Project Procurement Management Tutorial

12.1 Lesson 12—Project Procurement Management

Hello and welcome to PMP Certification Course offered by Simplilearn! In this lesson, we will focus on project procurement management. Let us begin with the objectives of this lesson.

12.2 Objectives

After completing this lesson, you will be able to: ?Define contract ?Differentiate between centralized and decentralized contracting ?Explain the different types of contract ?Identify the key terms used in Procurement Management ?Describe the Project Procurement Management processes In the next screen, let us take a quick look at the project management process map.

12.3 Project Management Process Map

There are 47 processes in project management grouped into ten Knowledge Areas, and mapped to five Process Groups. In this lesson, we will look at the ninth knowledge area, i.e., (Pronounce that is) Project Procurement Management and its processes. In the next screen, let us understand contract.

12.4 Contract

A contract represents a mutually binding agreement that obligates the seller to provide the specified products, services, or results, and obligates the buyer to provide the monetary or other valuable consideration in return. A contract can also be called an agreement, understanding, undertaking, or a purchase order. There are at least two parties involved in a contract. The party that provides the goods or services is called the seller and the party that buys the goods or services is called the buyer. The compensation can be in monetary or any other form. In the next screen, let us look at the various characteristics of a contract.

12.5 Characteristics of a Contract

A contract always has at least two parties. A contract must be formal and in written, and it must have legal remedies, if either party fails to honor their commitment, the other party can go to the court and appeal against the misdeeds. The legal processes being cumbersome, both the parties, in case of dispute should try settling the differences among themselves or through a mutually agreed mediator—sometimes called “arbitrator”. Changes to contracts must also be subject to the same checks as the contract itself. Larger organizations have full-time managers called contract managers or procurement managers. They are the ones responsible for creating and managing contracts. In the next screen, let us understand the difference between centralized and decentralized contracting and their advantages and disadvantages.

12.6 Centralized vs. Decentralized Contracting

When all the contracts of the organization are managed by a central contracting or purchasing department, it is called “centralized contracting”. Sometimes—typically, for large projects—there can be a separate contract manager assigned to the projects; this is called decentralized contracting. In decentralized contracting, the contract manager is assigned to the project and reports are given to the project manager. Both centralized and decentralized contracting methods have advantages and disadvantages. Centralized contracting results in increased expertise in contracting and helps in standardizing the best practices. However, it may be difficult to get assistance from the centralized contracting department as they may be serving multiple projects. In decentralized contracting, the project manager has more control and procurement process can be speeded up. It gives easier access to contracting expertise, but it may result in duplication of contract related expertise across multiple projects. It also prevents standardization and optimization of practices. In some cases, both types of contracting are used. For example, suppose British Petroleum has a project of setting up a new refinery plant in Nigeria. They might procure key machinery through their centralized purchasing department, and they can have a full-time contract manager for this refinery project who can procure few items locally. In this case, both the centralized and decentralized contracting methods are being used. In the next screen, let us discuss the different types of contract.

12.7 Types of Contract

There are three types of contract. They are cost based, time and material based, or fixed price based. Cost reimbursable type of contract is used when the scope is not clear for the buyer. In this type of contract, the buyer carries the risk. To motivate the sellers, the buyer pays addition fixed fee, incentive, or award based on the performance in addition to the actuals. Cost based contract can be further classified under various other categories as well. For instance, cost plus a fixed fee, cost plus a percentage of cost, etc. For example, suppose you want to construct a new building. You sign up with an architect. The architect charges you a fixed fee of $50,000 plus all the costs incurred as fee for his services. CPF: In case of cost plus fee, the seller will be paid actual plus a fee of about $1000, which is being agreed in terms and conditions. CPPC: In Cost plus percentage of cost the seller is going to get the money as per the actual plus percentage of say 10% from the actual. CPFF: Cost plus fixed fee is similar to CPPC instead of percentage a fixed fee will be paid CPIF: In case of cost plus incentive fee if the seller saves money from the estimated, the saved money will be shared between the buyer and seller with some ratio. For example if estimated is $200K, the buyer to seller ratio is 80/20 and actual price is $150K. The saved money is $50K and the seller gets 20% of $50K, which is $10K as incentive in addition to the actual price $150K. CPAF: In case of cost plus award fee, the seller will be paid the actuals and if is meets the performance level of the project as award. The award can be performance or early delivery. If this performance is not met then award will not be paid. Time and material (T and M) or unit price contracts are generally used for smaller projects, wherein customer pays on per item or per hour or per day basis. An example for such contracts can be call center contracts. Suppose, you want 5 people team to answer your customer queries. A company in Bangalore can provide you call center executives for 25 dollars an hour month, and the material cost. Fixed price contracts (or lump sum contracts) are generally signed when the scope of the work is very clear. For example, a new bridge needs to be constructed on a junction. The length and required strength of the bridge is well defined. In such case, City Corporation can ask for fixed price proposal from the bidders. FPIF: In fixed price contracts, sometimes an incentive fee is also introduced to incentivize the seller to complete the work before time. For example, City Corporation can ask bidders to complete the bridge in 12 months. For this, they get a fixed price bid for $2.5 million. In addition to this, if the bridge is completed in less than 12 months, they get $10,000 as incentive per week. Therefore, if they finish the bridge in 11 months, they get $40,000 as incentives for completing 4 weeks before time. FPEPA: Fixed price economically price adjustable type of contract is used where the project cost fluctuates because of economic condition. For example in case of construction project, the raw material price varies over a period. So here, the buyer and seller will have an agreement saying that whenever there is a variation in raw material prices the contract will also be renewed. FFP: Firm Fixed Price is used when the scope is clear and is in favor to buyer as the seller is carrying the risk. Here any increase in the cost will be borne by the seller. If the buyer raises the change request, it can increases the cost to the buyer. You may want to pause and think of the scenarios in which you want to choose a specific type of contract. For example, who bears the risk of cost escalation in a fixed price contract as opposed to a cost reimbursable contract? In the next screen, let us look into a business scenario to understand this concept better. After reading the problem statement, click the solution button to look at a possible answer.

