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ACKNOWLEDGEMENT
For the tremendous support and interest I received in carrying out this dissertation
project, I would to extend my sincere and profound gratitude to all the participants those
who have actively participated and contributed in the completion of this research project
and its report which is prepared in partial fulfillment of Executive Masters in Business
Administration (EMBA)-Operations.
My particular thanks go to our Dean Dr. Balakrishna Grandhi and Prof. Krishnan
Navgath for extending their kind support. I would also like to thank Mr. Nihar Kumthekar
for providing valuable guidance.
I also take this opportunity to thank my Industry mentor at Dodsal E&C Pte. Ltd., Mr.
Garry Crighton (Executive Director- Corporate QHSE) who has been my constant
source of strength. He not only guided me at crucial times but was also was
instrumental in extracting from me the best possible work.
Mr. Naresh Rijhwani (Vice President- Engineering) at Dodsal E&C Pte. Ltd. and Mr.
Jinesh K. Shah (Project Management- Wood group PSN) were also a great source of
knowledge and information on the research project. I am thankful for their motivation
and contribution in spite of their busy schedules.
Last but not least, I also want to thank to my colleagues at Dodsal, classmates at S. P.
Jain and LinkedIn community members for actively participating in concluding the
research. I am confident that the outcomes of this research project will be of benefit to
EPC sector stakeholders with regards to the cost escalation issues for their projects.
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EXECUTIVE SUMMARY
For Project Managers and Project Sponsors, scope creep and the project cost over runs are
major concerns. The average cost escalation on industrial EPC projects exceeds 12 to 15
percent from the original estimates. Design deviations (changes, errors, and omissions) are
accounted for roughly 80 percent of the increased costs. The value stated above is only the tip
of the iceberg and the real cost escalation sometimes go up to 33 to 50 percent of the estimated
cost for the project. Earlier identification of design issues (preferably at engineering stage) is
easier to handle and have lesser impact on project health.
The research analyzed such cases, referred to various online case studies and gathered expert
opinion through focused group discussions, personal interviews and online survey, as a part of
this process.
As a result, the research could conclude on various aspects of root causes that contribute to the
cost escalation during the detail engineering stage of the project and interestingly the opinion
believed that the major cost escalations originate from the estimation stage or proposal stage of
the project.
Various factors like short bidding time, Bid selection criteria, Inaccurate FEED (Front End
engineering Design) are identified as few of major issues and are discussed in detail inside the
report. Similarly the cost escalation issues arising from during detail design activities like Gold
plating, lack of proper change management, poor implementation of project management
practices were identified and discussed.
Various research methodology tools and techniques and the knowledge areas learnt through
out EMBA course were used in arriving at a systematic understanding of root causes for cost
escalation issues.
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List of Abbreviations
CEO Chief Executive Officer
DCN Design Change Note
DD Detail Design
DE Detail Engineering
E&C Engineering and Construction
EMBA Executive- Masters of Business Administration
EPC Engineering, Procurement and Construction
EPCI Engineering, Procurement, Construction and Installation
FEED Front End Engineering Design
FGD Focused Group Discussion
FIDICFIDIC
Federation Internationale des Ingenieurs ConseilsInternational Federation of Consulting Engineers
FPSO floating production, storage and offloading
FWBS Functional Work Breakdown Structure
GT Gas Turbine
HAZOP Hazard And Operability Study
HR Human Resource
HSE Health, safety and Environment
IFC Issued For Construction
IT Information Technology
ITT Instruction To Tenderer
LSTK Lump Sum Turn Key
MTO Material Take-Off
P&ID Process and Instrumentation Diagram
PHO Project Home Office
PM Project Manager
PMBOK Project Management Body Of Knowledge
PMC Project Management Consultant
PMI Project Management InstitutePMO Project Management Office
PMT Project Management Team
PO Purchase Order
QHSE Quality, Health, Safety and Environment
QRA Quantitative Research Analysis
ROM Rough Order of Magnitude
SIL Safety Integrity Level
SOW Scope Of Work
SPJSGM S P Jain School of Global Management
SPPID Smart Plant P&ID
SWOT Strength, Weakness, Opportunity and Threats
TQ Technical Query
USD United states Dollar
VAT Value Added Tax
VDR Vendor Document Review
WBS Work Breakdown Structure
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TableofContents
1. INTRODUCTION................................................................................................................................ 3
2. INDUSTRYBACKGROUND................................................................................................................ 4
3. INTRODUCTIONTODODSAL............................................................................................................ 8
4. PROBLEMSTATEMENT..................................................................................................................... 9
5. RESEARCHOBJECTIVE.................................................................................................................... 12
6. RESEARCHDESIGN......................................................................................................................... 13
7. PROJECTSCOPE.............................................................................................................................. 18
8. FINDINGANDANALYSIS................................................................................................................. 27
9. RECOMMENDATIONS.................................................................................................................... 36
10. MANAGERIALIMPLICATIONS
.........................................................................................................
45
11. THEWAYFORWARD...................................................................................................................... 48
12. CONCLUSION.................................................................................................................................. 51
13. BIBLIOGRAPHY............................................................................................................................... 52
List of Appendix
Appendix 01 InterviewTranscriptwithMr.JineshKShah
Appendix 02 InterviewTranscriptwithMr.NareshRijhwani
Appendix 03 TranscriptofFocusedGroupDiscussiononLinkedIn
Appendix 04 SurveyForm
Appendix 05 SurveyResults
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List of Figures
Figure 1 - Average Cost escalation/ Deviations ...................................................................................... 9
Figure 2 - Breakdown of Deviation ........................................................................................................ 10
Figure 3 - Deviation factor contribution % ............................................................................................. 10
Figure 4 - Factors Contributing to Design deviations ............................................................................ 11
Figure 5 - Major Cost Escalation Contributors ...................................................................................... 14
Figure 6 - Problem Area Graph ............................................................................................................. 28
Figure 7 - Problem Area Data ............................................................................................................... 28
Figure 8 - FGD Online Discussion Page on LinkedIn ........................................................................... 29
Figure 9 - Influential position at bidding stage for Cost Effectiveness ..................................................31
Figure 11 - Top Influencer in Estimation stage ..................................................................................... 34
List of Tables
Table 1- Top 5 Global EPC Contractors ................................................................................................. 4
Table 2 Top Oil and Gas EPC contractors in Middle East. ..................................................................... 5
Table 3 - Cost Escalation Factors at bidding stage .............................................................................. 30
Table 4 - Influential position at bidding stage for Cost Effectiveness ................................................... 31
Table 5 - Top Factors at the Detail Design stage ................................................................................. 33
Table 6 - Most Pivotal (Influential) role at Detail Design Stage ............................................................ 34
Table 7 Top Parameters for improving cost escalation ........................................................................ 35
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INTRODUCTION
The Engineering, Procurement and Construction (EPC) sector plays an important role to
play in economic and infrastructure development. This industry is working in many
sectors such as Oil & Gas, Petrochemical, Infrastructure, and Energy etc. From few big
players to many medium and small companies that work as EPC contractors for major
projects around the world. EPC project contract value varies from few million to multi-
billion US dollars.
