Contracting and procurement

Revision as of 10:03, 20 February 2018

Abstract

This article will present a review of the tendering phase and contract management of project procurement management. Decision factors and methods for a company's procurement division when selecting a supplier and negotiating a contract will be presented. Multiple factors should be considered when selecting a supplier and when the supplier has been chosen, a contract must be designed with some main objectives. The company must decide between a pool of sellers, which they seek offers from, or choose to negotiate with a given seller. When negotiating a contract, the main things to consider are to ensure that buyers are able to meet their customers' demand and propose a system where the supplier and the buyer share risks and cost. The article will first introduce briefly the definition of procurement and contracting separately, and then explain the relationship between the two. The article will then be divided into five main parts; defining the problem, defining the buyers' needs, determining the qualification of a supplier, choosing a supplier, and finally the negotiation factors. ^{[1] [2]}.

Contracting and Procurement

Procurement

Procurement is the acquisition of goods, services or works from external sources. The goal of procurement management is to identify a supplier to procure goods and services for a specific company. Suppliers can provide all from raw materials to finished products. Project Procurement Management spans a wide range and is present throughout the whole project process. ^[3].

Contracting

"An agreement between two or more parties, especially one that is written and enforceable by law." Contract management involves creating a contract, negotiating terms and conditions, compliance, execution and analyzation. In Project Procurement Management legal documents, or contracts, are made between the buyer and the seller. It is a document stating that the seller will provide some value in return for compensation from the buyer.^[4].

Contracting in Procurement

Figure 1: Five steps of Contracting in Procurement that will be demonstrated.

All companies have to make a decision to produce in house, or outsource the production. If the benefits for outsourcing exceed the benefits of producing in house, companies must find a supplier that is reliable and maintains a certain standard. Project Procurement Management includes all processes needed to deliver goods or services from outside the project team as well as the development of contracts issued with the supplier. In this article the scope of the buyer will be explored. The five steps that will be explored further in the following article are presented in Figure 1.

Defining the Problem

How much should the company itself produce, what is cheaper and/or justifiable to outsource? The first step is to define whether a problem is present. If companies lack capacity, if production is expensive, if they do not have the people, skills, or knowledge to execute, other solutions should be investigated. One of the options is outsourcing. Outsourcing is when a company requests goods or services from an outside party. Advantages and risks of outsourcing need to be evaluated, and an optimized plan developed for make/buy decisions. Justifications should be presented for outsourcing, and a production plan for in house production. A meaningful procurement strategy should be developed, with the following factors considered: ^[5].^[6].

• products
• services
• technologies
• financial plan
• global presence
• geopolitical and economic risks
• growth plans
• competition
• customer satisfaction
• corporate social responsibility
• regulatory and political environment
• employee growth and satisfaction

All available information about these factors should be gathered through company strategic and operational plans, annual reports and executive management input.

Benefits

The benefits of outsourcing are:^[5].

• Economies of scale
• Risk Pooling
• Reduce capital investment
• Focus on core competency
• Increased flexibility

Risks

The risks of outsourcing are:^[5].

• Loss of Competitive Knowledge
• Conflicting Objectives

When the procurement strategy has been defined and all outsourcing decisions been determined the next step is to define the buyer's need.

Defining the Buyer's Needs

After deciding which goods and/or services to outsource, the amount must be decided as well. After setting up a clear plan for all goods and services needed from the supplier, all possible suppliers should be specified and explored further. Suppliers with the people, skills, knowledge and capacity to meet the buyers demand should be explored.

Determining the Qualification of a Supplier

The third step is to examine the supplier's qualification and availability. The selection criteria is stated in the procurement documents, and often depends on many factors. It might only have one factor, cost, but in various businesses the requirements are more. Various factors to consider are:

• understanding of need
• overall or life-cycle cost
• technical capability, risk
• management approach
• technical approach
• warranty
• financial capacity production capacity and interest
• business size and type
• past performance of sellers
• references
• intellectual property rights and proprietary rights

Each business must identify their own selection criteria, depending on complexity of the product or service. Pharmaceutical companies selling on the US market for example, must select a supplier approved by the FDA (Food and Drug Authority) and the supplier must be audited to confirm they fulfill certain rules and regulations.

To verify a supplier's qualification buyers can take proactive steps. The buyer may ask previous customers for reference, and have them confirm a delivery performance and inform about any problems that arose. They may as well do financial status checks, and check if the supplier has access to more workforce or unused capacity of facilities in case of unexpected increase in demand. The buyer might have requirements of specific quality standards that need to be verified with the supplier, as well as request samples of supplier products and test them to see if they meet requirements.^[7].

If there are multiple suppliers that meet all requirements within the buyer's selection criteria the next step will provide further ways to analyze suppliers.

Choosing a Supplier

The qualified suppliers that fit the selection criteria might be multiple, but what would be the decision factor in those cases? Once the potential suppliers have been identified the next step is to request information. The first thing issued is Request for Information. This information contains what goods and services the supplier can provide and what differentiates them from other suppliers. The next document issued is Request for Proposal containing the performance requirements from the buyer. The suppliers respond with a detailed description of how they would meet these requirements and at which price. The last document would be Request for Quote which contains a statement that states detailed information of goods or services needed. When all suppliers still remaining have provided a quote, usually the supplier offering the lowest price is chosen.^[7].

