Risk Management for Contractors.ppt
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Contract Risk Management for Engineering Contractors J. Barry Orr MBE BEng (Hons), CEng, FIMech. E
Pre-Contract • Introduction • Trends in the Transference of Risk • Principal causes of loss • Essential Elements of Contract Risk Management (CRMP) – pre-contract © BARRY ORR FIG. 1
Reasons for Developing a Comprehensive CRMP • Risk management is a continuous process from first contact with a potential client to contract close-out • Clients were transferring more risk to contractors • Some risks were not being identified early enough • The result was profit erosion after the point of sale • Project managers were blamed for profit erosion • ‘Disaster’ contracts were endangering the company © BARRY ORR FIG. 2
Trends in the Transference of Risk • Tighter prices for the contractors • Lump sum fixed prices were normal • Technical change is accelerating – innovation • Plant performance tests more onerous • Trends towards re-vamping existing plants • Novelty of client, country, culture, language, applicable law • Clients becoming more commercially skilled • Contract terms becoming more onerous • Clients want predictability of cost, time, performance and return on investment FIG. 3 © BARRY ORR
Risk Assessment • Identification of risks • Response – Rejection – Amelioration – Transference – Acceptance • Analysis of accepted risks • Provisions/contingencies for accepted risks © BARRY ORR FIG. 4
Pre-contract Errors • No structured objective enquiry acceptance procedure • Inadequate quality of the proposal and estimate • Inadequate priority in staffing the proposal team • Inadequate involvement of senior management • Inexperienced proposal management • No structured tender approval procedure • Inadequate/inappropriate contract conditions • Failure to control the negotiation © BARRY ORR FIG. 5
TO BID OR NOT TO BID • • • Are sufficient resources available? Has the client allowed sufficient time? Are the ITB conditions compatible with the CRMP? What are the chances of success? Does client relationship demand that we bid? The above questions are addressed at the Enquiry Acceptance Meeting © BARRY ORR FIG. 6
Sales Strategy • • Reasons for bidding The winning features of the bid Importance of technical excellence Project execution strategy Commercial and financial aspects Strategic alliances and the reasons for these Government involvement Client contacts © BARRY ORR FIG. 6(a)
Sales Strategy (Cont. ) • • Agents Counter trade Competition Contractor’s weaknesses and strengths Proposal documentation Pricing Tender evaluation by client - method and time scale • Visits to client pre-tender © BARRY ORR FIG. 6(b)
Pre-contract Errors • No structured objective enquiry acceptance procedure • Inadequate quality of the proposal and estimate • Inadequate priority in staffing the proposal team • Inadequate involvement of senior management • Inexperienced proposal management • No structured tender approval procedure • Inadequate/inappropriate contract conditions • Failure to control the negotiation © BARRY ORR FIG. 5
The P. M. ’s ‘Trilemma’ Quality/Specn Risk P PM Cost FIG. 7 Time Risk © BARRY ORR Proposal Management Control
Pre-contract Errors • No structured objective enquiry acceptance procedure • Inadequate quality of the proposal and estimate • Inadequate priority in staffing the proposal team • Inadequate involvement of senior management • Inexperienced proposal management • No structured tender approval procedure • Inadequate/inappropriate contract conditions • Failure to control the negotiation © BARRY ORR FIG. 5
Some reasons why we take bad contracts We do not recognise or we ignore: • The effects of novelty in all its forms • The ability to justify a ‘thin’ estimate • Self delusion in avoiding under recovery/redundancies • Occasional technical weakness of our selling position • Inconsistencies/conflict in the contract documentation • The dangers in the ‘thrill of the chase’ • The many other potential risks in a particular contract © BARRY ORR FIG. 8
