Classic PM: 11 Procurements

Procurements

This is perhaps the most controversial area of knowledge of all presented in PMBoK. This is due to the fact that not in all countries are the principles laid down by PMI consistent with local legislation - this causes problems when following PMBoK regarding Procurement. Anyway, this area of knowledge is mandatory to study.

Despite the differences in legislation, Procurement in all countries is carried out on approximately one principle:

• Comprehend what is required - first of all, the customer has to determine what he wants. At this stage it is important to understand the main characteristics/functions/indicators that the final product should have;
• Analyse the market - this market survey is superficial in nature, excluding those potential performers who, in principle, could perform the required volume of work;
• Make requirements to suppliers - selected suppliers are sent proposals for the Procurement with limitations and Requirements;
• Choose the performer - final choice of the performer, coordination of all nuances of Requirements and restrictions of Procurement;
• Sign the contract - documentation of the agreed terms of execution of the purchase. It is important to indicate all the nuances, including organizational;
• Monitoring the progress of work - control of compliance with the provisions of the contract. Already at the Project Planning stage, it is important to achieve a trusting relationship between the parties; this will greatly simplify interaction;
• Check delivery - this mainly includes delivery of the purchase product;
• Close the contract - final stage, at which the result of the purchase is approved, the documentation is submitted, financial commitments are closed, etc.

De facto, the Project itself is a Procurement, but only the Project Manager and his Team are the performers, and the customer is a third party. Remember in the Initiation we already touched on the Statement of Work? It was said that this is an external document, which contains a description of what should be the Deliverables of the Procurement. If you carry out an internal Procurement (the customer and the contractor are within the same organization), then the agreement and Execution of the Project is greatly facilitated - the Statement of Work is very formal and is required only for compliance with norms and corporate rules. And the picture is quite different when carrying out an external Procurement - the document must very clearly describe the responsibilities of the parties, deadlines, and costs - the Statement of Work in this case will be a legal document.

It should be noted that PMI considers all parties to the contract as Buyer and Seller. Buyer is the one who orders the Execution of the purchase, Seller is the one who must execute the purchase.

Typically, the Procurement is managed by a Project Manager, but some organizations have separate posts to manage it. Typically, these are large companies that work with a large number of procurements and goods or services they need. However, in the field of work with Procurement the Project Manager can be assigned for the following features:

• the Project Manager must know important contract dates;
• promote the Execution of the Procurement;
• understand the terms and limitations of the contract;
• monitor Procurement execution and assist in problem resolution;
• participate in identifying risks and developing a response to them;
• participation in procurement change management.

Procurement Processes

Processes that manage the Procurement knowledge area use the following inputs:

Enterprise Environment Factors. Includes the state of the market, as well as a list of services available for purchase;
Organizational Process Assets. Include procedures, procurement documentation standards, Lessons Learned from previous projects, as well as a list of suppliers with whom the company has already established relationships;
Designated procurement manager;
Scope Baseline. Used to determine the content of procurements as well as their necessity;
Risk Register. Contains a list of assessed risks. Can be changed when managing Procurement. It should be noted that the risks associated with Procurement from a particular supplier must be assessed before the contract is signed;
Contracts already signed;
Project Schedule;
Preliminary estimates of the work requiring procurement. Estimations of the cost of procurement should be made before submitting a proposal to possible performers;
Cost Baseline.

The introduction to Procurement has been completed, below are the 4 processes:

• 12.1 Plan Procurement Management;
• 12.2 Conduct Procurements;
• 12.3 Control Procurements;
• 12.4 Close Procurements.

12.1 Plan Procurements Management

The main thing that this process should answer: «What services or goods should be purchased, how will we do it, and who can sell them to us?». Procurement Management Plan, which is one of the outputs of the process, includes a review of how to document purchases, who and how to judge what should be purchased, and by which principle Seller will be selected.

Make-or-Buy Analysis

Of course, the cost of buying something is often higher than the cost of producing it yourself, but this is not always true. For example, is it not easier to buy a manufactured good or service if its production requires special tools or staff skills? Or what if the Activities are so many that producing goods or services by our own will lead to an increase in project time or cost? All this is possible, but the reason that many forget - reducing Risks - when buying a product or service is to avoid a large number of Risks.

Creating a Statement of Work for each Procurement

As was pointed out in the review of the Integration knowledge area, for a project to be successful, it is necessary to understand its objectives and scope. As for all Seller, the ordered part of the work will be a separate project, they must provide Statement of Work. And, as in the case of the Statement of Work, the more complete and understandable it is, the higher the chances of realizing the project - here you need to put yourself in the place of the Seller and evaluate the quality of the information provided. PMI went further and recommends not only creating a job description but also creating a list of Activities that must be performed (including meetings, reporting, etc.). The level of detail depends on the type of order,;for example, when ordering a building, you may need a full list of government requirement (and other standards) that the product must meet; if software is to be produced, then it may be sufficient to list those functions that it has to do.