For EPC projects, the asset owner or the Client, after successful technical feasibility
study and commercial viability study, proposes to design, engineer and build a project
for practical business purposes. The basic design or the Front End Engineering Design
(FEED) is provided to technically qualified and experienced EPC contractors to propose
an estimate for the project.
In this region (GCC) the contracting strategy adopted that of Lump Sum Turn Key
(LSTK) where the successful bidder are who submitted the lowest price. More Often
than not the project schedules are tight. The fast track nature of this business results in
limited time, resources, Information and funds at the bidding stage does not allow a
Contractor performing due diligence of the tender.
The competitive environment in EPC sector is pushing EPC Contractors to win project
bids at cut-throat prices on Lump sum basis. While executing the project, a new team is
formed to carry out the detail design. There are many discrepancies between the
estimated and the actual design. As a result, escalation of cost and time are inevitable.
Cost escalation and scope creep are the top concerns of an EPC Project Manager or a
Project Sponsor since at the end of the day; he is responsible for maintaining the
bottom-line to green.
This research document studies and analyses the factors contributing to such cost
escalations for the EPC contractor during the detail design phase of the Oil and Gas
EPC project execution.
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INDUSTRY BACKGROUND
Engineering, Procurement and Construction (EPC) sector has grown with consistent
pace in last 5 to 6 decades. Initially dominated by Contractors from developed countries
like USA, Europe and Japan, the sector was highly profitable. Technological
advancement, research & development and methodological advancement in the sector
reached saturation in late 20th century. In past 20 years, the industry has grown from
few players to over 150 around the globe. At the same time large projects are sub
divided in smaller packages & sub-contracts, depending upon the value associated and
the complexity of the project.
EPC contracts are mainly in following sectors:
Infrastructure/Building Construction
Oil & Gas,
Power,
Chemicals & Petrochemicals and
Specialized Sectors
Following are Top 5 contractors of the time.
Table1- Top5GlobalEPCContractors
RANK FIRM TOTAL 2012
REVENUE $MIL2013 2012
1 1 Bechtel 29,436.0
2 2 Fluor 22,352.83 3 Kiewit 9,600.7
4 4 Turner Corp 9,084.9
5 6 PCL Construction 6,841.5
(https://enr.construction.com, 2013)
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Over the period there is growing concern on contractors capabilities and project
management skills. Projects contracting strategies have mostly transited from item rate
based contracts to LSTK based. By signing a Lump-sum contract, todays contractor is
deemed to have obtained all necessary information as to risks, contingencies and other
circumstances which may influence or affect the Works.
Table2TopOilandGasEPCcontractorsinMiddleEast.
RANK FIRM TOTAL 2012REVENUE $MIL
2012
1 Petrofac 7006.3
2 Saipem 4245.0
3 Samsung Engineering 3130.0
4 Technip 7099.0
5 Flour 2291.0
31-50 Dodsal E&C Not Known
(Oil & Gas Middle East, 2012)
By signing the Contract, the Contractor accepts total responsibility for having foreseen
all difficulties and costs of successfully completing the Works; and the contract price
cannot be adjusted to take account of any unforeseen difficulties or costs.
As the majority of project risks are transferred to EPC contractors, the contractors risk
appetite and the financial capacity becomes increasingly significant. The burden of the
project management has shifted from the owner/developer to the Lump sum EPC
contractor. Consequently the risk of time and cost overruns are transferred to the EPC
contractors.
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The rise of China, India and Korea has stretched the competition even further. The rise
of unrest in middle-east has further changed the scenario where the localization is
mandated by the local governments and main works of EPC projects are expected to be
done by local contractors. Overall, the situation is high risk ownership, low profit
margins and cut-throat competition. On average if one contractor moves out, five new
payers enters the market.
Given this scenario, EPC contractors are bound to find new ways to improve operations
and re-engineer its processes to ensure that they survive in the market. With increasing
energy demands, desire for better life, Government investment to push growth model
and technological advancement in energy exploration will ensure that the sufficient
number of projects is created in next 10-20 years.
The major Types of EPC contracts are:
Fixed price (Lump Sum Turn Key)
Firm Fixed price (FFP)
Fixed price Incentive Fee (FPIF)
Fixed price with Economic price adjustment (FP_EPA) (Project
Management Institute,Inc., 2008)
Cost Reimbursable Contracts
Cost plus Fixed Fees (CPFF)
Cost plus incentive Fee (CPIF)
Cost Plus Award Fee (CPAF) (Project Management Institute,Inc., 2008)
Time and Material Contracts.
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For the Cost reimbursable type of contracts, the risk is shared between EPC Contractor
and the owner and the EPC Contractor is more protected for the risk.
For the Time & Material type contract the majority of the project risk remains with the
owners. Such contracts are exercised rarely and only when the result of the project is
unknown.
Majority of the contracts in the GCC region in Oil and Gas sector are LSTK bases.
Hence, the research in this project is mainly based on LSTK EPC contracts in Oil and
Gas sector projects.
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INTRODUCTION TO DODSAL
The Dodsal group of companies was founded in Mumbai, India, in 1948 by the Nandlal
Kilachand family as a trading company in partnership with a British trading company
(DODWEL) and Mr. Karsa Salem. Since then, Dodsal has transformed from a family
trading enterprise into a multi-billion dollar Organization.
Today, Dodsal is a Dubai based diversified multinational conglomerate which operates
in the areas of Engineering, Procurement and Construction; Trading and Distribution;
Exploration and Production; Casual Dining Restaurants; and Manufacturing.
