Maximizing Efficiency in EPC Projects

For large construction projects and new builds, manufacturers and owner companies often employ an Engineering and Procurement Company (EPC), to manage the project from ideation to commissioning. EPCs do everything from preliminary design to budgeting. It is critical to engage with your EPC at the earliest stages to ensure projects have the best chance at being on time and on budget. There are a number of EPCs in the U.S. and internationally to choose from, but finding one with expertise in the client’s industry is worthwhile so the EPC can engage with vendors they have established relationships with to hopefully get better pricing, delivery and overall terms where possible. However, some clients choose to do their own procurement of equipment and other larger ticket items. There may be advantages to this, but there is also risk. This article explores both sides of this proposition.

Considerations need to be given to various areas for the client to make the best decisions when it comes to efficient procurement for EPC project cost control.

We will discuss several factors in this article:

1. How much will the EPC project's cost risk be reduced?
2. How do equipment lead times impact the EPC process?
3. How much time and effort is required to procure large, specialized industrial equipment and make sure it is delivered before needed, per the construction schedule?
4. Does the EPC project client have the staff to handle the procurement or all the items required for the project, and what is the cost of administration of those items?

What are the costs associated with delayed deliveries on an EPC construction project?

These costs can include contractor delay, productivity, and extended direct and indirect costs, as well as lost revenue from slower speed to market, with the owner company potentially missing contractual obligations if the project goes over deadline, and even receiving fines from regulatory bodies such as the EPA if the project isn’t built to code. There may also be challenges to procure certain items if the owner company or client doesn’t have relationships with suppliers; this can be an opportunity for an EPC to source already fabricated, undelivered equipment or systems, and determine the actual cost of the purchases. These issues will be addressed one at a time in more detail below.

How much will the EPC procurement cost risk be reduced if the client purchases the equipment (or material)?

We will use the term equipment, interchangeably, to cover material as well. Material can be considered any permanent plant structure, such as a structural steel package. For the most part, the client and EPC contractor should have the right amount of information to order equipment at around the same time. In general, cost risk is dramatically reduced at the time of the purchase. Many purchase order contracts include terms and conditions that protect both the buyer and seller. The sooner a purchase can be made, the better. There is always an outside chance the purchase price could be reduced as time moves on; however, it is more likely to increase than decrease. Equipment should be ordered as soon as possible. This does not remove all risk, but it does reduce it.

EPC Project Procurement Lead Times

A proper schedule is important to every EPC project. The project schedule should start with a start date and a target completion date. This identifies the EPC project's critical path. Lead times for equipment should be entered into the schedule to determine when items are needed on-site. If the schedule is accurate and built into the project’s critical path to completion — which includes the logic, predecessors and successors for each step of the project — and includes a master schedule that can be used by all stakeholders to track the project, then that schedule is the contractor’s best tool to plan the project.

When a contractor puts together an estimate for a project, a schedule is used to determine the costs associated with time. These costs can be significant and vary depending on the size, speed and manpower required to complete the project. Anytime that an owner-supplied (or contractor-supplied) delivery date is missed, and it is on the critical path, it costs the contractor time and money, which is then passed through to the client. These costs can come in the form of extended time on the project, which extends indirect costs (site staffing and costs just to be on-site) and variable costs such as keeping a specific size crane on-site just to set the piece of equipment that the contractor is waiting on.

How much time and effort are required to procure industrial equipment and make sure it is delivered before needed per the EPC construction schedule?

Many clients may not realize the time commitment required to procure items for an EPC construction project. Getting items quoted, negotiating terms and conditions, and issuing purchase orders is just the beginning. To ensure equipment arrives on time, several things must happen:

• Freight must be arranged.
• Loading and unloading of items must be arranged. Typically, the contractor handles the unloading as it is often involved in the installation or staging.
• Freight claims must be handled if something shows up damaged or incomplete, or doesn’t meet the terms on the purchase order.
• Down payments may be required, and they might need to be pushed through the accounting group.
• Site visits to the equipment fabricator’s facility might be required for items that are critical to the success of the project.
• Follow-up calls and proof of progress need to be made. This could be concerning the engineering, shop drawing and fabrication phases.
• Many sophisticated clients may require fabricators to provide fully assembled equipment to make sure it will fit on the job site. Clients usually like to have a representative on-site to witness this.

