ASSESSMENT OF CHALLENGES AND BEST PRACTICES OF

PRICE ADJUSTMENT ON FEDERAL ROAD CONSTRUCTION

PROJECTS

By

TESFAYE MANAYE ZEGEYE

A Thesis Submitted to
College of Architecture and Civil Engineering for the Partial Fulfillment of
the Requirements for the degree of Master of Science in Civil Engineering
(Construction Technology and Management)

ADDIS ABABA SCIENCE AND TECHNOLOGY UNIVERSITY

FEBRUARY 2019
 DECLARATION

I hereby declare that this thesis entitled “Assessment of Challenges and Best Practices
of Price Adjustment on Federal Road Construction Projects” was composed by
myself, with the guidance of my advisor, that the work contained herein is my own
except where explicitly stated otherwise in the text, and that this work has not been
submitted, in whole or in part, for any other degree or professional qualification.

Name: Tesfaye Manaye Signature: ____________ Date: __________

ii
 CERTIFICATE

This is to certify that the thesis prepared by Mr. Tesfaye Manaye Zegeye entitled
“Assessment of Challenges and Best Practices of Price Adjustment on Federal Road
Construction Projects” and submitted in fulfillment of the requirements for the Degree
of Master of Science complies with the regulations of the University and meets the
accepted standards with respect to originality and quality.

APPROVED BY BOARD OF EXAMINERS:

______________________________ _______________ ___________

INTERNAL EXAMINER SIGNATURE DATE

______________________________ _______________ ___________

EXTERNAL EXAMINER SIGNATURE DATE

Wubishet Jekale Mengesha (Dr.-Eng.) _______________ ___________

THESIS ADVISOR SIGNATURE DATE

iii
 ABSTRACT

Construction industry is one of the major industries assisting impressively to the growth
of the socio-economic development of a nation, especially in the developing countries. In
Ethiopia road transport is the dominant mode of motorized inter-urban freight and
passenger movements. However, most federal road construction projects are being
completed by highly inflated prices as year goes on; mainly due to price fluctuation and
improper administration of contracts with respect to price adjustment formula in case of
inflation or deflation.
With this background, this study tries to assess Ethiopian Roads Authority‟s (ERA)
practice in managing price fluctuation on federal road construction projects, to identify
challenges of price adjustment and methods used to improve price fluctuation administration
system on federal road construction projects.
The study concepts were developed through literature survey that enables to find out the
variables. Then, the data required for this study was collected through self-administered
questionnaire survey, interview and desk study. Sample respondents were randomly
selected from ERA, contractors and consultants who are actively participating on federal
road construction projects. In this thesis, a descriptive statistical method has been used for
the analysis of the data. Interpretation and discussions were made on the basis of results
from the analysis.

The results of this study show that the adjustable/variable elements currently included in
price adjustment clauses are representative for all other construction inputs used in road
construction projects. Based on the survey result, it was also found that the pattern of
price fluctuation in major road construction inputs is the increase in prices (13.09% to
124.96%) within the last three years. The other result of this research also revealed that,
there is a huge difference in weight range provided for non-adjustable component in the
price adjustment formula (10% to 70%) set for different federal road construction project
contracts and in most of the National Competitive Bidding (NCB) it is observed to be on
the higher side. The result of this research also revealed that, in federal road construction
projects, the percentage amount of adjustment paid to contractors reaches more than 20%
within the last four year (January 2015 to December 2018).
In this research, change in project costs and reliable sources of indices, the use of constant
weighting throughout the project lifetime, existence and use of composite (foreign and
proxy) indices, failure to make periodic payment, failure to complete projects on time and
making an adjustment for non-used items are identified as the major challenges of price
adjustment using formula method.

Finally, based on the analysis of the results, recommendations have been proposed that
enables to improve existing practices of price fluctuation administration system and to
reduce challenges of price adjustment on federal road construction projects.
Key Words: Construction industry, Federal road construction projects, price fluctuation,
Price Adjustment, price adjustment administration system, indices method.

iv
 AKNOWLEDGEMENTS

First of all I would like to thank the Almighty God, for his help throughout my life and
enable me to come up to the accomplishment of this thesis.

My deepest gratitude goes to my advisor, Wubishet Jekale (Dr.-Eng.), for structuring the
research, providing different reference materials, for his valuable advice and invaluable
suggestions. His constructive and timely comments combined with strong support and
encouragement guided me throughout the process of writing this research and contributed
significantly to its success.

I would like also to thank all Ethiopian Roads Authority Staffs and other organizations
for their direct or indirect contribution by providing all the necessary documents and
support for the realization of this thesis. Especial thanks are forwarded to those who are
participated in the interview, contractors, consultants and ERA Staffs who sacrificed their
time in filling the questionnaires.

Then, I would like to express my sincere appreciation to my friend Asnake Mamo, for his
continuous support throughout the preparation of this thesis.

Finally, it gives me a great pleasure to thank my family for their understanding all the
situations during my study and unconditional love throughout my life.

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 TABLE OF CONTENTS

ABSTRACT …………………………………………………...……………………….. iv
AKNOWLEDGEMENTS …………………………………………………….…………. v
TABLE OF CONTENTS ……………………………………………………………….. vi
LIST OF TABLES …………………………………………………………………..….. ix
LIST OF FIGURE ……………………………………………...……………………….. x
LIST OF ABBREVIATIONS ………………………………………………….…..…… xi
CHAPTER ONE ……………………………………………………………………..….. 1
1. INTRODUCTION …………………………………………………………………... 1
1.1 Background of the study ………………………………………………………… 1
1.2 Statement of the problem ……………………………………………..…………. 3
1.3 Objectives of the study …………………………………………..………………. 5
1.4 Research Questions ……………………………………………..……………….. 5
1.5 Significance of the study ……………………………………………………...…. 5
1.6 Scope and limitation of the study …………………………………………….….. 6
1.7 Organization of the study ………………………………………….…………….. 6
CHAPTER TWO …………………………………………………………...…………… 7
2. REVIEW OF LITERATURE …………………………………………………..…… 7
2.1 Introduction ………………………………………………………………...……. 7
2.2 Construction Industry ………………………………………………………...….. 7
2.3 Construction Industry in Ethiopia ………………………………………….....…. 9
2.4 Challenges encountered on road construction projects in Ethiopia ………….… 11
2.5 Construction Price Fluctuation ………………………………………………… 12
2.6 Inflation and the Construction Industry …………………………………...…… 13
2.7 Price Estimation Methods and Setting of Prices ………………………… 16
2.7.1 Cost component ………………………………………………………..… 16
2.7.2 Profit component ……………………………………………………….… 18
2.8 Price change measurement tools …………………………………………..…… 19
2.9 Construction price indices ……………………………………………………… 20
2.9.1 Sources of price indices ………………………………………………..… 21
2.9.2 Types of Construction Price indices ………………………………...…… 22

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 2.10 Price adjustment in construction industry …………………………….……… 25
2.11 Price Adjustment Methods …………………………………………………… 26
2.11.1 Basic Price/Proven cost Method ……………………………………….. 27
2.11.2 Indices/Formula Method …………………………………………..…… 29
2.12 Advantages and disadvantages of price adjustment ……………………..…… 32
2.12.1 Advantages of price adjustment clauses ………………………………...…. 32
2.12.2 Disadvantages of price adjustment clauses ……………………………... 33
2.13 Standard Forms of contract and rice adjustment clauses ……………......…… 34
2.13.1 Local Conditions of Contract …………………………………...……… 35
2.13.2 International contract forms …………………………………….……… 42
2.14 Price adjustment administration system practiced by ERA ………..………… 44
2.15 Challenges of price adjustment on federal road construction projects ……….… 47
CHAPTER THREE ………………………………………………………………….… 49
3. MATERIALS AND METHODS ……………………………..………………...… 49
3.1 Introduction …………………………………………………………………….. 49
3.2 Description of the study area ……………………………………………..……. 49
3.3 Research Approach …………………………………………………………..… 50
3.4 Data Collection ………………………………………………………………… 51
3.4.1 Sources of Data …………………………………...……………………… 52
3.4.2 Data Collection Instruments …………………………………..…………. 52
3.5 Sample Size and Sampling Techniques ……………………………………...… 53
3.5.1 Sample size ……………………………………………………………..... 54
3.5.2 Sampling Techniques ……………………………………………….……. 55
3.6 Method of Analysis …………………………………………………………….. 55
CHAPTER FOUR ……………………………………………………………………… 57
4. RESULT AND DISCUSSION …………………………...……………………...… 57
4.1 Introduction ……………………………………………………………………. 57
4.2 Response rate and characteristics of respondents ……………………………… 57
4.2.1 Questionnaire response rate ……………………………………...………. 57
4.2.2 Experience of respondents in federal road construction projects …...….... 57
4.3 Price adjustment administration practices in federal road projects ………….… 59

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 4.3.1 Data sources used by contractors to estimate bid prices …………….…… 59
4.3.2 Contractors‟ ability to accommodate representative elements …...……… 61
4.3.3 Representativeness of variable/adjustable elements ……………….…….. 65
4.3.4 Fairness of weighting ranges assigned to adjustable elements ………..…. 66
4.3.5 Road construction inputs susceptible to price fluctuation ……………..… 68
4.3.6 Predictability of price fluctuation ……………………………………...… 70
4.3.7 Advantages of incorporating price adjustment clauses …………...……… 72
4.3.8 Risks of incorporating price adjustment clauses …………………….…… 74
4.3.9 Methods adopted by stakeholders to exercise formula method …….……. 75
4.3.10 Accuracy of estimated quantity of works at tender stage …………..….. 77
4.3.11 Rationality of the weight range provided for fixed components …….… 78
4.3.12 Criteria used to select representative construction materials ………..…. 80
4.3.13 Percentage amount of price adjustment paid to contractors …….…..…. 82
4.3.14 Fairness of compensation secured by using formula method ………..… 85
4.3.15 Risk sharing practices between contracting parties in Ethiopia ……...… 87
4.3.16 Conditions of contract used to administer road project contracts ……… 89
4.4 Challenges and improvements needed in price adjustment methods ………...… 90
4.4.1 Difficulties associated with usage of construction price indices ………… 90
4.4.2 Challenges and malpractices in indices method of price adjustment .…… 91
4.4.3 Methods to improve price fluctuation administration system ……..…...… 95

CHAPTER FIVE ……………………………………………………………………... 99

5. CONCLUSION AND RECOMMENDATIONS ……………..………..………… 100
5.1 Introduction ………………………………………………….………….…..… 100
5.2 Conclusions …………………………………………………………...…..…... 100
5.3 Recommendations ………………………………………………….…..….…… 101
5.3.1 To improve existing practices of price adjustment ………………..……… 101
5.3.2 To reduce challenges of price adjustment ………………………..……... 102
REFERENCES …………………………………………………………………………. 105
APPENDIX ……………………………………………………………..……………… 109

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LIST OF TABLES

Table 4.1: Experience of respondents on federal road construction projects ……..…… 58

Table 4.2 Data sources used to estimate bid prices ………………………………….… 60
Table 4.3: Ability of contractors to accommodate representative elements ………….... 62
Table 4.4: Representativeness of variable/adjustable elements in formula method ….... 65
Table 4.5: Result on fairness of weighting ranges assigned by contractors …………… 67
Table 4.6: Construction inputs susceptible to price fluctuation ………………………... 69
Table 4.7: Percentage of price change on construction materials ……………………… 70
Table 4.8: Predictability of price fluctuation on major road construction inputs ……… 71
Table 4.9: Benefits of using price adjustment clauses ………………...……………….. 73
Table 4.10: Risks of using price adjustment clauses ……………………………...…… 74
Table 4.11: Methods to exercise formula method in a better way …….……………….. 76
Table 4.12: Rationality of the weight range provided for fixed component ………...…. 79
Table 4.13: Criteria used to select representative construction materials ……………… 81
Table 4.14: Percentage amount of price adjustment paid to contractors ……..…………… 84
Table 4.15: Problems encountered in application of price indices …………………...... 90
Table 4.16: Challenges of using indices method of price adjustment ……….........…… 92

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 LIST OF FIGURE

Figure 3.1: Map of Ethiopia ……………...……….…………………...……………….. 50

Figure 4.1: Distribution of respondents by their work experience …………………….. 58
Figure 4.2: Sources of data used by contractors to estimate bid prices ……...………… 60
Figure 4.3: Contractors ability to accommodate representative elements ……………... 62
Figure 4.4: Methods used to accommodate risks due to price fluctuation …….……….. 63
Figure 4.5: Reasons that allow contractors to give less attention to price fluctuation …. 64
Figure 4.6: Representativeness of variable/adjustable elements ………………..……… 65
Figure 4.7: Fairness of weighting ranges assigned by contractors …….…………......... 67
Figure 4.8: Predictability of price fluctuation on major road construction inputs …...… 71
Figure 4.9: Accuracy of estimated quantity of works at tender stage ………….…......... 77
Figure 4.10: Fairness of the weight range provided for fixed component ……………... 79
Figure 4.11: Selection criteria for representative construction materials ……………….. 81
Figure 4.12: Percentage of amount paid for price adjustment ……………………...….. 83
Figure 4.13: Fairness of compensation secured by using formula method …………...... 86
Figure 4.14: Risk sharing practices between contracting parties in Ethiopia ……...….. 88
Figure 4.15: Suitability of FIDIC form of contract to administer frderal road projects .. 89

x
 LIST OF ABBREVIATIONS

BaTCoDA Building and Transport Construction and Design Authority

CPA Contract Price Adjustment
CPI Consumer price indices
ERA Ethiopian Roads Authority
FIDIC Fédération Internationale des Ingénieurs-Conseils
GCC General Conditions of Contract
GDP Gross Domestic Product
GOE Government of Ethiopia
ICB International Competitive Bidding
MoI Ministry of Infrastructure
MoUDH Ministry of Urban Development and Housing
MoWUD Ministry of Works and Urban Development
NCB National Competitive Bidding
OECD Organization for Economic Cooperation and Development
PAC Price adjustment clause
PPA Public Procurement Agency
PPI Producer price indices
PPPAA Public Procurement and Property Administration Agency
RSDP Road Sector Development Program
SCC Special Conditions of Contract
SDB Standard Bidding Document
SNA System of National Accounts
UNIDO United Nations Industrial Development Organization,

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 CHAPTER ONE

1. INTRODUCTION
1.1 Background of the study

Construction industry is one of the major industries assisting impressively to the growth
of the socio-economic development of a nation, especially in the developing countries. A
Construction project is a time-bound, high value and special construction mission of
creating a construction service with the predetermined performance objectives defined in
terms of quality specification, completion time, budgeted cost and other specified
constraints (Chitkara, 2011).

Construction industries have become an important player and are vital for the economic
development of any country particularly for developing countries. There cannot be much
progress in the nation‟s development without construction, particularly in developing
countries where there is lack of infrastructure and other basic facilities. But especially in
developing countries this industry suffers from a number of problems that affect the time,
cost and the quality performances. As a result, successful completion of construction
projects within the specified budget has become a challenging task from time to time.
Findings of resent researches conducted in developing countries including Ethiopia
shows that most of the construction projects are not completed within the estimated time,
budget and desired quality (Shambalid A. Sakshi G. & R.K.Malik, 2017).

Ethiopia is still a developing country; and there is a huge development activity yet to be
undertaken. One of the key factors to ensure a desired level of economic growth in a
developing country like ours is achieving a significant amount of investment by the
private as well as the public sector. In this development activity the infrastructure
development sector is the one in which the construction industry is a front line role player
(Asteway, 2008).

In Ethiopia road transport is the dominant mode and accounts for 90 to 95 percent of
motorized inter-urban freight and passenger movements. Since 1993/94, the Ethiopian
government has been implementing various reforms that have involved the processes of

1
structural adjustment programs along with commercialization of agriculture, private
sector development, and a number of related poverty alleviation programs. Successful
implementation of the programs requires an efficient infrastructural system. In particular,
road transport is supposed to create a network over a wide array of infrastructural
facilities. In addition, the road transport sector is essential for developing countries for
the reason that provision of other advanced means of transportation is expensive
(Ibrahim, 2011).

Road sector construction projects in Ethiopia are way through which development
strategies are achieved. Development strategies which are fulfilled through successful
road projects to import accessibility of rural areas, lower costs associated with transport
maintenance and open more areas for development activities. Road projects, involving
large amount of capital, also contribute to the total economy through job creation and in a
ripple effect to other business activities (Abubeker, 2015).

Recognizing the importance of the road transport in supporting social and economic
growth, and its role as a catalyst for meeting poverty reduction targets, the Government
of Ethiopia (GOE) has placed increased emphasis on the improvement of the quality and
size of road infrastructure in the country. To address constraints in the road sector, mainly
low road coverage and poor condition of the road network, the Government formulated
the Road Sector Development Program (RSDP) in 1997.

The RSDP has already been implemented over a period of eighteen years and in four
successive phases until June 2015 and the 5th phase starts from July 2015 to June 2020, as
follows:

 RSDP I – Period from July 1997 to June 2002 (5 year plan), completed
 RSDP II – Period from July 2002 to June 2007 (5 year plan), completed
 RSDP III – Period from July 2007 to June 2010 (3 year plan), completed
 RSDP IV – Period from July 2010 to June 2015 (5 year plan), completed
 RSDP V – Period from July 2015 to June 2020 (5 year plan), ongoing

While the construction industry makes major contributions and is the basis for national
economic development of any country, it is suffering for so many problems and
2
difficulties to meet the national development objectives of developing countries like
Ethiopia. To address the problems and accelerate the growth of the sector and its
contribution to national economic growth; policies and strategies have been adopted and
implemented during the past four phases of RSDP and continues to be implemented
during RSDP V(ERA, 2015).

In connection, all previous experiences related with the financing and construction of the
roads in Ethiopia indicate that most projects face budget overrun and unnecessary delay
due to unexpected higher construction cost incurred during the construction period.
Although the problems associated with the cost increase and delay in most of the projects
are of different natures, inflation, fluctuations in currency exchange, and change in
government legislation have significant impact in the increase of the construction cost of
roads in Ethiopia. Due to this reason, federal road construction project contracts
incorporated price adjustment provisions to compensate the contractor or the employer in
case of rise or fall in cost of labor, material, equipment or any other changes in
legislation.

Price adjustment clause (PAC) is a contractual mechanism that allows a contractor to be

at least partially protected against construction material, equipment or fuel price increases
that may occur between the contract award and the execution of the work. This is done by
having an owner accepting the risk for escalating prices by offering a PAC that pays the
contractor for any increase above agreed upon threshold (trigger value). Many PACs
contain provisions for the contractor to provide a rebate to the owner in the event of
decreasing prices (David E. et al. 2012).

In general the incorporation of PACs in construction contracts enables the contractor or

the owner to be protected against price fluctuation that may occur between the contract
signing and execution of the contract.

1.2 Statement of the problem

The construction industry in Ethiopia is challenged by several problems which tend to

confront the sector and thus making efforts at developing the construction industry is

3
very difficult and complex. The underlying problems of the construction sector can be
classified into two main categories. The first is related to the consequences of the fact that
the sector is not viewed and planned in an integrated manner, but rather, operates with
fragmented, unrelated and often conflicting components (Wubishet Jekale, 2004). The
second problem is related to deficiencies and market price fluctuation of the inputs
required for the construction (Gebre-Michael, 2002).

The deficiencies and market price fluctuation of construction inputs directly affect
contractors and owners, since they are the front line role players in the construction
industry. The occurrence of frequent and unpredicted price increases in construction
inputs may lead contractors into failure to complete projects within the planned cost for
themselves, within the planed accomplishment date and quality for the client.
Accomplishment reports on the first four road sector development programs (RSDP I-
RSDP IV) and practices on federal road construction projects show that, most federal
road projects are being completed by highly inflated prices mainly due to price
fluctuation on construction inputs and improper administration of contracts with respect
to price adjustment formula in case of inflation or deflation.

To manage financial risks and compensate loses on contractors and clients due to price
fluctuation of construction inputs, price adjustment clauses are included in federal road
construction project contracts. However, there are a lot of challenges to secure fair risk
sharing/allocation between contracting parties and to administer price escalation. Some of
the major challenges to administer price escalation in federal road construction projects
are:

 Change in project costs,

 Use of constant weighting/coefficients throughout the project life time,
 Change in reliable sources of indices,
 Failure to make periodic payment,
 Failure to complete projects on time and
 Adjustment for non-used items.

4
Different literatures show that, the adjustment amount paid to contractors in federal road
construction projects is about 30-40% of the total project cost. This result indicated that a
huge amount of money is paid to price adjustment, which may affect the overall
performance of construction projects. To mitigate the adverse effect of price escalation, it
is necessary to adopt and develop best practices and to improve current price escalation
management or administration systems. Therefore the aim of this research is to assess best
practices in managing price fluctuation and identifying methods that can be used to
improve price adjustment administration systems on federal road projects.

1.3 Objectives of the study

The main objective of this research is to assess price adjustment administration systems
currently practiced in federal road construction projects. Based on the problems stated,
this study is undertaken with the following specific objectives:

i. To assess ERA‟s practice in managing price fluctuation on federal road construction

projects.
ii. To identify challenges of price adjustment and methods used to improve price
adjustment administration system on federal road construction projects.

