Creating Value through the Benchmarking of Capital Projects · Creating Value through the Benchmarking of Capital Projects Measuring the relationships ... 0.9 1 1.1 1.2 89 90 91 92

Creating Value through the Benchmarking of Capital Projects

Measuring the relationshipsbetween

what you get

what you do

and...

Purpose of the Discussion

n Discuss the progress of the process industries in capital effectiveness

n Explore primary drivers of project excellence

n Bring data to some contentious issues

Basis for the Discussion

n Each year Independent Project Analysis (IPA) conducts about 600 project evaluations for the process industries:

Ø oil (upstream and down)Ø chemicalsØ pharmaceuticalsØ mineralsØ consumer productsØ power

n We now have databases containing over 5000 major projects and 1400 small projects

Characteristics of the Databases

Data for each project are quite detailed: over 1500 variables describe the projects from inception to completion

All data were obtained through face-to-face interviews with the project teams and sponsors in addition to the documentation

All data are normalized to a common time and place and external factors are removed

We then develop statistical models to create indexes for cost, schedule, operability, etc.

Outline

þ Keys to improvement

þ The role of contracting strategies

Ø Is fixed-price best?

ØDo incentives work?

Progress in capital effectiveness

Progress

The cost of facilities has improved by about 12 percent in real terms over the past 5 years

Execution schedules have improved nearly 30 percent over the past decade

Construction safety has improved dramatically

Operability has held steady

CONFIDENTIAL - FOR USE OF I BC CO MPANIES ONLY 1

Cost Performance Is Improving

0. 8

0. 9

1

1. 1

1. 289 90 91 92 93 94 95 96 97

Ind ustry Top Quarti leYear of Au th orizatio n

Rela

tive

Cos

t Ind

ex

CONFIDENTIAL - FOR USE OF IBC COMPANIES ONLY 2

Schedules Are Improving0.9

1

1.1

1.2

1.3

1.489 90 91 92 93 94 95 96 97

Exe

cutio

n S

ched

ule

Inde

x

Industry Top Quartile

Year of Authorization

CONFIDENTIAL - FOR USE OF IBC COMPANIES ONLY 3

Operability Shows No Change

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0.9

1

1.1

1.2

89 90 91 92 93 94 95 96 97

Ope

rabi

lity

Inde

x

IndustryTop Quartile


Safety Performance is ImprovingLost Time

1989 1990 1991 1992 1993 1994 1995 1996 1997

0

0.5

1

1.5

2

Authorization Year

Lost

Tim

e R

ate

Total Recordables

1989 1990 1991 1992 1993 1994 1995 1996 1997

0

1

2

3

4

5

Authorization Year

Rec

orda

bles

Rat

e

*Using all PES database projects authorized after 1992.IPA

Top Quartile PerformanceCan Increase IRR by 5%

0.9

1

1.1

1.2

1.3

1.41989 1990 1991 1992 1993 1994 1995 1996 1997

Exe

cutio

n S

ched

ule

Inde

x

Industry Top Quartile

0.8

0.9

1

1.1

1.21989 1990 1991 1992 1993 1994 1995 1996 1997

Rel

ativ

e C

ost I

ndex

Cost Schedule

Operability

Top adds 2.5% IRR over IndustryTop adds 3.9% IRR 1998 vs. 1989

Top adds 2.5% IRR over IndustryTop adds 3.9% IRR 1998 vs. 1989

0.8

0.9

1

1.1

1.2

1989 1990 1991 1992 1993 1994 1995 1996 1997

Op

erab

ility

Ind

ex

Top adds 0% IRR over IndustryTop adds 0.6% IRR 1998 vs. 1989

Top adds 0% IRR over IndustryTop adds 0.6% IRR 1998 vs. 1989

Top adds 0.5% IRR over IndustryTop adds 0% IRR 1998 vs. 1989

Top adds 0.5% IRR over IndustryTop adds 0% IRR 1998 vs. 1989

Top adds 3% IRR over IndustryTop adds 5% IRR 1998 vs. 1989

Top adds 3% IRR over IndustryTop adds 5% IRR 1998 vs. 1989

Outline

þ Progress in capital effectiveness




Ø Do incentives work?

