The Seven Deadly Mistakes

in Industrial Megaprojects

Meet Alaska 2012

Ed Merrow
January 6, 2012
 Our Vantage Point on the Industry

• Independent Project Analysis evaluates industrial projects,

large and small, around the world
– Are the projects ready to proceed to the next phase?

– Are the projects set up to succeed (or fail)

– At the end, did the projects accomplish their goals?

• In a typical year, 600-700 new projects are added to our

databases

• About 10 percent of these projects fall into the very large

category—over $1 billion in capital

• Projects in the $5-$10 billion range are now common and 5

projects over $40 billion are headed for authorization

CONFIDENTIAL 2
 Industrial Megaprojects
• Megaprojects executed by the petroleum, minerals, chemicals,
and power industries are now shaping the economic landscape
around the world

• Easily accessed mineral resources close-to-market have largely

been depleted

• Oil companies must venture into deep water and difficult

environments because national resource holders control much of
the easily-developed petroleum

• Chemical companies seeking low-cost feedstocks or fast-growing

markets must exploit economies of scale to compete globally

• Extensive infrastructure development requires projects to be large

enough to spread the infrastructure costs over a wide base of
beneficial production to be economic
CONFIDENTIAL 3
 IPA Forecast of Industrial Megaproject
Activity, 2000 - 2015
225
Annual Spend in Billions of Dollars

200
175
(Escalation Removed)

150
125 Over-Heated Market
Growth Rate Project Market
100 Growth Rate
~24%
75 Even Faster

50
25
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

CONFIDENTIAL 4
 Geographical Distribution of Megaprojects
Evaluated

Canada Europe
7% 15%
Central Asia
4%

US 13%
Asia
9%

Middle East
15%

South America
19% Africa
9%

Australia
9%

CONFIDENTIAL 5
 The Key Issues

• Projects are getting larger and more complex

everywhere in the world

• As we will see, large projects are failing much too

often

• Do large projects fail more often simply because

they are more difficult—or…

• Do we alter our practices?

• What do we need to do differently going forward?

CONFIDENTIAL 6
 Defining Success and Failure

• We deem a project to be a failure if Failure Rate

one or more of the following occurred: 100%

Costs grew (real) 25% + 90%

Schedule Slipped 25% + 80%

70%
Overspent (Absolute Measure) 25% + Megaprojects
60%
Severe and Continuing
Operational Problems for 2 Yes 50%
Years or more after startup
40%
Projects
30% <$500 MM

• About two-thirds of large projects 20%

failed by these criteria—twice the rate 10%
of smaller projects
0%

CONFIDENTIAL 7
 Megaprojects Split Into Radically Different Groups
COST INDEX (competitiveness)
Failed Projects
1.3 (65 percent)

Successful Projects
1.2 (35 percent)

1.1
COST GROWTH
PRODUCTION
SUCCESS
40% 1.0 40%
30% 60%
20% 10% 80%
0% 100%

0%
1.0
10%
1.1
20%
1.2

EXECUTION 30%
1.3 EXECUTION
SCHEDULE INDEX SCHEDULE SLIP
(Competitiveness)

CONFIDENTIAL 8
 Seven Deadly Mistakes in Industrial Megaprojects

1. I want to keep it all!

2. I want it yesterday!
3. We’ll just work out the details of the deal later.
4. Why do you want to spend so much up-front?
5. Let’s cut that cost estimate down!
6. Let contractors the risk; they’re doing the project!
7. If the project manager overruns, fire the bastard!

CONFIDENTIAL 9
 I Want to Keep it All!

• Megaprojects affect many more people than just the

investors

• All those affected by the project will want some say in

how the project is organized and executed and
especially in how the value of the project is allocated

• If these stakeholders—claimants on project value—

are not satisfied that the allocation is fair, they disrupt
the project and render it unmanageable

• Disruption kills megaprojects because they are

inherently fragile; when they break they tend to
shatter

CONFIDENTIAL 10
 I Want it Yesterday! Speed Kills

• The drive for speed, results in the projects

outrunning:
– Basic technical data development
– Stakeholder alignment
– Permitting requirements
– Front-end loading development
– Even the business deal
• Large projects are complex and tightly inter-
connected
– They cannot recover from cut-corners
– There are no “work-around” strategies that actually
work
CONFIDENTIAL 11
 Speed Kills
Dimensions of Failure
• High cost growth (25%+) • Severe schedule slip (25%+)
• Large overspend (25%+) • Production Failure (first two years)
Less

+1 std. dev.
1.40 MEAN
Schedule Aggressiveness
Sanction Schedule as % of Benchmark

-1 std. dev.
1.20

1.00

0.80

0.60

0.40
Successful 1 2 3
More

Project
Number of Dimensions In Which A Project Failed

CONFIDENTIAL 12
 The ABCs of Megaproject Failure

Antecedent Behaviors Consequences

Incomplete or Incorrect
Basic Data +33% Cost Growth

+37% Less Cost

Poorer Front-End
Aggressive Loading
Effective

+30% Schedule
Project Is Harder to
Schedule Staff 48 Percent of
Planned Production
achieved 17 months
Higher Project Leader after promised date
Turnover

Team Is Not Integrated

CONFIDENTIAL 13
 Mamas, don’t let your babies
grow up to be cowboys!
Willie Nelson

CONFIDENTIAL 14
 “We’ll Work Out the Deal Later”
• The contours of the business deal, especially between
resource holders and project sponsors, must be
worked out before the project scope is developed
– Exactly how are we going to generate a large enough
revenue stream to repay the investment plus some
profit?

