Part 52: Project Procurement Management Processes
Project Procurement Management
- Plan Procurement Management
- KEY BENEFIT: Determines what outside support our project requires (if any), and how & when to acquire it
- In this process, we
- Determine if we can perform all the work ourselves, or if we need to hire subcontractors and/or purchase components (outside support), and where to get them from. Almost every project needs something from the outside (components, raw materials, insurance policies, or consultants).
- Identify project needs that can be met by acquiring products, services from outside of the organization
- Identify & evaluate potential sellers
- Document project procurement decisions
- Evaluate the risks associated with each decision
- Make-or-Buy decision
- The Make-or-Buy decision applies to products and services
- For any project component or material, we can choose to Make It, Buy It, Both, or Neither
- This is known as a “Make-or-Buy” decision. For any given product or service required by the project, we might have the ability to make it, buy it, both, or neither (in which case the project will fail).
- This also applies to human resources; we can hire the required resources directly (make them), or subcontract them (buy them)
- There are advantages and disadvantages for Making and Buying products. We should consider all the factors when deciding
- How much will it cost to make vs buy in the required quantity?
- In order to Make It, we must design the component, acquire the necessary equipment, acquire the necessary raw materials, acquire trained technicians, and then manufacture the component.
- For a small quantity of components, a third-party supplier (Buy It) will be cheaper. Our overhead in manufacturing the component will be high.
- The supplier may have a large minimum order quantity. If we require a small quantity, it may be cheaper to Make It.
- For a larger quantity of components, manufacturing it ourselves (Make It) will be cheaper. Our overhead will be low. The third-party supplier will sell us the components at a profit.
- For example, we need gears. Gears cost $2 each. It will cost us $1000 to buy gear making equipment. Then we can make the gears for $1 each.
- If we only need 10 gears, we should buy them. The cost is $20 to buy 10 gears, and $1010 to make them ($1000 for the equipment, and $10 for the gears).
- If we need 2000 gears, we should make them. The cost is $4000 to buy them, and $3000 to make them ($1000 for the equipment, and $2000 for the gears).
- How long will it take to acquire the component?
- It will take a long time to design the component, and acquire the equipment, raw materials and training, and make the component ourselves. If a third-party supplier (Buy It) has the completed components sitting on a shelf, ready for sale, then it will be faster to Buy It.
- A third-party supplier (Buy It) may have a long lead time. For example, they may ship the component by sea, which takes one month. If we already have the equipment, design, and training, we can manufacture the product on demand, in a matter of hours or days.
- For example, we need gears. Our supplier ships gears in two business days. Setting up the equipment will take two weeks. If we need the gears right away, we should buy them.
- What if our supplier takes a month to ship gears? Then setting up the manufacturing equipment is faster.
- Other considerations
- The third-party supplier may have a patent on the design of the component. In that case, we may have to purchase the component from the supplier regardless of the cost and/or schedule. If we try to manufacture the component ourselves, we could be sued for patent infringement.
- Providing sensitive information and/or trade secrets to a third party could put us at a competitive disadvantage
- If our product is sensitive, the government may not allow us to purchase some components from a foreign company
- Long-term financial situation of the supplier. If we rely on the supplier for components, and the supplier goes out of business, we will have to find a new supplier or shut down our project. We should make sure that the supplier is financially sound or considering Making the components ourselves. If the supplier is critical and small, we could consider buying the supplier’s company and/or patents.
- We may have a contractual obligation to purchase an item from a specific supplier. This obligation could be part of the project’s contract or our organization may have a larger deal with a preferred supplier. For example, our company agreed to purchase batteries from Energiser. We wouldn’t be able to buy batteries from Duracell for our specific project.
- How much will it cost to make vs buy in the required quantity?
- There are advantages and disadvantages for Making and Buying people. We should consider all the factors when deciding
- How much will it cost to make vs buy the person? How soon do we need the work done? How long will the job take?
- The cost of advertising the job, interviewing candidates, hiring a candidate, and providing training is high. The cost could be tens of thousands of dollars.
