Achieving synergy through Cost Management

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Achieving synergy through

Cost Management

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Achieving synergy through

Cost Management

Master Thesis

Author Remco Bouma

Student number 1418505

Publication date October 9, 2006

Pages 74

Company Nederlandse Aardolie Maatschappij B.V.

mentor R.W. Spelten

University University of Groningen

faculty Management & Organization

study Technology Management (MSc)

first mentor dr. W. Westerman

second mentor dr. J.H.M. van Kesteren

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Executive Summary

Nederlandse Aardolie Maatschappij (NAM) B.V., founded 1947, is a Shell operated joint venture between Shell and ExxonMobil. Since October 2003 NAM became part of the Shell Exploration and Production organisation in Europe (‘EP Europe’), like the other seven participating companies maintaining its status as a separate legal entity. This research focuses on the execution of cost management in one single Integrated Services Contract in EP Europe.

Nowadays business environment is characterised by a strong focus on operational and cost excellence. Global integration and competition have led to the development of strategies aiming at world-class performance through continuous improvement and tight control. For Nederlandse Aardolie Maatschappij (NAM) B.V. as part of Shell Exploration and Production, this focus is recognised in at least half of the business priorities:

• Effective project delivery • _{Operational excellence} • _{Competitive cost structure}

Effective and efficient project delivery is typified by quality work to be delivered in time, at expected costs. The ability to control and monitor costs in the maintenance area in a selected ISC is perceived as being sub optimal as budget overruns occur frequently while missing the ability to timely intervene. After delivery of an estimate, there is little insight in deviations between expected and actual costs, be it due to scope changes, inefficiencies or other unexpected factors. This document describes empirical research into cost management to enhance transparency and suggest improvements towards a higher level of cost control as detailed in the charter in appendix 1. The approach to this complex field with multiple stakeholders on different locations working for two companies is supported through documentation, interviews and hands-on access. Analysis of processes, systems and structures is based on a functional view on the underlying systems to focus on measurable data rather than personal interpretations of defined workflows. The first step in the empirical approach is to build a generic cost management framework based upon contractual and workflow related documentation.

Hands-on access and thirty interviews conducted from several locations serve as major input to enrich this framework to address and support potential weaknesses. Numerical analyses are introduced to test potential weaknesses to build towards complete understanding of the activities subject to improvement. The dynamic framework that is set up in Microsoft Excel is included on the supporting CDROM.

The main findings on the defined levels of analysis are covered by: • Processes

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o Scope changes and an insufficient level of detailed level 3 estimates on the initial SLA causes job cancelling due to fixed budget levels introduces problems, inefficiencies and waste in several dependent processes. Only 30% of the 2006 SLA is based on level 3 estimates in June 2006 incorporating a 42% increase in value when estimates were changed from level 1 to level 3.

• Systems

o Several local administration tools and interfaces decrease efficiency and give reason for concern relating to accuracy, maintainability and potential local data optimisation.

o SAP is not in use for local project control but as invoicing system, caused by lacking customer needs identification and a missing link between P3e and SAP. o The physical progress input is weak and not fully embedded in the processes to

timely reflect accurate data in the systems necessary for hands-on control. • _Structures

o The data structures applied in estimates, SAP and P3e do not match missing transparency and the ability to feed back knowledge to several systems and processes to sustainable improve the business’ performance.

A set of three major improvements is suggested to enhance transparency and controllability:

o Stabilise the running SLA

In the initial 2006 SLA, roughly 30% of the jobs relate to 80% of the SLA value. By freezing the scope for these jobs whilst requiring a level 3 estimate to be available from the start of the year, effort and attention can be spent towards effectively monitoring and controlling these jobs whilst leaving a flexible budget for smaller jobs that require less detailed preparation.

o Link SAP and P3e

When linking planned and actual expenditures, the need for several local administration systems and interfaces will disappear reducing waste and enhancing insight and control. After successful implementation of the link between these systems, careful attention to users’ information needs and inputs (e.g. offshore progress) is required to work towards a single-point project control and information system.

o Separate controllable and non-controllable elements and ensure quality input

Figure 1- In/Out decisions ( SLA - 2006)

IN/OUT Jobs 2006 -6000 -4000 -2000 0 2000 4000 6000

JAN FEB MRT APR MAY

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The introduction of non-controllable elements on job level via the estimating process sets unachievable goals upfront while missing transparency throughout the cost data in the several processes. On job level, SAP should only contain the items (material budgets and planned man hours) that can actually be controlled locally to encourage efficiency improvements leading to positive scorecard results.

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Key Words

Cost Management, Project Management, Integrated Services Contracts

Preface

In March 2006, I started working on my master’s thesis in the Contract & Costs/Planning department at the Nederlandse Aardolie Maatschappij (NAM) in Assen. Getting to know a massive organisation to finally identify with the organisation charts and business functions was found to be the first of many challenging aspects on the road towards this final thesis.

The subject of cost management proved to be an interesting and complex area involving multidisciplinary influences from technical, financial, cultural and behavioural sides on different organisational levels. The application of a rigid research setup was one of the valuable main cornerstones adapted from writing my preliminary thesis in Information Technology to start a manageable and sustainable research project.

Writing a thesis is a long and occasionally tedious process. The ultimate goal of delivering a theoretically supported though practically applicable result requires setting clear guidelines and milestones. A well-known paradox is perceived when gaining increased knowledge about a complex subject: the deeper the knowledge about the subject itself, the more difficult it is to go back several steps to bring out the picture to a general audience as in a thesis. During investigation and writing, several feedback sessions helped me to reflect findings and concepts to be able to drive towards a contented result.

While accepting the fact of undoubtedly being incomplete, many thanks go to Walter Spelten, Peter Toelen, Bryan Ridd and Alison Bower in no particular order for their positive critical and largely constructive comments and feedback during all phases. The positive climate and willingness to participate and bring up issues by all stakeholders encountered in my investigation was a strong driver towards the final outcome of this project. Furthermore, the encouraging support, even outside office hours, given by my girlfriend Carolien definitely had a positive influence on the process towards this deliverable. Critical thinking about the problem itself and its approach were highly encouraged and supported by the representatives of the University of Groningen, Wim Westerman and Jos van Kesteren.

