Contracting is very likely the single most difficult element of project management. It requires a broad range of skills—strategy, understanding of legal concepts, good relationship skills, negotiation skills, understanding of the projects market, and the ability to put oneself in the other person's shoes. In my experience, it causes owner project managers more stress than any other part of their job. Because contracting is stressful, there is an understandable temptation to look for a magic fix for the problem—an approach that will solve all problems. Alas, the magic fix will not be forthcoming here (or anywhere else).

The relationship between owners and contractors is often characterized as fraught with conflict. Some conflict does exist at the organizational level; it is real and unavoidable because of the principal‐agent problem, moral hazards, and the reality of human fallibility—what my clergyman brother would call “original sin in action.” The only misalignment of goals that is necessarily present is the owner's desire for lower cost versus the contractor's interest in being more profitable. There is no point in pretending that misalignment does not exist. If that were the only misalignment problem, however, contracting wouldn't be so difficult.

The serious problems arise when the risk profile of the project does not turn out as expected. Sometimes this is due to bad luck (e.g., the market heated up and escalation became an issue, or bad weather complicated execution, and so forth). Murphy is still the patron saint of projects. Sometimes, the contractor was not competent to do the work or could not find the people he assumed would be available. However, much more often there is something amiss with the project fundamentals: the business objectives changed or were never very clear, a previously missing owner function showed up at an inopportune time, or the front‐end loading contained holes and errors that threw execution into chaos.

Contracting cannot fix fundamental problems with projects, but good contracts can help limit the damage. Contracts that are clear and honestly assign risk are the best that can be done to control conflict at the organizational level between owners and contractors and between primes and subs. The intractable project‐damaging conflicts between contractors and owners at the organizational level are usually caused by surprises about who was carrying which risk. The more complete and transparent the risk assignment, the less likely those surprises are to occur. The complete elimination of conflict at the organizational level is a futile and therefore irrelevant goal.

The existence of inherent and irreducible conflict at the organizational level does not need to exist and for the most part does not exist at the level where it most counts—the workface. Some believe that any organizational tension must bleed into the workface and therefore should be eliminated. But that just plain isn't true. If conflicts exist at the workface, they are not generated by the organizations but by the same forces that can create conflict in any human interactions: lack of mutual respect and willingness to cooperate.

I have worked with many project teams in FEED and execution over the course of my career. Many times on good projects, I cannot distinguish who is owner from who is contractor, and the contractual form offers no clue. Lump‐sum or reimbursable, EPC or split, the working relationships between owners and contractors are controlled by the quality of project leadership on both sides far more than any other factor when the project fundamentals are sound. When the project fundamentals are poor, even extraordinary leadership will struggle to avoid the blame game.

What Contracts Should Do

A contract should lay out the scope of work in as much detail as reasonably possible. In defining the scope, the contract should be especially clear at the “edges” of the work where it must interface with the work or systems of others. It should define the rights and duties of both parties, lay out the payment scheme, describe the change process, and provide the usual contractual requirements—breach provisions, dispute resolutions, force majeure, etc. But above all else, contacts should assign risks and discuss why particular risks were assigned the way they were in the contract to facilitate conflict resolution during execution if the need arises. A good contract should leave both parties feeling secure that if they do their roles well, they will be successful. Far too often the end of contract negotiations has at least one party ready to go on the defensive for the duration of the project.

What Contracts Should Not Attempt to Do

Contracts should not be expected to manage the project. That is the task of project leadership on both sides. The contract should not attempt to dictate behavior through penalties or bribes—whoops, excuse me—incentives. The contract should not seek to “foster collaboration.” Contracts should do what they are supposed to do and leave project management to the participants. Almost all nasty disputes are picking through the detritus of bad projects. And those were almost always bad projects from the outset. Owners must remember it was usually their shortcomings that started the project in the wrong direction. Rather than spending hours giving depositions and bending the truth into a pretzel in arbitration or court, the parties should be in deep conversation about what went wrong and why.

