The procurement process
Developed by Paolo Meneghini
Each project needs a certain amount of resources. Usually, not all of these are already owned or available within the project organization. Therefore, the company will purchase some of the required sources or services from other firms. In a project, the statement of work describes the needed resources in detail. The project team will examine this document and decide which of the items that can be found or produced internally and which one to purchase. When all the needed resources are identified, they are communicated to the procurement function. The procurement function searches for the best seller for each specific resource or a purchase category. For this purpose, buyers and procurement managers start to communicate with potential suppliers, through the exchange of procurement documents. Typically, each document reflects a stage of the buying process. In each stage, the buyer and the vendor require and provide different information. The purpose of the first contact between procurement and vendor is to establish the supply scope and expectations. When the process evolves, the communication includes more details about technical requirements. These documents are sent to all the potential suppliers by different channels, depending on the size of the purchasing, the selling company, and their policies. Contractors and buying organization negotiate the contractual form that regulates the provision. The choice of contract typology, from the buyer organization, has the goal to avoid, mitigate or transfer the risk to the vendor.
Verify need to purchase, Make or Buy
The first step of the procurement process is to assess if there is any actual need of purchasing. The company could, in fact, own internally the necessary resources to fulfill the work. However, these resources should not be available in time and in amount, that is defined by the project schedule. If the project organization doesn't have the resources to complete the work in time, the organization will make a buy decision. In this case, the company can decide if lease or purchase the assets.
When the organization states the need for acquisition of external assets, it has to acquire internal and external knowledge about the market and the delivery modes of the required products.
Different kind of expertise may contribute in defining the purchase strategy. Experienced buyers are good sources of market knowledge. While the legal department usually guides in defining the clauses and the liabilities that regulate the provision. The internal client is the person or department in the project organization that demands the purchase. The internal client communicates qualities and specifications.
Market research and meetings
Market research consists in examining existing suppliers’ capabilities. This can be done by attending sector conventions or examining reviews from the internet or other buyers. Purchasing objectives can be adapted for leveraging mature technologies. By communicating directly with the vendors during the bidding process a higher level of knowledge will be reached. We will examine this process in the following sections.
Definition of the required items, Statement of work
The statement of work (SOW) is a document that summarizes the tasks and the targets to fulfill in a project. The SOW is settled from the project scope and defines what should be included in the supply contract. A procurement SOW is comprehensive of detailed information about:
- Goals and motivation, why the project was started
- Scope, detailed description of what is (and what is not) included in the project
- Deliverable, what must by achieved in the project
- Quality, standard and metrics adopted to guarantee the quality of the project output
- Resources, Materials, Personnel and Financials necessary to complete the project
- Schedule and Cost, of the the project over its lifetime
- Target, how the success of the process will be measured
- Period of performance, start and end date of the project
The procurement SOW includes also an overview of the collateral services required, such as performance reporting or post-project operational support for the supplied item. In some application areas, there are specific content and format requirements for a procurement SOW. The procurement SOW can be revised and refined as required as it moves through the procurement process until incorporated into a signed agreement. Essentially, the SOW includes all the information on the needed items in relation with the project characteristics. By examining it, a potential seller should be able to know if he can, or can't, provide the required products or services.
Identifying the supplier
When a company is about to start a new project, one of the first activities is to estimate the necessary resources. Documents as activity lists and activity attributes give an overview of all the necessary resources. If the company has no similar projects in its portfolio, probably the procurement has no contact with the companies providing products and services that are required in the project. For this reason, the first document that the procurement function issues is a request for information.
Mapping of the market, Request For Information (RFI)
The main purpose of RFI is to gather information about potential suppliers. This is particularly helpful if a single or few contractors are expected to provide a large amount of services and materials in a single project. RFI can be very beneficial in scanning the market for product and services providers for long-term supply agreements. The internal client, the person or business unit requiring the purchase, is responsible to provide the technical specification or to write the request for information itself. The document is received by the procurement function that is appointed to make it available to potential suppliers.
The document is published, or sent to a broad base of potential supplier, on channels defined by the buying company policy. For many suppliers, replying to RFI is a chance to promote their product and services. Consequently, companies may include special incentives and discount prices in their quotations. By responding to a request for information a business is showing interest in meeting the needs of the company that sent out the request. Procurement may use RFIs to list the products and services to require a first quotation. The pricing obtained at this stage is used to estimate the different companies price level. This information can be used later in the negotiation phase and should not be considered for buying decision. The quotation provided at RFI level will not necessary reflect the final ones, suppliers will redefine it as they get more information. Through analysis of RFI: responses, strategic options, lower cost alternatives, and cost reduction opportunities may be identified. The different vendors that reply to the request are inserted in a database. This is used for future supplier negotiations on the quality and price of the supply.