ENGINEERING, PROCUREMENT AND CONSTRUCTION
Dodsal Engineering and Construction Pte. Limited, the holding company for the
Dodsals Engineering and Construction business is one of the leading EPC players in
the Energy, Industrial and Infrastructure sectors and has successfully implementedprojects in over 22 countries in the Middle East, Europe, Africa, the Indian Subcontinent
and South-East Asia.
Dodsal E&C Pte. Ltd. also carries out Infrastructure development and management
projects and has already completed on finance, build, operate and transfer basis,
pipeline projects in India and North Africa.
Engineering and Construction is the flagship business of the Dodsal that undertakes
Engineering, Procurement and Construction projects as well as large scale complex
Construction only Projects in the Energy, Industrial and Infrastructure sectors in the
Middle East, Asia, Africa and Europe.
On its projects, Dodsal deploys full time Project Management task forces comprising of
project personnel from all disciplines, including Project Management, Engineering,
Procurement, Construction, Commissioning and Project Support Services.
Dodsals Engineering and Construction teams have a proven track record of high safety
standards and the company has achieved Lost Time Injury Frequencies that are
consistently well below industry averages, receiving several letters of appreciation andsafety awards for their successful and timely project execution. (Dodsal E & C Pte. Ltd.,
2012)
You can find more details of company business at company website:
http:\\www.dodsal.com
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PROBLEM STATEMENT
Highly competitive Oil & Gas EPC market is yet another Red Ocean where the
contractors bid projects absorbing very high business risk. Oil & Gas Companies, taking
advantage of the market situation, pass on complete project risks to the EPC contractor
in the form of Lump-sum Turn Key (LSTK) contracts.
It is highly essential for the EPC to complete the project within Time, Cost and Quality
constraints, absorbing all the risks. The cost escalation during the project execution is
highly detrimental to the financial health of the project. For many contractors, it is a
matter of survival in the industry.
In spite of due care in project estimation process, the contractor encounters various
unforeseen cost escalations during the execution of an EPC project. Engineering phase
being most critical phase in deciding the desired project output; identifies many issues
that lead to the cost escalation for overall project.
The average cost escalation on industrial EPC projects exceeds 12 to 15 percent.
Figure 1 - Average Cost escalation/ Deviations
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RESEARCH OBJECTIVE
The objective of this research project is to identify and address the root causes
contributing to the cost escalation during engineering phase of EPC oil & Gas Project
execution. The project research shall not only focus on the root causes contributing to
the cost escalation but also to suggest recommendation to overcome the risk of Cost
escalation.
The research will be carried out based on Industry data; Web based case studies,
captured cost escalation cases (Within and outside Dodsal) and lessons learnt on
recent EPC projects executed by Dodsal in recent past.
The main research objectives are:
To study and identify the factors contributing to cost escalation during project
Engineering execution phase.
To study and identify the operational issues in engineering execution process
for EPC project.
To conform if the problems are company specific or across the EPC sector.
To gather information on the best practices adopted across the industry.
To apply Management knowledge area tools and techniques for identifying
remedies to the contributing factors.
To propose the improvements in current process to avoid the risk of cost
escalation.
To establish a well-rounded report and conclusion at the end of the study.
At the end of the research project, a comprehensive project report and Power point
presentation is prepared based on facts, findings and resultants of the qualitative and
quantitative research. The project reports not only focus on the root causes contributing
to the cost escalation but to suggest recommendation to overcome the risk of Cost
escalation. A brief power point presentation shall be conducted for the stake holders.
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RESEARCH DESIGN
The Research Design was combination of both Qualitative and Quantitative
methodology. The below paragraphs details the type of research data used for the
project. Both Secondary and Primary data research carried out as part of the project
work.
Secondary research data:
The Secondary research data in terms of Design change notes, Lessons learnt from
previous projects and web based literature was referred.
The Design change notes, lessons learnt with cost variation notes are captured and
stored from various recent projects within the company. Engineering failures and quality
non- conformance identified in past were reviewed and identified to prepare the
preliminary basis to start the project.
Web based research data, competitor data, and research work carried out in past were
cited for problem definition.
Primary research data:
Personnel interviews and web based Focused Group Discussions as primary research
was conducted for problem definition and inputs to generate the basis for quantitative
research.
Qualitative research in the initial stages of the survey, incorporating video calls,
Focused Group discussions and debates helped broaden our knowledge and
understanding of the problem providing an exploratory report.
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Since there are various research instruments, a healthy mix of survey was selected for
great benefit to establish the desired results.
The steps and procedures was followed systematically and included:
Content Analysis.
Evaluation Research on the various triggers of cost Escalation.
Human Factors and psychology of the Team members.
Organizational analysis of different competitor industries.
Extensive Surveys
Sampling Methodology
There are various methods that can identify the frame of aspects contributing to the
cost escalation factors as understood by the stakeholders. However, the 2 methods
incorporated were:
Systematic sampling (75%)
Stratified sampling (25%)
Systematic sampling conducted by arranging a target population to which we
reached out to with the set questionnaire. A key study was drawn initially to ensure
that the target population selected was all of the similar experience levels with
similar industry sector. This was aimed to produce accurate results.
Stratified sampling was important to accurately draw a final conclusion. Here we
gathered a whole target population after which we divided them into individual strata.
Each Stratum was divided by the years of experience, positions held, Complexity
and performance on cost escalation sides. This method ignored irrelevant and
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incomplete data; targeting achievement of efficient results. It permitted greater
balancing of statistical power of tests of differences between the different strata and
sample equal numbers from the varying audience.
Systematic sampling technique used predominantly throughout the research. The
participants for personal interview and FGD were selected from the relevant groups
and organizations, based on their relevance to the subject, willingness to contribute
and experience level.
For Quantitative research, the online questionnaire was distributed through e-mail
and web based survey will be conducted.
Sample Size
The sample size for personal interview was 2.
One person within and one person outside company, within industry.
100+ responses collected for detailed questionnaire.
Target Respondent
The Qualitative research was planned in two parts, that is Personal interview and
Focused group discussions. Two detailed interviews conducted Mr. Naresh
Rijhwani from Dodsal and Mr. Jinesh K Shah from the similar EPC industry player.
The criteria for the selection of the personnel were on the basis of the participants
experience and his willingness to contribute for the cause. Their experience level
varies from 20 to 35 years in EPC industry having senior to top management level
position.
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Focused group discussion was conducted in EPC consultants group on LinkedIn
with more than 28000 professional and experts coming from various disciplines,
whose interests are linked with the project. Please refer appendix-03 for details of
the FGD opinions. Estimation, HR, HSEQ, Project Planning, Project controls are
few disciplines to name a few in the list with engineering discipline.
