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The Art (and Risks) of Managing Owner-Furnished Equipment – Part One

Editor’s Note:  This is Part One of a three-part series focusing on the management of Owner-Furnished Equipment.  Once posted, Part Two can be found here, while Part Three can be found here.

Risk Avoidance by Vessel Owners and Shipyards

The provision of owner-furnished equipment (“OFE”) and owner-furnished information (“OFI”) after a ship construction or conversion contract has been signed introduces multiple risks into the contractual relationship between the vessel owner and the shipyard that has to use that OFI and/or install the OFE. If any of these risks transition from the ‘possible’ to the ‘actual’, the cost and schedule impacts can quickly escalate to disproportionate magnitudes.

Understanding this, there should be a tendency to a general reduction in the use of OFE and OFI, giving the shipyard the responsibility to obtain all that equipment and information and therefore bear the associated risks. However, vessel owner’s staffs recognize that shipyards rarely understand the particulars of the specialized equipment that is being integrated into ships with increasing frequency. Accordingly, owners sometimes cannot afford the risk of allowing shipyards to acquire such specialized equipment since the shipyard will be looking for low cost. Thus, the shipyard-selected equipment may not necessarily incorporate all the features and characteristics that owners look for when acquiring such equipment. Therefore, the use of OFE and OFI will continue.

In view of that fact—the continuing use of OFE and OFI—it appears desirable to identify the causes of problems that have arisen so that the owner’s participants in the OFE/OFI acquisition process can better understand these potential risks to avoid their onset. This also educates shipyard personnel in the identification of the early signs of OFE/OFI-related problems, thereby allowing them to prod their client owners to attend to the matters in order to avoid development of the risks, or at least to limit the cost and/or schedule impacts on the ship construction or conversion project.

Based on Fisher Maritime’s extensive experience (43 years) of assisting project management teams cope with the problems arising from mis-managed or un-managed OFE and OFI acquisitions, this article lists and describes the major aspects from which OFE/OFI problems tend to arise. With this information in mind, both the owner’s and the shipyard’s participants in projects involving OFE/OFI will be more likely to work from the outset to avoid such problems, or at least to identify the problems as they begin to emerge, rather than fail to understand the origin of such problems until the impacts have already become unmanageable or unacceptable.

The Motivation Behind the Use of OFE/OFI

Some owner’s are motivated to acquire the equipment because it necessitates a long lead-time for acquisition; the purchasing process for the equipment has to commence earlier than the awarding of a contract to a shipyard to install the equipment. This appears to be a reasonable basis for the use of OFE/OFI. Another equally valid reason is the specialized nature of the equipment, necessitating considerable dialogue between vendor and purchaser (the future user of it) to ensure that the precisely-needed product is acquired, instead of a less-costly, not-quite-adequate substitute selected by the shipyard. Some owners, however, are motivated by cost considerations and fantasies of savings; they think they can avoid the shipyard’s mark-up of eight-to-20 percent by providing the equipment to the shipyard. If cost considerations are the primary basis for the owner’s decision to acquire the equipment, this is realized to be faulty reasoning when the components of the shipyard’s mark-up are considered.

When an item of equipment comes to the shipyard, the shipyard has to receive it, warehouse it, track it, and possibly maintain it until installation. The costs of these services are part of the mark-up; but if the owner buys the equipment instead, the shipyard includes these costs elsewhere in the contract price because those costs will be incurred regardless of which party actually purchases the item. Later, the item of equipment has to be transported from warehouse to the ship, which transportation costs are routinely covered as part of the mark-up; but if the owner purchases the item, the shipyard will include that transportation cost elsewhere in the contract price. Once the item of equipment comes into the shipyard, the shipyard is responsible for its care and well-being until the ship sails away with the equipment installed.

