GUEST EDITORIAL: Project delays and cost overruns: the professionals speak out
Published: 03 August 2015
Major projects are renowned for encountering difficulties. Even projects that are not the first of their type can encounter massive problems, no matter how good the initial planning. Howard Steinberg, Partner with the New York-based Shearman & Sterling LLP – which has been advising many of the world’s leading corporations and financial institutions, governments and governmental organizations for more than 140 years – wonders how such problems can be avoided. In this distinctive and informative article Howard pulls together interviews with leading experts around the world (extracts from his new book, due out in November 2015) and compiles a list of must-have "take away" messages for managers of projects great and small.
Newspapers the world over delight in stories of major corporate or government-funded projects that fall behind schedule and suffer massive over-spends. Headlines ridicule the incompetents who allow this to happen. Meanwhile, back in the "real world" we know that things can and do go wrong. Our task, as project managers, is to learn from each other.
Howard Steinberg, Partner with the New York-based Shearman & Sterling LLP, has been advising many of the world’s leading corporations, financial institutions and governmental organizations for more than 25 years. With two famous "real world" examples in mind, Howard sets out to help project managers (and their clients) avoid embarrassing and expensive failures …
Six defenses to protect against being ambushed by overruns and delays
Defense #1 – Analyze the risk
What can go wrong? Who knows? What is likely to go wrong? Lots of people probably know. Breaking a monster project down into the smallest number of components and applicable disciplines will allow you to seek advice and wisdom from experienced experts who can often surmise the likely risks (and often most effective precautions) from a combination of their training, experience and "gut" intuition.
- Take Away – Seek advice early and often.
Defense #2 – Defensive planning
Good planning is not just about how to get from Point A to Point B. It is about anticipating what could stop you from getting from Point A to Point B so you don’t have to improvise on the spot.
- Take Away – Identify all the routes on the project schedule and seek expert advice from an expert guide who has made it to Calvary before.
Defense #3 – Identifying the right people and matching them to the right role
Different horses for different tasks. Find the most experienced people and slot them into tasks and conditions they are comfortable in and have adapted to before. You don’t send a Clydesdale to work in the desert and you don’t send your most genteel project manager to work for two years in a trailer in Siberia. Nothing can be worse than having to swap out managerial personnel during the execution phase of a project.
- Take Away – Motivation, new challenges, lucrative bonuses, titles and perks are no way to ensure smooth or successful transition to unfamiliar territory. Go with someone who has been to hell and back. When hiring subcontractors, make sure they choose people for roles the same way. Make sure the contract provides that if a key person leaves for any reason except for death or sudden physical disability, the subcontractor gives a meaningful price rebate to you. Freaking out under abysmal conditions, promotions, retirement, marital problems and substance abuse only mean the subcontractor did not do sufficient screening to pick the right person for the job.
Defense #4 – Continuous feedback loop during the implementation phase
Just reviewing progress reports and sending back electronic comments is one of the booby traps that the internet has set. Miscommunication is the undetected cancer of any project. Constant interpersonal feedback loops are necessary on a frequent and immutable schedule. Schedule standing conference calls, video meetings and face-to-face meetings and don’t change their days, times or frequency even if not all people are available. The show must go on. Supplemental and additional meetings are always fine but a routine schedule reminds everyone that they need to prioritize and achieve tasks on "internalized" deadlines. Otherwise, unfortunately, much of project management can turn into "taking names and numbers" of who is not doing their duties.
- Take Away – Create habit-forming behavior centered around performance and feedback.
Defense #5 – Measuring progress
Always measure where you are against where you projected you would be at this time when you started the project. At project inception "freeze" the baseline schedule. The baseline schedule never changes. Schedules are always updated because the actual schedule is always changing. But don’t fall into the trap of measuring progress against the previous schedule because that can give a false sense of comfort. Measure progress against the baseline schedule so the lack of progress on activities in serious jeopardy will be pronounced and easy to spot. The same goes for physical measurements, tolerances, corrective factors and adjustments for actual conditions, which are all rubrics which can mask real shortcomings. Understand the procedures and protocols involved and learn about their limitations. Everything works on paper.