The representatives are 1-40 years of experience working in EPC sector similar to
Dodsal.
For quantitative research, a questionnaire was prepared on
www.surveymonkey.com and distributed through e-mail and website (LinkedIn)
connections. Please refer to the appendix-04 for details of the survey form.
At least 200 respondents working in various EPC contractor companies attended
the survey, out of which 100+ completed survey result were considered for further
analysis. Refer appendix-05 for survey results.
Web assistance ofwww.surveymonkey.com orwww.linkedIn.com helped targeting
the right audience with higher number of respondents. A larger data collection
brought a good collection and the target respondents were found to be key stake
holders of EPC project execution.
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PROJECT SCOPE
The EPC project life cycle typically vary from 1 to 3 years and gets executed broadly in
3 phases as the name suggests- Engineering, Procurement and Construction. The
Engineering process during the project execution is generally called as Detail
Engineering Design. The research project will mainly focus on the Engineering part of
the EPC life cycle.
In addition, the estimation process involves limited amount of engineering (Pre-bid
Engineering) that leads to cost estimation of the project bid shall be covered in the
project scope. Though, the pre-bid engineering does not form the part of the project
execution, it defines the cost and schedule base lines for the project. Hence, it has a
considerable impact on project engineering execution. The research is mainly focusing
on the operational issues of the proposal stage and detail engineering design and will
not address the contractual and financial aspects of the project.
Though the explicit procurement and Construction phase cost escalation are not part of
the research, the research recommendations shall address the issues originating at
engineering phase.
The scope of the study will also cover the Human resource aspects like skill sets,
competency and soft issues essential for smooth project execution.
The project mainly focuses on the identification of cost escalation factors and proposes
possible check points to avoid such occurrence for few cases. The judgment for the
proposed check point is an expert opinion and shall be applied on case to case basis
specific to company. EPC sector is widely diversified in terms of geographical regions,
culture, complexity, and scales and hence the concepts discussed may not be used
directly- as is - but with tailoring to the operating context.
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Various cost escalation reports with company were reviewed and analyzed. The
relevant data are classified information and cannot be displayed in the report. However,
the leanings out of the cases were captured in the research project.
EXCLUSIONS
Any cost escalation arising explicitly related Procurement and Construction issues are
excluded from the scope of the research. However, any development or triggers
originating from engineering having major cost impact on the procurement and
construction activities of the project shall be studied and discussed in detail.
The research is mainly focusing on the operational issues of the proposal stage and
detail engineering design and will not address the contractual and financial aspects of
the project.
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LITERATURE REVIEW
The cost escalation in EPC sector is a matter of concern for all project holders. In order
to understand the EPC industry, we could find and review various online reports.
Pratap Vijay Padode, Editor-in-Chief, Infrastructure Today and Managing Director,
ASAPP Media Information Group say that delays in our development projects are
forcing more developers to go the EPC way. The new emphasis on EPC is also, sadly,
because investments are looking south. With a double-dip threat in the global economy,
the worst industrial growth in eight quarters in India and projects down to a trickle, EPC
is a stable option. (Ernst & Young Pvt. Ltd., 2011)
A decade ago, the EPC industry comprised a handful of large, complex projects and
multitude small packages and subcontracts. Today, there is no dearth of high value and
complex projects being executed by government and private players. The increasing
size and complexity of projects has, however, led to a growing reliance on contractors
capabilities and project management skills. (Ernst & Young Pvt. Ltd., 2011)
Contracts have evolved from item rate packages to lump sum fixed price binding
contracts. Slowly but steadily, the onus of project management has shifted from the
owner/developer to the contractor. Gradually, the risk of time and cost overruns has
been transferred to the contractor, along with the responsibility of designing,
procurement of materials and construction. Standard clauses and conditions prevailed,
but the EPC contract model has evolved to reflect the shift in balance of risk between
the owner/developer and the contractor. (Ernst & Young Pvt. Ltd., 2011)
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The problem of cost escalation, schedule escalation and scope creep in the fields of
project management are not new. Various online magazines line Engineering News
records, World Oil, offshore Engineers etc. shall be referred to identify the horizons the
problems in Industry. Websites related to EPC companies and market like MEED,
ZAWYA and PMI were explored to gather the secondary data for the project. Various
study books like PMBOK by PMI, were be referred to standardize the terminology and
learning area.
One recent example studied in the MEED was related to Saudi ARAMCO Wasit
offshore gas project. The project was awarded to Saipem with specified sulfur content in
the project specification. However, while executing the project, there was unexpectedly
high sulfur content. There was a difficult situation for both client and Contractor to
absorb the risk as the project estimated value was amounting to almost 6 Billion USD.
(MEED, 2012)
A recent news article reveals that the South Korean construction stocks have lost
almost 20 percent of their value, falling to levels last seen four years ago, after huge
losses at two firms sparked widespread fears of overseas projects going sour. After the
2008 financial crisis, South Korean builders such as Samsung Engineering Co Ltd and
GS Engineering & Construction Corp won a raft of foreign orders, particularly in the
Middle East. (http://au.news.yahoo.com, 2013)
Some of those contracts have turned into losers as fierce competition has driven down
prices, and inexperience in new areas has meant extra costs. Lack of understanding of
business conditions in new markets and risk arising from moving into new products
resulted in big cost increases in some projects, the firm said in a statement. Across the
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sector, the decision to chase foreign orders that have turned out to be unprofitable is
expected to hurt bottom lines. (http://au.news.yahoo.com, 2013)
There are various case studies and lesson learnt on the issue are available on web
based literature. At the same time, Dodsal has got vast experience carrying out projects
in different sectors, locations and at different timeline.
The Design change notes, lessons learnt with cost variation notes are captured and
stored from various recent projects. We have strong database within the company for
engineering failures and quality non- conformance identified in past. The same will be
identified and reviewed to prepare the preliminary basis to start the project.
