The provision of goods and services make up the majority of the projects cost (circa
90%). The objective of contracting-out is to obtain, at the best possible commercial
terms, specific works, materials, services and expertise that the company cannot provide
for itself. Selecting the correct contracting strategy for the opportunity is one of the most
important strategic management decisions of a project.
The contracting strategy should address both the provision of services (e.g. drilling,
engineering, construction, logistics) and the provision of materials and equipment at the
same time as the two will usually overlap, with contractors supplying some of the latter
and with issues such as location, transport and storage having a mutual impact.
The strategy should be addressed at the earliest possible time in the project lifecycle,
generally in ORP Phase 2 – Select, and then should be updated with time as more
information becomes available. For any significant project, the strategy would normally
be developed in a peer-assisted workshop.
The range of contract content options in a project is wide and the option chosen for a
particular opportunity will depend on the size and nature of the opportunity and its location.
Project contracts can and do span the full range from utilisation of regular call-off contracts
to unique one-off specifically designed ones. These specific contracts can range from
covering a specific specialised project element, (e.g. an electronic as built survey of a facility)
to a total life cycle service to procure and operate an FPSO. There are no restrictions in the
form of contract other than those imposed by ethical, political and legislative considerations.
The skill is in designing a contract strategy that
- meets the project’s objectives
- is more cost effective than any alternative strategy over the life cycle.
The contracting world is changing very rapidly. What was a successful contracting strategy
for previous projects may not be the case today. There are significant, measurable, cost
benefits potential from some risk and reward sharing contracts; for others the jury is still out.
A further factor is the changing relationships between Shell Contracts and Procurements
and its suppliers. The trend is towards global purchasing with its considerable leverage
potential. Other industries e.g. automobile, electrical also exhibit these trends.
More than ever before, the engineer will need to approach contracting strategy from first
principles. He/She will have to carefully plan and evaluate alternative strategies on a life cycle basis. This will need to be a multi-disciplined team effort, and will increasingly
involve not only the development of facilities, but also their operation.
In the past contracting procedures, often reinforced by Tender Board rules, have tended
to inhibit contract negotiations. In today’s more cost competitive world, bids can be
regarded more as the starting point for both parties. Discussion and negotiation can
often improve uponTotal Cost of Ownership. “If you can do this, we can reduce that”
can show significant reward, and should be encouraged. In doing so, however, it is
important that Shell’s business ethics are not breached, and that an audit trail of
negotiations always be made.
Common Approaches to Contracting
The contracting strategy selected will depend to a large extent on the Work Breakdown
Structure and the project challenge as discussed in 2.2, Defining the Opportunity,
especially the contracting skills base and maturity of the project location. The different
types of contracts/management explained below entail progressively less direct Company
involvement and are possibly more relevant for major projects than for small ones. They
are further examined under Contract Design in 3.6.3 below.
Direct Project Management by Company staff, without any management
contractor obviously requires the greatest amount of Company involvement.
However, key Company staff can be supplemented by third-party contract staff.
Such a team operates entirely using Company procedures and systems but whilst it
retains the maximum Company control, it may be less effective in its response to
changing circumstances.
Project Services Contractor to supply certain staff to the Project Management
team. In this case some contractor procedures and systems may be employed, but
the Company remains in control, and there is a single, integrated project team with
Company staff in key positions. Procurement services are an example of this type of
contract.
Managing Contractor to be responsible for the administration of most of the major
contracts, (perhaps also those for materials procurement) under the direction of a very
small Company team. The managing contractor acts as an agent and has wide but
defined discretion in the execution of the project. However, beyond the limits set by
the Company this discretion ceases to operate, and authority is again as per Company
procedures.
‘EPIC’ Contractor (Engineer, Design, Procure, Install and Commission), who is
directly contracted to execute the total scope of the work within a project (as opposed to
a Managing Contractor who manages other contracts on the Company’s behalf ). An
EPIC contract may include several phases, each with its own terms and conditions, but
the contractor remains responsible for interface management. A simplified form of this
type of contracting is called EPC (Engineer, Procure, Construct), and can be applied to
parts of a larger project.
Alliance Contracts have evolved from EPC/EPIC contracts and are contracts in which
contractors and client share the risk and reward in achieving their joint objectives.
They work on the principle that client and contractor(s) work together using their
joint skills and resources
4
. The starting point is usually an EPC bid proposal,
adopted as a base cost schedule. There is an initially agreed target value acceptable
to both the client and the contractor, where the contractors’ participation in project
risk is already taken into account. Thereafter both parties have the objective of
beating the target through enhanced performance. Both parties become, in effect,
shareholders in the contract. Sharing the rewards i.e. savings under target on an
agreed shareholder basis, and sharing the risks on cost over-runs, usually to some
predetermined limit, after which the client assumes total liability. Much of the cost
saving requires negotiation between the parties on a variety of issues, many on
technical specification, suppliers, design innovation, staffing (best person for the
job), elimination of duplicated work, etc. To be fully effective, the client needs to
have strong technical support in the initial stages which might not be so essential
for EPC/EPIC contracts. When appropriate and successfully applied, Alliance
contracts have recorded a substantial reduction in costs and improved schedule in
relation to the EPC/EPIC approach.
To put these various types of contract in some perspective (“traditional” linear
progression contracts, EPC, “Alliance”) the following order-of-magnitude illustrations
are useful:
In “traditional” contracts, clients usually carry all the interface risks. EPC contracts
transfer these risks to the contractor, who in addition to risk assesment must weigh
the need to be competitive. This can introduce adversarial behaviour, as client and
contractor objectives are not fully aligned. “Alliance” encourages the focus on truly
common objectives with shared gain and pain.
Turnkey Contractor, is given a defined starting point and has to achieve a defined
result. Since the contractor has complete responsibility for both managing and executing
the work (and also design responsibility), the Company as client should have little need
to be involved directly in the management of the work.
Clearly, the use of such a contract strategy demands that the work specification
be completely defined at the outset and that sufficient contractors capable of carrying
out all aspects of the project are available to provide a genuinely competitive situation.
This type of contract is usually awarded on a lump sum basis, in which case the
contractor also bears a major financial responsibility.
The attraction of the turnkey approach is that it reduces to an absolute minimum the
number of Company staff required for the project and moves substantial elements of
risk to the contractor. The contractor is reviewed at regular intervals to assess work
performance and quality. It enables the contractor to expedite completion by having
total responsibility for all interfaces. However, it should be emphasized that changes
made during the project lifetime after a turnkey specification has been completed, will
almost always involve significant additional costs.
Since there can be many variations on these themes for the constitution and operation of
a Project Management team, and hence the degree of Company involvement, none of
these arrangements needs to be rigidly adhered to. However, it should be remembered
that direct involvement is no guarantee of proper control. Control comes from effective,
timely and reliable reporting, and the ability to take prompt action based on anticipation.
As the customer in a contract situation, the Engineer should always ensure he/she is informed
about what is going on and be in a position of authority to take any necessary action.
The engineer can and should modify the basic principles as required before any
management contract is awarded.