- For a small task that may take days or weeks to complete, it is cheaper to subcontract the work. Especially when it requires a skilled trade (plumber, electrician, etc.), or a professional (engineer, database architect, etc.). Many companies advertise their services. Other types of labor can be obtained from staffing agencies.
- For a longer task that may take months or years to complete, it may be cheaper to hire the person directly.
- When work is subcontracted, the risk of not completing the work on time, properly, or on budget, can be passed to the subcontractor. When hiring staff directly, the risk is borne by us.
- The job market may be difficult. It may be difficult to find qualified employees.
- Hiring a person takes time. If the work must be completed urgently, we can subcontract it.
- For large projects with fluctuating labor requirements, we can use a combination. Hire the minimum number of people required and subcontract the rest. It is easier to fire/lay off a subcontractor.
- Other considerations
- The person we need has very special expertise. Like a world-renowned architect or designer. He may be unwilling to work as an employee.
- Visas and work permits. If the work is being performed in a foreign country, we may have to hire local people. The government may not allow us to hire people who don’t have the required work permits.
- How much will it cost to make vs buy the person? How soon do we need the work done? How long will the job take?
- Remember also
- We can do “both”. We can hire employees to work on the project, and contractors to supplement them when the workload increases. We can purchase components and manufacture them if we require larger quantities.
- We can do neither. If we can’t find the labor we need, or can’t find it at the right price, the project might not be feasible. If we can’t purchase the components at the right price, or can’t manufacture them, the project might not be feasible.
- Remember
- We can acquire goods and/or services from external third parties, and from other components of our organization
- Steps in Procurement
- Create a Statement of Work (SOW), Request for Proposals (RFP), or other procurement document (Exactly what do we want to buy?)
- Create a cost estimate to determine the budget (How much do we think it will cost?)
- Advertise the opportunity or contact potential suppliers
- Evaluate the responses (cost and technical) received from potential sellers against predetermined criteria (Which sellers can supply exactly what we want to buy? Throw out the ones who didn’t meet our requirements. From the remaining sellers, who has the best price?)
- Select a seller
- Sign a contract with the seller
- These steps can change substantially, and depend on the policies of the organization, and the type and quantity of materials/services being acquired.
- We may have a “no bid” contract, where we determine that only one seller can supply the product. For example, we want to purchase a Ford automobile. We must purchase the automobile from Ford.
- We may not have a bidding process if the item is small. For example, if we want to change a light bulb, we won’t advertise the opportunity in the newspaper. We may just go to Yelp or Homestar’s and find the most qualified electrical contractor.
- Contract Types
- There are three contract types: Fixed-Price, Cost-Reimbursable, and Time & Materials
- Fixed-Price Contract
- The price is predetermined when the contract is signed.
- Firm-Fixed Price (FFP)
- Most common
- The price is predetermined when the contract is signed, and not subject to change
- Buyers like this because the price won’t change
- For example, the cost to remove the old driveway, and pour a new one is $2000.
- Firm Price Incentive Fee (FPIF)
- The price is predetermined when the contract is signed, and not subject to change
- The seller may have a bonus (for better performance) or penalty (for poor performance)
- For example, the cost to remove the old driveway, and pour a new one is $2000. If the seller recycles the old concrete, the buyer will pay an additional $200. If the seller completes the driveway ahead of schedule, the seller will pay an additional $200. If the seller completes the driveway behind schedule, the seller will deduct $400.
- Fixed Price with Economic Price Adjustments (FPEPA)
- The price is predetermined when the contract is signed, and not subject to change
- The price is adjusted for the cost of external factors beyond the control of the seller
- Typically used for long-term arrangements
- Typically adjusted for inflation, cost of raw materials (commodities), or currencies
- For example, we are manufacturing a car. The contract is worth $40,000 per car. The car requires $1000 worth of aluminum. The cost of aluminum goes up to $1200, a $200 increase. Therefore, the cost of the car goes up by $200 to $40,200.
- For example, we are manufacturing a car. The contract is worth $40,000 per car. The inflation rate is 10%. Therefore, next year, the cost of the car goes up by 10% to $44,000.
