Contract Risk Management for Engineering Contractors J. Barry

Contract Risk Management for Engineering Contractors J. Barry Orr MBE BEng (Hons), CEng, FIMechE

© BARRY ORR Pre-Contract Introduction Trends in the Transference of Risk Principal causes of

© BARRY ORR 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 FIG. 2

© BARRY ORR 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

© BARRY ORR 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 FIG. 5

© BARRY ORR 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? FIG. 6 The above questions are addressed at the Enquiry Acceptance Meeting

© BARRY ORR 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 FIG. 6(a)

© BARRY ORR 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 FIG. 6(b)

© BARRY ORR 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 FIG. 5

© BARRY ORR The P. M.’s ‘Trilemma’ FIG. 7

© BARRY ORR 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 FIG. 5

© BARRY ORR 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 FIG. 8

© BARRY ORR 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 FIG. 9

© BARRY ORR CRMP IS NOT ANTI-SELL IT IS INTENDED TO ENSURE: OBJECTIVITY CONSISTENCY

© BARRY ORR 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 FIG. 10(a)

© BARRY ORR 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 FIG. 11

© BARRY ORR What is a fair price? PRICE =

© BARRY ORR 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 FIG. 13

© BARRY ORR Corrected Risk Provision Calculation FIG. 14 and Rc =

© BARRY ORR 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 FIG. 15

© BARRY ORR 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 FIG. 16

Contract Risk Management for Engineering Contractors Part 2: Post-contract

© BARRY ORR 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 FIG. 1

© BARRY ORR Contract Start-up Meeting Internal 1 Background to the project The sales process: 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 FIG. 2

© BARRY ORR 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 FIG. 3

© BARRY ORR 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 FIG. 4

© BARRY ORR 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 FIG. 1

© BARRY ORR 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 FIG. 5

© BARRY ORR 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 FIG. 6

© BARRY ORR 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 FIG. 7

© BARRY ORR Control of Quality Quality plan should be part of contract controls Apply quality assurance – BS5750 (Part 1), ISO 9001 Engineering Procurement Construction Vendors Subcontractors Familiarity with quality manual Apply technical audits to engineering Implement quality control through inspection FIG. 8

© BARRY ORR 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 FIG. 9

© BARRY ORR 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 FIG. 10

© BARRY ORR Contract Reporting (Part 1) Internal PM’s Monthly Report Executive Summary Contract Financial Status Report Progress Summaries – E, P, C1, C2 Claims Analysis Areas of Concern Risk Management Strategies FIG. 11

© BARRY ORR 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 FIG. 12

© BARRY ORR 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, C1 & C2 Force report Photographic record of site progress FIG. 13

© BARRY ORR 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 FIG. 14

© BARRY ORR Contract Audit Principles Impartial and objective Competent audit team Authority from

© BARRY ORR 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 FIG. 16

© BARRY ORR 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 FIG. 17

© BARRY ORR 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 FIG. 18

© BARRY ORR 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 FIG. 19

© BARRY ORR 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 FIG. 20

© BARRY ORR The contractors 12-point plan for project success 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 FIG. 21