It is considered that there are the following types of Statement of Work:

Performance. This type describes only those indicators that the product should be able to commit («We need a crane, which can lift weight up to 10 tons in height up to 100 meters»);
Functional. Describes the goals and objectives that the product should perform and may contain basic characteristics («We need a crane with load capacity of 20 tons»);
Design. Contains a ready-made description of the actions that need to be simply performed («It is necessary to construct the crane according to the provided blueprints»).

Type of Statement of Work the Project Manager must choose himself, but Performance and Functional are used in IT, research, industry, etc.; Design is also used in heavy industries, manufacturing, and construction.

Types of contracts

The large number of contracts can be broken down into the following broad categories:

• Fixed Price;
• Time and Material;
• Cost Reimbursable.

Before considering the categories and types of contracts, you should talk about the interest of the parties in the implementation of the Project. Of course, the main purpose of the Seller is to receive money for successfully completed work. At the same time, Buyer wants to get quality goods as quickly as possible and, of course, as cheaply as possible. To resolve these two competing interests, it is recommended to use a compensation system that provides for the Buyer to reward successful work. In addition, payment dates should be mentioned in the contract to avoid conflict situations. Continue, and consider all categories and types of contracts.

Fixed Price

It is the most common type of contract, used when there is a clear specification or product Requirements. Buyer risks are quite low, so these contracts are beneficial for those areas of the Project that are not vital.

This category of contract types may be based on the previous experience of the Seller or Buyer in selling/buying a similar product or service.

It is highly recommended not to use contract types from this category for projects whose content is not obvious and cannot be written immediately, as this may entail a large number of changes in the Project that will negatively affect the interest of the Seller at the end of the Project.

Contract = $1000

Fixed Price Incentive Fee, FPIF

Type of contract, which is intended to encourage the Seller to hurry along the work. The full cost is calculated on the basis of the formula to be specified in the contract, as shown below:

Contract = $900 + $50 for advance of schedule (6 periods totally)

Fixed Price Award Fee, FPAF

This type of contract is similar to the Fixed Price Incentive Fee, FPIF, except that the considered type limits the amount of reward. For example, it can be said that the reward for being ahead of schedule will be monthly N, but the total sum of the reward cannot exceed N.

Contract = $900 + $50 for advance of schedule (6 periods totally, no more then $400)

Fixed Price Economic Price Adjustment, FPEPA

A contract that allows the price to be raised in case of certain events or moments in time. Naturally, these events or times should be clearly written in the contract, and both parties should monitor their advance.

Contract = $800 + possible 10% exceeding if commodities price increase by 15% in 4 months

Purchase Order

The simplest type of contract is a simple purchase of goods or services, similar to a purchase in a grocery store.

Contract = 3 items of the Unit (code: XX00ABC) with the of $150 each

Time and Material

This type of contract is characterized by the fact that the Buyer pays for «work per hour» or «production per unit». When purchasing a service through this type of contract, its main weakness is the high probability of inaction on the part of the Seller - this is due to the fact that he does not receive any benefit from the rapid completion of the work.

Compared to the other two categories of contract types, Time and Material have an average risk level for the Buyer.

Contract = $50 per hour

Contract = $150 per Unit

Cost Reimbursable

Contract types from this category are applied in case of unclear Procurement boundaries and content. Under the contracts of this category, the Buyer undertakes to pay the Seller the amount denoted in the contract, and additional payments depend on the terms of the contract, as well as those circumstances that occur during the Execution of the Procurement. For successful management of the contract, it is necessary to have accounts (or any other economic department) with both parties.

There are two entending categories bellow

Cost Plus Percentage of Costs, CPPC

The contract obliges the Seller to pay the full cost of performance of the contract, as well as an additional percentage of this cost (which is the profit of the Seller). The drawback of this type is that the Seller may as much «twist» the cost of Execution of the contract and this will lead to unreasonable expenses on the part of the Buyer.

Contract = Total price of the Procurement + 10%

Cost Plus Fixed Fee, CPFF

A common type of contract, which includes the cost of carrying out the Procurement, as well as some predetermined amount as payment for the services of the Seller.

Contract = Total price of the Procurement + $500

Cost Plus Incentive Fee, CPIF

Contract with reimbursement of Procurement implementation Costs, as well as additional payments depending on the terms of the contract and performance of the Seller. Normally, this type of contract includes the terms and conditions for allocating the money saved on the Project.

