Order 1328631: Project Management

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11/21/18

Project Management Class – 11

Procurement and Contracts

Learning Outcomes

Ø Understanding project procurement management Ø Identifying key procurement categories Ø Following an appropriate procurement process Ø Selecting appropriate contract types Ø Soliciting responses and selecting sellers Ø Administering and closing contracts Ø Understanding ethical concerns

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Why Outsourcing?

Ø You are a PM in a “new office construction project”.

Ø The level 1 activities may include: § Excavation foundation § Concrete foundation § Building and roofing § Electrical and lighting § Plumbing and piping § Energy systems (heating, cooling, water unit)

Ø Your company is not expert (has not enough experience) in electrical and lighting!

Ø Outsource or insource?

Outsourcing Pros vs. Cons

Ø Some common reasons for make-buy decisions at this level follow: § Delivery failure or poor service by existing source § To allow the client organization to focus on its core business § Gain access to world class capabilities § Reduced capital requirements and staff costs § Pressure to reduce costs

Ø Some problems with outsourcing § Long term commitment § Communication with suppliers § Dependence on suppliers § Lack of control over supplier and quality of work

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Procurement & Project Procurement Management

Ø Procurement is the act of finding, acquiring, buying goods, services or works from an external source, often via a tendering or competitive bidding process. (Wikipedia)

Ø Project Procurement Management includes the processes required to acquire goods and services, to attain project scope, from outside the performing organization. (PMBOK® Guide). § Project Procurement Management is typically discussed from the perspective of the project

team as the buyer in the buyer-seller relationship.

§ However, the project team could also be selling the project deliverables to an external client.

Ø Depending on the application area, the seller may be called a contractor, subcontractor, vendor, or supplier.

Ø For simplicity, goods and services will generally be referred to as a product.

Tendering: make a formal written offer to carry out work, supply goods, or buy land, shares, or another asset for a stated fixed price.

Procurement Categories

Ø Not all project procurements are created equal;

§ Some purchases are big, others are small

§ Some procurements carry high risks, other have only minimal/no risks

§ Some requires a major long-term commitment from seller, but some are immediately available for purchase in the open market

Ø Why place these various procurements into different categories? § You manage project procurements differently, according to their

complexity, their risks, their unique characteristics.

Fleming, Quentin W. Project procurement management: contracting, subcontracting, teaming. Fmc Press, 2003. 6

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Major Complexity Procurement

Ø Major (high risk) complexity procurement involves the purchase of something which does not exist, and is tailored to the project's unique specification.

Ø They represent high risks to the project’s technical, quality, costs, and schedule.

Ø They often require the creation of something new by a seller: § It may push the state of the technical art

ü The development of a new radar system ü The development of a new computer software program ü The design and development of a new airplane

§ It may be technically routine, but had never been done before ü Design and construction of a new production factory ü The architectural design of a new commercial centre

Fleming, Quentin W. Project procurement management: contracting, subcontracting, teaming. Fmc Press, 2003. 7

Minor Complexity Procurement

Ø Minor (low risk) complexity procurements will often represent large monetary values, but the commodities exist and will conform to the sellers existing product specification.

Ø Early identification of these items is important in order to properly schedule lead-times for each item and to budget the necessary funds for them.

Ø Some examples are § The purchase of existing automobiles, buses, and transportation vehicles § The purchase of an existing radar system § The purchase of large electrical generators § The purchase of existing but high value software § The purchase of existing computers

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Routine Buys of Commercial-Off-The-Shelf (COTS)

Ø It involves the purchase of substantial amounts of materials that are often commercially available as “off-the-shelf” articles, or routine services.

Ø The early identification of these procurements is typically not vital to the success of the project.