The shipyard has insurance to cover repair or replacement costs of damaged equipment; and the shipyard has to maintain that coverage for all equipment coming through the shipyard regardless of whether it was purchased by the owner or the shipyard. Accordingly, the portion of the markup that contributes to the cost of the insurance policy is included in the contract price when there is OFE instead. A shipyard always gives a warranty on its workmanship for installation of the items of equipment; so the shipyard needs a contribution to its warranty reserve fund regardless of whether the equipment was purchased by owner or shipyard. Accordingly, that portion of the mark-up is also included in the contract price where there is OFE.

The shipyard does not need the part of its normal mark-up to help cover the costs of its purchasing department, since the purchasing of OFE is accomplished by the owner, not the shipyard. So, while the owner will save only this last portion of the shipyard’s normal mark-up, the acquisition of OFE places a burden on the owner’s purchasing staff which not only causes the owner to incur greater costs, but also – and this is very important – transfers to the owner all of the purchasing, content, form and integration risks that would otherwise have been the responsibility of the shipyard. These risks are discussed below.

However, having assisted many project management teams to cope with the results of improperly managed OFE acquisitions, Fisher Maritime has concluded that the almost inevitable development of these risks always outweighs the cost savings. That is, the owner’s cost considerations (not having to pay the shipyard’s mark-up) should never be the basis for introducing OFE into a project, since such savings are not actually realized.

Purchasing Risks

Regardless of which party purchases the item of equipment, risks start developing at the commencement of the purchasing process. If the owner is providing the equipment as OFE, the management of the risks becomes the duty of the owner, and the consequences of any problems are the responsibility of the owner. Thus, understanding the possible origin of these risks will assist the owner’s project team in the management of the process which is necessary to minimize, if not eradicate, the possible development of problems originating with purchasing risks.

The first component of the purchasing risks is ensuring that the requested item is actually purchased. The owner’s purchasing department sends out a request for quotation (“RFQ”). The vendor’s responding quotation is supposed to be consistent with the RFQ’s attached (requested) technical specifications and with the owner’s terms and conditions (“T&Cs”), also attached to the RFQ. However, many vendors do not provide the exact form of response that has been sought. Instead a vendor may offer one of its standard models, which is close to, but not exactly in conformance with, the requested technical specifications. Unless the owner’s purchasing department asks the project team to compare the vendor’s offered technical specifications to the owner’s requested ones, the owner’s purchasing department may end up acquiring something different from what was expected by the project team.

The second component of purchasing risks is timing. The owner’s project team may recognize that the OFE has to be delivered to the installing shipyard by a certain date, but the owner’s purchasing department may not have given this acquisition process sufficient priority. The result is that the purchasing department starts the process later than is compatible with the project schedule. It may be that the owner’s purchasing department kept shopping around to get lower prices or extended negotiations to get better pricing, which delay in actually issuing the purchase order (“P.O.”) resulted in late delivery of the OFE to the shipyard.

The third component of purchasing risks is the “battle of the forms” which focuses on payment terms and warranty issues, among other matters. The RFQ anticipated that the item of equipment would be purchased in accordance with the owner’s T&Cs that address, among other factors, the timing of payment as well as the commencement and duration of the warranty. However, the vendor’s response to the RFQ may not have been merely a quotation, but instead was an offer-to-sell in accordance with the vendor’s T&Cs. The likely differences are timing of payment (vendor wants it sooner) and warranty (commencement and duration are different from that sought by owner). Also, the vendor’s T&Cs may state that no warranty is given if prompt payment is not received.

When the owner issues the P.O. at a later date, it is thought to be issued in accordance with the owner’s T&Cs, thus appearing to re-establish control of the payment and warranty terms per the owner’s ideas of what is needed. However, the vendor may not be content to accept those limitations. The vendor ships the equipment to the owner or shipyard, and has the recipient execute a delivery receipt, which states that the delivery is accepted in accordance with the vendor’s T&Cs attached to the delivery receipt. Thus, if this battle of forms has occurred, it remains unclear whether the owner’s or vendor’s T&Cs will control the payment and warranty issues. Accordingly, the owner’s project management team and purchasing department have to jointly monitor the potential development of these purchasing risks involving technical content, delivery timing, warranty (commencement and duration) and payment timing.