Essential elements of CRMP – Pre-contract • • • Enquiry acceptance procedure Tender approval procedures Risk assessment and analysis Contract start-up procedures Contract control procedures for time, cost, quality/specification Contract review and reporting procedures Staff training and development Contract auditing system Contract close-out reports © BARRY ORR FIG. 9
CRMP IS NOT ANTI-SELL IT IS INTENDED TO ENSURE: OBJECTIVITY CONSISTENCY HONESTY And TO AVOID SELF-DELUSION © BARRY ORR FIG. 10
Tender Approval Procedure • • Tender approval request Tender approval summary Estimate summary to standard format Commercial and technical appreciation Contract liabilities statement Country clearance report Risk assessment and analysis Cash flow analysis © BARRY ORR FIG. 10(a)
Essentials of our Risk Analysis • Based on collective experience of those involved • Maximum experience should be assembled • Participants need a common thought process – standardisation • Complete in one session • Address maximum number of elements of the estimate • Set a standard acceptable level of probability of breaking even • Simple and quick to operate and adjust • Market situation must not affect it © BARRY ORR FIG. 11
What is a fair price? PRICE = COST + PROFIT COST = BASE ESTIMATE + RISK PROVISION PRICE = BASE ESTIMATE + RISK PROVISION + PROFIT © BARRY ORR FIG. 12
Areas Addressed in our Risk Analysis • Estimating accuracy – all elements • Degree of definition – impact on activities • Contract conditions – risk areas • Financial risks in contract execution • Siteworks risks – if not covered above © BARRY ORR FIG. 13
Element RISK ELEMENT 1. 0 Estimating Accuracy 1. 1 Merchant Account Costs: 1. 2 Manhour Costs – In-House: 1. 3 1. 4 1. 5 1. 6 1. 7 1. 8 Value Mechanical Costs Electrical Equipment Instrumentation Steel Structures Bulk Materials Bought-Out Design Sub-Let Civil Works Sub-Let Installation Eng-Process Eng-Piping Eng-Elect. Instrumentation Eng-Machinery & Vessels Eng-Coordination Procurement Project Management/Control Site management Supervision of Construction Supervision of Commissioning Manufacturing In-House Shipping & Transport Expense Items Direct Labour Hire – Site Agency Manhours Escalation Allowance – 1. 1, 1. 2, 1. 3, 1. 6, 1. 7 Sub Total © BARRY ORR Risk % Amount Benefit % Amount
Element RISK ELEMENT Value 2. 0 Degree of Definition 2. 1 Additional Engineering 2. 2 Additional Supply 2. 3 Additional Construction 2. 4 Plant Performance Tests 2. 5 Other Sub-Elements Affected Sub Total © BARRY ORR Risk % Amount Benefit % Amount
Element RISK ELEMENT Value 3. 0 Contract Conditions 3. 1 Late Completion Penalty 3. 2 Prolongation Cost 3. 3 Plant Performance Penalty 3. 4 Rectification/Make Good 3. 5 Defects Liability 3. 6 Client ‘interface’ 3. 7 Norms and Standards 3. 8 Licensor Default Sub Total © BARRY ORR Risk % Amount Benefit % Amount
Element RISK ELEMENT Value 4. 0 Financial 4. 1 Non-Payment 4. 2 Cash Flow Finance 4. 3 Bonds & Guarantees unfair calling-ultimate net cost 4. 4 Duties & Taxes 4. 5 Income Tax Equalisation 4. 6 Escalation – if not in 1. 8 4. 7 Soft Currency Surplus 4. 8 Exchange Rate Variation Sub Total © BARRY ORR Risk % Amount Benefit % Amount
RISK ELEMENT Element Value Risk % Amount Benefit % Amount 5. 0 Siteworks (additional to elements 1 &2 ) 5. 1 Civil works growth 5. 2 Erection works growth 5. 3 Design Errors 5. 4 Soil Conditions & Climate 5. 5 Local Escalation 5. 6 Acceleration Costs 5. 7 Direct Labour Hire Disputes Sub Total Grand Total Footnotes: 1. The generic term ‘Expense items’ includes such things as cost of insurances, bonds and bank guarantees, travel and subsistence, miscellaneous home office and site costs not included in the overhead, Agents Commissions, Duties and Taxes. © BARRY ORR 2. The above list is not exhaustive and specific contracts may contain other risk categories.