1.4 Research Questions

i. How price fluctuation is administered by ERA on federal road construction projects?

ii. What are the challenges of price adjustment and methods that can be used to
improve price adjustment administration system on federal road construction
projects?

1.5 Significance of the study

Due to the complex nature of construction projects, federal road construction projects are
accompanied by frequent price escalation because of rises of prices of materials, labor
and equipment. To evaluate and compensation against variation in prices of construction
inputs, standard forms of construction contracts incorporate price adjustment clauses.
Therefore, the finding of this research may have its own contribution on price adjustment
administration system in construction industry in general and in federal road construction

5
projects in particular. Generally, the study may benefit different stakeholders to take care
and remedial action on challenges of price adjustment and price escalation administration
practices, it may also serve as benchmark for further studies on the subject matter.

1.6 Scope and limitation of the study

Ethiopian government has started a big road sector development program to increase the
road network in the country which includes new, upgrading and rehabilitation through its
representative (ERA). However, experiences on the first four successive road sector
development programs (RSDP I - RSDP IV) show that federal road construction projects
are suffered from cost and time overrun due to several reasons. Therefore, among
different problems affecting successful completion of federal road construction projects,
this study will focus only on identifying challenges of price adjustment and assessing
current best price adjustment administration practices on federal road construction
projects. Among different stakeholders in the road construction sector, only grade 1
general and road contractors, federal road construction projects owner (ERA) and
consultants actively participating in` federal road construction projects are participated in
the survey.

This study focuses on new and upgrading federal road construction projects implemented
by ERA during the RSDP IV and RSDP V. Due to time and budget constraint only six
new and upgrading federal road construction projects were covered in case study from
Eastern and Western region, that may limit its reliability.

1.7 Organization of the study

This thesis is organized with five chapters. The first chapter is designed to provide an
overall introduction of the study and it deal about background of the study, statement of
the problem, research objectives, research questions, significance of the study and scope
of the study. Literature review is dealt in chapter two in which different literatures related
to challenges and best practices of price adjustment are discussed. On the other hand
research materials and methods is discussed in chapter three followed by the fourth chapter
which encompasses analysis of findings and discussions part. The last chapter, chapter five,

6
comprises the conclusions made and recommendations forwarded based on the major
findings of the study.

7
 CHAPTER TWO

2. REVIEW OF LITERATURE
2.1 Introduction

In order to develop a better understanding of the research objective, a comprehensive

literature review has been conducted focusing on the subject of Challenges and best
practices of price adjustment on federal road construction projects.

This chapter mainly discusses about challenges encountered on road construction project,
construction price fluctuation, inflation and construction industry, price estimation
methods and setting of prices, price change measurement tools, construction price
indices, price adjustment methods, current practices and challenges of price adjustment
administration system on federal road construction projects, etc.

Generally the comprehensive literature review conducted in this chapter is aimed to

address the objectives of the research through a brief discussion on past findings related
to challenges and best practices of price adjustment on federal road construction projects.

2.2 Construction Industry

The term construction covers a wide variety of activities and it can be described as the
sum of all economic activities related to civil and building works: their conception,
planning, execution, and maintenance. Such works normally comprise capital investment
in the form of roads, railways, airports, ports and maritime structures, dams, power
generating stations, irrigation schemes, health centers and hospitals, educational
institutions, warehouses, factories, offices and residential premises.

The construction industry makes its direct contributions to economic growth by providing
the basis upon which other sectors can grow by constructing the physical facilities
required for production and distribution of other goods and services i.e. the sector
indirectly stimulates other sectors through economic multiplier effects and makes a
significant contribution in terms of conserving and generating foreign exchange. This
latter contribution has implication for the economic development trends of most
developing counties (Kasiem S. 2008). It is not possible having extensive investment in

8
manufacturing, agriculture or service sectors without construction of infrastructure
facilities in place (Merid T. 2016).

According to Chitkara (2004) the contribution of the construction industry to the Gross
Domestic Product (GDP) of many countries ranges between 6-9% and 10% respectively.
In Ethiopia the contribution of construction industry as reported by Ministry of Works
and Urban Development (MoWUD, 2006) is estimated to be 3%, which is much lower
than sub-Saharan average of 6%.

The industry also employs a large proportion of the civilian labor force in countries at all
levels of economic and social development and in that way, it affords income earning
opportunities and helps in the improvement or acquisition of skills as part of the direct
benefits of the sector. The industry is likely to provide from 6 to 10 percent of
total employment in most of the developed countries and from 2 to 6 percent in
developing countries (Kasiem, 2008).

According to Abebe (2003) cited in Mohammed (2013) construction industry employs

about 20% of the workforce and covers about 30% of the capital budget of the
governments in developing countries. Wubishet (2004) in his work, however, indicated
that the construction industry accounts even for more than 50% of the capital budget in
developing countries. According to him, for instance, in Ethiopia (1997/98 to 2001/02),
the industry accounted for 58.2% of the capital budget. In both cases it has to be noted
that the construction industry covers a large portion of the government‟s capital
expenditure.

According to Abraham (2004), the construction industry is one of the major development
constraints in developing countries. This is mainly because; developing countries are
considerably dependent on the growth and development of their physical infrastructures.
Without the development of these physical infrastructures, developing countries will
remain deficit in:

 Distributing resources within and across countries;

 Providing access to economic, political and social services; and
 Attracting local and foreign investments, etc.

9
As a result they consume unprecedented budgetary resources towards developing
these infrastructures. Unlike the developed world, most of these infrastructures remained
the burden of the public sector because the private sector in developing countries is weak.

2.3 Construction Industry in Ethiopia

Construction sector is one of the most important contributors to the political, economic,
social and technological development. The construction industry is one of the most
important sectors to be given due consideration in Ethiopia because it directly or
indirectly affects all other sectors of the economy.

The construction industry is vital for the development of any nation. In many ways, the
pace of the economic growth of any nation can be measured by the development of
physical infrastructures, such as buildings, roads and bridges. Construction project
development involves numerous parties, various processes, different phases and stages of
work and a great deal of input from both the public and private sectors, with the major
aim being to bring the project to a successful conclusion (Wubishet, 2004).

The construction industry in Ethiopia consists of various sectors. These are the building
and residential development sector, civil engineering sector, professional services sector
and self-building sector. In Ethiopia, the construction industry is one of the three sectors
of the economy identified by the Ethiopia Government for special consideration to foster
the country‟s economic development. However, the general state of the domestic
construction industry in Ethiopia is still characterized by inadequate capital base, old and
limited numbers of equipment, low levels of equipment availability and utilization,
deficiencies in technical, managerial, financial and entrepreneurial skills, limited
experience and participation of the private sectors in construction and consultation works,
and insufficient and ineffective use of labor-based road construction and maintenance
technology (Tecle H. & Mahelet S. 2009).

According to Wubishet (2005) cited in Getaneh (2011) the construction industry in

Ethiopia has been in the process of transformation. This transformation is based on
improving the competitiveness of the construction industry and enhancing its ability to
fulfill the national development demands.

10
According to Abraham (2008), the construction industry in Ethiopia like other developing
nations suffers a lot of difficulties and shortages. The major ones are:
 Scarcity of finance: Finance is one of the big problems that domestic construction
firms are facing today.
 Big projects off-limits to domestic firms: Although the majority of local
construction firms specialize in infrastructures, most of them lack the experience
and the capacity to undertake major road projects that requires big sum of money
and high technology.
 Lack of skilled manpower and professionals: The success of any project greatly
depends on the capability of its human resource. To improve the workmanship,
design, and other related jobs, skilled labors and professionals are indispensable.

All the above mentioned and other shortages serve as an input and take the lion share
among the problems that domestic construction firms are suffered from.

Road sector construction projects in Ethiopia are way through which development
strategies are achieved. Development strategies which are fulfilled through successful
road projects to import accessibility of rural areas, lower costs associated with transport
maintenance and open more areas for development activities. Road projects, involving
large amount of capital, also contribute to the total economy through job creation and in a
ripple effect to other business activities (Abubeker, 2015).

The country‟s vision to reach low middle income country by 2025 is the basis of all
sectoral development plans. All sectoral development plans have to consider the levels of
social, economic and infrastructural development of middle income countries. The Road
Sector Development Vision of ERA is to ensure access to standard and safe road to all
people living in rural and urban areas and open up all development potential areas in the
country thereby support the accelerated and sustained economic growth; so that the
country will reach middle income country category by 2025 (ERA, 2015).

Even if the country‟s vision is to ensure access to standard and safe road to all people
living in rural and urban, in Ethiopia Construction projects typically Federal road
construction projects are undertaken in fluctuating natural and business environments,

11
which leads to price escalation. As a result it is common to make price adjustment on
Federal road construction projects in Ethiopia.

2.4 Challenges encountered on road construction projects in Ethiopia

While the construction industry makes the above mentioned contributions and is the basis
for national economic development, it is suffering for so many problems and difficulties
to meet the national development objectives of developing countries. In these countries,
the public sector is the main employer of the industry that forces most formally
constituted contractors and consultants to rely on the public sector for work. This is
mainly because the commercial or private sector is relatively undeveloped (Kasiem,
2008).

Despite significant achievements of the road sector, there are also impediments
encountered during implementation of RSDP, the major impediments encountered are
discussed below.

According to (ERA, 2015) as a result of the implementation of RSDP programs, the total
road network of the country and its condition has been improved. There was a problems
encountered during the implementation of the first four phases of road sector
development programs (RSDP I – RSDP IV). The major problems can be categorized as;
problems associated with delay in the progress, problems related to consultants, rising
road construction costs and budgetary burden (cost related problems on federal road
construction projects), institutional capacity problems and etc.

Among these major problems as the interest and objective of this research, if we consider
the cost related problems on federal road construction projects, it starts at tendering stage.
Because almost all costs submitted by contractors are greater than engineering estimate.
Some of the major problems associated with cost are:

 Not up to scratch study of project before starting implementation.

 Un availability of institution to study market and give estimation information
 Capacity of estimating (forecasting)at tender preparation and tender opening
 Technical change mainly as a result of design, sub surface changes.

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2.5 Construction Price Fluctuation

Construction price fluctuation has been defined as; changes in price levels of construction
input resources driven by underlying economic conditions (Charles, 2014). This means
price fluctuation is the rise or fall of price of goods, materials and services on the
markets.

Price fluctuation can occur at any market, i.e. at international markets, local market
and/or at the labor market. These changes take place from one point in time to another.
Stukhart (1992) cited in Asteway (2008), explains that price fluctuation reflects changes
in price-drivers such as productivity and technology, Government‟s regulation on oil
price, as well as changes in market conditions such as shortage or excess supply at market
and increase or decrease in demand of a certain item.

Government’s regulation on oil price: the price of oil governs the cost of materials since
oil is related to production or transport of materials. When the government changes the
price of oil, the price of materials also changes accordingly.

Shortage or excess supply at market: the availability of certain item on market has an
inverse relationship with the price of the same on the market. If an item is supplied in
excess amount on the market, its price will reduce from its normal price, and inversely, if
there is a shortage of the same item, then its price will rise.

Increase or decrease in demand of a certain item: the price of a certain item has a direct
relationship with the demand of that particular item. If the demand for certain item rises,
then its price will also rise and vice versa.

According to Charles (2014), fluctuation in construction input resource price is a

construction risk which must be adequately assessed to ensure smooth implementation of
construction projects.

Coupled with the unprecedented escalation of fuel and construction materials costs, the
risk of price fluctuations has become more critical to construction works contracts for
both the contractor and employer. The risk is mainly in the volatility of costs of materials

13
and labor. Significant costs fluctuation may lead to under or over estimation of tender
costs and both parties may be exposed to unexpected risk at different times in the
business cycle.

2.6 Inflation and the Construction Industry

According to (Amaha, 2012), inflation can be defined as the rate of increase in general
price levels in an economy. Inflation is also defined as a sustained increase in the general
level of prices for goods and services and it is usually measured as an annual percentage
increase. As inflation rises, every dollar you own buys a smaller percentage of a good or
service. When inflation goes up, there is a decline in the purchasing power of money.

Inflation is the process of continuously rising prices, or equivalently, of a continuously

falling value of money (Akintola et. al., 2009 in Mohamed, 2013) Inflation produces a
general rise in price levels but, more importantly, causes a decrease in the monetary unit
with time, and these consequences are proportional to the rate of inflation. If the effects
of inflation are not included in financial and economic studies, possible outcomes include
selecting incorrect alternatives, understanding budgets, and overstating profits.

The growth in total investment costs for the education sector development, road sector
development, water sector development and energy sector development reflects the
severe effects that economic factors have had on construction. The last few years have
seen even greater distortion in the economy and in particular, in the construction industry.
Construction owners are aware of the overall rise in construction costs, and the increase
in cost of labor and materials is the most obvious manifestation.

Inflation has become a chronic problem whose effects permeate the entire construction
industry. Contractors are faced with server uncertainty in bidding and financing work on
projects. Owners are not only paying for the increased costs of facilities and capital but
also for premiums on construction prices because of the uncertainties of inflation and its
side effects. Productivity is affected because contractors cannot accurately forecast long-
term returns on their investments and are required to divert necessary capital to meet
resource costs. In particular, the proper assignment of economic risks in contracting

14
should reduce costs in the long term, although this would entail considerable change in
construction industry operations (Stukhart, 1982 quoted in Asteway 2008).

According to Pilcher (1994) cited in Amaha (2012), the effects of inflation can cause
serious difficulties for contractors. Fluctuations in the rate of inflation can cause serious
problems in the economic processes in the construction industry. This is because of the
difficulties inherent in construction contracting. Due to the nature of the process and the
rate of return for work undertaken on construction projects, the effects of inflation can
cause loss or profit.

The degree of the inflationary burden to be borne by a contractor will depend on the
nature or type of contract, the duration of the contract and the availability of credit
purchase opportunities, the extent of imported components. When, for instance the
contract is of the fluctuating type, the contractor relies heavily on inflationary indexing in
order to claim for the increase in price levels of the resource inputs. When the duration of
the contract is short, such claim may not be tenable except in cases where there is rapid
change in the price level. Inflation will affect not only the cash flows of a project but also
on the rate at which the cash flows need to be discounted (Amaha, 2012).

Inflation has been one of the predominant factors contributing to the increase in the
original estimates of road construction costs in Ethiopia. The original project cost
estimate by all contracting parties may take inflation in to consideration. However, the
rates of inflation of construction materials and equipment in the world market in general
and within the country, often reach a double digit inflation figure, and in particular have
usually been above the forecasted level throughout the course of the construction period,
leading invariably to higher construction cost for the contractors and to budget deficit to
the Employers as most projects do not meet the initial budget target. Obviously, any other
factor that delays a project will expose the project to the risk of further inflationary cost
increases.

According to (Amaha, 2012), constant devaluation of local currency, which has been
prevailing since the implementation of the Road Sector Development Program (RSDP) in
Ethiopia, has been pushing the inflation rate in the country even higher. This gives

15
another dimension to the problem of the project cost increase as most construction
materials and equipment required for the project work becomes more expensive,
especially for the National Competitive Bidding (NCB) Contracts, than it is originally
predicted.

The major risks/impacts of currency devaluation on the direct costs of the local
construction industry includes, but not limited to, the following points:

 The exchange rate for securing hard currency for the importation of light and
heavy construction equipment and some critical construction materials become
very expensive.
 The already high inflation rate of local construction materials and fuels gets even
higher as it automatically reacts to the risk of currency devaluation.
 Ultimately, the labor cost also becomes more expensive for the reason that the
work force demands higher salary due to the lower purchasing power of local
currency.

Change in governmental legislation which includes increment of sales taxes and other
regulations do affect the construction of domestic contractors for National Competitive
Bidding (NCB) contracts as the taxation is considered as other cost element of the
project. Hence, if a change happens to occur in government legislation, the cost for the
construction of the project would ultimately increases.

Due to the nature of the process and the rate of return for work undertaken on
construction projects, the effects of inflation can cause loss of profit to contractors and
higher cost overrun to project owners.

Generally price fluctuation can have effect on contractors, clients/owners and the project
itself. The major effects of price fluctuation, if not well compensated, can be summarized
as follows:

 Profit loss of contractors

 Cash flow (project financing) problem of the projects
 Delay in project completion

16
  Poor quality of project outputs

Many articles address how one may gain limited protection from chronic inflation. Most
familiar is indexing which is a means of discounting actual birr to “real‟‟ or inflation-
adjusted birr. But this adjustment infrequently applied dose not account for other effects,
such as individual price distortion or hidden costs resulting from the inability to forecast
on one‟s investment. It is common, even with the national attention on focused on the
problem, for members of the construction industry in the Ethiopia to ignore or assume
zero inflation perhaps this behavior is due to believing that inflation is a temporary
phenomenon and that overcorrecting for inflation may exacerbate the problem (Stukhart,
1982 cited in Asteway, 2008).

2.7 Price Estimation Methods and Setting of Prices

Price Estimation is the process of pricing work based on the information/specification

and or drawings available in the preparation of submitting an offer for carrying out work
for a specified sum of money. This specified sum is known as the Tender Sum (Charles,
2014).

In the traditional three-stage tendering process, tender documents are usually prepared by
the client‟s representative or project management firm. This document contains the Bills
of quantities which are prepared in accordance with a standard set of measurement rules.

Pricing in construction projects is a critical step that has to be undertaken very carefully.
It is a process whereby the organization interested in the construction of a project
attempts to determine the expenditure of resources such as materials, manpower,
machineries, finance and time necessarily to realize the intended project and also
determine the revenue it expects from the execution of the same. Therefore, it can be put
as pricing as two major components: the cost component and the profit component.

2.7.1 Cost component

The cost component consists of the direct construction cost, indirect construction cost
and risk allowances. Tadesse Y (2006) categorized the cost components in the
following manner:

17
a) Direct construction costs

Direct construction costs are all costs that can be specifically recorded with an
activity in a project. The direct cost cover the largest portion of the total project
cost and these costs can be budgeted, monitored and controlled far more
effectively than the indirect costs. Direct construction costs mainly include:
 Direct material cost
 Direct labor costs
 Direct equipment costs and
 Subcontract costs.
b) Indirect costs

Indirect construction costs are all costs, which cannot be directly booked under a
specific activity in a construction project but required to keep the whole project
operational. These costs are also called overhead costs, which mainly include the
head office and site overhead costs as listed below.
i) Head office costs
Head office overhead costs are all costs required to run the whole operation of
the construction company, which usually administers different projects at a
time. These include: Senior management costs, indirect labor costs (salaries
and benefits of staffs other than the senior management members), head office
building costs, bidding expenses, expertise service costs i.e. for professional
services such as external auditors, lawyers, management consultants and
external trainings, office furniture and equipments, office running expenses,
workshops, garages and warehouses, bank charges, insurance charges,
transportation and travel expenses and sundry (miscellaneous) expenses.
ii) Site overhead costs
Site overhead costs are all costs required to run the whole operation of a
specific construction project at site level. These include: Site management
costs, indirect labor costs (salaries and benefits of staffs other than the site
management members working at the project site such as site engineers, office
engineers, administrative and finance staffs), mobilization and demobilization

18
 costs, site offices, office furniture and equipments, office running expenses,
radio communications, camp facilities, access roads, water and power supply,
workshops, garages and warehouses, bank charges, transportation and travel
expenses.

c) Risk allowance

It is very essential to incorporate risk allowance in pricing for construction project

pricing. This helps to compensate the negative impacts of different risks such as
contractual, technical, political and economic risks. Contractual risks are usually
stemming from the contract agreements with the project owner, subcontractors
and suppliers.
Technical risks are associated usually with the clarification of the technical
specifications, working drawings, construction technology and difficulties in
understanding new method of constructions.

Political and economic risks reflect the impact of political situations, stability of
economic policies, inflation and price fluctuation of the inputs (material, labor,
equipment and other related costs) on the execution of the intended construction
project.

The quality and accuracy of construction cost estimation can be continually

improved as the construction execution progresses where more detailed and actual
data become available.

2.7.2 Profit component

After carefully estimating the cost of a project, contractors need to decide on the
amount of their competitive profit they like to make from the project. The profit
margin they set depends on the scale of the project and the level of competition
between bidders. Sometimes, large profit margins are adopted in cases of uncertainty.
Any business company operating a profitable business in Ethiopia is obliged to pay
income tax based on the prevailing income tax law.

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2.8 Price change measurement tools

A variety of tools are used to measure price changes taking place in an economy. These
include consumer price indices (CPIs), producer price indices (PPIs), price indices
relating to specific goods and/or services, and GDP deflators.

 Consumer Price Index (CPI): the Consumer Price Index (CPI) is the most widely
used measure of inflation. It provides information about price changes in the
nation‟s economy to government, business, labor, and private citizens and is used
by them as a guide to making economic decisions. The Producer Price Index (PPI)
measures inflation at the wholesale level, and is viewed as a more appropriate
general index for heavy construction (Akintola et. al., 2009 quoted in Mohamed,
2013).