Ø Some examples are § Purchased labor, which will brought in plant and supervised by the project’s staff § Purchased services, such as testing § Raw materials: nuts, bolts, fasteners, sheet metal, paints § Office supplies and equipment: existing computers, printers, scanners § Outsourced services, such as cafeteria, security, and accounting

Procurement Risks

1. The risks associated with technical, quality, or performance Ø The possibility that the item being developed or procured will not perform

to the levels needed by the project. 2. The risks with schedule performance Ø The possibility that a critical item needed by the project will not be available

in the time-frame needed. Ø The technical risks may also cause adverse impact on the project schedule 3. The risks with cost performance Ø The possibility that the costs of the critical items will exceed that which has

been estimated, and budgeted.

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Project Procurement Management Processes Pr oj ec t Pr oc ur em

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M an

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1. Procurement Planning

2. Solicitation Planning

3. Solicitation

4. Source Selection

5. Contract Administration 6. Contract Close-out

Determining what to procure and when

Documenting product requirements and identifying potential sources Obtaining quotations, bids, offers, or proposals, as appropriate

Choosing from among potential sellers

Managing the relationship with the seller

Completion and settlement of the contract 11

1. Procurement

Planning

Ø Procurement planning involves identifying which project needs can be best met by using products or services outside the organization.

Ø It includes deciding § Whether to procure § What to procure § How to procure § How much to procure § When to procure

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Tools and Techniques for Procurement Planning Make or Buy Analysis

Ø Used to determine whether a practical product can be produced by the performing organization or purchased from someone else.

Ø Often involves financial analysis: § The possible increase in risk incurred by using a third party § Both direct and indirect costs § Prospective as well as the immediate needs of performing organization § For example:

§ Whether a capital good item can be used for other current or future projects of the organization

§ Whether additional capacity is available for use within the organization

Capital goods: goods that are used in producing other goods, rather than being bought by consumers.

Tools and Techniques for Procurement Planning Make or Buy Analysis

Ø You are considering whether to buy or make a software product: § If you buy, the cost is $80,000, and the cost of procurement and integrating

your company is $1,000.

§ If you want to make it yourself, the product will require seven software engineers working three months. Salary of each software engineer is $4,000 per month. The overhead costs apportioned to the project will be $2,000.

Ø Which option will you choose; make or buy? § If you buy => $80,000 + $1,000 = $81,000 § If you make => $4,000 * 7 * 3 + $2,000 = $86,000 § It is better to buy.

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2. Solicitation Planning

Ø Solicitation planning: documenting product requirements and identifying potential sources

Ø It involves preparing 1. Procurement documents: are used to solicit proposals from prospective

sellers. § Requests for Quotes (RFQ): used to solicit quotes for well-defined procurements (the

source selection is based on price) § Request for Proposals (RFP): used to solicit proposals from prospective sellers where

there are several ways to meet the sellers’ needs (the source selection is based on technical skills and technical approach)

§ Request for Information (RFP): used to obtain information from prospective sellers as to what products or services are available. Often used to build a list of sellers to sent a RFP to.

§ Invitations for Bid (IFB): an invitation to contractors or equipment suppliers to submit an offer on a specific project

2. Solicitation Planning (Cont.)

2. Evaluation Criteria § Used to rate or score proposals. § They can be objective (the proposed PM must be a certified PMP) or subjective

(the proposed PM must have previous experience with similar projects) § Evaluation criteria may be limited to purchase price if the item is readily

available from a number of acceptable sources. § Other selection criteria:

§ Technical capability: does the seller have the technical skills and knowledge needed? § Overall or life-cycle cost: will the selected seller produce the lowest total cost (purchase

cost plus operating cost) § Financial capacity: does the seller have, or can the seller reasonably be expected to obtain,

the necessary financial resources?

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3. Solicitation

Ø Solicitation involves obtaining responses (bids and proposals) from prospective sellers on how project needs can be met.

Ø Most of the effort in this process is expended by the prospective sellers, normally at no cost to the project.

Ø Tools and techniques: 1. Bidder conferences:

§ Meetings with prospective sellers prior to preparation of a proposal. § Provide assurance that all of the bidders clearly understand the requirements

of the RFP 2. Advertising

§ Expanding the list of potential sellers by placing advertisements in general circulation publications

4. Source Selection

Ø Source selection involves the receipt of bids or proposals and the application of the evaluation criteria to select a provider.

