The big print giveth and the fine print taketh away.
Bishop John Fulton Sheen
The thinking that has to go into the development of contracting and procurement
strategies and the types and extent of contracts that might eventuate have been discussed
in 3.5, Contracting Strategy. Contracts represent considerable commitment on behalf of
the Company. Some 80-90% of project expenditure may be by way of contracts and
purchase orders. It is important that appropriate business controls are in place to assure
the Company that effective control of the process and its associated risks can be
managed. This present section discusses some of the more important control aspects of
contracting and procurement.
Contracting Process
Contract Preparation
The contracting process is shown in Figure 4.4.1. The quality of the tender document
and the finally executed contract will have a fundamental impact on the success or
otherwise of the contract in providing the goods or services required from the contractor
strictly in accordance with the project cost, schedule and quality objectives. The contract
holder should be the intended OU Company Representative for the contract, if at all
possible and be responsible for the preparation of the tender document, the evaluation of
the tenders and the preparation of the contract document.
Increasingly, model forms of contract are available within an OU that are modified
to suit the particular needs of the project. If such model contract documents are not
available locally then the SIEP models should be used. Notwithstanding the use of model
documents, time-and-time again the problems that emerge with contracts are due to
paying insufficient attention to one or all of the three issues of:
- tender document preparation
- tender evaluation
- contract document preparation.
It is imperative that the most experienced and knowledgeable staff are used to examine
the tender document in its entirety to ensure that there is cohesion between the
Conditions of Contract, the Scope of Work and the Payment Schedules and that all
three fully represent the requirements of the project team.Particular attention is always
needed in preparing tender documents to:
- definitions
- termination
- suspension
- force majeure
- tax
- variations
- liabilities
- warranties
- bank guarantee/performance bond
- insurance
- scope of work
- payment schedules and retentions
A comprehensive tender evaluation plan (Control Process Tools, Contracting and Procurement – “Model Tender
Evaluation Plan” ) must be prepared and implemented with
adequate benchmarking established so that tendered cost and schedule can be compared
with expectations.
The contract document needs, again, to be validated by the best-qualified staff to make
sure that it truly represents the tender outcome and any subsequent negotiations.
If, for schedule reasons, a letter of intent is needed ahead of the signing of the contract,
then this must receive the same rigorous examination as the final contract document
with a clear limit on the cost to be incurred by the company if the contract cannot
ultimately be agreed with the contractor.
Tender Board approvals
Tender Boards are the means by which the Company’s contracting policies are assured.
Their role is to check the reasonableness of the contracting strategy proposed, to assess its
potential risks, and to provide experience. They will also require a check as to the Total
Cost of Ownership throughout the life cycle.
Unless preparatory work is of the necessary quality, the project may suffer delays in
approvals. The best protection against the risk of delay and deflection from plan is to
ensure fully completed staff work in the Tender Board submission and ensure competent
briefing. The Tender Board should be seen as part of the project’s quality assurance
process and there is every opportunity in the team to build-up a rapport with the Tender
Board through the several meetings needed as part of the tendering and award process.
These requirements need to be disseminated to all project staff involved with contracts,
and they should be aware that rejection of a project proposal is a serious failure and
setback both for the project and the Tender Board.
Depending on the size and scope of activities of the Company, there may be two Tender
Boards in operation; one for ‘Major’ and one for ‘Minor’ contracts; : The value of
contracts within the scope of the various Tender Boards will depend very much on the
Company’s operating environment. Additionally, large projects may also be given certain
authorities to award contracts up to a certain value through their own, internal Tender Boards.
Contract Control
Once the contract has been awarded, it is effectively too late to think about the ways that the
contract will be controlled – these need to be built into the tender and contract documents.
The following contract controls are likely to be applied in the following sequence:
For effective contract control it is essential that:
- all formal communication with the contractor be through the Company Representative
- the mechanisms for reporting progress are built into the contract documentation
from the tender stage and that these mechanisms are not compromised during
contract negotiations - mechanisms for agreeing the cost/time consequences of changes are incorporated in
the contract.
The detailed method of control and the requirements for progress reporting will vary
according to the size and type of contract. All control procedures, however, must include
the following within the final contract document:
- a formal plan for the contract. This should be in the form of a precedence network
with CTR catalogues - agreed milestone points, including such deliverables (in the form of physical
product) as may be appropriate - coordination and administration procedures with the appropriate rights of access
and audit - resource schedules (manpower, equipment, services)
- format and frequency of reports
- any additional data requirements
- control of quality
- control of safety
- change control
- claims procedure
- close-out procedures.
Contractors should be required to impose similar control procedures on their
subcontractors and vendors. The Company should reserve the right to approve selection
of subcontractors or vendors.
In administering the contract, ensure that weaknesses of the contractor recognized at the
tender stage are taken into account and that the Company’s efforts are directed appropriately.