The rate of change of the CPI gauges the change in purchasing power of money
and is therefore used as a measure of general inflation (Charles, 2014). The CPI is
used for various purposes. The most important ones are:

• Measurement of inflation in the macro-economic sense and comparison of

them with other countries
• Determination of economic policies of the governments
• Adjustment of wages and costs
• Purification of any value data from inflation
• As an indicator for national accounting
• As an indicator for price analysis
• As an indicator for retail price and the increase in rent

 Producer price index (PPI): Producer price index measures the average
movement of prices received by producers of commodities. The target set of
goods and services included in the PPI is the entire marketed output of producers
in a particular country. The set includes both goods and services purchased by
other producers as inputs to their operations or as capital investment, as well as
goods and services purchased by consumers either directly from the service

20
 producer or indirectly from a retailer. Because the PPI target is the output of
producers within a country, imports are excluded.

Various sectors of the economy also construct indices to measure the general
monetary price movement of a set of goods and services produced by the
particular sector. An example is the construction cost indices produced by the
construction industry.

2.9 Construction Price Indices

Construction price indexes are indicators, which show the trend of costs incurred by
contractor in construction. They are a measure of the prices of materials or groups of
materials and their current values are compared with their values at some time in the past.
An index usually represents a "basket" of similar materials or products. They only track
changes/trends and do not provide information on the current construction price (Charles,
2014).

Each of the expenditure components of the above model can be adjusted by the ratio of
today's value of the index divided by the base value of the index. Value of the base index
is usually fixed on the date and value 28 days before the submission of tenders (Amaha,
2012).

Price indices are important to the construction industry, economists, governments and
the general public. They are used for measuring relative price movements, cost of living
and inflation as well as microeconomic and macroeconomic variables. Most of the
information used in the compilation of construction price indices are derived from the
supply side of the industry (i.e. from construction firms, sub-contractors, materials supply
firms, etc.).

The idea of a price index comes when comparing prices of a good or groups of goods and
services at the same point in time. The above definition for price index implies that
comparison can also be done with respect to location at a particular time (Charles, 2014).

21
As the prices of different goods and services do not all change at the same rate, a price
index can only reflect their average movement.

2.9.1 Sources of Price Indices

Price adjustment formulae indices are designed for the calculation of increased or
decreased in costs on fluctuating or variation-of-price contracts. Indices are usually
produced by governmental departments of statistics to represent the costs of those
materials or groups of materials within the areas of influence of those departments.
Indices are, therefore, directly linked to the economy and accordingly the rate of
inflation, political stability and exchange rates, of that particular country or area of
influence. Because indices are area specific, they cannot be used as being
representative of other areas i.e. a fuel index from some other country would, today,
reflect the hyperinflation currently being experienced in that country and would give
no indication of what is happening with the cost of fuel in Ethiopia.

In the context of Ethiopian construction industry, the one of drawbacks of using the
formula method is the unavailability of reliable locally generated indices which are to
be used in such a formula. As a result, instead of indices, prices of cement, fuel and
reinforcement steel have been used as proxy indices and foreign indices are used in
the case of bitumen, foreign labor and equipment which do not have local
proxy/substitute indices in order to utilize the formula (Amaha, 2012).

If one were to use arbitrary indices, one would effectively "import" the inflation from
that area into the project and over or under compensate the Contractor for Contract
Price Adjustment. It is therefore essential that the sources of indices coincide with the
currencies of payment i.e. if the Contractor requested payment in Ethiopian Birr and
USD. The source of the indices must therefore be Ethiopia and the United States of
America.

All well developed countries produce such own indices, which are up to date and
readily available, usually accessible via the internet. However, where those are not
produced it becomes necessary to use proxy indices, which more often than not, are

22
actual material or product prices from reliable manufacturers or producers e.g. a
cement factory, government published minimum wage or fuel price etc.

Where even proxy indices are unavailable, contracts provide a relief mechanism to
use indices from a source other than the country of the currency of payment.
However, in this case it is necessary to apply a correction factor Zo/Zn to the
respective component factor in the formula.

Where:

Zo is the number of units of the currency of the country of the index, equivalent to one
unit of the currency of payment on the date of the base index, and

Zn is the corresponding number of such currency units on the date of the current
index.

2.9.2 Types of Construction Price indices

The statistics directorate of the Organization for Economic Cooperation and

Development (OECD) identifies three main types of price indices; input price indices,
output price indices and seller’s price indices.

The methods used to compile construction price indices vary significantly between
organization for OECD and European Union Member countries. Individual member
countries also use a variety of methods, data sources, etc. for the different
construction price indices they produce. Three main types of construction price
indices are compiled in OECD and European Union Member countries: input price
indices (measures the change in prices of construction inputs); output price indices
(measures the change in prices of what is produced by construction activities); and
seller‟s price indices (measures the change in price of construction output as paid by
purchaser or final owner).

23
2.9.2.1 Input Price Indices

Input price indices measure changes in the price of inputs to the construction
process by monitoring separately the cost of each factor. This generally entails the
compilation of a weighted index of the costs of wages and materials.

Initially, representative object (e.g. a dwelling of a specific type, size, style, etc.)
is taken and the quantity of labor hours and materials needed for its construction
calculated. These quantities are periodically multiplied by the corresponding
prices and the outcome totaled.

Input price indices should not be used to provide information on price movements
for finished construction work as they generally do not reflect the whole range of
influences that impact on market prices. These include changes in productivity,
profit, and trade margins of the construction contractor, and changes in actual
market conditions.

Input price indices only provide a reflection of changes in the prices of

construction inputs. The indices produced are production cost rather than
production price indices. As a result, the real trend of building costs may differ
considerably from the trend compiled solely on the basis of wages and material
costs. An input cost index is likely to overstate the price rise of completed
construction work as it ignores gains in productivity reflected in price reductions.

2.9.2.2 Output Price Indices

Output price indices measure changes in the prices of what is produced by entities
engaged in construction activity. It covers most of the items normally built into
the price paid by purchasers or clients to entities involved in producing the
completed output of the construction activity. These generally include materials,
labor, equipment hire, land preparation costs, bathroom/kitchen fittings,
overheads, profits, and trade margins.

24
Several different techniques are used to include all these components. One
method involves the inclusion in the index of all (or as many as possible of) the
individual factors involved in the construction of a dwelling, non-residential
building, etc. These include overheads, profits, trade margins, and any other costs
paid by the client or purchaser to the builder. An alternative method entails basing
the index on the prices of actual finished constructions. Both methods are
described in detail below in the typology of methods used to compile construction
price indices.

2.9.2.3 Seller’s Price Indices

Seller‟s price indices measure changes in the prices of construction output paid by
the purchaser or final owner of the output of construction activity. The term
“seller‟s price” is used to distinguish it from the “purchasers‟ price” as defined in
the System of National Accounts (SNA).

Seller‟s price indices include the total sales price of completed construction,
including not only the cost of labor and materials, but also land, direct and
indirect selling expenses, and seller‟s profits. House price indices compiled in the
United States and Canada, and the dwelling price index compiled in Spain, are
conceptually broader in item coverage than almost all input and output indices
compiled in other OECD and European Union Member countries.

The resultant indices compiled in these countries for houses include most factors
which influence movements in home prices. These include both supply factors
such as wage rates, material costs, and productivity, and demand factors such as
demographic changes, incomes, and the availability of mortgage finance. These
indices are the closest approximations in item coverage to the actual price paid for
construction output.

Some of these countries also compile seller‟s price indices excluding the land
component. The inclusion in the index of all the cost elements paid for by the
final owner of the construction (particularly the land, finance costs, selling

25
 expenses) conceptually brings a seller‟s construction price index close to being a
consumer price index.

2.10 Price adjustment in construction industry

A fundamental principle of risk management is to allocate the risks to the party best able
to manage them. In the road construction industry, prices of materials, equipment and
labor can be highly variable due to fluctuations in the local and international market. It is,
therefore, thought prudent to assess bids for projects using a “present price” value, but
keeping provisions for a Price Adjustment clause to accommodate agreed future
fluctuations.

In projects of reasonably long duration, Employers consider it reasonable to compensate

Contractors for losses which they might suffer as a result of increases in the prices of
labor, Materials, Fuel, and Plant etc. The exception is projects which are governed by the
Ethiopian Public Procurement Agency‟s (PPA) standard conditions of contract, where it
is stated that projects with duration less than 18 months may not have any provision for
adjustment of prices. The PPA conditions of contract are applicable only in projects of
relatively small scale, as opposed to most Ethiopian Roads Authority (ERA) projects
which are based on FIDIC condition of contracts, and have provision for price adjustment
under Clause 70.

Whenever there is a price fluctuation due to legislation change, decrease or increase in

cost of direct inputs (material, labor, equipment, energy, etc.), change in monitory value
(inflation or deflation) etc. the contract prices need to be adjusted if the contract has the
price adjustment provision.

Most engineering construction based contracts contain provisions for adjustments to

changes in cost (i.e. price escalation) utilizing a price adjustment formula to take into
account the increases in the costs of lab our, equipment, plant, material and fuel over the
period of contract.

Price adjustment is a method of transferring the risk associated with increasing material
prices from the contractor to the contracting agency. Since price fluctuation is a common

26
phenomenon on federal road construction projects standard forms of federal road
construction contracts incorporate price adjustment clauses as a mechanism to evaluate
changes in prices of construction resources.

Standard forms of construction contracts incorporate fluctuation clauses as a mechanism

to evaluate changes in prices of construction resources. The incorporation of price
adjustment clauses are not mandatory but the inclusion of the clauses as a reasonable
compensation against variation in prices of inputs allows the price of material to fluctuate
without imposing additional risk to the contracting agency or the contractor and helps to
administer contracts in a fair, equitable and just manner.

Whenever there is a price fluctuation due to several reasons, such as change in

legislation, change in monetary value(inflation or deflation), decrease or increase in cost
of direct inputs (Material, Labor, energy, etc) the contract price needs to be adjusted if the
contract has price adjustment provision.

The purpose of a price adjustment clause in a construction contract is to provide a

mechanism for reimbursing contractors or client for changes in construction input prices
which occurred during the construction period. Where there is increase in input price, the
contractor will be reimbursed and it is expected that the client will be reimbursed in the
event of a downward movement of input prices.

2.11 Price Adjustment Methods

The provisions of price adjustment on account of increase or decrease in costs of goods

and services in construction contracts are practiced world over to have more realistic
competitive bids and execution of contracts on equitable and just manner. Prices of goods
and labor are highly variable due to fluctuations in the currency market. As a result, most
engineering construction based contracts contain provisions for adjustments to changes in
cost (i.e. price escalation) utilizing a price adjustment formula to take into account the
increases or decreases in the costs of labor, equipment, plant, material and fuel over the
period of the contract.

27
Due to the complex nature of construction projects, domestic construction projects are
accompanied by frequent price escalation because of rises of prices of materials, labor
and equipment. There are a number of methods available for calculating the contract‟s
price adjustment. Whichever method is used it usually provides for both increases and
decreases in prices and can accordingly result in either an increase or a decrease in the
contract price. To accommodate price fluctuations there are two alternative methods
commonly employed in the local context to determine such variations practiced in the
construction industry. These methods are “Basic Prices” or proven cost method and
“Price Indices” or Adjustment formula Method (ERA, 2006).

2.11.1 Basic Price/Proven cost Method

The proven cost method is used to determine actual price increases of materials, and
labor. In this method the contractor attaches a list of input materials and labor with
their corresponding prices known as “basic price list” prevailing twenty-eight days to
opening of tender as part of the tender documents. A base date is thus pre-determined
at tender stage (Charles, 2014).

When this method is used the Contractor is required, at tender stage, to list those
elements of his costs which he requires to be subject to contract price adjustment
(CPA). In support of this he includes a list of the actual costs and suppliers of the
various elements upon which he based his tender. When the Contractor purchases
these materials he presents proof of the actual price paid and receives compensation
for the difference between the "Basic Cost" and the "Actual" invoiced cost of those
same items. It is therefore important to ensure that all purchases are from the
suppliers identified at the time of the tender. Any change in suppliers is likely to
result in an invalid comparison of prices and accordingly overcompensation (ERA,
2006).

The contractor is reimbursed for increases in the prices of the materials and labor in
the course of construction on the basic price list. Cost increases are evaluated on
items provided in the basic price list only. Items not provided for in the list do not
attract fluctuations even if those prices changes. This method is a partial fluctuation
reimbursement, because the amount of increase recovered is much less than the total

28
amount by which costs have really increased. The following are some of the
difficulties associated with the proven cost method;

 Labor: There is great difficulty in defining labor cost: there have been doubts
about whether the several ancillary costs of labor, qualify for reimbursement or
not. Statutory increases and other labor cost increases are generally known
throughout the industry, hence they are easily agreed. However, where a
contractor pays higher rates of wages than the nationally negotiated, he cannot be
reimbursed for any increase, even if on a pro-rata basis. This is the common
situation in Ethiopia where most contractors pay higher wages than governmental
organizations.
 Materials: There is the difficulty of how to determine what “market price‟ or
“market increase‟ is; as a result of different interpretations giving rise to different
applications in practice. To be allowable for recovery under the basic price
computation method, all fluctuations must:

• Relate to materials listed on the contractor‟s basic price list

• Be due solely to changes in market prices. Claims due to buying in small
quantities, buying from a source which offers less favorable discounts and
buying a different though similar material.

It is clear from the foregoing that if a material is not listed it does not qualify for
price adjustment.

 Plant: Fluctuations in plant hire rates are not covered by the proven cost method
of computation. However the cost of plant in construction projects can be very
high especially road construction projects where plant cost make up
approximately fifty-five percent of the total cost. The basic price method places
the burden of proof on the contractor. This computation method also takes a great
deal of staff time to prepare. This method is therefore inadequate to reimburse the
contractor.

When using this method, that the Client verify the authenticity and reliability of
the suppliers and prices quoted as the base prices. Any change in supplier is likely

29
 to result in different base prices, which will complicate the calculation of contract
price adjustment (CPA). It is not the preferred method by the Employer as it has
the potential for abuse by: under quoting base prices, over invoicing current
prices and changing suppliers.

2.11.2 Indices/Formula Method

The formula method was introduced in the United Kingdom in the 1970s as
an alternative to the traditional method to fully reimburse the contractor for losses
incurred due to price fluctuation.

This method uses a mathematical model of the construction contract to calculate the
contract price adjustment (CPA). The Client develops the model by identifying the
items of greatest expenditure and combining these with statistically derived indices,
which indicate the changes in the cost of these items.

With this method the works, to be undertaken, are mathematically described in a

formula. The formulae are based on price indices for material, fuel and the consumer
price index published by the central statistics office in its monthly statistical release.
The similar formula is used to determine permitted labor increases using the
difference between the registered employment agreement hourly rate at the Base Date
and the current registered employment agreement rate. The formula contains a
number of factors representing the various elements of the project at the time of
tender and a number of similar factors for the various elements of work at the time
that the works are undertaken. By using these factors in the formula a percentage
increase in the tendered value of work done is obtained and the amount resulting from
this represents the CPA due to the Contractor (ERA, 2006). To address these
problems, the MoWUD 1994 (amendment of MoI 2004), FIDIC 1999, MDB FIDIC
2006, PPA 2006 and PPPAA 2011 form of contracts provide an adjustment formula
for price escalation.

In general the formula method uses a set of formula rules which define a technical
financial calculation, based on a wide variety of categories and published indices

30
(usually monthly) by which each sum should be multiplied. The purpose of the
formula method therefore is to reduce the amount of time spent by the project team in
evaluating fluctuations and to overcome some of the disadvantages of the proven cost
methods.

In accordance with the widely-used International Conditions of Contract: FIDIC-

2006, Sub clause 13.7, the price adjustment formula is generally a function of;

i) a fixed (non-adjustable) portion,

ii) the type of adjustable (variable) elements and
iii) the number of adjustable (variable) elements,
iv) the weighting/coefficient of the adjustable elements,
v) the correction factor for currency fluctuation

 Fixed Portion: The first item in the expenditure schedule is termed as

"Fixed", which is obviously not a material or materials associated expenditure.
The larger the size of the fixed component the more the contractor takes a
financial risk resulting from inflation. On the other hand if price goes down it is
going to be the Client who losses the benefit from the adjustment if the fixed
portion is made relatively large. Therefore, it is to the benefit of both contracting
parties to be as rational as possible in analyzing and deciding the magnitude of the
fixed component of the formula. In such cases, the fixed portion of the formula is
supposed to incorporate;
• Input prices not subject to price fluctuation, such as materials supplied
“free issue” to contractors by the client at fixed price,
• an allowance estimated to avoid over compensation to the contractors,
• an amount to be included by the contractors to motivate them to make
their purchases well in advance and the general items to be paid around
the commencement of the works.

 Adjustable (variable) elements: Adjustable Elements are defined based on the

nature of the work, and each Adjustable Element consists of both materials and
labor.

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 The major components of construction cost directly involved consist of
material, labor and equipment costs. While there is a change in cost of these
construction inputs during project implementation, different provisions provide
price adjustment clauses to compensate the loss of contractors or clients due to
price fluctuation in these cost components. Among other materials used in road
construction projects, only four material components, cement, bitumen,
reinforcement bar and fuel are allowed for price adjustment in the local context.

Owing to limited capital base of domestic contractors, they are at a disadvantage

position resulted from this limited adjustment. Recently ERA allowed adjustment
for foreign labor and equipment cost components. In light of this, the majority of
contractors, consultants and employers respectively strongly agree on such limited
adjustment scheme as affecting domestic contractors (Getaneh, 2011).

 Weightings/Coefficients of Adjustable Elements: During the process of

tendering, weighting ranges for various construction inputs such as; bitumen,
cement, steel, equipment, fuel, labor etc. are provided by the Employer under the
bidding document. These would be used as a base for the Contractors to come up
with their weighting proposal, which should be within the provided range. Hence,
the induction of more realistic ranges of weightings that can properly consider the
proportion of all the construction inputs in a particular project is very crucial to
come up with the best price adjustment formula that can minimize the problem of
unfair risk sharing/allocation during the implementation of the project.

The basis for the determination of the weighting of the adjustable elements is the
Engineer‟s estimate. For instance, the Engineer calculates the range of estimated
cost of fuel in a project. Then the Employer takes this figure and divides it by the
overall estimated cost of the project as calculated by the Engineer and accordingly
the range of percentage weighting is determined. Here it is worthy to note that the
accuracy of the Engineer‟s estimate has paramount importance so as to avoid
disputes during implementation.

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 If the quantity, unit rates or both computed by the Engineer are erroneous, this
would mean that the ranges of weightings may not be correct. During the
execution of a construction contract if the workload of a project is affected either
due to variations resulted from wrong estimates, design modification or any other
reason, the weightings of the adjustable elements are subject to modification
(Amaha,2012).
2.12 Advantages and disadvantages of Price Adjustment

Contract price adjustment is commonly used to mitigate cost increases in projects where
inflation is a factor and risk transfer options are limited, in order to achieve best value.
However the incorporation of price adjustment provisions in a contract has both merits
and demerits for contractors as well as clients.

2.12.1 Advantages of Price Adjustment clauses

Some of the merits of incorporating price adjustment clauses in construction contracts

include: lower bid prices, increase number of bidders, market stability, few
contractors‟ defaults/bid retractions and consistent contractor profit margins.

A potential benefit of price adjustment clause is the ability to increase stability,

perhaps leading to an increase in the number of bids and reduced uncertainty could
increase the desirability of the market resulting in new entries to the market and
limiting firms exiting. The presence of price adjustment clause can potentially reduce
risk, decrease the use of added risk pricing and increase bid competition. The
consequent reductions of overall bid prices and increased numbers of bids per project
can result in lower overall costs to the contracts (Amaha, 2012).

In the absence of CPA clauses contractors may add contingencies to cover material
price risk and rapidly fluctuating prices may cause contractors to face large loses on a
particular contract. This may lead to contractor defaults, non-performance, and exit
from the market.

Different researchers identify the advantages of price adjustment clauses for

contractors and employers as follows:

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  For the Employer:
• Encourage competitive tenders by releasing contractors from the need to
include speculative pricing for fluctuation in tender bids;
• Avoids potential works interruptions/terminations due to financial difficulties
of contractors associated with increases in construction costs;
• Reduces the risk of substandard works due to the use of poor quality or
insufficient materials or labor force due to unexpected cost pressure;
• Minimize the possibility of sacrificing quality and safety due to significant
cost-cutting measures in an inflationary economy and avoids any extra
expenses arising from efforts in investigation, administration work;
• Benefits from reduced construction costs in a deflationary economy;
• Rationalizes construction costs in the long run due to decreased risks; and
• Enhances a harmonious and cooperative working environment between
employers and contractors and reduces the risk of commercial disputes.

 For the contractor:

• Avoids the loss of competitiveness due to overstated tender amounts to
provide for construction costs increases;
• Lowers risk of financial loss/insolvency due to understated tender amounts or
unforeseeable inflation in costs where actual construction costs cannot be
recovered from employer‟s payments;
• Ensures compensation by employers for the relevant portion of any increased
amount of construction costs in an inflationary economy; and
• Reduces the scope for commercial dispute

2.12.2 Disadvantages of Price Adjustment clauses

Even if price adjustment had the above stated and other advantages for both
contractors and employers it has also demerits. Some of the disadvantages of
incorporating price adjustment clauses in construction projects include:

 It may require a more detailed payment application process requiring more

resources and therefore greater cost to manage;

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  May encourage contractor to speculate on fluctuation compensation;
 May introduce an additional variable for the assessment of tender prices;
 May create uncertainty in estimating individual project cost;
 May appear to increase construction costs in an inflationary economy;
 The benefits of a fluctuation compensation method may not get passed to
lower tiers of subcontractors.

