In Procurement Management, the basic knowledge and skills of a project manager should include being able to help create, read and manage contracts.
AN OVERVIEW OF PROCUREMENT MANAGEMENT PROCESS
A formal process to obtain goods and services is known as Procurement. Procurement Management Plan, Procurement Statement of Work (SOW), procurement documents, change requests, additional procurement documentation and lessons learned are the outputs of a Procurement Management Process.
Procurement department is the most common name for the department that handles and controls procurements. In some companies, these departments are also called contracting, purchasing or legal departments. A few skills required for managing procurements include possessing legal knowledge, negotiation skills and understanding procurement process.
In case of a project requiring to buy goods or services, the procurement department comes into action. A project manager is expected to understand what procurement experts will need from them, provide the experts with that information, and then work with the procurement department throughout the life of the procurements.
Post the decision of procuring goods or services, the procurement manager:
Facilitate to create a Procurement Management Plan
Create Procurement Statement of Work (SOW)
Determine type of contract
Determine procurement document: Request for Proposal (RFP), Invitation for Bid (IFB), Request for Quotation (RFQ)
Send the documents to the seller
Seller Reviews the documents, seeks additional information (if needed), sends required documents
Negotiations take place with the seller and contract is signed with right seller
Procurement administration is the next step
Monitoring and Control of Procurement administration is done
Procurement closure involves procurement audit and lessons learned
Final Payment is made
BUYERS AND SELLERS
Sellers are also called as contractor, sub-contractor, designer, vendor, etc.
IMPORTANT POINTS RELATED TO PROCUREMENT MANAGEMENT
Contracts cannot be informal. It requires formality.
All project management requirements should be specifically stated in the contract.
A Change Management Procedure is the only way to include any activity in the contract, if that activity is not already in the contract.
Contracts are legally binding, the seller has no choice but to perform as agreed in the contract.
Contracts help mitigate project risks.
Most governments back all contracts that fall within their jurisdiction by providing a court system for dispute resolution.
THE PROJECT MANAGER’S ROLE IN PROCUREMENT
A project manager should be able to read and understand the contracts.
A project manager should ensure that scope of work and project management requirements should be included in the contract.
Identify risks and create appropriate risk response plans for risk mitigation.
Project manager should tailor the contract to the unique needs of the project.
Project manager should be involved during contract negotiations to maintain the relationship with the seller.
Project manager should protect the integrity of the contract.
Project manager should ensure all work such as reporting, inspections and legal deliverables are met. Release of liens and ownership of materials is another critical activity of the project manager.
Project Manager works with the procurement manager to manage changes to the contract.
CENTRALIZED / DECENTRALIZED CONTRACTS
In a centralized contracting environment, there is one procurement department, and a procurement manager handles multiple procurements for different projects.
In a decentralized contracting environment, a procurement manager is assigned to one project full-time and reports directly to the project manager.
PROCUREMENT MANAGEMENT PROCESS
The procurement process is designed to obtain a seller at most reasonable prices. The process involves waiting time for the sellers to look at the needs of the project and to respond. The process can thus, take from one month to three months for this type of procurement.
The project manager needs to be involved in the entire process of procurement management and he also needs to plan for the amount of time procurements take.
The four sequential procurement management processes are:
INPUTS TO PROCUREMENT MANAGEMENT PROCESS
Procurement Manager Assigned; If the amount of procurement is high, a procurement manager needs to be assigned for the process.
The Scope Baseline (WBS, WBS dictionary, project scope statement); it helps in making the project members understand the need of procurement.
Risk Register; an understanding of risks uncovered to date is termed as risk register.
Any procurement already in place for the project; the project manager must manage interface between multiple sellers and multiple procurements on one project.
Identification of resources not available within the performing organization; One of the critical aspects is to determine if services need to be procured. This steps allows us to think about it.
The project schedule; the project schedule helps determine when the procurements are needed.
Initial cost estimates for work to be procured; an initial cost estimate is required for each work that is getting procured to compare between the seller’s prices.
Cost baseline for the project; knowing the cost baseline helps to make sure the procurement fits within baseline costs.
The buyer has needs and he has criteria using which he will select a seller. The plan procurements process involves creating procurement documents which describes these details. Additionally, this process also explains the procurement management plan. The Plan Procurements process includes:
Perform make-or-buy analysis
Create procurement management process
Create a procurement statement of work for each procurement
Select a contract type for each procurement
Create the procurement documents
Determine the source selection criteria
MAKE OR BUY ANALYSIS
The organization has several constraints including one constraint, cost. The organization needs to decide about whether to do project work themselves or procure services for some or all the work.
