Introduction: What This Book Is About

When a manufacturer or resource development company wants to build a new facility or refurbish an old one, the owner personnel put together the business case for the new project, develop a scope for the project, and assemble the preliminary design. If the facilities require a good deal of exacting engineering, an engineering contractor usually performs the final stage of preparation on the engineering side, while owner personnel put together the execution plan. Few companies in the process industries1 maintain the people resources needed to engineer the final stage of preparation on their own. After owner authorization, a contractor will be required to execute the detailed engineering, and that contractor will also usually procure all of the major equipment and the engineered materials for the project. The owner will require a construction contractor to build the facility. Contractors may or may not be involved in the commissioning and startup of the facilities depending on the skills and preferences of the owner.

The process of figuring out how the contractors will be selected, how they will be paid, how much work any one contractor will do on the project, and the legal framework under which the work will be done (the contract terms and conditions) is what we call contracting strategy. For reasons that will become obvious, the owner must form the contracting strategy for a project early in project development or the contracting decisions will be entirely tactical and expedient rather than strategic and thoughtful.

For some, contracting strategy is a matter of strongly held beliefs that sometimes resist any appeal to facts. This point was underscored for me recently when I asked a project system director of a large, publicly owned airport if he wanted to join a study of contracting strategies for airport projects we were proposing. His answer "No! I know integrated project delivery2 is the best contracting approach, and I don't want anybody trying to prove otherwise!" For many others, the contracting strategy followed on any particular project is more accident than design. By the time contracting strategy is broached as an issue with an owner project team, it is often too late in project development to make any changes: "Well, we are just doing what we always do." Or my favorite response: "We are just doing what the FEED3 contractor suggested."

Employing engineering and construction contractors to execute a project may not seem like an inherently difficult task. As individuals, we hire professional service firms all the time-doctors, lawyers, dentists, and so forth. Hiring engineering and construction contractors is much more difficult for a number of reasons. Projects are joint products of an owner and the contractors. It is not a simple matter to parse out who is responsible for what, even in retrospect. As projects get larger and more complex, control of the project and the contractors' performance becomes progressively more difficult. The lack of transparency gives rise to endless variations on the "principal-agent" problem, which, as we will later discuss fully, is the problem that sits at the heart of contracting. Finally, the contracting entity for projects is not a person but an organization-a corporation-and exactly who makes the decision about the contracting strategy and process within that corporation often materially affects how well the decisions are made. Decision-making responsibility is often assigned to the wrong entity within owner organizations or is assigned ambiguously.

My first goal for this book is to bring facts to the discussion of which contracting strategies work best and in what circumstances. Contracting strategy is the most difficult problem for most project managers. Contracting for engineering and construction services is always a combination of hoped for collaboration and feared conflict. For that reason, contracting strategy is less about the legalities of contracts and much more about human behavior. Some facts about what works should be the start of any contracting discussion, but owing to lack of reliable data, anecdote and opinion often have had to suffice as poor substitutes.

My second goal is to provide insight into why different contracting strategies produce different outcomes. That goal requires that we discuss the underlying principles that shape the effects of contracting strategy, for example, the principal-agent problem, the principles of risk pricing and risk assignment, and the principles of sound project preparation by owners. A focus on the principles that underpin contracting is essential because the principles provide the basis against which we must test any particular contracting strategy. When a contracting strategy flouts a core principle, that contracting strategy will lead to grief.

My third and ultimate goal is that an accounting of the facts of what works and what does not in contracting for industrial projects might facilitate reform of the sorry state of owner/contractor relationships. It is an understatement to say things have not been going well. Many contractors are just barely profitable. Many owners are frustrated and unhappy with contractor performance. The problems are deeper than the current state of contractor demographics. My hope is that some focus on the facts will help start positive change.

Point of View: What Constitutes Success?

To have a coherent discussion of contracting, it is necessary to define what successful contracting means. Success, of course, is defined differently depending on who is defining it. Throughout this discussion, I will be considering the various dimensions of success and failure from the viewpoint of those investing in the asset that the project will create. Contractors may object that defining success in this manner leaves their welfare out of the picture. But upon reflection, I believe that contractors would have to agree that if a contracting strategy routinely produces poor-quality, high-cost assets in which contractors are the only ones making money, the model is not sustainable. Conversely, if an approach produces good results for owners, that approach is ultimately sustainable only if contractors are successful as well. The problem is mostly one of finding a stable mutually beneficial model.

I find that many owners as well as contractors wonder if the current engineering and construction market is a sustainable business model. I share that concern, which is one of the reasons I felt compelled to write this book. My position, which is supported by data throughout, is that the key weaknesses in the current market start with weaknesses in owner project organizations. Owner project organizations are too weak to create a stable, self-enforcing business relationship between owners and contractors. Those driving the relationships on the owner side are frequently too transactional in their approach to foster a stable market. It is my hope that this book may help move the discussion toward more sustainable and robust relationships in the future. Just to be clear, however, I do not believe that gimmicky contracting approaches will accomplish that goal. The focus on project fundamentals must remain strong.

The Context

Contracting for a project must start with the project. How big is it? How many distinct elements of scope does it contain? Where is it going to be geographically? Geography is the single most important element in understanding the contractor market for most projects. How technically difficult is the project? Does the project use routine technology or require something new to the owner or even new to the industry? We will discuss all of these issues later as we explore how the project and the contracting strategy interact.

Next, we need to consider the competence of the owner projects organization to undertake this particular project. Does the owner have the personnel needed to front-end load-fully define-this project? Does the owner have estimating, planning, and scheduling capability? Can the owner field a strong controls team? Does the owner have the capability to do quality control and inspection of engineering and construction? Has the owner built this sort of facility recently, and are those who remember that project still around? Owners with weak project organizations struggle with all forms of contracting, but some forms are poison for them. Blithely assuming that one can do anything by simply buying consultants, agency personnel, or individual contractors from the market suffers from the defect of not actually being true.

Defining the Elements of Contracting Strategy

Like any other aspect of project management, contracting requires a series of activities and decisions, which need to be supported by work processes that guide how things are done at a given owner company. I see seven major elements of contracting strategy, each of which needs to be navigated successfully. Often discussions of contracting strategy begin and end with the compensation scheme that will be used: fixed price (lump-sum) or reimbursable. Although compensation scheme is important, it is but a single element in the mix, and compensation scheme is often dictated more by the market than by owner strategy.

• Structure: By phase and activity, how much work should any one contractor do? I consider structure to be considerably more important than the compensation scheme in understanding contracting. In many projects, a...