Transforming Procurement

I have written about this topic many times. I believe that many of the problems with projects today result from the project participants following historical practices that are now very inefficient and therefore ineffective for the current class of projects. The prime example I have used to explain this phenomenon is procurement. I selected procurement because it is a major project activity that historically requires a lot of resources, time and cost to deliver the necessary results. I know there are other project areas that suffer from the maintained historical practices.

Owners have wanted to reduce the growing cost of procured equipment for major projects for decades. This has been considered a key contributor to the rising, high cost of projects. The historical procurement process used by almost all project organizations consumes hundreds of resources and thousands of hours on a typical major project. By adopting a totally different approach, Owners can reduce the purchase price of procured equipment by 30%, reduce the number of hours to execute procurement by 50%, possibly reduce the size of the project teams and definitely shorten the duration of projects. The article explains how to achieve this. Sorry for the length of the article but there is a lot to cover. There is so much history, ownership and comfort with the historical practice that every detail of the different approach must be discussed.

First, it is important to understand what the cost of procured equipment is for a typical project. It is not just the cumulative purchase price of all the tagged equipment. There is also the cost from the time of the Owner’s and EPC’s procurement staffs, the Owner’s and EPC’s engineering staffs, the Owner’s and EPC’s quality staffs and the Owner’s operations staff. All of these groups play important roles in the procurement of the tagged equipment for a project and their involvement could account for hundreds of resources and thousands of hours that must be included in the total cost of the tagged equipment. Failure to consider these additional costs means project leaders are missing the much bigger picture when it comes to lowering the cost of project procurement.

One of the problems with achieving the maximum savings is that there are so many groups involved in the procurement of equipment. There is Procurement, Engineering, Quality/Inspection, Operations, Documentation, Contracts and Law. Each individual group can work and have worked to optimize their portion of the procurement process but that will not achieve the maximum savings. To achieve the maximum savings, the entire procurement process must be looked at collectively and systematically.

Several initiatives have been pursued with the hope of reducing the cost of equipment. One initiative was to only purchase “industry standard” equipment. The belief was that uncontrolled engineers created specifications with a lot of costly and unnecessary or unjustified requirements that drove up the cost of equipment. The idea was to eliminate the costly requirements by only purchasing equipment with something called “industry standard” requirements. Several studies have shown the unique owner requirements only drive up costs by 3-5%. There was always a few exceptions where a very costly requirement was included that was used to justify the “industry standard” approach but these were exceptions and not the norm. This initiative created conflict between the Owner’s engineering staff and the Owner’s leadership. The engineers believed if they specified only what was absolutely required or could be economically justified, they were specifying the lowest cost solutions by definition. The Owner leadership was convinced usually by the EPC leadership that the Owner engineering requirements were a major contributor to the high cost of the equipment. As I will explain later, this initiative missed the much larger picture and did not result in the maximum cost reductions. I will say, however, that the industry standard approach will reduce costs for commodities like pipe or structural steel where the profit is realized from the source of the raw materials or the source of inexpensive labor and the technical details are the same from Supplier to Supplier. For engineered products like electrical gear or control systems or machinery like turbine-compressors, you will never get multiple suppliers to build the very same product that only complies with industry standards. For the engineered products, a different approach must be taken.

Another initiative that has been pursued is to increase the purchase volume with each supplier and use that increased volume to negotiate lower pricing from each supplier. Increasing the purchase volume could be achieved by requiring every business unit within a single company to use the same specifications and order the exact same equipment or to get multiple large companies to agree on a set of specifications and all of the companies purchase the same equipment from each Supplier. The belief is that a savings of 5-10% can be achieved with this approach. Although this can be a significant amount of money on a project, it misses the much bigger picture and does not achieve the maximum possible savings.

Another approach generally pushed by Procurement is to increase the number of Suppliers bidding on an order. The idea is that the increased number of Suppliers will force lower bids. This may result in lower pricing, but the lower pricing is not enabled by true Supplier lower costs which can force the selected Supplier to achieve the necessary margins by other means. This can include taking short cuts, reducing resources assigned to the order, reducing quality or other undesirable behaviors.

To achieve the maximum savings, the entire procurement process must be understood. The entire process includes all of the following:

1. Owners maintain a set of global practices. This can include 300 or more specifications and costs millions of dollars each year to maintain.

2. For each project, the global specifications are converted to project specific specifications that only include requirements applicable to the specific project. This can take up to 7-9 months for the EPC engineers and the Owner engineers to publish all of the specifications and this time and resource consuming step is executed for every project.

