Infrastructure windfall

McKinsey says governments can generate $1.4 trillion benefit through more efficient project delivery.

   Experts at management consulting firm McKinsey & Co. say there are smart ways for governments, in the United States and around the world, to stretch their transportation dollars and better leverage private investments to close the gap in infrastructure supply.
   A study last year by researchers at the McKinsey Global Institute argues that nations generally can obtain the same amount of infrastructure for 40 percent less by adopting best practices for project delivery. 
   But beyond the $1 trillion in estimated annual savings, increased infrastructure investment can support between $295 billion and $400 billion worth of increased economic output per year, millions of jobs and improved health, education and social outcomes. 
   McKinsey, which helps about 90 percent of Fortune 100 companies better organize their operations, did not have an infrastructure practice until early 2012. The firm now has more than 100 people focused on helping companies and public-sector entities make more efficient use of infrastructure.
   It does not act as an advisor for financial transactions in the sector.
   Keeping pace with projected global productivity growth will require $60 trillion to $67 trillion worth of infrastructure construction through 2030—about $60 trillion if the world spends the historical average of 3.8 percent of GDP on infrastructure and $67 billion if countries seek to maintain an estimated 71 percent ratio of infrastructure stock to GDP, according to the study.
   The projected demand covers all modes of transport, power, water and telecommunications. And the costs could be even higher. Most estimates of global infrastructure do not account for either the additional cost of making infrastructure more resilient to the effects of climate change or lessening the impact of infrastructure on the environment, the McKinsey team said.
   China has overtaken the United States and European Union as the largest investor in infrastructure, as a percentage of GDP. China spends about 8.5 percent of its economic output on the nation’s physical backbone ($503 billion in 2010), while the United States and the European Union spend 2.6 percent of GDP on highways, bridges, water treatment plants and other types of assets. U.S. investment peaked at 3.1 percent in 2000 during the dot.com bubble, according to McKinsey. About two-thirds of U.S. infrastructure spending is by the private sector.
   The United States and Europe face the problem of rehabilitating old, deteriorating infrastructure that has reached or exceeded its design life, but do not have a clear strategy for recapitalization. U.S. investment, in particular, is lagging relative to its economic growth.
   China and Japan arguably have the opposite problem: a “massive misallocation of resources” because of heavy spending on many projects that generate low returns, Tyler Duvall, a principal in McKinsey’s infrastructure practice who led the policy office at the U.S. Department of Transportation during the Bush administration, said during an Infrastructure Week conference in May organized by business groups.
   China really only needs to spend 6.4 percent of GDP on infrastructure, while Japan would be fine spending 2.6 percent rather than 5 percent of GDP on the social grid.

The Solution.  To deliver $1 trillion in savings from infrastructure development, the McKinsey report recommends that governments make better decisions selecting projects for investment, streamline project delivery and make the most out of existing infrastructure assets through demand management, better operations and optimized maintenance.
   “On the whole, countries continue to invest in poorly conceived projects, take a long time to approve them, miss opportunities to innovate in how to deliver them, and then don’t make the most of existing assets before opting to build expensive new capacity. In many countries, the process of selecting, building, and operating 
infrastructure — and the governance systems that could force improvements — has not changed for the better in decades. In the construction sector, for instance, labor productivity has barely moved for 20 years in many developed countries despite steady and significant gains in the productivity of other sectors,” the infrastructure productivity report said.
   “All too often,” it continued, “a surprisingly stable status quo persists in which inaccurate planning and forecasting lead to poor project selection. A bias among public officials to build new capacity, rather than make the most of existing infrastructure, is common, leading to more expensive and less sustainable infrastructure solutions. A lack of incentives, accountability, and capabilities as well as risk aversion has prevented infrastructure owners from taking advantage of improvements in construction methods such as the use of design-to-cost and design-to-value principles, advanced construction techniques, and lean processes. Infrastructure authorities frequently lack the capabilities necessary to negotiate on equal terms with infrastructure contractors, rendering them unable to provide effective oversight and thereby drive performance.”
   Improving project selection could save $200 billion a year globally, McKinsey said.
   Often money is better spent on resolving bottlenecks, improving land-use planning, enhancing public transit and managing demand than widening an arterial road into a city.
   One of the problems transportation planners face is political pressure to back projects favored by powerful politicians. Duvall and colleague Mike Kerlin said the best way to neutralize those screaming the loudest is to establish clear metrics about what a project should achieve and conduct an extensive benefit-cost analysis so that a project is scored simply on the facts. Beyond that, planning agencies should use a system-based approach so projects are considered as part of a larger program and not simply standalone, individual projects.
   The United States, for example, does a poor job prioritizing surface transportation projects based on long-term multiplier effects for goods movement, congestion reduction, safety and reduced air pollution. The 2009 Recovery Act highlighted the weakness of quickly getting money to the best projects in the queue, according to Duvall. Those types of externalities should be monetized—a value placed on travel time savings, fatality reduction, land development, and so on—to help identify projects that deserve resources.
   “The pipeline is not conducive to spending money rapidly on high-return projects, which leads us to spend a lot of money quickly on either low-return projects or creates pent up capital,” he said. “Our push has been ‘let’s systematize this as much as possible so that we can compare across projects.’ There is no question that the science of cost benefit is more art in many cases than it should be, but that doesn’t mean we shouldn’t start to define that,” he said.
   Duvall said McKinsey was able to convince a strong anti-tax Republican governor it was advising to shift the state’s portfolio mix from the existing plan for new transportation projects because it could show a massive improvement in the return on investment.
   “This is a guy who never supported tax increases in any area previously,” but was willing to do so when it was clear taxpayers would get their money’s worth from the government, Duvall said.
   McKinsey’s analysis also resolved a dispute between the Swedish Ministry of Finance, which wanted to clamp down on transportation spending, and the Transport Ministry, which wanted to build more roads and bridges.
   “So we came back to the Finance Ministry and said, ‘there are 15 things you can do to drive down costs and deliver projects more efficiently at the road agency, but they still need a lot more money to achieve the results you want,’” Duvall said, adding, “Savings doesn’t mean you don’t need more investment.”
   The United States has begun to implement some reforms in its highway program. In 2012, Congress passed a two-year surface transportation measure that consolidated various programs, calls for streamlined environmental reviews to get projects started faster, and set standards for measuring and reporting how projects are meeting intended mobility, safety or economic objectives.

