A lump sum contract offers an owner a low financial risk and a higher return to a contractor for superior performance.

It appears to be a preferred contract style. However, many fast-track projects in the pulp and paper industry lack the luxury of
“time.’ Cost reimbursable contracts are established at early stages to enable the overlapping of design and construction. The
main thrust is to shorten the project schedule to meet the market need dates.

When an opportunity arises, lump sum contracts are awarded to engineering and/or construction firms. Awarding an
EPC (engineering procurement construction) lump sum contract to a single supplier is not a prevailing style in the pulp and
paper industry on large projects (over $100 million). Based on our limited experience, EPC lump sum contracts could also be
used on fast-track projects.

There are many proven techniques that could be used to ensure the successof lump sum contracts. The Construction
Industry Institute (CII) publication C~nust~~~ctiorm
Contractor lFilann@ ffor Rxed-ll%se C~nsUuuction[3] offers ‘several good ideas.
Ronald Stilhnan outlines an approach to control lump sum projects [5]. Another CII publication, I&&l Rammhr~and
ConUnnWmgSysbm fforrJEPCeff IlnaUurstiaU lI%o~ec~[4] contains many useful suggestions. The majority of publications and
papers on the topic deal with how to manage lump sum contracts from the supplier’s (contractor’s) perspective.

This paper addressesthe experience of managing an EPC lump sum contract from an owner’s perspective. Factors
influencing the use of EPC contract style are explored. Procedures enhancing the project successare discussed. “Lessons
learned” on managing EPC contracts are also included for further improvement.

There are three principal types of contracts [2]:

0 reimbursable,
0 tit price, and
0 lump sum.

Table 1 below shows the comparison of these contracts. The objectives of safety, cost, time, quality and liabilities
must be analyzed and placed in some priority, since tradeoffs will probably be necessary in deciding the type of contract to be
used.

G.&l
 1993 AACE TRANSACIIONS
Table l-Contract
Contract Type Owner’s Perspective
Reimbursable
l suitable for fast-track project (shorter
overall schedule)
0 assuming the highest risk on
cost/schedule
l highest potential savings if well
managed
0 higher.owner’s administrative costs
0. easier to make changes
0 must have experienced and committed
project team to manage
Unit Price
suitable for repetitive installation
l ha&g a ftrm unit price at early stage
l assuming the risk of quantity variation
LumpSum
l putting the best people on job to yield the highest
locking in the cost early
0
longer overall schedule
shiftins risks to contractor
lowest level of project control-
“hands-oft” approach except when
safety; specifications, quality,. and
schedule is questionable
managing. “changes” has great influence
need good design definition .,
0
no cost savings to owner after award
G.8.2
Comparison
ContractoA Perspective
0 enabling overlapping of engineering,
procurement and construction
l
assuming the lowest risk
0 profit is guaranteed but is less than a
well-managed lump sum contract
l could staff with some new members to *
gain experience
0 taking advantage of “learning curve”
0 requiring sufftcient design definition’ or
experience to estimate unit price.
0 assuming the risk of fixed unit price
profit
assuming risks by increasing contingency
l .highest level of project control
l
changes in scope/schedule could bring additional profit
on the final cost
l
need well defined scope and documents
0 allowing better planning for labor and material
requirement
There are several reasons driving an owner toward the use of an EPC lump sum contract. Key reasons are as follows:

0
benefiting from a contractor’s technical expertise and process knowledge;
0
perceived lower cost;
0
single source of responsibility;
0
boundary limits (physical and process) can be easily defined,
0
having a well-defined scope already in place;
0
willingness to take time from preparing a bid inquiry to awarding a contract (this process could be as long as
six months on a large contract); and
0
good past experience with EPC lump sum contracts.

Before an owner considers an EPC lump sum approach or secures EPC bids, the following prerequisites are essential:

0 having a well- defined scope of work at detailed level;

0 establishing a clear EPC battery limit;
0 defining what owner will provide outside the EPC battery limit;
0 developing a set of clear equipment and construction specifications and standards;
0 identifying any specific requirements unique to the project;
0 resolving site preparation issues, such as laydow areas and storage requirements;
0 approving a list of acceptable suppliers for commodity equipment, Ei. motors, pumps, and instruments;
0 developing warranty and guarantee criteria;
0 determining the level of control on the lump sum contract required to ensure owner’s comfort;
0 defining the types, formats, and frequency of reports required from the contractor;
0 committing to a minimum number of changes;
0 ensuring a competitive bidding environment; and
0 defining battery limits with other contractors.