2.13 Standard Forms of Contract and Price Adjustment Clauses

In some lines of business like construction works, it is practicable to prepare standard

contract forms that can be used repeatedly by merely filling in the pertinent names, dates,
prices, terms of payment, etc. appropriate to the particular situation. These standard
contract forms eliminate the need for composing new documents each time when a
similar contract is made. After a considerable use, such standard contract forms will
generally have been proved by experience to be satisfactory and any errors will have been
found and remedied (Kasiem S., 2008).

Price adjustment clause also known as Economic Price Adjustment, Cost Adjustment,
Escalation Clauses or Price Indexing; consists of providing contractors with protection
against materials, Labor, fuel, plant, etc price increases that may occur during the
execution of the work through the use of Price Adjustment Clauses (PACs). Under these
provisions, the employer accepts the risk for increasing prices by offering a PAC that will
compensate the contractor for any increase above the bid price or a trigger amount of a
specific material or fuel.

Result of researches conducted on the importance of price adjustment clauses in the

transportation construction industry shows that the incorporation of price adjustment
provisions in construction contract has the following benefits:

 Lower bid prices

 Increased number of bidders and fewer bid retractions
 Better market stability
 Better reliability in the supply chain
 More consistent contractor profit margins

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Price adjustment clauses help in addressing the issues caused by commodities with
volatile prices. The uncertainty about future costs brings large risks to the construction
contracting industry. As a result, under regular payment provisions, contractors try to
include risk premiums to their bids to ensure profitability through unforeseen
circumstances causing overall higher bid prices. In addition, for the case of long term
projects, changing prices result in much higher risks as the changes increase with time
resulting in unrealistic bid prices. By transferring the risks from the contractor to the
employer, the need for these contingency costs is eliminated resulting in better bid prices.
In addition, by eliminating the risks, PACs shield construction firms from large losses on
single contracts. PACs help to reduce the number of firms that exit the market and
provide better market stability.

Price adjustment clauses are heavily dependent on project duration. In shorter duration
projects it is easier to forecast the price of materials until the end of the project as there
will be small variations in time. In longer duration projects however, it is harder to
forecast these prices as they can vary greatly over time resulting in higher risks.

The various forms of construction contracts make provision for evaluating fluctuations on
the price of selected construction inputs. In Ethiopia construction industry price
escalation is administered by using the following local and international contractual
clauses:

2.13.1 Local Conditions of Contract available in Ethiopia construction industry

The evolution of conditions of contract in Ethiopia dates back to 1959. The first ever
conditions of contract prepared by MoUDH in July 1959 was entitled “General
conditions of Construction Contracts”. In this contract form Price escalation is not
mentioned.

After three decades since the first conditions of contract comes into effect, the
Standard Conditions of Contract for Construction of Civil Works Projects was
endorsed by BaTCoDA in December 1987.

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The Standard Conditions of Contract for Construction of Civil Works Projects
by MoWUD was enacted in December 1994. The PPA General Conditions of
Contract for the procurement of works is the recent contract form issued in
January 2006 as part of Standard Bidding Document (SDB) for international and
national competitive bidding. Since these and other local and international conditions
of contract are functional in our country the choice of contract condition depends
on owner and international agencies involved in the work.

In Ethiopia FIDIC contract condition is widely used in construction works funded by

international agencies more significantly for public projects such as roads and hydro-
electric power. MoWUD 1994 is mostly employed for domestic building projects
especially sponsored by private owners whereas PPA 2006 is employed for public
building projects.

i) BATCoDA 1987 Contract Form

As stated above BaTCoDA is the second version of local contract form “Standard
Conditions of Contract for Construction of Civil Work Projects” in December 1987.
Unlike that of MoUDH 1959, BaTCoDA 1987 incorporates price escalation clause.

Clause 70: Changes in Cost and Legislation, Sub clause (1) Increase or Decrease of Costs

The only adjustments to be allowed are on the difference between the basic prices and
market prices of the materials and goods listed in the appendix to the bill of quantities
after the bid pricing date.

• The Rates contained in the priced bill of quantities are based upon the market
prices of the materials and goods specified in the appendix to the bill of
quantities and current at the date of bid pricing (Basic Price).

• If the market price of any of the materials or goods specified in the basic price
shall be increased or decreased after the said date of the bid pricing, then the net
amount of the difference between the basic price and the market price payable
by the contractor.

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ii) MoWUD 1994 Contract Form

MoWUD issued the third generation of local contract forms, “Standard Conditions of
Contract for Construction of Civil Work Projects”, in December 1994.

Clause 70, Sub clause (1) Changes in Cost and Legislation

The contract price shall be considered to have been calculated in the manner set out
below and shall be subject to the adjustment in the events specified here under:-

• The rate contained in the priced Bill of Quantities are based upon the rates of
wages and other emoluments and expenses applicable at the site date of bid
pricing.

• If the said rates of wages and other emoluments and expenses are increased or
decreased by any Act, Statute, Decree, Regulation and the like after the said
date of bid pricing, then the net amount of the increased or decreased of the
emoluments and expenses shall, after due consultation.

• By the Engineer and shall form an addition or deduction as the case may be to or
from the Contract Price and be paid to or allowed by the Contractor
accordingly.

• The rates contained in the priced Bill of quantities are based upon the rates of the
Contractor‟s compulsory contributions payable at the date of bid pricing under
or by virtue of any Act, statute, Decree, Regulation and the like applicable at the
Site.

• If any of the said rates of contribution shall be increased or decreased after the
said date of bid pricing or if any new compulsory contribution becomes payable
after that date, then the net amount of the difference between what the
contractor actually pays in respect of works people engaged upon or in
connection with the works and what he would have paid in respect of such
persons had any of the said rates not become payable as aforesaid shall form an

38
 addition or deduction as the case may be to or from the contract price and be
paid to or allowed by the Contractor accordingly.

MoWUD assumed that the market to be a stable one. These conditions do not
explicitly address an increase or decrease in cost of labor or materials with respect to
the country‟s market but rather dealt with only increase or decrease of rates of wages
and other emoluments and expenses subsequent to change in legislation. It used to
amend and ratifies price rise/falls from time to time to address adjustments attributed
to price escalation. However, these provisions were later put in to effect through
„Construction Conditions Amendment 001/1996 E.C‟ by MoI in March 2004. The
directive comprises nine amendment clauses where provisions on advance payment
and price escalation are dealt with among others.

iii) PPA 2006 Contract Form

The latest contract form put in place is released by PPA in January 2006. PPA issued
two sets of SBD for the Procurement of Works for NCB and ICB.

Clause 47: Price Adjustments

Sub Clause 47.1: Prices shall be adjusted for fluctuations in the cost of inputs only if
provided for in the Special Conditions of Contract. If so provided, the amounts
certified in each payment certificate, after deducting for Advance Payment, shall be
adjusted by applying the respective price adjustment factor to the payment amounts
due in each currency. A formula indicated below is applicable in this contract
condition to compensate losses due to price fluctuation:

Where:
Pn is a price adjustment factor to be applied to the amount in each payment certificate
of the work carried out in period “n”, this period being a month unless otherwise
stated in the Contract Data;

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“A” is a constant, specified in the Contractor‟s Bid, representing the nonadjustable
portion in contractual payments;

“b”, “c”, “d”, etc., are weightings or coefficients representing the estimated
proportion of each cost element (labor, materials, equipment usage, etc.) in the
Works or sections thereof, net of Provisional Sums, as specified in the Contractor‟s
Bid; the sum of A, b, c, d, etc., shall be one

“Ln”, “En”, “Mn”, etc., Ln, Mn, En, etc., are the current cost indices or reference
prices of the cost elements at the date 28 days prior to the deadline for bid
submission; and

“Lo”, “Eo”, “Mo”, etc., are the base cost indices or reference prices corresponding to
the above cost elements at the date 28 days prior to the last day of the period
to which a particular Interim Payment Certificate is related.

Sub Clause 47.2: The sources of indices shall be those listed in the Contractor‟s Bid,
as approved by the Engineer. Indices shall be appropriate for their purpose and shall
relate to the Contractor‟s proposed source of supply of inputs. As the proposed basis
for price adjustment, the Contractor shall have submitted with his bid the tabulation
of Weightings and Source of Indices, which shall be subject to approval by the
Engineer.

Sub Clause 47.3: If the value of the index is changed after it has been used in a
calculation, the calculation shall be corrected and an adjustment made in the next
payment certificate. The index value shall be deemed to take account of all changes in
cost due to fluctuations in costs.

iv) PPPAA 2011 Contract Form

Clause 62: Price Adjustments

Adjustments of contract prices shall be allowed after twelve (12) months from the
effective date of the Contract where it is verified that the performance of the contract
requires more than 18 months.

40
Request for price adjustment in relation to a particular work items under this Contract
may be filed by the Contractor after twelve (12) months from the effective date of the
Contract where it is verified that the performance of the contract requires more than
18 months, which adjusted price takes effect as the new Contract Price in relation to
that work item on the expiration of 30 days from the date on which the Public Body
receives notification of that adjusted price from the Contractor, unless another date is
agreed in writing between the Parties.

Price Adjustment shall be applicable as payable in full for the original scheduled
completion period. In the event the completion of contract exceeds the original
scheduled period:

• In case of default on the part of the Contractor causing delay in original

scheduled completion, the rate of Price Adjustment will be frozen at the original
scheduled date of completion; however Price Adjustment will be applicable till
actual completion. While computing Price Adjustment beyond the scheduled
completion period, in the event the rate is reduced, then that reduced rate will be
applied.

• The Price Adjustment will be payable in full for the extended period if the
Contractor has been granted an extension of time for no fault on the part of the
Contractor, duly approved by the Public Body.

Adjustments in compensation may be either plus or minus depending on the

differences between the Benchmark Price Index and the Monthly Price Index.

To determine the adjustment on each item any such price variation shall be
calculated in accordance with the following formula by applying the combination of
above said criteria

41
Where:
PA = the amount of the Price adjustment to be paid to, or recovered from the
contractor, in currency specified in SCC;
NV= The fraction which represents Non Variable element of the Contract Price that
is free of contract price adjustment, as specified in the Contractor's Bid;
A = The fraction of the Contract Price subject to adjustment in accordance with
movements of the selected Average Labor Category Earnings Index;
MLI = The most recently available selected Average Labor Category Earnings Index
on the date on which the Public Body received notification of the proposed increased
price from the Contractor;
BLI = Benchmark Average Labor Category Earnings Index applicable to the Works
either: at the bid closing date, or if the Contract Price has been adjusted previously,
the date on which the Public Body received notification from the Contractor in
respect of the last adjustment to effect the current Contract Price;
B = The fraction of the Contract Price subject to adjustment in accordance with
movements of the selected Material Price Index
MMI = The most recently available selected Material Price Index on the date on
which the Public Body received notification of the proposed increased price from the
Contractor;
BMI = Benchmark selected Material Price Index applicable to the Works either: at
the bid closing date, or if the Contract Price has been adjusted previously, the date on
which the Public Body received notification from the Contractor in respect of the
last adjustment to effect the current Contract Price;

C = The fraction of the Contract Price subject to adjustment in accordance with

movements of the selected Equipment Price Index
MEI = The most recently available selected Equipment Price Index on the date on
which the public Body received notification of the proposed increased price from the
Contractor;

42
BEI = Benchmark selected Equipment Price Index applicable to the Works either: at
the bid closing date, or if the Contract Price has been adjusted previously, the date on
which the Public Body received notification from the Contractor in respect of the last
adjustment to effect the current Contract Price;
D = the fraction of the Contract Price subject to adjustment in accordance with
movements of the Average Fuel Price Index
MFI = The most recently available Average Fuel Price Index on the date on which the
Public Body received notification of the proposed increased price from the
Contractor;
BFI = Benchmark Average Fuel Price Index applicable to the Works either: at the bid
closing date, or if the Contract Price has been adjusted previously, the date on which
the Public Body received notification from the Contractor in respect of the last
adjustment to effect the current Contract Price;
BC = Current Contract Price applicable to the Works
Q = Quantity;
And where: NV+A+B+C+D are equal to 1.00

The fraction for each specified element and exact combination of elements that will
be applied in the formula for price adjustment shall be determined in the SCC.

2.13.2 International contract forms in use by Ethiopia construction Industry

Recently FIDIC red book subsequent editions (FIDIC; 1987, 1999 and 2006 MDB)
have become the most commonly used contract forms in the construction industry of
Ethiopia. Now a day, among these subsequent editions, FIDIC 2006 MDB is most
common and applicable contract form on federal road construction projects.

 FIDIC 2010 MDB Contract Form

Clause 13: Variation and Adjustments

Sub Clause 13.7: Adjustment for change in Legislation
The Contract Price shall be adjusted to take account of any increase or decrease in
Cost resulting from a change in the Laws of the Country (including the introduction
of new Laws and the repeal or modification of existing Laws) or in the judicial or

43
official governmental interpretation of such Laws, made after the Base Date, which
affect the Contractor in the performance of obligations under the Contract.

If the Contractor suffers (or will suffer) delay and/or incurs (or will incur) additional
Cost as a result of these changes in the Laws or in such interpretations, made after the
Base Date, the Contractor shall give notice to the Engineer and shall be entitled
subject to Sub-Clause 20.1 [Contractor‟s Claims] to:

(b) Payment of any such Cost, which shall be included in the Contract Price.

Sub Clause 13.8: Adjustment for change in Costs

If this Sub-Clause applies, the amounts payable to the Contractor shall be adjusted for
rises or falls in the cost of labor, Goods and other inputs to the Works, by the addition
or deduction of the amounts determined by the formulae prescribed in this Sub-
Clause. To the extent that full compensation for any rise or fall in Costs is not
covered by the provisions of this or other Clauses, the Accepted Contract Amount
shall be deemed to have included amounts to cover the contingency of other rises and
falls in costs.

The adjustment to be applied to the amount otherwise payable to the Contractor, as

valued in accordance with the appropriate schedule and certified in Payment
Certificates, shall be determined from formulae for each of the currencies in which
the Contract Price is payable. No adjustment is to be applied to work valued on the
basis of Cost or current prices.

The formula and its application is the same as that of used by PPA 2006 with some
additional clarifications as described below.

The cost indices or reference prices stated in the table of adjustment data shall be
used. If their source is in doubt, it shall be determined by the Engineer. For this
purpose, reference shall be made to the values of the indices at stated dates for the
purposes of clarification of the source; although these dates (and thus these values)
may not correspond to the base cost indices.

44
 In cases where the “currency of index” is not the relevant currency of payment, each
index shall be converted into the relevant currency of payment at the selling rate,
established by the central bank of the Country, of this relevant currency on the above
date for which the index is required to be applicable.

Until such time as each current cost index is available, the Engineer shall determine a
provisional index for the issue of Interim Payment Certificates. When a current cost
index is available, the adjustment shall be recalculated accordingly.

If the Contractor fails to complete the Works within the Time for Completion,
adjustment of prices thereafter shall be made using either:

 Each index or price applicable on the date 49 days prior to the expiry of the Time
for Completion of the Works, or
 The current index or price: whichever is more favorable to the Employer.

The weightings (coefficients) for each of the factors of cost stated in the table(s) of
adjustment data shall only be adjusted if they have been rendered unreasonable,
unbalanced or inapplicable, as a result of Variations.

2.14 Price adjustment administration system practiced by ERA

In consideration of the prevailing current situation in the Ethiopian road construction

industry, the formula method to adjust price escalation/fluctuation is provided in most of
the contracts, both NCB and ICB. In principle the formula/mathematical model as
discussed above is assumed to comprise the fixed portion, the variables/adjustable
elements, the coefficient/weightings of the variables and the currency correction factor.

All contracts have conditions, divided into two parts, provided for the administration of
the project. The first part is the General Conditions of Contract (GCC) and the second
part is the Special Conditions of Contract (SCC) that is a modification of the GCC. It is,
therefore, in the special condition of contract that makes the difference between contracts,
which means any contract has its own special conditions of contract even though the
general condition of contract is same.

45
Ethiopian Roads Authority (ERA) incorporates price adjustment clauses through its
general conditions of contract to administer federal road construction project contracts.
ERA‟s GCC adopt formula method of price adjustment under clause 70 (Change in Cost
and Legislation).

Sub clause 70.1: Price adjustment

The amounts payable to the Contractor shall be adjusted in respect of the rise or fall in
the cost of labor, Contractor‟s Equipment, Plant, materials and other inputs to the Works
by applying to such amounts the formula prescribed in this clause.

Sub clause 70.2: Other change in cost

To the extent that full compensation for any rise or fall in costs to the Contractor is not
covered by the provisions of this or other Clauses in the Contract, the unit rates and
prices included in the Contract shall be deemed to include amounts to cover the
contingency of such other rise or fall of costs.

Sub clause 70.3: Adjustment Formula

The price adjustment formula used by ERA is one which is specified by FIDIC and PPA
conditions of contract (above stated, Equation 2.1).

Sub clause 70.4: Source of Indices and Weightings

The sources of indices shall be those listed in Appendix to Tender, as approved by the
Engineer. Indices shall be appropriate for their purpose and shall relate to the
Contractor‟s proposed source of supply of inputs on the basis of which his Contract Price
shall have been computed. As the proposed basis for price adjustment, the Contractor
shall have submitted with his Tender the tabulation of Weightings and Source of Indices
in the Appendix to Tender, which shall be subject to approval by the Engineer.

46
Sub clause 70.5: Base, Current and Provisional Indices

The base cost indices or prices shall be those prevailing on the day 28 days prior to the
latest date for submission of Tenders. Current indices or prices shall be those prevailing
on the day 28 days prior to the last day of the period to which a particular Interim
Payment Certificate is related. If at any time, the current indices are not available,
provisional indices as determined by the Engineer will be used, subject to subsequent
correction of the amounts paid to the Contractor when the current indices become
available.

Sub clause 70.6: Adjustment after completion

If the Contractor fails to complete the Works within the time for completion prescribed
under Clause 43, adjustment of prices thereafter until the date of completion of the Works
shall be made using either the indices or prices relating to the prescribed time for
completion, or the current indices or prices, whichever is more favorable to the
Employer, provided that if an extension of time is granted pursuant to Clause 44
(Extension of time for completion), the above provision shall apply only to adjustments
made after the expiry of such extensions of time.

Sub clause 70.7: Weightings

The weightings for each of the factors of cost given in the Appendix to Tender shall be
adjusted if, in the opinion of the Engineer, they have been rendered unreasonable,
unbalanced or inapplicable as a result of varied or additional work already executed or
instructed or for any other reason.

Sub clause 70.8: Subsequent Legislation

If, after the date 28 days prior to the latest date for submission of Tenders for the
Contract, there occur in Ethiopia changes to any National or State Statute, Ordinance,
Decree, or other Law or any regulation or by-law of any local or other duly constituted
authority, or the introduction of any such State Statute, Ordinance, Decree, Law,
regulation or by-law which causes additional or reduced cost to the Contractor, other than

47
under the preceding sub-clauses of this clause, in the execution of the Contract, such
additional or reduced cost shall, after due consultation with the Employer and the
Contractor, be determined by the Engineer and shall be added to or deducted from the
Contract Price and the Engineer shall notify the Contractor accordingly, with a copy to
the Employer. Notwithstanding the foregoing, such additional or reduced cost shall not be
separately paid or credited if the same shall already have taken into account in the
indexing of any inputs to the Price Adjustment Formulae in accordance with the
provisions of Sub-Clauses 70.1(Price adjustment) to 70.7 (Weightings).

2.15 Challenges of price adjustment on federal road construction projects

According to Getaneh E. (2017), the most common challenges of making price

adjustment on construction contracts are:

 Constant weighting coefficients throughout project lifetime: The consumption of

inputs in construction is not constant throughout the project lifetime. For example,
the consumption of reinforcement bar, cement and fuel at the start of a project
will not be equal to the consumption at the mid or end of the project. In
construction projects, where price adjustment is effected by index formula, it is
common to use varied sets of weighting coefficients to make price adjustment for
adjustable cost components during different phases of the project while keeping
their sum to unity. Unfortunately, this is not so in practice; constant or average
weighing coefficient is being used in the construction industry.
 Different estimators give rise to different weighing coefficients: It is quite apparent
that many contractors may have their own preferences and peculiar method of
constructions, estimations, and output or productivity. Evidently, estimators may
end up with quite different weighing coefficients. One may argue that it is the
same with price difference adjustment. However, slight weight changes affect
adjustment factor and price adjustment amount heavily unlike price differences
adjustment.
 It does not consider actual labor work time: When calculating weights for classes of
labor, the weighing coefficients are calculated using normal working hours.