12.8 Business Scenario—Problem Statement

In the next screen, let us discuss the advantages and disadvantages of contract types.

12.9 Types of Contract—Advantages and Disadvantages

Each type of contract has certain advantages and disadvantages. The advantages of cost reimbursable contracts are that they turn out to be less costly than fixed price because the seller is assured that the cost will be covered and carry lesser risk. Such contracts tend to be simpler to draft. The disadvantage is that the buyer needs to audit all the invoices and exercise cost control. Since the seller makes more money if the costs go higher, there is no incentive for the seller to control cost and the buyer carries the risk. In case of fixed price contract, the advantage is that the seller tries to control the cost and the buyer does not have to worry about managing the cost. However, the disadvantage is that the seller can under quote initially less to get the contract and later try to overcharge if there are any change requests to cover the costs. Therefore, the statement of work needs to be drafted carefully as the seller may try to wriggle out of the commitment. The time and material contracts are easy to create. Such contracts are suitable for resource augmentation projects, where cost risk is shared by buyer and seller. However, there is no incentive of seller to control cost. Therefore, such situation requires the buyer to monitor the work being delivered on a day-to-day basis and is suitable for small contracts only. There may be business scenario based questions in the PMP exam, where a contract type has to be chosen based on its advantages and disadvantages. So understanding the advantages and disadvantages of different contracts will help you answer such questions correctly. In the next screen, let us look into a few key terms used in procurement management.

12.10 Key Terms

Earlier to procuring goods and services by means of contract, the organization must identify what it requires. In case it is not clear on the requirements, it can issue an RFI or request for information. After receiving the RFI, the organization is aware of the process, and it can now issue an RFP or request for proposal. The sellers can submit their proposals against RFP. RFP is also called as RFB or request for bids. RFQ or request for quotation is issued for purchasing standard items off the shelf. In such cases, buyer generally compares prices from multiple vendors and selects the lowest bidder. Request for Bid (RFB) is used by the buyer to get bids from the shortlisted sellers. Purchase order or PO is the simplest type of commercial contract. In such contracts, buyer mentions item type, quantity, and price. PO is generally issued for small purchases. Statement of work or SOW (pronounce as “S-Oh-W”) defines the scope of the deliverables as per the contract. Generally, contracts are drafted by the legal department, whereas SOW is drafted by the project team to define the deliverables required as per the SOW. It’s a good practice to make reference of SOW in a contract. A quotation is a submission of a response by a vendor to a request from the buyer. A quote contains the commercial terms for the work being done. NDA stands for non-disclosure agreement. NDA is signed to maintain the confidentiality of the information of each other. For example, as a seller, you have the right to know about the buyer, and by signing NDA, you abide by the agreement to not disclose the information with any of the seller’s competitors. It is applicable for the seller as well. LOI (pronounce as “L-Oh-eye”) or letter of intent is generally issued by the buyer to the seller. It indicates to the seller (without yet being legally bound) that the buyer is interested in buying their services. For example, a buyer states that he or she will purchase the software only when ten new additional features are integrated. The seller in turn gets the buyer to sign LOI, so that he or she can be sure of buyer’s interest in purchasing the software after the modification. The key term T and C stands for terms and conditions. In any contract, there are various terms and conditions. Similarly, a procurement agreement includes certain terms and conditions (T and C), and may incorporate other items that the buyer specifies regarding what the seller should perform or provide. Some other legal terms that may be found in contracts are: Force majeure: This clause essentially frees either party from the terms of a contract in the event of an unforeseen incident that is outside the control of either party, such as a WAR or a RIOT or act of God, like earthquakes or hurricanes. Doctrine of waiver: Waiver is a voluntary act by a person or party that surrenders a legal right. For example, if an insurance company has prior knowledge of facts that may bar its liability to pay compensation, but choose to still collect premiums from the insured—then it implicitly waives its rights to use that fact as an excuse to refuse payment. Privity of contracts: The doctrine of Privity implies that the contract cannot confer rights or obligations to any party other than those directly involved in the contract. Dispute resolution: In the event of a dispute regarding the terms of a contract, the parties need to stipulate how those disputes would be resolved. Either they can choose to assign an arbitrator explicitly or they could take legal action. Termination for convenience of the buyer: These provisions allow the buyer to terminate the contract even in the absence of a breach or default by the seller. In the next screen, let us discuss project procurement management.

