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last month W. Howard Bezenah of Dow Chemical Co. presented management’s viewpoint on the all-important question of selecting the right contractor and the proper type of contract when building a chemical plant. This month we have the opposite side-the viewpoint of the contractor. The song i s essentially the same, but the tune is different. This i s to be expected, and i s one of the reasons why we elected to present this subject, as well as that for the next two months, in two parts. Although the Dow Chemical Co. has some quite definite preferences as to contract types, Mr. Bezenah made a deliberate effort to present the case factually and fairly for a l l the types of contracts discussed, realizing that some individual company factors will be superimposed on these basic conditions and characteristics. In this month’s article, Lorne C. Reynolds, executive vice president of C. F. Braun & Co., gives us an example of the contractor’s viewpoint, based on a classic publication of the late Carl F. Braun. Although the Braun viewpoint does take sides and deflnite preference i s shown for one type of contract, adequate support is given and Mr. Braun’s philosophy i s forthright and direct-hitting.
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From Vision to Supervision
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Selecting the Contract and the Contractor The Contractor’s Viewpoint
MANAGEMENT’S FIRST gumiTroN should
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be “How soon can the plant be built?” This question usually overshadows any other as to costs or contracts. The answer varies with almost every situation. But the cost of delaying the on-stream time of any new process facilities should be estimated with great care and with impartial judgment. Several important factors must be considered. For example, if the plant pays out in 3 years, then 4 months’ delay is worth over 10% of the investment. And that is only part of the cost. Add to it the value of reaching the market with the product ahead of competition, or ahead of seasonal demand. Add the value of the money tied up in the uncompleted plant. Add the extra cost for supervision and overhead beyond the most reasonable completion date. Don’t forget the increase of construction costs-about 291, per quarter has been the trend for the past decade. The total will be surprising. One thing is clear-the longer construction takes, the more it costs. What factors are involved in selecting the right contractor for a job? And what are the advantages and disadvantages of the various contracts, such as competitive fixed price (or lump sum), cost plus a percentage, cost plus a fixed fee, and guaranteed maximum with the division of savings? These questions have developed perennial discussion among owners and contracts throughout many 35 A
years. In last month’s analysis from the point of view of management, Mr. Bezenah discussed lump-sum, guaranteed-maximum cost with division of savings, and cost-plus contracts, without distinguishing between the two types of cost-plus contracts. A classical analysis of the subject of contract and contractor selection appears in a little known book by the late Carl F. Braun, founder of C. F. Braun & Co. His presentation was made to various leaders of the refining and chemical industries during the 1930’s, and was published privately in 1946 under the title “Contractual Relations in Engineering Construction.” Since Mr. Braun’s analysis has stood the test of time and his viewpoints have gained rather wide acceptance by both contractor-engineers and industry, this article consists of direct quotation and paraphrase of his philosophy. THE CONTRACT IS A TOOL. The design and construction of any important work should partake less of a business venture, and more of a professional service. Those who render that service with honesty, with ability, and with proper facilities, should be paid not according to gamble taken, but in proportion to service rendered. This principle applies to any project in which the constructor’s design know-how or his completion times, or the quality of his work, are important considerations. Volumes have been written on the subject of contracts
Lorne C. Reynolds began work with C. F. Braun & Co. in 1922. He served successively as purchasing agent, director of purchases, and manager of district sales and engineering. Since 1944 he has been Braun’s executive vice president. Carl F. Braun. 1884-1 954, graduated in mechanical engineering from Stanford University and received the degree of doctor of laws from Occidental College. He was founder and for more than 40 years president of C. F. Braun & Co., serving the petroleum, chemical, and ore processing industries. INDUSTRIAL AND ENGINEERING CHEMISTRY
AUGUST 1955
for engineering construction-on the proper verbiage, on the fine points of law, on how to take over from a contractor in default, or perhaps in bankruptcy, on how to recover damages for fraud, or for failure in performance. All of this tells how to get out of a bad bargain. But what about the real problem? There is almost complete silence on how to get into a good bargain. Every owner, when he has some engineering project to be built, has this very real problem, one that is twofold. He must select among competing constructors the one he considers most competent to do the work. And if he wants to get the best out of that constructor’s organization, he must set up an arrangement designed to draw the best out of them. This working arrangement, this contract between the owner and the engineering constructor, has a great bearing on the effectiveness of the service the constructor can render. I t is the most important tool contributing to the building of a properly working plant in proper time, and a t proper cost. This must be the basic concept of a contract. If suitable incentives are lacking, if ordinary human motives are disregarded, if responsibilities are not clearly assigned, if dealings cannot be entirely open, then much of the energies of both constructor and owner are inevitably directed against each othei, instead of to the benefit of the job. It is to these human considerations more, and to the legal ones less, that the effective contract mill give its attention. Certain fundamentals involved in getting good work or good service from human beings, are well established, and will scarcely be questioned by anyone.
