Managing the Managers Effective PMC Oversight on Large Infrastructure Projects

Transcription

1 Perspective Eric Kronenberg Fadi Majdalani Ekaterina Arsenieva Jennifer Latka Managing the Managers Effective PMC Oversight on Large Infrastructure Projects

2 Contact Information Beirut Fadi Majdalani Partner Dubai Ekaterina Arsenieva Senior Associate Florham Park, NJ Eric Kronenberg Partner Jennifer Latka Senior Associate Booz & Company

3 EXECUTIVE SUMMARY Cost overruns and schedule delays are endemic to completing large infrastructure projects. Nine out of 10 projects incur some cost escalation, and an even larger number of projects are completed later than originally anticipated. Although these issues cross all borders, they are very pronounced in developing nations where new, less-experienced institutions in both the public and private sectors are embarking on large, complex projects. In the Middle East, many companies engage seasoned program management consultants (PMCs) with sterling reputations to oversee the process of a large infrastructure project. But using a PMC does not guarantee successful results. Burj Khalifa, Dubai Metro, Masdar City, and Khalifa Port and Industrial Zone (KPIZ) are among recent examples of large PMC-led projects in the region. All of those projects experienced schedule delays, which in many cases can lead to cost escalations. From an external perspective, it is difficult to pinpoint what triggers delays and cost overruns in any specific large-scale project. However, many projects cost more and take longer than anticipated because of a lack of coordination and alignment of interests between the project owner and the PMC. Owners can improve their relationships with PMCs and increase the likelihood of project success by focusing on three areas: defining the right management structure or operating model, designing the PMC contract to provide effective incentives, and developing adequate internal capabilities to monitor the project. Booz & Company 1

4 HIGHLIGHTS Recent examples of large infrastructure projects show that the delays can run from months into years, and costs can be up to four times as much as estimated. Properly structuring the relationship between the owner and the PMC, with the right operating model, can increase the likelihood of project success. The right kind of contract for the project will ensure alignment between the owner s interests and those of the PMC. The owner must have sufficient internal capabilities to manage those aspects of the project that are critical to its business, as well as the ability to provide sufficient oversight on those areas managed by the PMC. THE CHALLENGES OF MANAGING INFRASTRUCTURE DEVELOPMENT For most organizations, successfully managing large infrastructure development is an extremely difficult task. Cost overruns and schedule delays tend to be the norm rather than the exception. There are notorious examples of troubled projects: The Panama Canal took two years longer and cost three times as much as anticipated. 1 The Big Dig in Massachusetts a three-decade-long quest to expand Boston s major interstate highway, bury it underground, and carve out a new tunnel to its international airport took 22 months longer than expected, and the cost was quadruple initial expectations. 2 No sector is immune to these challenges: Rail development projects experience cost overruns of 45 percent on average, tunnel and bridge projects more than 30 percent, and road projects about 20 percent. 3 Problems in project execution have significant implications for owners financial losses and lost business opportunities, as well as political pressures and damaged reputations. Project management issues are even more pronounced in the Middle East, where many newly formed organizations are embarking on unique and ambitious projects. 2 Booz & Company

5 Many project owners find that they lack the resources, tools, and processes required to manage projects within their own organizations. Furthermore, the benefit of building a large internal workforce with these capabilities often does not outweigh the cost. Therefore, instead of serving as the program manager themselves, owners hire professional PMCs to manage project execution, expecting that they can ensure successful project delivery. The PMC acts as the owner s representative and is expected to provide skilled personnel, relevant experience, and world-class tools and processes. But by no means does the hiring of a PMC guarantee that a project will be delivered on time and on budget. Many recent regional projects underscore this point including the building of the Burj Khalifa, Dubai Metro, Masdar City, and KPIZ. Each of these projects had a PMC of good repute responsible for project delivery. Yet, all incurred schedule delays, which in many cases can lead to cost escalation. Owners were left wondering: How did these PMCs fail to foresee, mitigate, and manage the project risks? It is difficult for an outsider to know what went wrong with any given project. Many factors can prevent a project from being completed successfully and some are outside the control of either the owner or the PMC, such as weather delays and increases in the cost of materials. Most projects, though, run into severe trouble if the objectives of the owner and the PMC are not aligned. Over the next 20 years, spending on transportation, industrial, and real estate infrastructure in the MENA region is expected to exceed US$680 billion (see Exhibit 1). 4 Owners must develop a structure that aligns the PMC s objectives with their own objectives to ensure successful project completion. A project s owners must address three key areas: the operating model, the contract with the PMC, and their own internal capabilities and organization. Exhibit 1 Infrastructure Projects Require Substantial Investments MENA INFRASTRUCTURE PROJECTS PROJECTED INVESTMENTS BY SECTOR ( , US$ BILLIONS) Railways and Metro Airports Roads Ports Bridges, Tunnels, and Waterways Industrial Zones Free Zones Other Developments Mixed Developments Leisure, Entertainment, Community, Hotels Total Transportation = $377 billion Industrial = $245 billion Real Estate / Travel and Tourism = $62 billion Source: International Monetary Fund; Global Insight 2009; MEED; Zawya; Booz & Company analysis Booz & Company 3

