NATIONAL PETROCHEMICAL & REFINERS ASSOCIATION

1899 L STREET, NW, SUITE 1000

WASHINGTON, DC 20036

MC-02-167

VALUE BASED CONTRACTING

By

Tim Horner
Vice President

And

Phil Kirby
Operations Director

Faithful & Gould Inc.

Houston, TX

Presented at the

NPRA
2002 Annual Refinery & Petrochemical Plant
Maintenance Conference and Exhibition
May 7-10, 2002
San Antonio Convention Center
San Antonio, TX
This paper has been reproduced for the author or authors as a courtesy by the National Petrochemical &
Refiners Association. Publication of this paper does not signify that the contents necessarily reflect the
opinions of the NPRA, its officers, directors, members, or staff. NPRA claims no copyright in this work.
Requests for authorization to quote or use the contents should be addressed directly to the author(s)
VALUE BASED CONTRACTING Have you ever wanted to leverage your
suppliers and improve the performance
level of the labor force?
By
Tim Horner – Vice President Are you seeking to reduce your levels of
Phil Kirby – Operations Director spend without reducing work scope?
Faithful&Gould Inc
Are you and your Contractors struggling
to attract quality labor in to your
workplace?

1 INTRODUCTION
The drive to reduce cost and improve margin is never ending; stimulating new
areas of innovation that are constantly being tested in the marketplace. The US
Refining Industry is currently embarking upon a step
change in its Contracting Solutions one which
promises to “reduce cost, improve productivity in the
workplace and potentially provide a more attractive
Savings of up to 45%
environment for new recruits” – too good to be true?

Value Based Contracting is such a Solution. Not so

much a recent innovation but a tried and tested
product. In use for over thirty years, mainly in Europe, when used correctly it can
have a significant impact on your “bottom line” – savings of up to 45% have been
achieved when compared with the more traditional cost reimbursable
procurement method. Interested? Read on.

What is VBC?
2 SO WHAT EXACTLY IS A VALUE
BASED CONTRACT • More
More than just a Contract
Unit
Rates
• Not
Not just about the administration of
Simply put “you pay a consistent price for Unit
Unit Rates

the end product that you receive; • A

A Contracting Solution which:
– manages
manages risk
regardless of the resources expended by – promotes
promotes best
best performance
performance
– optimizes
optimizes price
price throughout
throughout the
the supply
supply
chain
chain
the supplier (labor, equipment or material)
It is not the only Contracting Solution
Solution
which may vary from time to time” 2001 F a i t h f u l&Gould Inc

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 Imagine going to the grocery store and seeing price fluctuations on a weekly
basis ranging from 5% to 40%. What would that do your household budget? How
could you realistically plan ahead for that new kitchen or extension? To US
Refiners and their Suppliers these fluctuations in Cost are not unusual – indeed it
is most probably the norm; especially when the basis of procurement is cost
reimbursable (T&M). Moreover, because of the reimbursable nature of the
contracting process, there are no metrics in place that enable the purchaser to
determine what return he is getting for his dollar.

Value Based Contracts provide a mechanism to give a high degree of cost

certainty. The Unit rates contained therein are essentially “mini lump sums” yet
the Contract is more than this as it offers robust work process protocol which
manages the effectiveness and associated risk throughout the work supply chain.

The program is not just about having measured unit rates for components of
work it is a flexible contract which combines the mechanics of more than one
contract type enabling users to flex between Measured Work (Unit Rates) and
Non Measured Work (Cost Reimbursable – T&M). Key Performance Indicators
(KPI’s) control the success of the implementation.

3 SOUNDS FAMILIAR?
VBC should be a familiar concept to anyone involved in the new
construction and or maintenance arena. It is by no means rocket
science and has been around for over 30 years - not just in Europe
but also here in North America - JOC (Job Order Contracting) is a similar
contract model and is being used successfully in the Public Sector; the concept
has been tried in the Private Industrial Sector including Refining and Chemicals
as recently as the mid 80’s, although the mechanics of the contracts were less
than adequate and there was insufficient focus on cost efficiency (more on this
later).

