Several factors impact cost management like engineering design, fluctuating commodities and currency, procure and timely deliveries while depending on your key vendors along with risk involved in freight and finally constructing the project out in the field. Risks related to these steps are tremendous.
As we dive in the details of the article I will highlight how to approach cost management on EPC projects, the key from the beginning is to define Scope and Budget from the beginning and tracking cost and changes to enable Project Management Teams to make informed decisions when the time comes.
Cost Management What is it?
For Several years reality of not being able to deliver EPC projects underestimated cost have haunted the EPC contractors. If the projects are cost reimbursable the loss is recoverable from the customers in some cases but do cost the reputation loss for not being able to deliver on time and/or under cost. but on lumpsum contracts it is hard to recover not only financial loss but have caused major EPC contractors to go bankrupt.
Cost Management have several branches or areas when combined defines the spine of Project Management
- Cost Estimation
- Target Budget Definition
- Cost Monitoring and tracking
- Change Management
- Backcharge/Claim Management
- Cost Forecast
All these branches together define the core of Cost Management and when executed properly results in incredible outcome.
Before we move into overview of these branches, I find it necessary to mention cost management is not limited to tracking numbers, maintaining ledgers and reporting to Management where we are. Cost management requires in depth understanding of scope than only a Cost Engineer can do effective analysis of cost optimization.
Cost Estimation is the first step to evaluate the cost of building a Project in EPC industry outcome of Pre-FEED (Pre – Front End Engineering Design) followed by FEED (Front End Engineering Design) determines the Estimate. Establishing a high-quality Cost Estimate is very essential not just for EPC contractor but for customers as well because they have to secure funding to build the project.
Quality of Cost Estimate depends on the several factors
- EPC Contractor’s experience in building similar projects.
- EPC Contractor’s understanding of commodities/resources required to build the plant.
- Understanding of Labor market where the project is built, along with the resource availability knowledge of labor productivity in the region is critical.
- Clear path forward on how the material will be delivered on site and from which part of the world, a failure in handling logistics can cost millions of dollars.
- Clear definition of Escalation and contingency as these projects lasts several years.
Target Budget Definition
This is the phase when an EPC Project enters in Execution and without any doubt the first step is define project budget targets for seamless execution.
“An idol project will be the one which is built with highest safety standards, is durable and works as it supposed to be with most optimized cost expenditure.”
To achieve this a comprehensive exercise to define target budgets for Engineering, Procurement and Construction is required. This is where team will define potential cost optimization efforts, some examples are listed below
- Value Engineering: Design optimization
- Procurement strategies
- Logistics optimization
- Defining Construction Direct and indirect costs by setting achievable productivity targets.
This step is integral part of project Setup as the work breakdown structure in which the cost and schedule information will be collected is defined here for the lifecycle of the job. This step can sometime make or break the project if we have to deal with claims in future.
Cost Monitoring and Tracking
Target Budget definition set the framework for tracking and monitoring the cost, it is important that the actual cost follow the same work breakdown structure in which budget is broken out otherwise the reports produced will not be meaningful.
Two key aspects of Cost tracking are progress and performance. Progress and performance reporting for Engineering, Procurement and Construction need to be published biweekly for management to take effective actions before things go south.
I will discuss in detail about Cost Monitoring and Tracking in my upcoming publications.
Change Management program help us track the changes in scope of the project and its impact on cost. On a lumpsum project changes can be of two type
- Scope Change: Changes driven by the customer; in simple words these will be paid for by the client.
- Non-Scope Changes: These are internal changes which are required to achieve the existing scope of the project.
Both scope and Non-Scope changes can be either positive or negative based on addition or deletion of scope.
For the financial success of any project it is important to have a backcharge or claim procedures in place otherwise project is at risk of losing money and eroding cost performance.
- Backcharge: These are the expenses made by project to rectify any issues which were part of vendors or subcontractors’ scope of work. These charges need to be collected in very organized manner as per the work breakdown structure to be recovered from Vendors or subcontractors.
- Claim: Claims can be of multiple type, they can be weather related, schedule related, quality and standard related. Key while handling claims is the ability to dissect the cost and schedule for the subject of claim.
Cost Forecast provide a health check of the project it tells if the target budgets are holding or not it allows us to close any open-ended items on which enough information was not available while creating the target budgets.
There are two critical points where a forecast is most meaningful in EPC life cycle one after 90% completion of Engineering because at this time the quantities on the project are completely designed and at 50% construction completion where we have a very good idea of how our labor rates and productivity are shaping up.
We looked at the critical aspects of Cost Management, understanding the importance of Target Budget definition to tracking and monitoring the cost. Small negligence can cause millions of losses on these mega EPC projects, understanding the stakes and excelling our industry in cost management is how we can make a strong EPC industry globally. I my op coming articles we will discuss more about my research on Innovation in cost tracking and monitoring and will dive deeper in details of areas we discussed in this article.