Project Procurement Management Tutorial

Welcome to the eleventh lesson ‘Project Procurement Management’ of the CAPM Tutorial, which is a part of the CAPM Certification Course offered by Simplilearn. In this lesson, we will focus on project procurement management.

Let us begin with the objectives of this lesson.

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 section, let us take a quick look at the project management process map.

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., Project Procurement Management and its processes.

In the next section, let us understand the contract.

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 section, let us look at the various characteristics of a contract.

Characteristics of 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 section, let us understand the difference between centralized and decentralized contracting and their advantages and disadvantages.

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 listed as follows:

Method

Advantages

Disadvantages

Centralized contracting

  • Increased expertise in contracting

  • helps in standardizing the best practices

  • Difficult to get assistance from the centralized contracting department as they may be serving multiple projects

Decentralized contracting

  • more control on the project and procurement process can be speeded up

  • It gives easier access to contracting expertise

  • Duplication of contract related expertise across multiple projects

  • It also prevents standardization and optimization of practices

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 section, let us discuss the different types of contract.

Types of Contract

There are three types of contract. They are:

  • cost based

  • time-based

  • material based, or fixed price based

Cost reimbursable type of contract is used when the scope is not clear to 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 into 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 the 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 the 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 it meets the performance level of the project as an award. The award can be performance or early delivery. If this performance is not met then the award will not be paid.

Time and material (T and M) or unit price contracts are generally used for smaller projects, wherein customer pays per item or per hour or per day basis. An example of 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 the 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 the price of raw material prices the contract will also be renewed.

FFP: Firm Fixed Price is used when the scope is clear and is in favor of the buyer as the seller is carrying the risk. Here an increase in the cost will be borne by the seller. If the buyer raises the change request, it can increase 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 section, 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.

Business Scenario—Problem Statement

Scott is the Project Manager for a global project. His Project Sponsor is confident in his team’s ability to finish the project under budget and ahead of schedule, although the project is very demanding and critical to the business.

To manage the huge demand, Scott has to make a decision to procure additional resources. The additional resources would be responsible for activities requiring more specific skills, which his project team lack.

The customer has an incentive clause in the project’s agreement that yields a bonus for early completion. Scott has a vision for the work the additional resources will complete, but there is also an opportunity to expand their scope of work, especially if he runs into scheduling problems that will require him to crash the critical path.

What contract should Scott establish to procure the additional resources?

Business Scenario—Solution

Although Scott wants to complete his project early so the team can receive the early completion bonus, he has to pick a contract that is less risky, also one that makes sense based on the scope of work. Out of the available contracts, the best choice for Scott is the Time and Material Contract.

Time & Material Contract allows Scott to have more flexibility. Fixed Fee contracts require a well-defined scope of work and Time & Material is the only option that accommodates open-ended work arrangements.

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

Types of Contract—Advantages and Disadvantages

Each type of contract has certain advantages and disadvantages.

Type of Contract

Advantages

Disadvantages

Cost Reimbursement

  • Less costly than fixed price because the seller does not have to account for their risk

  • Simple to draft

  • Requires auditing all the seller invoices and thus increases buyer efforts

  • Seller has less incentive to control cost, thus these contracts are inefficient, i.e., riskier for the buyer or the project manager

Fixed Price

  • More efficient as the seller has strong incentive to control cost

  • Requires less effort by the buyer to manage contracts as cost risk is with the seller

  • Seller may under quote initially and later try to make high margins on change requests

  • Not having a proper statement of work(SOW ) can result in seller not providing some of the deliverables

Time and Material

  • Easy to create

  • Good for resource augmentation assignments, where cost risk is shared by buyer and seller

  • Seller has no incentive to control costs

  • Requires monitoring of daily output

  • Can’t be used in bigger and large projects

There may be business scenario based questions in the CAPM 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 section, let us look into a few key terms used in procurement management.

Key Terms

The following are the key terms used in Procurement Management:

Request for Information

Earlier to procuring goods and services by means of the 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.

Request for Proposal

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.

Request for Quotation

RFQ or request for quotation is issued for purchasing standard items off the shelf. In such cases, the buyer generally compares prices from multiple vendors and selects the lowest bidder.

Request for Bid

Request for Bid(RFB) is used by the buyer to get bids from the shortlisted sellers.

Purchase order

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

Statement of work or SOW 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.

Quotation

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.

Non-disclosure Agreement

NDA stands for a 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 to the seller as well.

Letter of Intent

LOI 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.

Terms and Conditions

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 section, let us discuss project procurement management.

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 the material contract should be issued. These processes also guide on how to manage the contracts, once issued to the seller.

In the next section, let us look at the different Project Procurement Management Processes.

Project Procurement Management Processes

There are four project procurement management processes as follows:

  • Plan Procurement Management - which belongs to planning process group

  • Conduct Procurements - which belong to executing process group

  • Control Procurements - which belong to monitoring and controlling process group

  • Close Procurements - which belong to the closing process group

In the following sections, we will learn each of these four processes. Let us begin with plan procurement management in the next section.

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 to 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 a 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, the 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 documentation like RFP, RFI, etc. are also created as an 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 section.

Conduct Procurements

Conduct procurement is the process of selecting the seller by evaluating the proposals submitted by different sellers and awarding them a contract.

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

  • 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 the 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 the 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 section.

Control Procurements

Control procurements is the process of managing procurement relationships, monitoring contract performance, and making changes and corrections as needed.

The key inputs to this process are:

  • procurement documents

  • agreements

  • 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 about 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 the 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, organizational process asset, 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 the 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 section.

Close Procurements

Close procurements is the last process of the project procurement management. This is the process of formally closing the contract. The input of this process is the project management plan and the procurement documentation, like the 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.

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.

Conclusion

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

  • Disclaimer
  • PMP, PMI, PMBOK, CAPM, PgMP, PfMP, ACP, PBA, RMP, SP, and OPM3 are registered marks of the Project Management Institute, Inc.

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