As you can see, there is more of a commitment than just issuing a purchase order to complete the EPC procurement process.

Does the client or owner have the staff to handle the procurement or all the items required for the project, and what is the cost of administration of those items?

This may require dedicated personnel or more time than the current owner’s staff can manage. Considerations need to be made to make sure that the client can properly handle these tasks. Some owners choose to hire a third-party project management group and they can include procurement in their scope. Using the engineer of record on the project to procure some of the owner-procured items is also an option. Another option is to include it in the contractor’s scope of work, which is likely the easiest option for the client. This places sole responsibility for procurement (and follow-up) on the contractor. Many companies are opting for this option in today’s unpredictable procurement climate.

What costs are associated with delayed deliveries on an EPC construction project?

There are a variety of costs that can associated with this, including delay costs, costs of lost productivity, and extended direct and indirect costs. Here are some examples that show how they can build up and greatly increase the cost to the owner.

• Contractor Delay Costs — When a contractor bids on a project, they normally put a preliminary construction schedule together as part of their proposal. Smart contractors have language in their proposal identifying or pointing out assumptions made for owner-procured delivery dates. To stay competitive, contractors make these assumptions to estimate how much time they will be on the project and what staffing level is needed. These durations and staffing levels are dependent on the owner’s delivery dates. Some larger projects may have a field office staff of more than 10 people and direct project staff of well over 100 people. For example, if the field office has 10 people in the office at an average of $75/hour, that is $750 per hour. This does not account for any other indirect costs such as a job trailer, temporary utilities and more. If there are 100 workers in the field at an average of $65 an hour, that is $6,500 an hour. If you add the field office staff and the direct staff, you are over $7,000 an hour in labor costs alone. If the awaited material delivery is on the critical path and no other work is available for the same skilled craftsmen, this could cost the contractor over $70,000 a day. This does not account for the cost of rental equipment, including cranes, which could put the cost over $100,000 a day. If the delays were caused by the owner company, costs would be passed on to them, potentially creating overruns in addition to the time delays.
• Contractor Productivity Losses — In addition to the costs associated with the field staff not being able to work on the planned installation, they would likely be either sent home (laid off) with a strong risk of not getting them back, sent to another project (with costs to relocate them) or redirected to another task. The other task may not be their specialty or could be well below their capabilities or skill set. Just the cost of regrouping, rerigging and starting another task could decrease productivity by as much as 30-40%.
• Contractor Extended Indirect Costs — I gave an example above of how the contractor’s indirect project costs can be affected by extending the project due to a late delivery on an owner-supplied (or contractor-supplied) item. Indirect costs are the costs associated with a project that are usually a function of time and are somewhat fixed costs. Labor costs would include a project manager, site manager, safety, QC, admin and any other field office staff or direct home office staff. Rentals could include a crane, rigging, crane mats, skid steers, telescoping forklifts and any other required specialty equipment. Other indirect costs would be costs associated with just being on-site. This might include job trailers, break trailers, ice machines, copiers and temporary utilities. If the project is extended, these costs can be substantial.
• Contractor Extended Direct Costs — Included in the example above, this is primarily the site craftsmen and the costs associated with their presence on the project. This can be about 70% of the total project costs. Keep in mind that many contractors have traveling crews and they get paid per diem if they are working or not. Per diem can be anywhere form $100-200 per day, depending on position and location. Rental equipment, which is specific to a task, is considered a direct cost as well. If a crane is utilized for multiple tasks and is kept for the whole project, it may be considered an indirect cost.
• Speed-to-Market Costs — Speed to market is key in many industries. Once a client determines that a project is financially viable, it is almost a race to proper completion. This may include complete engineering, procurement, permitting and construction. The time value of money must be considered on every project. Markets change often and it is important for clients to be responsive to market forces before the demand wanes. Careful planning is required and many clients opt for an EPC approach that includes the EPC contractor procuring materials and equipment. A single source for a project delivery can make the most sense as many EPC contractors have relationships with their vendors and can expedite materials and equipment easier than a client who is just buying one or two of the same products and won’t need another one for years. Many EPC contractors also already have credit accounts set up. This enables better pricing and can avoid the days or weeks for the process of someone setting up a new account. The relationships are also already built between the vendor’s staff and the EPC’s procurement staff.
• Client Contractual Obligations and Lost Sales — Let’s say a client wants to build a fracking sand plant. A customer has committed to buying the sand for a premium at $100 per ton if the new plant is up and running in eight months. The company signs a contract with their customer and experiences delays in getting the wet plant up and running due to a late delivery on a hopper to load product. A month goes by putting the project past the eight-month committed completion date. The customer needs the sand so they find an alternate supplier that may take over the entire project The project income that would offset the cost for the new plant can go away and the owner company may never recover from this financial setback, with financial repercussions for months or years ahead.