– How is the cost/tax regime of the resource going to be

adjusted to fit the economic realities?

– How will downside risks be allocated?

– How will any upside be divided?

• The deal must shape the project; the project cannot

shape the deal!
CONFIDENTIAL 15
 Why Do You Want to Load-up the Front-End?
• The front-end of projects—before we authorize them—
is the time for defining the scope and planning the
execution in detail

• What is done (and not done) on the front-end has

more bearing on megaproject outcomes than anything
else

• But it’s expensive—3 to 5 percent of eventual total

cost—and people are often cheap in the name of being
frugal

• Loading up the front-end is the best possible

investment
BEST GOOD FAIR POOR INADEQUATE

CONFIDENTIAL 16
 FEL is Most Important for Megaprojects
Effect of FEL on Cost Competitiveness

40%
Megaprojects

Note that FEL is also crucial 250 - 500

30% for even “largish” projects

20%
100 - 250

<100MM
10%

0%
BEST
Best Practical GOOD
Good FAIR
Fair POOR
Poor INADEQUATE
Screening

FEL Index

CONFIDENTIAL 17
 FEL Drives Cost Predictability

100%
Pr > |t| < 0.0001
80%

60%
Cost Deviation

40%

20%

0%

-20%

-40%
Best Good Fair Poor Inadequate

FEL Index
Shading represents ±1 standard deviation
CONFIDENTIAL 18
 FEL Drives Schedule Predictability

100%
A poorly front-end loaded megaproject is
Execution Schedule Slip

80% likely to be 26 months late to completion!

60%

40%

20%

0%

-20%
Pr > |t| < 0.001
-40%
Best Good Fair Poor Inadequate

FEL Index
Shading represents ±1 standard deviation
CONFIDENTIAL 19
 FEL Reduces Operability Problems
Failure to produce at or close to the rate promised at authorization is
debilitating to the economics of the project!

80%
Pr > |X2| < 0.001
Were Operability Failures
Percent of Projects That

60%

40%

20%

0%
Best Good Fair Poor Inadequate
FEL Index
CONFIDENTIAL 20
 Execution Planning Improves Safety

1.20
Injury and Accident Rate per

Recordable Incident Rate

1.00
DART Incident Rate
200K Field Hours

0.80

0.60

0.40

0.20

0.00
Definitive Preliminary Assumed

Project Execution Planning

Data are restricted to countries with strong reporting standards
CONFIDENTIAL 21
 How Well Are Megaprojects
Defined at Authorization?

70%

60%
Percentage of Projects

50%

40%

30%

20%

10%

0%
BEST GOOD FAIR POOR MISERABLE

FEL Index

CONFIDENTIAL 22
 What Difference Does it Make?

Percent in Group Percent Successful in Group

70%

60%
Percentage of Projects

50%

40%

30%

20%

10%

0%
BEST GOOD FAIR POOR MISERABLE

FEL Index

CONFIDENTIAL 23
 Let’s Get that Estimate Down!
• A good many megaprojects die when the first full cost
estimate is prepared….and that’s a good thing!

• What is not good is when the business response to an

estimate that is higher than the budget is “sharpen
your pencils!

• Cost estimates are merely a reflection of the scope of

the project that you want to do and the circumstances
in which you must do the project

• Nearly 20 percent of the megaprojects in our database

attempted a “cost-reduction exercise” just before or
just after authorization

• Every last project failed.

CONFIDENTIAL 24
 The Contractors Should Carry the Risk!

• We often attempt to transfer cost risk to contractors in

the form of lump-sum (fixed price) contracting; “we’ll
put a ceiling on the cost!”

• In megaprojects, risk transfer rarely actually occurs

and even when it does, it is necessarily economically
inefficient

• Contractors are non-capitalized, variable-cost firms

• They have very limited ability to carry large equity-

type risks and price risk very aggressively when they
are forced to carry it

• That is not gouging; it is plain common sense

CONFIDENTIAL 25
 Let’s Hold the Wrong Folks Accountable!

• The very high failure rate in megaprojects is indeed

the result of an accountability problem

• But those actually responsible for the failures are

almost never those actually blamed

• Of the 207 failed industrial megaprojects that I

reviewed, project management was actually culpable
in less than 10 of the cases

• Overwhelmingly, the source of failure can be found in

the within the business promoting the project

• The search for scapegoats should always start with

the morning mirror
CONFIDENTIAL 26
 Seven Key Virtues
Seven Deadly in in
Mistakes Industrial
Industrial Megaprojects
Megaprojects

1. I want to allocate
keep it all!
the value fairly and stabilize the project
2. I want it yesterday!
on a schedule that will permit success, no faster
3. We’ll justwill
The deal work out theand
precede details
shapeof the deal
scopelater.
4. Why
We will
do follow besttopractice
you want spend soin much
front-end definition
up-front?
5. The only
Let’s cutway
that itcost
canestimate
cost lessdown!
is if I want less
6. Let
It iscontractors
our project.the
Werisk;
carrythey’re doing the project!
the risk
7. Accountability and responsibility
If the project manager start
overruns, fire theat bastard!
home

CONFIDENTIAL 27
Thank you!

Meet Alaska 2012

Ed Merrow
January 6, 2012