Feedback Request For Answers To Chapter 12 (Procurement)

Explain five components of a procurement strategy.

The first key component of a procurement strategy is the ‘make or buy’ decision. Will the project make the required item in-house or will it be brought in from an external source. Generally, this decision will be driven by cost – is it cheaper for us to make it? – and available resources – can we make it? Clearly if the decision is to make the item no further action in terms of procurement is required but if the item is to be brought there are other important factors to consider.

The type of contract which will be entered into with the supplier is also a key component of a procurement strategy. The most common and straightforward contract is a single contract between client and supplier but several other types exist. For example, there can be parallel contracts, where two contracts with separate suppliers run in parallel, or sequential contracts, where the contract with supplier 2 is dependent on the successful end of the contract with supplier 1. There are also prime contracts where the client contracts with the main, prime, supplier who contracts other work out. Clearly the type of contract to be entered into must be decided early as it will be important in negotiation and determining a cost.

Payment term is another key component of a procurement strategy and is distinct from contract type. The payment term, or reimbursement method, details the way the price with the supplier is agreed. This has important implications for cost and risk as different reimbursement methods will put the onus on different parties. For example, a fixed unit cost price puts the risk of further expense on the client as they are committed to paying per unit – so if a project is estimated to take 20 days but takes 30 they will pay the higher amount. On the other hand a fixed price will place the risk with the supplier as the client has only agreed to pay a fixed price; this may inflate the price slightly as the contractor will factor this risk into their costs.

A fourth component in a procurement strategy is an organisations own practices for supplier selection. Most organisations will have a set way for a supplier to be selected including a tender process, queries, negotiation and the award of a contract. A project manager must be aware of the organisations’ procurement method to ensure they follow it when selecting a supplier.

A final component of procurement is Contract Administration. Once a contract is entered into it must be administered to ensure both parties are fulfilling their contractual obligation. Contracts will generally involve penalties for any breach of contract on both the side of the client and supplier so efficient contract administration is required to minimise the likelihood of a breach. The procurement strategy will describe the arrangements that will be put in place for this, such as KPIs to be for contractor reporting.

 

Explain what is meant by the term ‘procurement’.

List and describe two contractual relationships.

List and describe two project reimbursement (payment) methods.

Procurement is the process by which an organisation or project acquires goods and services from a supplier. It involves the development of a procurement strategy, selection of a supplier and the details of the contract to be entered into as well as the management of that contract.

Two contractual relationships are:

A prime contract is where a client enters into a contract with a supplier – the prime contractor. In turn the prime contractor will enter into various subcontracts as required to carry out the required works. For example, a main building contractor employed by a client may employ a mechanical or electrical sub-contractor. While the prime contractor is responsible for liaising with and organising the works of the subcontractor, the client will still have oversite of the work they are carrying out.

A turnkey contract is a contract whereby a client will enter into a contract with a supplier who is responsible for providing everything required for the contract. In this instance the client will not be aware of the subcontractors – ultimately all they will do is ‘turn the key’ on the end product.

Two project reimbursement methods are:

Cost plus is a reimbursement method whereby the client agrees to pay the supplier their costs plus an additional fee. This additional fee can either be a fixed fee or can be a percentage of the cost. This method provides clarity to the client and profit to the supplier, although the supplier may prefer the percentage addition to the fixed addition as this will increase their profits. The client is likely to prefer the more certain cost plus fixed.

The target cost reimbursement method is where the client and supplier agree between them a target cost for the works. Any overrun on costs is then split between them. This has the advantage of providing an incentive to both parties to work constructively together thereby minimising the chance of incurring additional costs.