Successful contracts require
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Sufficiency of compensation Steadiness of supervision Completeness of cooperation
With these principles in mind, the following discussion considers various methods for selecting a constructor and examines a number of current types of contractual relations, pointing out defects and pitfalls, offering correctives, and seeking to put the rdiole problem in a clear light. COMPETITIVE FIXED-PRICE BIDDING. Process units, and many other industrial projects, involve considerable know-how-know-how on design for the particular service, on the particular type of workmanship required, on handling labor, on getting a job done on time. It is chiefly pro-
fessional services that the owner seeks from the contractor. It scarcely needs arguing that professional services cannot profitably be purchased under competitive fixed-price bidding, or lump-sum contract, whether it be doctor, lawyer, engineer, or constructor that is sought. For as a rule, the highest professional talent commands the highest fee-commands it, of course, because his record is one of better service, better value. Under competitive price bidding, the work of investigating, conferring, engineering, designing, pricing, quoting, presenting, modifying, is very great. To the unsuccessful bidders, this work is a total loss. These losses cannot be covered by the obtainable margin on an occasional successful bid; therefore, these fruitless bidding costs will probably be squeezed from the quality of such work as the bidder does get. If anyone doubts that all costs, plus a living profit, are not squeezed from the work, he need only recall the operations of price control. Everything ’was degraded, or skimped, or otherwise shorted. And the shortchanging was so subtle that even a vast organization of government inspectors, backed by stiff punitive provisions, mas never able to stop it. Then look at the prevalency of cartels, pools, professional societies, labor unions, and other means of price fixing. People of mrious aims, various capacities, even natural enemies, are too often forced to band together that they may maintain prices and conditions under which they may improve themselves, give decent service, and yet live. Look at the thousands of financial statements made public each year by American corporations. Not one in 50 shows a net profit on its turnover, its total sales, of more than 5%. Many of them show much less. There is not much slack for absorbing cxcessive bidding costs. Such costs mill surely come out of the work. Faithful, safe, and honorable building cannot be espected as the fruit of competitive fixed-price bidding. Scarcely a week passes without an explosion, fire, or other costly failure-the delayed result of the determined effort of some contractor t o live, to keep within his too-low price forced upon him by the pressure of price bidding. Yet these major and publicized failures are really the least of the evils of price bidding. Perpetual repairs, high operating expense, lost operating time, lack of flexibility, general inefficiency, inferior products, all eat into the owner’s net income beyond calculation. True, the weight of the penalty is not immediately felt, and is often for a long period hidden from the eye of management. Another snare of competitive price bidding is extras. Experience shows that the total of extras is much greater than under other types of contracts in which owner and constructor work out plans and estimates together. 1\11..
THE CONSTRUCTOR SHOULD BE PICKED ON HIS RECORD 0
How have his performed completion times stacked up with his promised times?
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Have his plants gone on stream quickly, and stayed on stream?
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How have his plants proved out a s to throughput, goodness of product, completeness, quality of plant, maintenance cost?
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How have his performed costs stacked up with his estimates?
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Has he the tested organization, and of sufficient size, for doing the work? Is he fully and modernly equipped for doing the iob, as to all its major parts?
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COST OF DELAY What i s the cost for, say, 4-month delay in getting a new process plant on stream? The answer varies with almost every situation. Several important factors must be considered-the plant size, the product, its competition and market, the construction-cost trend, sometimes other things. Here are some representative figures for 4-month delay of a typical chemical plant operation.
