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Advanced Project Management

August 2017
Project Procurement Management

Project Procurement Management

Includes:
the processes necessary to purchase products, services, or
results from outside the project team;
the contract management and change control processes
required to develop and administer contracts or purchase
orders issued by project team;
controlling any contract issued by an outside organization
(the buyer) that is acquiring deliverables from the project
performing organization (the seller), and administering
contractual obligations placed on the project team by the
contract.
Project Procurement Management

During the project performing an organization plays both


roles of seller in relationships with outside customer and
buyer in relationships with its subcontractors and vendors.

Buyer can be identified as: Seller can be identified as:

Client Contractor
Customer Subcontractor
Prime contractor Vendor
Contractor Service provider
Acquiring organization Supplier
Service requestor
Purchaser
Project Procurement Management

Project Procurement Management Processes

Plan Procurement Management The process of


documenting project procurement decisions, specifying the
approach, and identifying potential sellers.
Conduct Procurements The process of obtaining seller
responses, selecting a seller, and awarding a contract.
Control Procurements The process of managing
procurement relationships, monitoring contract performance,
and making changes and corrections as appropriate.
Close Procurements The process of completing each
project procurement.
Project Procurement Management

Plan Procurement Management


Inputs Tools & Techniques Outputs

Project management Procurement


plan management plan
Requirements Procurement statement
documentation of work
Make-or-buy
Risk register analysis Procurement
documents
Activity resource Expert judgment
Source selection
requirements Market research criteria
Project schedule Meetings Make-or-buy decisions
Activity cost
Change requests
estimates
Project documents
Stakeholder register
updates
EEF
OPA
Project Procurement Management

Contract Types

Fixed Price (Lump Sum) Contracts


Cost-Reimbursable Contracts
Time and Material (T&M) Contracts
Project Procurement Management

Fixed Price Contracts

Firm Fixed Price (FFP) Contracts


Fixed Price Incentive Fee (FPIF) Contracts
Fixed Price with Economic Price Adjustment
(FP-EPA) Contracts
Purchase Order
Project Procurement Management

Fixed Price Contracts


The main advantage of Fixed Price Contract is that both
parties know the scope of the work, and the total cost of the
task before the work is started.
Generally, outsourcing and turnkey procurement contracts
are signed under a fixed price contract on a deliverables
basis.
This type of contract is very useful if the scope of work is
defined accurately. Fixed price contracts are good for
controlling the cost.
However, changes in scope must be carefully observed,
otherwise the cost of the project may be elevated significantly
because it is seen that the contractors get the contract by
bidding the lower price and then try to cover the cost with any
opportunity, such as added scope.
Project Procurement Management

Firm Fixed Price Contract (FFP)


This is the simplest type of procurement contract. In this type
of contract, the fee is fixed. The seller has to complete the job
within an agreed amount of money and time. Any cost
increase due to bad performance of the seller will be the
responsibility of the seller, who is legally bound to complete
the job within the agreed amount.
A Firm Fixed Price (FFP) Contract is mostly used in
government or semi-government contracts where the scope
of work is specified with every possible detail.
Since the risk is borne by the seller, the cost tends to be
higher. Another drawback of a Firm Fixed Price Contract is
that, if the scope is not clear, there can be disputes between
the buyer and the seller.
Project Procurement Management

Fixed Price Incentive Fee Contract (FPIF)

In this type of contract, although the price is fixed,


the seller is given an additional incentive based on
his performance. This incentive lowers the risk borne
by the seller.
The incentive can be tied to any project metrics such
as cost, time, or technical performance.

Example: 10,000 USD will be paid to contractor as


an incentive if he completes the work before two
months.
Project Procurement Management

Fixed Price with Economic Price Adjustment


(FP-EPA) Contracts
If the contract is multi-year long, a Fixed Price with
Economic Price Adjustment Contract is used. Here
you include a special provision in a clause which
protects the seller from inflation.
Example: About 3% of the cost of the project will be
increased after a certain time duration based on the
Consumer Price Index.
Project Procurement Management

Purchase Order
Purchase order is the simplest type of fixed price
contract. It is normally unilateral (signed by one
party).

This type of contract is used to buy commodities.


