Dr. Ajit Patwardhan
World Bank approved Professional trainer and International Consultant in Infrastructure Development & Contract Management

This year, the Nobel Prize for Economics, has been awarded to Prof. Richard Thaler of Chicago University, for his contribution to Behavioural Economics. In the press statement, the Royal Swedish Academy of Sciences described his contribution as under:

“Thaler has incorporated psychologically realistic assumptions into analyses of economics decision- making. By exploring the consequences of limited rationality, social preferences and lack of self-control he has shown how these human traits systematically affect individual decisions as well as market outcomes….

“In total, Richard Thaler’s contributions have built a bridge between the economic and psychological analyses of individual decision- making. His empirical findings and theoretical insights have been instrumental in creating the new and rapidly expanding field of BEHAVIOURAL economics, which has had a profound impact on many areas of economic research and policy.

Reason for raising this issue:
Before proceeding further on the details of his theory and applicability of his academic work, this writer intends to share with readers, the reason why, this article is being written, in the context of Project procurement and its Execution.

It is a well known fact that large Infrastructure Projects awarded by Public bodies in India and other countries are manyatimes delayed resulting into substantial time and cost overrun. Sometimes these projects are stalled for years causing serious losses to the Country and the Economy. Many External and Internal factors are responsible for this situation. Whatever the nature of problems, the biggest hurdle in settling those issues is the inability of two parties to the Procurement contract to interact and resolve the problems and reach amicable solutions.

Is it possible that two parties to such Contracts do not see the way out, because of their irrational BEHAVIOURAL attitude, rather than lack of possible remedy to the problems faced by them. Studies conducted by many experts about such disputed cases in this field, suggest that not so rational approach, based on unwarranted pride and prejudice alongwith adversarial nature of relationship between the two parties might be responsible for this dilemma.

Applicability of the theme:
If we try to apply theory of Nobel Lauret Prof. Thaler about human irrational behaviour in Economic decisions making, to above Projects related problems, you get surprised by the relevance of his many ideas in this context. This writer would like to show the connection between Prof. Thaler’s and other experts’ ideas, and the problems faced in Project execution, to establish the relevance of these concepts and possible remedies, based on these theories from Behavioural Economics.

To connect the issues properly, Prof. Thaler’s ideas are first quoted and its applicability to Project contract issues are then examined.

Idea of Limited Rationality:
Prof. Thaler developed the theory of mental accounting, explaining how people simplify financial decision- making by creating separate accounts in their minds, focusing on the narrow impact of each individual decision rather than its overall effect .He also showed how aversion to losses can explain why people value the same item more highly when they own it than when they don’t a phenomenon called the endowment effect. Prof. Thaler was one of the founders of the field of Behavioural finance, which studies how cognitive limitations influence financial markets.

This concept of limited rationality can explain, why various claims or disputes are not seen as a whole, but a separate & limited view is taken of each claim, rather than its overall effect. In many disputed cases, it is noticed that of a party to the dispute concedes their liability in a particular issue, other party is also willing to concede their deficiency on the other issues, but it is resisted by parties due sense of actual loss then rather than likely future gain, due to sense of limited rationality.

Idea of Social preferences:
Mr. Thaler’s theoretical and experimental research on fairness has been influential. He showed how consumers’ fairness concerns may stop firms from raising prices in periods of high demand, but not in times of rising costs. Thaler and his colleagues devised game, an experimental tool that has been used in numerous studies to attitudes to fairness in different groups of people around the world.

This principle of fairness if applied by the Client to its Contract structure can result into a very competitive prices being quoted by the Contractors, because of balanced terms and conditions. It is a common experience that fair & balanced contracts can attract competitive prices in International bidding of Infrastructure projects, resulting into win-win situation. However this is resisted by Client writing the contract, to protect only his risks and interests.