12.11 Project Procurement Management

Project procurement management includes the processes required to purchase or acquire products, services, or results that are needed from outside the project team. So, by following the procurement management process, you can determine whether issuing a fixed price contract is the right thing to do for the project, or a time and material contract should be issued. These processes also guide on how to manage the contracts, once issued to the seller. In the next screen, let us look at the different Project Procurement Management Processes.

12.12 Project Procurement Management Processes

There are four project procurement management processes. Plan procurement management belongs to planning process group, conduct procurements belong to executing process group, control procurements belong to monitoring and controlling process group, and close procurements belong to closing process group. In the following slides, we will learn each of these four processes. Let us begin with plan procurement management in the next screen.

12.13 Plan Procurement Management

Planning procurement is the first step in project procurement management. In this step, what needs to be procured from outside the project is identified. Once the items to be procured are identified, the next step in project procurement planning is to decide on the procurement approach and identifying the potential sellers. Plan procurement management is, therefore, the process of documenting project purchasing decisions, specifying the approach, and identifying potential sellers. It belongs to the planning process group. The inputs of this process are as follows. The project scope comes from the project management plan and the requirements documentation, because what needs to be procured externally must be the part of the project. You also need to make sure that you go through the risk register, because procuring from outside might introduce additional risk. Even though the project items are being procured externally, these items must be within the project schedule and activity cost estimates. Suppose, you have the project schedule ready for the whole project and some items are being procured externally. Now, if the seller is not providing those items on time, it may delay the other dependent project activities. This is why project schedule is an input to this process and when awarding the contract to a seller, project schedule should be clearly communicated to the seller. Similarly, when you procure items externally, the seller price quotation should be within the cost estimates created for the project. The stakeholder register is record of what the project stakeholders need in making the determination about what should be procured for the project. Organizational process asset is the standard set of processes for procurement management, for example, standard template for RFP, RFI, etc. Projects should use them. Other inputs include activity resource requirements and enterprise environmental factors. The technique for procurement planning is, “make-or-buy analysis” – i.e., to decide whether the item to be procured needs to be procured externally, or to get it done internally. For example, if you do not have competency within the project, you have to look for a seller who can do this for you, this can be easier and cheaper to buy than to build internally. In procurement planning, it is also important to know which contract is best suited for the purpose. Other techniques are expert judgment, market research—which helps in understanding what is available in the market—and meetings for making decisions about procurement. The key output of this process is the procurement management plan. Along with that, it is important to specify what needs to be procured externally in the form of make-or-buy decisions and the procurement statement of work. For the government projects, it is important to publish the source selection criteria to ensure transparency in the procurement process. Sometimes, some other procurement related documentations like RFP, RFI, etc. are also created as output of this process. Due to these decisions about procurement, there may be change requests raised on the project and updates to the project documents. Let us now discuss the conduct procurements process, in the next screen.

12.14 Conduct Procurements

Conduct procurement is the process of selecting the seller by evaluating the proposals submitted by different sellers and awarding them a contract. It belongs to the executing process group. Most of the inputs of this process are the outputs of the previous processes, such as procurement management plan, procurement documents, make-or-buy decisions, source selection criteria, and procurement statement of work. The addition to these is the seller proposals. Once the procurement documents and qualified seller list are ready as part of the procurement planning process, you can ask these sellers to submit their proposals against the RFP. Project documentation and Organizational process assets help in conducting procurements. Let us now look at the tools and techniques used in this process. Most of the sellers, when they get procurement documents, usually have some doubt on the project scope. To ensure that all sellers get the same information, you can organize a bidder conference, wherein all sellers can participate. In these conferences, sellers put forth their queries, which are clarified by the buyers, and are conducted when all the sellers are present. In this way, no seller has undue advantage of having information, which others might not have. Various other proposal evaluation techniques might be used. Suppose, four different sellers submit their proposals, which vary in the cost quoted. To evaluate the proposal, you get the cost estimation done by an independent expert who can provide independent estimates. Sometimes, advertisements are also used to reach the potential sellers. These techniques are used when you do not have sufficient list of qualified sellers to submit proposal on your project. Analytical techniques might be used to analyze the seller proposals received. Once the qualified list of sellers is further narrowed down, negotiations are done with two to three best vendors to finalize the contract to the winning vendor. The reason why more than one vendor is finalized, because, the chosen best vendor might not agree on few terms and conditions, which you think is very important. In such cases, you would want to keep your options open by negotiating with more than one vendor. The output of this process is obviously the selected sellers and the agreements or contract documents. Along with this, change requests, resource calendars, and updates to project management plan and project documents may also result from this process. It is essential to study the process of conducting procurements to answer scenario based questions on this topic. Let us now discuss the control procurements process, in the next screen.