48
 Otherwise, it will be a sheer guess if one tries to incorporate them at bid or
contract signing. However, it is common for a contractor to work overtime to get
finished a particular urgent or continues work.
 Change in project cost: The amount stated in the contract can only be a reasonable
estimation. The actual cost usually goes up or rarely the actual cost my get down
at the end of a project. Besides, there may be an alteration, addition or omission of
works (variations) or claim for extra payments and times. All these affect the
weighting coefficients and then the price adjustment factor too. If weighting
coefficients left unrevised at final payment and price adjustment is not
recalculated for all interim payments, the adjusted price no longer reflects the true
or reasonable value.
 Constant input material amounts: The weighting coefficients are computed assuming
constant amount of components or ingredients in a given work item. For example, it is
assumed that C-25 concrete requires 360kg of cement. However, it is common that to
raise or lower the cement quantity depending on the prevailing site conditions and/or
ingredient materials and tests. This is especially prominent in fluid retaining structure,
where strict quality control is mandatory.
 Computation time: The other important factor is the computation time. Compared
to price differences adjustment, price adjustment using indices takes longer time
to compute price adjustment weights and there may also be a disagreement among
parties which will cause delay. This may delay the contract signing date, project
start and completion.
 Considering only extreme prices: Whenever prices are deemed to be substitute of
indexes, there will not be any consideration for price fluctuates between the
extreme values (base and current) values. In some cases, however, prices may
substitute indexes for items which do not show drastic and frequent price change
in course of time.

49
 CHAPTER THREE

3. MATERIALS AND METHODS

3.1 Introduction

Research methodology is a way to systematically solve the research problem and research
methodology shall identify the research basis, research hypothesis or questions, research
design and research analysis (Abraham, 2008).

According to Poilt and Hungler (1985), research methodology and research design are
sometimes incorrectly used interchangeably, they are distinct concepts with well-defined
and circumscribed meanings. Research methodology refers to the principles, procedures,
and practices that govern research, whereas research design refers to the plan or
organization of scientific investigation, designing of a research study involves the
development of a plan or strategy that will guide the collection and analysis of data.
Methodology should be thought of as encompassing the entire process of conducting
research (i.e., planning and conducting the research study, drawing conclusions, and
disseminating the findings). By contrast, “research design” refers to the many ways in
which research can be conducted to answer the question being asked.

Accordingly, this chapter discusses about the various research methods employed in
finding answers to the research question. The methods selected in this study were
designed based on the nature of research questions to be answered to achieve each
research objectives. The main topics included in this chapter are research approach,
sources of data, data collection approach, data collection instruments, sample size and
sampling techniques, data measurement and analysis methods of the research.

3.2 Description of the study area

The geographical organization of ERA constitutes five regions (North, South, Central,
East and West) which sub divide in to districts. Among these five regions this research is
conducted in the Western region of Ethiopia. The basis of selecting this particular region
is based on the researcher‟s experience on federal road construction project in this region
and availability of information and documents on the subject matter.

50
 Fig.3.1 Map of Ethiopia

3.3 Research Approach

Research strategies are categorized in to two major types, which are quantitative research
and qualitative research. Quantitative approach is used to gather factual data and to study
relationships between facts and how such facts and relationships accord with theories and
the findings of any research executed previously, but the qualitative approach seek to
gain insights and to understand people's perception of "the world" whether as individuals
or groups (Fellows and Liu, 1997) quoted in (Dereje Gezahegn, 2015). The decision in
the choice of the research type is mainly depends on the type of study and availability of
the information required for the study.

Based on the research objectives, the study was started with problem identification which
has been done through a preliminary literature review and informal discussion with
colleagues and professionals in the road construction sector. As an output of this step

51
Challenges and Best Practices of Price Adjustment on Federal Road Construction
Projects was identified as a proposed problem to be studied.

With reference to the research objectives and research questions of the proposed study,
the research design adapted for this research are both quantitative and qualitative research
of exploratory type which involves basically a questionnaire survey, interview, case study
and literature search in order to get deep understanding, diagnose a current situation,
assess alternative systems and discover new findings on present price escalation
adjustment practices on federal road construction projects.

Once the research area is identified conceptual and contextual literature review have been
done to have an in depth understanding on the research topic. The review includes books,
journal and articles, internet sources and archival document search such as progress
reports, completion reports and contract documents of federal road construction projects.

The literature search facilitates identification of major concepts; their correlation and it
helps the researcher to fill the knowledge gaps related to the field of interest and organize
ideas related to challenges of price adjustment on federal road construction projects.

After literature search the data collection process was proceeded by organizing
questionnaires and documents which are helpful to gather the required information in
order to achieve the stated objectives of the study.

3.4 Data Collection

Brukley et al (1976) cited in Tadesse (2009), grouped the methodology of data

collections under four headings, namely opinion research, empirical research, archival
research and analytical research. According to Brukley each method has its own strength
and limitation none of the above methods is superior that of the other. The choice which
one to use is decided based on the research/survey objective, the nature of the
information and resources available.

52
3.4.1 Sources of Data

In order to achieve the stated objectives of the study, the data sources used for
conducting this research are both primary and secondary sources. Primary sources are
self-generated and consist of survey data, participant observation data, and so on;
whereas Secondary data occur as raw data or processed.

In this research primary data was collected through questionnaire survey, interview
and case study on six selected new and upgrading federal road construction projects.
Secondary data also collected through review of civil engineering journals, internet
sources, archival documents, correspondences and other related documents focused
on challenges and best practices of price adjustment on federal road construction
projects. These secondary sources provide a general understanding of the subject area
by presenting a wide range of ideas in the field which help to supplement other
specific information obtained from the primary data sources.

3.4.2 Data Collection Instruments

Among different available data collection tools, self-administered questionnaire

survey, semi structured interviews and case study was used to collect all the relevant
data.

3.4.2.1 Questionnaire

Questionnaire provides firsthand information for the subject matter of a research

as it is focused on issues which further serves as a survey to understand the main
concerns and attitudes of respondents towards the problems (Kasiem, 2008).

In this research, a nine page questionnaire was developed and distributed to

selected representative of federal road construction projects owner (ERA),
Consultants and Grade I Road and General Contractors who have an exposure to
involve in the construction of new and/or upgrading federal road projects. The
responses of those selected respondents to questions raised through questionnaire
survey was collected both in hard and soft copy.

53
 3.4.2.2 Interview

Interview is one of the primary data collection methods, which is flexible and
adaptive way of investigating underlying motives of a subject in a way that self-
administered questionnaires cannot (Kasiem, 2008).

In this research semi-structured interview was conducted, which have a

predetermined set of questions (generalized form of questionnaire) with a flexible
order depending on what the interviewer perceives the subject matter by looking
at the respondent capability and exposure or experience. For this thesis, the
interview was made with six Engineers from the three major stakeholders of
federal road construction projects. Two Engineers were selected from each of
contractors, consultants and clients side.

3.4.2.3 Desk Study

Desk studies were used in this research to support or supplement responses and
arguments found by questionnaire and interview through in-depth analysis of
cases. Of course, as the nature of the cases focuses on one aspect of a problem or
practice, the conclusion drawn may not be generalized, but rather related to one
particular event (Naoum, 1998 cited in Kasiem, 2008). For this reason, in this
research case studies are used to verify the reliability of results and to supplement
the findings obtained through questionnaire survey and interview. The cases
considered in this thesis include: pattern and predictability of price fluctuation on
major road construction inputs, percentage amount of price adjustment paid to
contractors and accuracy of estimated quantity of works at tender stage.

3.5 Sample Size and Sampling Techniques

Wood and Haber (1998) cited in Abubeker (2015) defined the sampling as the process of
selecting representative units of a population for the study in research investigation.
Sample is a small proportion of a population selected for observation and analysis. In this
research the sample respondents were selected from Grade 1 general and road
contractors, consulting firms and client.

54
3.5.1 Sample size

To select appropriate sample size the following statistical equations were used:

Where:
SS - Sample size
Z - Z value (e.g. 1.96 for 95% confidence level)
P - Percentage picking a choice, expressed as a decimal (0.50 used for sample size
needed).
C - Margin of error (+5%)

 Correction for finite Population:

Where:
POP is the population of the proposed classes of contracting companies (Grade 1
road and general contractors) and consulting firms who have an exposure design and
give consultancy service in federal road construction projects.

Therefore;

The sample size formula used above provides the minimum number of responses to
be obtained should be 53, but 10% of the sample size was added to compensate for
non-response rate and a total number of questionnaires distributed to contractors and
consultants were 58, which will represent one respondent from each contracting
firms.

55
 Since the client of federal road construction projects is only one (ERA), no need of
calculation for sample size. Therefore, the questionnaire was distributed for five
Engineers in Ethiopian Roads Authority. Among 63 questionnaires distributed to
selected individuals 43 completed questionnaires were returned.

3.5.2 Sampling Techniques

A stratified random sampling technique was used to select a representative sample

from the research population. The research population was drawn from the three
major stakeholders of federal road construction projects, meaning Ethiopian Roads
Authority (Client), Grade 1 general and road contractors and consulting firms actively
participating on federal road construction projects.

The sample respondents from ERA was selected from engineers having an experience
in contract administration, involve in procurement process and those who are
responsible to check and approve interim payment certificates of federal road
construction projects in western region.

On the other hand project managers and office Engineers who have an exposure to
prepare interim payment certificate and compiling documents relevant to price
adjustment was selected from contractors‟ side.

The resident engineers, acting resident engineers and quantity surveyors was selected
from consulting firms due to their experience on contract administration and price
adjustment related issues.

3.6 Method of Analysis

In this research a descriptive statistical methods is used to analyze the data collected from
various sources. For summarizing the collected data and to determine the number of
responses belonging to each category, frequency tables and charts were used.

The data collected through questionnaire survey have been summarized by using
Microsoft Excel software. Then there were deep analysis, interpretation and comparison
on results secured using various research instruments.

56
Since the semi structured interview is designed to have predetermined set of questions to
fulfill the missing data, additional data secured through an interview is used to support
the result secured through questionnaire survey and desk study.

The mean score method of analysis is implemented to rank the data sources used to
estimate bid prices, benefits and risks/disadvantages of using price adjustment clauses,
problems encountered in application of price indices, etc. In accordance to Likert scale of
five ordinal measures of agreement towards each statement (1, 2, 3, 4 and 5), the mean
score is calculated for each statement that is used to determine the relative ranking. The
mean score (MS) for each data sources, potential benefit, risk and problems of
incorporating price adjustment clauses are computed using the following expressions:

Where:
MS – Mean Score
f – Frequency of responses for each score
S – Scores given to each statement (from 1 to 5)
N – Total number of responses concerning each statement

Based on cumulative mean score, ranking of variables were implemented to show the
degree of agreement between respondents involved in the survey.

57
 CHAPTER FOUR

4. RESULT AND DISCUSSION

4.1 Introduction

This chapter deals with the results and discussion of the data gathered from questionnaire
survey, interview and case study concerning about challenges and best practices of price
adjustment on federal road construction projects. In this part of the research the result of
the data gathered is presented, interpreted and analyzed in detail to identify current best
price adjustment methods, to justify the existence of challenges and improvements that
has to be made on price escalation administration systems currently used to administer
federal road construction projects.

4.2 Response rate and Characteristics of Respondents

4.2.1 Questionnaire Response rate

The study has focused on the major road construction stakeholders that have been
participating in federal road construction projects. Therefore, federal road
construction projects owner (ERA), Grade 1 general and road contractors and
consulting firms which has been actively participated in designing and consulting
federal road construction projects were considered and respondents were selected
from these major stakeholders. From the above stated stakeholders 63 respondents
were randomly selected considering their participation on federal road construction
projects and nine page structured questionnaire was distributed for them. Out of the
distributed 63 questionnaire, 43(68.25%) completed questionnaires were returned and
used for this study.

4.2.2 Experience of respondents in Federal Road construction Projects

The table below shows that majority of the respondents, 23(53.49%), 7(16.28%) and
2(4.65%), have been involved in 3-6, 7-10, and >10 federal road construction projects
respectively. This result revealed that the respondents could have adequate
knowledge and experience on federal road construction projects as majority of them

58
involve in more than three federal road construction projects. Thus, it can be
concluded that the result from the questionnaire survey reflects the actual situation in
Ethiopian road construction industry with respect to challenges and best practices of
price adjustment on federal road construction projects. Table 4.1 below illustrates the
distribution of respondents by the number of federal road construction projects they
have been involved.

Table 4.1 Experience of respondents on federal road construction projects

Respondents experience on federal <3 3-6 7-10 > 10 Total

road construction projects
Respondents (No.) 11 23 7 2 43
Respondents (%) 25.58 53.49 16.28 4.65 100

Figure 4.1: Distribution of respondents by their work experience

As discussed above and illustrated in Figure 4.1, considering the relatively high
experience of the respondents in federal road construction projects, the data obtained
from the questionnaire survey could contain a wealth of information that can help to
draw reliable conclusions and recommendations.

59
In addition, six Engineers who have an expertise and interests with regard to price
adjustment related issues were interviewed and their response is used to supplement the
data gathered through questionnaire survey. Desk study has also conducted in selected
topics to verify the reliability of results secured through questionnaire survey and
interview by analyzing actual data from selected federal road construction project.

4.3 Price adjustment administration practices in federal road construction projects

This part of the study deals with the analysis of the data gathered from questionnaire
survey and other research instruments on issues such as: ability of contractors to
accommodate representative and represented elements in formula method of price
adjustment, fairness of coefficients/ weighting ranges assigned to adjustable elements by
contractors, the representativeness of variable/adjustable elements to other road
construction inputs, predictability of price fluctuation on construction input, advantages
and risks of including price adjustment clauses in contract documents, rationality of
weighting ranges provided for fixed component of price adjustment formula, percentage
amount of price adjustment paid to contractors and fairness of compensation secured by
using formula method.

4.3.1 Data sources used by contractors to estimate bid prices

The first step to estimate bid prices in construction industry is gathering information
and collecting reliable data concerning about current price of major construction
inputs such as material, equipment and labor. Taking this in to account, there was a
question raised to respondents to identify the most commonly use data sources by
contractors‟ to gather information about the current market price of major
construction inputs and the respondents‟ response rate was as shown in Table 4.2
below.

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 Table 4.2 Data sources used to estimate bid prices

Sources of data about Extremely Very Slightly Non Mean

Rank
Frequent
current prices of frequent frequent frequent frequent score
construction inputs No. % No. % No. % No. % No. %
Simple Market survey 3 6.98 34 79.07 5 11.63 1 2.33 - - 3.91 1
Their own historical
- - 2 4.65 18 41.86 10 23.26 13 30.23 2.21 2
data
Magazines, Such as
National Construction - - - - 7 16.28 12 27.91 24 55.81 1.60 3
Magazine
Ethiopian Central
Statistics Agency - - - - 2 4.65 9 20.93 32 74.42 1.30 4
Publications

Figure 4.2: Sources of data used by contractors to estimate bid prices

As can be seen from Table 4.2 and Figure 4.2 above, contractors participating in
Ethiopian road construction sector mainly conduct simple market survey followed by
using their own historical data on prices of construction inputs to gather information
about current prices of construction inputs and estimate bid prices. However,

61
magazines such as national construction magazine and Ethiopian Central Statistics
Agency publications are not frequently used by contractors as reliable source
information about current prices of major construction inputs.

In addition, three of the interviewees said that even if price of some construction
inputs are published in Ethiopian central statistics agency publications and national
construction magazine, contractors do not widely use these publications. The reason
mentioned by interviewees for non-frequent usage of published data sources in the
country is that, the data published in these publications are less reliable due to
dynamically changing market situation in the country. The prices of construction
inputs vary within very short period of time while these publications publish the price
data in a very wide time range; as a result contractors are forced to conduct simple
market survey to estimate bid prices and give their offer.

An effort has been made to assess source of data used by three contractors to collect
current price of major construction inputs and estimate bid prices of projects. The
result revealed that, all of these contractors mainly conduct simple market survey to
estimate bid price and give their offer.

The above result confirmed that, due to the absence of well-organized construction
inputs price database in the country, contractors mainly conduct simple market survey
to collect data about current price of construction inputs for each particular project
they are giving their offer. Therefore, it can be understood that contractors
participating in Ethiopian federal road construction projects conduct simple market
survey to gather information about current prices of road construction inputs which
costs their time and money.

4.3.2 Contractors ability to accommodate representative elements

Since construction is a risky business, the offer preparation, usually known as the bid
pricing requires detailed market survey of the construction inputs. Therefore, before
dealing about price adjustment, it is necessary to assess the ability of contractors to
accommodate representative and represented elements in indices method of price
adjustment. Accordingly, respondents were asked to rate the ability of contractors

62
 participating in Ethiopian federal road construction projects to accommodate
representative and represented elements and their response rate was as summarized in
Table 4.3 below.

Table 4.3: Ability of contractors to accommodate representative and represented elements

Ability of contractors
to accommodate
representative and Excellent Very Good Satisfactory Poor Total
represented elements good

Respondents (No.) 1 6 22 9 5 43
Respondents (%) 2.33 13.95 51.16 20.93 11.63 100

Figure 4.3: Contractors ability to accommodate representative and represented elements

As we can see from Figure 4.3 above, 1(2.33%), 6(13.95%) and 22(51.16%) of
respondents said that contractors participating in Ethiopian federal road construction
projects have excellent, very good and good ability to accommodate representative
and represented elements in formula method of price adjustment respectively. Only
few respondents, meaning: 9(20.93%) and 5(11.63%) of the respondents rate to
satisfactory and poor ability of contractors respectively.

63
 In addition to this, respondents rating good and above ability of contractors were
asked to identify the methods commonly used by contractors to mitigate risks due to
price fluctuation on represented elements. The result confirmed that using reliable
source of construction materials and adopting high profit margin are the two most
commonly used methods to mitigate risks due to price fluctuation on represented
elements followed by using more accurate price indices. The respondents detail
response rate was as illustrated in Figure 4.4 below.

Figure 4.4: Methods used to accommodate risks due to price fluctuation.

Respondents also stated that during pricing of tender documents, contractors consider
risks such as: overhead costs in case the project delayed, price escalation, weather
condition, labor shortage etc. and add these cost by multiplying the estimated price
with risk factor.

On the other hand, respondents rating poor and satisfactory ability of contractors were
asked to identify the contractors‟ main reasons to be negligent in accommodating
price fluctuation on representative and represented elements during pricing of their
bid. The result obtained from the respondents was as illustrated in figure 4.5 below.

64
Figure 4.5: Reasons that allow contractors to give less attention to price fluctuation
As can be seen from figure 4.5 above, limitation in sources of construction materials
prices indices by rule and lack of documentation to match price indices are the first
two main reasons for contractors to be negligent in considering the effect of price
fluctuation on represented elements. Only 14.29% and 7.14% of respondents said that
contractors knowledge gap on the effect of price fluctuation and lack of contractors‟
awareness on price adjustment system are the main reasons that allow contractors to
be negligent in accommodating price fluctuation on represented elements.

In addition, interviewees from the three major stakeholders of federal road

construction projects (Contractor, Client and Consultant) stressed on the difficulty of
predicting price fluctuation on construction inputs due to dynamic nature of current
market situation in the country. Therefore, to mitigate the adverse effect of price
fluctuation, contractors have to give more attention to accommodate representative
and represented elements when preparing their bid document.

65
 4.3.3 Representativeness of variable/adjustable elements

The major components of construction cost consist of material, labor and equipment
costs. Current practice of Ethiopian Roads Authority contracts shows that labor,
machineries/equipment and only four construction materials; bitumen, cement, steel
reinforcement and fuel are subject to price adjustment. The respondents were asked to
rate the representativeness of these variable/adjustable elements for all other road
construction inputs that are susceptible to price fluctuation. The respondents‟
response rate on the representativeness of the above mentioned construction inputs
for all other construction materials was as summarized in Table 4.4 below.

Table 4.4: Representativeness of variable/adjustable elements in formula method

Representativeness of
Extremely Very
Variable/adjustable High Fair Poor Total
High High
elements
Response (No.) 1 12 8 20 2 43
Respondents (%) 2.33 27.91 18.60 46.51 4.65 100

Figure 4.6: Representativeness of variable/adjustable elements

The result illustrated in Figure 4.6 above clearly shows that, 1(2.33%), 12(27.91%),
8(18.60%), and 20(46.51%) of respondents rate the representativeness of variable/
adjustable elements currently included in price adjustment clauses as extremely high,

66
very high, high and fair respectively. Only 2(4.65%) of the respondents‟ said that the
representation of other construction inputs by these adjustable/variable elements is
poor.

The interviewees also stated that, even though there are items which show significant
price change from time to time such as sand, aggregate, explosives etc. for the
purpose of simplification of the application of price adjustment formulae, reducing
the number of adjustable elements/variables is desirable and the variable elements
currently included in PACs are representative.

On the other hand different literatures show that the adjustable elements currently
allowed for compensation in Ethiopian road construction sector covers the major
portion of construction costs.

From these results it can be understood that, the results secured through all types of
research instruments compliment to each other. However, since the adjustment is
made by using the assigned weighting/coefficients of these adjustable elements in
each series of activities, the fairness of compensation highly depend on rationality of
weight given for these variable elements in each series of activities.

