Complete Web Exercise 12.6? Upload your work via files as instructed.? In case the link in the book does not work properly,? this link will take you directly to the hardware PDF http://www.

procurement

Obtaining goods and services from providers outside the organization.

self-performed

Work done by members of the organization rather than outsiders.

outsourced

Services or products provided by another company.

CHAPTER 12

Project Procurement

To achieve the objectives of the project, the management team will typically purchase goods and some services. The process of obtaining goods and services from providers who are outside of the organization is procurement. This chapter discusses the process for selecting the work that will be procured and the different methods and processes for procuring the equipment, materials, and ser- vices for the project.

12.1 Identifying the Need for Resources Outside the Organization

Learning Objectives

1. Identify the factors that are considered when deciding whether to buy goods from within the organization or to obtain them from outsiders.

2. Identify what factors are considered when deciding to outsource or perform the work within the organization.

The project team decides the work that will be self-performed—performed by members of the pro- ject team—and the work that will be outsourced to others. The procurement strategy focuses on the work to be outsourced—performed by outsiders and the purchase of the goods and services needed by the project.

Luu, Ng, and Chen[1] studied project procurement selection priorities and identified budget and schedule as the most important considerations in the decision to outsource activities. This study of construction projects also identified other items that project managers must consider in develop- ing a procurement strategy, including quality, risk, complexity, and flexibility. Some outsourcing decisions are easy.

Outsourcing Steel and Concrete in New York

A construction company has a contract to build a large building in downtown New York. Most, if not all, the construction materials, such as steel and concrete, will be purchased from companies that specialize in steel and concrete. Existing companies that produce and sell steel can provide the steel the project needs at a much lower cost and faster than if the project manager’s organi- zation attempted to build the capacity itself.

Some outsourcing decisions—sometimes called make or buy decisions—are more difficult. On the same building construction project, new construction materials and methods are required that will make the building more energy efficient. The project manager can outsource this portion of the project to companies that have this expertise or develop this expertise on the project and self-

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FIGURE 12.1 Outsourcing supply of construction materials.

© 2010 Jupiterimages Corporation

perform the work. The costs of developing this expertise within the project will be more expensive and may take more time than outsourcing this work.

Self-performing this work also has benefits. The project team would develop this expertise and the additional expertise would add value to the parent company and save money on future pro- jects. The project management team would have greater control over the work because the work would be performed by members of the project team instead of outsiders. Self-performing and out- sourcing the work have both benefits and risks.

This decision is primarily influenced by the following:

• Cost (budget)

• Schedule

The following factors also influence outsourcing decisions:

• Risk

• Quality

• Flexibility

Outsourcing Versus Self-Performing

On the New York building construction project, the project manager decided to outsource the portion of the work that required new methods and materials. The project team assigned engi- neers from the project team to evaluate the work during the project and to assess the appropriate methods and costs for the parent company to develop this capacity within the company. The additional costs of developing the capacity and the additional risks of implementing a new method with existing resources outweighed the benefits of developing the capacity within the organization.

The project procurement strategy begins with these self-perform or buy decisions.

New York Construction Project

On the New York building construction project, the basic engineering and construction activities are core expertise of the parent company, and the project team had access to the qualified resources to perform the work. The decision to self-perform this portion of the work was easy because the company had a cost and schedule advantage by using the existing resources. The purchase of the steel, concrete, and other commodities was also easy because the costs of developing those resources far outweighed the benefit of purchasing them.

Some of the procurement decisions are not so obvious and the project team evaluates the cost, schedule, quality, flexibility, and risk implication of self-performing versus outsourcing the work.

Key Takeaways

• The factors that influence procurement are primarily cost and schedule but also include risk, quality, and flexibility.

• To determine whether to outsource or do the work within the organization, consider which option is less costly and which option can deliver the work on time.

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commodities

Items that can be bought off the shelf with no special modification for the project.

supplier

Source of commodities.

Exercises

1. The primary factors that influence procurement are cost and ____________.

2. In addition to the two primary factors that influence procurement, what are three other impor- tant factors?

3. What is one advantage of doing the work within the organization instead of outsourcing it?

Internalize your learning experience by preparing to discuss the following.

Choose a situation with which you are familiar where you or your organization chose to hire someone outside your organization instead of developing the skill yourselves. What factors were most important in making the choice, and how do they relate to the factors described in this section?