EPC Project Procurement Risks and Challenges in the Current Market

Market conditions continue to foster a feeling of uncertainty, with waxing and waning demand, increasing regulations and the advent of new technologies. Because of this, prices and deliveries are not as predictable as they once were. How do project owners or EPC contractors trying to supply everything protect their interests? It is not easy. The supplier world is a small world and many vendors trade employees like baseball cards. The market players get recycled, and we see them again with a different supplier. Burning bridges to get what you want on one project is one thing, but you will likely have to work with the vendor again if you are a contractor. What are your best options?

• Get delivery dates in purchase orders — A PO is not effective unless it has an expected delivery date on it. The ship date is important, but the delivery date is more important if the vendor is handling freight. Make sure and set a realistic fabrication time frame, and consider tying any liquidated damages to late deliveries.

• Communicate frequently and effectively — Regular communication with vendors and suppliers can help ensure there are no surprises with delays or cost overruns.
• Buy local — When possible, there can be distinct advantages to buying from local suppliers. Buying from a domestic shop makes it much easier to visit the shop and monitor progress. It also eliminates the added complications of dealing with international shipping. A major piece of equipment stuck in customs doesn’t make anyone money.
• New or Used? Should an EPC project client consider the purchase of used or already fabricated equipment? To save time and money, it can be advantageous to acquire gently used or new yet never assembled equipment whenever possible. Many EPC contractors have access to used equipment or equipment that someone cancelled the order on, which may offer cost and delivery time savings. If the owner chooses this route, it is critical to ensure the equipment is complete, fully functioning and, if possible, that it fits the application with no modifications required. For example, an EPC may find a great deal on some unused storage silos. Project engineers and designers must make sure they are rated for the weight of the product you are using and that any ancillary equipment is suitable for the final application Depending on age, some fasteners, lubricants and sealants might need to be replaced, even if the equipment was never installed. Used products may also not come with a warranty. Make sure to have someone with intimate knowledge of the product inspect the equipment prior to purchasing. Time and money can be saved; however, finding bargains is an art.
  

  Pumps and valves being installed at an EPC-managed job site.

 

 

 

 

 

 

 

The Real Costs of the Procurement Process for an EPC Construction Project

With all this information, what is the best thing for the owner to do? It really depends on how your company is set up. If your company has a “Projects” division with enough capacity to administrate your project, keeping some or all of the work in-house may make the most sense.

Eliminating different kinds of risk is key. Companies can eliminate cost risk and schedule risk by purchasing large pieces of equipment or materials very early in the project. That is what the EPC contractor is going to do and they will follow up on those critical path items on a frequent basis.

The critical components should also be checked during fabrication. Send someone to look (and take pictures) who knows what quality looks like and knows where the fabricator needs to be to stay on schedule. Owners or owner’s representatives who take the least expensive route and go with a lower budget, inexperienced, supplier could cost the project millions of dollars and months or years of delays. If POs aren’t issued in a timely manner or inexperienced employees are sent to monitor progress at a fabricator’s shop or equipment supplier, that could result in unexpected costs. Spending money upfront on hiring the right EPC or project lead can safe months or years of time and possibly millions of dollars on final construction costs, as well as massive delays in time lines that could cause a project to fail before it is even commissioned and operational.

Photos copyright of IAC International.

David Dorman has over 27 years of commercial and industrial construction experience. He maintains licenses as a project manager and an estimating professional. He has over 13 years of experience in the Oil & Gas industry where he has overseen design/build construction for production and storage support facilities for companies such as Chesapeake Energy, Enbridge Mid Continent, Tall Oak Midstream and Access Midstream.