Lack of self- control:
Mr. Thaler has also shed new light on the old observation that New Year’s resolutions in can be hard to keep. He showed how to analyse self-control problems using a planned-doer model, which is similar to the frameworks psychologists and neuroscientists now use to describe the internal tension between long-term planning and short-term doing. Succumbing to short term temptation is an important reason why our plans to save for old age, or make healthier lifestyle choices, often fail. In his applied work, Mr. Thaler demonstrated how nudging a term he coined, may help people exercise better self-control when saving for a pension, as well in other contexts.

This is a well known principle, followed in our personal life, is equally applicable to Life cycle approach in Project Management. Earlier many projects were awarded on the basis of quotation for only construction. Over period of time, Design Build & Commission project became more popular. But in recent times, when clients from Public Bodies, have started taking a long term view of projects by adopting for Design, Build Maintain & Operate, has resulted into savings & cost reduction over project life cycle in the long run. However this approach is not well settled in all project awards, resulting into apparent lower contract prices in the early stage, but much higher overall cost over the project life cycle.

Above quick observations are made to show connection between ideas of Behavioural Economics propagated by Prof. Thaler & other experts with Project execution. However, the readers of this article might seek more cohesive view for proper understanding. Hence, this writer has decided to present project life cycle flow, touching upon issues, which are affected by imperfect Behavioural attitude of Contracting parties resulting into unhappy and damaging outcomes.

Stages of Project Life Cycle & Impact of Non Rational behaviour:

Stage 1 : Concept & Feasibility :
Project concept is initiated with the input from planning dept. of Public bodies based on their approved objective and budget allocation. The Project Authority prepares the scope of the project scheme based on the concept of the project with design outline from Technical dept.

Non Rational choices & outcome:

  • The overall Price limit for the project is decided by budgetary allocation to the Project from the Funds available in the planned period, sometimes unconnected with the likely reasonable cost estimate of the proposed project, creating pressure on the scope and specification of the Project.
  • The time of completion is chosen to suit Public expectations and political compulsions, rather than within reasonable time frame. Contractor accepts such unrealistic time frame to get the business resulting into delays and penalty disputes.

Stage 2 : Scope & Tender Preparation:
The Procurement Authority issues Tender documents, by attaching standard commercial & contractual terms to the scope of works decided by the Project planning and Technical departments.

Non Rational choices & outcome:

  • The commercial & contractual terms are adopted from ongoing standard practices (for decades) without examining its relevance or the need for review with changing business environment.
  • Due to pressure from International Contractors some minor improvements are made to satisfy the expectations of Funding agencies, but the improvements are neutralised through provisions in particular conditions.

Stage 3 : Tendering & Bidding :
The usual Tendering process is carried alongwith the Site visits, Prebid meetings with Contractors & clarifications are issued for the points raised by participating Contractor.

Non Rational choices & outcome:

  • Site information provided by Public bodies is not adequate and contractors are required to satisfy themselves with all the needed details, which they cannot manage by short duration site visits.
  • Hundreds of queries raised by Contractors about the scope of work are not sufficiently clarified with standard reply about the need for “study of whole tender documents in proper manner”.

Stage 4 : Award of Contract:
The project is awarded to the lowest bidder when he makes an unqualified offer without any conditions or assumptions about the scope of work and withdrawing any exception suggested by him about scope or contractual terms and conditions.

Non Rational choices & outcome:

  • It is common knowledge that contractor withdraws any issues raised by him, to avoid getting disqualified and loosing present & future business though his real concerns are not addressed.
  • While as the choice of scope and main features of the project are decided by Public body, the contractor is required to take full responsibility of design and performance.

Stage 5 : Design & Engineering:
The successful Contractor submits Design & Detailed Engineering drawing for Client’s review and proceeds with execution after approval.

Non Rational choices & outcome:

  • Though contractor is responsible for developing designs & drawings fit for purpose, his design is reviewed with substantial comments for improvement without its impact on price and time of completion.
  • Even after compliance to the design review comments made by Client the Contractor is fully responsible for the project performance outcome.

Stage 6 : Planning & Execution:
The Execution plan made by Contractor is reviewed & approved by Clients with comments for implementation. The Contractor is required to mobilise his resources to achieve the objective and to attend promptly to decisions and instructions given by the Client.