Elements of Capital Effectiveness

Optimal

Scope forBusiness

Need

Executedwith

minimumchange

Front-End Loading

Discipline

Business Case Development

Timely Involvementof Contractors/Vendors

BETTERROI

BusinessStrategy

TechnologyStrategy

Team Integration

Key Performance IndicatorsKey Leading Indicators

Leading Technology

Low Cost

Excellent Operability

Fast Cycle Time

SAFETY

Use of Value Imp.Practices

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Optimal

Scope forBusiness

Need

Executedwith

minimumchange

Front-End Loading

Discipline



BETTERROI

BusinessStrategy

TechnologyStrategy

Team Integration


Leading Technology

Low Cost


Fast Cycle Time

SAFETY


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Integrated Project Teams

n An Integrated Project Team is a team of full or part-time representatives of the following areas (but are not limited to):

Ø Business Ø EngineeringØ ConstructionØ MaintenanceØ Operations/ProductionØ Health and SafetyØ Environmental (if needed)Ø Contractor (if appropriate)

n These representatives are identified prior to project authorization and have specific responsibilities that are defined and understood by all team members

n These representatives have authority to make decisions for the function they are representing and provide functional input to the project manager.

Definition of an Integrated Project Team

41

Integrated Teams Result in Better FEL andTherefore Better Performance

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2

3

4

5

6

Integrated Teams

Non-Integrated Teams

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1

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FEL Index Cost Index

Integrated Teams


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1

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1.5

Integrated Teams


Integrated Teams


Schedule Index Operability Index

*Using all PES database projects authorized after 1992

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Integrated Teams Even Help ProjectsWith Poor FEL

Cost

Schedule

Operability

0.5 0.6 0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5Performance Index

IntegratedTeamsNon-IntegratedTeams

Industry Average


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IPA


Optimal

Scope forBusiness

Need

Executedwith

minimumchange

Front-End Loading

Discipline



BETTERROI

BusinessStrategy

TechnologyStrategy

Team Integration


Leading Technology

Low Cost


Fast Cycle Time

SAFETY


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Components of Front-End Loading

SiteFactors

EngineeringDefinition

Project Execution

Plan

FELIndex

Local labor cost and productivity

Materials availability

Equipment layout

Soils data

Environmentalrequirements

Health & safetyrequirements

Engineering tasks- Detailed scope- Feedstock/product properties- PFDs- H&MBs- P&IDs -One-line elec. diagrams- Major equipment specs- Cost Estimate

Participation/buy-in of:- Operations- Maintenance- Business

Contracting strategy- Who- How

Team participants & roles

Integrated schedule- Critical path items- Identification of shut-downs for tie-ins- Resource requirements- Overtime requirements

Plans- Commissioning- Startup- Operation- Quality assurance

Cost/schedule controls

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FEL is Improving Slowly

19961990 1991 1992 1993 1994 1995 1997


BestSystems

Industry

10

1

2

3

4

5

6

FEL

Inde

x

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0.4

0.6

0.8

1

1.2

1.4

1.6

Front-End Loading Score

Act

ual C

ost/I

ndus

try

Aver

age

Cos

tBetter Front-End Loading Saves Money

More than industry average

Less than industry average

Pre 1990

Post 1990

1 Undefined GoodFairPoor Best Practical

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IPA

0.6

0.8

1

1.2

1.4

1.6

Front-End Loading Score

Act

ual M

onth

s/In

dust

ry A

vera

ge M

onth

sBetter Front-End Loading Saves

Construction Time

More than industry average

Less than industry average

1 Undefined GoodFairPoor Best Practical

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Optimal

Scope forBusiness

Need

Executedwith

minimumchange

Front-End Loading

Discipline



BETTERROI

BusinessStrategy

TechnologyStrategy

Team Integration


Leading Technology

Low Cost


Fast Cycle Time

SAFETY


IPA

The Value-Improving Practices

Project Phase

Pote

ntia

l to

Impa

ct V

alue

Authorization

R&D Front-End Loading Detailed Design Construction Startup

Technology SelectionProcess Simplification (Value Analysis)Classes of Facility QualityWaste MinimizationEnergy Optimization

Process Reliability ModelingCustomized Standards & SpecsPredictive MaintenanceDesign-to-Capacity

Value EngineeringIntegrated 3D CADConstructability Reviews

IPA

Which VIPs are Most Commonly Used

Constructability

Technology Selection

Customizing Stds.

Value Engineering

Design-to-Capacity

Process Simp.

Waste Min.

Predictive Maint.

Classes of Fac. Qual

Reliability modeling

Energy Optimization

0 10 20 30 40 50 60 70 80 90 100

% Opportunities UsedCompleted Projects

Authorizedin 1997

IPA

VIPs that Drive Cost Performance

Industry Average


Process Simp.

Customizing Stds./

Predictive Maint.

