Capturing Savings of Alliances in the Energy Sector

Energy sector capital projects typically cost hundreds of millions and even billions of dollars to construct. A major component of these projects is the engineered equipment that the facility is built around. Managing the engineered equipment is important during construction not only because of its high dollar value but also because of the long lead times to manufacture that may impact the overall project schedule. Procurement of engineered equipment has traditionally been done using lowest bid that does not satisfactorily integrate the suppliers’ detailed knowledge about the engineered equipment. One method to improve procurement of engineered equipment is through supplier alliances.

A recent research project completed by MBA student Doug Harper. His Master’s degree thesis in Construction Engineering involved a series of detailed interviews with 16 companies. Opportunities and barriers for supplier alliances in capital projects were identified. Opportunities were evaluated based on criteria involving cost, time, and quality. Questionnaire results and personal interviews revealed that time savings and quality improvements were perceived to be of greater value than the initial cost savings of the engineered equipment from supplier alliances. Industry experts estimated that supplier alliance initial price savings would range from six to ten percent. Procurement time savings of up to six months were suggested by an industry expert by eliminating the bidding cycle for engineered equipment. The most selected quality benefits point to supplier alliances designing better technical solutions due to the suppliers’ input of detailed equipment knowledge that would also contribute to reduced change orders.

A Capital Projects Supplier Alliance Model was developed. The model covers five stages of a supplier alliance. The first model stage is Company Management that advocates that a company assess their own culture to support alliances before considering the use of supplier alliance agreements. Alliances require collaboration between the partners which is not common with lowest bid contracting. The second step is developing a Business Case to support the development of the alliance. The third step involves Supply Base Management that will lead to the selection of the alliance supplier partner. The fourth step, Alliance Framework, addresses the issues, i.e. terms and conditions, standard specifications, alliance duration, etc., involved in establishing the alliance. The final step is Alliance Management that primarily focuses on performance metrics that should be used to evaluate the health of the alliance.

An interesting element of Harper’s research was that most respondents viewed the Owner-Supplier relationship as the strongest in the industry. The Owner-Contractor relationship was ranked second followed by the Contractor-Supplier relationship.

A representative of one company provided some insights into why Owner-Supplier alliances might be more beneficial:

“The owner has the incentive to spend the time and money necessary to collaborate with suppliers to optimize operability and the total life cycle cost of the given piece of equipment. General contractors working on some type of a fee or lump sum basis generally do no have the incentive (or in some case the operational knowledge) to collaborate on these “OPEX” (Operational Expense) issues, but rather are focused on “CAPEX” (Capital Expense) front-end costs.”

Several counter-arguments were offered from EPC companies suggesting why alliance agreements might be better suited between an EPC and Supplier. A representative from one company noted that most Owner-Supplier alliance agreements are focused on operational issues with an emphasis on equipment operability and with less focus on CAPEX (capital expense) cost. An important issue for these alliances is response time to repair or replace a major piece of equipment to resume operations. They felt that EPC alliance agreements could focus more on cost savings because capital projects are planned decisions that allow one to determine in advance when one will need a piece of equipment.

Supplier alliances are not a blanket solution for procuring all engineered equipment items. However, for engineered equipment items for which a business case can be developed, supplier alliances provide several benefits in terms of cost, quality and time. The Capital Projects Supplier Alliance model provides a framework for developing and managing supplier alliances. For further details, see Doug Harper’s report.