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SCRC Article Library: Managing Alliances in the EPC Industry

Managing Alliances in the EPC Industry

Published on: Aug, 02, 2003

by: Rob Handfield, Director

Supply Chain Resource Consortium (SCRC)

In the engineering project and construction (EPC) industry, a different market environment exists from many other industries. EPC’s are responsible for designing, constructing, and managing all issues associated with major projects, including chemical plants, power plants, and other large facilities. Very often, this occurs in developing countries where logistics is difficult and government agencies in some cases corrupt or extremely bureaucratic. Other characteristics that make this industry difficult to manage include.

  • High complexity – low commonality
  • Price, price, price is the basis for decisions – not lowest total cost

In the global market, risk is being pushed on to EPC via fixed price contracts

  • Balance of plant design starts after Tier 1 equipment is selected
  • Customers have strong supplier relationship and assign equipment to EPC contractor
  • Customer’s directed alliance supplier may not satisfy EPC company’s project risk profile
  • Suppliers can also be Owner’s or Competitors

The ultimate “owners” of these projects in many cases have a different set of priorities. The problem is that every Owner has different needs and wants to make changes to a “standard” plant concept. Most importantly, the Owners want a lower cost, but want the EPC to assume more risk and meet a tighter schedule.

A recent study undertaken by MBA student Doug Harper and a number of Owners and EPC’s including Bechtel, Shell Oil, and Chevron Texaco is underway. Some of the additional constraints and challenges in this environement include:

  • Increasing risk of the projects.
  • Paucity of transactions.
  • Project profit margin bottom line focus. Profit maximization. Time to market is key – but initial price is the key order winner not the longterm maintenance cost of the plant. Utility customers look at total NPV (maintenance, LCC). They want the same plant that cost $1200/KW in 1984 done for the same cost today
  • Suppliers will take advantage when they can exert leverage. Profit maximization.
  • Capacity availability a key driver to the market dymamics. Regulated (public) utilities also look at price to see what they can afford to buy. They need flexibility to move from one supplier to the next to meet the Owner’s requirements. Owners are usually locked in with certain suppliers.
  • Oligopolistic supply base is important issue.
  • Projects’ 2 to 4 year duration means a deal can easily become stale. Owner financing (e.g. GE Capital) may dictate equipment suppliers
  • Technology change can leave you behind with the wrong partner.
  • The labor intensive nature of certain products/services often leaves suppliers in developing countries with a comparative advantage.

This traditional industry thinking is reflected in some of the comments that Doug Harper learned about when he interviewed multiple owners, suppliers, and EPC companies in a project for Bechtel. These comments reflect a risk averse nature, and a resulting lack of commitment to any long-term relationship between parties – with the belief that the market drives a traditional bidding process that cannot be overcome. Clearly, this industry is ripe for a new business model. In this type of market environment, companies are now beginning to look at Strategic Alliances as a new way of doing business.

One company that has begun to examine this is the British Aviation Authority. They have adopted a fundamentally new approach to driving integration across not only the EPC industry, but all of the suppliers involved in this process. As they begin to revamp their airport construction projects, this new approach considers many more factors beyond price, and goes into detailed long-term contracts. The initial results from this strategy have been promising.

In only one case was Doug able to find a model of a long-term alliance relationship that worked in the industry. The alliance was established within Shell when it was determined that there was an on-going need for a certain type of equipment. It was also established that one supplier was normally successful in obtaining contracts. A series of discussions was started to establish whether there was an opportunity to create an alliance that would be good for both parties. Initially it was necessary to determine how trust would be established so that both parties would be able to operate without fear of risk (there had to be a management commitment). It was necessary to establish a system whereby pricing and some marketing information would have to be available, at the same time the vendor would have access to long range planning and engineering at Shell. Next there was established a system that would reward/share savings for pre-established decisions by the owner. The biggest thing that had to be created and established was a trust between parties. It was also determined that the alliance would be on-going, in other words, it was constantly being worked by a set group of people to involve/ make changes as work progressed. As a higher comfort factor evolved, the working of the process became easier and more advantageous for both parties. For the most part, when used, the degree of success was high and very helpful for project purposes.

WHAT MAKES THIS WORK? There clearly must be evidence that there is some system of cost savings sharing which will benefit all. There must be established some means of showing the client that changes and costs resulting are fair and not a means of gaining wealth. In all the client must be able to see why this is the best route and how he will be protected from pitfalls during the process. At the same time, the supplier must feel assured that his data/information will not be exposed to competition.

Doug Harper will continue to work on this project over the semester, and we will be posting some of the results from the project later. Stay tuned!

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