Therefore, the adjustable/variable elements currently included in formula method of

price adjustment are representative of other road construction inputs and it may help
to assure fair risk allocation between contractors and clients if appropriate or rational
weightings are assigned for them in each series of activities.

4.3.4 Fairness of weighting ranges assigned to adjustable elements

The induction of more realistic ranges of weightings that can properly consider the
proportion of all the construction inputs in a particular project is very crucial to come
up with the best price adjustment formula.

Current practice of Ethiopian Roads Authority shows that, during the process of
tendering, weighting ranges for major construction inputs included as adjustable
elements in the price adjustment formulae are provided by the employer under the

67
 bidding document. Then, based on the provided weighting range, contractors would
come up with their weighting proposal.

Since fairness of weighting ranges assigned by contractors are the basis to mitigate
unfair risk sharing problems, respondents were asked to rate the fairness of
coefficients/weighting ranges assigned to each adjustable elements by contractors
participating in Ethiopian federal road construction projects and the respondents
response rate was as summarized in Table 4.5 below.

Table 4.5: Result on fairness of weighting ranges assigned by contractors

Fairness of weighting
Extremely
ranges assigned by Very fair Fair Satisfactory Not fair Total
fair
contractors
Respondents (No.) - 12 19 10 2 43
Respondents (%) - 27.91 44.19 23.26 4.65 100

Figure 4.7: Fairness of weighting ranges assigned by contractors

From Figure 4.7 above, it can be seen that, 12(27.91%), 19(44.19%) and 10(23.26%)
of respondents rate the fairness of weighting ranges assigned by contractors
participating in Ethiopian federal road construction projects is very fair, fair and

68
satisfactory respectively. Only 2(4.56%) of the respondents said that the weighting or
coefficient assigned for adjustable/variable elements by contractors is unfair. This
result revealed that majority of contractors participating in Ethiopian road
construction sector assign fair weighting or coefficient ranges which would help to
secure fair compensation and mitigate risks due to price fluctuation on major
construction inputs.

Effort has been made to investigate the fairness of weightings assigned by contractors
to each adjustable element in three federal road construction projects. The result
revealed that, in all of these federal road construction projects, the weightings
assigned by contractors for each item of construction materials are within acceptable
weightings ranges set by the Employer.

Interviewees also said that, since weighting ranges for each adjustable element are
determined by using estimated quantity of works and unit rates for each item of work
during bid document preparation, the coefficients assigned by contractors for each
adjustable element are fair and within the specified range in bid documents.

In general all the above results confirmed that, weighting ranges assigned to each
adjustable element are specified in bid documents and the coefficients assigned to
each adjustable element by contractors are within the specified range in bidding
document and fair which enables to secure fair risk sharing between contracting
parties (contractors and the employer).

4.3.5 Road construction inputs susceptible to price fluctuation

To reduce the adverse effect of price fluctuation, it is necessary to assess the nature
and occurrence pattern of price fluctuation on construction inputs. The questionnaire
was developed in such a manner that allows the respondents to list road construction
inputs susceptible to price fluctuation and rate the occurrence of price fluctuation on
these major construction inputs. The major construction inputs susceptible to price
fluctuation was listed by respondents as summarized in Table 4.6 below and the result
shows that cement, steel reinforcement, bitumen, fuel, equipment and unskilled labor
are major road construction inputs particularly susceptible to price fluctuation. The

69
 result also shows that there is an increase pattern of price fluctuation in all of the
above listed construction materials with in the last five years.

Table 4.6: Construction inputs susceptible to price fluctuation and rate of price changes

Mean
Description Major Very high High Moderate Minor Rank
Score
Steel reinforcement 5 29 6 3 3.84 1
Cement 5 27 9 2 3.81 2
Equipment 7 21 6 8 1 3.58 3
Bitumen 3 24 10 5 1 3.53 4
Labor 29 9 3 2 3.51 5
Fuel 3 23 8 6 3 3.40 6

From the above result, it can be seen that the price of construction inputs have been
changed from time to time which negatively affect all parties involved in the road
construction sector and creates economic hardship to both Contractors and
Employers. The result presented in table 4.6 above clearly shows that, the change in
prices of major road construction inputs is very high. The result also revealed that, the
prices of reinforcement bar, cement and construction machineries was volatile within
the last five years.

To investigate the actual change in prices of these construction inputs and to support
the result secured through questionnaire survey, quantitative data showing average
annual prices of major road construction inputs was collected. Accordingly, prices of
cement has been obtained from Derba-MIDROC PLC, prices of steel reinforcement
bar was collected form Ethiopian Industrial Inputs Development Enterprise, Fuel
price from National Oil Ethiopia which is the biggest fuel distributor in Ethiopia and
prices of bitumen was collected from Country Trading PLC.

However, quantitative data could not be obtained for Equipment and both foreign
labor and local labor as there are no reliable locally generated sources of price for
these construction inputs. The data collected on price changes of cement,
reinforcement bar, fuel and bitumen within the last three years were as indicated in
Table 4.7 below.

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 Table 4.7: Percentage of price change on construction materials

2016 2017 2018 Total

Description Unit Unit Change Unit Change Change
price price (% ) price (% ) (% )
Fuel (ETB/L) 14.88 19.73 32.59 19.62 -0.58 31.85
Cement (ETB/qtl) PPC 189.75 195.50 3.03 214.59 9.76 13.09
Cement (ETB/qtl) OPC 259.90 265.65 2.21 277.15 4.33 6.64
Steel Reinforcement Ø 20
18.23 22.98 26.06 41.01 78.46 124.96
(ETB/Kg)
Bitumen AC 60/70
25,000 25,500 2.00 28,900 13.34 15.6
(ETB/Ton)

The above result revealed that the prices of all construction inputs such as fuel,
cement, steel reinforcement, and bitumen has been increased by 31.85%, 13.09%,
124.96% and 15.60% respectively between the years 2016 and 2018. From the above
result it can be conclude that the prices of these construction inputs show significant
increase within the last three years which correlates with results obtained from
questionnaire survey. However, the price change of steel reinforcement is extremely
high within the last three years. Since all of these construction inputs are included in
adjustment clauses as variable/adjustable element, the amount paid to compensate
such changes in price of these construction inputs would increase the project cost.

Generally, the result secured through both questionnaire survey and desk study shows
that, road construction inputs which cover the major portion of project costs are
susceptible to price fluctuation. Therefore, an effort has to be made to predict the
occurrence and pattern of price fluctuation in cost of construction inputs and proper
risk allocation mechanism has to be developed and included in contract documents to
mitigate the adverse effect price fluctuation in the successful completion of projects.

4.3.6 Predictability of price fluctuation on major road construction inputs

In the recent years, the price of materials is observed to be very unstable and changes
dramatically. The road construction sector is one of the victims of this unstable and
fluctuating market condition. Since predictability of price fluctuation is basic to come
up with best mitigation plan to price fluctuation related risks, respondents were asked

71
 to rate the predictability of price fluctuation in major road construction inputs and the
result was as summarized in Table 4.8 below

Table 4.8: Predictability of price fluctuation on major road construction inputs

Predictability of Highly Predict Fairly Less
price fluctuation Predictable able Predictable Predictable Unpredictable Total
Respondents in No. 8 4 18 13 43
Respondents (%) 18.60 9.30 41.86 30.23 100

Figure 4.8: Predictability of price fluctuation on major road construction inputs

From figure 4.8 above it can be seen that 8 (18.60%), 4(9.30%) and 18(41.86%) of
respondents stated that price fluctuation on major road construction inputs is less
predictable, fairly predictable and less predictable respectively. The remaining
13(30.23%) of respondents said that the occurrence and nature of price fluctuation on
road construction inputs is unpredictable.

In addition, the result secured through interview shows that with increasing demand
for construction materials such as steel reinforcement, cement and asphalt, there is a
continuous increment in prices of construction material. However, even though the
prices of major construction inputs are assumed to be increasing, it is difficult to
predict the future price fluctuation on these inputs; because the price changes

72
observed within the last few years are irregular in almost all construction inputs.
Different literatures also stated that, price fluctuation on construction inputs is less
predictable especially in developing countries like Ethiopia due to unstable economic
and political environment.

Generally, all the results discussed above clearly show that, the occurrence of price
fluctuation on road construction inputs is less predictable and it is difficult to
determine the price fluctuation factor of road construction inputs due to dynamic
nature of local market.

4.3.7 Advantages of incorporating price adjustment clauses

As discussed in the previous sections of this thesis, in the construction industry prices
of materials, equipment and labor are highly variable due to fluctuations in the local
and international market. Therefore, it is necessary to estimate bid prices for federal
road construction projects using current prices of construction inputs and prepare
contract documents incorporating provisions for price adjustment to accommodate
future price fluctuations. However, the use of price adjustment clauses has both
benefits and some associated risks/demerits.

Therefore, respondents were asked to express their level of agreement on the potential
benefits of using price adjustment clauses to administer federal road construction
projects contract. The result shows that majority of the respondents agree in almost all
stated benefits of incorporating price adjustment clauses in construction contract
documents. The respondents‟ level of agreement on the stated benefits was as
summarized in Table 4.9 below.

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 Table 4.9: Benefits of using price adjustment clauses

Benefits of Neither
Strongly Strongly
incorporating Agree agree nor Disagree

Mean

Rank
score
Agree disagree
Piece adjustment disagree
clauses No. % No. % No. % No. % No. %
Lower bid prices 23 56.10 15 36.59 1 2.44 2 4.88 - - 4.44 1
More consistent
contractors profit 13 31.71 25 60.98 - - 2 4.88 1 2.44 4.15 2
margins
Fewer contractors
default/bid 15 36.59 18 43.90 3 7.32 4 9.76 1 2.44 4.02 3
retractions
Increased number
11 26.83 21 51.22 3 7.32 3 7.32 3 7.32 3.83 4
of bidders
Better reliability in
8 19.51 15 36.59 4 9.76 9 21.95 5 12.20 3.29 5
the supply chain
Better market
2 14.63 7 46.34 1 4.88 23 12.20 8 21.95 2.32 6
stability

From table 4.9 above it can be seen that, among all other potential benefits of
incorporating price adjustment clauses; lower bid prices, more consistent contractors‟
profit margins, fewer contractors default/bid retraction and increased number of
bidders are the first four ranked advantages/benefits of using price adjustment
clauses.

Furthermore, the data collected through an interview shows that, in construction

contracts which do not allow price adjustment for change in cost of construction
inputs, contractors are obliged to anticipate/predict the future price fluctuation in
prices of construction inputs and include it in to estimated bid price of projects.
However, due to unstable market situation in the country it is difficult to attain
accurate and more realistic prediction, which may lead to either underestimation or
overestimation. If the risk is underestimated, the contractor will suffer from financial
loss and unable to maintain the progress of the project as required where as if the risk
is overestimated there is a possibility that the project cost could be inflated
significantly.

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 Generally, the results obtained from both questionnaire survey and interviewee
correlate to each other and confirmed that, incorporating price adjustment clauses
encourage competitive tenders, rationalize construction costs, mitigate risk of
financial loss for both contracting parties, enhance harmonious and cooperative
working environment between employers and contractors.

4.3.8 Risks of incorporating price adjustment clauses

Even though using price adjustment clause had the above stated and other advantages,
it has also risks/demerits. Some of the risks of using price adjustment clauses were
identified from literatures and a questionnaire was developed and distributed to
collect data about respondents‟ level of agreement on these potential risks. The
respondents‟ response rate for this question was as presented in Table 4.10 below.

Table 4.10: Risks of using price adjustment clauses

Risks/disadvanta

Mean score
Neither
ges of using price Strongly Strongly

Rank
Agree Agree nor Disagree
adjustment Agree disagree
Disagree
clauses
No % No % No % No % No %
Accuracy of
25.58 27 62.79 2 4.65 2 4.65 1 2.33 4.24 1
indices 11
Price adjustment
7 16.28 29 67.44 3 6.98 4 9.30 0.00 4.10 2
payouts
Increased
bargaining power
4 9.30 25 58.14 5 11.63 7 16.28 2 4.65 3.68 3
of suppliers in the
supply chain
Increased
administrative 18 41.86 21 48.84 2 4.65 2 4.65 3.44 4
costs
Program start-up
22 51.16 12 27.91 6 13.95 3 6.98 3.39 5
costs

The result presented in table 4.10 above show that, the first potential risk of using
price adjustment clauses is accuracy of price indices. Since the adjustment amount is
calculated by multiplying the executed amount of work with the weighting/coefficient

75
assigned for adjustable elements in each item of works, the overall performance and
effectiveness of price adjustment formula is definitely dependent on the accuracy of
price indices. The secondly ranked risk of using price adjustment clause is price
adjustment payout, meaning if prices change considerably, the client may be forced to
pay more through price adjustment and resulted in increased construction costs in an
inflationary economy. The thirdly ranked risk of using price adjustment clause is that
of increased bargaining power of suppliers in the supply chain followed by increased
administrative costs (cost incurred to maintaining a PAC program). Program startup
costs (cost of purchasing indexes, setting up resources and procedures) are the lastly
ranked risk of incorporating price adjustment clauses in construction contracts.

On the other hand, interviewees stated that the use of price adjustment clauses may
encourage contractors to speculate on fluctuation compensation during pricing of bids
and it will also create uncertainty in estimating final cost of individual projects at the
beginning.

Generally from the above result and discussions it can be understood that, even
though incorporating price adjustment clauses in construction contracts is very crucial
it has also the above stated and other associated risks. Therefore, contractors and
clients shall be aware on the existence of these and other related risks while using
formula method and it is important to add risk allowance in estimated cost of projects
to avoid the effect of such risks on construction projects.

4.3.9 Methods adopted by stakeholders to exercise formula method

The provisions of price adjustment are practiced worldwide to have more realistic
competitive bids and secure fair risk allocation/sharing between contractors and
employers. To accommodate price fluctuation on federal road construction project
inputs, indices/formula method is predominantly used. But the absence of well-
organized and reliable locally published price indices is considered as one of the
major drawback of using formula method in federal road construction projects.

Respondents were asked to rate the possible methods that have to be adopted by
stakeholders to apply formula method in a better way and getting optimum fair risk
76
 allocation. The result obtained from respondents‟ was as summarized in Table 4.11
below.

Table 4.11: Methods to exercise formula method in a better way

Mean Score
Not
Methods to exercise Extremely Very

Rank
Important Neutral importa
formula method in important important
nt
a better way
No. % No. % No. % No. % No. %
Establish local price
indices and revise 7 16.28 33 76.74 3 6.98 4.29 1
periodically
Use foreign price
indices and apply
2 4.65 17 39.53 24 55.81 3.66 2
currency correction
to balance inflations

The result presented in table 4.11 above shows that, establishing locally generated
price indices and revising it periodically is the first ranked method followed by using
foreign price indices to exercise formula method in a better way. This result revealed
that it is crucial to develop locally generated price indices for construction inputs.
However, till locally generated price indices are established, it is necessary to use
proxy indices for locally produced construction materials, which are actual material
or product prices from reliable manufacturers or producers. Foreign price indices are
also used from recognized institutes for construction inputs from foreign source.
However, to balance the inflation between local currency in which payment is due to
contractor and those currencies the indices are taken as the source, it is important to
introduce currency correction factor in the formula.

Generally, the above results show that, all stakeholders should have to work together
to establish locally generated price indices for construction inputs and these indices
should have to revise periodically within a regular interval of time (monthly is
recommended).

77
4.3.10 Accuracy of estimated quantity of works at tender stage

The quality and accuracy of construction cost estimation can be continually improved
as the construction execution progresses, where more detailed and actual data become
available. However, the quantity of works and the corresponding unit rates prepared
by the Engineer/designer at tender stage is utilized to determine the ranges of
coefficients/weightings of adjustable elements. It is known that, during the process of
tendering, weighting ranges for various construction inputs are provided by the
employer under the bidding document which would be used as a base for the
contractors to come up with their weighting proposal within the provided range. To
investigate the accuracy of estimated quantity of works at tender stage, respondents
were asked to rate the accuracy of quantity of works and the corresponding unit rates
prepared by the Engineer/designer at tender stage and their answer was as illustrated
in Figure 4.9 below.

Figure 4.9: Accuracy of estimated quantity of works at tender stage

The above figure shows that, 74.42% and 16.28% of respondents rate the accuracy of
quantity of works estimated by the Engineer/designer at tender stage 50-75% and
<50% accurate respectively. Only 9.30% of respondents rate the accuracy of quantity
of works and unit rates prepared by the designer at tender stage as >75% accurate.

78
It is known that quantity of works could be affected as a result of variations, design
modifications and any other reason during the execution of the works. Taking this in
to account, an effort has been made to investigate the accuracy of estimated quantity
of works at tender stage in one federal road construction project, Dima-Raad Bridge
Asphalt Road Project, which is under progress and its accomplishment is 76.58% on
December 2018.

The result of desk study on the above stated federal road construction project shows
that, there is 8.12%, 16.81%, 24.96% and 34.17% variance between initially
estimated quantities of works and actual work load in this particular project. The
major reasons for change in quantity of works in this road construction project are
omission of work items during design phase and design modification at construction
phase.

Generally, the result secured from both research instruments (questionnaire survey
and desk study) shows that, there is a gap between quantity of works estimated by the
Engineer at tender stage and actual quantities in federal road construction projects.
Therefore, to avoid unequal risk sharing between contracting parties due to use of
unrealistic coefficients to adjustable elements as a result of inaccurate estimation in
quantity of works and unit rate to each item of work, the quantity surveyors and
engineers/designers developing the initial estimated quantity of works at tender stage
has to be well experienced and trained.

4.3.11 Rationality of the weight range provided for fixed components

The fixed component in price adjustment formula is obviously not a material or

materials associated expenditure. It is also normal to include an item such as fixed to
cover a small portion of the expenditure for which the client does not assume the risk
of price variations. Therefore the weight ranges provided for nonadjustable/fixed
component in the formula has to be fair and rational because, if the amount of fixed
component is larger the contractor takes more financial risk resulting from inflation or
if price of construction inputs goes down the client will loss the benefit from the
adjustment.

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 The respondents were asked to rate the fairness and rationality of the fixed
component of the formula in federal road construction contracts and their response
rate was as summarized in Table 4.12 below.

Table 4.12: Fairness and rationality of the weight range provided for fixed component
Fairness and
rationality of the Extremely Very
Fair Satisfactory Unfair Total
weight range provided fair Fair
for fixed component
Respondents (No.) - 4 22 6 11 43
Respondents (%) - 9.52 51.16 13.95 25.58 100

Figure 4.10: Fairness and rationality of the weight range provided for fixed component

The above figure clearly shows that, 4(9.30%), 22(51.16%) and 6(13.95%) of
respondents stated that the fairness of weight range provided for nonadjustable/fixed
components is very fair, fair and satisfactory respectively. Whereas the remaining
11(25.58%) of respondents believed that the weight range provided for fixed or
nonadjustable component in most federal road construction projects is unfair.

To supplement the data collected through questionnaire survey the question was also
raised to interviewees. The interviewees stated that there is no consistent and

80
reasonable determination of the fixed portion of the formula while preparing bidding
documents by design consultants. As a result, there is a huge difference in weight
range provided for non-adjustable component set for different road construction
project contracts. It has to be noted that, the higher in the percentage of the non-
adjustable portion of the payment is the higher of the risks of inflation transferred to
the Contractor. In most of the domestic (NCB) local contracts it is observed to be on
the higher side. As a result, especially local Contractors share major risks because of
high percentage amount of non-adjustable portion in the price adjustment formula.

To verify the reliability of the above stated results obtained from all other research
instruments an effort has been made to investigate the weighting ranges provided for
fixed portion of the adjustment formula in six selected federal road construction
projects. The result secured through desk study revealed that, in these federal road
construction projects the weighting range provided for fixed portion of the formula
ranges from 10% to 50%. On the other hand recent researches show that in most
projects federal road construction projects, the non-adjustable portion of the
adjustment formula is not fixed in the manner that reflects the not material cost of the
project rather it is fixed arbitrary ranging from 10% to 70%.

From all the above results we can understand that, in federal road construction
projects, the weight range provided for fixed/non-adjustable component vary from
project to project. Therefore, to secure fair risk allocation between contracting parties,
the analysis and decision made on magnitude of the fixed component of the formula
and its weight range has to be rational which will reflect the actual not material cost
of projects for the benefit of both contracting parties.

4.3.12 Criteria used to select representative construction materials

Once a decision has made to implement a price adjustment clause, the next step
involves selecting the materials and other construction inputs that has to be included
in the formula as adjustable/variable element. As discussed in section 4.3.5 above,
currently federal road construction contracts allow price adjustment for only four
material components in addition to labor and equipment. Respondents were asked to

81
identify the criteria used to select construction materials as representative element in
formula method of price adjustment and the result was summarized in Table 4.13
below.