Contract models play very important roles in EPC sector. For understanding of type of
contracts the PMBOK Guide was referred. (Project Management Institute,Inc., 2008)
Additionally the FIDIC guidelines for construction contracts were referred. (Savage,
2012)
Various sections of the FIDIC Contract recommendations were studied for
understanding of EPC contracts:
Red Book: Conditions of Contract for Construction for Building and
Engineering Works Designed by the Employer;
Yellow Book: Conditions of Contract for Plant and Design-Build;
Silver Book: Conditions of Contract for EPC/Turnkey Projects;
Green Book: Conditions of Short Form of Contract. (Savage, 2012)
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Aim is to understand the contractual obligations of the EPC contractor to serve the
client. Since we are studying the cost escalation, in many cases, I would say in majority
of cases, there is thin line between the change of scope and the contractual obligation.
Hence, as an EPC representative, one should clearly identify and discriminate the
activities which are out of project scope. Also, it is imperative that the cost claims are
put forward in legitimate formats and with legal arguments. (Savage, 2012)
When we identify the variations in the scope and not take up the claims in a correct
manner that the efforts may go in to vein. Hence, various recommendations from FIDIC
for handling the claims were studied and identified as pa part of the research. However,
there are no specific recommendations made in the report for the FIDIC literature review
as it is assumed that the professional project management practice includes the
contract management skills. (Savage, 2012)
It is important learning that the effective contracts management as a part of project
management is essential to ensure that the cost claims are protected. It is important to
write change orders and claims in clear and unequivocal terms. It is important to avoid t
hint or insinuate. Effective record keeping can assist EPC contractors to prove their
entitlements and enable to accurately ascertain their positions in the event that a
dispute arises. (www.out-law.com, 2011)
Various reports on the similar lines from the competitors companies will be requested
and reviewed. Research work related on similar problems carried out by some other
companies, consultants in different sector, region or industry shall be cited for preparing
the basis. As the problem related data within company is available in abundance; more
focus was given to it.
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Various online articles on the estimation process were searched on websites and
referred. In the PMI knowledge self Hrishikesh Karekar, PMP mentions that the Cost
and timeline overruns are typically associated with what are referred to as forecasting
errors or technical errors, such as imperfect techniques, inadequate data, honest
mistakes, inherent problems in predicting the future, lack of experience on the parts of
forecasters, and so forth. (Karekar, 2013)
These overruns can occur at any point in the project life cycle and for a variety of
reasons: incomplete requirements, poor design (lack of skills to manufacture the
design), and inadequate testing. These reasons are valid and the inadequacies caused
by these reasons can be mitigated by rigorously following many of the standard project
management methodologies and best practices across organizations and industries.
(Karekar, 2013)
Various suggestions are discussed in detail for addressing the gap in estimation
process. The recommendations were analyzed for its application in current scenario.
While accessing the existing scenario in EPC markets, various online magazines were
reviewed and the Project Vendor was one of them. There were interesting articles in the
magazine and one Enhancing the EPC Efficiency was very interesting.
Mr. P. P. Gupta, Managing Director- Techno Electric & Engineering Co. Ltd says that
challenges are inevitable in current EPC market scenario, but the approach to the
management of such problems will be the key to the continuous success. (Project
Vendor, 2010)
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Mr. Gupta further explains that the qualification criteria for project award are being
limited to competitive pricing, the new inexperienced players winning the project at
reduced Pricing escalates the project risk to the significant high. (Project Vendor, 2010)
According to Mr. Susnato Sen, Project Head (Infrastructure), Tata strategic
management group say that the major challenges to the EPC sector are:
1) Shortage of skilled manpower
2) Low Focus on Engineering as compared to procurement and Construction
3) In efficient sourcing
4) Lack of advanced Project management practice
5) Risk management practices are not yet developed
6) Burdened with less expected revenues and higher debt. (Project Vendor, 2010)
The article discusses various factors that can affect the positive outcomes of the project
or the prevailing threats to the projects success. The major one identified and
discussed is Cost escalation. (Project Vendor, 2010)
The article describes delay in starts and completion of the project, ambiguity in design,
wrong methodology, lack of coordination, frequent changes and socio-economic factors
as major influencers to the cost escalation of the project. Bad project management is
identified as major factor for cost escalation by experts in the article. (Project Vendor,
2010)
The article also suggests the professional project management approach such as
process design flow, material management, and risk assessment can significantly
address the major cost escalation issue of the EPC project. (Project Vendor, 2010)
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To eliminate challenges in EPC project execution, Mr. Susnato Sen expresses that that
best-in-class project management tools and techniques need to be adopted. He also
emphasizes on necessity to develop an in-house team of experienced professional
project management personnel and developing more understanding of expert
engineering design, particularly for complex technology EPC projects. One of the
important suggestions by Mr. Sen in this context is to set up internal project
management and Engineering Management teams and factor in required time along
with a need to create a risk assessment /management team for large EPC projects.
(Project Vendor, 2010)
It was important to indicate the quantitative figures and facts that can demonstrate the
negative impact on the project. Various online data and previous research projects were
reviewed to judge the quantitative aspects. It is important to note that no clear band can
be defined for cost escalations and experiences have taught us that the cost escalations
can go up to 50% of the original cost depending upon the nature of the project and EPC
execution capabilities. (The Construction Industry Institute)
The Power Engineering magazine was reviewed for various types of contracts for the
understanding of the risk distribution between the owner and the EPC contractor. The
article describes the various approaches in EPC contract award and its estimation
processes. The article clearly says that the lump sum turnkey EPC with Firm Fixed
Price could be the most costly contracting approach and the majority of the risk lies with
the EPC contractor. (Power Engineering)
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FINDING AND ANALYSIS
The design change notes and the cost variations reports are major issues that spoil the
day. Cost overruns are difficult to justify and when we analyze them, we understand that
the time has already passed to correct or reverse those mistakes. They mostly come as
result of some actions taken or not taken in to the project engineering stage. On the
same lines, I decided to go ahead with my dissertation project and determined to
capture those cost escalations during the detail design stage of the EPC project.
The research started with the understanding that the majority of the cost escalation
came from the detail engineering stage. As we started analyzing the past project data,
industry cases and discussing in the expert forum we came to learn an important
opinion about root causes of cost escalation issues, which was different than the basic
understanding. When analyzed in detail, the cost escalation issues for its root causes,
an important learning came out and that says, for many cases the roots of the cost
escalation lies with the estimation or the bidding stage of the project.
The project scope was extended for the bidding stage analysis as the cost escalations
arising at detail design stage cannot be seen in isolation. It was evident in personal
interviews and the Focused group discussions that the majority of industry expert
believe that major cost escalations come from the bidding stage. The complete research
work then was divided in to two areas,
1. Cost escalations originating from bidding stage.
2. Cost escalations origination from Detail design stage.
Result of the online survey reinforced our understanding that the majority of cost
escalations come from bidding stage.