Example: Buy 10,000 bolts at the cost of $1,00.
Project Procurement Management

Cost-Reimbursable Contracts
This contract is also known as a Cost Disbursable Contract. In
this type of contract, the seller is reimbursed for completed work
plus a fee representing his profit. Sometimes this fee will be paid
if the seller meets or exceeds the selected project objectives; for
example, completing the task before time or completing the task
with less cost, etc.
A Cost Reimbursable Contract is used when there is uncertainty
in the scope, or the risk is higher. In this contract, since the buyer
pays for all cost, he bears the risk.
Scope Creep is an inherent drawback of a Cost Reimbursement
Contract, especially when there is no clarity in the requirements.
The seller will always try to elevate the cost because it will be tied
to some sort of fee. However, this difficulty can be minimized with
proper management of the contract and capping the sellers
profit; e.g. 10% of the total cost.
Project Procurement Management

Cost-Reimbursable Contracts

Cost Plus Fixed Fee (CPFF) Contracts


Cost Plus Incentive Fee (CPIF) Contracts
Cost Plus Award Fee (CPAF) Contracts
Cost Contracts
Cost Plus Percentage of Cost (CPPC)
Project Procurement Management

Cost Plus Fixed Fee Contract (CPFF)

In this type of contract, the seller is paid for all his


cost incurred plus a fixed fee (which will not
change), regardless of his performance. Here, the
buyer bears the risk.
This type of contract is used in projects where risk
is high, and no one is interested in bidding.
Therefore, this type of contract is selected to keep
the seller safe from risks.
Example: Total cost plus $25,000 USD as a fee.
Project Procurement Management

Cost Plus Incentive Fee Contract (CPIF)


In a Cost Plus Incentive Fee Contract, the seller will be reimbursed
for all costs plus an incentive fee based upon achieving certain
performance objectives mentioned in the contract. This incentive
will be calculated by using an agreed predetermined formula.
Here the risk also lies with the buyer; however, this risk is lower
than the Cost Plus Fixed Fee contract where the buyer has to pay
a fixed fee along with the cost incurred.
In a Cost Plus Incentive Fee contract, the incentive is a motivating
factor for the seller. If the seller is able to complete the work with
less cost or able to complete it before time, he may get some
incentive.
Most of the time incentive is a percentage of the savings, which is
shared by the buyer and the seller.
Example: If the project is completed with lesser cost, 25% of
remaining fund will be given to the seller.
Project Procurement Management

Cost Plus Award Fee (CPAF)


Here, the seller is paid for all his legitimate costs plus some
award fee. This award fee will be based on achieving
satisfaction on the certain performance objectives described
in the contract.
The evaluation of performance is a subjective matter, and
you cannot appeal it.
There is a difference between the incentive fee and the
award fee. An incentive fee is calculated based on a formula
defined in the contract, and is an objective evaluation. An
award fee is dependent on the satisfaction of the client and is
evaluated subjectively. Award fee is not subjected to an
appeal.
Example: If the seller completes the task meeting or
exceeding all quality standards, based on his performance he
may be given an award of up to $10,000 USD.
Project Procurement Management

Cost Plus Percentage of Cost (CPPC)

Here the seller is paid for all costs incurred plus a


percentage of these costs. This type of contract is
not preferred, because the seller might artificially
increase the cost to earn a higher profit.
Example: Total cost plus 15% of cost as a fee to
contractor.
Project Procurement Management

CPFF vs CPPC

Cost Plus Fixed Fee Cost Plus % Cost


Estimate cost = $100 Estimate cost = $100
Fixed fee = $10 Fixed % = 10%

CPFF CPPC
Actual $80 $100 $120 Actual $80 $100 $120
Cost Cost
Fee $10 $10 $10 Fee $8 $10 $12
Actual $90 $110 $130 Actual $88 $110 $132
Price Price
Project Procurement Management

Contract Types vs Risks

Buyer risk
High Low

CPFF CPIF FPIF FFP


Cost Plus Cost Plus Fixed Price Firm
Fixed Incentive Incentive Fixed
Fee Fee Fee Price

