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Monday, June 20, 2011

Chapter 44: Procuring the Project Resources

In the previous chapters, we have identified how many people are required to work on our project and the amount of money we can spend on the project. But, it frequently happens that we don't have all the necessary expertise to complete a project by the resources within our organization. In such a case, we may have to procure the services from a third party service provider. A simple example will be procuring Weblogic Servers to run the in-house web applications we are developing for our company. In this chapter, we are going to take a look at how we are going to handle procurement management as a process.

So, lets get started!!!

What is Procurement and Procurement Management?

Procurement refers to obtaining; purchasing or renting products, services, or results from outside the project team to complete the project. Accordingly, procurement management is an execution of a set of processes used to obtain (procure) the products, services, or results from outside the project team to complete the project. There are two main parties involved in procurement management:

• Buyer - The party purchasing (procuring) the product or service.
• Seller - The party delivering the product or service to the buyer.

To understand the process, look at the picture below:

As illustrated in the picture above, procurement management includes the following:

• Plan procurements - This is the process of making and documenting purchasing decisions, identifying potential sellers, and determining the approach toward these issues.
• Conduct procurements - This is the process of soliciting seller responses, selecting sellers, and awarding contracts.
• Administer procurements - This is the process of monitoring the contract execution, making approved changes and corrections, and managing relationships among the parties involved in the procurement.
• Close procurements - This is the process of completing each project procurement and giving it a proper closure as planned.

Planning for Procurement

Planning procurements includes making and documenting purchasing decisions, identifying potential sellers, and developing a procurement approach. Although the procurement planning should be done early in the project, like any other planning, it might be necessary at any stage of the project as the need arises due to approved changes or other circumstances.
Procurement is planned by performing the Plan Procurements process.

As shown in the picture above, during procurement planning, you will be looking at lots of information, such as the scope baseline, stakeholder requirements, partner agreements, risk registers, activity resource requirements, and cost baseline. All this information will help you identify what needs to be done to complete the project, what the risks involved are, and what needs to be procured. Enterprise environmental factors, such as market conditions, availability of the product in the market, past performance of potential suppliers, and unique local conditions, must be considered as input to this process. The organizational process assets that can influence procurement planning include procurement policies and procedures of the performing organization, a supplier system of already established sellers that the organization currently deals with, and an information system that can be used to develop the procurement management plan. You will also need to know how to make make-or-buy decisions and what the different contract types are.

Make-or-Buy Decisions

Obviously, procurement refers to buying something as compared to making it in-house. The decision to buy or make can be based on one or more of the reasons explained below:

Factor Reasons to make it In-House Reasons to Buy
Cost Less cost Less cost
Skills availability Use in-house skills In-house skills don’t exist or are not available
Skills acquisition Learn new skills that will be used even after this project These skills are not important to the organization
Risks Deal with the risk in-house Transfer the risk
Work Core project work Not core project work
Human resource availability Staff available Vendor available
Buy can mean to purchase or to rent. The decision to purchase or to rent should be based on the effective cost in the long term. For example, if it is a piece of hardware that will be used only in this project, you do not anticipate its use in any future project, and renting is significantly cheaper than buying, you should probably rent it. You might decide to buy it if this hardware is of common use in the kind of work your organization does and therefore it will be used in other projects as well.

An output of the procurement planning process is the statement of work (SOW), which is a document summarizing the work to be performed. The SOW can be written by the buyer or the seller to specify what products will be delivered or what services will be performed. It is also called the contract statement of work.

Before you can buy, you need to get information from the sellers. In other words, you need to request seller responses. Make-or-buy analysis is a technique used in the plan purchases and acquisitions process. Also in this process, you need to use a technique to determine the type of contract you will use for the procurement.

Making a decision of choosing the vendor to procure the service is not usually in a project manager’s hand. We can try to influence the project sponsor to choose a certain vendor but ultimately it is their decision. And almost always, the cost at which the vendor offers the service is one of the overwhelming factors that affect the decision by the project sponsor.