The academic and continuously challenging environment with a strong support for own initiatives turned out to be a perfect fit to dig deep and deliver useful insights and improvement suggestions. I am grateful for the opportunity to gain this much knowledge about the oil and gas world and NAM and Shell Exploration & Production in Europe in particular as in the last six months.

Groningen, October 2006

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Abbreviations

AA Activity Allowance

ACWP Actual Cost of Work Performed

AFE Approval For Expenditures

BCWP Budgeted Cost of Work Performed

BCWS Budgeted Cost of Work Scheduled

BOE Barrel of Oil Equivalent

CAPEX Capital Expenditure

CTCE Contractor’s Target Cost Estimate E&M Engineering & Maintenance

EP Shell Exploration and Production

EP Europe Shell Exploration and Production in Europe

DTL Delivery Team Leader

HSE Health, Safety and Environment

ISC Integrated Services Contract

IST Invoice Support Tool

LE Latest Estimate

MIP Minor Investment Proposal

OPEX Operational Expenditure

PCC Project Cost Controller

PIR Problem Improvement Report

PLC Public Limited Company

SLA Service Level Agreement

TL Team Leader

TQM Total Quality Management

VOWD Value of Work Done

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syn·er·gy (s n r-j )

1

n. pl. syn·er·gies

1. The interaction of two or more agents or forces so that their combined effect is greater than the sum of their individual effects.

2. Cooperative interaction among groups, especially among the acquired subsidiaries or merged parts of a corporation, that creates an enhanced combined effect.

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1 Introduction

This section introduces the global Shell organisation and narrows down to the level of execution and management of maintenance activities carried out in NAM within Shell’s Exploration & Production division in Europe where the project to be dealt with focuses at.

1.1 Shell worldwide

A company employing approximately 119,000 people in more than 140 countries needs little introduction. Whilst starting in the early 20th_{century, Shell has been well known for its activities} leading to world-class standards on environmental, educational and social levels for over 100 years. Royal Dutch Shell PLC´s2_{global activities as in figure 2 nowadays consist of gas and oil} exploration and production, the delivery and trading of chemicals and the production of green power by Shell Hydrogen and Shell Solar.

Figure 2 – Shell’s global activities

At the time of writing, the Shell group is divided into four major product divisions that are supported by company-wide functional groups such as Central HR, Global Finance and IT Support. The product divisions are categorised as upstream divisions on the one side, that are responsible for the exploration and production of raw materials. On the other side, the downstream divisions’ main activities are to transfer these raw materials into marketable products. Figure 3 gives a global overview of these functional divisions and their relative contribution to the company’s income of € 21.6 billion3_{in 2005.}

2_{Further referred to as ´Shell´}

3_{http://www.annualreview.shell.com/(gxtub255joaslk4501r3e4b0)/arsfs/financialhighlights/financialhighlights.html}

Figure 3 – Shell’s value chain

Exploration and Production (53%)

Searches for and recovers oil and gas in 34 countries

Gas and Power (6%)

Liquifies and markets gas, trades electricity

Oil products (37%)

Markets fuels and lubricants

Chemicals (4%)

Produces and sells petrochemicals to industrial customers upstream

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1.2 Exploration and Production

This project focuses on the execution of cost management for maintenance activities carried out in Shell’s Exploration and Production (EP) division. The financial performance of EP, although being biggest contributor to Shell’s total performance only employing 15% of total staff, is heavily influenced by actual oil and gas prices. Multiple variables as global politics, production decisions and new field discoveries have led to price variations as in figure 4 from $34_{in 1948 to} over $75 in 2006 per Barrel of Oil Equivalent (BOE). After a rapid price decline around 1998, a strict focus on the core business prorities has been carried out to deliver stable and predictable production levels originating from accuractely defined reserve bases.

The business priorities aimed to deliver Shell’s objective of “ensuring that we extract and deliver oil and gas profitably and in environmentally and socially responsible ways5” are stated as6:

• Reserve Replacement Ratio > 100% in 2004-2008

• Production of 3.5 - 3.8 million BOE per day in 2005-2006 • Grow the resource base

• Effective project delivery • Operational excellence • Competitive cost structure

Ranked on the basis of oil and gas reserve holdings, 14 of the top 20 upstream oil and gas companies in the world are national oil companies or newly privatised national oil companies. State monopolies represent the top 10 reserve holders internationally. When comparing reserve levels, ExxonMobil and the Shell Group are ranked 12th_{and 13}th _{respectively, leaving British} Petroleum and Chevron Texaco behind7_{. Shell’s relative size becomes clear when comparing its} current daily production rate of about 3.4 million BOE targeting at 4.5 million BOE in 2014 to the global market size of over 86 million BOE8_.

Shell’s recent financial performance led to a third place ranking in Fortune’s Global 500 in 20069 as reflected in table 1. Despite slightly lower than planned production levels, actual profit numbers show a 36% increase for the second quarter in 200610_{. The} total investments planned for new developments in 2007 are well over an impressive € 17.2 billion.

4_{http://www.wtrg.com/prices.htm, Adjustment for inflation will lead to a price of approximately $ 15 per barrel} 5_{http://www.annualreview.shell.com/(p45itf45ohsd5t55ihao5z55)/arsfs/aboutrdsplc/rdsvision.html} 6_{http://sww.shell.com/home/sbw2005/strategy.html} 7_{http://www.rice.edu/energy/research/nationaloil/} 8_{http://www.est.org.uk/aboutest/news/dailynews/index.cfm?mode=view&articleid=17204988} 9_{http://money.cnn.com/magazines/fortune/global500/2006/full_list/} 10_{http://www.finanznachrichten.de/nachrichten-2006-07/artikel-6766382.asp}

Table 1- Fortune global 500 top 4 (2006)9

# Company Revenues ($ millions)

1 Exxon Mobil 339,938

2 Wal-Mart Stores 315,654

3 Royal Dutch/Shell Group 306,731

4 BP 267,600

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1.2.1 Future directions

Because of capital-intensive investments with payback times of multiple decades for new production facilities, a long-term view is essential when making strategical decisions. The complexity and unpredictability of nowadays’ world is well reflected by the consequences caused by events with global environmental and economical impact such as the collapse of Enron11_and the catastrophe on 9/11. To cope with complexity and uncertainty, Shell’s global strategy is guided by scenarios that describe the possible world towards 2025. In the model in figure 5, three fundamental forces that have major impact on Shell’s business environment are taken into account: market incentives, aspirations to social cohesion (the force of community), and the level of provision of security and the level of regulation by the state12_{. Three scenarios have been} defined based on combinations of different strengths of these components.