Very few owners or contractors go into a project intending to exploit the other side. Unfortunately, there are exceptions. I once asked an owner business sponsor why he was suing a contractor (for more than its net worth) over a project that the owner screwed up. His answer: “For the money, of course, this is just one of 23 suits I have going.” And to balance that, I know of a major contractor who carefully inflates the bulk materials in hard‐to‐find places on every reimbursable project they do in order to increase their take. So yes, there are predators on both sides. But most contractors and most owners simply want a good project that makes both parties successful. Neither wants the contract to unfairly disadvantage the other party.

It is not, however, enough for the contract to be “fair and balanced.” The contracting strategy must be selected to fit the project's goals, the project's characteristics, the owner capabilities, and the skills of the contractors available to execute the project. And the project must be set up to succeed by the owner on the front end. “Fair and balanced” is good. “Fair, balanced, and smart” is far better.

The Primacy of the Owner Role

All contractors are aware—perhaps painfully so—that they are dependent on the owners for their livelihood. Just as with any other professional services relationship, clients are everything. The owner hires the contractors; the owner sets the contractual basis for the project, although contractors may seek to influence the strategy. This dependency of contractors on owners sets up some of the pathology that often seeps into the relationship—such as “You're the boss,” while figuratively rolling your eyes and thinking, this guy doesn't know what's he talking about.

However, there is an even deeper dependency that owners and contractors often miss: the dependence of every project's health (and therefore riskiness) on the performance of the owner, often before the contractor is engaged. The data tell a compelling story: if the business case is not sound, if the owner team is not strong, and if the front‐end loading is not completed before execution begins, the project, the contractor, and the owner team are set up to fail.

The contractual strategy modulates how the failure plays out. In some forms failure is exacerbated by the contracting strategy, and in other cases it is mitigated.

• Poorly prepared EPC‐LS projects bog down in the mud of endless change orders. If the change order process does not work extraordinarily well, claims result. When the claims resolution process fails, arbitration or litigation completes the project cycle.
• Failing EPC‐R and EPCM projects crank what seem to be endlessly inefficient hours in both engineering and construction and ultimately end in mutual disgust between owner and contractor at the end. These forms, however, rarely result in arbitration or litigation because the owner has taken on essentially all risk and cannot shed it.
• Alliance/IPD projects fall into an orgy of acrimonious finger‐pointing in execution and feelings of betrayal all around or become exercises in unseemly denial.
• Failure in the split form projects is characterized by less acrimony because the form provides an opportunity to recover and refocus between engineering and construction that is not afforded by the EPC forms. Engineering may have been a debacle, but construction tends to be at least mediocre.

In principle, it is possible for a contractor to take a well‐prepared and thought‐out project and utterly destroy it. Certainly, owners have accused many a contractor of doing so. However, in practice it is rare to the vanishing point to actually see such projects. The contractor that would take a good project and destroy it could not survive in the market because if the contractor would destroy a good project, they would never succeed on any project and would be quickly driven out of business.

Returning to a Normal Relationship

A number of years ago, Ted Kennedy, the executive chairman of EPC firm BE&K, gave the keynote speech at a large conference of the owners and contractors of the process industries in the United States. Ted was the consummate gentleman and friend to all of us fortunate enough to have known him. His speech started this way: “To my contractor colleagues here today, I have only one thing to say: we are a bunch of whores. [Stunned silence] And to my friends on the owner side, you are the pimps.” (His head of business development later told me that he wanted to slip quietly under the table.) Ted's point was a profound one: the relationships between owners and contractors had come to resemble a series of “one‐night stands” rather than a healthy business relationship.

There is an old expression in contracting that “the owners make the market.” That is true, of course, in the simple sense that buyers—customers—make any market, not sellers. In contracting, that old expression has a much deeper meaning—owners make the relationship. As we have already discussed in several places in this book, the business relationship between owners and contractors is not a normal relationship between a provider and user of professional services. For most industrial projects larger than the site or business unit–managed projects, the contractual relationship is a one‐off transaction.

This situation has developed and steadily deteriorated over the last 30 years. Most attempts to change the dynamic have been to embrace collaborative contracting approaches such as integrated project delivery. As we have discussed, those approaches have been largely unsuccessful in industrial projects. They have been unsuccessful in my view because they do not address the central problem.

Owners have created the transactional approach to contracting by failing to honor the fundamental implicit agreement in professional services relationships: good work leads directly and predictably to more work. In other words, when a contractor performs well on a project, that performance will substantially increase the chances of getting the next project from the owner that requires similar expertise. Almost no industrial owners honor that principle today.