Many factors infhtence the selection of an EPC contract. Key factors are as follows:

0 Does the supplier has a safe project track record?

G.8.3
 1993 AACE TRANSACTIONS

0 Supplier has the experience and resources to provide the full range of engineering, procurement, and
construction. If not, does the supplier have reliable partners to jointly provide the service?
l Is it possible to stretch the suppliers beyond their normal area of expertise as EPC
suppliers?
a What is the quality track record of an equipment supplier when performing under EPC style?
0 Is the work and cost breakdown structures of equipment, engineering, and construction suitable for an EPC
contract?
0 What is the value of a single source of responsibility to an owner?
0 What is the trust level between the owner and the prospective EPC contractor?

CONTRACI- RELATIONSHIP

The owner’s working relationship with an EPC lump sum supplier (contractor) has to be at “arm’s length.” This is to
utilize the contractor’s expertise and to allow the contractor me legal right of “non-interference.” However, the contract
documents must specify the owner’s project control and reporting requirements, particularly in respect to progress measurement
of the work and schedule/status information. On cost matters, the working relationship is centered around the ‘contract
changes” provisions of the contract agreement [2]. In general, an owner has a limited access to the contractor’s cost data.
However, the owner should clarify his or her involvement in the contractor’s supplier and subcontractor selections.

Trust between contracting parties is a valuable commodity. The lack of trust would force the contract administration to
become a legal exercise. When this occurs, all parties are losers. The intangibles of creating trust are many, but two aspects
are clear:

Is the owner prepared to pay a fair price for a fair day’s work?
l Is the contractor prepared to give a fair day’s work for a fair price?

These two simple principles can quickly solve most of the contract problems of interpretation, enor, conflict, change,
and financial difficulty [ 11.

One of the significant benefits of a well-managed contract is that of “no surprises.” This results in an effective
program to constantly monitor and evaluate a contractor’s performance such that the status/forecast of scope, changes, costs, and
progress will always be known.

PROCEDURES LEADING TO A SUCCESSFUL EFC! CONTRACT

The successof an EPC contract begins at the initial project planning and contract negotiation session. It is necessary
for an owner engaging an EPC contract to pursue procedures outlined below as a minimum:

l
Freeze the process, layouts, and key discipline specific requirements early.
0 Participate in the conceptual stage of design by providing inputs and preferences when the cost/schedule
impact is minimal.
0 Have project objectives bought into and supported by the contractor.
0 Define and commit to the document approval turnaround cycle.

G.8.4
 Tltere am many ways bo manage an EPC contract Typidy, a c~ntmct co&h&or is required to work &!h &c
CQntractQlT b erxmre timely decision-makhg and issue resollutionn. Oana large projec& ?he owner may assign a &nUMmeWC
co~tit~r. Tbis ptxsm’s primmy limcti~ns would include the following:

0
TVpromote safety in design, equipment, c~Has$laclion,start-IQ, and operation;
0
a0 pmde Ubeccmtmct~fs planning athe,
0
to coordioate Qwrnel%carry tecnmicarillpb;
0
Uo impIemennt a QVQC pgmm;
0
a0 manage changes;

0
b track p-ogress ad n&x&me idtzimmm~
0 to resolve issues;

G.8.5
 1993 AACE TRANSACl’lONS

0 to administer contractual matters; and

l to manage information flow affecting other parties associated with the project.

One of the easy ways to track a contractor’s progress trend is to use a performance index. Figure 1 is an example of
measuring the monthly and cumulative schedule performance indices (SPI’s). The schedule performance index is defined as

Earned Value % Actual Complete

SPI = = (equation 1)
Planned Value % Scheduled Complete

Since the actual work-hour required to complete the work may be considered confidential by the contractor, no attempt
was made to measure the cost performance index.

The project objectives must be fully communicated to both the owner’s and contractor’s organizations. The concept of
safety first should be instilled in all team members’ minds. The priority of quality, performance, team relations, cost, and
schedule needs to be defined early. Open commuuication among project teams must be maintained. Upholding a high mutual
trust level is vital.