Aligning buyer and supplier expectation, Request For Proposal (RFP)
The main outcome of the RFI is a first overview of potential suppliers. At this point, the procurement communicates the willingness to consider a partnership and states the availability of funds. This is done through a request for proposal. The RFP states the contract terms and provides guidance on bidding form and process. The request describes the solution that the company requires and the criteria on which each proposal is graded. Requests for proposals could include a statement of work, describing the tasks to be performed by the winning bidder, and a timeline for providing work or material. An effective RFP also contains information about the supplier profile, as this should be compatible with the buying organization objectives. A request for proposal for a specific project may require the company to review the bids to not only examine their feasibility but also the health of the bidding company and the ability of the bidder to actually provide what is requested.
Benchmarking and selection, Request For Quotation (RFQ)
Once a range of suppliers is available, buyers aim to collect more precise information to make a comparison between the different offers. To make this possible, procurement sends a request for quotation to all the suppliers that showed interest in RFI's answer, or to those that are already present in the database. Better supply quality is most likely achieved when procurement sets specific parameters and defines specifications. Consequently, the RFQ should contain a detailed list of specifications for the intended purchase. All the potential suppliers replies by following a defined framework including information such as:
- Personnel skills, training level or competencies
- Part descriptions/specifications or numbers
- Description or drawings
- Quality levels
- Delivery requirements
- Term of contract
- Terms and conditions
- Other value added requirements or terms
- Draft contract
If this is done correctly, it will be easier to evaluate the quotations of the different firms. The offers replying an RFQ are received in many cases in form of a sealed bid, in one or more submission rounds. All the answers are evaluated by the same criteria. Essentially, key parameters will represent hard constrains. For instance, external IT contractors will be required to have specific competences and know particular programming language. All the offers that don't respect these constrains will not be considered. If the item purchased is a commodity, price per item or per unit of service can be the main evaluation criteria, otherwise it will be considered the trade off between the quotation and the other parameters. The procurement department makes the final supplier decision following a comparison and analysis of the RFQ responses for negotiation benchmarking advantage.
Get the best available provision, Request For Tender (RFT)
Purchase of extended or large amount of products or services may require a tender. A tender is published on channels determined by the company purchasing policy. Larger companies has their own platforms or employee third parts tender platforms, others publish the tender on public newspapers, trade journals, public registries, or on the internet. The RFT contains well defined specifications about the requested provision. The detail degree of RFT should reflect the one of the RFI's answer. Sometimes the buying organization makes available ad-hoc forms that the bidders must fill and submit to participate in the tender. If the buyer misses to specify exactly what the organization needs, the quality of the bids will be affected by the supplier's interpretation. Tenders are appropriate tools when requirements of products or services are known with satisfactory advance, compared to their actual period of usage (defined in the project schedule).
Once the buyer (or the project team in absence of a procurement function) has identified the most appropriate vendor, the two parts sign an agreement. Skilled procurement professionals are able to negotiate the best contractual form for their organization. Each contract type divides differently the responsibilities of the two parts. Also the remuneration criteria for the contractor differs between agreement categories. Companies have different policies about who will sign the contract on the company’s behalf. Some policies define a maximum contractual value that each buyer can sign up. There exists three main categories of contracts used in supply agreement:
- Fixed-Price contracts
Fixed-Price contracts assign a fixed total price for the provision of products of services. This type of agreement can include financial incentives when some target performance of quality or schedule are achieved. The contract binds the supplier to provide all the items agreed, penalties are applied if the terms are not respected.
- Cost-reimbursable contracts
In cost-reimbursable contracts the client refunds the seller for the cost sustained over the project. In addition, the customer will provide the supplier with a fee, representing the vendor’s profit. The contract may include clause for financial reward in case of an outstanding expenditure or time performance.
- Time and material contracts
Time and material contracts are used when the organization knows the typology of material or staff that must be outsourced, but is not known the amount needed or the time horizon of the provision. They are particularly useful to employ external staff for a defined period.
The table shows a synthetic overview of the types of contract present in the three categories:
|Fixed-Price contracts||Firm Fixed Price Contracts (FFP)||The price for the goods is set by the vendor, and once the contract is signed, it cannot be changed. The only case in which the price can vary is when the scope of the project is revised or when the client requires different specifications from the ones stated in the contract.|
|Fixed Price Incentive Fee Contracts (FPIF)||FPIF contracts allow a degree of flexibility on the cost of the item. This flexibility is linked to the supplier performance. Performance targets are set by the vendor, and they relate to time, schedule and technical performances. The cost of the supply is billed when the work is finished. In this way, the client recognizes the supplier financial incentives in case of outstanding performances. However, the cost cannot exceed a price ceiling previously set. The supplier must cover all the costs surpassing that threshold. Vendors are also legally liable for the completion of the work.|
|Fixed Price with Economic Price Adjustment Contracts (FP-EPA)||FP-EPA contracts are designed for long term supply agreements. These,contracts are usually valid for many years. For this reason, the fixed price is adjusted on the base of precise indicators. Indicators involve variation of the price of commodities and financial index monitoring inflation changes. These adjustments protect both buyer and vendor from adverse scenario variation.|
|Cost-reimbursable contracts||Cost Plus Fixed Fee Contracts (CPFF)||The vendor is reimbursed for all costs sustained in the provision. Additionally, he receives a fee computed as percentage of initial estimated project cost. The fee doesn't depend by the seller performance and can be revised in case of scope changes.|
|Cost Plus Incentive Fee Contracts (CPIF)||In CPIF the seller is reimbursed of all allowable costs sustained for completing the work. Furthermore, he receives a fee depending on fulfillment of performance objectives stated in the contract. Cost that is lower than the budget (or exceeding the budget) are shared by vendor and buyer, according to formulas defined in negotiation phase.|
|Cost Plus Award Fee Contracts (CPAF)|| The vendor is reimbursed for sustained cost. The fee is based solely on performance achievement stated in the contract. The fee is defined by the buyer on her/his perception of the seller performance. Fee definition is not subject to appeals.