% o f Plant investment Cod
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INVESTMENT, the cost of money tied up in uncompleted facilities, at 3%
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PRODUCT REVENUE, assuming the plant pays out in 3 years
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MARKET, beating competition to market, or seasonal demand, say (This factor may amount to much more in many situations)
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CONSTRUCTION-COST TREND, based on 10-year trend of increase
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TOTAL COST of 4-month delay as a percentage of plant-investment cost
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Bezenah pointed out that extras are usually high in cost and must be negotiated. It is not unusual for the extras to run a third of the total performed cost. Hence the supposed competition of bidding is largely nullified. Why are there so many extras? They occur chiefly because the owner’s engineers cannot as a practical matter write a specification that will fully cover what the owner wants. In chemical and petroleum refining construction me deal as a rule with a complex project. Furthermore, if the elected constructor is a good one, he will more often than not be able to point out deficiences in the owner’s indicated design, and suggest profitable changes, but changes which will cost additional money. What the owner’s engineer has lacked is a good estimate. A good estimate, made hand-in-hand with the design, and well broken down, is an indispensable tool to the plant designer. But under competitive price bidding the estimate is the property of the constructor. How can the owner’s engineer, in writing his specification, be expected to arrive a t a well balanced and economic design, when he cannot know the cost of either the whole or the parts? Surely, competitive price bidding harbors great potential evils. But does it accomplish even that which its proponents claim for it? Are competitive fixed-price bids actually a good measure of the competency of the several bidders? They might be, possibly, if the bids could be reduced to a comparable basis. But every experienced buyer knows that this is not possible. I n any major work where the constructor designs, or partially designs, the variations in the offerings are almost infinite. S o practical amount of analyzing, weighing, adjusting, will ever provide a practical common denominator. One more thing heavily condemns competitive price bidding. The owner loses an enormous amount of his own time. Preparing elaborate specifications, analyzing bids, discussing bids with bidders, all consume the owner’s manpower, and cost him direct money. Worse than this, they defer the time when he will get his unit. At least 3 or 4 months are lost in placing the contract and getting to work, with corresponding loss of plant use and profit, and perhaps too, of a lucrative market. Generally, of course, the owner may not be willing to give up the principles of competition. But it is a grave
fallacy to think that fixed-price bidding and competition are synonymous. The true essence of competition demands that the owner have freedom of choice among contenders whose records of performance he can verify.
COST PLUS A PERCENTAGE. Many buyers, perceiving or suffering the ill results of competitive fixed-price bidding, turn a t last to cost-plus. They find a constructor of proved ability, of known integrity, who is properly organized, and is well equipped. They agree to just compensation. To the constructor, the arrangement sounds eminently fair. He accepts the trust, and proceeds with enthusiasm, pride, and vigor, exactly as though both project and cost were his own. But unless the constructor has the full confidence of the owner, things will start going wrong. The very arrangement itself may give rise to disquieting suspicions. Minute checkings, endless questionings, time-consuming justifications may become the order of the day. Attention is diverted from the whole to the parts. Too much time goes to item costs, with little, if any, attention paid to over-all cost. The goodness of the job gives way to small cheapenings, and progress is continually impeded. Furthermore, some of the owner’s men are likely to feel a t full liberty to advise or even to dictate as to method and procedure, and a few of them invariably do. Responsibility is divided, and harassing by the owner’s men may all too likely become the usual thing. Unity of purpose is weakened; the keenness of the constructor’s men is gradually dampened; the job suffers. The owner has become his own worst enemy. No one definitely controls either over-all cost or speed. But for these, the owner’s men nevertheless look to the constructor. They will blame him when the job has overrun proper cost and reasonable time. Yet to prevent these overruns, the constructor is almost powerless. The owner pays the bill. Therefore, protest a t owner action, however damaging to cost and schedule, stands in the light of gratuitous criticism. Another pitfall in cost plus a percentage is carelessness about an initial estimate. Every one is likely to question the spending of time and money on a good estimate. Thus the planning of the work necessary to a good estimate is too often missing. The result is a stream of changes (all the more because they do not have 37A
to be negotiated) , a general lack of orderly procedure, and high costs. Experience teaches that unless these pitfalls are frankly recognized a t the outset, and adequate safeguards against them are set up by both owner and constructor, the costplus contract will not make for a high standard of work, nor for best economy, nor for most rapid completion. And when the day of reckoning comes, the divided responsibility prevents the placing of blame where brame fairly lies. If, therefore, the circumstances of the work seem to call for cost-plus, then the indispensable requirement to a successful job is that all job action clear through the constructor, that he be given full authority, and that he accept corresponding full responsibility.
ideal wherever the circumstances are such that the scope of the work can be clearly defined, and the cost safely predicted. It has three outstanding features. The constructor’s estimate is a t the outset open to the owner, and serves both owner and constructor in arriving a t the most economic design. When the design becomes reasonably outlined, the estimate is discussed by both parties, and agreement reached. The constructor guarantees a maximum price based upon the agreed-upon estimate. Any savings in estimated cost are usually shared between the owner and constructor. Anything going into the plant that lends itself to price bidding is purchased under price bidding by the constructor, and to the benefit of the job. Much of the materials and equipment needed for the job fall under this category. Thus competitive prices come into play where they properly apply. The open estimate gives the owner a means of intelligently judging the price. It removes all causes of suspicion, and paves the way for frank and fair dealings. Mr. Bezenah has indicated that the same disadvantages relating to changes under lump-sum contracts are also characteristic of guaranteed-maximum price contracts. This is true, but even though many changes become necessary, the very act of prepricing in orderly fashion measures the correctness of design, and promptly shows up unprofitable features. The guaranteed-maximum price gives the owner a definite measure of liability, fixes responsibility squarely upon the constructor, and sets up a clear mark for everyone. The division of savings feature gives both parties a powerful incentive for cost reduction. Under this type of contract the owner and the constructor are in every sense of the word partners.