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As a result of the online survey,
Inaccurate FEED,
Skills of Estimation Team and
Improper FEED verification
are identified as top 3 factors.
Table 3 - Cost Escalation Factors at bidding stage
Inaccurate FEED3.86
Skills of Estimation Team3.84
Improper FEED verification3.72
Insufficient review of ITT documents3.64
Selection of bid without evaluating its SWOT3.63
Bidding completely new sector3.62
In adequate Risk analysis
3.59
Short bidding time3.57
Overoptimistic Feasibility Study3.56
Absence of lessons learnt from previous projects3.55
Ignoring and poor assuming of non-material costs3.54
Improper bid coordination/management
3.40
Insufficient contingency reserve3.31
Too many applicable standards3.03
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Majority of the opinion said that the Estimation/Proposal Manager has the highest
influence over the cost escalation and the contracts manager has the lowest.
The key factors identified for the cost escalation during detail design stage of EPC
project are as listed below:
1. Improper change management
2. Poor Risk Management
3. Different team for estimation and detail design
4. Poor coordination between Lead engineers
5. Poor Coordination with Client/PMC
6. Realizing of unstated requirement in Bid
7. Improper multidisciplinary/internal review of documents
8. Engineers biased to high tech products
9. Over specifying (Gold plating)
10. Incapable project manager
11. Interference of client Operation/production team
12. Scope creep due to detail studies (Hazop/QRA etc.)
13. Client/PMC with highly wishful thinking
14. Client/PMC delaying disputes, decisions and reviews
15. Technically weak Client PMC team
16. Engineering subcontractor delays
17. Cost Insensitive Engineering Subcontractor
18. Manpower shortages
19. Frequent changes in Engineering team
20. Inexperienced engineering team
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As a result of the survey the top five factors identified are:
Inexperienced Engineering team
Incapable project manager
Improper change management
Client/PMC delaying disputes, decisions and reviews
Frequent changes in Engineering team
Table 5 - Top Factors at the Detail Design stage
Inexperienced engineering team3.94
Incapable project manager3.90
Improper change management3.79
Client/PMC delaying disputes, decisions and reviews3.79
Poor Coordination with Client/PMC3.69
Frequent changes in Engineering team3.69
Cost Insensitive Engineering Subcontractor3.62
Improper multidisciplinary/internal review of documents3.60
Engineering subcontractor delays3.57
Scope creep due to detail studies (HAZOP/QRA etc.) 3.55
Poor Risk Management3.54
Realizing of unstated requirement in Bid3.54
Client/PMC with highly wishful thinking3.51
Poor coordination between Lead engineers3.46
Over specifying (Gold plating)3.46
Interference of client Operation/production team3.41
Manpower shortages3.39
Technically weak Client PMC team3.31
Different team for estimation and detail design3.28
Engineers biased to high tech products3.09
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The majority believed that the Engineering Manager, Project Manager and Discipline
Leads are the key influencers to the cost escalations.
The research is intended for the resolution to the problem; hence it is import to judge
that what are the influential factors that contribute to effective cost management of
the project?
When asked- Please rate below parameter on the scale of 1-5 that can
improve/avoid cost escalation. (1 lowest, 5 highest)
Table 7 Top Parameters for improv ing cost escalation
Strict project design change management system3.98
Implementation of proper Project management practices. 3.81
Careful Selection of Bid after proper evaluation.3.76
Implementation of proper Risk management practices.3.71
Cost/Budget awareness programs.3.71
Focus on motivated Team to execute the Jobs.3.71
Emphasis on learning from past projects.3.68
Emphasis of capturing and review of lessons learnt. 3.63
Continuous focus on Learning and Growth.3.46
Implementation of Award and Recognition program3.22
The top 3 factors were
Strict project design change management system
Implementation of proper Project management practices.
Careful Selection of Bid after proper evaluation.
The least important factors were:
Continuous focus on Learning and Growth.
Implementation of Award and Recognition program
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Preliminary review of the FEED content shall be carried out by the select team of
expertise from Contracts, estimation and Engineering for its completeness.
Comprehensive SWOT analysis needs to be done and shall form the basis of Go/ No
Go for the project.
Implementation of Risk Management Process at phase - 2 to 5
Proper Risk management practices shall be implemented in both bidding and detail
design phase of the project. In fact the process shall be extended for the entire project
life cycle. Qualitative and quantitative risk identification tools and techniques may be
included as per the nature of the project. All risks, may it be smallest and have lowest
impact shall be captured and evaluated for its avoidance, transfer, acceptance and
mitigation. A comprehensive risk register shall be a must requirement.
A proper Risk data quality assessment, risk categorization, risk urgency assessment
and continuous update of risk register shall be implemented. Identified risks and its
triggers shall be well documented. The ownership of the risk shall be distributed to
project personnel for continuous monitoring and update of the risk register.
Professional Project management approach for not only execution but to Bid
stage at phase - 2 to 5
There is no doubt that companies implementing professional project management
during project execution achieve higher rate of success. However, the bid estimation
stage is executed in traditional way. The bid estimation shall be considered as a project
itself. A complete project management practice shall be applied in carrying out the
project Bid. All five process groups and various processes as documented and guided
by PMBOK shall be considered with appropriate selection and tailoring of the project
management processes.
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Each phase of the estimation process and lessons learnt, assumptions shall be
captured and documented so that it can be passed on to the execution team for post bid
works. Clear-cut project baselines in terms of schedule, cost and quality shall be
defined and issued for execution.
Implementation of scope identification and scope definition with help of detailed FWBS
(Functional Work Breakdown Structure) shall be practiced and the bottom-up estimation
shall be used. Apart from above methods, tools like analogous estimation, parametric
estimation and reserve analysis shall be used to achieve correct rough order of
magnitude. It is important to remember that the estimation being short-time process
may not allow the estimation to be accurate to the extent of +/- 10%. Hence the reserve
analysis and cost of quality like tools shall be employed as required.
Use of software based estimation shall be considered to avoid manual errors.
Many organizations have different teams for estimation and execution processes. These
results in loss of information and knowledge gathered during the bidding process. Key
personnel for bidding team shall form the part of EPC execution and shall be made
responsible for capturing cost at early stage.