This type of contract can be signed by contractors that want to gain a good reputation with the customer as tie the profit to the quality of the work delivered.
|Time & Materials||The contract defines the unit price for specific items, for example daily wage of an expert or a unit of material, but it doesn't state the amount. The volume of the supply is defined over time by the clients need. Therefore, the cost of the contract is billed to the buying organization on ongoing basis, depending by its usage of the resources.|
When a company needs to purchase commodities on recurring basis, the term and conditions of the trade are negotiated by the two parts and then stated into a framework agreement. The agreement will regulate all the future purchases of the items it includes. When this agreement is in place, the buyer can release a purchase orders (PO), a document containing the types and the amounts of purchased goods or services. When the supplier accepts it, the purchase orders become a legally binding document. From that moment, the buying organization will be liable to pay for the supply. Once the vendor receives the payment, she/he releases an invoice. This can be used by the buying company for controlling purpose by making it match with the corresponding PO.
Risk and pitfalls
As many other project management activities, procurement includes several risk and pitfalls. These can involve the internal procurement process, poor definition of supply specifications and delivery modes or lack of strategic prospective.
Meet requirements for negotiation time
Not always the required purchases are available in project planning documents. Many times, internal clients manifest to the procurement the need to acquire external capabilities with little or no advance. In this case, buyers have few bargaining power toward any potential seller as there is no time left for effective negotiation. Therefore, the interested business unit or process owner are responsible to communicate the buying decision to the procurement. Only in this way is possible to achieve buying performance through negotiation.
Get what is needed
In many procurement categories, especially the services one, it is particularly challenging to define what is needed. Contracts state the duration of service provision but not always are clear about how services are delivered and which services are included. To overcome the possibility of lacking service level, buyers should negotiate with vendors the inclusion of service KPIs into the contract. This is usually the case of IT services based on the Cloud, where up time is regarded as an essential metric. The solution is to identify the metrics that characterize the service and negotiate to include them in contracts. Financial penalty should be included when a KPI is not meet for one or several times.
Define pricing policies
Another arising issue of IT service contracts is the vagueness of pricing profile over time. Many services are offered at favorable initial prices. Companies can be tented to subscribe. However, if buyer fails to negotiate long term pricing profiles, suppliers will have the chance to increase billing prince extensively. Service providers can make leverage on the technical lock up and the elevate switching costs to increase their revenue.
Strategic procurement, Supply relationship management
Traditional relationship between a company and its suppliers have tactical or operational prospective. Supply relationship management (SRM) is the activity of connecting the interests of the organization and the ones of its extended supply chain. Naturally is not possible to establish this kind of relation with all the supplier. It is necessary to categorize suppliers on their strategic importance for the organization. In this way, the focus will be directed only toward the most relevant suppliers. SRM starts with finding the right stakeholders and aligning strategic objectives with them. This kind of approach is particularly beneficial for long term supply relationship as it can bring
- Efficiency improvement
- Cost reduction
- Risk mitigation
- Increased potential for innovation
- ↑ http://www.humanwareonline.com/project-management/center/sow-statement-of-work/
- ↑ https://www.slideshare.net/datacenters/request-for-information-rfi-4493196
- ↑ http://www.method123.com/template--rfi.php#!prettyPhoto
- ↑ http://www.investopedia.com/terms/r/request-for-proposal.asp
- ↑ https://www.negotiations.com/articles/procurement-terms/
- ↑ https://www.ariba.com/
- ↑ the particular graph is created by the author of the article, First Name Last Name, for the purposes of the APPPM course
- ↑ https://blog.procurify.com/2013/09/23/all-you-ever-needed-to-know-about-purchase-orders/
- ↑ http://www.zdnet.com/article/cloud-computing-pricing-beware-the-bill-shock/
- ↑ Deloitte: Supplier Relationship Management (SRM), Redefining the value of strategic supplier collaboration (2015), https://www2.deloitte.com/content/dam/Deloitte/de/Documents/operations/Supplier_Relationship_Management_2015.pdf