Ø Price may be the primary determinant, but the lowest proposed price may not be the lowest cost, e.g., the lowest-price seller is unable to deliver the product in a timely fashion

Ø Proposals are often separated into technical (approach) and commercial (price) sections with each evaluated separately

Ø A weighting system may be used to § Select a single source to sign a standard contract § Rank order all proposals to establish a negotiating sequence

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Tools and Techniques for Source Selection

Ø Contract negotiation: involves clarification and mutual agreement on the structure and requirements of the contract prior to the signing of the contract.

Ø Weighting system: a method for quantifying qualitative data to minimize the effect of personal prejudice on source selection. It usually involves: § Assigning a numerical weight to each of the evaluation criteria § Rating the prospective sellers on each criterion § Multiplying the weight by the rating § Totaling the resultant products to compute an overall score

Ø Independent estimates: The procuring organization may prepare its own independent estimates as a check on proposed pricing. § Significant differences from these estimates may be an indication that the SOW was

not adequate, or the prospective seller failed to respond fully to the SOW Ø Best and final offer (BAFO): The procuring buyer who has received several

offers will ask either all bidders or the top bidders to submit their best and final offers.

Weighted Scoring System: Evaluation Criteria

Category Category Components Weight Scoring Seller price Labour, material, overhead, and

local taxes costs 35% 0: Not provided; 1: >$100,000; 2:

50,000 to 100,000; 3: <50,000 Delivery costs All transportation costs from seller

to destination, packaging costs 5% 0: Not provided; 1: >$10,000; 2:

5,000 to 10,000; 3: <5,000 Quality costs Cost of inspection, rework, product

returns 10% 0: Not provided; 1: >$10,000; 2:

5,000 to 10,000; 3: <5,000 Reputation Reputation impact of performance

problems 20% 0: Very bad; 1: Bad; 2: No impact;

3: Improvement Other costs Exchange rate trends, taxes, duties 5% 0: Not provided; 1: >$100,000; 2:

50,000 to 100,000; 3: <50,000 Seller capabilities

Replenishment lead time, flexibility, information coordination capability

25% 0: Very bad; 1: Bad; 2: No impact; 3: Good

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Weighted Scoring System: Sellers

Ø 3 sellers have responded to your RFP: § Apex: The low cost, low quality startup provider at $40,000 based

in a nearby community § Big Guy: The market leader located in Europe with a cost of

$110,000, with an excellent reputation § Cammon: Based on Canada but on the other side of the country,

gaining market share and having growing problems with a cost of $60,000

Ø Which one do you pick?

Weighted Scoring System: Scoring Results

Criteria Weight Apex Big Guy Cammon Price 35% 3 1 2 Delivery Costs 5% 3 1 2 Quality Costs 10% 1 3 2 Reputation 20% 1 3 2 Other costs 5% 3 1 3 Seller Capabilities 25% 1 3 1 Weighted Total 100% 1.9 2.1 1.8

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5. Contract Administration The Contract Ø In order for a contract to be formed all three of the following required

elements must be present:

Contract = Offer + Acceptance + Consideration

Ø Contracts include: § Technical, management and commercial requirements § Specific descriptions of technical and management programs § The proposed prices

The Contract Example

Ø Person A approaches Person B and states, “I’d like to rent your 300 acres to plant corn and I will pay 40% of the input costs and receive 40% of the profits.” Person B agrees to Person A’s terms.

Ø In this Example, the Person A makes the offer and Person B accepts the offer.

Ø Person A’s consideration is that she will pay 40% of the input costs and 60% of the profits to Person B.

Ø Person B’s consideration is agreeing to Person A renting his land and paying 60% of the input costs.

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Key Contract Terms

Ø A project manager needs to be familiar with the contract, in particular some key terms:

§ Payment Terms: How does the seller get paid? What is the buyers responsibilities?

§ Termination: How can the contract be terminated? What happens when the contract is terminated? What are the warranty conditions?