COST PLUS FIXED FEE. Somewhat different from cost plus a percentage is the cost plus fixed-fee arrangement. Here the scope of the work is defined, and the cost is estimated. The constructor is paid a fixed fee based upon the estimate, and thereafter is paid only actual costs. This fixed-fee type of contract is a t times better than the cost plus a percentage. The constructor’s fee does not change whether actual cost is above or below estimate. Thus the potential element of suspicion present under cost-plus is largely removed. Furthermore, to fix the fee, an estimate must be made. Thus under cost plus fixed fee as against cost plus a percentage there is much greater pressure a t the outset for a careful definition of scope, and for a reasonably accurate estimate, all so necessary to proper job planning, job progress, and control of job cost. One evil, however, must still be guarded against. Owner interference, and the consequent divided responsibility, are as likely to be present as under cost plus a percentage-unless, of course, competent safeguards are set up in the beginning.
ABILITY, INTEGRITY, EQUIPMENT. S o type of contract, no specification, no inspection, will yield good results, of course, if the constructor lacks ability, or if he is not properly equipped with men or tools, or if he is dishonest. By dishonesty, the grosser forms of cheatingfalse entries, estimate padding, suppressed discountsare not implied. These are seldom encountered in any large organization. Only the subtler forms of dishonesty -those that operate without attracting immediate attention, and can therefore be engaged in with relative impunity-need to be considered. Among the subtler forms of dishonesty are low fixed-price bids put in with the intention of using extras to convert loss into profit, promises of short completion times, based on hope and on assumed ideal conditions that never exist, skimped quality, quantity, or completeness of work. These are the things that do the damage. Subtle they are, but, by that very fact, vicious. An owner may analyze a bid and proposal as much as he likes, but he will not be able to discover these tangible shortcomings, to say nothing of intangible ones that may be even greater. If good results are to be had, the constructor must be picked on his record, not on his price or promises. The real thing that must be kept in mind is that the operation of the project, and its earnings, are the chief considerations. There must be no grasping a t an altogether doubtful dime in plant first cost, a t the risk of an almost certain dollar in plant profits. Management’s viewpoint as presented by Mr. Bezenah seems largely in agreement with the reasoning expressed here. However, it should be emphasized that with competitive fixed-price bidding, the extra time for designs, specifications, quotations, and bid analyses, represents a major delay. This delay can be largely eliminated with a negotiated contract based on guaranteed maximum with division of savings, negotiated with a constructor in whom the owner has full confidence,
GUARANTEED MAXIMUM WITH DIVISION OF SAVINGS. The evils of competitive price bidding seem clear. So do the pitfalls inherent in cost plus a percentage
or cost plus a fixed fee. How can an effective type of contractual relations free of these pitfalls be devised? Remembering that all people act on motives, we see that under competitive price bidding a constructor has little motive to build a proper plant of most suitable materials, and of most fitting workmanship. Rather, the reverse is more often true. Further, once the contract is placed, no motive prompts the owner to care about keeping cost down. Self-interest urges him to get all that he can for nothing, whether he needs it or not. Under cost plus a percentage, or under cost plus fixed fee, there are the dangers of owner interference and divided responsibility, where no sharp motive prompts anyone to fight for a creditable job, for rapid progress, and for low over-all cost. Indifference may supplant the great prompter, pride. Summing up, two of the conditions for success previously specified are likely to be absent from each type of contract thus far discussed. Under competitive price bidding, sufficiency of compensation is as a rule absent, and no competent motive makes for cooperation. Under cost plus a percentage or cost plus a fixed fee, divided responsibility may destroy both steadiness of supervision and completeness of cooperation. What sort of a contract will embody all three of the specified conditions for success? m h a t sort of a contract will make a truly effective tool? The answer as it appears through the experience of many owners and contractors is guaranteed maximum price contract with division of savings. It meets all requirements of motive. It fulfills all the premises which are prerequisites t o a sound relationship. The guaranteed maximum with division of savings is 38 A