The size and composition of the team managing the contractor should be appropriate to
the type of contract, capability of the selected contractor and the complexity and
importance of the work involved. The authority of the Company Representative should
be established in writing to the contractor.
Contract Variations and Claims
Changes to the work can be dealt with as a contract variations if both parties are in
agreement. If the parties are not in agreement then a claim situation has been reached.
A claim may arise out of a contract interpretation or it may be extra-contractual
(e.g. the contractor may ask for an ex-gratia payment). The claim’s legitimacy should be
established in a defined time and, if not legitimate, should be rejected.
Early identification and accurate recording and compilation of all relevant factors are
essential to enable the Company Representative to evaluate the claim. Any claim that is
to be rejected as not conforming to the contract or any proposal to settle a claim that is
outside the terms of the contract must be advised to the relevant Tender Board. Legal
advice may often be necessary before a claim is finally rejected.
Insurance Claims
A procedure for pursuing insurance claims must be put in place and a focal point
appointed for making and pursuing any claim. (On a major project this would normally
be the project accountant). Documentation of the claim (what happened and the cost of
remedying the problem) must be to a high standard. It is prudent to initiate a claim
immediately if there is cause to believe that the issue may be covered by insurance, even if
it is possible that the policy deductible may exceed the size of the final cost of the claim.
Close Out
It is the Company Representative’s responsibility to ensure that a project is properly
administered until such time as the contract is formally closed-out. This is particularly
important in the period immediately following completion of the physical work, as this
is the time when those staff who have been closely involved with the running of the
contract begin to disperse.
The purpose of the contract close-out procedure is to:
- monitor the process of finalising payments
- obtain a complete statement of contractual obligations and any claims
- identify at what point the insurable risk changes from the project
(Contractors All Risk) insurance to operating insurance - determine commencement dates for maintenance guarantees
- determine the extent of liquidated damages, if any
- obtain close-out certificates.
- capture lessons – learned for future contracts
Procurement Plus
The integration of the procurement process with parallel activities in the detailed design
phase of the project is shown in 5.4.4, Front End Engineering and 5.5.2 Detailed Design
The life cycle aspects of the process are illustrated in Total Cost of Ownership (TCoO)
terms in Figure 4.4.3.
The key control aspects of the procurement process are:
• Integration with Engineering/Operations
• Requisition and Order Planning
• Quality of Evaluation
• Manufacturing Quality
• Expediting and Delivery
• Change Management
• Factory Acceptance Testing
• Vendor Representatives
• Third Party Inspection
• Spare Part Ordering
• Purchase Order Closeout
• Disposal of Surplus
The key considerations in each of the above are discussed below.
Integration
Procurement must be integrated with Engineering and Operations whether performed
inside the OU or by consultants or contractors. It must be carried out by committed,
competent staff who are fully aware of the technical and commercial factors and who
maintain frequent communications with the project engineers and are motivated by the
same targets, using effective procedures. With its many interfaces, procurement is often
an ideal opportunity for ongoing quality improvement projects.
Requisition and order planning
Requisition and order planning and scheduling is the key factor to reduce lead times and
manage procurement. It should start as early as Front End Engineering with respect to
long lead items. The required on site (ROS) date for each item should be determined
from the basic schedule. It is then possible to work back, using typical deliveries for each
item, transportation times, allowances for bidding and awarding, to the critical date
when each requisition must be produced. This is usually the main factor for determining
the (detailed) engineering schedule. A spread sheet should be used to schedule and
monitor all milestones and deliverables for all requisitions on a project. Regretfully, there
is no substitute for detailed clerical control for managing materials and expediting
still needs very regular follow-up.
Quality of Requisition
The same strictures hold true on the quality of purchase order requisitions as they do on
the quality of a contract tender documents (see 4.4.1 above). It is vital that major
purchase orders receive adequate management attention. However, this is not always the
case, with the checking of the quality of the requisition left to work package engineers
who do not always have the requisite overview of the project needs nor the commercial
awareness needed to spot gaps or flaws in the requisition documents.
It is essential that spare parts (including insurance spares) and vendor representatives
needs and costs are dealt with at this stage and not negotiated after the award of the
purchase order when there is little-or-no bargaining power available to the project.
The philosophy on contingency quantities for bulk materials (e.g. pipe, valves, cable)
must be clearly addressed and monitored in the requisitioning process.
Quality of Evaluation
Far too often delays occur in the evaluation and award of major/critical purchase orders
because inadequate attention has been paid to the quality of the requisition and to the
evaluation plan and its required resources. Major purchase orders deserve formal evaluation
plans with a detailed schedule and identified resources.
Quality Manufacturing
The project quality plan should be used to define the level of activities necessary to
ensure quality (conformance to specification) for all items of material. The activities
required will need to be based on experience of each vendor’s performance (possibly
available from audits and SIEP) and not necessarily on whether they are formally
ISO-9000 approved, and on the criticality of the items.