§ Insurance, Bonds: What type of insurance and performance bonds are required?

§ Confidentiality: What are the requirement to protect confidential information?

§ IP ownership: Who owns the intellectual property created during the execution of the contract?

Contract Type Selection

1. Fixed price or lump sum: Involves a fixed total price for a well-defined product or service

Ø May include incentives for meeting project objectives such as schedule

2. Cost reimbursable: Involves payment (reimbursement) to the seller for its actual costs, plus a fee representing seller profit.

3. Time and material: Hybrid of fixed price and cost-plus contracts Ø Open ended, as full value of the contract is not defined at the time of award

4. Guaranteed maximum price: Protects buyer from excessive costs, and can also motivate buyer and seller to identify and share cost savings

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1. Firm Fixed Price – FFP

Firm Fixed Price Contract Type: Ø Buyer pays the Seller for agreed costs for a well-

defined statement of work § Seller is assured that scope of work is fixed

Ø Buyer Exposure is constant (except for any changes) as Seller’s firm bid includes their estimated costs plus a fee

Ø Seller Exposure varies: Seller Fee increases if actual cost of work is lower, but Seller Loss occurs if actual costs are much higher than seller had estimated

Seller estimate

Buyer Exposure

Seller lossSeller

fee

Actual Cost of Work

Co nt ra ct E xp os ur e

Firm Fixed Price Conceptual View © Copyright D. C. Bower 2017

Buyer Exposure is the amount paid to the Seller. Seller Exposure is the amount that the Seller spends to accomplish the work in the contract.

Fixed Price Incentive Fee – FPIF

Ø Includes financial incentives for meeting or exceeding specific project objectives, such as a tight time schedule

Ø Similar to Firm Fixed Price (FFP): § Seller’s bid includes their estimated costs

plus an expected fee § Seller’s fee increases if actual cost of work

is lower, but becomes a loss if costs higher Ø Different from FFP: Seller’s fee also

increases if they complete the project according to an incentive in the contract, such as “before a stated deadline”.

Seller estimate

Buyer Exposure

Seller fee

Actual Cost of Work

Co nt ra ct E xp os ur e

Fixed Price Time Incentive Conceptual View

Incentive bonus

Buyer Base

Seller loss

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Seller loss

Fixed Price with Economic Price Adjustment (FP-EPA)

Ø Includes provisions for adjusting the final price due to changes in conditions

Ø May be linked to indices for currency exchange rates, interest rates, etc.

Ø Similar to Firm Fixed Price (FFP): § Seller’s bid includes their estimated costs

plus an expected fee § Seller’s fee increases if actual cost of work

is lower, but becomes a loss if costs higher Ø Different from FFP: Seller’s fee also

increases if specified conditions change, such as the cost of a key material

Seller estimate

Price adjusted per index

Seller fee

Actual Cost of Work

Co nt ra ct E xp os ur e

Fixed Price EPA Conceptual View

Buyer Base

Seller fixed fee

2. Cost Plus Fixed Fee (CPFF)

Cost Reimbursable Contract Type: Ø Buyer pays the Seller for agreed project costs plus a fixed-fee payment § Seller Fee is based on the estimated project

costs, estimated hours, complexity, etc. § Seller assumes little or no risk

Ø Seller Exposure is the actual cost of work Ø Buyer Exposure will vary directly with the actual cost of work § Buyer assumes a high degree of risk

Ø No motivation for the Seller to decrease actual costs, as its fee is constant

Estimated cost

Actual Cost of Work

Co nt ra ct E xp os ur e

Cost + Fixed Fee Conceptual View

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Cost Plus Incentive Fee (CPIF)

Ø CPIF is similar to Cost Plus Fixed Fee: § Seller Fee is based on the estimated project

costs, estimated hours, complexity, etc. § Seller assumes little or no risk

Ø Different from CPFF: § Buyer also pays the Seller a bonus that

varies with how much they achieve a specific objective such as cost, time, etc.