Figure 5 – Shell’s global scenarios 12

• _{Low Trust Globalisation: A world of heightened globalisation and more coercive states.} The market itself does not resolve the crisis of trust and security. To cover for this, security is embedded and highly regulated by strong states in a globalised world. This ultimately slows down globalisation and decreases efficiency because of complex compliance, taxes and unpredictable governmental and legal regulation. Short-term portfolio optimisation and vertical integration are typical business elements in this world. • _{Open Doors: A world of heightened globalisation and more cohesive civil societies. The}

solution to the missing level of security and trust is built-in by the market itself, fully supporting seamless cross-border interactions. Certification and values are affirmed to create a value-chain of trust for investors and clients. There are many opportunities for medium and mid-sized (global) companies as well as for virtual conglomerates.

• _{Flags: Values are affirmed and states rallying divided societies around the flag. In a world} incorporating country-related risks, social conflicts and militant global campaigns, social groups tends to connect strongly showing high levels of internal trust. Across the different states or social groups however, a low level of trust is found lacking the win-win situation as in the ‘Open Doors’ scenario. Custom approaches to local situations are desired to create a sustainable business environment.

11_{http://www.chron.com/disp/story.mpl/special/enron/1260807.html}

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1.3 EP Europe

The EP Europe organisation was formed in 2003 incorporating the Nederlandse Aardolie Maatschappij (NAM) B.V. on the Dutch side. NAM was originally established in 1947 as a joint venture between Shell and Esso (now ExxonMobil) after the discovery of the Schoonebeek oil field in 1943. After adding the Groningen field to its portfolio in 1959, almost three quarters of the volume of natural gas in The Netherlands is currently supplied by NAM.

Nowadays, EP Europe is accountable for approximately one third of Shell’s total oil production and about 40% of Shell’s total gas production. Slightly over 4,000 staff are employed in EP Europe from the main locations in Norway, Ireland, the United Kingdom and The Netherlands.

1.4 Engineering & Maintenance in EP Europe

Continuous exploration and research activities are conducted to ensure a stable and predictable production reserve basis. New fields are discovered and older fields might be proven to be economically valuable when applying new techniques for gas or oil extraction. Once the decision to build a production facility has been made, the Technical Directorate (TD) carries out all engineering and construction activities from well plugging to raising the platform and installing the flow lines. After completion, the production facility is handed over to the Production Directorate (PD) responsible for safeguarding production and integrity during its producing lifetime to be finalised by the abandonment of the facility.

The Engineering and Maintenance (E&M) departments in the Production Directorate are responsible to ensure the integrity of the facilities contained in a specific geographical area, or Asset. Integrity is defined as the state where “under specific operation conditions, there is no intolerable risk of failure endangering the safety of personnel, environment or asset value13_”. Table 2 represents the organisational setup of EP Europe, and the E&M departments in specific.

13_{Shell intranet} EP Europe Technical Directorate Production Directorate Corporate Support Commercial Directorate NOV Directorate HR Directorate Asset Leads Logistics Production Services Engineering & Maintenance Discipline Engineering Contracts & Costs /Planning E&M Groningen E&M Land E&M Central E&M Norway / UK X-B E&M ONEgas E&M Mature Maintenance & Inspection

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1.4.1 Integrated Services Contracts in EP Europe In the mid-nineties, the development towards outsourcing all maintenance activities in EP Europe’s predecessor companies was initiated. Maintenance work had been carried out by in-house staff until then. Due to the vast amount of activities for maintenance work with annual expenditures of over € 450M, Integrated Services Contracts (ISC’s) have been set up to cover and manage the execution of all maintenance work in the six European Assets represented by figure 6.

Except for ISC number 3, which involves multiple Assets, each Asset is covered by its own ISC. During the lifetime of the contract, mostly awarded to consortia of main-contractors, all engineering, procurement and maintenance activities are carried out according to the work management and remuneration structures as defined in these contracts. Table 3 gives an overview of the contracts that are in execution for the Assets introduced.

The contract structures differ slightly from each other, where more recent contracts show tighter integration of work processes between Shell and the contracting parties. Comparing the setup of these ISC’s to other global petrochemical companies’ maintenance executing strategies14_labels the contracts mentioned above as quite progressive: the approach to outsource maintenance work while introducing tightly integrated work processes clearly reflects global trends in industry. The general philosophy to outsource maintenance work by for setting up long-term (typically 5 – 10 years) ISC’s aims at learning effects leading to efficiency improvement in:

• Environmental and safety issues • _{Quality and competence issues}

• _{Working methods}

• _Planning

• _{Work processes}

• _{Technology and innovation} • Standards

• Cost, norms, percentages and ratio’s

14_{Outsourcing total plant maintenance in Singapore petrochemical industry: A critical perspective, K.C. Nam, 2005}

Groningen Land ONEgas

(Offshore)

Central Mature Norway/UK

X-Border

Asset

1

ISC 2 3 4

Table 3 - Assets and their respective Integrated Services Contracts 13

5

Figure 7 - Clipper platform

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2 Research set-up

A complex and broad research subject requires a structured approach to deliver a solid framework that further analysis can be built upon. This section starts with an overview of the goals, boundaries and research questions as input to this framework. A further introduction to the management of maintenance activities is given first before introducing the subject of investigation in detail. The latter part introduces the methodology and research phases guiding towards a sound and justified investigation process.

2.1 Managing activities through Integrated Services Contracts

The management and introduction of activities performed under an ISC is generic across the several Assets in EP Europe. These activities are annually agreed between Shell and the contracting party and are covered in an annual Service Level Agreement (SLA). The SLA is generally setup about halfway the running year allowing sufficient time for planning, engineering, procurement and work preparation for the contractor.