One of the main reasons to buy is to decrease the project constraints. However, organizations should make if:
The organization has an idle plant or workforce
Work involves proprietary information or procedures
The organization wants to retain control
PROCUREMENT MANAGEMENT PLAN
This process involves the planning, execution and controlling of Procurement Management. It is done after the organization has made a decision to procure the services or products from outside sources.
PROCUREMENT STATEMENT OF WORK
The work to be done on each procurement is called “procurement statement of work”. The procurement statement of work must be clear, complete and as concise as possible. It should also describe all work and activities the seller is required to complete. The activities also include meetings, reports and communications.
TYPES OF PROCUREMENT STATEMENTS OF WORK
Procurement; this conveys what the final product should be able to accomplish.
Functional; this conveys the end purpose or the results than the specific procedures or approach
Design; this type conveys precisely what work is to be done.
Design procurements statement of work is most commonly used in construction and equipment purchasing. Performance and functional procurements statement of work is used in areas that have never been done before such as Information systems, information technology, research and development, etc.
The project manager selects the type of contract basis the purchase of a product or a service, the completeness of the statement of work, the level of effort and expertise the buyer can devote to the seller, whether incentives are involved for the seller, the enterprise environmental factors, etc.
The three broad categories of contracts are:
Fixed price (FP)
Time and Material (T&M)
Cost Reimbursable (CR)
FIXED PRICE (FP, or LUMP SUM, or FIRM FIXED PRICE)
The acquiring of goods or services with well-defined specifications or requirements and when there is enough competition to determine a fair and reasonable fixed price, these are the situations where a fixed price contract is used. These are the most common types of contracts. The seller bears additional costs if the costs are more than agreed upon costs. The buyer has the least cost risk in this type of contract. The seller is duly concerned with the specifications provided in the procurement Statement of Work (SOW).
A fixed price contract is inappropriate when either of the parties (buyer or the seller) do not have expertise or past experience to prepare the procurement statement of work or have detailed accounting records.
There are situations where companies are not having a complete know-how of the tasks to be done and even when the scope is incomplete, they ask the sellers to provide a fixed price. This leads to:
Forcing the seller to accept high level of risk.
Seller needs to add huge amount of reserves to cover their risks and the buyer then pays more than otherwise required.
Smart sellers can easily increase profits by cutting the scope of work and claim that work the buyer wants requires change as it is outside the contract.
In case if the seller realizes that he is not making any profits there is a risk that the seller might try to remove some work that is described in the contract, take actions to save money, decrease quality, take the best people out of the project, among others.
FIXED PRICE INCENTIVE FEE (FPIF)
In an FPIF contract, profits are adjusted based on the seller meeting performance criteria in a progressive manner such as completing the work in a cheaper way, faster and better. FPIF contract involves successive targets given to the sellers, in which the target for the incentive is changed after the first target is reached.
FIXED PRICE AWARD FEE (FPAF)
In a FPAF contract, the buyer pays a fixed price plus an award amount (a bonus) based on performance. This is very similar to an FPIF contract, except the total possible award amount is determined in advance and apportioned out based on performance.
FIXED PRICE ECONOMIC PRICE ADJUSTMENT (FPEPA)
If there are uncertainties about future economic conditions (future prices) for contracts that exist for a multi-year period, a buyer might choose a fixed price contract with economic price adjustments. Future costs of supplies and equipment that the seller might be required to provide under contract might not be predictable.
The simplest type of fixed price contract is a purchase order. This type of contract is signed by one party instead of two parties i.e. it is unilateral instead of bilateral.
TIME AND MATERIAL (T&M) OR UNIT PRICE
In this type of contracts, the buyer pays on a per-hour basis or per-item basis. Time and material contracts are frequently used for service efforts in which the level of effort cannot be determined when the contract is awarded.
COST REIMBURSABLE (CR)
A cost reimbursable contract is used when the exact scope of work is uncertain and, therefore, costs cannot be estimated accurately enough to effectively use a fixed price contract. This type of contract provides for the buyer to pay the seller allowable incurred costs to the extent prescribed in the contract. Following are common forms of cost reimbursable contracts:
A cost contract is the one in which the seller receives no fee (profit).