12.2 Procurement Plan

Learning Objectives

1. Describe the role of suppliers.

2. Describe the role of vendors.

3. Describe the role of partners.

After the outsourcing versus self-performing decisions are made, the procurement team develops the purchasing plan.

The method of purchasing products or services depends on the uniqueness and importance of the product or service. One way to organize the procurement plan is by the type of relationship with the providers of the outsourced goods or services.

Suppliers

Some of the goods or services are commonly available with little variation in quality or availability. Such goods and services are called commodities. The providers of commodities are suppliers and there are usually several from which to choose. Purchasing commodities from suppliers focuses on achieving the lowest cost. Cost of commodities can often be found in the supplier’s catalog. On smaller, less complex projects, supplies can be purchased as needed from the supplier’s catalog.

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request for quote (RFQ)

Requires a bidder to provide a price and additional information for a defined scope of work.

bid

An offer to provide something of value for compensation. A bid can be written or verbal and can be in response to a solicitation or unsolicited.

FIGURE 12.2 Commodities purchased from a supplier using an RFQ.

© 2010 Jupiterimages Corporation

key supplier

A person or organization supplying goods or services to the project that has a special relationship with the project or parent organization and might bypass the bidding process.

Vendors

Provider of products or services.

Additional cost savings are often available if large quantities of a commodity are purchased from the same supplier. On larger, more complex projects, a list of materials and supplies is devel- oped from the project cost estimate. This list is provided to suppliers as a request for quote (RFQ), and the suppliers respond with their lowest price. To avoid choosing a bid from a company that will make a promise it cannot keep, many organizations will maintain a list of suppliers that meet the organization’s requirements. These requirements usually include the proven ability to meet the quality and schedule specifications.

The project management team defines the methods and usually develops a procedure for requesting a quote. On smaller projects, the parent purchasing organization may process all RFQs. On larger projects, a procurement organization is established with expertise in purchasing. The purchasing team will develop a list of all procurement requirements for the project and develop a procurement schedule that assures the materials will be available to the project when needed.

The project team develops an RFQ based on the quantity and schedule needs of the project and sends the RFQ to the identified qualified suppliers. The suppliers then develop a quote that lists the specific materials to be provided, the price for each, and a schedule for delivery. The project team evaluates each quote from suppliers and determines that the supplier bid meets all the requirements, and in most cases, the supplier with the lowest price will be awarded the bid.

RFQ for Housing Contractor

A housing contractor who is building ten identical houses develops a materials list that includes all the carpentry, plumbing, and electrical supplies needed to build all ten houses. The housing contractor develops an RFQ for all these materials, including the construction schedule, and sub- mits the RFQ to the four largest building supply companies in the region. Each of the supply companies decides to bid on the project and provides a bid for the materials in the RFQ. One of the bidders has the lowest price but is unable to deliver the materials to the job site. The project team calculates the cost of transporting the materials to the job site. After the cost of transporta- tion is added to the bid, it is no longer the lowest total cost. The bidder with the lowest total cost is awarded the contract.

Some organizations that do a large number of projects will develop a relationship with one or two suppliers based on developing cost savings for both organizations. This relationship is com- monly called a key supplier relationship.

Key Supplier for Housing Supplies

The housing contractor develops a key supplier relationship with one or two of the building supply companies. The building supply company would guarantee a 10 percent discount on all materials and the contractor would promise to purchase exclusively from the key supplier. Both organiza- tions save the cost and time associated with preparing the bid. The building supply company plans on a consistent volume of business from the contractor and the contractor can expect pri- ority treatment when supplies are scarce.

Vendors

Vendors often provide a unique product or service that cannot be readily purchased in the market- place. The vendor typically provides a product or service that is designed for the project. The following are examples of products or services provided by vendors:

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request for proposal (RFP)

Requires a bidder to offer solutions and ideas on how to perform the scope of work and a price for performing that work.

FIGURE 12.3 Vendors provide solutions in response to an RFP.

© 2010 Jupiterimages Corporation

• A project to build a new patient tracking system at a large hospital system requires a new com- puter software designed to interface with the hospital’s existing systems. An RFP is issued to design and develop the new software.

• A new power plant construction project requires a new piece of equipment that meets new environmental air quality standards. Existing equipment does not meet these standards. An RFP is issued for the design, development, and production of the new equipment.

• Because of the change in the climate, the State of Texas awarded a contract for the evaluation of all flood control levees. The project scope included the development of equipment that would monitor the structural integrity of the levee and predict structural failure. The project manager issues a RFP for the new equipment.