Contract Management

The last step is to form a contract between the buyer and the supplier. Two types of legal contracts can be established, fixed-price contracts and cost-reimbursable contracts.

Fixed-price contracts contain a fixed total price for a specific product or service to be provided. This type of contract also often includes financial incentives regarding specific project objectives, that can be quantified and measured. Suppliers are legally obligated to fulfill fixed-price contracts, resulting in fees if requirements are not met. Fixed-price contracts split into

• Firm Fixed Price Contracts: The most common contract, with a set price for goods or services and not subject to change. If a cost increase occurs is responsible by the supplier which is bounded by contract to complete the task. In this type of contracts the buyer is obligated to state specifically all products or serviced to be procured.
• Fixed Price Incentive Fee Contracts: This arrangement gives some flexibility that allows some deviation in performance from the supplier. Performance target is set before the production starts but the final contract price is decided after it has completed. In the beginning a price ceiling is set and any increase above that is the responsibility of the supplier.
• Fixed Price with Economic Price Adjustment Contracts: This arrangement is usually used for a long-term contract over a period of years, which has a fixed price, but is subject to changes such as inflation changes, or cost changes for s raw materials. This type of contract protects both the buyer and supplier from out-of-control conditions.

Cost-reimbursable contracts involve cost reimbursements from the buyer to the seller for all actual costs that occur during the production, with a fee representing seller profit. It often includes financial incentives if the supplier does not meet preset targets for cost, schedule or technical performance. Cost-reimbursable contracts split into

• Cost Plus Fixed Fee Contracts: The buyer pays for all costs occurring during the contract work, with an added fee representing the profit of the supplier, which is a percentage of the cost of completed work.
• Cost Plus Incentive Fee Contracts: The buyer pays for all costs occurring during the contract work, as with the Fixed Fee Contracts, but in this type of contracts gets a predetermined fee based on how well preset performance targets are met, which have been stated in the contract before the project starts. If final costs deviate from the initial estimated costs, both the buyer and the supplier share the costs based on a prenegotiated cost-sharing formula.
• Cost Plus Award Fee Contracts: This arrangement has predefined performance criteria, and the buyer pays for all costs occurring during the contract work. However, the additional fee is determined based on the satisfaction of the performance criteria. In this case the buyer can determine the satisfaction and decide the additional fee.

The third type of contracts is Time and Material Contracts which is an aspect involving both fixed-price and cost-reimbursable contracts. They are often used when the work desired cannot be quickly prescribed. They can be left open ended and relate to cost-reimbursable contracts by being subject to increased costs for the buyer. Detailed requirements cannot be stated by the buyer initially so the contracts can increase in value. However, many Time and Material contracts have value ceilings and time limits to prevent unlimited growth. This relates to Fixed Price Contracts with certain specified parameters.

Conclusion

In conclusion the tendering phase of the project procurement management includes multiple steps. First the company must justify the reasons for outsourcing some products and/or services. The company must state their problem and needs in detail to determine the necessary deliverables from a supplier, and then determine the qualification of suppliers. Suppliers considered must have the skills, knowledge, workforce, and capacity to meet the buyer's demand. When all potential suppliers have been ruled, one needs to be chosen, and this is determined after requesting information, a proposal and a quote.

The last part of the article introduces contract management which explains the step after the supplier has been chosen. When the supplier has been chosen a contract between the buyer and the supplier needs to be formed. Three types of contracts have been introduced, fixed-price contracts, cost-reimbursable contracts and time and material contracts which are a mix of the two previously mentioned.

This article aims to analyze the tendering phase of the procurement process within a company. Supplier selection and contract management have been discussed in detail and key points been presented.

Bibliography

William R. Duncan. (2000). A Guide to The Project Management Body of Knowledge: This guide provides deeper insight into the topic of Project Procurement Management and was used as reference throughout the whole article.

References

1. ↑ Manelli, A., Vincent, D. (1995). Optimal Procurement Mechanisms. Econometrica.
2. ↑ Boer, L., Labro, E., Morlacchi, P. (2001) A review of methods supporting supplier selection. European Journal of Purchasing and Supply Management.
3. ↑ Weele, A. (2010). Purchasing and Supply Chain Management: Analysis, Strategy, Planning and Practice (5th ed.).
4. ↑ https://www.law.cornell.edu/wex/contract Contracts. Cornell University Law School. Retrieved 10-02-2018.
5. ↑ ^{5.0 5.1 5.2} Simchi-Levi, D., Kaminsky, P., Simchi-Levi, E. (2003). Designing and Managing the Supply Chain: Concepts, Strategies, and Case Studies.
6. ↑ Buck-Lew, M. (1992). To Outsource or Not. Stephen M. International Journal of Information Management.
7. ↑ ^{7.0 7.1} Beil, D. (2009). Supplier Selection. Stephen M. Ross School of Business.