COST PLUS FEE (CPF) OR COST PLUS PERCENTAGE OF COST (CPPC)
A CPF or CPPF contract requires the buyer to pay for all costs plus a percentage of costs for a fee.
COST PLUS FIXED FEE (CPFF)
A cost plus fixed fee contract provides for payment to the seller of actual costs plus a negotiated fee that is fixed before the work begins. The fee does not vary with actual costs.
COST PLUS INCENTIVE FEE (CPIF)
A cost plus incentive fee provides for the seller to be paid for actual costs plus a fee that will be adjusted based on whether the specific performance objectives stated in the contract are met. In this type of contract, an original estimate of the total cost is made (the target cost) and a fee for the work is determined (the target fee). The seller then gets a percentage of the savings if the actual costs are less than the target costs or shares the cost overruns with the buyer.
COST PLUS AWARD FEE (CPAF)
In a cost plus award fee contract, the buyer pays all costs and a base fee plus an award amount (a bonus) based on performance. This is similar to CPIF contract, except the incentive is a potential award, rather than a potential award or a penalty. The award amount in CPAF contract is determined in advance and apportioned out depending on performance. This is a type of incentive contract.
Incentives are bonus for the sellers. Incentives are designed to motivate the seller’s efforts towards things that might have not been emphasized otherwise and to discourage seller inefficiencies and waste in the areas in which the incentives are designated.
WHEN ARE PAYMENTS MADE?
Each contract will state when payments are to be made to the seller. Payments may be made as work is completed, as costs are incurred, according to a payment schedule, or only after the successful completion of the contract.
OTHER TERMS TO KNOW
Profits and costs have a distinct difference. Profit is the amount of money the sellers has left after costs are paid. There are some terms that we would like to know:
Price; the amount the seller charges the buyer.
Profit (fee); this is planned into the price the seller provides the buyer.
Cost; A buyer’s cost include a seller’s cost plus profit. For a seller, this is the amount charged to the seller to create, develop or purchase the product/service/raw materials.
Target price; this term is often used to compare the final price with what was expected.
Sharing ratio; incentives are usually expressed as a ratio, e.g. 90/10. This sharing ratio describes how cost savings or cost overruns will be shared between the buyer and the seller.
Ceiling price; the highest price the buyer will pay is the ceiling price.
Point of Total Assumption (PTA); This only refers to fixed price incentive fee contracts and refers to the amount above which the seller bears all the loss of a cost overrun.
PROCUREMENT DOCUMENTS (BID DOCUMENTS)
Once the contract type is selected and the procurement statement of work has been created, the buyer can put together the procurement document, which describes the buyer’s needs to the sellers. The different types of procurement documents include:
Request for proposal (RFP); RFP’s request a detailed proposal on how the work will be accomplished, who will do it, etc.
Invitation for Bid (IFB); IFB usually just requests the total price to do all work.
Request for Quotation (RFQ); RFQ’s request a price quote per item, hour, meter, or other unit of measure.
The objective is to provide the seller a clear picture as much as possible. The procurement documents should include:
Information for sellers: Background information about the purpose of the buyer wanting to get the work done, Procedure for trying to win the work, Guidelines for preparing the response, The formats for responses, Source selection criteria – the criteria the buyer will use to evaluate responses from the sellers and Pricing forms
Procurement statement of work
Proposed terms and conditions of the contract (legal and business)
SOURCE SELECTION CRITERIA
Source selection criteria are included in the procurement documents to give the seller an understanding of the buyer’s needs and to help the seller decide whether to bid or make a proposal on the work. Source selection criteria become a basis for the buyer to use in evaluating bids or proposals.
The source selection criteria include:
Number of years in business
Understanding the need
Price or life cycle cost
Quality of past performance
Ability to complete the work on-time
Project management ability
The following are additional terms, the project manager must be familiar with:
Nondisclosure Agreement; this is an agreement between the buyer and prospective sellers identifying the information or documents they will hold confidential and control, and who in the organization will gain access to the confidential information.
Teaming Agreement (Joint Venture); often two sellers believe that their chance of winning work from a buyer will be enhanced if they join forces for one procurement. In this case, they will sign a teaming agreement with each other to address the legal and business aspects of the arrangement.
Standard Contract; the contract terms and conditions are most commonly created by the buyer, who may even put their terms and conditions into the standard format that is used over and over for similar procurements. These types of standard contracts need no further legal review if used as they are.