Project Delivery. There is huge room for improvement in the way governments manage construction projects starting with land acquisition, planning and permitting to tendering, lean construction and oversight, according to McKinsey analysts. Investing heavily in early-stage project planning and design, and engaging cross-functional teams from the government and contractor side, can reduce the need for expensive change orders later in the process. Contractors can also be encouraged to use the lowest-cost means to achieve performance specifications and advanced construction techniques such as prefabrication and modularization.
   The report said nations could save $400 billion annually and accelerate project completion by using these types of management practices.
   “If you look at every major industrial company in the world that is building things like factories, refineries, and nuclear facilities, they are all basically deploying now a sophisticated approach to construction process management that is lacking currently around the globe in the public sector,” Duvall said. 
   “That’s not to say the public sector is worse or dumber. The reality is the incentive structure around these projects is not driving the sorts of capabilities within these government organizations to basically insist on this type of activity that reduces waste,” he added.
   Government oversight is made more difficult because agencies tend not to collect and analyze data about the cost structure of contractors the way private companies scrutinize their suppliers and they lose management talent to retirement or the private sector, the former DOT official said.
   “The reality is what you need is a lot leaner organizations that understand the complexity of project delivery. You don’t need thousands of engineers, you just need to deploy some of these techniques into a unit that can oversee the most complex projects,” he said.
   
Expanding Capacity. Increasing utilization of existing assets, optimizing maintenance planning and using demand-management can save another $400 billion per year globally.
   Transportation experts, for example, say technology and pricing mechanisms—such as time-of-day tolling—can squeeze more capacity out of existing highway networks. Roadway sensors, cameras and other technology can tell highway operators when congestion is increasing and when to raise, or lower, tolls to encourage people to drive during non-peak hours.
   Demand management remains politically unpopular because of tolls, “but we believe it has a ton of potential and its time will come,” Kerlin said.
   Technology can also play a big role with regard to preventive maintenance that can extend the life of infrastructure and save money. Smart water networks, for example, have sensors that can detect leaks and avoid the risk of over maintenance.
   The United States currently ranks low among the most developed nations when it comes to best-in-class infrastructure because of an unwillingness to invest and a lengthy decision-making process, according to many experts. One reason for delay, Duvall said, is other countries make a decision about whether a project meets national goals and then work to mitigate any social or environmental costs, while in the United States those external costs are part of the calculus as to whether the project should go forward at all.
   Changing that dynamic requires a new way of thinking about the big picture, Duvall said.
   “You have to prioritize. You need to decide that certain projects matter more than others. You have to put those projects on a different track than normal. And you need clear decision rights,” he said.
   “And this, I think, is where we struggle compared to the rest of the world. When you take a major port project, for example, that includes the Army Corps of Engineers, the Environmental Protection Agency, maybe the Federal Highway Administration, state and local resource agencies—the owner of the project is unclear. Everybody owns a decision, but nobody owns the decision,” he explained.
   The consultant pointed to New South Wales, Australia, where a dredging project in Port Sydney was taken from concept to completion in six months to illustrate how government can expedite a project when managed well.
   “The project got to the front of the queue because there was a consensus among the planning entities, which were unbiased and felt the project had merit, evaluated against its environmental costs,” Duvall said.
   It would also help if there was more transparency and certainty in the process so that project sponsors can find out a project’s status, whose desk it is on, and what concerns exist.
   On the tactical level, Kerlin said, governments “need better infrastructure for infrastructure,” meaning more data and better accounting for infrastructure stock and performance. Other recommendations for project execution include having qualified civil engineers on staff, being proactive in stakeholder engagement to nix any potential complaints early on, increasing coordination between institutions and insulating technocrats from politicians.

This article was published in the September 2014 issue of American Shipper.