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 Today most leading refining companies here in North America are considering
adopting a VBC program and some have already successfully transitioned their
T&M operations over to VBC equivalent types of performance contracts - utilizing
Unit Rates as their cornerstone.

4 IT IS NOT THE ONLY C ONTRACTING SOLUTION

4.1 VBC Generally
All good ideas need to be tested in new arenas; VBC is no exception to this,
being used in all types of New Construction and Maintenance. However, there
are many other types of Contracting Solution and these can be more suitable at
times.

As for VBC it is ideally suited to both Maintenance and Minor Capital programs. It
can be used on major capital projects although other forms of contract would
normally be considered more appropriate. VBC can also help with some Control
aspects including estimating, change management and even benchmarking.

“Having already procured

what are effectively mini It is not the only Contract Solution
High Low High
lump sums, with a pre Lump Sum
Definition of Requirements

Itemized Lump Sum

Administration Effort

determined specification;
Final Cost Certainty

Firm Bills of Quantities

Approximate Bills of Quantities

users of VBC Contracts Value Based Contracting

Management Fee
can quickly and efficiently
Reimbursable (T&M)
Low High Low
execute work with very Low Uncertainties High

Low Likelihood of Variations High

little scope definition yet Low Early Start Requirement High

Low High
with a high level of cost Wait During Execution

certainty” 2001 Faithful&G o u l d I n c

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4.2 Other forms of Contract
There are many other types of contract style, however, most performance-
orientated contracts use as a basis of one of the styles shown on the chart in
section 4.1 – applying a variety of performance metrics from safety, schedule and
cost.

5 WHERE CAN THE SOLUTIONS BE APPLIED?

5.1 Owners Activity
VBC is ideally suited to both Maintenance and Minor Capital programs. It can
also be used for major Capital projects – though with the latter consideration
should be given to alternate forms of contract. Turnarounds can use VBC but
even in Europe this is less prevalent due to the time constraints normally
associated with these
Where can the Solution be applied?
events.

•Capital
Capital Projects
More recently there is
an increasing trend • Maintenance
Maintenance / Minor
Minor Works
Works

towards applying the

• Turnarounds / Shutdowns
Shutdowns
principles of VBC to
Engineering and • Facilities Management

some consulting
functions and even
2001 Faithful &Gould Inc

some regular Office

functions.

5.2 Market Sectors

VBC can be used effectively in all aspects of the refining process from
Exploration right up to the retail selling at service stations. It can also be found in
most marketplaces from industrial markets (e.g. refining, chemicals, etc)
transportation markets (e.g. rail, aviation, road, etc) and property (e.g. banks,
retail, leisure, etc).

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5.3 Service excellence
VBC compliments the process of control and analysis to a high degree.
• Estimating – procuring items in such a manner allows the compilation of very
accurate price databanks. specific to a particular project type, geographical
location, business sector or trade
• Change Management – change control becomes less problematic as work
scope can be priced based on the Unit Rates – even difficult Time & Material
solutions can be cross checked
• Benchmarking – managing multiple activities and recording such data allows
the compilation of comprehensive rate schedules which can be a better fit
than off the shelf price books

5.4 The trades

The concept of VBC can be used for
Which Trades?
almost any routine operation. It is
• Soft Trades • Hard
Hard Trades
Trades
more commonly used in Scaffolding,
– Scaffolding – Civil/Structural
Civil/Structural

– Insulation
Insulation – Mechanical
Mechanical
Insulation, Painting, Tank
– Painting
Painting – Electrical
Electrical Maintenance, Civil, Structural,
– Tank Maintenance – Engineering
Engineering
Mechanical, Electrical and even
engineering support; though the
latter is a difficult application until
2001 Faithful&Gould Inc

definition has been created.

6 HOW DOES VBC WORK?

As mentioned earlier you pay the same price for an item of work “time and
again”. No variation except for inflationary increases. Unit Rates or mini lump
sums are procured for defined items of work. Schedules of rates comprising
hundreds sometimes thousands of line items are established in a “call-off” master
services agreement.