The level of attention could vary from a full team (resident engineer and inspectors) for a
major compressor to acceptance of the vendor’s own QA/QC system for bulk materials.
Quality should be applied to the full deliverable, from original design drawings through
to packing to prevent damage.
Expediting and delivery
The aim is to ensure that vendor documentation, needed to complete detailed design,
and the actual materials arrive by or before the planned dates.
Financial incentives can be used, with care, for critical items. Either the payment of a
milestone only when the deliverable is provided, thus improving the vendor’s cash flow, or
an actual bonus and/or penalty clause can be added to the purchase order. Group experience
with incentives is mixed and there is a concern that they can simply add to the overall price.
For many vendors there appears to be a communication gap between the commercial
side and those actually providing the deliverables. It may be more effective to constantly
expedite materials with regular site visits/phone calls to check that key activities have
taken place to plan and to demonstrate that the project team is serious about requiring
the contractual delivery. Some purchase orders may be so critical as to require a resident
engineer in the vendor’s works and for more items considered critical it is recommended
that the senior line managers (Project/Engineering/Procurement Managers) establish a
personal relationship with the vendor’s senior management at an early stage in the
proceedings-sometimes before award of the purchase orders.
Change Management
The Technical Change Management Process (4.8.2) needs to be applied to control
purchase order changes. Documentation of change sometimes leaves room for
improvement, leading to significant problems when closing-out commercial aspects of
the purchase order. Both cost claims and schedule claims (to avoid liquidated damages)
from the vendor can be difficult to rebut without clear evidence and a lot of time and
energy can be spent researching those claims at a point in time when many key staff have
left the project.
Factory Acceptance Testing
It should be a condition of the purchase order that the Factory Acceptance Testing (FAT)
uses the project’s equipment commissioning check lists/procedures as a record of FAT.
This can save considerable cost and time from duplication of work on site during the
commissioning phase.
The engineers responsible for commissioning the equipment should supervise FAT
(alongside work package engineers, if necessary) so that they get hands-on experience of
the equipment and any residual issues that may need to be addressed on site. Operations
staff who may become critically involved with the equipment should also attend.
Residual action items from the FAT need to be added to site punch lists so that they are
not overlooked.
Vendor Representatives
The cost of vendor representatives on a major project will be several million dollars. The
terms of service need to be spelled out in the original requisition and costs obtained and
built into the tender evaluation.
Proper attention to this issue at the time of issuing tender requisitions will save large
amounts of effort later. For administration purposes, separate purchase orders may be
issued for vendor representatives.
Vendors must be engaged in the planning for involvement of their representatives at site
during construction, commissioning and start-up operations so that they buy-in to the plans
and can be monitored against them. For large/critical involvement on site, vendors may be
given performance incentives so that their interest in project objectives is the same as the
project team’s. Administrative procedures for call-up of vendor representatives and control of
their costs need to be put in place and a high profile given to this administration.
Third Party Inspection
An inspection agency may well be needed to inspect and report on progress of materials
and equipment manufacture in the vendors’ works. The costs for such expensive but
necessary services need to be carefully monitored and strictly controlled.
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Spare Part Ordering
It is not unusual for the purchase of spare parts to become a critical path activity with respect
to commissioning
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or operations or both. There needs to be a fully defined plan for the
ordering of commissioning, operating and insurance spares that addresses responsibilities for:
• Developing spare parts estimates
• Defining spare requirements (Criticality of part? Criticality of operation?
Remoteness of location?)
• Developing the procurement plan and the resources to fulfil it
• Preparing Interchangeable Spare Parts Sheets
• Ordering and expediting spares
• Controlling costs
• Receiving and managing spares.
There is often confusion as to whether Operations or Engineering project staff have
some or all of the above responsibilities with respect to operating spares and the
responsible parties need to be clearly defined and adequate resources provided. Insurance
spares requirements will be agreed between Operations and Engineering and
ordered/expedited by Engineering as part of equipment ordering. Commissioning spares
requirements will be defined by commissioning staff and normally ordered by
Engineering against the commissioning budget.
Purchase Order Closeout
A plan for the technical and commercial closeout of purchase orders is needed and its
implementation requires careful monitoring. This can become an onerous task, dragging
on well beyond start-up if not adequately planned and resourced.
As commented previously, the documentation of change in purchase order requirements
needs particular attention so that evidence is available to support the project’s case on
responsibilities for extra time/costs.
A policy on the application and pursuit of liquidated damages for delivery overruns should
be established and carried out.
Agreement is needed on the amount of purchase order documentation to be passed to
Operations rather than archived or destroyed and a clear transfer of ownership of the
management of warranties needs to take place.
Disposal of Surplus
Decisions are needed on surplus material/equipment to be taken into stock and the
financial arrangements for this. A surplus disposal policy and plan must be developed
and implemented so that the maximum value is obtained for the surplus.
Clear targets
for the completion of disposal should be set and monitored.