Special Provisions (Special Conditions); The project manager must be able to read and understand standard terms and conditions and to determine what needs to be added, changed, or removed from the standard provisions. By doing so, the project manager can make sure the resulting contract addresses the particular needs of the customer.
TERMS AND CONDITIONS
The general categories of the terms and conditions that can make up standard and special provisions are:
Acceptance; description to specifically describe what is acceptable
Agent; the name of authorized representative from each party
Arbitration; this method uses private third parties to render a decision on the dispute. Arbitration is paid for by the parties and is used because it is usually faster and cheaper than the courts.
Assignment; the circumstances under which one party can assign its rights or obligations under the contract to another.
Authority; the names of individuals and their roles during project life cycle
Bonds; these are payments or performance bonds, if any, that must be purchased.
Breach Default; this occurs when obligation of a contract is not met.
Changes; involves incorporation of change management procedure.
Confidentiality; information classification that decides which information is to be given to which parties.
Dispute resolution; the procedure that will be used to settle any disputes, if they occur.
Force majeure; this is a situation that can be considered as act of God, such as fire or freak electrical storm. If a force majeure occurs it is considered to be neither party’s fault.
Incentives; the benefits the seller receives for aligning with buyer’s objectives of time, cost, quality, risks and performance.
Indemnification (liability); identification of individuals liable for personal injury, damage or accidents.
Independent contractor; this indicates the seller is not an employee of the buyer.
Inspection; audit process done during execution of the project.
Intellectual property; patents, trademarks, copyrights, books, etc.
Invoicing; which are the invoices, to whom they are sent and what documents are required.
Liquidated damages; estimated damages for specific defaults mentioned beforehand.
Management requirements; attendance, meetings, approval of staff assigned to the project, etc.
Material breach; this breach is so large that it may not be possible to complete the work under the contract.
Notice; the place or individual to whom the correspondence is to be sent.
Ownership; owner of tangible items (materials, buildings, equipment, etc) used in connection with or developed as a part of the contract.
Payments; schedule of payments to be made, provision of late payment charges, reasons for non-payments, etc.
Procurement statement of work; if it is not a separate document, it is included as a part of the document.
Reporting; the reports, formats, frequency, stakeholders, are listed.
Retainage; the amount of money, usually 5% to 10% withheld from each payment. This money is paid when all the final work is completed. It helps ensure completion.
Risk of loss; this allocates the risk between parties to a contract in the event goods or services are lost or destroyed during the performance of a contract.
Site access; requirements to access the site where work is to be performed.
Termination; stopping the work before it’s completed.
Time is of essence; this indicates deliverables are strictly binding.
Waivers; statements saying that rights under contract may not be waived or modified other than by express agreement of the parties.
Warranties; promises of quality of the goods or services delivered under the contract, usually restricted to a certain time period.
Work for hire; work provided under the contract will be owned by the buyer.
LETTER OF INTENT
A letter of intent is simply a letter without legal binding, which indicates that the buyer intends to hire the seller. It gives the seller the confidence that the contract will be signed soon.
Privity is a contractual relationship.
NONCOMPETITIVE FORMS OF PROCUREMENT
Sometimes, work is awarded to a company without competition. The situations include:
Project manager is under extreme pressure
Seller has unique qualifications
There is only one seller who can provide goods and services
Seller holds patent for the items you need
Other mechanisms exist to ensure seller’s prices are reasonable
Non-competitive procurements may include:
Single Source; a contact is established directly with a preferred seller without going through the procurement process.
Sole Source; in this type of procurement, there is only one source.
Conduct procurements process involves getting the procurement documents to the sellers, answering seller’s queries, having them prepare responses, reviewing the responses to select the seller. To initiate the process, it is important to attract the sellers, it is done using various methods, such as:
An advertisement is placed in newspapers, magazines, internet, etc to attract sellers.
QUALIFIED SELLER LIST
If a buyer purchases the same type of services often, the procurement team should find, investigate, and check the credentials of prospective sellers in advance.
The bidder conference is an opportunity for the buyer to discover anything missing in the procurement documents. A bidder conference can be key to making sure the pricing in the seller’s response matches the work that needs to be completed and is, therefore, the lowest price.
A seller proposal is a response to the RFP (Request For Proposal), RFQ (Request For Quotation) or an IFB (Invitation For Bid).
After receiving the proposal, the buyer uses the source selection criteria identified in the Plan Procurement process to assess the potential seller’s ability and willingness to provide requested products or services.
