Project Procurement Management

09 May, 2016

Some projects can proceed using only the resources internally available to the organization. In other words, the necessary skills can be found among our employees and all the equipment and material is already in stock. If this is the case then external procurement is not an issue.

However, if there is something missing – a particular skill, or a machine or some raw materials – we will need to look outside the organization for it. In the case of raw materials, the process is straightforward: approach vendors and get prices. Then choose the vendor who is either cheapest or who provides the best quality. Other factors might come into play such as location and reliability in terms of delivery. The main thing is that the materials need to be purchased for use during the project.

However, in the case of people and equipment, a bit more thought is required. Do we need this particular skill for this project alone, or would such a person be of benefit to the company at large? Do we see future projects using this technology, or is this something that we will not need again? Similarly, if a bulldozer or a rigid truck is needed for this project, will we need it again down the line?

What we are trying to decide here is whether to rent or to buy. The decision can be quite difficult. If we recruit a new employee, then we have all the overheads a permanent member of staff entails and we have to ensure they have work beyond the end of the project. However, if we hire on a contractor, we will have to pay higher day-rates and that expertise will not be available to us once the contract completes. To get the best out of contract workers, the tasks they need to do have to be clearly defined and the work closely managed. This is particularly true if we want to train an internal person up in the particular skill.

With equipment, all sorts of factors come into play. Buying capital equipment, such as vehicles or office buildings, offers tax advantages, such as depreciation write offs. However, once you own something, its maintenance becomes your responsibility. This is why aircraft leasing is so popular – the leasing company is expected to maintain the plane. Another consideration is resale value. If we only need the equipment for the duration of the project, it might work out cheaper to buy the equipment and sell it at the end of the project. However, the resale result is uncertain, so this becomes a risk to the project.

Another decision is the make-or-buy one. Should we buy in sub-assemblies for our products, or develop them in-house? This requires awareness of the organization’s strategy. Would developing this part of the product enhance our core competencies? Would it motivate our staff to work in this area? Would it prevent a third-party from gaining knowledge of what our project is for? This need for secrecy also is a factor on whether to hire contractors or use internal staff.

So the Project Manager needs to identify everything that needs to be bought in or rented. Then s/he will have to devise a Procurements Management Plan, detailing how these external resources will be acquired. Many organizations have purchasing departments and standard operating procedures to deal with procurements, so the Project Manager often has clear guidelines on what to do for each situation.

While ordering materials is straightforward – choose the vendor and order the stuff – other external procurements involve more complicated arrangements and need to be regulated through the legal framework of a contract. There are a variety of contracts and they distribute the risk differently between the customer and the external vendor. Broadly speaking, contracts are of three types:

  1. Fixed Price Contracts. These involve setting the price up front. If the cost of delivering the goods or services increases then the external vendor takes the hit. In times of high inflation or if there are other uncertainties associated with the delivery, vendors tend to steer away from these. So instead of an absolute fixed price, or Fair Fixed Price as it is called, customers can acknowledge the risk the vendor faces and offer a Fixed Price with Economic Price Adjustment, This allows the vendor to increase the cost if the costs of their materials increase during the contract. Another idea is the Fixed Price with Incentive Fee, offering a bonus if the items are delivered on time and to a high quality.
  2. Cost Reimbursable Contracts. This is where the customer guarantees to pay the vendor’s costs. This opens the door to corruption, where spurious invoices can be added to the bill. The customer can mitigate against this by specifying a Cost Plus Incentive Fee, which is awarded if the costs are lower than the estimate. Another option is the Cost Plus Award Fee. This offers a bonus if the quality is high, the cost is low and/or the delivery is on time.
  3. Time & Materials Contracts. A great deal of trust is required before one of these is entered into. Essentially, the customer is agreeing to pay all costs (as in the cost reimbursable case) but also will pay for the time put in. While this is appropriate in projects where there is high uncertainty about what is involved (software development for instance), it is important that the Project Manager does not offer a blank cheque here. There needs to be upper limits on what the customer is prepared to pay and the contract needs to be tightly managed.

Deciding on contract type is all part of the Plan Procurement Management process. Note that the Project Management Institute refers to contracts as “Agreements” – useful to know if you are planning to sit the Project Management Professional (PMP)® exam. Once the decisions are made and agreed, the Project Manager commences the Conduct Procurements process. This is where the business is put out to tender and tender responses are evaluated. The result of Conduct Procurements is a set of decisions as to whom to award the contracts (or agreements).

It cannot be emphasized enough that contracts with external parties need to be closely managed. The Project Manager (or an expert on the team) needs to be very clear on what is required and needs to monitor progress closely. The contract needs to permit inspections and audits of the vendor and have a well-defined change control mechanism. Obviously, there needs to be penalty and escape clauses, if the procurement is not working out. Obviously, this represents another risk to the project. For critical components, it is not unusual for two (or more) vendors to be commissioned to do the same work, just in case.

When the contract is complete and the deliveries have been accepted, the agreement must be formally closed. This is especially important in the cost reimbursable and time and materials contracts, as no new invoices should be permitted after the project is complete. A review of the agreement should take place in order to recommend the vendor for future work, or to dismiss them from the list of approved suppliers.

Given the nature of managing agreements with third-parties, for Project Managers “retail therapy” is something needed after a shopping spree!

By Velopi Seamus Collins

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