Determining Contract Types

A contract is a mutually binding agreement between a buyer and a seller that obligates the seller to provide the specified product, service, or result and obligates the buyer to make the payment for it. Contracts generally fall into the three categories discussed in this list.
Fixed-price contracts - A fixed-price contract, also called a lump-sum contract or a firm fixed-price contract or a fixed-bid contract, is an agreement that specifies the fixed total price for the product, service, or result to be procured. An example of a fixed-price contract is a purchase order for the specified item to be delivered by a specified date for a specified price. This category of contracts is generally used for products and services that are well-defined and have good historical information. A fixed-price contract for a poorly defined product or a service with very little historical record is a source of high risk for both the seller and the buyer.

Cost-reimbursable contracts - A contract in this category includes two kinds of costs:
• Actual cost - This is the payment (reimbursement) to the seller for the actual cost of the item, which includes the direct cost and the indirect cost (overhead). An actual cost, such as the salary of the project staff working on the item, is incurred directly from the work on the item, whereas an indirect cost, such as the cost of utilities and equipment for the office of the staff member, is the cost of doing business. Indirect cost is generally calculated as a percentage of the actual cost. The actual cost is also called the project cost. The project here refers to the project of the seller to produce the items for the buyer.
• Fee - This typically represents the seller’s profit.
As discussed in the following list, there are three types of cost-reimbursable contracts:
• Cost plus fee (CPF) or cost plus percentage of cost (CPPC) - The payment to the seller includes the actual cost and the fee, which is a percentage of the actual cost. Note that the fee is not fixed; it varies with the actual cost.
• Cost plus fixed fee (CPFF) - The payment to the seller includes the actual cost and a fixed fee, which can be calculated as a percentage of the estimated project cost. Note that the fee is fixed and does not vary with the actual project cost.
• Cost plus incentive fee (CPIF) - The payment to the seller includes the actual cost and a predetermined incentive bonus based on achieving certain objectives.

Both fixed-price contracts and cost-reimbursable contracts can optionally include incentives; for example, a bonus from the buyer to the seller if the seller meets certain target schedule dates or exceeds some other predetermined expectations.

Because cost overrun can occur in any type of cost-reimbursable contract, and the cost overrun will be paid by the buyer, this category of contract poses risk to the buyer.

Time and material (T&M) contracts - This type of contract is based on the rates of time and materials used to produce the procured product. This is a hybrid that contains some aspects from both the fixed-price category and the cost-reimbursable category. The contracts in this category resemble the contracts in the cost-reimbursable category because the total cost and the exact quantity of the items is not fixed at the time of the agreement. The contracts resemble fixed-price contracts because the unit rates can be fixed in the contract. These types of contracts are useful when you do not know the quantity of the procured items. For example, you do not know how much time a contract programmer will take to develop a software program, so you determine the hourly rate in the contract, but not the total cost for writing the program. In this category of contracts, the risk is high for the buyer because the buyer agreed to pay for all the time the seller takes to produce the deliverables.

Before we wrap up this chapter, lets take a look at who bears the risk in these different types of contracts we just discussed.

Contract Type Risk Bearer Justificiation/Explanation
Fixed price (FP) Buyer and seller The cost overrun is borne by the seller, whereas the price fixed higher than the actual cost hurts the buyer.
Time and Material (T&M) Buyer The increased cost due to the increased quantity of resources, such as work hours by a contractor, is borne by the buyer.
Cost plus fixed fee (CPFF) Buyer Cost overrun is paid by the buyer.
Cost plus percentage of cost (CPPC) Buyer Cost overrun is paid by the buyer. Because the fee increases with the increase in cost, this type poses maximum risk to the buyer.
Cost plus incentive fee (CPIF) Buyer Cost overrun is paid by the buyer.
The major output of procurement planning is the procurement management plan which outlines the plan with which the process of Procurement of services for our project will be managed. We will cover this exclusively in the next chapter.

Prev: Estimating Costs & Determining Budgets

Next: Procurement Management Plan

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