6 CHOOSING THE RIGHT OPERATING MODEL An owner can choose between several operating models to manage a large-scale development effort. First, for some projects, an owner can and should serve as its own program manager. This is especially the case if the project requires specialized capabilities that the owner can apply to similar projects in the future and that can serve as a source of competitive advantage. For example, The Walt Disney Co. serves as program manager for the development of all its theme parks, as that is a recurrent area of business expansion and one of its core competencies. In the case where project owners retain full control of the development, all program management activities are performed in-house and the owner shoulders the responsibility for integrating all parts of the effort. Other situations call for multiple PMCs working on various pieces of the development. The owner of the project monitors all activities and is responsible for overall integration, while the project managers retain some lower-level integration oversight. Finally, a project owner can engage a single PMC, handing over the full responsibility of integration and execution of the project while merely tracking its activities. There is no uniform prescription for project management; the correct model needs to consider elements such as the size of the organization, the owner s willingness and ability to be involved, the needed scope of integration, and whether or not the activity is critical to the owner s business model or obligation as a public-sector organization. In all instances, however, it is critical to note that the owner ultimately bears responsibility for the project and should provide oversight accordingly. As such, it must clearly determine and assign responsibilities at the outset to ensure that nothing slips through the cracks. 4 Booz & Company

7 DESIGNING AN EFFECTIVE CONTRACT STRUCTURE The contract between the PMC and the project owner is far from a mere formality; it is the vehicle that aligns the interests of the two parties. The financial arrangement must provide proper incentive for the PMC to act in the best interest of the project or else costs and delays could arise. The contract must also formalize the delegation of responsibilities that the owner and the PMC agreed upon when designing the operating model. PMC contracts in the Middle East typically have both financial and nonfinancial issues. The primary financial problem is the disconnect between payment and performance, caused by the terms typically employed in PMC contracts in the Middle East. The nonfinancial issues often involve poorly defined scope of work and minimal performance standards. Financial Structure Issues Perhaps the most critical aspect of a contract with a PMC is its financial structure, as the PMC typically is motivated by its own business objectives. There are three primary contract types: lump sum, time and materials, and cost plus incentive fee. Lump sum payment structures, in which a flat price is agreed upon at the outset, offer the lowest risk to the owner and the highest risk to the PMC, since the PMC will be forced to eat the cost of any increased costs or overruns. Although this model offers the PMC a strong incentive to finish on time and on budget, it is likely to make the PMC extremely inflexible regarding necessary changes and could even lead to quality concerns as it tempts the PMC to cut corners. In lump sum arrangements, the owner must also be prepared for the PMC to submit claims, sometimes of dubious merit, for increased costs that it believes were directly or indirectly incurred by the owner and should not be borne by the PMC. Many contracts in the Middle East stipulate a simple time and materials structure, in which the PMC Booz & Company 5

8 negotiates hourly or daily labor rates for each of the staff positions that will support the project. These rates typically cover both PMC costs and profit. In contrast to the lump sum approach, this assigns the majority of risk to the owner and little to the PMC. If the PMC is compensated on this basis and the contract lacks strong oversight mechanisms, the PMC has little incentive to complete the project on schedule, as delays will actually increase its revenue and profit. The time and materials contract has advantages: It is appropriate when technical requirements are still evolving or when there is a high degree of specialization or technical difficulty. However, it mandates that strong oversight mechanisms are included in the contract. Regular performance evaluations must be rigorous, and the owner s right to terminate the contract must be well defined. An effective model for many contracts is a cost plus incentive fee structure, which covers costs and provides a fee for bringing the project to fruition on time or within a budget range; this approach shares the risk evenly between the owner and the PMC. Although this type of contract is a bit more complex than the other two and not yet common in the Middle East, such performance and cost incentives are commonly used in Europe and the U.S. to align the objectives of the owner and the PMC. Nonfinancial Issues There are several examples of nonfinancial contract issues that can have a significant impact on the PMC s performance. First, the scope of work must be described thoroughly and explicitly, including specific tasks, anticipated outcomes, and associated deliverables. Without such clarity, the owner has minimal recourse 6 Booz & Company