The VBC program is more than just a schedule of Unit Rates. It is a Quality
Assured process that impacts all aspects of the Work Supply chain affecting
Asset Management/Life Cycle Costing continually stimulating improvement as
both Owner and Suppliers work in harmony to increase their margins – “each
knowing that a fair deal is being struck”.

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 There are several fundamental items that
differentiate VBC from regular performance
contracts not least of which are the Control
Procedures and the Standard Method of
Measurement (SMM).

7 CONTROL PROCEDURES
Most Contracts generally contain some form of Control procedure whether this is
simply how to fill out a timesheet and have it authorized or a detailed work
process. However, it is not the writing that is the issue it is the subsequent Post
Contract Administration.

7.1 More than just a contract

Far too often Contracts are written with little or no thought having been put into
the Post Contract Control.
Contracts are often not VBC – More than just a Contract

owned or understood once

INPUTS Pay
e
urc

they have left the Valuation

so
Re

Execute
Contracts /Procurement
Contract/
Supply
Group. If procedures / Plan/
Schedule

processes do exist they Estimate

KP men e
re cce
su aann

t
Definition
ea rm

often sit on a bookshelf,

M erfo

Idea / Need
I’ss

OUTPUTS
P

hard disk drive, intranet/

internet; often ignored by 2001 Faithful& Gould Inc

all parties - relying on experienced individuals to execute Control in their own

style. Such reliance can be costly and incorrectly controlled VBC is not
uncommon, as Owners struggle to accept the increased overhead cost of post
contract administration required for this style of contract.

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7.2 Example Control parameters
• Idea/Need – using pre-established performance metrics the continuous
improvement loop ensure that everyone is focused on process excellence.

• Definition – no matter what the scope of work VBC has a tailor made
Standard Method of Measurement that makes interpretation of requirements
crystal clear.

• Estimating – using archived unit rates which can complement any estimating
activity from conceptual, feasibility, sanction through to control estimates

• Plan/Schedule – planned maintenance activities can be executed with a high

degree of cost certainty. KPI’s identify bottlenecks in the work management
process (for both Owner and Supplier) ensuring optimal attention to the
planning and scheduling activity.

• Contract/Supply – master call off agreements facilitate a speedier route to

market

• Execution – robust procedures are needed to

ensure that appropriate resources are used not just
for the process inputs but also for the correct
interpretation of the KPI’s

• Valuation – the need to effectively manage the Unit Contract pricing element
is seen as little more than an overhead burden by some organizations.
However, this process is key to any VBC program and when properly
managed can provide a level of control on project expenditure that fully
justifies the cost of implementation. Modern technology in the form of
electronic validation systems and Palm computers can greatly increase the
efficiency and effectiveness of those involved in evaluating the work.
Many owners are struggling with using a combined technical oversight with
commercial control. Normally this is fraught with problems as the old
dilemma of cost or schedule is driven to the fore. A typical refining company
will normally want the work executed as quickly as possible hence the more
rigorous cost controls are often not fully implemented.
• Payment – would normally be expected to be slower than a T&M contract
however, providing that there are adequate controls in place then normal
payment terms (less than 30 days) should be capable of being maintained.

• KPI’s – each process step needs to have appropriate KPI’s. The most
common of which is the Measured Works versus Non Measured Work.
Typically an 80/20 ratio is an acceptable target here in North America though
this will vary depending upon the selected trade. Some European sites have
seen the ratio as low as 97:3

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7.3 Warning – VBC Can cost you more than expected
A poorly implemented contract can cost Owners more than a traditional T&M
Contract and Contractors/Suppliers will not attain the efficiencies that will keep
them competitive in the marketplace. Recent audits are indicating that some
Owners are indeed paying more than expected due
to poorly implemented controls. These “backdoor”
payments/claims are largely resultant from poor
contract administration as Contractors/Suppliers
look to use the mechanics of the contract to their
advantage adopting “measured work” when
favorable; reverting to the T&M option at the
slightest sign of difficulty.