2.1.1 Standard maintenance

The SLA covers two major activity classifications: standard maintenance and modifications. Standard maintenance covers the execution of regular maintenance and inspections that are agreed on a target sum that is based on historical data. Due to clear knowledge about the activities to be performed, a fixed payment provides an unambiguous connection and control mechanism to these activities that cover less than half of total maintenance expenditures.

2.1.2 Modifications

Next to standard maintenance and inspection work, improvements and repairs to installations form the foremost part of the SLA portfolio in both expenditures and effort. Because of uncertainty about the appearance of problems or improvement suggestions, high priority work forces changes to the work plans to be made during SLA execution. Due to both financial and workforce related resource constraints, the total value of work executed in a year is to remain stable. To control the amount of work and its total value in the SLA, mechanisms are in place to introduce, skip or change jobs during the year of execution that had already been agreed as explained in figure 8.

Modification jobs in the SLA are funded through either Capex (Capital Expenditure) or Opex (Operational Expenditure) budgets depending on their nature and size. The bigger and generally more expensive Capex jobs aim at upgrading facilities and are managed through separate project teams while Opex jobs are managed by the default engineering and maintenance teams.

Maintenance Yearplan

Figure 8 - ISC acitivity coverage

SLA Contractor Shell

repairs

suggestions screening _selection

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2.1.3 Work management process

Activities covered by the SLA are executed in several phases described by an integrated work management process15_{. The contract setup strives towards tight integration of processes between} both parties to enhance efficiency, control and a seamless workflow throughout both organisations. The work management process that covers the consequential phases in job execution is divided as in figure 9.

• _{Feasibility study}

After the initiation of a job by Shell, a feasibility study is carried out to investigate doability, potential savings, technical implications and improvement levels. Additional risk and value assurance reviews are conducted to assure a broad and sound investigation basis for further investments.

• _{Conceptual / Detailed design}

The decision whether to continue executing the job is based on the information provided by the feasibility study. After final acceptance of the job, it is handed over to the contractor that delivers a conceptual design including a rough cost estimate for the job. Afterwards, the detailed design delivers rigid scope, cost and time information to guide the execution of the work itself.

• _{Construction and Commissioning}

The contractor is fully responsible for the construction and commissioning activities, based on its own engineering and planning documentation delivered in earlier stages. For bigger or high-impact jobs that require (partly) shutdown of installations, work plans have to be aligned with maintenance shutdown plans provided by Shell. After construction and commissioning has finished, the part of the installation is handed back to Shell to be included in the production process again.

2.1.4 Job management

Scope, planning, progress and cost information play a vital and non-interchangeable role for the management of job execution. Perfect job delivery is characterised by top-quality work to be delivered in time, at expected costs. To do so, high quality information has to be available anytime, for anyone involved in controlling the business. High quality information is hereby defined as to be16_:

• Value-added

• Relevant

• Complete

• Timely

• The appropriate amount

15_{ISC Contract}

16_{What data quality means to data consumers, R.Y. Wang; D.M. Strong, 1996}

Initiation Conceptual

design

Detailed design

Construction Commissioning Close out

Figure 9- Work management process 15 Feasibility

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2.2 Problem statement

The ability to estimate costs based on a scope of work in the design phases is quite well versed. During execution of a job, the function of cost management aligned with the work management process is to deliver insight in actual costs and progress to maximise control to finish the project in time, at expected costs. Ultimately, tight hands-on control is required to feed back knowledge to several disciplines to improve the business’ performance.

Unfortunately, the relationship of cost management activities to the several work execution phases is rather fuzzy and poorly defined. There is no auditable trail of changes in estimates during the life of the project, and their cause. A low level of transparency in expected costs leads to late discovery of deviations between actual and expected costs, if ever. The ability to effectively control the execution of work is difficult, causing problems to update budgets, plans, and estimating data. Fixed budgets force maintenance jobs to be postponed or cancelled due to uncontrolled cost increases, potentially endangering platform integrity.

2.2.1 Problem owner

Referring back to table 2, Engineering & Maintenance activities are supervised by the Asset’s E&M leader. In the end, the Asset’s E&M leader is responsible for managing the execution of E&M activities in an Asset and is hereby defined as the problem owner.

2.2.2 Problem statement support: job no. xxxx

A recent internal project17_{has investigated and traced through the available scope, cost} estimates and project control information available at several stages for a specific job that was executed in 2005. Tracing down from the initiation phase until close out, dramatic changes have been found between expected and actual costs.

The most remarkable conclusion is the fact that the changes only became clear during the final phases of execution, underpinning the importance of solid scope and cost management to control and manage a job during execution instead of afterwards. Weak communication, documentation and the inability to freeze phases of the execution of the job were found as major contributors to the massive overspend that occurred. Figure 10 summarises the total estimated value for this job in several phases in the work management process that was initiated to quickly replace a worn suction line due to sand flow.

17_{Flagship Report for job xxxx}

Figure 10 - Summary of investigation of xxxx 17

Initiation 23-09-2004 € 500K Conceptual Design 23-11-2004 € 435K Detailed Design 23-06-2005 € 988K Detailed Design 20-07-2005 € 621K Construction 01-02-2006 € 1000K

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2.3 Problem approach

Because of the complexity and breadth of the problem area, a fundamental and challenging aspect is to find or create a structured and theoretically supported problem approach. Jackson18 provides a classification of research methods with regard to two dimensions:

First, the objective – subjective dimension relates to the way the underlying system should be interpreted. The objective view adheres to the application of scientific methods that can be applied equally well to both the natural and social universe19_{. On the other hand, the subjective} view aims at understanding systems by interpreting different subjective experiences so to incorporate different visions and viewpoints to the same system.

The second dimension, conflict - order, relates to the way the social world is organised. The conflict approach recognises change, conflict and disintegration as exists in complex human relationships. Regulating approaches assume stable systems based on functional co-ordination and order that can be described by organisational schemes and process maps.

