The Procurement Management Process
Project managers often come to contract managers saying, “I need a seller NOW!” Contract managers would like to say, “There is a procurement process designed to obtain the best seller at the most reasonable price. That process includes waiting time for the sellers to look at our needs and respond. The process can take from one to three months for this type of procurement.
Why did you not manage your project well enough to account for this time in your schedule?” This is one of the reasons a project manager must understand the procurement process. Not only does the project manager need to be involved along the way, assisting the procurement or contracting office with project input, but he also needs to plan for the time procurements take.
Many questions relating to the procurement process are similar to those in risk management and the project management process. You must MEMORIZE what happens when, how procurement management works on a real project and how it relates to the project life cycle.
The six sequential procurement processes are:
- Plan Procurement Management
- Conduct Procurements
- Control Procurements
- Close Procurements
Inputs to the Procurement Management Process (or “What do you need before you begin the procurement process?”)
Procurement is the one area that has a lot of templates, procedures and information available in order to make the procurement process faster and easier.
Enterprise environmental factors Company culture and existing systems that your project will have to deal with or can make use of. For procurement, this includes marketplace conditions and what services are available to be purchased.
Organizational process assets Procurement procedures, standard contracts, lessons learned from past projects, lists of pre-qualified sellers.
Contract manager assigned This may come later depending on the amount of contracting.
Project scope statement
WBS and WBS dictionary
Risk register An understanding of risk uncovered to date. Remember, risk analysis of the project should be completed before contracts can be signed.
Any contracts already in place on the project The project manager must manage the interface between multiple sellers and multiple contracts on one project.
Resources that may be lacking in the performing organization.
What work is needed
The project schedule
Initial cost estimates for work to be contracted
Cost baseline for the project
Plan Procurement Management
This process answers the question, “What goods and services do we need to buy for this project?” Plan purchases and acquisitions includes the following activities:
The performing organization can make all it needs, buy all it needs, or any range of solutions in between. (As simple as this sounds, it has been a question on the exam!) The actual out-of-pocket costs to purchase the product as well as the indirect cost of managing the procurement should be considered in any “make-or-buy” decision. The cost savings to purchase may be outweighed by the cost of managing the procurement.
One of the main reasons to buy is to decrease risk to any component of the “triple constraint.” It is better to “make” if:
- You have an idle plant or workforce
- You want to retain control
- The work involves proprietary information or procedures
Sometimes the make-or-buy analysis involves a buy or lease question such as:
You are trying to decide whether to lease or buy an item for your project. The daily lease cost is $120. To purchase the item the investment cost is $1,000 and the daily cost is $20. How long will it take for the lease cost to be the same as the purchase cost?
Answer Let D equal the number of days when the purchase and lease costs are equal.
$120D = $1,000 + $20D
$120D – $20D = $1,000
$100D = $1,000 = 10.
The lease cost will be the same as the purchase cost after ten days. If you think you will need the item for more than ten days, you should consider purchasing it to reduce total costs.
Contract Type Selection
This is an important topic! You must understand the following contract types and be able to tell the difference. You should be able to answer situational questions describing what you would do differently depending on the contract type. There are also questions that require you to pick the most appropriate contract type based on a described situation. Think through this section carefully!
The goal of contract type selection is to have reasonable distribution of risk between the buyer and seller and the greatest incentive for the seller’s efficient and economical performance.
There are generally three types of contracts:
- Cost reimbursable (CR)
- Time and material (T&M)
- Fixed price (FP)
The following factors may influence the type of contract selected:
- How well-defined the contract statement of work is or can be
- The amount or frequency of changes expected after project start
- The level of effort and expertise the buyer can devote to managing the seller
- Industry standards of the type of contract used
- Amount of market competition
- Amount of risk
Cost Reimbursable (CR)
The seller’s costs are reimbursed, plus an additional amount. The buyer has the most cost risk because the total costs are unknown. This form of contract is often used when the buyer can only describe what is needed, rather than what to do (e.g., when the complete contract statement of work or requirements is unknown, as in situations of buying unique knowledge).
The seller will therefore write the detailed contract statement of work. Research and development or information technology projects where the scope is unknown are typical examples of cost reimbursable contracts.
Common forms of cost-reimbursable contracts include:
Cost Plus Fee (CPF) or Cost Plus Percentage of Costs (CPPC)
This type of contract is not allowed for either U.S. federal acquisitions or procurements under federal acquisition regulations, and is bad for buyers everywhere. Can you guess why?
This type of cost reimbursable contract requires the buyer to pay for all costs plus a percent of costs as a fee. Sellers are not motivated to control costs because the seller will get paid profit on every cost without limit.
Contract = Cost plus 10% of costs as fee.
Cost Plus Fixed Fee (CPFF)
This is the most common type of cost reimbursable contract. In this type, the buyer pays all costs, but the fee (or profit) is fixed at a specific dollar amount. This helps to keep the seller’s costs in line because a cost overrun will not generate any additional fee or profit. Fees only change with approved change orders.
Contract = Cost plus a fee of $100,000.