Design-to-Capacity

Value Engineering

0.5 0.6 0.7 0.8 0.9 1 1.1Cost Index

UsedNot Used

IPA

VIPs Use is Increasing

1990 1991 1992 1993 1994 1995 1996 19970%

10%

20%

30%

40%

50%


% V

IPs

Opp

ortu

nitie

s U

sed

BestSystems

Industry

IPA

Lack of FEL Results in Changes

Best

Good

Fair

Poor

Screening

0 20 40 60 80 100% Projects

Best

Good

Fair

Poor

Screening

0 20 40 60 80 100% Projects

Percent of Changes After Authorization

Percent of Changes Construction Only


IPA

Few Projects Meet All Objectives

Schedule

Cost

Cost & Schedule

Cost Predictability

Schedule Pred.

Cost & Sch. Pred.

Operability

All Objectives

0 20 40 60 80 100% Projects Meeting Performance Objectives

IPA

Why is Capital Effectiveness So Difficult?

n In capital intensive businesses, capital effectiveness is an avenue to success

Ø low cost producers have some volume, margin, and market share control

Ø cycles provide opportunities as well as headaches

n Yet many commodity businesses waste large amount of capital, because...

work process is inadequateaccountability is poor

cross-functional cooperation is lacking

Outline







OptimalScope forBusiness

Need

Executedwith

minimumchange

Front-End Loading

Discipline


Timely Involvement of Contractors/Vendors

BETTERROI

BusinessStrategy

TechnologyStrategy

Team Integration


Leading Technology

SAFETY


IPA

The Contracting Strategy Problem

n There are strongly held, diametrically opposed beliefs about the relative merits of different contracting approaches

n In general, these beliefs are unsupported by systematic data

n The contracting problem is also confused by the inability of many to distinguish between

Ø predictability and Ø effectiveness

Outline






Contract Approaches Examined

n EPC Lump-sum: detailed engineering, procurement and construction performed on a fixed price basis by same firm or consortium

n Reimbursable: all work performed on a cost-plus fee or cost-plus incentive fee basis

n Mixed: engineering & procurement performed on a reimbursable basis with predominantly fixed-price construction

n Results are controlled for definition; poorly defined EPC-lump sums have very large penalty

Contracting Strategy and Project Results

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Cost Index

Reimbursable

EPC Lump-Sum

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EPCLump-Sum& Reimb.

Mixed

EPCLump-Sum


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Cycle Time

Mixed

Reimbursable

EPCLump-Sum

Mixed

Mixed

Reimbursable

Contracting Strategy Results

n EPC Lump-sum is on average significantly more expensive than average

n Reimbursable engineering followed by any form of fixed price construction (the "mixed strategy") is the most cost-effective approach

n Although Mixed strategy execution time is longer, the cycle time is shortest

n EPC Lump-sum carries a heavy operability penalty

n On average the Mixed strategy appears best and EPC lump-sum worst

Why are EPC Lump-sums more Costly?

n This contract form seeks to shift risk to the contractor

n Theory is that because contracts lead execution, they should be better able to control risk

n However, contractors are not well-capitalized and cannot bear equity risks at low cost

n Therefore, contractors will normally bid on a higher than 50/50 basis

n The larger the project relative to contractor, the high the risk premium

Outline






The Role of Incentives

n Engineering incentives were amounts paid to the engineering contractor according to a formula for results versus targets

n Construction incentives were paid to the construction contractor

n "Both” are projects in which incentives were provided to both the engineering and construction contractors or to a single EPC contractor for overall cost and schedule results

n Too few contracts had meaningful provisions for operability incentives to be examined

Contract Incentives and Project Results(Non EPC-Lump Sum Only)

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1

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Cost Index

NO EFFECT ON COST

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1

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1.2

1.3

1.4

1.5

ENGINEERINGINCENTIVES


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0.5

0.6

0.7

0.8

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1

1.1

1.2

1.3

1.4

1.5

Cycle Time

NO EFFECT ON CYCLE

TIME

NO EFFECT ON

SCHEDULE

Conclusions about Incentives

n The use of incentive contracting has no reliable effects on cost, execution time, or cycle time

n Directionally the results are poorer rather than better with incentives

n The use of incentives for engineering is strongly associated with poorer operability of facilities

n This conclusion holds for all types of projects we have examined

n The use of incentives as currently practiced should be reconsidered

n Contractors are better at this than owners

If You Incentivize, Ask...

n Exactly, whose behavior are you seeking to change? How will the change mechanism work?

n Will engineers withhold good ideas unless their firm receives an incentive?

n Are there ways that the incentive can be "gamed", e.g. high estimates?

n Are there potential unintended consequences, e.g. managing to the incentives rather than the project?

Documents

Creating Value through the Benchmarking of Capital Projects · Creating Value through the Benchmarking of Capital Projects Measuring the relationships ... 0.9 1 1.1 1.2 89 90 91 92