8 STANDARD METHOD OF MEASURMENT (SMM)

8.1 So what exactly is an SMM
The SMM is a published methodology; which standardizes the
description/specification of definitive work components, these components
provide the basis for Measured Units contained within Schedules of Rates; which
in turn allows a common understanding across the marketplace (client and
suppliers alike).

8.2 Why do we need an SMM

Standardization normally is a platform for cost efficiency. The SMM is no different
in that it enables all parties to interpret construction, and maintenance, activities
in the same way. No more comparing apples with oranges on that bid return, no
more argument about what element of work was contained on that change order.
Furthermore it provides an endless ability to analyze performance; given that
budgets as well as actual metrics are all recorded in the same way – often using
technology (Contract Management Systems) which have been designed with the
SMM in mind.

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8.3 History of the SMM
First published in England in 1922 by a joint committee; comprising the Quantity
Surveyors Association, the Surveyors Institution, four nominated Contractors and
the Institute of Builders.

The express objective was to provide a uniform method of measurement

agreeable to both client requirements and the contractors estimating needs, and
remove doubt and uncertainty as to whether the price was complete or not.

Since that first issue, six revisions have been

made, to include for changing material
technology and contracting practice, the latest
being in 1988.

In addition to the Building Works edition, SMM’s

have been written for Civil Engineering work
(CESMM), Industrial projects (SMMIEC) and projects of an International nature
(Principles of Measurement International), to take into account the needs of
differing project types.

Main benefits can be summarized as follows:

• Certainty of what work elements are included in each priced item
• Ease of bid return analysis, and comparison to other similar projects
• More accurate estimating by contractors
• Reduction of disputes post contract
• Better bid documentation improving project communication
• Basis for the evaluation of project change now available

8.4 North America and SMM

Although there are many examples of SMM and even an International version
invariably these are not being adopted in the North American marketplace.
There are few trades which have adopted an SMM here in North America and
the European versions traditionally require the compilation of many more line

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 items – within the Contract Schedules – than has been desired by Owners;
typically concerned about the associated administrative difficulty

A project in Europe may be based

upon schedules of rates comprising
several thousand items, whereas a
comparative North American scheme
will typically adopt schedules
containing one-third the number of
items. The reduced number of priced
units may often lead to problems in
the interpretation and evaluation of
contract/scope changes and frequently requires the potentially adversarial
negotiation of rates to be applied to work items not covered by the original
schedules.

The marketplace is currently experiencing a convergence of interpretation of the

SMMs e.g. Europe are often relaxing their definitions creating more composite
items and North America is seeking ever increasing detail but not the to same
extent as traditional European practices. Faithful&Gould are at the forefront of
this development and have already successfully adopted a VBC standard on
both sides of the Atlantic.

There are many example of Pricing Books being used in the North American
marketplace including Means, Page & Nations, Richardsons etc – some are used
successfully in the fulfillment of Unit Rate type contracts however, these tend to
be utilized more in the Public sector than that Private.

8.5 SMM and the Challenge for Owners

As mentioned earlier VBC is not new to North America, however, a major reason
for earlier failures and the current sub optimal application is that Owners are
effectively “doing their own thing”. While some owners consider this to be a

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 competitive edge (with benchmark savings here in North America of 20%+ there
is little argument) optimum efficiencies will only be realized with Standardization
across the industry.

The major component of VBC is the transfer of some of the risk elements from
Owner to their Contractors. Contractors and Suppliers will be able to operate
much more efficiently if Owners can standardize how they do business. Much the
same as happened in England in the early 20th century.

E.g. several different Gulf Coast owners have undertaken VBC programs over
the past few years. All have very different SMM’s forcing the Contractors to adopt
multiple systems (IT and business process) to price and manage their affairs.
Similarly benchmark across the Industry is also more difficult.