- Take Away – Always know what your measurements relate to and whether you are dealing with an absolute scale (such as "pounds per square inch") or an interval scale (time from project start) so you can establish good and meaningful points of comparison that don’t move without you realizing it.
Defense #6 – Accounting and finance
Do not make your financial models so complicated that only your financial analyst can understand them! And don’t make your accounting systems so complicated only your accountant can understand them. You should not need a PhD in econometrics to understand your project’s finances. Make your professionals boil down the numbers into a report you are sure you understand. Don’t rely on your experts to spot trends. They can sometimes be too involved in keeping the ship’s engines running to notice that the ship is listing.
- Take Away – Experts are there to explain to you what is happening, not what they are doing. The process of how the ship runs is not your concern; the course the ship is on is your concern. Remember, the people who run the engines are not up on the captain’s deck looking out for bad weather or other ships on a crash course.
Case Study – Key aspects of any infrastructure project – The professionals speak
"The scoping document is usually the first screw-up," says John Vigman, general counsel for Veolia Japan. "All contracts should start with the statement that the owner has no responsibility for anything unless it is expressly stated in the contract as the owner’s responsibility." (See Negotiating EPC Contracts – Chapter 9 – The Work).
"It really shouldn’t be called ''The Scope' in the first place," says Cara Rodriguez, an attorney at AES in Virginia who negotiates engineering, procurement and construction (EPC) contracts to build power plants around the world. "Using the word 'scope' suggests that there are items outside the 'scope' that contractors can claim are extras. I like to go with something unrestricted like 'functional specification' which does not imply any limitation on the contractor’s work." (See Negotiating EPC Contracts – Chapter 9 – The Work).
- The design standards
"With so many international components to any job today, make sure to specify the design standards (for design and the material which will be used for manufacturing the equipment and system) and make sure they are in your language and that the contractor’s engineers are 100 per cent comfortable operating in the language of the design standards, otherwise, you are building a jalopy, not a formula one, no matter how good your design specifications are," says Hal Sunar, a chief operating officer at the Socar Power Energy Investments A.S. (a joint stock company), a subsidiary of Socar Turkey, which is a wholly owned subsidiary of State Oil Company of Azerbaijan in Turkey. (See Negotiating EPC Contracts – Chapter 9 – The Work).
- Performance security – make it "liquid"
"A letter of credit is a letter of credit is a letter of credit. Period," says Michael Peist, a banker at Investec in New York. "It’s like 'Coca Cola – The real thing'. One certificate to present to the bank and the cash is yours, the ultimate weapon against a bumbling EPC contractor. Parent guarantees, first demand guarantees, bonds and other instruments may have legal defenses to their draw so they can really be just a way to sue another party besides the EPC contractor. If you want attractive financing, a letter of credit is the only way to go." (See Negotiating EPC Contracts – Chapter 19 – Security For The EPC Contractor’s Performance).
- The price – nail it down at signing
"Escalation, provisional sums, risk pools, the list goes on and on. Eliminate them unless absolutely impossible to do so," says Diego Corp Hoces de la Guardia, a lawyer at Hydro Chile in Chile. "It’s hard enough to get everyone negotiating the EPC contract on the same page. Just wait until the people that have to administer the EPC contract step in. If you want to spend your time with accountants and lawyers arguing over formulae and how they apply, this is what you will be doing if you introduce these complicated schemes." (See Negotiating EPC Contracts – Chapter 21 – Payment For The Work).
- Force majeure – lift the veil
"Contractors like to see convolution and obfuscation in these provisions so they can try to make them cover anything they might run into on the job," says Armin Kluth, a lawyer at SASOL Limited in South Africa. "Always try to limit the geographical scope of the coverage of these clauses." (See Negotiating EPC Contracts – Chapter 12 – Unforeseen Circumstances, Adjustments and Change Orders).