Contract = Total price of the Procurement (no more then $500) + $500 for the success. 80% of saved funds returned to the Buyer and 20% returned to the Seller

Cost Plus Award Fee, CPAF

The Buyer will pay the full cost of execution of the Procurement, as well as a Profit (Fee) based on the performance of the Seller. This type of contract is similar to the Cost Plus Incentive Fee, CPIF except that it includes only payments from the Seller but excludes charging.

Contract = $500 + monthly payments by $100 for advance of schedule by 5 days (6 periods totally, no more then $400)

When choosing the type of contract, the Project Manager should answer the following questions:

• What is being acquired?
• State of the market and economy in general?
• What is the level of detail of the Statement of Work?
• Which industry standards are used in the contract?
• What is the level of skill and experience of the Seller?

Risks

As noted above, each type of Procurement has a certain level of Risk for both parties and here the situation is very simple - Fixed Price#Fixed-Price contracts carry less risks for the Buyer, but more for the Seller. Cost Reimbursable contracts have opposite dependencies; somewhere in the middle are the contracts for Time and Material. The complete diagram is as follows:

Terms

The following are useful terms to consider in the area of Procurement:

• Price - is the price that the Seller offers to the Buyer;
• Profit (Fee) - is part of the Price and is an additional cost for the Execution of the Procurement. Its value depends on many of the indicators to be specified in the contract;
• Cost - the amount that is required for the provision of goods or services by the Seller;
• Target Price - the amount that the Buyer actually paid to the Seller for the purchase of goods or services. Used for comparison with the originally planned to evaluate Procurement Execution;
• Target Cost - the amount that the Buyer has paid to the Seller only for the realization of the goods or services (excludes Profit (Fee));
• Sharing Ratio - here is the percentage of division of additional losses incurred from the Procurement Execution or division of saved funds. Usually registered as Buyer/Seller, e.g., 80/20;
• Ceiling Price - is the maximum amount that can be paid by the Buyer for the Execution of the Procurement;
• Point of Total Assumption - used only in Fixed Price contract to estimate the exceeding of the Target Price relative to planned expenses. Displays the quality of project management, calculated according to the formula:

$$''PTA''=\frac{''(CP\; -\; TP)''}{''R''}+''TC''$$

, where CP is the amount of Ceiling Price; TP is the Target Price, R is the percentage of Sharing Ratio, TC is the Target Cost.

Procurement documentation

These documents must be created by the Buyer, below are some of them:

• Request for Proposal (Request for Tender), RFP - a request for detailed information about the performer, his or her resume, experience, and proposed price for the execution of the Procurement. May also include information about how the Seller intends to carry out the Procurement. The response to this document is an official Seller Proposal;
• Request for Quotation, RFQ - request Price per unit/hour/etc. The answer to it is a Price Quote;
• Invitation for Bid, IFB - request the full Price of the Procurement. As a result of its provision to the Seller, a response in the form of a Bid should be expected.

Proposals for a Procurement may include:

• Information for the Seller;
  • The odds of winning the tender;
  • Subjects for writing a response to the proposal (may include listing of content, listing of particularly important sections, etc.);
  • Expected response format (including forms);
  • Precount criteria for the selection of the performer, preferably on the basis of some methematical values;
  • Expected forms of (superficial) Price estimation;
• Statement of Work;
• Terms and conditions of the contract.

12.2 Conduct Procurement

When conducting Procurement, the Project Manager should be able to justify his or her choice. Only the main points are presented below.

Choose a Seller

To select the Seller, the Project Manager can be guided by a number of criteria, in particular - experience of the company, its reputation, reviews of its work, its resume, cost of execution, value for money, location, etc. Each organization has its own criteria and principles for selecting Procurement bidders and PMI recommends following them, it is important to remember that all bidders should announce the rules by which selection will be made.

Also, there may be a list of the most preferred Sellers, often those with whom there is already experience of cooperation.

Seller Proposal

All interactions with sellers should result in a list of their offers. The final selection of the Seller should be based on the rules defined in the Procurement Management Plan. Depending on the complexity of the ordered project, different methods of evaluation of received proposals can be chosen, but anyway, it must be determined in advance, and all participants of the tender should be acquainted with it.