9 THE BENEFITS
The single largest issue with the VBC program is in believing the claimed
benefits - up to 45% - how can that
happen; many ask in disbelief? The Typical Client Benefit Profile
50%
answer is simple. This program has 45%
Documented Savings as a result of changing
From Time and Material to VBC
40% High
been around for over 30 years with 35%
Low

30%
% Savings

Faithful&Gould at the forefront of 25%

20%
managing the implementation and 15%
10%
control; proving time and again 5%
0%
that, done correctly, there are Scaffolding Insulation Painting Pipe Civil E&I

significant benefits to be gained. 2001 Faithful&Gould Inc

F&G have maintained a Unit Rate databank since the mid 80’s, applicable to
almost any industrial facility. This provides an abundance of data suitable for
trending the application of VBC. Although largely gleaned from European
Projects, there is a growing body of data being added from North American
companies that are being converted to belief in the worth of VBC.

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 “On day one of implementing a VBC Contract we saw a 30% reduction in the
Contractors workforce – giving immediate savings – with no marked impact upon
the support to the facility. Furthermore the influx of labor in to the marketplace
helped alleviate labor supply problems with adjacent worksites”
Typical client quote

“Using VBC has actually helped improve our margins, we are even looking at
being able to reward our labor force with the use of a productivity scheme”
Typical Contractor Quote

How can these savings be achieved?

9.1 Supply Chain Risk Management

The concept of VBC firmly apportions the risk across a greater number of
resources within the supply chain. Unlike a traditional T&M style contract where
the owner generally pays for labor hours worked (or even labor hours in
attendance) the owner now shares Risk Management in the Supply Chain
the risk with the their suppliers and
even the suppliers workforce.
T&M
Labor

Most current forms of VBC have Contractor

successfully transferred the Risk
from the Owner to the Owner VBC
Challenge
Contractor/Supplier. This is of great
benefit to the Owner, but the 2001 Faithful &Gould Inc

Contractor now has the burden of extra risk and still has the age-old problem of
how to motivate the labor force.

The most successful forms of Contract seek to further transfer share the risk with
the labor force ensuring that performance related benefits are available to all.

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9.2 Typical Owner Benefits
Aside from the monetary efficiencies VBC has a considerable impact on
Business processes throughout the work supply chain. Including speedier
completion of work task not just because the suppliers are more productive but
also because the Owners
More Owner Benefits
themselves can accelerate
the procurement process • Reduced
Reduced time
time for price negotiations (call -off
-off contract)

• Early
Early engagement
engagement of suppliers with minimum
(with a high confidence engineering
engineering detail

Pre
Pre-determined performance
performance levels
level in price certainty) and • levels

• Risk
Risk shared
shared with
with Suppliers
Suppliers
are continually removing
• Pricing
Pricing data provides up
up--to
to--date
date estimating norms
bottlenecks in the work
• Provides
Provides fair method for evaluating scope change
change
process as a result of • Promotes
Promotes comparison
comparison of
of Best
Best Practices
Practices and
and migration
migration
across
across business units
strategically placed KPI’s.
2001 Faithful& Gould Inc

E.g. planned maintenance work routine is held up because of permit delays; this
will be identified with the procedures - the work p roductivity will have been
affected by this delay and remedial action will be taken for an excess problems
with permit issue

E.g. an emergency failure occurs and work needs to start immediately. No need
to worry about price. The rates within the master agreement cover for all
eventualities and Owners are not penalized by traditional supply and demand
and they are less vulnerable to productivity issues.

9.3 Typical Supplier Benefits

Even though VBC is, primarily, being driven by Owners there are benefits to be
gained by the Suppliers/Contractors that embrace this process. Those that are
seizing the initiative and learning more about the program are gaining a
competitive edge. This is not a program that is going to go away. Globalization of
more and more companies will ensure that VBC practices are spread.

