CAPEX Project Risk Management: Are you dropping the ball?
Beyond their massive salaries, athletes also receive huge performance incentives. Major League Baseball (MLB) is known offering $1M or more for reaching a certain number of innings pitched, receiving MVP awards, and making all-star game appearances.
Performance-based contract incentives are added to athlete’s contracts to motivate players to improve performance in areas they have been historically poor, to drive record years, or to protect cap space against risk of injury.
Tracking these contract terms is a whole other ball game (pun intended). In 2001, Alex Rodriguez signed a $252 million contract - the biggest ever MLB contract at the time – which included a clause in the contract that would earn Rodriguez a $150,000 bonus for winning the Division Series MVP Award. It came with just one catch: there is no such award. I guess Rodriguez wasn’t concerned given the huge base salary, but this is a good example of contract terms slipping through the cracks.
The more complex the contract and the more variability that occurs throughout it’s term, the more difficult it is to maintain the intention behind the initial agreement.
Similar to athlete salaries, the cost of CAPEX projects is increasing…
MLB salaries have almost doubled since the early 2000’s, with the average paycheck growing from USD 2.37 million in 2003 to $4.36M in 2019 (source: https://www.statista.com/statistics/236213/mean-salaray-of-players-in-majpr-league-baseball/).
We are seeing similar trends in the construction industry due to the complexity of the relationships and contracting structures. According to the Construction Industry Institute (CII), the same heavy industrial project valued at $100 M in 1998 costs $222 M to produce today. In 2038, this investment is expected to increase to $568 M if the industry maintains the same processes.
Source: Construction Industry Institute (CII)
With more complexity comes higher costs, and therefore greater stakes. And in business, as in sports, reducing risk for better outcomes is the name of the game.
Deferring risk is not enough
Historical data from McKinsey shows that 98% of capital projects are delivered over budget and 8 of every 10 are delivered late.
The first step to solving a problem is admitting the problem exists in the first place. In other words, to effectively manage CAPEX project risk, you must accurately assess it. Many projects today underestimate the actual cost of execution to gain a financial investment decision (FID), which is critical to moving forward with the work. This creates an incredible amount of risk right off the start, and in the end, one (or more) party will come up short when the project is delivered off-plan.
If EPCs and Owner Operations want to make progress against the grim stats above, they need to recognize from the start what the true cost of execution really is and align their contractual agreements accordingly.
Unifying execution for success
Due to the size and complexity of the contracts, and the high chance of change throughout their terms - parallels can be drawn between the strategy behind athletic contracts and the agreements industrial Owner Operators and their contractors form for CAPEX project delivery.
To align project teams towards the same goal of on-time and on-schedule delivery, an Owner Operator might consider a unified approach to setting up the contractual ecosystem and put in place controls and tools to manage any unforeseen change.
Unified Project Execution (UPE) is a capital project execution approach that integrates people, systems, business structures and practices into a process that collaboratively harnesses the talents and insights of all participants to optimize project results, increase value to the owner, reduce waste, and maximize efficiency through all phases of procurement, construction and handover. AVEVA’s unified approach to CAPEX project risk management can be applied to a variety of contractual arrangements, allowing teams to include members well beyond the basic triad of owner, architect, and contractor. In all cases, unified projects are uniquely distinguished by highly effective collaboration among the owner, the prime designer, and the prime constructor, commencing at early design and continuing through to project handover.
Aligning incentives drives better business processes & automating processes allows better tracking against these incentives.
The contract strategy and execution mind-set is more similar in major projects and high performance sports than it seems at first glance. By aligning incentives with performance outcomes, backed by automated systems to track variables and enforce business processes according to the contractual agreement, a project is truly set-up for high performance results and simply put, everybody wins.
Learn how AVEVA’s Unified Project Execution approach could shave 15% off the cost of your next project.
Vanessa Erickson is the Global Marketing Lead for the Marine Industry at AVEVA. She is primarily responsible for thought leadership and customer engagement in the Marine industry across the engineering, planning & operations, monitoring & control, and asset management portfolios. Vanessa previously worked for Hexagon PP&M (previously Intergraph), and Acklands-Grainger where she held regional and global sales and marketing roles delivering transformational technology, construction & fabrication solutions to asset-intensive industries including Oil & Gas, Power, Petrochemical and Marine. Vanessa holds a B.Comm. in Marketing from the University of Saskatchewan.