Low High
Seller risk
Project Procurement Management

Fixed Price vs. Cost Reimbursable

Fixed Price Cost Reimbursable


Seller assumes risks Buyer assumes risks
Contract includes anticipated Contractor is paid cost plus an
profits additional amount for overhead
and profit
Contractor is independent and Buyer may direct work
performs the work as it sees fit
Scope of work is clearly The scope of work/cost may
defined to enable and accurate not be clearly defined
estimate
Project Procurement Management

Time and Material Contract

This is a hybrid contract of Fixed Price and Cost


Reimbursable Contracts. Here the risk is distributed to
both parties.
Time and Materials type of contract is generally used
when the deliverable is labor hours. In this type of
contract, the project manager or the organization will
provide the qualification or experience to the contractor to
provide the staff.
This type of contract is used to hire some experts or any
outside support. Here the buyer can specify the hourly
rate for the labor with a not-to-exceed limit.
Example: Technician will be paid $20 USD per hour.
Project Procurement Management

Procurement Management Plan

The procurement management plan can include guidance


for:
Types of contracts to be used
Risk management issues
Whether independent estimates will be used and
whether they are needed as evaluation criteria
Those actions the project management team can take
unilaterally, if the performing organization has a
prescribed procurement, contracting or purchasing
department
Standardized procurement documents, if needed;
Managing multiple suppliers
Project Procurement Management

Procurement Management Plan


(continued)
Coordinating procurement with other project aspects, such
as scheduling and performance reporting
Any constraints and assumptions that could affect planned
procurements
Handling the long lead times to purchase certain items from
sellers and coordinating the extra time needed to procure
these items with the development of the project schedule
Handling the make-or-buy decisions and linking them into
the Estimate Activity Resources and Develop Schedule
processes
Setting the scheduled dates in each contract for the contract
deliverables and coordinating with the schedule
development and control processes
Project Procurement Management

Procurement Management Plan


(continued)

Identifying requirements for performance bonds or


insurance contracts to mitigate some forms of project
risk
Establishing the direction to be provided to the sellers
on developing and maintaining a work breakdown
structure (WBS)
Establishing the form and format to be used for the
procurement/contract statements of work
Identifying prequalified sellers, if any, to be used
Procurement metrics to be used to manage contracts
and evaluate sellers.
Project Procurement Management

Procurement Statement of Work

Once the decision has been made to procure goods or


services from an outside source, the project manager has
to facilitate creating a plan for how the procurement
process will proceed (a procurement management plan)
and will create description of the work to be done by the
seller (Procurement Statement of Work Procurement
SoW).
The Procurement Statement of Work must be as clear,
complete and concise as possible, and it must describe all
the work and activities that the seller is required to
complete.
Procurement SoW is a project document.
Project Procurement Management

Procurement Documents
Procurement manager has to determine what type of
contract and procurement document should be used.
The most common procurement documents are:
Request for Proposal (RFP)
- Asks for the price and how/who will do the work
Initiation for Bid (IFB)
- One simple price to do the work
Request for Quotes (RFQ)
- Price per unit quote
Project Procurement Management

Source Selection Criteria


Some possible source selection criteria are:

Understanding of need. How well does the sellers


proposal address the procurement statement of work?
Overall or life-cycle cost. Will the selected seller
produce the lowest total cost of ownership (purchase cost
plus operating cost)?
Technical capability. Does the seller have, or can the
seller be reasonably expected to acquire, the technical
skills and knowledge needed?
Risk. How much risk is embedded in the statement of
work, how much risk will be assigned to the selected
seller and how does the seller mitigate risk?
Project Procurement Management

Source Selection Criteria


(continued)

Management approach. Does the seller have or can the


seller be reasonably expected to develop, management
processes and procedures to ensure a successful
project?
Technical approach. Do the sellers proposed technical
methodologies, techniques, solutions and services meet
the procurement documents requirements or are they
likely to provide more or less than the expected results?
Warranty. What does the seller propose to warrant for
the final product and through what time period?
Financial capacity. Does the seller have or can the
seller reasonably be expected to obtain, the necessary
financial resources?
Project Procurement Management

Source Selection Criteria


(continued)

Production capacity and interest. Does the seller


have the capacity and interest to meet potential future
requirements?
Business size and type. Does the sellers enterprise
meet a specific category of business such as small
business (disadvantaged, specific programs, etc.) as
defined by the organization or established by
governmental agency and set forth as a condition of
the agreement award?
Past performance of sellers. What has been the
past experience with selected sellers?
Project Procurement Management