3. The EPC’s Procurement organization and the Owner’s Procurement staff assigned to each project create Request for Quotation (RFQ) packages for each order. This includes the applicable project specifications and references to the applicable industry standards. They also include the terms and conditions created specifically for the project. A typical RFQ can be 12-24 inches of paper not including the applicable referenced industry standards. Just as a side note, I am willing to bet that there is never a single Owner or EPC individual that has read every single page of any of the RFQ packages and this occurs because many groups and individuals contribute to the RFQ package and the person preparing the RFQ packages simply assembles documents from numerous groups without reading all of the content.

4. Each Supplier bidding on an order has to put together a Proposal Team to review the entire RFQ, highlight what is standard for them and what is not, prepare any spec deviations and generate the proposal. This team is necessary because the RFQ for the same equipment is always different between projects and there are a lot of different requirements to review. Frequently because of the way the RFQs are put together, there are conflicts and inconsistencies that the Supplier Proposal Team must identify and have addressed.

5. The EPC then has to put together a Proposal Review Team for each order and review every proposal to ensure compliance with all of the specifications and identify inconsistencies between proposals. This is a challenging activity because every proposal looks different and it is difficult to get everything on an apples and apples basis. Proposal clarifications meetings with all of the Suppliers are typically conducted for the larger orders. Spec deviation reviews are typically necessary for most orders.

6. The RFQ proposal analysis with the identified recommended Supplier then has to be reviewed and approved by the Owner’s representatives on the project.

7. The purchase order documents are then put together with all of the spec deviations included in the attached project specifications.

8. For the large orders, a Bid Award meeting is held with the selected Supplier to ensure an understanding of all of the specifications, agree on the required documentation and agree on the planned inspections. There is a Package Engineer from the EPC assigned to every order.

9. The Supplier than has to create drawings for every order to incorporate all of the non-standard requirements into their standard solutions. This is typically an activity where many of the suppliers do not have sufficient engineering staff to publish the necessary drawings in a timely manner.

10. The EPC and the Owner representatives must review and approve the applicable drawings for each order. Typically, this takes several submittals and resubmittals between the EPC/Owner and each Supplier to get the necessary approvals. Almost always, the delivery of the final approved drawings are late.

11. Once the drawings are approved, the Supplier can begin planning the manufacturing process for the order. Because of the non-standard features included in each order, the Supplier must modify their manufacturing process including inspections and testing to comply with the project specifications. 

12. Owner/EPC must plan and execute inspection activities primarily to ensure all of the customized features are being included as specified. These inspections could include hold points which require stopping the work until designated inspections are conducted.

13. Once the manufacturing is complete, the Supplier will conduct an internal FAT without the client to ensure the FAT that is witnessed by the Owner’s engineers and operating organization and the EPC will go without problems. 

14. A full witnessed FAT is then conducted. For certain equipment, these FATs can last weeks or even months for a very large automation system where all of the equipment is staged in one location.

All of these steps could consume a year or more for one piece of equipment and can consume hundreds of resources between the owner, the EPC and the Supplier. The total process for a single piece of equipment will consume a large number of resources, a significant number of hours and cost a lot of money well beyond the purchase price of the equipment. 

If an Owner is focused on the purchase price of the equipment and the cost for all of the Owner’s unique requirements, they have missed the much bigger picture. The issue is not the cost of the content of the specifications but the fact the Owner modified the Supplier’s standard solutions. Even though the cost of most individual customizations is not significant, it is the fact that the customizations exist that drives the need for most of steps in the procurement process. Much of the process could be greatly simplified with even some steps almost completely eliminated if the Owner would never customize a Supplier’s standard solution.

What every Owner should do is work with all of their key Suppliers, including multiple Suppliers for each product line, to agree on the details of a completely Supplier standard solution without any customizations by the Owner. This is not easy, takes time but is achievable. This requires discussions between the Owners and the Suppliers where the differences between the Suppliers standard product and the Owner’s standards are discussed and either incorporated as a standard feature/option or the Owner agrees to not apply. Agreements can and should be reached on standard vendor data, standard drawings, inspections, testing and standard terms and conditions. The resulting agreements should be documented in a standard specification owned by the Supplier, not the Owner. The idea is that the Supplier could use the specification to sell their standard products to their other clients further reducing the cost of the standard solutions. It is important that for anything new that is incorporated, it must be something the Supplier will sell to their other clients. Never should a Supplier incorporate a feature that they will only sell to one client. To do otherwise would defeat many of the benefits of a completely standard solution. The Owner’s procurement organization should also create standard forms that all of the bidders for an order would use to generate their proposal. This would make every proposal identical in format and much easier to analyze.

The benefits of Owners only purchasing completely standard solutions from their Suppliers include the following:

1. Project specifications for procured equipment would not be necessary. All that would need to be generated on the project are completed data sheets to cover those specific standard options that are applicable for the specific project.

2. The RFQ package will be significantly simplified because the specifications, terms & conditions, documentation requirements and inspection requirements will already be agreed.