The company shall look in to the possibility to reduce the number of design changes by:
1. Comprehensive project scope definition.
2. Interdisciplinary reviews with affected stake holders and
3. Implementing processes to limit scope modifications. (Construction Industry
Institute, 2013)
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The rotation of few members of bidding team and EPC execution team has been found
to be a useful concept. By doing this as the knowledge of execution problems can be
well covered in both bidding and execution stage.
Development of Skil led Estimation team at phase - 1 & 2
Estimation being short time period process needs higher level of experience. A team of
experienced engineers mainly from detail engineering background shall be made lead
for engineering team.
Concepts of value engineering and innovative approach are must for acquiring the
competitive advantage over other bidders. An alternate bid with improved functionality
and reduced cost can outperform the competitors. Careful material selection, optimized
quantities, proper FEED endorsement, innovative construction methodology, optimized
man power deployment plan, effective scheduling techniques along with
detailed/improvised technical documentation at bid stage can reduce the cost escalation
risk for the EPC contractor.
Learning and development are important factors for skill development. Vendor
presentations, Technical seminars, new products, innovative hardware and construction
technology are important factors that can bring competitive edge in bidding process.
The report recommends following main action plans for the Detail design stage of the
project.
Implementation of Strict Change management system at phase - 3
While execution stage, most of the documents are developed based on the given FEED
documentation. Clear baselines in terms of scope, cost and schedule are inputs to the
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execution process. While developing the detail design it is important that any change is
identified and captured at the first/generation stage. All updates, changes, upgrades,
improvements, detail design, addition, reduction in whatever name it comes shall be
compared and identified as change and shall be registered in the change register.
Any change shall be evaluated for its necessity and impact on the project output. If the
change is agreed to be necessary or unavoidable, shall be routed through its implication
review. The ROM shall be made and determined if the change comes from the client or
as a result of detail design.
Only execute the change that is agreed and approved by project Change management
committee.
In the below section, the research process have tried to explain the proposed Change
management process that can be implemented in order to manage the project changes
effectively. The basis of the design is based on expert judgment and experience gained
in past.
Step-1
The change management process starts with the identification of change/deviation
event. This is broadly called as initiate change. The variation or the deviation shall be as
compared to baselines (Cost/scope and schedule)
Responsibility: Any project team member.
Time frame: 1 to 2 days
Output: Intimation to Project controls department.
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Step-2
Register the change description in to project change register/log or IT enabled Change
management system. Minimum assignments are change number and its Type.
The Change types can be classified as following:
Client initiated (scope/schedule and reimbursable cost escalation)
EPC in-house (value Engineering/ detail Development/ deviation/ baseline shift)
Output: intimation to Change control Board with change intimation form.
Step-3
The change control board shall take the decision on whether to proceed with the
deviation. It is important while analyzing such trends/changes that the project cost,
scope and cost baselines shall be evaluated for impact of changes.
If the decision is made in favor of the change, then the Rough order of magnitude
ROM estimate shall be prepared and all impact report shall be prepared. The
proposed changes shall be conveyed to the stakeholders including the client as
appropriate. Proceed to step-4.
If the change management board thinks that the change shall not be processed,
it will advise the project team to develop the mitigation plan. The Change register
shall be updated for the outcome and the concerned team members shall be
informed for rejection.
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Step-4
If the change is Client dependent or initiated by client requirement, then the change
approval shall be taken-up with client for approval for its impact on cost, schedule and
scope baselines. If not, then proceed as in-house change.
Detailed estimate on Cost, schedule and scope shall be prepared by project
controls with the help of project management team. The help of Engineering,
procurement, construction and estimation team may also be taken for arriving on
definitive estimate. The impact on the project based on definitive estimate shall
be evaluated for the feasibility and viability. If satisfactory, the Completed
definitive estimate irrespective of client originated or in-house changes shall be
submitted to client for final approval.
Step-5
The estimate, discussions and negotiations with Client and the project management
shall continue and shall be iterative until the agreement for approval or rejection is
reached.
If not agreed by client, appropriate mitigation plan shall be prepared by the
project team. The change register shall be updated for the outcome. Concerned
team members shall be informed.
If agreed by the client, and if the change is client initiated, official change order
shall be signed. The change register shall be updated for the outcome. Project
team shall be informed to execute the approved changes.
Only agreed change order shall be processed for execution. Reconcile the Cost,
scope and schedule baselines with execution plans.
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The potential Change Notice Form being first important step in the process, following
important fields shall be included in the form as minimum.
1. Project Change order number
2. Client name
3. Project name
4. Location
5. Project ID
6. Date initiated
7. Discipline engineer
8. Discipline Lead
9. Description of potential change notice
10. Possible Cost impact on Project (Yes/No)
11. Possible Scope impact on Project (Yes/No)
12. Possible Schedule Impact on Project. (Yes/No)
13. Requesting person
14. Reason for change
15. Other disciplines affected
16. Impact if the change is not implemented.
17. Source (Client change/ in-house change)
18. Approval (prepare ROM/ reject)
19. Comment note
20. Approval authority
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Human recourse plan for all Phases of project life cycle.
Companies relying on qualified personnel are more insulated from the risks.
Qualified and certified executives with right experience implementing the project can
drastically change the project outcomes. Researchers have found that the certified
project managers, Estimation managers and Engineering Managers are vital influencers
in avoiding the cost escalations
The process starts with the comprehensive human resource plancareful selection of
Qualified, certified and well experienced personnel is a first step in process
A comprehensive performance review and reward system needs to be developed in
order to retain the key people for the success of the project. There should be incentive
for Lead engineers to stay with company for specified period as the lead engineers
leaving in-between the project can significantly hamper the process.
Skill development for engineers and technocrats can be an important tool that can uplift
the talent pool for the company. Regular technical trainings and technical participations
can bring positive results.
Companies build on its expertise bay carrying the experiences and lessons learnt from
one project to the next. The right mix of young graduates and long-term employees play
major role in the process improvements and provide backbone for innovation in order to
achieve the strategic advantage over the competitors.
A comprehensive learning management concepts including, process mapping, goal
setting, balance score cards, 360 degree appraisal process, Team building and internal
customer satisfaction shall be inducted in to the system to achieve higher satisfaction
and morale of the team.
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MANAGERIAL IMPLICATIONS
The research identifies various factors contributing to the cost escalation in bidding
stage and the detail design stage of an EPC project. The key influencers identified in
the process of cost optimizing are Estimation Manager, Project Manager and
Engineering Manager.