9 when disagreements arise over what is required of the PMC to execute the project. For example, if a quality assurance function is not explicitly required and detailed in the contract, the owner will not be able to hold the PMC accountable for lack of oversight of contractor quality issues. As a result, PMC contracts must include a comprehensive set of performance standards and metrics that define the measurement process and the acceptable level of PMC performance. The owner must specify expectations on factors such as timeliness, quality of work, responsiveness, and contractor management standards. If such standards are not defined, there is no way to establish and take action on subpar performance. For instance, an owner can require a certain average number of days to review design deliverables, set an average number of days to solve urgent issues, and specify a percentage of milestones that need to be completed on time during a certain period. It is important to have a balanced set of standards, covering both schedule and quality, to ensure that the PMC does not sacrifice either of those. Additionally, contracts must make staffing processes transparent, and PMC personnel levels must be based on workload. Unless the contract is lump sum, the owner must have some control over the number of PMC staff to avoid escalating staff costs. As part of contractual negotiations, the owner and the PMC should agree to a staffing plan that details the PMC s tasks and the level of effort required to complete them. Changes to staffing levels should be approved by the owner. This is required for cost-plus contracts, because the PMC will be motivated to increase staffing levels rather than improve performance of existing personnel. The owner and the PMC should agree to a staffing plan that details the PMC s tasks and the level of effort required to complete them. Booz & Company 7

10 BUILDING INTERNAL CAPABILITIES AND ORGANIZATION Many owners are quick to use a PMC without fully thinking through what is required of their organizations. It is important to recognize that the owner of a project always bears the ultimate responsibility getting credit for project success as well as blame for failures. In the recent example of the oil spill in the Gulf of Mexico, it is not entirely clear what happened or which company BP or its contractors is to blame. But regardless of who is at fault, BP is, at the very least, bearing the brunt of the negative publicity and the resulting damage to its reputation and brand. If choosing to use a PMC, a project owner must consider first the appropriate level of involvement in day-to-day project management, given its own capabilities and manpower, the complexity of project integration, and the knowledge that the owner will need to retain within the organization at the end of the project. Second, the owner must determine how to make decisions efficiently and what level of control to delegate to the PMC. Level of Involvement Two distinct situations have surfaced among many PMC-led projects one in which the owner 8 Booz & Company

11 is too involved in the daily program management, performing duplicate roles with the PMC, and one in which the owner is too far removed from the program management, lacking any control over the project s success. In the first situation, the responsibilities of the owner versus the PMC are not defined clearly. With blurred responsibilities, there can be duplication of roles in the two organizations, leading to a lack of accountability. The Big Dig is a notorious example of this: The owner, Massachusetts Turnpike Authority (MTA), had an internal program management team that worked as a partner with the PMC, Bechtel/Parsons Brinckerhoff. This duplication of roles resulted in no supervising authority to hold the program manager accountable when a problem arose, it was unclear who was accountable because both the owner and the PMC were functioning as program manager. 5 When there is unclear accountability, it is easy for cost and schedule overruns to occur as the owner and the PMC point fingers at each other. In general, when using a PMC, the owner should assume the supervisory role, overseeing the PMC and monitoring the project s progress. The roles, responsibilities, and governance structure determined by the operating model and spelled out in the contract must be accounted for within the organization. In the second situation, owners rely too heavily on the PMC and underestimate their own responsibilities. This also typically results in cost and schedule overruns; the PMC cannot be given free rein because it has inherently different objectives from the owner. Again, this is true even in lump sum contracts because the PMC may cut corners or file excessive claims. With blurred responsibilities, there can be duplication of roles in the two organizations, leading to a lack of accountability. Booz & Company 9

12 Once again, in its role as supervisor, the owner should actively monitor the PMC s performance and the project s progress. This includes a certain level of cost, schedule, and quality auditing. It requires that the owner have a small, experienced staff capable of performing the audits and asking the right questions. Prior to hiring a PMC and kicking off a project, the owners should ensure these internal capabilities are in place. Owners need to retain control over critical project decisions, such as approvals of major changes to scope and schedule or contractor selection. These roles require a certain level of program management expertise and previous experience to understand schedule and cost trends, integration intricacies, risks and quality issues, and contractor agreements. These capabilities need to be built without dramatically expanding the workforce. The owner can have a small staff comprising experts in project controls; contracts; engineering; construction; and health, safety, and environment. Decisions and Control Furthermore, owners must establish a clear, explicit, and efficient decisionmaking chain for the project, both between the PMC and the owner, and within the owner s organization. Owners can delegate some decisionmaking authority to the PMC in 10 Booz & Company