Source Selection Criteria


(continued)

References. Can the seller provide references from


prior customers verifying the sellers work experience
and compliance with contractual requirements?
Intellectual property rights. Does the seller assert
intellectual property rights in the work processes or
services they will use or in the products they will
produce for the project?
Proprietary rights. Does the seller assert
proprietary rights in the work processes or services
they will use or in the products they will produce for
the project?
Project Procurement Management

Conduct Procurements
Inputs Tools & Techniques Outputs

Procurement Bidder conference Selected seller


management plan
Proposal Agreements
Requirement evaluation
documents Resource
techniques calendars
Source selection Independent
criteria Change requests
estimates
Seller proposals Project
Expert judgment management plan
Project documents Advertising updates
Make-or-buy decisions Analytical Project documents
Procurement techniques updates
statement of work Procurement
OPA negotiations
Project Procurement Management

Control Procurements
Inputs Tools & Techniques Outputs

Project Contract change Work


management plan control system performance
Requirement information
Procurement
documents performance reviews Change requests
Agreements Inspections and Project
Approved change audits management plan
requests updates
Performance
Work reporting Project
performance documents
Payment systems updates
reports
Clams administration OPA updates
Work
performance data Records
management system
Project Procurement Management

Procurement Terms

Arbitration Third party dispute resolution


Breach/Default When a contract provision is not
met
Force Majeure Riots, wars, weather, or other
Acts of God
Indemnification Who is liable
Liquidated Damages Estimated damages for
specific types of defaults as defined in the contract
Material Breach A violation of the contract of
sufficient magnitude that the contract cannot be
completed
Project Procurement Management

Procurement Terms

Retainage Monies withheld to ensure performance


at the end of the contract
Termination Stopping the work before it is
completed
Waiver Statements in the contract that indicate that
rights cannot be ignored or modified without written
agreement between the two parties
Time is of the essence Seller is placed on notice
that delivery agreements are strictly binding
Work for Hire At the end of the contract the work
product generated will be owned by the buyer
Project Procurement Management

Procurement Terms

Sole Source refers to a market condition in which


only one qualified seller exists in the market.
Single Source refers to a market condition in
which the company prefers to contract with only
one seller.
Oligopoly refers to a market condition where very
few sellers exist, and the action of one seller will
have impact on other seller prizes.
Contract Work Breakdown Structure (CWBS): A
portion of the work breakdown structure for the
project developed and maintained by a seller
contracting to provide a subproject or project
component.
Project Procurement Management

Negotiating Tactics

Attacks Argue a point Fair and Reasonable


Personal Insults Attack Delay Tabling issues
other sides negotiator important to the other side
Good Guy/Bad Guy Extreme Demands
Deadline The offer stands Withdrawal Feigning
until interest
Lying Fait Accompli Done
Limited Authority Deal, this is how we have
I need to check with Mrs. XYZ to do it.
Missing Man She is out
today, I will have to get back
tomorrow

These are all tactics, but not necessarily good tactics!


Point of Total Assumption
Project Procurement Management

Point of Total Assumption

PTA is amount above which the seller bears all the loss of
a cost overrun.

PTA = [(Ceiling price Target price) / Buyers share ratio] +

+ Target cost
Exercise 1

A cost-plus-percentage-cost (CPPC) contract has


an estimated cost of $120,000 with an agreed
profit of 10% of the costs. The actual cost of the
project is $130,000. What is the total
reimbursement to the seller?
Exercise 1 Solution

Estimated Cost = $120,000


Actual Cost = $130,000
Agreed Profit = 10%

Reimbursement amount=
Actual cost + % profit of actual cost =
$130,000 + (10% of $130,000) = $143,000
Exercise 2

A cost-plus-incentive-fee (CPIF) contract has an


estimated cost of $150,000 with a
predetermined fee of $15,000 and a share ratio
of 80/20. The actual costs of the project is
$130,000. How much profit does the seller
make?
Exercise 2 Solution

Estimated Cost = $150,000


Predetermined fee = $15,000
Share Ratio = 80/20 (80 is for the Buyer and 20 is for
the Seller)
Actual Cost = $130,000
Saving = Estimated Cost - Actual Cost = $20,000