The first step in the direction will be to form a task force to for identification and
application of researched data in to present organizational context. The task force
members shall be selected on the bases of Qualification, certification and expertise in
the EPC sector. Discipline engineers shall be involved. If required the external
consultant shall be appointed.
As a result, the company wide message can be given on emphasis on the cost
awareness. Management can achieve its goal only with help of the employees and the
team for the project. Concept of PMO is very important in this context. For consistency
across the projects and achieving long terms objectives the PMO can provide trained
project managers, processes and procedures. It can also help providing cultural
backbone for professional EPC project management.
The additional man hour costs for the above activities shall be tracked and mapped as
cost of Quality and cost of prevention. It is important to remember that above
recommendation increases the overhead expenses of the company. The cost of
prevention shall be much lower than the cost of defect repair.
The second step is to collect the organizational process maps. Identification of list of
important process maps shall be developed and compared with the existing processes.
If required the new process maps shall be drafted.
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It shall be ensured that all critical activities are cover by one or multiple process maps.
Each cost escalation factor identified in the research shall be applied to the existing
process/processes. Separate checklist based on the for Estimation, Project
management and Engineering management shall be prepared.
Cost awareness, tight project control and effective project management are more of
organizational culture and team work than the demonstration of individual skills. In the
process, it is important that decisions are taken in favor of companys stated interest of
effective EPC project execution efficiency based on procedures and not individual
capacity. The project management team needs continuous guidance from the
organizational process assets and even the lowest hierarchy of the project team is able
to take appropriate decisions based on the company guidelines, without waiting for
higher-ups.
As recommended, the strict project change control system shall be implemented so that
only the approved changes are implemented, Concerns are addressed, unnecessary
work and consequent rework can be avoided. The most important achievement of the
process is no surprise. All potential deviations and changes are identified at the initial
stage and not when the consequences are out of control. This will also avoid burden of
cost overrunning and budget constraints on project management team, increasing
morale.
The focus shall be
1. To identify any change at the earliest stage of the project.
2. Identified change shall be immediately reported to Change management system.
3. Thorough review and approval of Change.
4. Execution of approved changes only.
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It is assumed that the Risk management activities are carried out by the Project
Manager and Estimation Manager. If this is not the case, Risk manager shall be actively
involved in the project.
Specially, at the estimation stage, risk register shall be initiated with the inputs from all
concerned disciplines. Careful consolidation of risk register is important. Once the risks
are identified, logged and consolidated, adequate contingency reserves shall be
proposed in addition to project costs. The same risk register shall be handed over to the
project risk manager for tracking and further updating. The advantage is that the project
manager is aware in advance for envisaged and considered project risks and its
triggers. A very common scenario in the project execution time that the risk has realized
and there is no plan or contingency reserve provision for it can be avoided.
The Human resource management needs to be involved for devising the mechanism to
recruit, train and retain the project staff. The average cost salary of certified Project
manager or Risk Manger will be 10-15% more. The retaining costs of the qualified
people are also higher. However the value buy-in is in multifold.
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THE WAY FORWARD
From the analysis of secondary and primary research results I am able to identify and
analyze the list the cost escalation factors in EPC sector and especially for EPC
contractors.
The most important factors and influential parameters are identified in the research. A
proposed way of resolving the one of the major factors- Change management plan is
illustrated in the project report. The first thing that needs to be looked in is the existing
Change management process. The process needs to be reviewed for fulfillment of its
intended purpose. If required, needs to be updated or revised to the desired level. The
work shall be accomplished within 2 weeks time. Once approved by management, the
Change management process shall be mandated to all existing projects. A special
introduction of Change management plan through trainings, seminars and focused
Group shall be discussed among the project teams. Within 2 month the process shall be
operational. A careful monitoring shall be carried out specially for initiating the change
requests.
Parallel to above, based on the organizations present situation, the process maps
related to Estimation and Engineering processes needs to be revisited and the
adequate check points needs to be ensured in the process. This process takes around
4 to 8 weeks time or 4-8 months based on preparedness and maturity of the
organization for its process assets. If required separate checklists shall be prepared and
implemented across the projects. Since the estimation process is shorter in time as
compared to Detail design, a special care shall be taken in designing the checkpoints
ensuring that the check points do not make the process sluggish.
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Organizations which does not have formal process maps for those activities, may start
developing the check list as a quick tool to ensure that the cost escalation factors are
not ignored and in fact captured at the initial stage. Companies can look for IT based
solutions to reduce the human errors.
Strict implementation of professional project Management and Risk management
practices shall be emphasized. The recruitment process shall be updated for more
focus on right mix of Qualification and experience while selecting the project team.
A comprehensive skill development and rewards/recognition system to be initiated to
retain the talent pool of the organization.
The recommendations need strong management support for implementation.
The research work was primarily carried out for the Estimation/ bidding stage and detail
design stage of the EPC project. The EPC sector has two more major phases that
consumes majority of project budget. Though the activities carried out in procurement
and construction is based on specifications, drawings and guidelines generated from
the engineering stage, it has its own area where there is risk of the cost escalation. This
research being time bound and for academic purpose, limited its scope to Bidding and
Engineering stage only. Management may take the further decision to promote carrying
out further research in the area of procurement and Construction of the projects.
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The time line for implementation of the Implementation process is advised as below.
Activi tyResponsible
Function
Key responsible
personDuration
Review and update of existingChange management system
PMO Head PMO
2 weeks
Implementation of Change
management system
Project
ManagementProject Manager
1 month
Process mapping for Estimation
and Engineering processes
Engineering /
Estimation
Discipline
Manager
1 to 8 Months
Implementation of engineering
checklistsEngineering
Engineering
Manager
3 months to 1
Year.
Development of Skill
development programHuman Resources
HR Manager/
Discipline
Manager
3 moths
Development for reward and
recognition systemHuman Resources HR Manager 3-4 months
Preparation and implementation
of Training calendarHuman Resources
HR Manager /
Discipline
Manager
6 Months
Start further research on
Procurement and construction
phase for identifying the cost
escalation issues
Management CEO 1 Year.
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CONCLUSION
The cost escalation issues can be effectively handled by EPC organizations at the early
stage of the EPC projects, mainly during the estimation and detail engineering stage by
implementing Professional Risk Management and Project Management practices. Early
identification and definition of cost triggers can be punched in project risk register and
actively monitored by the project management team during the project life cycle.
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