Corrected Risk Provision Calculation P 100 -P Bt Rc BE Benefit R P R O B A B I L I T Y % Rt Risk Cost = Price – Profit (Base Estimate + Rc) and Rc = Rt - R © BARRY ORR FIG. 14
The Negotiation • One leader and decision-maker and small team • Prepare and identify the objectivity and walk away point • Retain the support of vendors and subcontractors • Share the ‘pain of concessions’ • Continually update the risk analysis • Negotiate reallocation of risk • Data base for evaluation of scope changes • Achieve a fair/acceptable deal or walk away • Seek reapproval before settling © BARRY ORR FIG. 15
Re-allocation of Risk • • • Longer project schedule Relax plant performance criteria Reduce liquidated damages Reduce defects liability period Early freeze date for basic engineering Apply international design standards Client to provide insurance cover Improve terms of payment Relax bonds and guarantees Client responsibility for duties and taxes Client accepts tender-to-contract exchange rate risk © BARRY ORR FIG. 16
Contract Risk Management for Engineering Contractors Part 2: Post-contract
The PM’s ‘Trilemma’ Quality/Specn Risk P PM Risk Provision Valve FIG. 0 Cost Time Risk © BARRY ORR Risk Management Control
Post-contract Errors • Inadequate attention to contract start-up • Inexperienced Project Management • Inadequate authority of the Project Manager • Inadequate control procedures • Inadequate reporting and forecasting • Inadequate Risk Management strategies • Poor Contract Administration • Inadequate Involvement of Senior Management © BARRY ORR FIG. 1
Contract Start-up Meeting • Background to the project • The sales process: • • – – – Internal 1 Enquiry acceptance Development of the proposal Assumed contract execution strategy The as-sold estimate The contract programme Tender acceptance documentation Finally negotiated scope and responsibilities Details of contract documentation Client personnel and relationships Third parties involved Meeting led by Chief Sales executive Preliminary handover to Operations © BARRY ORR FIG. 2
Contract Start-up Meeting • • Internal 2 Introduction of key members of team Confirmation of the as-sold scope P. M. ’s view of risk analysis Strategy for execution and risk management Responsibilities of each discipline Cost control budget Contract programme Quality plan Meeting led by Project Manager Final take-over by Operations © BARRY ORR FIG. 3
Contract Start-up Meeting With Client • • As-sold scope Project administration procedures Contract variation procedure Client responsibilities and timing Reporting and review meetings Basic design freeze dates Client involvement and lines of communication Training requirements To set the ground rules for the contract © BARRY ORR FIG. 4
Post-contract Errors • Inadequate attention to contract start-up • Inexperienced Project Management • Inadequate authority of the Project Manager • Inadequate control procedures • Inadequate reporting and forecasting • Inadequate Risk Management strategies • Poor Contract Administration • Inadequate Involvement of Senior Management © BARRY ORR FIG. 1
Risk management – Key Requirements • PM to review risk provision at contract start-up • PM to develop strategies for each area of risk • PM reviews strategies regularly (monthly) • PM repeats risk analysis monthly • Application of QA reduces risk • Operational audits on contracts confirm strategies © BARRY ORR FIG. 5
Essential Elements of a CRMP • • • Enquiry acceptance procedure Tender approval procedures Risk assessment and analysis Contract start-up procedures Contract control procedures for time; cost; quality/specification Contract review and reporting procedures Staff training and development Contract auditing system Contract close-out reports © BARRY ORR FIG. 6
Contract Administration • Full time contract administrator • Detailed records and computerised retrieval system • Credit control • Contract variations and change control • Site controls and record keeping – – – Daily diaries As-built programmes and drawings Minutes of meetings Dated progress photographs Site instructions and valuations Weather and lost time records © BARRY ORR FIG. 7
Control of Quality • Quality plan should be part of contract controls • Apply quality assurance – BS 5750 (Part 1), ISO 9001 – – – Engineering Procurement Construction Vendors Subcontractors • Familiarity with quality manual • Apply technical audits to engineering • Implement quality control through inspection © BARRY ORR FIG. 8
Safety and Operability Reviews • HAZOP studies – Qualitative and systematic – Based on PFDs and PIDs • HAZAN studies – Quantitative – Based on fault tree analysis for major hazards • Engineering safety reviews – Checklist method – Based on protection systems, site plans and area classification © BARRY ORR FIG. 9