3. The proposals from the Suppliers will be significantly simplified and consist of completed standard forms used by all of the bidders.

4. Analyzing the various proposals will be simpler and not take much time. No bid clarification meetings will be necessary.

5. Once the selected Supplier is selected, no Bid Award meeting is necessary.

6. Generating the necessary drawings and data should be significantly easier and minimal reviews will be required by the Owner/EPC. Drawing recycle should not occur.

7. Since the products are completely standard, Owner/EPC involvement in inspections should not be necessary. The Owner/EPC should be able to rely upon the agreed testing and inspection conducted by the Supplier.

8. Even staged FATs may not be necessary. For programming, a virtualized version of the system could be created, and all programming tested and verified “in the cloud” from anywhere. This can be a significant savings in resources, time and cost.

There will be resistance throughout an Owner’s organization to accept completely Supplier standard solutions. Engineers will feel a completely standard solution is not possible because no Supplier builds what they want without Owner guidance. The Owner’s operators will be accustomed to certain features that are not considered standard and will demand that they be included. Procurement and Law will demand that certain terms and conditions must be imposed. However, every concern can be addressed by investing time with every Supplier one time.

The historical practice of an Owner customizing practically every aspect of an order needs to stop. This was an acceptable practice when projects were smaller, less complicated and more local. When the projects became mega in size, significantly more complicated with purchases and manufacturing occurring around the globe, a different approach is necessary, and that approach must be based on Supplier standard solutions without any exceptions.

I know for sure every Supplier would prefer to never have to customize their standard solutions. Including non-standard features costs the Suppliers a lot of time, resources and cost. Every Supplier can lower their cost of their equipment by up to 30% by needing significantly less resources and greatly simplifying their bidding, manufacturing and quality processes. For these reasons, every Supplier will invest the necessary time to establish completely Supplier standard solutions.

Owner’s global standards should be their database for lessons learned and not the direct basis for procurement specifications. Critical learnings should be shared with the Owner’s key Suppliers with the hope certain features will be added as pre-engineered standard options/features. Then and only then should an Owner select a feature or option when ordering equipment. 

Competitive bidding is still possible with Supplier standard solutions, but the bidders can only be allowed to offer their standard solutions agreed with the Owner without any compromises. Each bidder cannot eliminate any of the agreed standard options in order to win a competitive bid. In order to be competitive, the Suppliers must find ways to include the agreed features at a lower cost. When bidding, only Suppliers who have agreed on standard solutions should be allowed to bid. Including others could jeopardize the proposals offered by those that have reached agreements with the Owner.

By only ordering Supplier standard equipment, the quality of the delivered equipment goes up and this is because the Supplier does not have to include non-standard features that they do not provide very often and does not have to modify their manufacturing process for every order. Delivering the very same product over and over again ensures improved quality.

There are a number of known problems with the historical procurement process that users have just learned to accept without challenge. Competitive bidding to a detailed RFQ package including detailed specifications creates a number of undesirable behaviors. First, it encourages minimal compliance with the specifications. This may sound okay but because the Suppliers must keep their price as low as possible, they may remove features that are necessary to meet the intent of the specifications but not called out specifically in the specifications. They may remove standard features that bring value but are not called out specifically in the specifications. They may replace components with lower quality components that meet the wording of the specifications. They may make changes that cannot be identified in a review of their proposal for the expressed purpose of lowering their price. All of these behaviors to reduce price create many other problems that may not be discovered until the order is awarded or during manufacturing or even much later when the product is in service. Additionally, any changes they make to their standard solutions creates all of the problems caused by customization discussed in this article.

The proposals that are created in competitive bids are usually very detailed but also very unique meaning the proposals between the bidders are very different and it is always a challenge to figure out what is included and what is not and how to get everything on an apples and apples basis. It takes a lot of time to perform the necessary analysis of all the proposals. For a major project, the analyses for all of the equipment orders consumes a significant amount of time. 

This Supplier standard approach was adopted by ExxonMobil Upstream and Downstream for electrical switchgear, transformers and motors in 2016 and in the first application, the selected Supplier stated they were able to reduce the cost of the equipment by 30% relative to what they had offered before in competitive bids and the EPC preparing all of the procurement documents stated they reduced their time and resources by 50%. This demonstrated the approach worked with more than expected savings. These stated savings did not include the savings from the reduced effort by ExxonMobil’s participants or the other savings resulting from reduced inspections and testing or the benefits from the resulting improved quality. 

This approach dramatically changes the historical practice, can be applied to all disciplines for all equipment and certainly transforms the complete procurement process. I am convinced this approach is the best and most effective way to reduce the cost of procured equipment by greatly simplifying the procurement process for the Owners, EPCs and Suppliers.