Products and services from vendors need input and insight from the vendor. Instead of issuing a request for quote (RFQ) for a list of commodities, the project team issues a request for proposal (RFP). Companies responding to an RFP are invited to provide creative approaches to adding value to the project. Bidders are encouraged to offer design alternatives, alternative uses of materials, and scheduling alternatives that meet all the project requirements and also reduce the total project cost. The bids are evaluated on the total value to the project, including the contribution to the pro- ject goals.

RFP for Mining Operation

A copper mining project in Argentina included the design and construction of the mine site, the extraction of copper from the raw materials, the building of a pipeline to transport the copper ore to the Atlantic coast, and the construction of a port to enable the loading of the copper ore into various size ships. The construction materials, such as lumber, steel, and concrete, were pur- chased through suppliers, including key suppliers.

Some of the equipment used to extract the copper ore from the raw materials costs several mil- lion dollars and is only fabricated by a few companies. The project team designs the equipment to meet characteristics of the mining environment in Argentina: size, hardness, and composition of the raw material. The bid documents sent to the mining equipment vendors included the design specification and performance specification of the equipment, the project schedule, and the min- ing process. A request for proposal (RFP) was issued to each of the vendors.

Because vendor performance is critical to the success of the project, the management of the vendor relationship is a project management priority. Project management will often implement processes that encourage the vendors to submit suggestions that will reduce total project cost, shorten the schedule, or improve the performance. The project management team will often assign someone from the team to monitor the relationship and provide support from project resources to help assure vendor success.

Partners

If the parent organization lacks key skills or relationships, it might work with other organizations as partners—especially on international projects.

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partnership

Formal arrangement to execute the project with each party contributing resources.

FIGURE 12.4 Partners provide missing skills and relationships.

© 2010 Jupiterimages Corporation

Partnership on Mining Project

In the Argentina mining project example, the United States parent organization had project management, engineering, procurement, construction, and mining technology expertise. The company also had relationships with major mining equipment vendors. The U.S. construction company partnered with an Argentinean company that had expertise and relationships important to the success of the project.

The Argentinean company contributed local knowledge of the construction workforce; local engineering and construction practices, knowledge, and expertise in the government permitting processes; and an existing relationship with potential key suppliers and local vendors.

A partnership is a formal arrangement to execute the project with each party contributing resources. In most partnerships, both parties benefit from the success of the project and share the costs associated with a less successful project. Critical to the success of a partnership is the clear definition of roles and responsibilities on the project, a common understanding of the project goals, and a scope of work for each partner.

Building the relationship between major partners on the project is similar to building relation- ships with clients. On a large, complex project, a partnership alignment session is often required to build the trust required for open communication channels. Maintaining the relationship permits more effective problem solving and coordinated action on the project. A well-managed partnering relationship can contribute to the achievement of project goals, reduce overall costs, and shorten the project schedule. In most cases, the parent organization is aware of weaknesses in the project resources or skills and searches for a potential partner that has the needed resources or skills. In our Argentinean example, the parent company knew that construction experience in Argentina would be important to a successful project. Both companies will research the capability of the other company to assure that the partnership is appropriate for both companies.

Biotech Plant Partnership in Puerto Rico

On a project to build a new biotech plant in Puerto Rico, a large engineering and construction company selected a Puerto Rican civil engineering company to design the site work on the pro- ject. Because the plant was needed quickly, the project schedule was an important component of every discussion, and meeting the project end date was a major goal. The Puerto Rican company was asked to begin developing the civil drawings early, before much of the needed information had been developed. This was a situation where a partnering relationship would benefit the pro- ject. Both companies would mutually support each other to achieve project goals and both would benefit from project success.

In this situation, the project procurement plan specified the development of a subcontract for the civil engineering, and a contract was developed with a clear scope of work and a cost based on completing the work in the contract on time and according to specification. Because the aggres- sive project schedule required the civil engineering company to begin work before all the needed information was available, change orders were required when new information became available. The contract allowed several days to evaluate the impact of the change on cost and schedule, and the time evaluation process began to cause delays in the project.

Eventually, a new contract was developed to make the Puerto Rican company a partner. These new partnering arrangements allowed the engineers to get early information and contribute ideas that would shorten the schedule. This case is an example of the need to evaluate the project goals and environment and develop a procurement strategy that matches the conditions of the project.