Table 4.13: Criteria used to select representative construction materials

Selection criteria for representative Respondents Respondents

construction materials (No.) (%) Rank
Cost impact of changing prices 43 100.00 1
Contractor‟s ability to control prices 34 79.07 2
Availability of price index 27 62.79 3
Validity of the selected index 16 37.21 4
Method for measuring quantities used 9 20.93 5
Program setup and administration cost 3 6.98 6

Figure 4.11: Selection criteria for representative construction materials

82
The result illustrated in figure 4.11 shows that, cost impact of price changes on
construction material, contractor‟s ability to control the price of construction material
and availability of price index for particular construction material are identified as the
first three basic selection criteria to include construction materials as representative
elements in formula method. These results clearly show that, construction materials
which cover major project cost have to be selected as representative element in price
adjustment clauses. On the other hand the result presented in table 4.11 indicated that,
construction materials are selected as adjustable element when the price changes on
the construction materials is beyond contractors ability to control change in prices of
materials by preparing stockpile on projects and availability of price indices. Since
price adjustment is made by using price indices of construction inputs, availability of
reliable price indices is one of the criteria used to select representative construction
materials in formula method price adjustment.

In addition to the above discussed criteria, validity of the selected price index,
difficulty in measuring the quantity of material used and program setup and
administration costs to manage price adjustment are also used to select representative
construction materials.

Generally, from the above result it can be understood that the basic selection criteria
to include particular construction material in price adjustment clauses are high impact
on the overall project cost and high variability in their price, the difficulty to control
the occurrence and effect of price fluctuation on them and availability of reliable
price index.

4.3.13 Percentage amount of price adjustment paid to contractors

It is known that the fundamental principle of risk management is to allocate the risks to the
contracting parties. To compensate for the rise and fall in prices of the major
construction inputs, price adjustment clauses are incorporated in federal road
construction project contracts. The respondents was asked to perceive the amount of
price adjustments paid for contractors to compensate for the rise and fall on prices of

83
the major construction inputs and their response rate was as illustrated in Figure 4.12
below.

Figure 4.12: Percentage of amount paid for price adjustment

As we can see from figure 4.12 above, 9.3% and 48.84% of respondents said that in
most federal road construction projects, the amount paid to contractors to compensate
loses due rise and fall on prices of road construction inputs is <10% and 10-20% of
the total project cost respectively. The remaining 20.93%, 6.98% and 13.95% of the
respondents said that the amount paid to contractors through price adjustment is 20-
30%, 30-40% and >40% respectively.

Respondents‟ supportive comment revealed that, foreign contractors are by far better
benefitted from price adjustment and the amount paid for them through price
adjustment is higher as compared to local contractors. This difference is mainly due
to the exclusion of labor from the adjustable elements and the fixed portion is very
high in most local contracts.

To investigate the actual percentage amount of price adjustment in federal road

construction projects and to verify the reliability of the result secured through
questionnaire survey, an effort has been made to collect quantitative data from six

84
 selected federal road construction projects. The result of the data collected from those
selected federal road construction projects was as summarized in Table 4.14 below.

Table 4.14: Percentage amount of price adjustment paid to contractors

Amount paid to price

S/No. Project Name adjustment (%) Total
2015 2016 2017 2018
1 Kongo-Begundi Wenbera road Project 0.29 2.21 4.69 9.05 2.50
2 Dima-Raad Bridge Asphalt road project 0.001 3.75 9.44 15.64 8.43
Abobo -km 76 Design and Build Road
3 15.50 20.39 19.33
Project
4 Dulecha-Awash Arba Junction 9.34 22.58 16.34
Adama Awash Road upgrading and
5 6.60 20.12 10.85
overlay project
6 Awash-Mille Asphalt Over lay project 0.81 10.18 3.37

As can be seen from the above table, even though all of the projects are under
progress when the data is collected (December 2018), in these federal road
construction projects the amount paid to price adjustment ranges from 2.5% to
19.33% of the total amount paid to contractors, within the last four years (January
2015 to December 2018). In addition to this, the result clearly shows that, in federal
road construction projects, the percentage amount of price adjustment paid to
contractors increase from year to year and it reaches more than 20% of the amount
paid to contractors within the last four years, which is due to an increase in cost of
construction inputs.

On the other hand the analysis on indices used to make price adjustment in these
federal road construction projects show that, due to the absence of locally generated
price indices in the country, the source and figure of price indices used in federal road
construction projects are different in the same period interval. As a result, there is a
big difference in figure of price indices used for the same construction material at the
same period interval in different road construction projects, especially for locally
produced construction materials. For example, on average there is 34.34 Birr/kg and
33 Birr/qtl difference in figure of price indices used to make price adjustment on steel

85
reinforcement bar and cement respectively at the same period interval. This result
clearly indicated that, the absence of locally generated price indices for major
construction inputs and use of proxy price indices for construction inputs in different
road projects will affect the percentage amount of price adjustment and the overall
performance of federal road construction projects.

The result illustrated in table 4.14 above clearly show that, even though all the
projects are under progress and revision would be made on price indices and price
adjustment, a huge amount of money is spent for price adjustment due to an
inflationary market situation. On the other hand recent researches show that, on
average the amount of price adjustment paid to contractors‟ range from 30% to 40%
of the contract amount in federal road construction projects.

Generally, the results obtained from all types of research instruments revealed that,
the amount paid to price adjustment vary from project to project. From the above
discussion it can be understood that, there is a little gap in findings obtained from
literature search and other research instruments (case study and questionnaire survey).
However, since the selected projects are under progress and the percentage amounts
of price adjustment paid to contractors vary from project to project, it can be
understood that the amount paid to price adjustment in federal road construction
projects ranges from 20% to 40% of the contract amount.

4.3.14 Fairness of compensation secured by using formula method

The purpose of price adjustment clauses in construction contract is to provide a

mechanism for reimbursing contractors or client for changes in construction input
prices which occurred during the construction period. Where there is increase in input
price, the contractor will be reimbursed and it is expected that the client will be
reimbursed in the event of a downward movement of input prices. Respondents were
asked to rate the fairness of compensation secured through the currently practiced
price adjustment system in federal road construction contracts by Ethiopian Roads
Authority (ERA) and their answer was as illustrated in Figure 4.13 below.

86
Figure 4.13: Fairness of compensation secured by using formula method

The above figure clearly shows that more than half of respondents 26(60.47%) stated
that currently practice formula method of price adjustment helps to secure fair
compensation for both contracting parties, i.e. contractors and the federal road
construction projects owner (ERA). The other 3(6.98%) and 9(20.93%) of
respondents rate the current compensation system as very fair and satisfactory
respectively. The compensation secured by the currently practiced formula method of
price adjustment is rated as unfair by only 5(11.63%) of the respondents. These result
revealed that, the formula method is suitable and it may enables to secure fair
compensation, if properly applied in the construction industry.

In addition to questionnaire survey an effort has been made to investigate the fairness
of compensation secure by using indices method through semi structured interview.
Unlike that of results obtained by questionnaire survey majority of the interviewees
stated that, the compensation currently secured using formula method is unfair and
contractors are major risk takers. In calculating the amount of compensation to be
paid to contractors during price increase or the amount from contractors during price
decrease, the prices at two critical times are the leading variables i.e. the price of the

87
inputs during bid pricing and the current price. However, since the market price is not
centrally governed by any legislative body except for fuel, it has been very difficult to
determine how and how much the price of inputs has fluctuated and it affect the
fairness of compensation secured through formula method.

The interviewees also suggest that, contractors should have to be aware on the effect
of weightings given for adjustable elements and assign proper coefficients for each
variable element and add reliable risk allowance on bid prices to compensate loses
due to time overrun and other unavoidable risks on construction industry which
cannot be compensated by using formula method.

From the above discussions it can be understood that, as there is a gap between results
obtained from questionnaire survey and interview. Generally, from these results it can
be concluded that, currently contractors involved in federal road construction projects
are not fully compensated by formula method. However, the result secured from both
research instruments confirmed that if properly implemented, indices method is
suitable to enable fair compensation.

4.3.15 Risk sharing practices between contracting parties in Ethiopia

Fluctuation in construction input price is a construction risk which must be

adequately assessed to ensure smooth implementation of construction projects. The
federal road construction project contracts incorporate price adjustment clauses as a
mechanism to mitigate the risk of unpredictable price fluctuation. However, the
incorporation of these clauses could not assure fair and equitable compensation
against price fluctuation on construction inputs. To assess the fairness and equitability
of the risk shared by the federal road construction projects owner (ERA) and
contractors; respondents were asked to identify the contracting party which accept the
major risk of price fluctuation and their answer was as illustrated in Figure 4.14
below.

88
Figure 4.14: Risk sharing practices between contracting parties in Ethiopia

As can be seen from figure 4.14 above, majority of respondents 25(58.14%), stated
that in Ethiopia road construction industry contractors accept the major risk of price
fluctuation while the other 16(37.21%) of the respondents said that, Ethiopian Roads
Authority (ERA) accept the major risk of price fluctuation. Only 2(4.65%) of
respondents said that both contracting parties share the risk equally. This result
clearly shows that, contractors bear the major risk of price fluctuation in construction
industry.

Interviewees also said that, due to lack of knowledge and awareness with respect to
risk allocations in the contract provision during pricing of tender documents and
inflationary market condition in our country, contractors (especially local contractors)
accept major risks of price fluctuation and the employer is favored. In addition, due to
inconsistent determination of nonadjustable portion of the formula and lack of
accuracy in quantity of works estimated at tender stage which is utilized to determine
the weighting ranges for adjustable elements, compensation secured through price
adjustment does not fully recover the contractors additional cost incurred as a result
of price fluctuation.

89
 Therefore, even if additional data and investigation is required to decide, from the
above result and discussion we can conclude that currently contractors are bearing
heavy risks because of increase in cost of construction inputs used in federal road
construction projects.

4.3.16 Conditions of contract used to administer Federal Road projects contract

International contract forms, especially FIDIC form of contract has been intensively
used for the last two decades on major infrastructure projects such as federal road
construction projects in Ethiopia. Respondents were asked to rate the suitability of the
most dominating condition of contract (Harmonized MDB FIDIC 2010) to administer
price adjustment in Ethiopian road construction sector and their response rate was as
illustrated in Figure 4.15 below.

Figure 4.15: Suitability of FIDIC form of contract to administer federal road projects

As illustrated in figure 4.15 above, 17(39.53%), 8(18.60%), and 13(30.23%) of the

respondents stated that the suitability of FIDIC form of contract to administer federal
road construction projects is very good, good and satisfactory respectively. It was also
rated as poor by only 5(11.63%) respondents. This result shows that, if it is exercised
effectively the condition of contract currently used by ERA is suitable to administer
federal road construction projects.

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 4.4 Challenges and improvements needed in price adjustment methods

As discussed in previous sections of this study, formula method was introduced as an

alternative to the traditional/proven cost method to fully reimburse the contractor for
losses incurred due to price fluctuation. However, there are difficulties associated with
the usage of construction price indices. The major problems associated with indices
method of price adjustment were addressed through questionnaire survey and an
interview as discussed in the next sections of this study.

4.4.1 Difficulties associated with usage of construction price indices

Potential problems associated with usage of price indices were identified and
respondents were asked to rank these difficulties based on their frequency of
occurrence and the respondents‟ response rate was as summarized in Table 4.15
below.

Table 4.15: Problems encountered in application of price indices

Problems associated with Extremely Very Slightly Not

Mean

Rank
score
usage of price indices frequent frequent frequent Frequent frequent
No. % No. % No. % No. % No. %
Late release of published
17 39.53 14 32.56 7 16.28 3 6.98 2 4.65 3.95 1
data in using foreign indices
Inadequate recovery of costs 9 20.93 23 51.22 6 13.95 4 9.30 1 2.33 3.81 2
Particular work item of
interest will not be included 3 6.98 8 17.07 16 37.21 11 25.58 5 11.63 2.84 3
in the published indices
Non familiarity with
- - - - 4 9.30 3 6.98 36 83.72 1.26 4
computation
Indices based on historical
- - - - 2 4.65 4 9.30 37 86.05 1.19 5
data
High subscription fees - - - - 1 2.33 3 6.98 39 90.70 1.12 6
Obsolete methods and
- - - - - - 4 9.30 39 90.70 1.09 7
components
Human error - - - - - - 4 9.30 39 90.70 1.09 7

The above table clearly shows that, the most frequent problem encountered in using
indices method of price adjustment is late release of published data in using foreign
indices followed by inadequate recovery of costs. The late release of published data

91
could lead to under or over-recovery because if published data of price indices are not
timely released, practitioners preparing payment certificates have to rely on outdated
indices, further resulting in low/high cost recovery depending on the difference
between base price and current price of resources. For locally produced materials
proxy indices are used and price adjustment is usually made by collecting monthly
selling prices of construction inputs from those companies indicated in the
appendixes of each contract document; usually their selling prices of construction
inputs at bidding stage are taken as base price.

Assessment in one of the federal road construction project revealed that, when
compiling this thesis (December 2018), the indices available for reinforcement bar
and bitumen were for December 2017 and January 2018 respectively. As a result in
this project, practitioners preparing payment certificates for December 2018 rely on
those outdated indices resulting in low cost recovery.

In generally, from the above result it can be understood that, all the problems
presented in table 4.15 are some of the difficulties faced in construction industry
while implementing indices method of price adjustment.

4.4.2 Challenges and malpractices in indices method of price adjustment

As discussed in section 4.3 of this research paper, currently formula method is the
predominantly used method of price adjustment in federal road construction projects.
However, there are challenges to implement indices method of price adjustment in
federal road construction projects. According, the most prominent malpractices and
challenges in indices method of price adjustment were listed and respondents were
asked to express their level of agreement on them. The respondents‟ level of
agreement on each identified challenges of using indices method was as summarized
in table 4.16 below.

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 Table 4.16: Challenges of using indices method of price adjustment

Challenges in Strongly Strongly

Agree Neutral Disagree
practicing formula Agree disagree

Mean

Rank
score
method of price
adjustment No. % No. % No. % No. % No. %
Change in project
7 16.28 27 62.79 6 13.95 3 6.28 - - 4.07 1
costs
Use of constant
weighting/Coefficie
7 16.28 26 60.47 7 16.28 3 4.86 - - 4.05 2
nts throughout the
project life time
Change in reliable
5 11.63 27 62.79 7 16.28 2 4.65 2 4.65 3.90 3
sources of indices
Existence and use
of composite
2 4.65 13 30.23 3 6.98 7 16.28 18 41.68 2.51 4
(foreign and proxy)
indices

The result presented in table 4.16 above shows that, change in project costs, use of
constant weighting/coefficients throughout the project life time and change in reliable
source of price indices are the first three most important challenges of using indices
method. The amount stated in the contract can only be a reasonable estimation
whereas the actual cost usually goes up or rarely it my get down at the end of the
project and the consumption of inputs in construction is not constant throughout the
project lifetime. However, in indices method the adjustable component of the formula
and the coefficients provided to each variable/adjustable element depends on the
estimated quantity of work and prices of construction inputs at tendering stage. As a
result, if weighting coefficients left unrevised at final payment and price adjustment is
not recalculated for all interim payments, the adjusted price will no longer reflects the
true or reasonable value.

Since there are no published domestic price indices, composite (foreign and proxy)
indices are used alternatively in Ethiopian construction industry. Assessment in federal
road construction projects indicated that, foreign indices are used for inputs from a
foreign source and proxy indices from local recognized manufacturers or distributers
for locally produced construction materials. In addition, as each adjustable element can

93
have its own set of indices, the employer and the contractor can agree on different
indices for different adjustable elements and this will increase the complexity of the
fluctuation adjustment calculation.

The above result also revealed that, changes in reliable sources of indices is one of the
major challenges to use indices method in federal road construction projects. Because
if the value of the index is changed after it has been used to calculate an adjustment,
then any such adjustment is recalculated using the revised index figure.

In addition to the above discussed challenges while using indices method there are also
another challenges and malpractices identified through respondents supportive
comment and an interview. Some of them are:

 Failure to make periodic payment: The essence of price adjustment is to make

compensation for actually executed work in the particular interim payment
application period. Therefore, to secure fair compensation for actual executed
work in particular interim payment application period, payment certificates has
to be prepared periodically (preferably monthly). However, due to various
reasons payment certificates may not be always compiled monthly.

Assessment on six federal road construction projects show that, sometimes

contractor fail to make interim payment certificate monthly and prepare it in
the next month by adding the previously executed amount. For instance in one
federal road construction project the payment certificate was prepared in
December 2018 by adding the amount executed in three months (October 2018
to December 2018). As a result, the adjustment amount was inflated and the
client pays more due to an inflated market situation.

 Failure to complete projects on time: time overrun is one of the common

phenomena in Ethiopian construction industry including federal road
construction projects. As discussed in section 2.12.2 of this research paper,
FIDIC 2010, sub clause 13.8 states that “If the Contractor fails to complete the
works within the time for completion, adjustment of prices there after shall be
made using either: each index or price applicable on the date 49 days prior to

94
 the expiry of the time for completion of the works, or the current index or price
whichever is more favorable to the Employer.” This clause is also adopted in
ERA general conditions of contract under Sub clause 70.6 and clearly it shows
that, the Contractor is not entitled to an adjustment for increases in labor,
machinery and materials costs that may occur after the date of substantial
completion or approved extension of time. This means that, under this price
variation clause, the Contractor cannot claim for price increases that occur after
the date for Substantial Completion time. Two interviewees argue in this sub
clause and they said that, since contractors cannot be compensated for
additional costs incurred after the time of completion (or approved extension of
time), it can be used as the driving force for contractors to complete projects on
time.

 Adjustment for non-used items: As discussed in the previous sections of this

research paper weighting/coefficients are assigned for each item and included
in the adjustment formula. Then price adjustment is made to the work executed
in particular payment using adjustment formula in which weighing/coefficients
are already assigned for each adjustable element. This means adjustment is
made for all variable elements whether or not all adjustable elements are
consumed in the period of payment certificate, which may leads to compensate
the contractor for non-used items in that payment.

In addition to this, almost in all federal road construction projects selected for
case study, it is observed that adjustment is made for non-used items due to the
presence of their weighting in the formula. For example, assessment made by
researcher revealed that, in one selected federal road construction project only
excavation work was performed under minor drainage in one payment
certificate application period. However, the executed amount was adjusted for
changes in prices of equipment, fuel, cement, and reinforcement bar.

 Constant input material amounts: It is known that in formula method the

weighting coefficients of adjustable elements are computed assuming constant
amount of components or ingredients in a given work item. However, it is

95
 common that to raise or lower the quantity of ingredients in a given work item
depending on the actual properties of ingredient materials and tests on each
work item, because each construction project is unique by nature.

The analysis of data collected from six selected federal road construction
projects revealed that, on average it was assumed that C-25 and C-30 concretes
require 360kg/m3 and 400kg/m3 respectively, based on which the weighting
coefficients is computed to implement formula method. However, the actual
amount of cement required for C-25 and C-30 concrete works is on average
407kg/m3 and 452.3kg/m3 respectively. This result clearly shows that the total
quantity of cement was underestimated at tender stage in these federal road
construction projects. Therefore, the weighting/coefficients assigned for
cement in these projects may not reflect its contribution to the total project cost
and the resulting adjustment may not also reflect the actual value of loses/gain
due to price fluctuation in price of cement.

4.4.3 Methods to improve price fluctuation administration system

As discussed earlier price fluctuation is one of the main reasons for cost overrun in
federal road construction projects and price escalation clauses are included in federal
road construction project contracts to allocate risks for each contracting parties. But
managing price fluctuation in construction industry is not an easy task. Taking this
into account interviewees were asked to identify potential methods that may help to
manage price escalation in federal road construction projects. The result secured
through both desk study and an interview revealed that, incorporating price escalation
clauses in federal road construction project contracts is very crucial to manage or
administer price fluctuation and mitigate its adverse effect in federal road
construction projects. Two of the interviewees said that, to mitigate the adverse effect
of price fluctuation it is necessary to identify construction materials which can be
stocked on site and their price is likely to be increased. Then, the contractors have to
utilize the advance payment of the projects to purchase those construction materials in
bulk.

96
Considering locally produced materials in designing federal road construction
projects is also identified as one of the mechanisms used to manage price escalation.
The use of locally produced construction materials mainly used to reduce excessive
price fluctuations associated with the use of foreign price indices and application of
currency correction factor in the adjustment formula for imported construction
materials.

Interviewees also said that, to reduce the gap between the estimated project cost at
tender stage and actual project cost at the end of the project, more accurate estimated
quantity of works and duration of projects should be developed at tender stage and
stakeholders should work together and conduct regular cost monitoring throughout
the project.

From the above discussions it can be understood that incorporating price escalation
clauses in road construction contracts is the first most important method to administer
price escalation followed by considering locally produced construction materials in
designing road projects. Bulk material purchase and regular cost monitoring
throughout the project life time are also other important methods mentioned by
interviewees to manage/administer price fluctuation and mitigate its adverse effect in
federal road construction projects. A questionnaire was developed and distributed to
respondents which allow them to give their suggestion for each stakeholder in the
road construction industry and the result was as presented in the next sections of this
research paper.

4.4.3.1 Respondents suggestion for contractors

Since contractors are being the first victims of price fluctuation and the major role
players in the construction industry, a lot is expected from them to mitigate the
adverse effect of price fluctuation. Majority of the respondents, 32(74.42%) said
contractors should have to obey favorable rules and work hard with others to
bring improvement on the available compensation system. The other 16(37.21%)
and 13(30.23%) of respondents stated that contractors should have to properly
implement price adjustment clauses and develop their own price database

97
respectively. Only 5(11.63%) of respondents said that contractors should have to
improve their ability to predict price fluctuation and propose fair coefficients‟ for
adjustable elements.