Relating these approaches to the problem to analyse, an objective view is most appropriate for analysing and improving clearly definable workflows without any room for personal interpretation. Further, the assumption of functional co-ordination to exist as workflows and systems are the main components in the investigated area leads to the functionalist approach area as to apply best. Consequently, this approach ignores behavioural and cultural differences.

2.3.1 Functionalist approaches

Two further system approaches are available within the area of functionalist approaches, referred to as hard or soft systems approaches. Differences amongst these two refer to the dynamics (variety in the state and changes in relations) and the variance (number and diversity of elements and relations) of the subject of examination.

18_{Systems Approaches to Management, M. C. Jackson, 2000, 1}st_ed.

19_{Modeling Frameworks: The Essential Link Between Methods and Methodologies, P.M. Steele, 1999}

Post modern Emancipatory

Interpretive Functionalist The sociology of radical change (conflict)

The sociology of regulation (order)

Figure 11 – Functionalist approaches 19

D y n a m i c s Variance

Complex system Very complex system

Simple system Complicated system

Table 4 – System approach classifications 18

Soft Systems approach

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Due to the assumed stable but complicated structure of the system to analyse, the hard systems approach suits the specific situation best. Checkland and Holwell20 confirm this choice by relating the following properties to situations in which to apply the hard systems approach:

• Complicated problems

• Well definable problems • Technical systems

• Looking for the best solution

2.3.2 Modelling

Modelling is an important tool for capturing and interpreting essential data to get insight in processes. A model forms “an abstraction or simplification of some part of the present or proposed information system” (Avison & Fitzgereland, 1995). Since analysis and improvement of cost management is only possible after modelling the relevant aspects, attention is required to the selection of modelling tools and techniques.

Methods available to apply within the hard systems approach are21:

• _{Operations Research}

Refers to “the application of the methods of science to complex problems arising in the direction and management of large systems of men, machines, materials and money….” and “The purpose is to help management determine its policy and actions scientifically.”

• _{Systems Engineering}

Is “the science of designing complex systems in their totality to ensure that the component subsystems making up the system are designed, fitted together, checked and operated in the most efficient way.”

• _{Systems Analysis}

Is “the science dealing with analysis of complex, large scale systems and the interactions within those systems – and designing additional ones if those examined are found wanting.”

As this project focuses on the analysis and possible redesign of existing systems and activities and not on managing scarce resources or building new systems from scratch, the systems analysis approach is applied. Systems analysis breaks down complex systems into the three basic concepts of processes, systems and structures so the same structure is adapted for analysis of systems and activities in further sections as reflected in figure 12.

Processes, or decision-based activities, that force information to flow to different systems Systems that contain data for project control Structures of data in systems that is transferable into information for project control purposes

20_{Information, Systems and Information Systems, P.B. Checkland; S.Holwell, 1998, 1}st_ed. 21_{Systems Approaches to Management, M.C. Jackson, 2000, 1}st_ed.

systems processes

structures

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2.4 Problem analysis

Verschuren22_{heavily underlines the significance of defining a general applicable and narrow} problem statement to the problem to approach. Managing, evaluating and motivating research will only be possible after rigidly delimiting the subject and the introduction of both research questions and objectives. A slightly broader framework including these concepts is based on methodologies developed by De Leeuw23_{represented by figure 13. All components in this method} relate to each other forcing decisions about its elements to be made with respect to impact on the others. The project goals and phases in this section are developed through filling in the boxes in De Leeuw’s model based on the defined problem approach assure the delivery of a structured research framework.

• Problem statement: ‘What is to be produced, and for who?’ • Concepts to be used: ‘What theories are to be applied?’

• Observation methods: ‘How will data be extracted from sources?’ • Data sources: ‘From which sources will the data be adapted?’

• Methods for analysis: ‘How will data be analysed and be further turned into knowledge?’

2.4.1 Research Goal

The problem statement reveals weak definition and execution of cost management for maintenance expenditures, resulting in an insufficient level of project control. The low level of auditability and transparency in scope and cost information lead to regular budget overruns and potentially endanger platform integrity. To resolve this, the goal of this project is stated as:

Based on current workflows and activities, the goal of this project is to improve the execution of cost management. After analysis of the current situation, increased transparency and clearing weaknesses will have to ensure the delivery and fulfilment of reliable estimates and deliver insight in every phase of contract execution. The higher level of control will prevent from budget overruns and gain more insight in actual performance to increase both financial and handling efficiencies.

22_{De probleemstelling voor een onderzoek, P.J.M. Verschuren, 1992, 4} th_ed. 23_{Bedrijfskundige Methodologie, A.C.J. de Leeuw, 1996, 5}th_ed.

Problem statement Methods for analysis Observation methods Concepts to be used Data sources

Figure 13 - De Leeuw's research set-up methododology 19

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2.4.2 Research Scope

• Because of time and resource constraints, the analysis and improvement scope is limited to research and improvement in a single Asset in EP Europe. The similarities of the contract structures in EP Europe suggest transferable research approach and findings to other contracts after finishing the project to cross learn and develop “best practice cost management”.

• Efficiency, soundness and effectiveness are aspects continuously underlined24 to ensure a timely and accurate deliverable in line with the objectives. After further introduction and analysis of the field of research, a framework is developed to capture relevant, and only relevant, data from practice.

Asset selection

Selection of the Asset to investigate is based on:

• _{Contract maturity}

As some contracts in EP Europe were only setup recently, process evolution and integration will not have reached equilibrium yet. Analysis of these processes will reflect a snapshot more than a stable, improvable set of activities.

• _{Location of contract control}

Since interviews and tight communication and stakeholder involvement are the fundamentals of this project, easily contactable stakeholders will enable all parties to be tightly and continuously included in research execution.

(removed due to confidentiality)

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2.4.3 Research Questions

To deliver the research goal of this project, the central research question to be answered is:

To answer this question, several sub questions have to be answered first while ensuring to address all components and their relationships introduced in figure 13:

1 What is the structure of the specific Integrated Services Contract?

The structure of the contract stipulates the structure of the work management processes between Shell and the contractor. The ability to monitor and control costs is heavily influenced by these contractual obligations regarding work processes, systems and structures. Literature and contract documentation are the main sources to gain knowledge about the structure of Integrated Services Contracts and the ISC in particular.

