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Procurement Management Overview

Knowledge Areas Covered on the PMP® Certification Exam

In Procurement Management, the basic knowledge and skills of a project manager should include being able to help create, read and manage contracts.

Procurement Management is often a challenging knowledge area on the PMP® exam. Our skilled instructors will break down this area in our PMP® Certification course and assist you as you prepare for the exam. 

What is Procurement Management?

Procurement Management is used to obtain goods, services or scope from outside the organization. For project managers, procurement can be tricky because many project managers do not have training in procurement or may work in a company where procurement is completely handled by a designated department. Before we go any deeper in procurement, it is critical to distinguish the procurement roles of buyer and seller. Buyer is purchasing the goods or services. Seller is providing or delivering the goods or services to the buyer.

In a project, you figure out what kinds of contracts make sense for your project, and you try to define all the parts of the project that will be contracted out. A contract is a when parties enter into a formal and legally binding agreement. There are different types of contract, but we will review a few of them.

Let's start with fixed price contract or lump sum contracts. These are generally a single payment, but payment terms can be specified. However, no matter how much time or effort goes into them, the client always pays the same. Within this contract type, there are few different types, Firm Fixed Price, the price is fixed, the risk is completely born by the seller. Fixed Price Incentive Fee, the price is, but there is an incentive for meeting a target. A common motivation is completing the work before the target finish date or completing the project under budget. This contract requires that both seller and buyer agree to a price ceiling and all costs above the price ceiling is the responsibility of the seller. Fixed Price Economic Price Adjustment is commonly used for unusually long projects that span years. The most common use of this type of contract is the inflation-adjusted price. For example, if the currency exchange rates change drastically.

Our next type of contract is Cost Reimbursable Contracts where the buyer agrees to pay the seller for actual costs plus fees. That fee is the seller’s profit. Cost-reimbursable contracts are commonly used when the scope of work or the costs for performing the work are not entirely defined. The project uses a cost-reimbursable contract to pay the seller for allowable expenses related to the work. With this type of contract, the seller has much less risk associated with cost increases. The cost-reimbursable contract reduces the amount of money the seller puts aside for potential cost increases. However, the seller is not highly motivated to search for cost savings measures unless there is an incentive to do so.

There are three common types of this agreement. Cost Plus Fixed Fee, Cost Plus Incentive Fee and Cost-Plus Award Fee. Cost Plus Fixed Fee is where the seller passes the cost back to the buyer. The receive an additional fixed fee upon completion of the project. The fee is calculated as a percentage of the planned costs. Cost Plus Incentive Fee seller passes the cost back to the buyer. The seller is incentivized for meeting a target (i.e. keeping costs low). Cost Plus Award Fee reimburses the seller for all allowable costs plus a fee that is based on performance criteria. The fee is typically based on goals or objectives that are more subjective. An amount of money is set aside for the seller to earn through excellent performance, and the decision on how much to pay the contractor is left to the judgment of the project team. The amount is sufficient to motivate excellent performance.

In a time and materials contract, usually for smaller activities where the uncertainty runs high, the seller might charge an hourly rate for labor, plus the cost of materials, plus a percentage of the total costs. This type of contract is called time and materials (T&M). Work is usually performed on an hourly basis.

Now it is time to review the Procurement Plan. Once it has been determined which components or services will be made, performed internally or outsourced, a Procurement Plan should be put into place. Depending on the complexity of the project, the plan may take a few hours or weeks to complete. The plan should include details such as vendor relationships, awarding and signing contracts, evaluation of partnerships, Request for Proposals, managing changes
in the contract etc. If your organization does have a procurement department, more than likely you will work hand and hand with them to create this plan. They may even have templates that can be used. It is key that the requirements are captured to avoid and legal obligations as well to avoid changes later that may impact cost.

There are many considerations that are considered when selecting a seller. You may go the for the least cost. This can be used when quality is not in question. For example, if there is a governing body that has sent standards the product must comply with, you may feel the product will sufficiently meet your needs and will be free of defect. The organization may select based on qualifications. Normally they are looking for a specific criterion and will compile a short list of sellers that match their criterion. An organization will select a seller based on quality, the seller with the highest quality ranking will be the selected. In some instances, you do not have a selection, there is only one vendor. In this case, there is not much benefit of conducting procurement. Another option is a fixed budget, where the buyer discloses the budget to the seller and the parties then proceed to negotiate. There are various ways to conduct procurement. Typically, a prospective seller will provide a proposal to perform the work. There may be times, where you feel you are not getting the response you expect. A way to widen the pool, it can be advertised in trade publications, online sources, etc. It is essential that throughout the project, it is reviewed that good and services are being delivered, are invoices being reviewed and paid in a timely manner, are the terms and conditions of the contract being met. There are times where disagreements occur and must be dealt with, this is known as claims administration. How a claim should be handled should already be defined in the procurement plan.