- Cost-Reimbursable Contract
- The Buyer reimburses the Seller for all the Seller’s costs in performing the contract plus an additional fee
- Project management and engineering services frequently use Cost-Reimbursable Contracts
- Cost Plus Fixed Fee (CPFF)
- The seller is paid for all costs plus a fixed fee
- The fee is usually a percentage of the estimated total cost, and is determined when the contract is signed
- If the costs exceed or are lower than the estimate, the fixed fee does not change
- For example, the cost to build the office building is $1,000,000. We hire a project manager to oversee the project. His fee is 10%, or $100,000.
- If the project is overbudget, underbudget, or on budget, he still makes $100,000.
- Cost Plus Incentive Fee (CPIF)
- The seller is paid for all costs
- The buyer and seller share the risk if the project goes overbudget, and share the reward if the project is completed underbudget
- The share of the risk/reward may be a percentage, and is known as the Incentive
- For example, the cost to build the office building is $1,000,000. We hire a project manager to oversee the project. His fee is 10%, or $100,000.
- The buyer and seller share the risk/reward.
- If the project is overbudget by $100,000, the total cost is $1,100,000. The buyer and seller share the risk at $50,000 each. The project manager is only paid $50,000 ($100,000 fee less the $50,000).
- If the project is underbudget by $100,000, the total cost is $900,000. The buyer and seller share the risk at $50,000 each. The project manager is only paid $150,000 ($100,000 plus the $50,000).
- Cost Plus Award Fee (CPAF)
- The seller is paid for all costs
- The seller is paid incentives based on specific performance criteria
- For example, the cost to build the office building is $1,000,000. We hire a project manager to oversee the project. His fee is 10%, or $100,000.
- The seller is paid an additional $50,000 for each month ahead of schedule that the project is completed.
- The project is completed two months ahead of schedule. Therefore, the seller is paid $200,000 ($100,000 fee plus $50,000 for each month ahead of schedule)
- Cost Plus Fixed Fee (CPFF)
- Time and Material Contracts (T&M)
- Used when we don’t have a clear idea about the scope of work, or when we don’t know how long the job will take
- We negotiate a fixed price contract for labor (typically an hourly or daily rate) and materials (cost per pound, cost per foot, etc.)
- The seller invoices the buyer for labor and materials used
- For example, our contract with an electrician is $130 per hour of labor (time), and $1 per foot of electrical cable (material). The electrician installs 100 feet of electrical cable in two hours. We receive a bill of $360 ($260 for the two hours of labor, and $100 for the electrical cable)
- Conduct Procurements
- KEY BENEFIT: Select a qualified seller and sign a contract with them
- In the Plan Procurement Management process, we figured out what products and services we’re going to obtain from third parties.
- In this process, we
- Look for sellers to supply the goods or services, obtain seller responses (bids or proposals), apply selection criteria, select a seller, and award a contract
- For a large procurement, instead of immediately awarding a contract, several qualified sellers may be shortlisted, and invited to submit more detailed proposals
- Control Procurements
- KEY BENEFIT: Ensures that buyerss and sellers perform in accordance with the project’s requirements
- In this process, we
- Manage procurement relationships
- Monitor contract performance
- Make payments to the seller
- Some organizations manage contracts as an administrative function, separate from the project
- Administrative duties can include
- Collecting data about technical and financial performance
- Adjust procurement schedules
- Pay invoices
- Make reports to the organization
- Payments made to the seller should reflect actual work being accomplished. If the seller is behind schedule, then the payments will also be delayed.
- We also evaluate the seller’s performance. We use the data we collect to decide if we are going to keep buying products and services from this seller in future projects. We also use to data to figure out if the seller is meeting its obligations under the contract.
- Close Procurements
- KEY BENEFIT: Documents agreements and related documentation for future reference
- In this process, we close our contracts with the sellers. This includes administrative activities to finalize open claims, update records, and archive procurement information
- Procurements are closed at the end of each project phase
- In some circumstances, contracts can be terminated early
- By agreement (the buyer and seller agree to an early termination)
- By default of one party (typically the seller has failed to deliver goods/services on time or to the correct standard)
- At the buyer’s discretion, if provided for in the contract
- In an early termination, the rights and responsibilities of each party are defined by the contract