- Change orders – somebody left the back door open
"It’s great to lock up your price so the deadbolt is set on the front door of your contract – but the backdoor is wide open unless there is a clear set of rules for how the contractor can get a change order through." (See Negotiating EPC Contracts – Chapter 12 – Unforeseen Circumstances, Adjustments and Change Orders). "Change order sections are usually the weak underbelly of some of the best EPC contracts I have seen," says David Seitzinger, a project manager at GDF Suez in Texas. "Do yourself a favor – spell it out in the change order section of the contract in detail – 'who, what, where, when, why and how.' That’s what I live by on any size project. And be as specific as you can as to what will not be force majeure. I know people see French or Latin words and think to leave those legal looking sections to the lawyers but if you do you will be dealing with these lawyers for a very long time." (See Negotiating EPC Contracts – Chapter 12 – Unforeseen Circumstances, Adjustments and Change Orders).
- Acceptance, commissioning, testing – whose test is it anyway?
"Don’t forget to customize industry tests to your specified needs. The standards society didn’t have your project in mind when they wrote their test protocols. Especially don’t forget to incorporate your offtaker’s requirements," says Chris Morris, a lawyer at Abengoa Solar in California. (See Negotiating EPC Contracts – Chapter 16 – Testing and Completion of The Works). "Otherwise your contractor may be long gone before you realize you have a problem."
- What does the warranty really get me?
"You never know if a contractor will make good on its warranties. Holding back some of the contract price until the end of the warranty period is obviously a good way to go but isn’t always commercially acceptable to reputable contractors," says Jorge Clúa Gomis, at Repsol in Spain. "Always focus on the duration of coverage and make sure it is not shorter than any period that may be imposed by law. You don’t want to shorten the warranty period by mistake." (See Negotiating EPC Contracts – Chapter 18 – The EPC Contractor’s Warranties of The Work). "Also focus," he says "on the exclusions from warranty coverage and make sure that they are crystal clear and narrow in their scope."
- Pre-empting the fight
"On larger projects establishing a 'dispute resolution panel' gets my vote," says Jack Smith, a lawyer at the Gornitzky Law Firm in Israel. "Setting up a panel of three or more impartial experts that meet every so often to review the project can be invaluable to a speedy resolution of a technical dispute if it arises." (See Negotiating EPC Contracts – Chapter 24 – Dispute Resolution And Governing Law).
- Do I want to be in court or go for arbitration?
"If the contractor submits to court without a jury trial in a jurisdiction with a developed body of construction law – a court outcome can be much more predictable based on statutory and case law guidance if applicable in the jurisdiction," says Wendy King, a lawyer at Capstone Mining in Canada (See Negotiating EPC Contracts – Chapter 24 – Dispute Resolution And Governing Law). "If circumstances do not make a court proceeding possible, an international arbitration has the benefit of flexibility of the parties to set the ground rules and the confidentiality of the arbitral decision. Documents are never filed for possible review by the public. Just make sure your counterpart has a significant presence in a jurisdiction that has treaty protection in the involved countries because you don’t want to go through arbitration only to learn the judgment won’t be respected or is problematic to enforce in the county where the counter party’s assets are located."
Five common reasons why infrastructure projects fail
In summary, there are five common reasons why infrastructure (and other) projects fail:
- Improper scoping
- Underestimating costs
- Inexperienced general contractor
- Inexperienced subcontractors
- Contractor/subcontractor bankruptcy
What would you add to this list? And what solutions do you recommend? Share your skills and knowledge by posting comments below this article, or begin a discussion in the GpmFirst forum.
Howard Steinberg's book, Understanding and Negotiating EPC Contracts, will be published later in 2015. Add it to a Gower wishlist.