§ Example: if actual costs are below the seller’s estimate, then the Buyer and Seller will share those savings equally

Ø Both the Buyer and Seller benefit if the total costs are less than estimated

Seller fixed fee

Estimated cost

Actual Cost of Work

Co nt ra ct E xp os ur e

Cost + Incentive Fee Conceptual View

Incentive bonus

3. Time and Materials Contracts

Time & Materials Contract Type: Ø Buyer pays Seller for all costs they incur

§ Seller costs include their fees to cover overhead and profit; Seller assumes no risk

Ø Different from Cost Plus Fixed Fee: § Rates for labour and materials are fixed and

usually include the Seller’s fees

Ø Possible to convert to a fixed-price or cost- plus contract later, once project underway

Ø Upper cost limit for government contracts § Limitation on signing an open-ended contract

Upper cost limit

Seller labour and materials costs

Seller fees/profits

Actual Cost of Work

Co nt ra ct E xp os ur e

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4. Guaranteed Maximum Price (GMP)

Guaranteed Maximum Price Contract Type: Ø Similar to Cost Plus Fixed Fee: § Buyer pays the Seller for agreed project costs

plus a fixed-fee payment Ø Different from Cost Plus Fixed Fee: § Seller is subject to a ceiling price in the contract § Any savings are returned to the Buyer

Ø Seller Exposure is the actual cost of work § Seller incurs a loss if costs exceed ceiling price

Ø Buyer Exposure is limited to the ceiling § Buyer gains if actual cost is below ceiling price

Ceiling Price

Actual Cost of Work

Co nt ra ct E xp os ur e

Guaranteed Maximum Price (GMP) Conceptual View

Seller loss

Seller fixed fee

Reduced Seller fee

Guaranteed Maximum Price (GMP) Incentive Fee

Ø GMP – Incentive Fee is similar to GMP: § Buyer pays the Seller for agreed project costs

plus a fixed-fee payment § Seller Exposure is the actual cost of work § Seller incurs a loss if costs exceed ceiling price § Buyer Exposure is limited to the ceiling

Ø Different from regular GMP: § If actual cost of work is below ceiling price,

then Buyer and Seller share in the savings

Ø This contract arrangement encourages Buyer and Seller to identify cost savings

Ceiling Price

Actual Cost of Work

Co nt ra ct E xp os ur e

GMP with Incentive Fee Conceptual View

Seller loss

Seller incentive fee

Reduced Seller fee

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Buyer and Seller Contracts Risks

Ø The various contract types represent different levels of risk to the Buyer and Seller.

Ø FFP contract represents the lowest level of risk to the Buyer, but the highest level to the Seller.

Ø CPIF contract represents the lowest level of risk to the Seller (who will be reimburse for all costs and is eligible for an incentive fee) but the highest level of risk to the Buyer.

FFP (Firm Fixed Price)

FPIF (Fixed Price Incentive Fee)

T&M (Time and Material)

CPFF (Cost Plus Fixed Fee)

CPIF (Cost Plus Incentive Fee)

Ri sk t o B uy er

(o r D eg re e of U nc er ta in ty )

Risk to Seller (or Scope Information)

6. Contract Close-out

Ø Contract close-out includes § product verification to determine if all work was completed correctly and

satisfactorily § administrative activities to update records to reflect final results § archiving information for future use

Ø Procurement audits: Ø A tool for contract closeout Ø It is a structured review of the procurement process from procurement

planning through contract administration. Ø Following audit, the seller may receive a formal written notice that the

contract has been completed.

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Resolution of Contract Claims

Ø It is not uncommon that there are claims during the contract § Buyer claiming the product or service is not functional as required § Seller claiming the requirements have changed

Ø All contract claims must be resolved prior to contract close out. Ø Ways to resolve contract claims:

§ Negotiations: The buyer and seller enter into negotiations to resolve the disputes

§ Mediation: A mediator is engaged to find a middle-ground which both sides will accept as reasonable

§ Arbitration: More formal than mediation typically using a 3 member panel and can be binding on non-binding

§ Legal: Using the courts to resolve the dispute