Cost Plus Incentive Fee (CPIF)
This type of cost reimbursable contract pays all costs and an agreed upon fee, plus a bonus for beating the performance objectives stated in the contract. See more on incentives at the end of this topic.
Cost Plus Award Fee (CPAF)
This type of cost reimbursable contract pays all costs and an apportionment of a bonus based on performance. This is very similar to the CPIF contract except the award amount is determined in advance and apportioned out depending on performance. For example, the buyer might say that there is a $50,000 award fee available. It will be apportioned out at the rate of $5,000 for every month production on the project is over a certain amount.
Time and Material (T&M) or Unit Price
This type of contract is usually used for small dollar amounts. The contract is priced on a per hour or per item basis and has elements of a fixed price contract (in the fixed price per hour) and a cost reimbursable contract (in the material costs and the fact that the total cost is unknown).
In this type, the buyer has a medium amount of cost risk compared to CR and FP because the contract is usually for small dollar amounts and for a shorter length of time.
Contract = $100 per hour plus expenses or materials at cost
or $5 per linear meter of wood.
Fixed Price (FP, or Lump Sum, Firm Fixed Price)
This is the most common type of contract in the world. In this type of contract, one price is agreed upon for all the work. The buyer has the least cost risk, provided the buyer has a completely defined scope, because the risk of higher costs is borne by the seller. Therefore, it could be said that the seller is most concerned with the contract statement of work in this type of contract.
This type of contract is most appropriate when the buyer can completely describe the contract statement of work. (Do you see anything different from what you are doing in the real world? Maybe having the wrong contract type is the root cause of some of your problems!)
Contract = $1,100,000.
Fixed Price Incentive Fee (FPIF)
There are also incentives for fixed price contracts. The incentive is the same as CPIF.
Contract = $1,100,000. For every month early the project is finished,
an additional $10,000 is paid to the seller.
Fixed Price Economic Price Adjustment (FPEPA)
Sometimes a fixed price contract allows for price increases if the contract is for multiple years.
Contract = $1,100,000 but a price increase will be allowed in year two based on the U.S. Consumer Price Increase report for year one.
Or the contract price is $1,100,000 but a price increase will be allowed
in year two to account for increases in specific material costs.
A purchase order is the simplest type of fixed price contract. This type of contract is normally unilateral (signed by one party) instead of bilateral (signed by both parties). It is usually used for simple commodity procurements. Purchase orders are considered contracts when they are accepted either by performance (i.e., equipment is shipped by the seller—a unilateral PO) or by signing a purchase order (a bilateral PO).
Contract to purchase 30 linear meters of wood at $9 per meter
Advantages and Disadvantages of Each Contract
Type A trick on the exam is to realize that in the real world, the buyer must select the appropriate type of contract for what they are buying. This exercise helps test whether you really understand the different types of contracts. It will help you select the appropriate type of contract on the exam.
Exercise 1 In the chart below, write the advantages and disadvantages of each form of contract from the perspective of the BUYER.
Answer There can be more answers than listed here. Did you identify and understand these?
|Simpler contract statement of work||Requires auditing seller’s invoices|
|Usually requires less work to write the scope than fixed price||Requires more work for the buyer to manage|
|Generally lower cost than fixed price
because the seller does not have to add as much for risk
|Seller has only a moderate incentive to control costs|
|Total price is unknown|
Time and Material
|Quick to create||Profit is in every hour billed|
|Contract duration is brief||Seller has no incentive to control costs|
|Good choice when you are hiring
“bodies” or people to augment your staff
|Appropriate only for small projects|
|Requires the most day to day oversight from the buyer|
|Less work for buyer to manage||Seller may underprice the work and try to make up profits on change orders|
|Seller has a strong incentive to control costs||Seller may not complete some of the contract statement of work if they begin to lose money|
|Companies have experience with this type||More work for buyer to write the contract statement of work|
|Buyer knows the total price at project start||Can be more expensive than CR if the contract statement of work is incomplete
The seller will need to add to the price for their increased risk
Risk and Contract Type
The exam may ask questions that connect risk with the different types of contracts. The diagram below shows the amount of risk the buyer has with each contract type. Use it to better understand the different contract types, and also to answer questions such as:
Who has the risk in a cost reimbursable contract, the buyer or seller?
Answer Buyer. If the costs increase, the buyer pays the added costs.
Who has the cost risk in a fixed price contract, the buyer or seller?
Answer Seller! If costs increase, the seller pays the costs and makes less profit.
Allows an incentive (or bonus) on top of the agreed upon price for exceeding time or cost as specified in the contract. An incentive helps bring the seller’s objectives in line with those of the buyer. With an incentive, both buyer and seller work toward the same objective, for instance, completing the project on time.
You should have some experience calculating the revised fee and total costs associated with this type of contract (see the next exercise). Such questions occasionally appear on the exam.
Exercise In this cost reimbursable contract, the cost is estimated at $210,000 and the fee at $25,000. If the seller beats that cost they will share the savings; 80 percent to the buyer and 20 percent to the seller. If the actual costs come in at $200,000, what is the final fee and final price?