Of course, no offer received is final, and if the Project Manager is interested in choosing a certain Seller, then negotiations should be conducted to choose the most favorable (from all points of view - economic, qualitative, executive, etc.) and execute the Procurement in progress. It should always be remembered that the completion of a project within the framework defined by the Project Charter is the most important task of the Project Manager. The purpose of the negotiations may be to improve the relationship with the Seller and, finally, reduce the cost of the Project. Moreover, the second goal may have to be in the first place, because the quality of the relationship with the Seller (a lot) will depend on the outcome of the Project Execution. In negotiations (not only before the contract is concluded), contract sides usually discuss Scope, Schedule and Cost, but beyond these basic areas of the Project, also often discussed:

• eesponsibility for any areas of the Procurement and contract obligations;
• authority;
• project management methods used;
• schedule of payments for Project Execution;
• various clauses of the treaty.

The signing of a contract is an official procedure, which depends on many factors, in particular corporate rules and the influence of the legal and economic departments of both parties. It is important to note that the contract should not contain points of potential conflicts - for this it should be drafted without ambiguity, describing the exact dates, content of the work, Deliverables and cost.

12.3 Control Procurement

The main purpose of this process is to monitor the implementation of the agreement between the parties. If you need to change the terms of the contract, you should go through a procedure similar to the process of [Integrated Change Control]. By the way, Buyer will be the main source for initiating Changes.

In general, this process is a simplified version of all processes from the Monitoring and Controlling - it is necessary to follow very superficially all areas of knowledge as well as changes required for Procurement. The main features of this process are as follows:

• All Requirements of the contract must be fulfilled;
• Different types of contracts have different levels of control;
• The Project Manager should make every effort to carry out the Procurement;
• The Project Manager should be ready to perform actions (listed below) of this process at any time.

The following is a list of actions that may require execution in the Control Procurements process:

• Documentation (from entering entries in the required project documentation to entering entries in the Lessons Learned;
• Performing the Integrated Change Control for Procurement;
• Timely execution of payments;
• Definition of what is and is not part of the contractual obligations;
• Problem solving and conflict resolution;
• Communications with the Seller;
• Performing easy management of Cost and Schedule;
• Participation in the management and control of [Scope] of Procurement;
• Help in the identification of Risks, especially high-level;
• Participation in audits;
• Quality assessment;
• Communication with the main Stakeholder of Procurement.

In addition to these actions, it is possible to highlight those that are characteristic of certain types of contracts:

• Fixed Price contracts;
  • Monitor the completeness of execution of the Scope and Requirements for Quality by the Seller;
  • Assurance of the purchase price;
  • Special tracking of Change Request going beyond the original Scope of Procurement;
  • Tracking changes of Scope;
• Time and Material contracts;
  • Daily interconnection with the Seller;
  • Receipt of the confirmed Deliverables fully satisfied by the Scope requirements;
  • Control of the time required for the execution of the purchase;
• Cost Reimbursable contracts;
  • Audit of accounts;
  • Performance control of the Seller;
  • Revaluation of the Cost of Procurement (especially in case of Changes);
  • Track changes - changes can add already approved Scope.

From the noticed above actions to be carried out by the Project Manager in terms of [Control Procurement], it can be inferred that the Project Manager should participate in the monitoring of the Procurement but not go into the details of its Execution. So, for example, when buying a garage construction, there is no need to monitor it as closely as your main Project (building the house). At the same time, it should be remembered that the Quality and success of the Procurement depend on the Quality and success of the entire Project.

To manage changes, it is recommended to develop some system for managing them. As a rule, this is simply a list of rules and a sequence of actions that both parties to the contract must perform. These actions may include identifying those changes that require meetings between the parties, describing how changes are assessed, etc. However, the basic sequence of actions remains unchanged:

• Identification of the reason for Change;
• Assessment of the impact of the Change on Procurement;
• Change Execution;
• Documentation update;
• Assessment of Change made.

12.4 Close Procurement

As can be easily assumed, there are only two reasons why a procurement may be closed - successful completion of the Procurement and failure to complete it - and, as a consequence, breach of contract. Regardless of the reason for closing the Procurement, the Project Manager is required to complete this process.

The process itself can contain the following actions:

• Confirmation of Deliverables. The Project Manager must confirm that all Scope of the Procurement has been completed in full according to the contract;
• Final meeting. Meeting to summarize the implementation of Procurement;
• Closing financial obligations. Executed by the Buyer, confirmed by the Seller;
• Procurement audit. Verification of the Procurement process only - this action does not imply verification of the budget (verification of the budget can be carried out separately at the request of the Buyer). The main objective is to evaluate Procurement from a management perspective;
• Completion of the final purchase report. Performed by Seller;
• Update of Lessons Learned. Adding all useful information about the purchase;
• Final official confirmation of Execution of the purchase. Performed by the Buyer in case of successful execution of the purchase.