The seller proposals are usually reviewed, compared, or selected by the evaluation committee using one or a combination of the formal, structured processes.
This allows the buyer’s evaluation committee to select a seller by weighting the source selection criteria according to the evaluation criteria.
The buyer may compare the seller’s proposed cost with an estimated created in-house or with outside assistance.
A screening system eliminates sellers who do not meet the minimum requirements of the source selection criteria.
PAST PERFORMANCE HISTORY
The buyer may consider their past history with the prospective sellers in determining which seller to award the procurement to.
Some sellers may be asked to make presentations of their proposals to the buyer so the buyer can select the most appropriate seller.
The objective of negotiations is to obtain a fair and reasonable price and develop a good relationship with the seller.
Some of the negotiation tactics are:
Attacks; “If your organization cannot provide the right details for the bid, perhaps it should have not sent a response to our RFP!”
Personal insults; “If you cannot perform even after 10 months of being in the organization, you should leave!”
Good guy/bad guy; one person is helpful to the other side, while the other is difficult to deal with.
Deadline; “We need the closure of this task by 4:30 pm today.”
Lying; Lying may be hidden. It may also be obvious.
Limited authority; limited authority statements may or may not be true.
Missing man; act as if the decision maker is not available and the current options are better.
Fair and reasonable; being impartial and practical
Delay; delay the point, discussion or decision to a later date.
Extreme demands; these demands are not appropriate for the given contract.
Withdrawal; lessening of interest shown by emotional or physical withdrawal.
Fait accompli; this is a done deal.
Scope, schedule and price are the main items to negotiate in the contract. Other than these, other items include responsibility, authority, applicable law, project management process, payment schedule, among others.
The contract defines the roles and responsibilities, make things legally binding and mitigate risks. A contract is the entire agreement between both parties. It also includes terms regarding payments, reporting requirements, marketing literature, proposal, and procurement statement of work, among others. Changes to the contract are made formally in writing.
For a legal contract, we should have an offer, acceptance of that offer, consideration, legal capacity and legal purpose.
Managing the relationship between the buyer and the seller and assuring both parties perform as required by the contract is termed as Administer procurements.
The specific actions involved while Administering Procurements are reviewing invoices, completing integrated change control, documenting every record, managing changes, authorizing payments to the seller, interpreting what is and what is not in the contract, resolving disputes, procurement performance reviews, performance reports, monitor cost, schedule and technical performance against the contract, understanding the legal implications of the contract, controlling quality, among others.
In the event of a conflict, the procurement manager or a contract administrator is the one with authority to change the contract. The project manager may initiate the change by requesting one, however, it needs the approval for the procurement manager.
CONTRACT CHANGE CONTROL SYSTEM
The system includes change procedures, forms, dispute resolution processes, and tracking systems as specified in the contract.
PROCUREMENT PERFORMANCE REVIEWS
During the Administer Procurements process, the buyer’s project manager analyzes all available data to verify that the seller is performing as they should.
A claim is an assertion that the buyer did something that has hurt the seller and the seller is asking for compensation. The best way to settle them is through negotiation or through the use of the dispute resolution process.
RECORDS MANAGEMENT SYSTEM
Record-keep is of critical importance if actions taken or situations that occurred during the procurement are ever in question after the work is completed. A record management system can be quite extensive and can include indexing systems, archiving systems, and information retrieval systems.
Contract interpretation is important and may require a lawyer’s assistance to understand it and interpret it appropriately.
Termination can be done for cause or convenience. The contract should have provisions for terminations.
Procurements are closed when a contract is completed OR when a contract is terminated before the work is completed. The Close Procurements is a part of Closing Process Group. All procurements must be closed out, no matter the circumstances under which they stop, are terminated, or are completed.
Work that must be performed during Close Procurement phase:
Product verification; involves checking to see if all the work is done correctly and satisfactorily.
Negotiated settlement; final settlement of all claims, invoices and other issues.
Financial closure; involves making final payments and completing cost records.
Procurement audit; structured review of only the procurements process.
Updates to records; making sure all of the records of the project are complete and are accessible in the records management system.
Final contract performance reporting; this is creating a final report.
Lessons learned; lessons learned from everyone including the seller are documented for the project.
Procurement file; the file includes contract, changes, submittals from the seller, financial information, inspection results, lessons learnt.
FORMAL ACCEPTANCE AND CLOSURE
Once closure is completed and the seller has received formal sign-off that the products of the procurement are acceptable from the buyer, the procurement is closed.