The contractor selected should have at least many years of experience in process, mechanical, and piping. It is
possible that some of the engineering work would be subcontracted to others (civil/structural, electrical/instrumentation, etc.).
Figure 2 displays a method to calculate the earned value.

TOTAL EPC ENGINEERINQ = 100% %cuMuATlllE EARMD- A I I(Ls

%CUMAAlMEPlANNED=B-4u2
OH-Sa-EmAEPERFO MM-m
% ClJMlJlATlVE EARNED = 40.5 -UB=4QY4a2=cw4

I I
I I

ENQINEERINQ 1 ENQINEERINQ 2 ENQINEERINQ 3

TOTAL EFFORT= 100% TOTAL EFFORT= 100% TOTAL EFFORT= 100%
WEIQHT = 0.55 WEIQHT = 0.15 WEIGHT .2
56COMPLETED= 50 % COMPLETED= 20 56COMPll& 25
96 EARNED = 32.5 %EARNED =3 %EARNED =5
figure 2-F&lneering Earned Value Example

An owner needs to provide all specifications and unique requirements to the contractor at the time of the contract
award. A plastic model of the building, equipment, piping, cable tray, etc. is a valuable design, construction, and training tool.
It is desirable to have a large number of the owner’s operators, maintenance people, and engineers participating in various

G.8.6
design reviews to foster the ownership. The owner must manage his document approval turnaround cycle to support the
contractor’s design schedule.

The contract should include a provision for both an owner and a contractor to establish mutually agreeable monthly
milestone events. Periodic evaluation of the progress is needed to release the appropriate payment Team effort is required to
take the necessary corrective actions to maintain the overall schedule.

Continuous improvement is a way of life. Key areas to implement in an EPC contract are as follows:

0
Incorporate a more thorough requirement of using an earned value system with an objective measurement
method. Try to use the contractor’s standard system to its full extent and make sure it is an objective, not a
subjective, measurement.

0
Specify the types, formats, and frequency of reports in the contract to set the expectations and to avoid
disturbing contractor’s standard practices.

0
Agree on the monthly percent completion of engineering, procurement, and construction early and compare
them with other past EPC project experiences.

0
Continue the use of Rmonthly milestone event.9 evaluation and payment structure.

0
Distinguish documents subject to the owner’s approval (within a three-week turnaround) and docrmtents
subject to the owner’s review (design may proceed while under the owner’s review).

0
Assign owner% specific equipment and drawing numbem early.

0
Ask each discipline engineer to write and communicate the three hottest items/concerns in their areas of
responsibilities in the early stage of the project.

0
Promote a proactive planning effort throughout the organization.

0 . Devise a method to facilitate the early detection of potential cost and schednle deviation to minimize
SurpriES.

0 Use variance analysis (exception report) to concentrate the management efforts.

0 Ensure that milestone events and progress curves support each other,

0 Clarify owner’s role in construction, commissioning, and start-up.

0 Idenw commissioning systems/eventsearly.

G.8.7
 1993 AACE TRANSACITONS

SUMMARY

For owners to manage EPC lump sum contracts, they need to understand lump sum contract characteristics fi-om the
perspectives of both a contractor and an owner. A thorough up-front plank&coping is essential. However, the
plan&&coping is-not wasted. Other types of contracts aIso need this pIanni&scoping. The difference is in the level of
&ail. An EPC hnnp sum contract offers the owner a low financial risk. It is a viable contract type. A properly cuordinated
and managed EPC lump sum contract could yield a handsome reward to both a contractor and an owner.

1. Bent, James A. 1985. How to SIICC~~ Negotiab and A-r Co-

1985 MCJC lhnsactions. Paper N.4.

2. -. 1989. Eflective Contmct Management. 1909 MCE Thusactions. Paper S-11.

3. Consttuction Contrtzctor Phmning for Fixed-plice Construction. November 1986. Cmstmction Industry Jnstituk
Source Document 20.

4. Model Phmning and Conhvlling System for EPC of Industrial Pmjects. April 1987. Con&&on Mu&y Iostllute.
Publication 6-3.

5. Stillman, Ronald G. 1986. Ptvject Con& Reporting on Lump Sum hjects. 1986 MCE lhnsactions. Paper B.7.

Mark T. Chen, PE CCE

Weyerhaeuser Paper Company
WTC lC39
Tacoma, WA 98477

G.8.8