Profit to Seller is =
Predetermined fee + (Share ratio of Seller * Savings) =
$15,000 + (20% * $20,000) = $19,000

Final cost of contract = $130,000 + $19,000 = $149,000


Exercise 3

A Fixed-Price-Plus-Incentive-Fee (FPIF) contract


has a target cost of $130,000, a target profit of
$15,000, a target price of $145,000, a ceiling price
of $160,000, and a share ratio of 80/20. The actual
cost of the project was $150,000. How much profit
does the seller make?
Exercise 3 Solution
Target Cost = 130,000
Target Profit (Fee) = $15,000
Target Price = 145,000
Ceiling Price = $160,000
Share Ratio = 80/20 (80 is for the Buyer and 20 is for the Seller)
Actual Cost = $150,000
Here, the actual cost is less than the ceiling price and is more than the
target cost.

Final Fee = [(Target cost - Actual Cost) * Seller ratio] + Target fee =
= (($130,000 - $150,000)*20% + $15,000 = (- $20,000*20%) + $15,000 =
= - $4,000 + $15,000 = $11,000;
Final Price = Actual cost + Final Fee = $150,000 + $11,000 = $161,000.
But this is more than the ceiling price which is $160,000. So the final price
which the seller gets is $160,000.
So the profit that seller gets is $160,000 - $150,000= $10,000
Exercise 4

A project is contracted as a Time & Material


(T&M) type of contract. The service provider
initially estimates that the total effort involved
would be about 1000 hours of effort. The project is
contracted at a rate of US$ 75 per hour of effort. If
the project ended up with 1200 hours of effort,
what would the contract payout be.
Exercise 4 Solution

Since this is a T&M contract, the contract is open-


ended in value.
Hence the contract value is the actual effort
multiplied by the agreed rate = $ 75 1200 =
$ 90,000.
Exercise 5

A project is contracted as a Cost-Plus-Incentive-


Fee (CPIF) type of contract. The project is
negotiated such that if the final costs are less than
expected costs, the sharing formula for cost
savings is 75:25. The targeted cost is $100,000
with an 8% incentive fee on the targeted cost. If
the project comes in at $80,000, what would be the
cost of the total contract?
Exercise 5 Solution

Incentive fee based on budgeted costs =


8% of $100,000 = $8,000
Actual costs = $80,000
Cost saving = $100,000 - $80,000 = $20,000
Share of cost savings = 25% of $20,000 =
$5,000

Hence the cost of the total contract will be


= $80,000 + $8,000 + $5,000 = $ 93,000.
Exercise 6

A project is contracted as a Cost-Plus-Fixed-Fee


(CPFF) type of contract. The targeted cost is
$200,000 with a fee of $30,000. If the project
comes in at $170,000, what would be the cost of
the total contract?
Exercise 6 Solution

In a Cost-Plus-Fixed-Fee (CPFF) type of contract, the


seller is reimbursed for allowable costs and receives
a fixed fee payment calculated as a percentage of
the estimated project costs. The fixed fee does not
vary with actual costs unless the project scope
changes.
In the current scenario, the fixed fee is fixed up as
$30,000. Although the actual project comes in at
$170,000, the fixed fee remains the same.
Hence the total cost to the project will be
$170,000 + $30,000 = $200,000.
Exercise 7

A project is contracted as a Cost-Plus-Incentive-


Fee (CPIF) type of contract. The project is
negotiated such that if the final costs are less
than expected costs, the sharing formula for
cost savings is 80:20. The targeted cost is US$
500,000 with a 10% fee. If the project comes in
at US$ 450,000, what would be the cost of the
total contract?
Exercise 7 Solution

In some cases, if the final costs are less than the


expected costs, then both the buyer and the seller
benefit from the cost savings based on a pre-
negotiated sharing formula.
In the current situation, the predetermined fee is
10% of $500,000 = $ 50,000. Since the project
came in at $450,000, the savings is $500,000 -
$450,000 = $50,000. The sharing formula is 80:20,
hence the additional payout to the seller = (20/100)
* $50,000 = $10,000.
Hence the value of the total contract, i.e. money
that will earn the seller
= $450,000 + $50,000 + $10,000 = $ 510,000.