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With the shift in risk the Contractor now has a greater responsibility for the
management of their business. As the specialist they will be the ones looking for
innovation and sharing best practices between their clients in order to improve
their own margins.
Supplier Benefits
ü They manage their own business
The ability to increase margin
ü Able to attract more recruits & higher
also provides a needed caliber (not constrained by ceiling
T&M rates)
stimulus to the recruitment
ü Less
Less demand
demand on Contractor resources
market. Most trades/crafts are
competing with other
industries that are seemingly
ü Encourages improvement via “lessons
more lucrative and just as learned”
2001 Faithful&Gould Inc

easy to enter. With

incentivization schemes labor remuneration packages have the potential to
increase significantly (in Europe it is not unusual to have crafts earning twice
their basic pay).

As well as stimulating recruitment the implementation of VBC will also free up

resources as everyone strives toward improving productivity. E.g. the scaffolding
crews awaiting the next job to come along will no longer wait, they will be looking
for work in order to attain a greater bonus. If work is not available at a particular
site the Contractors themselves will seek greater mobility, permitting them to
reallocate resources to other work fronts. Otherwise it is likely that they will be
seeking more monies in compensation for non-productive labor.

Informative reporting protocol will ensure that both the clients and contractors
interests are taken care of. Delays by the clients will be penalized and increased
productivity by the contractor will be rewarded – giving a “win-win” situation for
everyone. When penalty costs are i ncurred this will stimulate close scrutiny, in an
effort to improve procedures and avoid similar future incidents..

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10 IMPLEMENTING VBC
10.1 Benchmarking
Before undertaking this program you need to be sure that VBC is right for the
particular Refinery. Benchmarking current activities is a sure way of
understanding the opportunity available and preparing the business case.

10.2 Implementation Sequence

Always start with the soft trades; these are the easiest to administrate and also
offer the largest savings – ensuring that you obtain buy-in for a full-scale VBC
program encompassing all proven trades/crafts.

10.3 The Contracts

Not just a basic contract this is a cornerstone activity and needs to encompass
appropriate work control processes as well as adopt correct SMM. Again the
latter is generally the most
Typical Process
problematic as there is no one 3 - 6 months 3 – 15 months

standard which Owners and Implement 6

Contractors use. Faithful & Project Execution

Plan
Business
Requirements
3
Gould are working to address 2
5
this, ensuring that the entire Price Negotiation

4
Refining Industry (as well as Contract
Preparation
1
other business sectors) benefit. Benchmarking

2001 Faithful&Gould Inc

10.4 Bid Duration

Anything from 2 weeks for soft trades up to 6 weeks for hard trades should be
allowed for Contractors to compile their prices. In some regions there is adequate
data available and consideration can be given to bidding against pre-defined
norms. Bidders will quote their percentage adjustments to these norms (this
accelerates the learning curve for VBC and tends to put the focus on Control
process and not just the price.

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10.5 Bid Analysis
An appropriate model is required to correctly analyze bid returns. This is a
comprehensive, quantified schedule of rates and it is important that each owner
models their operations according to the expected work content for the duration
of the Contract term – normally 2 years in duration.

10.6 Selection
Don’t limit consideration to price. A Contractor displaying thorough understanding
of VBC may deliver greater benefits.

10.7 Post Contract Control

Remember mechanical completion is very different from commercial validation.
This is not a process whereby a signature on a time sheet is sufficient.
Measurement and validation of the work in progress is an on-going requirement.
Often trade supervisors are only interested in getting the works completed and
plant back on line; the commercial controls take a back seat and Accounts
Payable cannot validate Contractor claims. For this reason it is recommended
that responsibility for mechanical completion and commercial validation are
segregated.

10.8 Time for Implementation

Anywhere from 3 months to 18 months for a full program – dependant upon trade
sequence and scope.

11 SUMMARY
The risk sharing aspect of VBC makes it an effective and fair means of doing
business. It continues to gain acceptance as more organizations from both the
Owner and the Contractor sides of industry become aware of the benefits that
are there for the taking. VBC is here and here it will stay. However, before the full
potential can be realized the US Refining Industry, and its Contractors, need to
achieve standardization on the documentation governing the means of
interpreting work scopes. Individual companies continuing to do their own thing
will work, but not as effectively as it could.

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