Reasonable EPCM Cost Multiplier or Fingers Crossed?!!

Choosing the best contractual strategy for developing and delivering of major infrastructure projects has never been an easy task – and won’t be! Different types of contract allow the risks and uncertainties associated with the project to be transferred from the owner of the project to various counter-parties for a PRICE! Most recently our team helped a client in market data benchmarking for assessing a suitable ‘EPCM multiplier’ and potential influencing risk factors for an EPCM cost reimbursable model on a major brownfield project. This article is a brief of many similar discussions with a number of clients on this important topic and hopefully will generate further discussions (and possibly debates!).

The common types of contracts are below. Each of these types of contracts produce a different risk profile depending on risk allocations between parties.

• Traditional
• EPC (Engineering, Procurement and Construction)
• EPCM (Engineering, Procurement, Construction and Management)
• Early Contractor Involvement (ECI), Managing Contractor (MC)
• Collaborative Contract, e.g. Alliance, Competitive Alliance, Incentivised Collaborative Contract, Delivery Partner, etc.

The important difference between the EPCM and EPC forms of contract is that under EPCM contract, the contractor is NOT a principal in relation to the procurement of plant and materials, or construction. Hence, the EPCM contractor’s main liabilities elate to:

• Negligence in the performance of the design works, and
• Negligence in managing the procurement and construction work.

Figure above is a good project delivery model comparisons for EPC, EPCM and Integrated Project Delivery - Ref: Project Management for Mining Handbook, by Robin Hickson and Terry Owen, 2015.

In EPCM cost reimbursables, it’s quite common to apply a model with a single multiplier on the bare (actual) labor rates. In best practice for EPCM ENR projects, it is recommended that multiplier should only include:

• Base Rate (Wages)
• Payroll additive burdens and benefits, usually about 40% to 50%
• Overhead expenses (direct and indirect including office overhead), usually about 55% to 65%

For large EPCM contractors, this generally comes out between 2.1 and 2.7, although in tough times large contractors may decide to go below 2.0 range just to keep their staff. Although in my experience, unless the overall risk profile across their projects portfolio meets the desired confidence level, e.g. P80, this decision is not recommended. On the other side, really small contractors need to consider higher average multipliers, probably 3.0 to 4.0, to achieve their objectives. 

The items not covered by multiplier, and thus needing to be billed as separate additional cost add-ons, include IP and technology usage fees (software, etc.), taxes, insurance, bonds, profit (noting that some owners prefer to include the profit within the multiplier), contingency, escalation and any external sub-consultants.

If we agree on this breakdown, the key question is:

How the risks and uncertainties should be assessed when setting/agreeing the ‘EPCM multiplier’ - what's the relationship with 'contingency' then!? (I can't write an article without referring to risk and contingency!! :))

This is now getting a bit tricky!!

Extra consideration is needed when using any data benchmarking and organisation’s Risk Breakdown Structure (RBS) for assessment (both qualitatively and quantitatively) of risk factors in setting the EPCM multiplier. In short, two main approaches are available:

1. If the team would like to use their full RBS template, an additional column of applicability is needed with three drop-down options: ‘Contingency’, ‘Escalation’ and ‘Multiplier’. This is to ensure that the team fully understand the appropriate allocation of risks to different buckets, so optimum allowances being determined.
2. Alternatively and because the approach above might be a bit confusing for some teams, a shorter list of relevant risk factors for the purpose of ‘multiplier’ determination can be prepared, separately from the full RBS. The key risk drivers on multiplier include:

• Industry Type
• Project Type
• Market Conditions
• Project Location
• Magnitude of the project
• Size of EPCM
• Owner’s requirements as to level of involvement, e.g. any requirements for Integrated Project Controls reports or level of DE/BIM requirements
• Owner’s internal project delivery resources and skill set
• Level of integration between the project parties’ respective teams

With all these structures and formula/benchmarking in place to calculate a reasonable ‘multiplier’ the next key question is: How can the same sense of urgency and efficiency in the EPCM contractor and its personnel over a long period be achieved as compared to a fixed priced model?

These factors should be addressed while setting/agreeing KPI incentive regime. In my experience, without a risk-based KPI incentive mechanisms, it is very difficult, if not impossible, to achieve effectiveness and value for money from EPCM contracts. In other words, the multiplier will act like a ‘Base’ while EPCM Contractor will also be entitled to bonuses or subject to a reduction in payment under agreed KPI’s (i.e. time, cost, safety, environment and community) – which will be discussed/agreed while all wider project risks and uncertainties being assessed. 

It is critical to the success of the KPI incentive regime that, when formulating the targets and methods of measuring performance, there is sufficient clarity of project scope and the owner’s requirements.

The last but not the least, since the EPCM Contractor will typically drive/set the key project targets (e.g., project budget and the schedule including completion dates), appropriate independent due diligence and assurance program is definitely recommended by the Owner, or its independent adviser, to establish that the project targets are sensible in the context of the project proposed. 

 What do you think? Your views and experiences are definitely appreciated and welcomed, as always. :)

The views expressed in this article are those of Pedram Danesh-Mand and do not reflect or represent the official policy, position or recommendation of the KPMG Australia, Engineers Australia (EA) or Risk Engineering Society (RES).