2 What activities are executed when managing job execution and what are

the areas of attention for cost management?

Project management consists of a collection of activities that relate to one or more phases in the work management process. Following project and cost management theory adapted from literature, the main aspects in cost management are addressed to analyse in later phases.

3 How will data be extracted from the area of investigation and how will data be analysed?

Sound understanding of all cost management related activities in the complex field with stakeholders in two different companies is required to extract data for analysis. Based on the systems analysis approach defined in this section, a structured methodology is set up to approach the real world systems to address and analyse potential improvements.

4 Following analysis, what are the areas for improvement and how can

these issues be improved?

This concluding phase delivers the final answer to the central research question towards a higher level of cost control. Based on data gathered through analysis of documentation, interviews and hands-on access, potential improvements are addressed and solutions are presented.

Table 5 summarises the four phases introduced:

Phase Research Topic Source wk

1 Integrated Services Contracts, selected ISC

Literature, Shell Intranet, Shell hand books and contract documentation

17

2 Project management and cost management Literature, Shell Intranet, contract documentation 22 3 Methods for data extraction and analysis Literature, flow diagrams, contract documentation 26 4 Analysis of data and improvement

suggestions

Process maps, hand books, interviews, hands-on access

37

Table 5- Project phasing

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2.5 Conclusion

The focus on cost management activities involves a complex area including stakeholders from two companies that are guided by an integrated work management process. The value to Shell of a rigid cost management process is heavily underlined by the business priorities introduced in the first section, as cost management has impact on three out of the six current business priorities:

• Effective project delivery • Operational excellence • Competitive cost structure

The research framework to approach the problem is developed by filling in the boxes in De Leeuw’s methodology to strictly define and delimit the research area and to identify the methods for analysis. The viewpoints that are applied to the real world systems, defined as being a complicated system, are adapted from the systems analysis methodology.

In systems analysis, systems are split up in three basic components to be analysed separately and to construe their reciprocal relationships. This separation in processes, systems and structures is applied to the field of cost management to analyse and improve the current situation. The project goals and research questions guide the phasing and report structure of this project in table 6 towards the final goal, improvement of cost management for maintenance expenditures that are covered by Integrated Services Contracts.

Phase Research Topic Chapters

1 Integrated Services Contracts, selected ISC

3: Integrated Services Contracts 4: Selected Integrated Services Contract 2 Project management and cost management 5: Project Management

3 Methods for data extraction and analysis 6: Cost management analysis set-up 4 Analysis of data and improvement suggestions 7: Cost management analysis: processes

8: Cost management analysis: systems 9: Cost management analysis: structures 10: Summary and recommendations

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3 Integrated Services Contracts

“The problem of organising is seen as one of transforming a conflict system into a cooperative one. A conflict system is one in which individuals have objectives that are not jointly consistent. It organises through exchanges and other interactions between strategic actors. A cooperative system is one in which individuals act rationally in the name of a common objective25.”

Organising the execution of maintenance work is structured through comprehensive service contracts that are developed through conducting many engagement sessions. Since maintenance is essential to the continuity of the firm, much has been done to align the objectives of the two parties, being Shell and the contractor, to move towards cooperation to mutually reap benefits. The potential benefits when reaching the right contractual relationship is clear when capturing cost decreases up to 30% from empirical research26_{. In this section, contract and project} structures are expounded according to the first research phase.

3.1 Project types

The execution of any project structurally carries some degree of uncertainty with it27. The architecture of the contract covering the project’s execution strongly contributes to the ability to manage this uncertainty for either party. Both the knowledge about the product itself and about the process to achieve it contribute to the total level of (un)certainty and lead to a classification of four contract archetypes in figure 15.

• _{Type 1 projects}

Both the goals and methods for achieving the project’s goals are well defined. Engineering projects are typical for this category. Because of both clarities, detailed planning can quickly be started and adhered to during execution.

• _{Type 2 project}

Type 2 projects have clearly defined goals, but the method of achieving them is vague, for instance because of novelty to the producer. Milestones towards the deliverable can be defined, but planning is complicated.

The methods to apply are clearly defined, but the outcome is unclear. Examples can be found in IT projects, where detailed product development cycles and phases are common practice.

Research and change projects are typified by a type 4 classification with both unclear methods and outcomes.

25_{Organization Theory: from Chester Barnard and the Intelligence of Learning, B.Levit; J.G.March, 1995, p.12} 26_{Contract management better practice guide, Australian National Audit Office, 2001}

27_{Lessons in Project Management, T. Mochal; J. Mochal, 2003}

Figure 14 – Project types 27

Type 2 Projects Product Development

Type 4 Projects Research and change

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3.1.1 Remuneration structures

“…the only way to eliminate risk is to do nothing, which is itself more than risky - it is the path to oblivion28_.”

The availability of uncertainty insuperably leads to the existence of risk that deviations will occur between estimated and actual project outcomes as time and costs. Risk is definitely not bad by definition, it is a natural element that parties should be aware of and that has to be properly managed. Mechanisms29_{are available to distribute or completely buy off risk, depending on the} proportion the buyer is willing to accept in the specific transaction. Three fundamental contract architectures to financially distribute risk through contracts are:

• _{Cost-plus (I)}

In a cost-plus contract, the contractor is repaid all expenses, plus an agreed fixed or percentual profit margin. The risk, and so potential benefits, is completely owned by the buyer. Cost-plus contracts are best applicable to type 4 projects, where both the process and the final products contain a level of uncertainty before and during execution.

• _{Remeasurement (II)}

Remeasurement refers to refunding produced quantities based on a schedule of rates, a bill of quantities or a bill of materials. This structure includes a motivating element, since higher productivity leads to higher profits. The total risk is split between both parties, where certainty about the processes to use is necessary to agree on unit rates (typical for type 1 or 3 projects).