Generally, this result revealed that contractors should have to work hard in
harmonious and cooperative way with other major stakeholders to counter
challenges and improve the currently practiced price fluctuation administration
systems.

4.4.3.2 Respondents suggestion for consultants

Consultants play a vital role in road construction projects from inception to the
final commissioning of projects and in linking the contractor and the client.
Majority of respondents, 37(86.05) said that consultants should have to develop
more accurate estimated quantity of works at tender stage, which would affects the
overall performance of indices method. Consultants are suggested to prepare
contract documents including price adjustment clauses by 29(67.44%) of
respondents. On the other hand 23(53.49%) of respondents suggests that
consultants should have to propose other best price adjustment method or
improvements needed on existing price adjustment methods.

In general the above results revealed that, consultants should have to develop their
skill and ability to develop more accurate estimated quantity of works when
preparing bid documents and they have to work intensively on the improvements
needed on currently used price fluctuation administration methods.

4.4.3.3 Respondents suggestion for clients

All things that will affect successful completion of projects in terms of time, cost
and quality are clients concern. Therefore, the respondents were asked to give
suggestion for clients to minimize the adverse effect of price fluctuation on federal
road construction projects. The result shows that, 23(53.49%) and 16(37.21%) of
the respondents suggest the client to incorporate price adjustment clauses in their
contract documents and develop their own price databases respectively.

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Since projects are initiated and financed by clients, price fluctuation on
construction inputs directly affect the project owners. Therefore, to reduce the
adverse effect of price fluctuation, clients should have to incorporate price
adjustment clauses in their contract documents. The clients should invest their effort
at planning phase of the projects to properly plan the project in terms of cost, time
and quality.

4.4.3.4 Respondents suggestion for regulatory bodies

Regulatory bodies may not be directly involved in projects, but they have the
power to set standards, rules and regulations through which contractors,
consultants and clients should act. They also have the authority to establish price
database to be used across the country. Respondents were asked to give their
suggestion for regulatory bodies and the result show that 21(48.84%), 16(37.21%)
and 11(25.58%) of the respondents suggest regulatory bodies to regularly monitor
application of existing rules, review and amend regulations and develop strong
and reliable price database respectively. Only 5(11.63%) of the respondents said
that regulatory bodies should have to always control and regulate the market. In
addition to this respondents supportive comment revealed that, government should
have to give capacity building trainings for professionals and firms on the
construction sector so as to develop their awareness on contract documents and
impact of price escalation.

From these results we can understand that, regulatory bodies should have to
regularly monitor the application of existing rules, seek alternative mechanisms,
review and modify standard conditions of contract to mitigate the adverse effect of
price fluctuation in construction inputs.

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 CHAPTER FIVE

5. CONCLUSION AND RECOMMENDATIONS

5.1 Introduction

This chapter presents the conclusions and recommendations of the research which are
based on the results of data analysis and discussion made on the previous chapter.
Recommendations will be forwarded to reduce the challenges of price adjustment and
improve existing practices of price fluctuation administration system.

Conclusions for this study will also be based on the objectives of the research. All
objectives of the research have been achieved and the research carried out has shown that
the challenges of price adjustment on federal road construction projects. The following
conclusions and recommendations are drawn from the investigation undertaken on the
research.

5.2 Conclusions

As it is clearly stated in section 1.3 of the introduction part, the objective of this research
is to assess price adjustment administration systems currently practiced in federal road
construction projects. In light of this, the research is aimed to assess ERA‟s practice in
managing price fluctuation, to identifying challenges and improvements needed in price
adjustment administration system on federal road construction projects. To achieve these
objectives, the study use questionnaire survey, interview and desk study as a research
instruments. The data gathered from the survey was analyzed using the percentage method
and mean score (MS). The result obtained in this processes have been presented and
discussed in the previous chapter. In this chapter the major findings of the research which
have been discussed before will be briefly summarized in accordance with the objectives
of the research.

The first objective of the research was to assess ERA‟s practice in managing price
fluctuation on federal road construction projects. Based on the data obtained from
questionnaire survey, interview and case study, the research concluded that:

100
The adjustable/variable elements currently included in price adjustment clauses are
representative for all other construction inputs used in road construction projects and it
enables to have fair risk allocation between contractors and clients if rational
weighting/coefficients are assigned for each of them.

The other result of this research also revealed that, there is a huge difference in weight
range provided for non-adjustable component in the price adjustment formula (10% to
70%) set for different federal road construction project contracts and in most of the
domestic (NCB) local contracts it is observed to be on the higher side. From this result it
can be concluded that such arbitrary and inconsistent way of setting fixed portion of the
formula would affect the weighting proportion of variable elements and the overall
performance of the adjustment.

Based on the survey result, it was also found that cement, steel reinforcement, bitumen,
fuel, equipment and unskilled labor are major road construction inputs susceptible to
price fluctuation and the pattern of price fluctuation that has been occurring almost all the
time is the increase in prices (13.09% to 124.96%) with in the last three years, which
creates economic hardship for both contractors and the employer.

The result of this research show that, due to lack of knowledge and awareness with
respect to risk allocations in the contract provision during pricing of tender documents
and inflationary market condition in the country, contractors (especially local contractors)
accept major risks of price fluctuation on construction inputs and the employer is favored.

The other result of this research also revealed that, in federal road construction projects
the percentage amount of adjustment paid to contractors reaches more than 20% within
the last four year (January 2015 to December 2018). The survey result also indicated that
FIDIC forms of contracts are suitable to administer federal road construction project
contracts.

The second specific objective of the research was aimed to identifying challenges of price
adjustment and methods to improve price adjustment administration system on federal road
construction projects. To achieve this objective, potential challenges of price adjustment
and methods that can be adopted by major stakeholders to mitigate the adverse effect of

101
price fluctuation on federal road construction projects were identified from literatures and
distributed to respondents in questionnaire form.

The result secured from all research instruments show that, change in project costs, the use
of constant weighting/coefficients throughout project lifetime, change in reliable sources
of indices, existence and use of composite (foreign and proxy) indices, failure to make
periodic payment, failure to complete projects on time and making an adjustment for non-
used items are the major challenges to manage or administer price fluctuation in cost of
construction inputs using formula method.

The survey result also revealed that, incorporating price adjustment clauses in contract
documents, considering locally available construction materials in design, purchasing
construction materials in bulk, exercise regular cost monitoring throughout the project life
time and developing better risk management systems are identified as methods which would
help to manage or administer price fluctuation in federal road construction projects.

5.3 Recommendations

As discussed above the main objective of this research was to generate findings from the
hypothesized problems addressed in the literature review through questionnaire survey,
interview and case study. Therefore, the recommendation will focus in addressing methods
that would help to improve current practices of price fluctuation administration system and
forwarding recommendations to key role players in construction industry to reduce
challenges and mitigate adverse effect of price fluctuation on federal road construction
projects.

5.3.1 To improve current practices of price fluctuation administration system

1. Intensive trainings, workshops, and seminars should be arranged (especially by
public bodies) to manage the problems that arise from lack of knowledge,
awareness, and skill gap with respect to risk allocations in the contract provision
during pricing of tender documents.
2. Comprehensive and reliable construction inputs price database should be established
by joint effort of major stakeholders of the construction industry and the database
should be updated regularly at short time interval to give realistic price data.

102
3. Contractors, consultants, owners and regulatory bodies should work together to
improve the compensation system in which a wider range of inputs will be allowed
for compensation and the method of price fluctuation compensation calculation
should be clear and consistent.

5.3.2 To reduce challenges of price adjustment

Based on the findings of the research, the following recommendations are forwarded for
key role players in federal road construction projects:

A. For contractors
1. Contractors should have to obey favorable rules, properly implement price
adjustment clauses, develop their own price database and work hard with others to
bring improvement on the available price fluctuation administration system.

2. The contractors should consider and analyze the effect of price fluctuation critically
before submitting their tender documents and agree on the way that risks associated
with price fluctuation are fairly shared/allocated through provisions in conditions of
contract.

3. They should start their work within minimum time after contract agreements are
signed and undertake the project activities on time. It is observed that the magnitude
and effect of price fluctuation increases with time. Therefore, it is strongly
recommended for the contractors to start and complete projects on time.

4. Contractors should have to identify and purchase construction inputs whose prices
are likely to be increase or be in short supply. They should utilize the advance
payment they receive for similar purpose for the same project.

B. For Consultants
1. Consultants should have to develop more accurate estimated quantity of works at
tender stage which is utilized to determine the coefficient/weighting ranges of
adjustable/variable elements in the formula of indices method.

103
2. Consultants should have to hire a qualified technical staff to manage the project in
proper way, to give right instruction at right time and to answer any question raised
by contractor to avoid project delay and related price fluctuation risks.

3. Consultants should have to provide proper consultation to accommodate and reduce

the adverse effect of price fluctuation at earliest stage (i.e. during feasibility study,
planning and design).
4. They should continue their effort to study the likely occurrence of price
fluctuation and propose improvements needed on existing price escalation
administration methods.

C. For Client (ERA)

1. The client should have to consider the effect of price fluctuation and incorporate
price adjustment clauses in contract documents to assure fair risk sharing/allocation
between contractors and employer.

2. Develop their own price database and update it regularly at short time interval to
properly anticipate the future price fluctuation and develop device mechanisms to
secure fair risk sharing/allocation in federal road construction projects.

3. The clients should invest their effort at planning phase of the projects to properly
plan the project in terms of cost, time and quality. This would help to mitigate
disputes and price fluctuation related risks on both contractors and client.

D. For Government
1. Public authorities should have to investigate the impacts of price fluctuation and
seek alternative mechanisms to solve the practical problems observed in
implementing existing standard conditions of contract on federal road construction
projects.
2. Government should have to give regular capacity building trainings for professionals
and firms on the construction sector so as to develop their awareness on contract
documents and impact of price fluctuation.

104
3. The Ethiopian central statistical agency or other regulatory body should have to
develop and publish price indices of construction inputs at a certain period. This will
help to avoid imported inflation while using foreign sources of indices.

105
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APPENDIX

Questionnaire

110
 Addis Ababa Science & Technology University
College of Architecture and Civil Engineering
Department of Civil Engineering
M.Sc. Program in Construction Technology & Management
Questionnaire Survey
On
Assessment of Challenges and Best practices of Price Adjustment on Federal
Road Construction Projects
Dear Sir/Madam,
This research survey is an individual research designed to fulfill an academic
requirement for M.Sc. program in Construction Technology and Management at
Addis Ababa Science & Technology University.
This questionnaire is prepared to assess challenges and current best practices of price
adjustment systems in local and international context and recommend possible
remedial measures that will minimize the risks of price fluctuation in Ethiopia road
construction sector.

Your response, in this regard, is highly valuable and contributory to the outcome of
the research. I can assure you that your response will be kept strictly confidential,
where only my academic advisor and I will have access to the information you
provided and it will be exclusively used for the research. You may kindly aware of
time constraints in such academic requirement researches; hence, I sincerely request
you to complete and return the questionnaire in a week time to enable me finalize the
research on time to meet the deadline.

Thank you for your invaluable time and cooperation!

Submitted by: Tesfaye Manaye

Supervised by: Wubishet Jekale (Dr: - Ing)
Address: Tel. 0913774753
E-mail –[email protected]
September, 2018

111
Please give your response for the questions here under by putting a “√” mark at your
appropriate choice and/or idea by putting your answers in the space provided. You can
use the back side of the paper if the space provided is not sufficient.
Part One: General / Personal and Organization Information
1.1 Name of Organization (Optional): ______________________________________
1.2 Your position in the organization: _____________________________________
1.3 Number of federal road projects you have been involved?

` < 3 projects ` 3-6 projects ` 7-10 projects ` >10 projects

Part Two: Questions related with price adjustment administration practices
2.1 How do you rate the ability of contractors participating in Ethiopian Federal road
construction projects to accommodate representative and represented elements in
formula method of price adjustment?
5= Excellent, 4 = Very good, 3 = Good, 2 = Satisfactory, 1= Poor
5 4 3 2 1

a. If your answer for question number 2.1 is 3 and above, which of the following
methods are most commonly used to accommodate risks due to price fluctuation
on represented elements?
Using reliable sources of construction materials
Introducing risk factor to estimated price
Adopting high profit margin
Using more accurate price indices
Other methods (please specify) ________________________________________
b. If your answer for question number 2.1 is 1 or 2, which of the following could
be the main reason that allows them to be negligent to accommodate price
fluctuation on represented elements during pricing of their bid?
Lack of contractors‟ awareness on price adjustment system
Contractors‟ knowledge gap on the effect of price fluctuation
Rule limit sources of construction materials
Lack of documentation to match indices
Other reasons (please specify) ________________________________________
_______________________________________________________________

112
2.2 How do you rate the fairness of coefficients/weighting ranges assigned to
adjustable elements by contractors participating in Ethiopian Federal road
construction projects?
5= Extremely fair, 4 = Very fair, 3 = Fair, 2 = Satisfactory, 1= Not fair
5 4 3 2 1

2.3 The following table contains data sources which are commonly used by
contractors‟ participating in Ethiopia road construction sector to gather
information on prices of major construction inputs. How do you rate the use of
information by contractors to estimate bid prices?
5= Extremely frequent,4 =Very frequent,3 =Slightly frequent,2=Frequent,1=Non frequent
S/No Sources of data on price of major Rank
. construction inputs 5 4 3 2 1
1 Simple Market survey
2 Ethiopian Central Statistics Agency
Publications
3 Magazines, Such as National Construction
Magazine
4 Their own historical data
If any others, please specify
4
5

Please add supporting comments _________________________________________

2.4 Current practice of Ethiopian Roads Authority contracts shows that only bitumen,
fuel, cement, equipment, steel reinforcement and labor are subject to price adjustment
in local context. How do you rate the representativeness of these variable/adjustable
elements to other road construction inputs which are susceptible to price fluctuation?

` Extremely high ` Very high ` High ` Fair ` Poor

2.5 What are the major road construction inputs susceptible to price fluctuation in the
last five years? How do you rate the price change on these construction inputs?

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 1= Increase, 2 = Decrease

Major Very High High Moderate Minor

S/No Description
1 2 1 2 1 2 1 2 1 2
1 Material






2 Labor
Skilled
Un Skilled
3 Equipment

Please add any supporting comments_______________________________________

___________________________________________________________________
2.6 How do you rate the predictability of price fluctuation in major road construction
inputs such as labor, machinery/equipment and materials (you list for question
number 2.5 above)?
5=highly predictable, 4=predictable, 3=fairly predictable, 2=less predictable, 1=unpredictable
Predictability of inflationary factor
S/No Description
5 4 3 2 1
1 Material






2 Labor
 Skilled
 Un Skilled
3 Equipment

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 2.7 The following table contains possible benefits of incorporating price adjustment
clauses in contract documents. Please express your level of agreement by putting
a () sign on the space provided and rank them?
5 = Strongly agree, 4 = Agree, 3 = Neither agree nor disagree, 2 = Disagree, 1=Strongly disagree
S/No. Benefits of using price adjustment Level of agreement
clauses 5 4 3 2 1
1 Lower bid prices
2 Better market stability
3 Increased number of bidders
4 More consistent contractor profit margins
5 Fewer contractor default/bid retractions
6 Better reliability in the supply chain
If any others, please specify
6
7

Please add supporting comments _________________________________________

2.8 The following table contains possible risks/disadvantages of incorporating price
adjustment clauses in construction contracts.Please express your level of
agreement by putting a () sign on the space provided?
5=Strongly agree, 4= Agree, 3= Neutral, 2= Disagree, 1= Strongly disagree
S/No Risks of using price adjustment clauses Level of agreement
5 4 3 2 1
1 Accuracy of indices
2 Program Start-up costs
3 Price adjustment payouts
4 Increased bargaining power of suppliers in
the supply chain
5 Increased administrative costs
If any others, please specify
6
7

Please add supporting comments _________________________________________

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2.9 In the context of Ethiopian construction industry, one of the drawbacks of using
the formula method is unavailability of reliable locally generated indices. How
formula method of price adjustment can be exercise to secure fair compensation?
a) Establish local price indices and revise it periodically
b) Use foreign price indices and apply currency correction to balanced inflations
Other (Please specify) _______________________________________________
_________________________________________________________________
2.10 How do you rate the fairness and rationality of the weight range provided for
non-adjustable (fixed component) in formula method of price adjustment?

` Extremely fair ` Very Fai ` Fair ` Satisfactory ` Unfair

2.11 How do you rate the amount of price adjustment paid for contractors to
compensate for the rise and fall of prices on the major construction inputs of
federal road construction projects?

` < 10% ` 10-20% ` 20-30% ` 30-40% ` > 40%

Please add supporting comments/data ___________________________________
__________________________________________________________________
2.12 Construction materials are included in price adjustment clauses by using
selection criteria. Which of the following selection criteria are suitable to select
representative construction material and include them in price adjustment
clauses?
Availability of price index Validity of the selected index
Method for measuring quantities used Contractor's ability to control price
Cost impact of changing prices Program setup and administration cost
Other reasons and supporting comments(please specify) _____________________
2.13 How do you rate the accuracy of quantity of works and the corresponding unit
rates prepared by the Engineer/designer at tender stage which is utilized to
determine the ranges of coefficient/weightings of adjustable elements, based on
which the contractors to come up with their weighting proportion?

` > 75%accurate quantities of measurement and unit rate

50-75% accurate quantities of measurement and unit rate
`
` < 50% accurate quantities of measurement and unit rate

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 If less than 50% accurate, what do you recommend to improve the accuracy of
estimation and minimize the problem of unfair risk sharing/allocation?
__________________________________________________________________
2.14 Taking in to account the current market situation and price adjustment method
practiced by Ethiopian Roads Authority, which of the contracting parties accept
major risk of price fluctuation?

` Ethiopian Roads Authority ` Contractors ` Both parties share the risk equally
Please add supporting comments/data ___________________________________
__________________________________________________________________
2.15 Current practice of ERA shows that FIDIC form of contract is used to
administer price escalation in Federal Road Construction Projects. How do you
rate the suitability of FIDIC form of contract to administer price adjustment in
Ethiopian road construction sector?

` Excellent ` Very Good ` Good ` Satisfactory ` Poor

What points do you recommend to improve in this form of contract (if any)?
__________________________________________________________________
__________________________________________________________________
2.16 How do you rate the fairness of compensation secured to price fluctuation
through formula method of price adjustment, which is current practiced by
Ethiopian Roads Authority?

` Extremely fair ` Very fair ` Fair ` Satisfactory ` Unfair

If unfair, what are the points you recommend to improve? ______________________
_____________________________________________________________________
Please add any supporting comments ________________________________________
_____________________________________________________________________

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Part Three: Questions Related with Challenges and improvement on price adjustment
3.1 The following table contains a list of possible difficulties associated with the use
of construction price indices. Rank them based on their frequency of occurrence?
5=Extremely frequent,4=Very frequent,3=Slightly frequent,2= Frequent,1=Non frequent
No Difficulties associated with using price Frequency of occurrence
. indices 5 4 3 2 1
1 Late release of published data in using
foreign indices
2 Inadequate recovery of costs
3 Particular work item of interest will not
be included in the published indices
4 Non familiarity with computation
5 Indices based on historical data
6 High subscription fees
7 Obsolete methods and components
8 Human error
If any others, please specify
8
9
Please add supporting comments ________________________________________
3.2 The following table contains possible challenges of using formula method of price
adjustment on federal road construction projects. Please express your level of
agreement by putting a () sign on the space provided?
5=Strongly agree, 4= Agree, 3= Neutral, 2= Disagree, 1= Strongly disagree
S/No Challenges of using indices method of Level of agreement
price adjustment 5 4 3 2 1
1 Change in reliable sources
2 Existence and use of composite (foreign and
proxy) indices
3 Change in project costs
4 Use of constant weighting/Coefficients
throughout the project life time
If any others, please specify
5
6

Please add supporting comments _________________________________________

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3.3 How do you suggest that contractors, consultants, clients and regulatory bodies
should do, to reduce challenges of price adjustment and mitigate adverse effect of price
fluctuation on federal road construction projects?
i. Contractors:

` Obey favorable rules and propose improvements needed on available price

adjustment methods
Properly implement price adjustment clauses
`
` Develop their own price database and use it to estimate bid prices
` Improve their ability to predict price fluctuation and propose fair coefficients‟
for adjustable elements
Others/please specify __________________________________________________
ii. Consultants:

` Propose other best price adjustment methods and improvements needed on

existing price adjustment methods

` Prepare contract documents allowing price adjustment

Develop accurate estimate of quantity of works and unit prices at tender stage
`
Others please specify __________________________________________________
iii. Clients:
Incorporate price adjustment clauses in their contract documents
`
` Develop their own price databases
` Always ask for firm prices
Others/please specify __________________________________________________
iv. Regulatory bodies:

` Develop strong and reliable price database

` Always control and regulate the market
` Regularly review rules and regulations
` Regularly monitor application of existing rules

Others please specify __________________________________________________

Thank You!!!

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