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contract

An agreement that is legally enforceable.

Key Takeaways

• Commodities are purchased through suppliers using a request for quote (RFQ) and selected on the basis of price. An exception is the key supplier relationship where the supplier-organi- zation relationship is long term and the supplier passes along some of the savings of avoiding the bidding process.

• Vendors provide products and services that are designed for the project based on a request for proposal (RFP) that invites the vendors to meet the goals of the request using their prod- ucts and skills.

• If the organization lacks key skills or relationships, it might form a partnership arrangement with another company to share the benefits and risks of the project.

Exercises

1. Commodities are described in an ______ (three-letter acronym).

2. The objectives of the work are described in an _____________ (three-letter acronym), and the details of how to accomplish those objectives are proposed by the vendor.

3. If a project takes place in a different country, the project team might seek a _________ with a local company to provide local contacts and expertise in local issues.

4. What is different about a key supplier relationship?

5. What is the difference between an RFP and an RFQ?

6. How is a partnership different from a vendor relationship?

Internalize your learning experience by preparing to discuss the following.

If you were building your own house, what would be an example of something that would be procured using an RFQ and something that would be procured with an RFP? Describe how your choices meet the descriptions of products or services procured from suppliers or vendors.

12.3 Selecting the Type of Contract

Learning Objectives

1. Identify factors that determine which type of contract to select.

2. Describe the types of fixed cost contracts.

3. Describe the types of cost reimbursable contracts.

An agreement between the organization and an outside provider of a service or materials is a legal contract. To limit misunderstandings and make them more enforceable, contracts are usually writ- ten documents that describe the obligations of both parties.

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contracting plan

Defines the relationship between the project and the subcontractors—supplier, vendor, or partner—and also defines a process for making changes in the agreement.

FIGURE 12.5 Contracts are legally binding agreements.

© 2010 Jupiterimages Corporation

fixed price contract

A type of contract that pays a contractor an amount that is agreed upon at the start of the project.

Because legal agreements often create risk for the parent organization, procurement activities are often guided by the policies and procedures of the parent organization. After the project man- agement team develops an understanding of what portions of the project work will be outsourced and defines the type of relationships that are needed to support the project management plan, the procurement team begins to develop the contracting plan. On smaller, less complex projects, the contract development and management are typically managed through the parent company or by a part-time person assigned to the project. On larger, more complex projects, the procurement team can consist of work teams within the procurement function with special expertise in contracting. The contract plan defines the relationship between the project and the subcontractors (supplier, vendor, or partner) and also defines a process for making changes in the agreement to accommo- date changes that will occur on the project. This change management process is similar to the change management process used with the project agreement with the project client.

The contracting plan of the project supports the procurement approach of the project. The fol- lowing are some factors to consider when selecting the type of contract:

• The uncertainty of the scope of work needed

• The party assuming the risk of unexpected cost increases

• The importance of meeting the scheduled milestone dates

• The need for predictable project costs

There are several types of contracting approaches and each supports different project environ- ments and project management methodologies. The legal contracts that support the procurement plan consist of two general types of contract: the fixed price and the cost reimbursable contracts, with variations on each main type.

Fixed Price Contracts

The fixed price contract is a legal agreement between the project organization and an entity (per- son or company) to provide goods or services to the project at an agreed-on price. The contract usually details the quality of the goods or services, the timing needed to support the project, and the price for delivering goods or services. There are several variations of the fixed price contract. For commodities and goods and services where the scope of work is very clear and not likely to change, the fixed price contract offers a predictable cost. The responsibility for managing the work to meet the needs of the project is focused on the contractor. The project team tracks the quality and schedule progress to assure the contractors will meet the project needs. The risks associated with fixed price contracts are the costs associated with project change. If a change occurs on the project that requires a change order from the contractor, the price of the change is typically very high. Even when the price for changes is included in the original contract, changes on a fixed price contract will create higher total project costs than other forms of contracts because the majority of the cost risk is transferred to the contractor, and most contractors will add a contingency to the contract to cover their additional risk.

Fixed price contracts require the availability of at least two or more suppliers that have the qualifications and performance histories that assure the needs of the project can be met. The other requirement is a scope of work that is most likely not going to change. Developing a clear scope of work based on good information, creating a list of highly qualified bidders, and developing a clear contract that reflects that scope of work are critical aspects of a good fixed priced contract.

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