Overcoming Ambiguity

The process industry has grown increasingly reliant on a contract labor workforce for both routine and complex maintenance. The transition from an employed workforce to one comprised largely of contract labor is a strategic move designed to help manufacturers compete globally.

This evolution has spurred a variety of contracting solutions. However, plant owners often miss the mark when it comes to contract management, allowing contract ambiguity to negatively impact maintenance schedules and budgets. With turnarounds that can reach the multi-million dollar mark, ambiguity can quickly lead to budget overruns as well as numerous other issues.

Contract negotiations and owner/contractor relationships in general are often best described as extended arm-wrestling sessions. One way to put disparate motivators aside and focus on common goals (like safety, reliability and quality) is to start with a well-written, risk-balanced agreement between plant owners and contractors.

To contract or not to contract?

The first question to be answered is, “Should we hire or contract?” The answer may differ from project to project, and year to year, and competitive pressures may modify last year’s strategy. But the decision must be a deliberate one.

Prime opportunities for contracting include:

  • Tasks that are one-time or short duration;
  • Project work—construction, demolition, turnarounds/outages/shutdowns;
  • All non-core activities; and
  • When specialized labor and equipment are needed for a limited time/project.

After the decision is made to contract, the next job is matching work to specific types of agreements. There are several dominant contract types used around the world: time and materials, fixed price or lump sum, and unit price.

Choosing the right contract type for the right project can result in a significant financial difference both in the bids you receive, and the final cost of the project. For example, it makes little sense to ask a contractor to provide a lump sum bid for a multi-year project with loosely defined scope. The contractor is left with no choice but to inflate his bid to attempt to protect his company from the uncertainties of the job, which in turn results in the owner paying a 20-30 percent premium for the dubious pleasure of attempting to shift risks to the contractor.

Competitive selection is an important part of the process. Prequalify and invite at least three capable contractors to bid. Keeping the playing field level throughout the process and demonstrating knowledge and fairness will encourage contractors to compete aggressively for work.

Time and materials contracts

When work scope is difficult to ascertain, a time and materials contract is often the best match. A well-drafted time-and-materials contract includes:

  • A risk-shared legal boilerplate;
  • Clearly stated rate structures for labor, equipment, materials, incidentals like per diem; and
  • Balanced commercial terms and conditions.

Labor rates in North America are usually straight-time, time-and-a-half, and double-time with very clear descriptions for when each rate should be in effect. In a time-and-materials contract, the starting day (usually Monday at 12:01:01 a.m.) of the work period (typically a week that ends midnight Sunday) is defined. Nine-80s are also popular, as are rotating shifts that may span several months. Straight-time, time-and-a-half, and double-time are all defined. It’s important to note that time-and-a-half is not 150 percent of straight time nor is double-time 200 percent of straight time. They are more like 140 percent and 185 percent, respectively.

Well-written agreements will also specify the penalties associated with arriving late or exiting early. The logic of penalties has to do with the time it takes to get to the actual work site from the gate coupled with the idea of “a fair day’s pay for a fair day’s work.” Rounding rules often are written into contracts and can come into play here: for instance, if the worker is six minutes late, he will be docked 15 minutes.

Invoices for contractor time and materials services, computed by the contractor, display earned labor and equipment hours and material quantities plus incidentals, multiplied by the appropriate rate(s). Hours and dollars are then distributed to customer purchase orders and work orders. Unfortunately, manual invoices produced every two weeks or once a month present project costs and progress too late to inform the project team of tasks that are behind schedule or over budget.

Fixed price or lump sum contracts

Projects with many engineered drawings/specifications, a well-defined scope of activities for each contractor, and good start and finish expectations match up nicely with fixed price or lump sum contract types.

Payment terms differentiate fixed price from lump sum. Fixed-price contracts typically have progress payments based on agreed-to benchmarks like percent complete. Once the contractor and owner agree that a benchmark has been achieved (successfully meeting all contractual requirements), payment is calculated.

Lump sum contracts differ in that the project duration is typically much shorter and a single payment is made upon final acceptance of the work.

Sub-species of fixed price and lump sum contracts are designed to focus contractor efforts to deliver completed work on a particular, clearly stated objective like delivery date and time. Other incentives might be designed to emphasize daily progress, daily availability of requisite labor and supervision, availability of specialized equipment (such as monster cranes), and other project specific variables that make unusual contributions to overall project success.

Unit price contracts

While of limited use in North America, unit price contracting is common in Europe. A unit price contract is the agreement between a contractor and an owner that virtually any work activity can be described in standard man hours. For example, a butt weld of two 20-foot sections of 3-inch 304SS Sch10 pipe, at grade in daylight, will always take the same crew skills and hours.

The owner and contractor must agree on the standards since they form the basis of the contractor’s bid for work. Once standard man hours are agreed to, competitive bidding begins. Each bidder is asked to propose a crew rate for classes of work (like piping or electrical) that is their specialty. The contractor will also be asked to bid a discount or premium to standard man hours effectively stating their appetite for work.

Each base price is subject to conditions, which is where it can get complicated. Remember, the base rate assumed the work was performed at grade, in daylight. If the work was performed above-grade then additional resources (man lift, scaffolding) can be required that a contractor needs to also be compensated for. In a well-written unit price agreement there will be hundreds of base rates each with many conditions modifying the base price. The final number of rates plus conditions can reach into the tens of thousands. Once the unit price rate schedule is established for a class of work, the hardest part of the unit price contracting battle is complete.

Unit price contracts have great traction in other parts of the world because a well drafted unit price contract shifts most, if not all financial incentive, to the contractor. He will always be paid the same amount per activity, regardless of how productive his crew is each day. On the other hand, contractors can maximize their profits by putting their very best crews on unit price jobs and their less capable guys on time and materials work. That works out well for the owner with the unit price contract.

When unit price contracting is in use, owners are somewhat freed from controlling contractor time and attendance. The owner can focus on evaluating the quantity of units produced each day and their quality. Needless to say, unit price contracts are difficult to get in place. Once in place they are easy to use.

Combining multiple contract types

Because work types dictate contract types, a single contractor might have time and materials, fixed price and unit price work going on simultaneously at one site. Plant owners can control contractor “cross-dipping” by calculating total contractor work hours at each shift. The hours worked on time and materials are allocated to dollar rate work and deducted from total hours. Remaining hours are allocated to lump sum or unit price work at zero dollar rates. Lump sum and unit price effort is compensated on a benchmark basis or units completed basis. By controlling the total, plant owners can control the pieces.

In today’s atmosphere of contractor-heavy workforces, on-time and on-budget maintenance projects can be optimized by creating fair contracts that balance risk between owners and contractors, and ensuring that each contract is appropriate for the type of work it is prescribing.

About the Author:

Bob Harrell

Bob Harrell is the CEO of Track Software, a provider of contractor management solutions for cost control, project visibility and administrative ease of use. For further information, please visit www.tracksoftware.com

Takeaways:

  • Start with a well-written, risk-balanced agreement between plant owners and contractors
  • Prequalify and invite at least three capable contractors to bid
  • When work scope is difficult to ascertain, a time and materials contract is often the best match

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