How Smart Contracts are Reducing Inefficiencies in Construction
The construction industry notoriously lags in productivity improvements and technology adoption. Its sluggish pace results in billions of dollars in lost value – approximately $40 billion a year. One underlying cause of this lagging performance is the way the industry develops complex physical assets, a process that has essentially remained unchanged in the face of technology advances adopted by other industries.
Prevailing contracting models and disparate systems within the industry limit the movement of information and harden distrust between companies. The industry is situated at a grand intersection and several of its biggest challenges can be attributed to the nature of the sector: every project is a one-time event requiring multiple companies to come together.
The Hidden Burden of Costs
Projects are stuck in a “paper-based” operating model that relies on the creation and movement of documents through antiquated review and approval processes. Yes, there are 3D CAD, Enterprise Resource Planning (ERP) and Project Management Systems (PMS) that automate workflow, but these systems simply digitize processes and perpetuate “paper-based” thinking. In turn, they create a productivity drag within companies that is exacerbated when companies come together to execute projects.
According to Stephen Mulva, Director of the Construction Industry Institute (CII), a collaborative research organization housed at The University of Texas at Austin, this efficiency is a hidden cost that may be as high as 40 percent of the cost of a project. Tackling this inefficiency is the driver behind CII and CURT’s Operating System 2.0 (OS2) initiative, which seeks to fundamentally change how projects are developed and executed. To bring about the digital transformation of the industry, from “paper-based” to “digital” ways of working, change must start with the instrument that binds companies together – the contract.
The good news is that smart contracts, combined with Industrial Internet of Things (IIoT) and distributed ledger technology is already making headway in improving historical inefficiencies by solving fundamental problems. These technologies are being deployed on complex service contracts in the upstream oil and gas sector and the parallels to construction are clear.
First, Foster Trust
The first pain point that must be solved for is the lack of trust among companies and project stakeholders. Worsened by disparate work cultures, disconnected technology solutions, and legal constructs, distrust is the basic root of the “paper-based” approach to executing projects. On any project today, there is no single source of the truth and when problems inevitably arise there is a lot of finger-pointing between parties. By uniquely combining three technologies, a project can establish a single source of truth that provides a platform for establishing and building trust between project parties.
The best time to address this challenge is upfront during contract formation by being specific on how performance will be measured, the sources of data for that measurement and how compensation will be tied to performance. Then automate how and when the data is captured as well as how the data is used to calculate performance and payment. Finally, post the results along with the source data and substantiating documentation to a distributed ledger that can be seen by all parties and changed by none.
Together, the data capture, calculations, and distributed ledger form a truly neutral and independent business to business (B2B) platform that becomes an immutable record for a project. By establishing a central source of truth, the platform of IIoT, smart contracts, and distributed ledger capabilities deliver visibility into productivity, cost, schedule and safety performance through the simultaneous sharing of information that is coded to automatically execute based on captured data. Blockchain removes human emotions from decision-making processes. And with terms agreed upon upfront, there are no contractual surprises, which enables a more efficient project execution.
Then, Tackle Payments
According to CII analysis of the 40 percent inefficiency drag on the industry, finance charges and the cost of capital is the single greatest burden. From the source of funding down to the smallest subcontractor or supplier, cash flow is a major challenge that holds back the industry. Contractors have limited cash flow with a majority cobbling together temporary solutions to complete a project – 88 percent of contractors surveyed for a bid procurement platform reported that they face DSO over 30 days, forcing them to cover the gaps with personal savings or credit lines. Midway down the construction pipeline, foundation, structural and exterior contractors report an average of 63 DSO, while building finishing contractors hover around 77 DSO.
In oil, gas and process industries it is not uncommon for DSO metrics to exceed 100 days, even for major contractors. McDermott, an international provider of integrated engineering, procurement, construction and installation services (EPCI), recently made headlines for seeking a bridge loan to cover its $1.7 billion working capital gap.
The industry’s cash problem can be directly addressed by shifting from the “paper-based” approach that dominates projects today to a digital approach that can take DSO from 100 to one. This can be made possible by all of a project’s parties being connected through smart contracts with performance data coming into via IIoT and resulting transactions being posted to a distributed ledger.
Smart contracts use inputs from IIoT data to verify the conditions of a contract have been met. If validated, corresponding compensation can be automated to either be executed by the company’s ERP system or move directly to ACH for payment. When forming a smart contract, the parties must have agreed on the calculations for performance and the sources of data for said calculations. Then they are able to review results with the substantiated data and documentation. This entire process streamlines the current paper-based approach to invoicing including backup, review, approval, and payment to be executed in a single day.
An Automated, Digital Future
According to PWC, the estimated growth for the volume of construction output is expected to hit $15.5 trillion by 2030, up from today’s $9 trillion. Sustainable competitive advantage is there for the taking, and implementing smart contracts on a B2B platform is one, relatively easy way to streamline operations, grow trust, reduce the cost of capital and reduce DSOs from 60 to 70 days down to one or two days.
To get there, the error-prone administrative burden that weighs down construction’s current operating model must be lifted. And automated, smart contracts do just that.
This article was originally published at www.curt.org. Learn more about this owner-driven construction association by clicking the link. Reprinted with permission.