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EPC gives scope to value engineering and project cost optimisation

EPC gives scope to value engineering and project cost optimisation

The Engineering, Construction and Contracts (ECC) Division of L&T, whose major activity is under EPC, has a claim to be the largest construction and EPC company in the country. L&T ECC was ranked 35th among the world’s top contractors, and handles more than 50 per cent of L&T’s order book, which now stands at Rs 115,400 crore. Two of L&T-IDPL’s National Highway Projects in Gujarat and Tamil Nadu concluded financial closure last quarter and went into the construction order book. Although foreign contracts form only five per cent of the company’s order book, the company concluded major infrastructure contracts of bridges and interchanges in Abu Dhabi, UAE. KV Rangaswami, Whole-time Director and President, in interaction with Pratap V Padode and Shashidhar Nanjundaiah, explains how EPC is a value-adding method in infrastructure.

What are the biggest constraints in the EPC industry? In the light of an ever-increasing order book, how are you gearing up to meet the requirements of scale in equipment, labour, capital and management bandwidth?
The equipment can be bought and capital can be sourced, but the real challenge is human capital. Be it skilled workmen or engineers, there is a shortage and talent acquisition is a big challenge. We have seven skills training institutes across the country through which the raw hands from needy society are trained and put into our projects. We also train our existing subcontractor workmen to enhance their skills, thereby increasing the productivity.

With regards to management bandwidth, we have rigorous leadership development processes in consultation with international consulting firms to groom potential leaders in-house; we also recruit from outside including expats for select positions.

How do you overcome the manpower deficit?
Dearth of skilled manpower is a real challenge facing the industry: Many people do not prefer this industry because of its tough working environment, frequent mobility affecting family life, etc. We are trying to provide better living standards and reasonable job security in order to retain the skilled workforce.

In case of technical expertise, we still depend on international experts to execute complex projects. But the expertise is built back home nowadays.

When you build on an EPC contract, are developers increasingly asking for post-construction responsibility?
A typical EPC contract has a clause called a Defect Liability Period, anywhere between six months and two years, during which period the contractor needs to ensure that the performance project is as per the contract.

The contractor also issues a separate guarantee in the form of a performance bank guarantee to the client. In some cases the developers or owners also assign the responsibility of operations and maintenance (O&M) to the contractors.

Is the extension of an EPC contract to include (a viable) O&M a better guarantee of funding opportunities for a project?
Yes. It would, as the lenders would perceive this as extended warranty (though at a cost) and so the quality of construction will be better.

However if the volumes don’t justify, then it may be difficult to attract large cap EPC players into O&M. On the other hand, the O&M costs for low volumes may also go up if done by major players.

Is the fact that larger projects are still on EPC partly an indication of the financial constraints of our private sector, or perhaps the financeability of the larger projects through private means?
I don’t think EPC model is chosen for reducing the financial burden on the clients. EPC is a preferred mode as it greatly relieves of the pressure on the clients from integration. EPC also gives a lot of scope to “value engineering” and optimisation of overall project costs. EPC lessens the blame game between engineering and construction and helps in speedier completion.

Which do you anticipate as the infrastructure sector in India with the maximum growth in the year to come?
The government continues to have an ambitious target in building roads. Metro rail is the other sector which is seeing a lot of growth with about 12 cities building metro corridors in various phases.

Metro rail projects in India are being developed on both EPC and PPP models. Which has been more effective, and to what would you attribute that effectiveness? Is there scope for a hybrid model?
As a model, PPP has been quite successful in the road sector, and has helped the country roll out many projects in a short period. Mumbai and Hyderabad metro rail projects are being implemented under the PPP mode whereas Delhi, Kolkata, Bangalore and Chennai have largely taken the EPC route. In my view, both the models are effective provided you have right leadership and top-level vision. While Delhi Metro was done in time, Bangalore Metro took a lot of time to finalise the packages. The success of the PPP model does not merely depend on ticket revenue, but a host of other sources of income like real estate, advertisements, and so on. However, it is yet to be tested on the ground. The private parties involved in these projects need to supplement their ticket income with the income from real estate and other sources. Both EPC and PPP projects have been planned around that concept. State governments provide land to the company along the route where tracks are being laid; the company is allowed to develop that land and supplement the income. The companies are interested as they know that in exchange of their investment they can make money out of developing real estate on the land.

L&T has been working very aggressively in the Middle East—exemplified most recently (albeit in consortium) by the Salalah airport in Oman and the Rs 716 crore Abu Dhabi bridge cum road project. Do you see that market as particularly lucrative in a recovering economy?
Slowdown in the Middle East (particularly in Dubai) has happened mainly in real estate. Our PT&D business did pretty well. Infrastructure sector is showing a lot of promising opportunities and we are placed well to tap those. However, the GCC governments have been rather cautious about spending.

Between various sectors in infrastructure which have adequate steam left in terms of margins as per L&T’s definition of worthy projects?
Competition cuts the margin in any business and in infrastructure; of late, all the sectors are highly competitive with the entry of many new contractors. Another margin deterrent factor is breaking-up the packages, though it adds pressure to clients and delays the project completion, some players resort to this route. Margins comparison may not be much meaningful strictly in the above sense, but competition level in the roads sector is severe when compared to metros. Similarly margins in long gestation projects like hydro power depends more on how you manage the project than on competitors. Turnkey
construction of airports offers a slightly better margin.

Which areas need further attention if the construction business has to get a stature of having good standards of corporate governance?
Our construction industry needs to improve the risk assessment and mitigation processes. The sector also needs to ensure ethical practices. Companies need to have proper systems put in place to ensure checks and balances at various project sites. Most often, the construction industry works close to the end consumer, ensuring their safety and focus on enhancing value for end consumer.

The Indian construction industry is not so well-organised and many small players are operating in the domain. Alhough individual companies—leading ones—have good corporate governance in place, the smaller ones needs a lot of improvement. A lot of professionalism needs to come into the construction companies, particularly the middle level companies.

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