W4_FELIX_LUMPSUM CONTRACT AND ISSUE

1)      Problem Recognition, Definition and Evaluation

I have 4 EPC project with lump sum contract type and three of them have financial problem, delay schedule, penalty and therefore request for change order and additional time.

In my topic this time I will try to describe the common problem encountered and what alternative solution to solve the problems.

Lumpsum contract definition

The term firm fixed price or lump sum contract refers specifically to a type or variety of fixed price contract where the buyer or purchaser pays the seller or provider a fixed total amount for a very well-defined product.

Refer to the PMBOK Chapter 12, fixed price contract involves a fixed total price for a well-defined product. The simple form of a fixed price contract is purchase order for specified item to be delivered by specified date for specified price.

So there is 3 (three) factor that is freeze from the beginning of the contract i.e:

1.       Money

2.       Time, and

3.       Scope

Indonesian Government rule:

In the Article 50 paragraph (3) Article 51 of Indonesian government law; Perpres No. 54 of 2010 said:

Lump sum contract is a contract for Procurement of Goods / Services within a certain limit schedule as specified in the Contract with the following conditions:

a. The price is fixed and price adjustments are not possible;

b. All the risk is borne by the Supplier of Goods / Services;

c. Payment is based on the progress of the output in accordance with the contents of the Contract;

d. The nature of job is output based;

e. Total bid price is fix and bind;

f. Not allowed for any change order.

Lump sum contract common issue.

In the application almost EPC lump sum contract vendor have problem to complete the job as the owner requirement. (in my case ¾=75% delay and request change order)

Base from interviewing with contractor there are some common issue for EPC lump sum contract project i.e.:

a.       Cost overruns

b.      BM/BQ and the drawing are not the same, owner request high demands

c.       Market price become higher than contractor proposal issue

d.      Miss understanding of lump sum contracts

e.      Lack of trust between contractor and owner

Outcome of the issue

So what the outcome of this problem occur?

Firstly, often the Contractor profit is eroded as they compromise to meet the owner demands.

Secondly, the Owner may have to pay more for change requests when the contractor is no longer willing to compromise around what, in their eyes, appear to be changing requirements.

2)     FEASIBLE alternatives

So what kind feasible alternative if the problem exist?

In this topic I will made alternative

a.       Option 1 : Owner give change order (weather it is cost or duration)

b.      Option 2 : continue the project even there is some discrepancy and going to arbitration when the project is complete.

c.       Option 3 : reduce the contractor scope.

d.      Option 4 : Termination

3)     The outcomes for each feasible alternatives

a.       Change order

Advantage      : the execution of the project continue until the project completely finish

                              Agreed additional cost and additional time can be defined

Disadvantage : Owner should pay additional money and additional schedule

                              Change order should be auditable

b.      Going to arbitration

Advantage      : the execution of the project still continue until the project finish

                              Accountability and auditable

Disadvantage : commercial issue and final payment must be wait for arbitration decision

                              Contractor cash flow will be delayed.

                              Additional or reduce of the cost cannot be defined until arbitration decision

c.       Reduce the contractor scope :

Advantage      : the execution of the project still continue but not completely finish

Disadvantage   : Owner must use remaining budget to complete remaining job

d.      Termination the project contract :

Advantage      : with proper justification can be auditable and accountable

Disadvantage : The project stop un finish

4)     Selection of the acceptable criteria.

a.       Cost to owner : minimum cost is better

b.      Cost and time early define : higher is better.

c.       Possibility Completion of the project : higher possibility is better

d.      Owner Auditable risk : lower is better

e.      Fairness : if both party satisfy is better

5)     Analysis for the alternatives

By using Compensatory Models from Chapter 14. Engineering Economy Book, I Compare the outcomes from each alternative analysis done in Step 3 against the minimum acceptable criteria from Step 4 which is can be seen in below table:

6)     Select the preferred alternative

Base from above calculation Going to arbitration become best choice for the owner if there is some disputes with the contractor.

Very interesting result that lump sum project is can be fair and accountable when there is third party to escort the project execution.

7)     Performance Monitoring & Post Evaluation of Result

This result will be submit to the management and the result will be reported at the end of the year.

8)     Reference:

i.            Factors in Selecting Contract Types                                                         

        http://nawctsd.navair.navy.mil/Resources/Library/Acqguide/selecting-contract-types.htm

ii.           The Engineering Tool Box:

           http://www.engineeringtoolbox.com/contract-types-d_925.html

iii.          Project Contract Types

           http://www.tutorialspoint.com/management_concepts/project_contract_types.htm           

iv.          Engineering Economy

           William G. Sullivan, Engineering Economy, Fifteenth Edition, 2012