• Fixed price (III)

When working on fixed price basis, risk is completely transferred to and managed by the seller. Depending on the risk level and its potential consequences, he will include a premium to the price covering the risk after agreeing on what to produce. The risk relating to the processes to apply is then completely owned by the seller (type 1 or 2 projects). Although benefits arise when agreeing on a beneficial remuneration mechanism, hidden effects might cause contradictory effects to occur. Transaction costs, the costs occurring when executing the contract except those for the product itself, vary between different contract types. These costs typically consist of the costs of:

• _{Specifying the product.}

• Specifying the work (processes).

• _{Managing variations in the product during delivery.} • _{Managing variations in the process during delivery.} • _{Monitoring the costs of work being done.}

Careful consideration of the contract structure to apply is stressed through figure 16 as transaction costs can form the major part of the total costs under contractual exchange.

28_{http://www.smh.com.au/news/Perspectives/Risk-is-good--learn-to-manage-it/2005/04/25/1114281483515.html} 29_{Project contract management and a theory of organization, J.R. Turner, 2001}

% of total costs I II III remuneration structure transaction costs

Figure 15 - Transaction costs versus product costs (stylised)

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3.1.2 Behaviour and output measurement

During execution of any project, information is needed for management accounting and control purposes to control the project’s outcomes. The focus of these accounting and control systems has evolved from being purely financial towards a broader, organisational-wide perspective incorporating complete understanding of the underlying process30_.

A complex environment lacking complete process overview and insight depends on information that is provided and collected through several stakeholders in the process to become the decision-maker’s perceived reality. Behavioural responses to these systems have impact on the quality of this information in place for measurement and control purposes. Stakeholders responsible for feeding and communicating information theoretically have the ability to affect the outputs in a way that reflects their actions in the best possible manner. Examples of dysfunctional behaviours examined in practical research include:

• Smoothing : Delaying or accelerating information through time.

• Biasing : Showing good performance through setting easily achievable targets. • Focusing : Highlighting positive data and degrading negative signs.

• Gaming : Managing the job towards locally favourable measures.

• Filtering : Only sending out the required data lacking problem indicating messages. • Illegal acts : Falsifying data through any optimising act.

3.2 Integrated Services Contracts in EP Europe

Building and maintaining production platforms with a lifetime of many decades involves planning and executing activities on a broad scale. The activities that are executed in consequential phases as geological research, development and production until the final abandonment of the platform are grouped into business processes as in figure 17. The execution of maintenance activities in the production directorate to ensure the platform’s integrity and productivity are contained within the A72 section31_.

The A72 process describes the framework of activities that should be performed to maintain platforms from a high level, without specifying the methods to do so:

• The definition of the maintenance and integrity requirements according to local strategies. • The setup of maintenance plans and the maintenance organisation itself.

• Scheduling, executing and analysing maintenance activities.

The detailed design of the activities to fulfil the activities that are declared in the A72 process is embedded in the ISC’s itself whose setup is managed and supported by the Contract & Costs / Planning division.

30_{The Organizational Context Of Accounting, J.G. Birnberg; L.Turopolec; S.M. Young, 1983} 31_{Opportunity and project management guide, Shell Internal Guide}

Figure 16 - Business processes in Asset Management 31

A11 develop concepts design & construct wells design & construct facilities

produce maintain abandon

wells & facilities

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3.2.1 Trust versus control

Trust, integration and transparency on all levels have gained increased attention during recent contract negotiations to maximise transparency and to align objectives. This focus aims at providing financial and learning benefits for both parties. Although trust and distrust are sometimes viewed as being two ends of a continuum, theoretical frameworks advocate32_{the idea} that right levels of both trust and distrust strongly relate to interorganisational performance and the level of control that should be applied. A certain level of (functional) distrust has been found vital to prevent from group cohesion that precludes from sound decision-making33_{. Trust has} been found important in control structures with a significant level of uncertainty and strong dependencies between parties34

Figure 18 shows three situations with a different distribution of trust and control. In a contractual relationship with full company control, much effort is needed to document and embed a strong level of company supervision. When increasing the level of trust as in Shell’s more recent philosophy, management information supplied by the contractor is the key source to control the contract execution upon that requires less effort to collect and control.

3.3 Conclusion

The organisation and execution of maintenance work is structured through the application of comprehensive Integrated Services Contracts. As any project structurally carries uncertainty with it, the distribution of trust, distrust and risk highly contribute to the ability to measure and control the outputs and to the contract’s effectiveness and efficiency in general.

Project classification relates to uncertainty about the final deliverable and that of the delivering processes. Applying this categorisation to the area of maintenance work suggests a Type 1 Project classification, where high repeatability and detailed product specification are common elements. Consequentially, remeasurement or fixed price contracts form the most logical risk distribution methodology to apply.

Management accounting and control systems depend on information that is transmitted by stakeholders in the processes itself. Since Shell’s contract philosophy strongly adheres to a high level of trust to manage information provided by the contractor, high attention is required to the design and use of measurements to control the project’s execution.

32_{On the Evolution of Trust, Distrust, and Formal Coordination and Control in Interorganizational Relationships: Towards} an Integrative Framework, P.W.L. Vlaar; F.A.J. Van den Bosch; H.W. Volberda, 2006

33_{http://www.beyondintractability.org/essay/distrust}

34_{Management Control of Interfirm Transactional Relationships: The Case of Industrial Renovation and Maintenance, J.} van der Meer-Kooistra; E.G.J. Vosselman, 2000

Level of company control required

Level of contractor initiative

Figure 17 – Control and trust distribution 31

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Figure 18 - ISC cost transparency model

4 Selected Integrated Services Contract

This section finalises the first research phase with the introduction of the contract’s specific remuneration model and return structures that clearly align with Shell’s current philosophy with a strong focus on trust and transparency.

4.1 Philosophy: transparency on all levels

The selected ISC is built around an integrated work management process incorporating high levels of transparency aimed at minimising:

• _{Scope creep}

Uncontrolled changes in the project’s scope that lead to budget overruns are prevented to occur through application of rigid scope control.

• _{Hidden profit}

Through transparency in estimates and invoicing and auditing actual costs spent on man-hours.

• _{Inefficient work}

Through the application of tendered, fixed norms and factors together with efficiency-stimulating mechanisms.

