern of Steven and Mark? Did they adopt a value or risksharing perspective? Why?OGHQ faced a major instance during the procurement of concrete and steel works whichwas the issuing of new requirements by the building authority (see stage 7 in Table 1): Theremaining two bidders were invited to risk mitigation talks, where the causes andconsequences of the disturbance were shared and both asked for ideas and proposals toreduce risk. Both were given the opportunity to adjust their quotes accordingly and it can betaken from Figure 4 that there were some price adjustments. Hence, Steve and Markadopted a risk sharing perspective in order to motivate the agent – in our case the tworemaining bidders Build and Construct – to cooperate.9. Would you have done anything differently to Steven and Mark? Why?This should be an open discussion amongst the participants. They might contribute variouspoints of view and justifications which we are unable to cover comprehensively here. Thereare various instances where Steven and Mark had options on how to design the procurementprocess for the concrete and steel works. As outlined initially, they could have chosen thetraditional way of competitive tendering with a sole focus on price, they could have exploredusing open book contracts or they could have employed a general contractor instead ofprocuring by work packages. We don’t know what the outcome of the project would havebeen if a different procurement method was chosen. However, we know that the chosenmethod was highly successful and hence, we assume that it was the best and mostappropriate solution for this project.Steven and Mark could also have handled the instance of the changed requirements fromthe building authority differently. They could have provided the bidders with the informationthey had and requested to include it in their quote; they could have hidden the informationand only provided it after contract award trying to pretend it was already included; they couldhave paused the procurement process in order to update the design – again, there are manydifferent options and we don’t know what would have been the outcome if a different way ofdealing with this instance was chosen, but Steven’s and Mark’s approach proved once moresuccessful and hence, we conclude that they acted appropriately.10. In your opinion, is it likely that Steven’s and Mark’s approach contributes to thesuccess/failure of the project? Why?4 Recent psychological research indicates, that teams are motivated by monetary incentives to perform non-routine tasks quickerthan in their absence. We assume that penalties have a detrimental effect on performance. See also Engelmaier F., Grimm S.,Schindler D., Schudy S. (2018),The Effect of Incentives in non-routine analytical Team Tasks – Evidence from a Field Experiment,CESifo Working Paper No.6903, Category 13. Behavioural EconomicsResolving agency issues in client-contractor relationships21This should be an open discussion amongst the participants. They might contribute variouspoints of view and justifications which we are unable to cover comprehensively here. Basedon our analysis, we conclude that Steven’s and Mark’s approach had an impact on theoverwhelmingly successful completion of the project. They put in place the appropriatemeasures to overcome agency related issues and tried to build trust between the clientorganization and its representatives, the principal, and Construct, the agent. This allowedthem the manage a complex project with a reasonably high degree of uncertaintycollaboratively without losing Construct’s commitment. They decided to reward positivecontributions to the project which facilitated the achievement of critical milestones withoutestablishing a blame culture if these milestones were not met. They achieved that Constructacknowledged and recognized the importance of the project and that Construct adopted theirgoal of delivering a successful project.EPILOGThroughout the post contract award phase of project execution, Steven, Mark and their teamnoticed that the positive attitude and collaboration with Construct persisted despite alldifficulties and problems that inevitably occur in most largescale, complex projects. Constructmet certain milestones and hence, bonus payments were made, whereas milestones whichwere not met, were redefined towards new goals. In total bonus payments worth 1.5% ofConstruct’s contract value were paid. However, several change orders were issued andacceleration measures were commissioned which led to an increase of the contract value of11%. Finally, adjustments in actual quantities added another 5% to that sum, so thatConstruct’s contract was closed at 117.5% of its original value. This amount was withinMerck’s budget including risk provisions and hence, Steven and Mark were very pleased withthe overall result of the tendering package concrete and steel works. Especially, as thequality of the work was outstanding which was recognized through an honorary mention atthe European Concrete Award 20195 by the European Concrete Societies Network (ECSN).Eventually, the project was finished on time and in budget to the full satisfaction of Merck andall other stakeholders. The Innovation Center was inaugurated by the German chancellorAngela Merkel, a representative of the owner family of Merck and Merck’s CEO on 3rd May2018 during the celebratory event for the 350-year anniversary. The buildings and the publicsquare were critically acclaimed in architectural critiques and selected as a finalist for severalimportant awards. This again made Steven and Mark as well as their team very happy andprovided a confirmation for them that the chosen collaborative approach was appropriate andnecessary. Steven and Mark are convinced that with a traditional procurement process theywould have never achieved this result.5 See http://ecsn.net/ Excerpt from ECSN award brochure: “Ed. Züblin AG realised the MerckInnovation Center, located in Darmstadt, which will be a best practice example for fairfaced concrete inperfection. Both the building as an example for a complex structure using a high amount ofreinforcement, rounded geometry and fairfaced concrete requirements, as well as the supersurface asa place of representation for Merck, built using a white, burnished and polished concrete surface in athree- dimensional geometry, required a big effort of concrete structural knowledge, concretetechnology knowledge and a manufacturing experience.”Resolving agency issues in client-contractor relationships22

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