The team should start the process of developing the main project contracting strategy during ORP Phase 2-Select and the strategy should be completed and approved as required by the project schedule but no later than FID (except for Operating Phase Contracts, the strategy for which will generally be developed during ORP Phase 4-Execute if the Company is going to operate the asset). A team-based, structured, workshop approach should be used in developing the strategy.6 An indicative programme is shown in Figure 3.6.5
The contracting strategy should address7:
- the contract plan defining what is to be contracted out and when
- analysis of available Shell staff resources relative to the Work Breakdown Structure (WBS) and the complexity of the project challenge
- the preferred types of contracts for the given circumstances
- a risk analysis of the contracting alternatives
- the basis for contract award e.g. to the technically acceptable tender yielding the lowest “life time” cost to the Company
- the facilities and services which may be provided by the Company to contractors
- the proposed use of incentives to encourage and reward contractors, versus guarantees and penalties to prevent under-performance
- allocation of risk between Company and Contractors
- the minimum requirements for contract monitoring/control
- the local commercial and political regulatory environment and local content issues
- the competitive situation and political tenderers.
Major projects, with their large commitments, have considerable scope for innovative contracting and such strategies need to be carefully reviewed and agreed with management to ensure they do not conflict with other Company interests. The manner in which the contracting objectives are to be achieved will depend very much on local circumstances.8 Developing the contracting strategy constitutes a vital part of initial project planning as it derives from the WBS and drives the organisation (single point responsibility) structure. Thus, individuals should have responsibility for one or more contracts, which in turn, cover one or more intersections on the asset/activity matrix defined in the WBS. Such dove-tailing allows clear responsibilities to be outlined and helps to minimise the number of interfaces to be managed.
The contracting strategy should seek a balance between the conflicting desire for a minimum number of contracts, and hence interfaces to manage, with the contractor’s competence for performing all the activities or sub-activities. A useful tool to promote discussion and resolution of this balance is a Contracts Plan or Matrix.
The Contracts Matrix (Figure 3.6.6) shows in a matrix format overlaid on the hardware/function matrix the packages of work which are to be separately tendered.
- retention of single point responsibility for managing each contract (and contractor or partner)
- the availability of suitably qualified contractors and suppliers, with acceptable
- quality and HSE management systems
- the ability to integrate contractors effectively into the project
Commercial Strategy includes:
• how the contractor should be remunerated by the Company
• how payment and cost control will be established
• how negotiations should be handled
The three basic methods of contractor remuneration used in EP are:
• Lump sum
• Unit rate
• Reimbursable cost
These can be used as a basis for remuneration of different types of contracts, such as turnkey, bills of quantity, time/dayrate, time and materials, parent agreement, see Figure 3.6.7. In principle, any permutation of the type of contract and remuneration is permissible to cater for the needs of a particular contracting strategy.
Lump sum contracts decrease the level of risk and financial exposure for the Company, whereas reimbursable contracts, because of the need for detailed work definition, require more contract management and administrative effort by the Company.
The responsible engineer and the line management responsible for making the decision as regards commercial issues, should understand clearly the advantages and disadvantages of selecting a particular type of contract, and the implications for the amount of control and Company effort required.
Incentive policies
Apart from the incentive provisions of Alliance contracts, incentive arrangements should be incorporated into any contract, whenever there are clear, quantifiable benefits from doing so.
The aim for all incentive schemes should be to reward a proper balance between timeliness and delivery of a quality product. Ideally, incentives should create a win-win situation for both parties. The Company wins by getting a quality product delivered on time, and the contractor wins the financial incentive.
Care should be taken to ensure that targets are aligned not only between the Company and the prime contractor, but also between other contractors, subcontractors and suppliers involved in the project. Incentives agreed with prime contractors should be applied ‘back-to-back’ with sub-contractors whenever possible. Both parties need to
understand the objective/problem and agree the methods to be employed to achieve it. The most effective form of incentive is to link bonus payments to physical progress by work measurement or milestones. Incentives should be negotiated after the contract has been
awarded, to prevent the contractor including them within a bid in order to make it more competitive. The clear intention is that incentives are for better performance than the contract terms. To ensure commitment to the incentive deal, it is preferable to let the contractor propose the details. This is particularly important in cases where the incentives may not be achieved. The project team needs to be able to define the ‘worth’ of the incentive to the project in Total Cost of Ownership (TCoO) terms.
Note that the proposed use of incentive schemes must be covered in the ‘Contract Plan’, and agreed with the Tender Board before inclusion in the contract.
Liquidated damages (an assessment of the direct cost to the Company if contract completion is delayed (i.e. excludes consequencial cost such as revenue loss)) are often inserted into contracts (including purchase orders) as a ‘negative’ incentive to contractors.
The ability and the wish to apply the liquidated damages clauses will depend on the circumstances of the contract. Although such clauses can give rise to argument, they are useful in concentrating the mind of contractors. Careful attention is needed to the calculation of the liquidated damages and how these will be applied.
Contract Design
Before inviting contractors to bid for work, a choice has to be made between single or multiple contractors (single or multiple sourcing). The advantages and disadvantages of each are as follows.
| Single sourcing | Multiple sourcing |
| Close relationships can be established. | Business can readily be placed elsewhere if contractor fails to perform. |
| Both communication and mutual understanding of needs. | Greater flexibility to meet sudden fluctuations in requirements. |
| The cost of tendering can be avoided. | Greater awareness of the technical developments of different suppliers. |
| Scheduling can be simplified. | Competition can usually be maintained. |
| Quality appraisal and control costs are reduced. | Less vulnerability to major changes in the supplier’s business. |
| Possible price reductions through economies of scale. | Better protection against exploit-ation by a single source supplier. |
| Possible upon long-term cooperative activities, e.g. QA process re-engineering and security benefits. | Standardisation will be harder to maintain. |
| Unsuccessful competitors may be dissatisfied. | Suppliers will not become over-dependent on Group business. |
| Value for money not easy to demonstrate | Demonstrates value for money. |
Turnkey Contract
A Turnkey Contract is one in which the essential design is created or supplied by the contractor and is then followed by procurement, construction and commissioning. The contractor to a large extent has the legal responsibility for the design, and performance of the work after completion.
A Turnkey Contract is therefore not necessarily a lump sum contract, nor a contract with a single contractor for an entire project, although this is often the case.
Payment and Cost Control
Payment under a bills of quantities contract may be on a monthly basis against measured quantities, or against a series of milestones. Milestone payments are preferred when the milestones can be clearly defined.
Parent or call-off agreements
Parent Agreements, sometimes called Umbrella or Call-off Agreements, are contracts covering multiple assignments, sequential or concurrent, usually issued in the form of ‘Project Orders’. Such contracts have a specified term, and a schedule of payment, usually rates. They are normally established by competitive tenders, awarded to three to six companies offering the most favourable rates within the terms of the Company. The main advantages of parent agreements are the ease of administration, and continuity in the contractual relationship. Project Orders below specified limits can be entered into without reference to the Tender Board’.
If parent agreements are used as ‘call-off contracts” to provide supplementary manpower, the Company policy regarding manpower establishment must be followed.