12.15 Control Procurements

Control procurements is the process of managing procurement relationships, monitoring contract performance, and making changes and corrections to contracts as appropriate. It belongs to the Monitoring and Controlling Process Group. The key inputs to this process are procurement documents, agreements, and work performance data. Work performance data has the information on the progress of the work, i.e., how much work is completed and the cost incurred to complete that work. In this case, it has information like how much work is completed and money spent to get that work completed as per the contract. Work performance reports are the reports created by the seller on what they have completed. Change requests that are approved may also be an input to the control procurements process. The project management plan is also listed as input because the contract work should progress as per the project plan. There are several tools and techniques used for administering procurement. The contract change control system is similar to a normal change control system, but used specifically for managing changes to the contract. Usually, the process of making changes to the contract, i.e., contract change control system, is listed in the contract document itself. The next technique is procurement performance reviews. This is the process of formally reviewing the seller deliverables. This is also documented in the contract document. In many large contracts, the procurement performance reviews are done once a month. Sometimes unscheduled inspection and audits can also be performed by the buyer to ensure that seller is following the processes that they claim they do. This is often done to ensure compliance. For example, as a buyer you can have a policy that all your sellers should comply with ISO 9001:2008 standards. You can do your own audit on seller to check whether they really comply with that standard or not. Performance reporting is also one of the tools and techniques used in this process. Releasing the payment of the work performed by the seller is also part of this process. Sometimes buyer and seller may get into a dispute regarding a change. The seller may ask for additional money for the change and buyer may claim that it is the part of the original scope. Such contested changes are also called claims or disputes. The contracts usually have claims administration process to settle such disputes. The best way to settle such disputes for the buyer and the seller is to sit across a table, negotiate, and agree on a midway. Records, related to an agreement or contract, are kept carefully in records management system. The key output of the process is the change request. In addition to this, project management plan updates, organizational process asset updates, and project document updates also happen as part of this process, because, if there were a delay in getting a contract deliverable, they would result in delay of the whole project. Any such delay needs to be updated. Work performance information may be generated through this process. It is advisable to study the process of controlling procurements to answer scenario based questions in the exam. Let us now look into the last process, i.e., close procurements, in the next screen.

12.16 Close Procurements

Close procurements is the last process of the project procurement management. This is the process of formally closing the contract and it belongs to the Closing Process Group The input of this process is the project management plan and the procurement documentation, like contract, RFP, performance reports, etc. These are the inputs, because all such documents need to be archived for future reference purposes. The key technique for this process is procurement audits. The aim of procurement audit is to identify successes and failures of the contract administration process and use the findings for the lessons learned documentation. Any claims or disputes should also be resolved through negotiation before closing the contract. The records related to the closed procurements must be maintained using the records management system. The output of the contract closure is actual letter handed over by the buyer to the seller informing about the contract closure or closed procurement. Organization process assets also are updated because of this process, mainly the part, which covers lessons, learned. It is advisable to study the process of closing procurements to answer scenario based questions in the exam. Let us now check your understanding of the topics covered in this lesson.

12.17 Quiz

A few questions will be presented in the following screens. Select the correct option and click submit to see the feedback.

12.18 Summary

Here is a quick recap of what was covered in this lesson: A contract is a mutually binding agreement that obligates the seller to provide the specified products, services, or results, and obligates the buyer to provide the monetary or other valuable consideration in return. In centralized contracting, a single contract manager handles multiple projects, whereas in decentralized contracting, a contract manager is assigned to a project full time, and reports to the project manager. The three types of contacts are Cost Reimbursable (CR) or Cost Plus, Time and Material (T and M) or Unit Price, and Fixed Price (FP) or Lump Sum. Project procurement management includes the processes necessary to purchase or acquire products, services, or results needed from outside the project team. There are four Project Procurement Management processes. They are Plan Procurement Management, Conduct Procurements, Control Procurements, and Close Procurements.

12.19 Conclusion

With this, we have come to the end of this lesson. In the next lesson, we will discuss project stakeholder management.

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