4.2 Remuneration model

Instead of the expected application of fixed price contracts, the focus on trust and transparency have led to the introduction of a combination of cost-plus and fixed elements in the remuneration structure of the contract. Controllable and non-controllable cost elements have been separated in this structure and are refunded based on different remuneration structures.

Direct labour & materials

All costs made for engineering, construction, materials and for personnel directly involved in the execution of work are being repaid to the contractor based on net costs. A target cost estimate for these costs has to be delivered per job before it is executed to be able to control and assess and stimulate efficiency.

Team fee and overhead fee

A fixed payment is annually agreed between parties to cover indirect personnel costs such as management, work preparators and supervisors totalling 180 Full Time Equivalent (FTE) in 2005. Additional, an overhead fee covers other costs for elements as buildings, tools and support. Return

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Extraordinary Return

The introduction of new, efficiency-improving methods and processes is encouraged by the extraordinary return mechanism. After mutually agreeing the amount of savings that has been introduced, a one-time additional payment is done based on a per case agreed proportion of the annual savings.

Figure 20 gives a graphical overview of the remuneration structure applied in the selected contract. In this figure, the cost elements and their respective remuneration structures are outlined as defined in the contract.

4.3 Contractual norms

The target cost estimates that are delivered before the execution of a job is started are calculated based on tendered norms and factors. This allows for consistent, contract compliant costing of projects and benchmarking with other contracts. To drive and cover expected efficiency improvements that occur due to learning effects during contract execution, these norms incorporate downward adjustments during the contract period. Table 7 covers the uplift factors that have been agreed to apply in cost estimates.

Discipline Factor 2003/2004/2005 2006 2007 2008

Engineering In-house engineering norm 100% 96% 94% 92%

Indirect Costs 4% 3% 2.5% 2%

Supervision 10% 9.8% 9.6% 9.4%

As-built & Close-out 10% 9% 8% 7%

Prefab Non productive hours 2% 2% 2% 2%

Construction Plant&Equipment 20% 19% 18% 17%

Supervision 10% 10% 10% 10%

Non productive hours onshore 5% 5% 4.5% 4.5%

Non productive hours offshore 35% 32% 31% 30%

Table 7- Tendered contractual uplift factors

Direct labour Materials

Figure 19 - Remuneration model of the selected ISC

Team/OH fee Return EO Return method scorecard % fixed price

proportion of 1 Year’s savings

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Figure 20 - Domain of business performance 35

4.4 Return mechanism

The annual profit percentage is calculated through the application of a multi-dimensional scorecard. This mechanism is set up to assess and encourage the performance of the business as a whole. Because of the non value-added nature of the measurement process per definition, careful selection of included measures has to prevent the process to become a system itself. To be efficient, the indicators should ideally be directly derived from the service provided35_.

Classification of business performance concepts covers three areas: Financial and operational performance, that build towards the broadest scope of organizational effectiveness.

• _{Financial performance is measured by the}

fulfilment of pure economic indicators by the firm.

• _Business _performance, or operational

performance, includes measures such as quality, value-added and efficiency that might lead to financial performance. The relationship between those financial and operational aspects of performance has to be clearly addressed.

• _{Organisational effectiveness includes multiple} possibly conflicting organisational goals and the fulfilment of goals of all relevant stakeholders. Measurements for this performance area are most difficult to obtain and possibly biased thus less useful when addressing performance for operational purposes.

4.4.1 Scorecard elements

Relating the concepts introduced to the elements that are included in the scorecard mechanism highlights the assessment of both financial and business performance indicators in the selected ISC. When the contractor is able to achieve on-target performance, a return percentage of 5% is awarded that is calculated over the annual SLA turnover. Poor performance on all elements can lead to a negative return of –2.4% where outstanding performance on all elements delivers a profit of 12%. Table 8 gives an overview of the elements included in the scorecard.

Scorecard Element Target cost compliance Close-out success Safety

Customer satisfaction Delivery of SLA targets Maintenance compliance Non-routine compliance Business improvement targets Reliability

Table 8- ISC scorecard elements

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5 Project Management

Cost management is one of the key concepts in the wider field of project management. This section starts with an introduction of project management theory with a strong focus on activities that relate to different project phases in the work management process. The concepts introduced in this section are key input to the development of the framework for analysis and improvement in coming phases.

5.1 Project management functions

The field of project management is divided into five strongly interconnected areas36_{that require} custom approaches and management:

• _Scope

Scope management aims at ensuring that enough, but only enough work is undertaken to deliver the project’s objective successfully.

• _Organisation

The organisation to deliver the objectives should be properly aligned with the objectives, with clearly defined roles and responsibilities.

• Time

Proper planning and monitoring has to ensure timely delivery of the objectives.

• _Cost

Cost management focusing on delivering the project at expected costs.

• _Quality

Quality management and assurance is typically managed through the definition of standards and by applying tools such as quality control and quality assurance.

5.1.1 Bi-project management

Van der Velde and Van Donk37_{introduce bi-project management as the management of two} separate, but strongly dependent processes in industrial construction projects characterised by the interdependence of two actors: the owner of the installation and the contractor responsible for executing the work. In the specific area of investigation where the complex, dependent relationship between Shell and the contractor undoubtedly has a significant impact on project management, some insights and lessons in bi-project management will be kept in mind during further empirical analysis.

First, it is stated that general project management techniques can be applied, but will not be sufficient to effectively control the project as a whole. As uncertainty, change and dependency are common features in these projects, systemised information exchange showing consequences from certain decisions is strongly encouraged.

36_{The handbook of project-based management, J.R. Turner, 1999}

37_{Bi-project management in Engineering Complex Industrial Construction Projects, R.R. van der Velde; D.P. van Donk,} 2000

Figure 21 - Project management focus areas 36

Achieving synergy through Cost Management

Achieving synergy through

Cost Management

Achieving synergy through

Cost Management

Executive Summary

Key Words

Preface

Abbreviations

Table of contents

syn·er·gy (s n r-j )

n. pl. syn·er·gies

1 Introduction

2 Research set-up

3 Integrated Services Contracts

4 Selected Integrated Services Contract

5 Project Management