Non Rational choices & outcome:

  • Normally Contractor is unable to mobilize as per promise made by him since those are unrealistic and his resources are still engaged in some other projects under completion.
  • Client expects complete mobilisation in short time despite site handling over by him is not completed. This is expected because release of full advance is connected with full mobilisation.

Stage 7 : Revised Planning & Execution :
It is clearly expected that whenever project is delayed compared to its schedule, the revised plan has to be submitted by Contractor to catch up with the original schedule.

Non Rational choices & outcome:

  • The Contractor is required to revise the planed schedule to catch up by mobilising additional resources without any settlement about the increased cost or who should bear, what share of cost for the delays.
  • Delays due to reasons beyond the control of contractor are allowed, but not compensated since, client is also not responsible for those delays.

Stage 8 : Change Requests & Variation order:
After some initial period of work, need for changes in scope of work arise due to various reasons. Despite variation procedure provided in the Contract, changes related Variation orders are delayed or unresolved.

Non Rational choices & outcome:

  • There is always some disagreement about the change request being part of original scope of work or genuine addition to original scope because of lack of certainty of inclusion at initial stage.
  • In Design, Build Contract models this is supposed to be Contractor’s responsibility, which is resisted by him, by claiming that it is an addition to the original scope resulting into unresolved claims.

Stage 9 : Claims & Dispute Resolution:
When claims are raised, but cannot be settled due to disagreement, proper mechanism is generally provided in the Contract, consisting of Engineer’s determination and/or Dispute Board’s decision.

Non Rational choices & outcome:

  • The Engineer’s determination though provided is rarely invoked due to lack of faith in the determination by the Engineer, who is appointed and paid by the Client.
  • Dispute Board mechanism does provides decisions on disputes, but never honoured by parties . The affected party prefers Arbitration under Law; rather than trusting the Dispute board decisions.

Stage 10 : Arbitration & Litigation :
When disputes are brought to Arbitration, due process is started to resolve them. Though the Arbitration takes long time, it is supposed to end with an award on disputed matters.

Non Rational choices & outcome:

  • The Arbitration award though final and binding, is challenged & bought to the Court on technical ground or on partiality & bias to avoid implementation of the award.
  • The Court, though not supposed to easily admit the challenge to the Arbitration award, readily agrees and admits the cases for review, which takes years for conclusion, damaging the interests of the affected party, mainly the Contractor.
  • The Contractors are asked to provide Bank Guarantee to get 75% amount released pending Litigation, which they cannot manage because of financial constraints.

This Project life cycle review gives the impression that the non-rational behaviour originates mainly on the Client side. In reality, the Contractor is also responsible for accepting non-rational conditions and decisions and making unrealistic promises for getting the business. They also treat their Sub-contractors with quite unfair provisions in the sub- contracts, knowing that such irrational conditions will not work.

Conclusions and Way forward:
After reading about these Non Rational Choices listed here, one keeps wondering, if some remedies exist to overcome these irrational outcomes.

Fortunately Prof.Thaler & other Behavioural Economists have suggested remedies to overcome this dilemma. In his famous book ‘Nudge’ co-authored with Prof.Sunstein. Quite a few Nudging ideas are suggested for managing these non-rational financial decisions. If there is basic consensus among all the stakeholders, that, there are number of non-rational decisions , taken in Infrastructure project execution and need rational way out, then we can nudge all the interested parties towards, fair and balanced outcomes saving country and the economy tremendous time & considerable costs, for the benefit of common citizens.

This question is not only about who is responsible for non-rational choices and outcomes, but about if something can be done by applying Behavioural theories proposed by Nobel Lauret & other experts. Luckily in many countries the remedies suggested by them are being adopted in deciding Public policies, towards better outcome. Simply put, concerned Govts. And Public authorities can be nudged towards right remedies, if all accept that many policy decisions are taken with restricted rationality, if not by completely irrational manner.

If there is some consensus about these problems faced in project life cycle, more detailed debate can be conducted and specific remedies can be searched to reduce the adverse impact of non rational choices & outcomes, on large projects.