As you know, in construction practice, especially in the region of former Soviet republics, for many years the most preferred approach for the Owners to implement large investment projects, there were fixed price or lump sum approaches, or according to the principle of ”turnkey”, as well as their different combinations, f.i. such as “lump sum turn-key” approach (LSTK).
In international practice, these approaches are grouped together in the so-called EPC type of contract, that is, in a contract of Engineering-Procurement-Construction type. Under this strategy, the Owners and Investors expect a certain degree of assurance regarding the time and cost of the project implementation.*
It’s no secret that in Western Europe and other CIS countries, large construction companies traditionally have better commercial experience compared to the Owner and / or the Investor, which means they have definite advantages in the process of contract negotiations. As a result, the main EPC contractors, feeling their strong position in negotiations with Customers, learned to overestimate their profitability, and at the same time, reduce their level of risk by transferring it to the Owner and / or Investors.
Despite the undeniable benefits that a Lump Sum EPC contract gives to an Investor and Owner, an alternative to this approach was required in response to the disadvantages for the Owner of the terms that are dictated by the EPC contractors.
The latter led, on the one hand, to the gradual avoidance of the LSTK model. On the other hand, in many sectors contracting with only one EPC contractor is considered more as an exception than a rule.
Later on, with the implementation of international infrastructure and large investment projects, it was increased number of so-called EPCM contracts (Engineering-Procurement-Construction Management).
Taking into account these market conditions, here in this article we would like to explain how a typical EPCM contract works and thereby identify some key differences from an EPC type contract. In the end, they sound almost the same, but there are still many people involved in the construction, which can not completely clarify the main differences between them.
In short, an EPC contract is a design and construction contract, where one contractor assumes responsibility for all elements of design, construction, and procurement.
The following is a typical schema of the EPC approach:
On the contrary, an EPCM type contract is a contract for professional services, and has a completely different risk distribution principle and different legal consequences. The key difference is that under the EPCM contract, the other parties are responsible for the construction – the EPCM contractor is NOT a construction contractor!
The following is a typical schema of EPCM approach:
The decision as to which contract model (contract strategy – see our previous article) is more appropriate for construction is often postponed until the final development of the Project Concept. Namely, when the Owner, on the basis of the developed basic (conceptual) design packages, gets a more complete picture of the market of services and information on prices for construction and installation work, and can assess the degree of uncertainty and risks associated with its project. On the other hand, the Owner can also understand the existing market environment for EPC services to assess all the advantages and disadvantages of EPC or EPCM-based approaches.
The logic of this type of contractual relationship suggests the expediency of attracting the same company that actively participated in the conceptual design development of the Project. It is precisely this company that is most successfully positioned for the control and maintenance of the construction process, after the selection of the General Contractor. Such a company of consultants and engineers is “EPCM Company” itself.
The nature of the organization of the Owner (the Customer) and the degree of control that they wish to have during the implementation of the project also influences the decision which EPC or EPCM option will be selected.
As we may see from the above brief analysis, there are serious differences between the EPC and the EPCM contracts. And although the process of such a comparison is more likely as to compare the advantages of an Apple vs an Orange (or vice versa), we will try to somehow systematize our knowledge.
The advantage of the EPC contract from the Customer’s point of view is that the contractor in this case is fully responsible for the final cost of execution of works, especially in case of a contract with a lump sum (“lump sum”). He is responsible for the completion of work and for the quality of project documentation and construction and installation work with guaranteed quality level.
This approach allows for the Customer to avoid possible disputes with multiple project participants and thus he has only one party with full responsibility.
However, the main drawback of the EPC contract for the Customer in comparison with the EPCM approach is that the development of the working documentation is its (EPC contractor) prerogative. Therefore, in the EPC approach, the Client should pay serious attention by describing the main parameters of the design documentation and works (including all project life support systems of the object) in such a way as to obtain as a result of the project at the required level and with the protection of its commercial interests.
Usually, this requires much more than a simple indication of the criteria of efficiency and quality in relation to the object under construction, and also must take into account the operational life cycle of the object and its maintenance. Which means, The Customer has to have enough number of qualified engineering staff to control all the project stages…
The EPCS contractor, in turn, acts as the Representative of the Owner (the Customer) and acts on his behalf in the framework of direct contractual relations between the Customer and suppliers of equipment and construction contractors. Each such construction contractor and / or supplier of equipment and technology has a direct contract with the Customer. That means, the Customer should have the EPCM company that manages and administers the construction work. In fact, EPCM contractor provides a sufficient number of his own experienced specialists to coordinate and control the project realization, which is especially important at the stage of construction management.
In that fact, the EPCM contractor is directly responsible for the management and administration of all design and construction works, for the allocation of responsibilities among all participants in the construction process (the services, which, in fact, EPCM company and receives payment for).
In turn, from the point of view of the EPC contractor’s, frequently encountered problem areas in this approach are the interface between the different phases of design: the conceptual project and the design stage / detail design stage of the project, especially if the EPC contractor is responsible for the design documentation, but was not involved into the conceptual design stage.
During the selection phase of the EPC contractor, the latter generally requires full compliance with the sketch and / or conceptual design, and it is assumed that it follows such compliance, even if this is physically impossible due to a relatively short bidding period.**
Thus, as we have already pointed out in our previous article, a competent selection of the appropriate contractual strategy in combination with a competent pricing policy will minimize the risks to the Owner as much as possible.