The rise in transactional contracting was the logical concomitant of the weakening of owner engineering and project organizations. Strong owner project organizations were able to carefully measure and track contractor performance and had the freedom to reward good work. As procurement organizations came to have more influence over contracting, transactional contracting become the rule rather than the exception. The only contracting strategy that has a clear nontransactional methodology among the 10 strategies we have reviewed is repeat supply chain, and note that RSC does this without altering the contracts themselves.¹ IPD/alliancing talks about collaboration but is nonetheless a one‐off arrangement; relationships are not the goal.

With the exception of traditional² EPC lump‐sum, any contracting strategy could be used in a relational self‐enforcing manner. But if we are going to return to a more orderly and normal professional services relationship between owners and contractors, the owners will have to lead the way.

Suggestions for Owners

The following are suggestions for owners:

• If the projects organization does not currently control contracting decisions, the first task is to gain that control. The projects organization should lead the contracting process from contract strategy formation in early FEL‐2 through prequalification to actual selection of contractors in late FEL‐2 and FEL‐3. Contracting strategy is an integral part of project management. It is not a purchasing process, and it is not a transaction. Smart contracting decisions depend on deep project management understanding and expertise. No other organization within any owner has the depth of expertise needed. This does not mean that other functions do not have important roles; they definitely do. It means that decision control must be with the projects organization.
• Some owners try to make every project and every situation fit a single contracting strategy. Others go with whatever strategy strikes the project team as best and end up completely eclectic and scattered. Neither approach is sensible. Select a few contracting strategies that fit with the business drivers for most (not all) of your projects.
  • If predictability in schedule and cost have real business value for the company, consider GMP plus one cost‐driven strategy, such as Re/LS and another such as incentivized Re/Re for schedule‐driven projects.
  • If your businesses produce commodities, then capital cost effectiveness is normally the most important attribute of the project system. Consider design competitions for large projects and Re/LS for others. Look to develop repeat supply chains wherever it appears feasible. If the market is low, consider EPC‐LS, but do not make it your staple because markets do not stay down forever.
  • If your businesses produce high margin specialties, consider Re/Re and learn how to use the construction contracting market well. If unit rates are widely available, that is a good Re/Re alternative. If you need speed, learn how to incentivize the engineering firm, but keep it simple.
  • If your businesses are required to commit to projects during FEL‐2, which is common for industrial gases companies, pipelines, and renewables projects subject to reverse auction bidding, consider partnering alliance FEED and engineering contractors. It is probably best not to include construction and construction management services in such partnering alliances because of the local nature of construction activities.
• Don't be cheap. Contractor fees are a miniscule element of total capital cost. Yet many owners seem far more concerned that a contractor is making too much fee than in generating a strong project result. When owners try to squeeze contractor fees, the contractor must look for other ways to make a profit. (Remember, contractors have shareholders too!) Non‐fee approaches to making profits harm owners, so don't make it necessary.
• When a contractor performs well, honor the implicit bargain that is essential to a healthy relationship: ensure that contractor is advantaged in getting the next similar project. Nurture relationships with those contractors. Make other contractors envious of that relationship.

Suggestions for Contractors

The following are suggestions for contractors:

• Push back forthrightly on risks you cannot manage or cannot carry. Nobody wants to snatch defeat from the jaws of victory during negotiation of terms and conditions, but sometimes that has to be risked. Many of those negotiating on the owner side do not understand that pushing a risk the owner controls onto the contractor actually costs the owner money. It creates losses for contractors too, but that is unlikely to change minds. Try to force clarity in risk assignment.
• When promoting your services for a job, be careful about your choice of words. I am not suggesting that you should advertise your weaknesses, but sometimes contractor promises about what they can do sound like repealing the law of gravity. I was recently involved in a situation in which the contractor had described the owner's manifestly shoddy work on the front end as “FEED quality.” It wasn't pig feed quality. But those words eviscerated the contractor's defense when the results of the owner's poor work resulted in a terrible project and the resulting lawsuit.
• If you find an owner who honors the implicit bargain of more work for good work, you need to honor it as well. Owners who behave in that way should become customers for life.