HAZOP Study Reviews • Review 1 – Proposal stage – Safeguards the estimate • Review 2 – Soon after start-up – Basic engineering confirmed • Review 3 – Major review after basic engineering – Provides sound basis for detail design • Review 4 – Prior to AFC stage – Provides sound basis for construction • Review 5 – Prior to commissioning – Provides final assurance that plant as built is fit for commissioning © BARRY ORR FIG. 10
Contract Reporting (Part 1) • • • Internal PM’s Monthly Report Executive Summary Contract Financial Status Report Progress Summaries – E, P, C 1, C 2 Claims Analysis Areas of Concern Risk Management Strategies © BARRY ORR FIG. 11
Contract Reporting (Part 2) Report to client – lump sum contracts • General description of scope including plant layout • Management summary • Areas of concern • Major events in the period • Schedule review • Commercial review • Engineering/technical review • Procurement/manufacturing review • Construction/commissioning review © BARRY ORR FIG. 12
Contract Reporting (Part 3) Report to client – Management reimbursable contracts • • • Project Director’s executive summary Expenditure and commitment reports with ‘S’ curves Approved budget changes report Current budget. forecast variation report Escalation report Risk provisions review Cash flow report Detailed progress for E, P, C 1 & C 2 Force report Photographic record of site progress © BARRY ORR FIG. 13
Principal objectives of a contract audit • • • Compliance with the CRMP Adequacy of contract control procedures Assess risk management strategies Carry out current risk analysis Produce cost report and profit forecast Recommend corrective actions/solutions © BARRY ORR FIG. 14
Contract Audit Principles • • Impartial and objective Competent audit team Authority from Main Board Comprehensive scope from enquiry receipt to time now © BARRY ORR FIG. 15
Preparations for Audit • Develop standard interrogation procedure • Set up standard format for recording responses • Follow audit trail from first contact with client to time now • Advise parties in advance of documentation to be available © BARRY ORR FIG. 16
Audit Execution - Presale • • • Full overview briefing by project manager Interrogation of sales Interrogation of proposals Interrogation of estimating Check risk analysis presale Check tender approval submission Review changes during negotiation Check final approval Review commercial contract © BARRY ORR FIG. 17
Audit Execution – Start-up • Check handover procedure from proposals to operations and start-up meeting minutes • Review preliminary contract instructions • Review as-sold scope documentation • Review minutes of start-up meeting no. 2 • Review final contract instructions • Review minutes of start-up meeting with client • Review initial staffing of contract © BARRY ORR FIG. 18
Audit Execution – Contract Management • Controls for: – Time – Cost – Quality/specification • Cash management • Site controls – goods receipt to final acceptance • Control of vendors/subcontractors • Client involvement • Risk identification and management • Contract financial status report – including risk analysis © BARRY ORR FIG. 19
Contract Close-out and final actions • Progressive dismantling of task force – Staff appraisals – Re-entry to home office organisation • Agree outstanding claims from/on client and subcontractors • Confirm final acceptance by client • Recover bonds and guarantees • Invoice for remaining retentions • Produce final contract financial status report • Write close-out report © BARRY ORR FIG. 20
The contractors 12 -point plan for project success 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Formal enquiry acceptance procedure Tight proposal management Comprehensive risk assessment and analysis Standardised tender approval procedure Thorough preparation for and discipline during negotiations Avoid pitfalls with ‘Letter of Intent’. And implement a formal contract start-up procedure Effective contract administration and application of time/cost/quality controls from Part (1) Accelerate design whenever possible to create float in the programme Apply risk management strategies including regular technical, managerial and safety audits and reviews Site construction requirements to be paramount – locate project manager on site Thorough preparation for systematic handover to client and expeditious completion of plants/systems performance tests, and monitoring of client operations post handover Comprehensive close-out of project including obtaining outstanding retention/bonds, settling claims and issuing internal close-out report © BARRY ORR FIG. 21
Risk Management for Contractors.ppt