The following advice comes from FIDIC under the heading: “Which FIDIC contract should I use?“
“Is it a Process Plant or a Power Plant (or a factory or similar) where the Employer – who provides the finance – wishes to implement the Project on a Fixed-Price Turnkey Basis?Then the Employer wishes the Contractor to take total responsibility for the design and construction of the process or power facility and hand it over to operate “at the turn of a key”,
If this is what he wanted – choose the Conditions of Contract for EPC/Turnkey Projects (The EPC Contract).
Recent projects presented us with challenges to achieve difficult targets. We share our views:
PROJECTS IN A FAST WORLD
The modern economy is fast: business opportunities need to be exploited quickly and efficiently. Capital comes at a cost, and the shorter the circulation period, the better the returns.
Projects are unique: to launch a project means that a process is to be constructed that is not an off-the-shelf solution.
Projects do not just happen: it requires skilful and intensive management throughout to achieve its goals. The decision-making body of a venture is faced with the upfront, pre-project decision on how to manage the project. The core decision in the primitive stage of the project, is whether to manage the details hands-on or to outsource details management.
Ventures that regularly undertakes significant projects, may find it worthwhile to maintain a project section, but smaller ventures would have less options, and may be forced to outsource the detailed project execution.
Outsourcing is a mechanism aimed at making the business commercially flexible and adaptable. It is then a paradox that outsourcing limits flexibility in the project execution phase.
Once the project is supposed to fly, it is susceptible to high cost risks if any changes are attempted, while time and quality is left to the success of failure of a single, arms-length entity.
OWNERSHIP AND CONTROL
The owner of the information controls the project. By outsourcing a project to an Engineer, Procure and Construct (EPC) contractor, the EPC contractor effectively owns the project, which place the employer in a weak position to make change or influence design decisions in a cost-efficient manner.
EPC has been employed successfully, but the cost margin that it adds compared to a less risk-carrying piece by piece contracting method, is difficult to establish, since no two projects are directly comparable. The cost risk is controllable to some extent, if the EPC contract is devised with the necessary diligence and suitability for particular circumstances.
For time and quality, the EPC approach place all the eggs in one basket: if the EPC contractor fails, the project fails, with little or no option to remedy the situation without suffering severe consequences.
The EPC portion is contractually simplistic to the employer, but removes the employer from access and influence to the details of the project, as illustrated in Figure 1 below:
Figure 1: EPC Project Structure
The view often held by employer’s internal project managers, that a turnkey contract is the no-nonsense and cost-efficient option, should be carefully considered against the magnamity of the risk in the single decision of the selection of an EPC contractor.
It is not necessary to have an internal projects section, complete with designers and draughtsman, to size this risk down to a more acceptable level: the solution is in assuming more internal management and co-ordination responsibility to manage a more divided and thus smaller risk per unit structure in which outsourcing is conducted.
It had been shown in Part 1 of this article, that Engineer, Procure and Construct (EPC) contracts are not always the turnkey solution that leaves the employer without risk: there could in fact be a significant time and quality risk by placing all the eggs in one basket.
MANAGE THE RISK
How can this problem be addressed – the risk lessened – without establishing, administering and managing an internal team of designers and managers to execute the project? Larger corporations may have its options open, but smalles ventures might want to undertake a single project only and thus has to find a way to control the risks.
One way is to ensure that the best researched, communicated and legally sound EPC contract is put into place. It would assist to optimize the limited flexibility of the client, and would put mechanisms in place to force the Contractor to perform for time and quality. If the EPC contractor has though an inherent flaw in his management and execution of the contract, hardly any penalty or forced acceleration measure would significantly impact on the problem.
The opposite effect could also be true: run the risk and achieve the result with a small amount of management effort internally.
A more controlled approach is to divide the EPC functions amongst more than one entity: a design contractor(s) is appointed, then a construction contractor(s) and specialists or supplier and commissioning team separately appointed or derived from the separate team as is the best for each situation. This approach allows for varying levels of management intervention to maintain control throughout the project. There is the possibility of further dividing our grouping activities to suit the project as it unfolds. Replacement of non-performing participants is possible if extreme circumstances necessitates drastic measures, without affecting all of the works simultaneously.
The building industry typically structures projects in the manner illustrated in Figure 2 below:
Figure 2: Typical Building Project with Single Responsibility Consultant
In this model, the client has a direct contractual relationship and thus control, with the consultant and building contractor separately, although the principal agent is de facto in control of the building contractor.
If the client wish to obtain more direct control and the possibility of more independent management views, the alternative on the model in Figure 2, is to establish direct links between himself and the various consultants (see Figure 3 below). Functions such as design and cost management is then both indepedently available to the employer.
Figure 3: Typical Building Project with Direct Consultants Appointments
The selection of the most appropriate project structure is dependant of a variety of factors and the employer’s risk management strategy.
Typical factors are:
Risk assessment should be the key to the decision on the project structure. It has been shown that the EPC function can be divided; whether or not the employer has internal project resources.
The lack of options with internal resourcing need not preclude the employer to place himself closer to the action and thus in better control of the project. It can be done directly or with an independent project manager as illustrated in Figure 4 below:
Figure 4: Flat Structure for Process Installation Project
This flat structure model is particularly well-suited for projects with complexities such as:
It provides the opportunity to the employer to influence all aspects throughout the project, even during execution phase. By creating direct contractual links with the different entities, even the project manager can be bypassed. The disadvantage is that the employer’s administrative involvement is increased: the project manager would normally set up all necessary systems and documentation, but payments has to flow directly from the employer to the various participants.
The flat structure allows incremental appointments as well as replacement of non-performing elements in serious cases. Functions can be combined and split to suit changing circumstances or the specific capabilities of the preferred suppliers. The options are though left open, for example, whether to award process and electrical design in one package, or to hand it out in separate packages to smaller specialist consultants.
Projects involving advanced technology can benefit from the ability to establish direct contracts with specialists who could be individuals who can each only provide a specific, but crucial, element. If there is sensitivity about confidentiality, which is often the case with advanced technology, the employer retains a high level of information control down to the level of individuals involved.
Costs can be influenced deep into the project, since contracts are awarded only when the function is required. The proximity of the employer to the design elements, and the potential to award the procurement and construction contracts only when design is well-advanced, keep options open for implementing alternatives without contractual difficulty.
Many undertakings find themselves in a feeling of uncertainty when approaching a project. The turnkey solution which its single line of communication and contracting could be a viable solution, but the benefits derived from a more involved approach can be substantial.
The independent project manager can fill the gap to provide the project systems and controls that the employer might not have available in his own organisation.
The flat project structure deserves thorough consideration in a modern world which runs at an incredible pace.
Leonard van der Dussen