13 order to successfully execute the project on time, based on dollar amount or type of decision; the maturity of the relationship and the previous successes of the PMC will determine how much control the owner is willing to give up. The key is to find a balance between too much and too little authority. For example, in a recent client engagement, we encountered a situation in which the PMC had no monetary authority limit and had to obtain client approval even on $1 changes, delaying the project s progress. Clearly, the owner here had too much control, delegating almost no authority to the PMC. But too little control is equally problematic for changes to the project that have significant implications in terms of cost, schedule, or scope, the PMC must present the problem and potential solutions to the owner, who must make the final decision. For a project to run smoothly without schedule delays, this control structure must be defined before the PMC begins working. A separate decision-making entity (a small committee, for instance) could facilitate project decisions. Therefore, if approval from a board is required for critical decisions, yet that board meets only monthly, a subset of the board members may form a committee meeting weekly or as necessary. Owners must establish a clear, explicit, and efficient decision-making chain, both between the PMC and the owner, and within the owner s organization. Booz & Company 11

14 Conclusion Over the next 20 years, infrastructure owners in the MENA region will make massive investments in large projects. Managing those projects will not be a simple task: An overwhelming number of large projects end up mired in delays or over budget. As a result, project owners will continue to turn to professional program managers to help them execute projects. That alone is not enough. Signing up a PMC, even a very good one with a strong track record, does not guarantee success. Project owners tend to underestimate the amount of work that needs to be done internally even when bringing on a PMC. To reap the benefits of engaging a PMC and to increase the likelihood of success, project owners need to clearly define the relationship with the PMC up front. They need to establish effective project governance, enter into an effective PMC contract which aligns all parties interests and encourages performance and build internal capabilities to track and monitor the project s progress. Without these measures in place, new infrastructure projects are likely to stumble over the same issues that have plagued their predecessors. 12 Booz & Company

15 Endnotes 1 Panama Canal Construction, , GlobalSecurity.org. 2 Bent Flyvbjerg, Cost Overruns and Demand Shortfalls in Urban Rail and Other Infrastructure, Transportation Planning and Technology, vol. 30, no. 1, February 2007 ; Raphael Lewis, Big Dig overrun is just plain big, Boston Globe, July 14, 2002; Raphael Lewis and Sean P. Murphy, Artery errors cost more than $1b, Boston Globe, February 9, Completing the Big Dig : Managing the Final Stages of Boston s Central Artery/Tunnel Project, The National Academies Press, Raphael Lewis, Big Dig overrun is just plain big, Boston Globe, July 14, 2002; literature search; Booz & Company analysis. 4 International Monetary Fund; Global Insight 2009; MEED; Zawya; Booz & Company analysis. About the Authors Eric Kronenberg is a partner with Booz & Company in Florham Park, N.J. He specializes in developing functional excellence in program and project management, engineering and design, and manufacturing and construction in multiple industries, including aerospace and defense, energy, and transportation. Fadi Majdalani is a partner with Booz & Company in Beirut and leads the firm s transportation practice in the Middle East. He has advised on strategic and operational topics for a number of transport infrastructure stakeholders, including policymakers, regulators, operators, and investors. Ekaterina Arsenieva is a senior associate with Booz & Company in Dubai. She specializes in market assessment and strategy development, strategic and business planning, and organizational development and transformation for public transport authorities, investment entities, infrastructure, transportation, and logistics companies. Jennifer Latka is a senior associate with Booz & Company in Florham Park, N.J. She focuses on improving organizational effectiveness and operational efficiency for commercial aerospace, defense, and transportation companies. Booz & Company 13

16 The most recent list of our offices and affiliates, with addresses and telephone numbers, can be found on our website, Worldwide Offices Asia Beijing Delhi Hong Kong Mumbai Seoul Shanghai Taipei Tokyo Australia, New Zealand & Southeast Asia Adelaide Auckland Bangkok Brisbane Canberra Jakarta Kuala Lumpur Melbourne Sydney Europe Amsterdam Berlin Copenhagen Dublin Düsseldorf Frankfurt Helsinki Istanbul London Madrid Milan Moscow Munich Oslo Paris Rome Stockholm Stuttgart Vienna Warsaw Zurich Middle East Abu Dhabi Beirut Cairo Doha Dubai Riyadh North America Atlanta Chicago Cleveland Dallas DC Detroit Florham Park Houston Los Angeles Mexico City New York City Parsippany San Francisco South America Buenos Aires Rio de Janeiro Santiago São Paulo Booz & Company is a leading global management consulting firm, helping the world s top businesses, governments, and organizations. Our founder, Edwin Booz, defined the profession when he established the first management consulting firm in Today, with more than 3,300 people in 61 offices around the world, we bring foresight and knowledge, deep functional expertise, and a practical approach to building capabilities and delivering real impact. We work closely with our clients to create and deliver essential advantage. For our management magazine strategy+business, visit Visit to learn more about Booz & Company Booz & Company Inc.