PMP Exam Prep – Part 15: Project Procurement Management

The PMBOK addresses Project Procurement Management from the buyer’s perspective, in other words, we play the role of the buyer looking to contract some project work to a seller that is external to our Organization. Buyer and seller are common terms that are used in the exam as opposed to contractor and owner. This is not an exam that focuses on the legal aspects of contracting and procurement and questions typically relate back to processes of Project Procurement Management.

Exam questions frequently put the candidate either in the position of the buyer or the seller. Care should be taken to verify which perspective you need to take when answering a question during the exam. For example, you may be asked to identify whether the buyer or the seller bears the most risk when work is performed via a fixed price contract. The answer is that the seller bears the most risk. This is because in a fixed price contract, the seller agrees to do the stipulated work for a fixed sum of money. This means that if there should be any unanticipated increases in costs to the project, the buyer is not obliged to pay any more money to offset these costs and it falls entirely on the seller to  absorb these costs. The seller therefore bears the most risk.

Project Procurement concepts covered in this section

There are several procurement concepts that we will cover in this section

  • Project Procurement Definition
  • Statement of Work (SOW)
  • Contract Categories
  • Solicitation Process
  • Contract Negotiations
  • Contract Clauses

We will take a look at the types of procurement planning and the issues associated with procurement planning and solicitation planning as well. We will also delve further into solicitation when it comes to source selection; contract administration; contract closeout and the Organizational issues relating to procurement.

Plan Procurements

Procurement Planning is the very first step. A lot of Project Managers do not get involved at this stage. According to the PMBOK, however, the Project Manager is responsible for describing the subcontract requirements in terms of the specification, so the Project Manager is responsible for procurement planning. As the buyer, we need to define what we need the seller to perform for us.

  • Specification: A specification is defined as a precise description of a physical item, procedure or result for the purpose of purchase or the implementation or an item or service. It is important that the Project Manager specify exactly what it is that he or she wants. Additionally, we can also use drawings to complement or supplement the specification. For example, when procurement planning is performed in the construction industry, it is common to define out technical specifications as plans and drawings.
  • Delivery dates: The delivery dates of the product or service must be laid out in the specification as well.
  • Independent Estimate: The independent estimate refers to a cost estimate that the project team obtains from a vendor or external stakeholder that is not directly related to the project delivery.  Independent estimates are commonly used when a buyer is trying to obtain a rough idea of how much money a particular work package might cost, or when the buyer is wants to verify that the quoted prices received by potential sellers seem to be reasonable and accurate.
  • Assistance: It is important to note that the project manager has assistance from his team when coming up with the details that support the procurement exercise. For example, technical specifications are developed with some help from the engineers allocated to the project.

Make-or-buy decisions

Essentially we are trying to determine if we should perform the work ourselves or whether should we simply buy the finished product from another party. This is analysis is not always going to result in an either / or decision. It can go into many degrees. For example, we may choose to do some of the work ourselves and go outside of our project team for the rest.

In the PMBOK, the possible outcomes from a make-or-buy analysis include:

  • Procure virtually all goods or services from a single supplier
  • Procure a significant portion of the goods and services and make the rest
  • Procure a minor portion of the goods and services and make the rest
  • Make all of the good and services

Statement of Requirements / Statement of Work

The project team uses the Statement of Work to communicate their requirements in the event that a decision is made to procure a portion of the deliverables of a project. The Statement of Requirements (SOR) or the Statement of Work (SOW) is a document package that describes the specifications and other details required to tell external parties exactly what is needed to fulfill a procurement need.The SOW is an output from the procurement planning process and this is a fundamental document that you have to be very familiar with for the exams. PMI may sometimes use the acronyms SOW or SOR interchangeably in the exam.

Contract Types

In addition to the Make-or-buy decision, we also need to make a decision as to what type of contract we are going to use in order to procure that product or service. For the exam, you will need to be familiar with the various types of contracts that can be used to structure formal business relationships.

  • Fixed Price Contracts: The principle of shared risk applies to Fixed Price Contracts. In this case, the risk of the contract is shared between both the buyer and the seller.
    • Firm Fixed Price Contract (FFP): This is the most common form of Fixed Price contract and is also known as the ‘lump sum’ contract. In this particular type of contract, the seller bears all of the risk because she agrees to provide all of the goods and services for a fixed price and regardless of the costs incurred. There is one upside to a Firm Fixed Price Contract for the seller. The upside is that when the FFP contract type is used, the seller has the greatest chance to make a profit. There also is one other benefit that both buyer and seller will realize from this type of contract, which is that this type of contract has the least amount of administrative hassle.
    • Fixed Price plus Incentive Contract (FPIC): Here, the seller takes on more risk than the buyer. This is because regardless of the incentives put into the contract, the seller has to deliver the work at a fixed price. If that price is exceeded, the seller is going to incur those additional costs. For any range of costs or pricing mechanisms, the seller has the incentive to earn more fees, but generally as specified in a contract, if a particular level of cost is exceeded, then the seller will not realize any profit from performing the work and every dollar that the seller spends to complete the work will come directly out of his or her own pocket. The Point of Total Assumption occurs when the seller starts to take on all the costs of the contract because the seller is close enough to the ceiling of costs as specified in the contract. The seller is not necessarily losing any money at this point but is assuming 100% of the total costs from that point forward within the contract. The ceiling price as set within the contract can be thought of as being the level where buyer has specified that he will not pay any more money that this level for the work to be performed.
  • Cost Reimbursement Contracts: These are the most unfamiliar types of contracts in the exam, particularly for international candidates.
    • Cost plus Percentage of Cost Contract: This contract type has zero risk to the seller and stipulates that the seller is going to pass all of her costs directly on to the buyer. The profit that the seller is going to make out of this contract will be based on a percentage of the costs incurred. In other words, the higher the costs incurred, the greater the profit for the seller. The obvious motivation for the seller would be to incur as much costs as he possibly can, since his profits will be increased as a factor of those costs. This contract type is illegal in the United States Federal Government. The buyer has all of the risks and the seller has no risks for this type of contract.
    • Cost plus Fixed Fee Contract (CPFF): At the outset of a contract, the costs are going to be estimated by the buyer and the seller for the work prior to the work being performed. Based on these cost estimates, a fee is going to be fixed for the seller. For example, if a job is going to cost $2 million dollars to get the work done, the buyer and seller can agree that 8% of the fee or $160,000 is going to be a reasonable fee. In the event that the job was performed under the agreed to cost of 2 million dollars, the seller is still going to get her fee because the fee is fixed. In fact, if the seller incurs a cost above 2 million dollars, he or she will still get the originally agreed upon fixed fee. The cost may vary, however the fee is going to be fixed. However, there might be a clause in the contract that the fee may have to be re-negotiated if the costs go beyond a pre-determined threshold amount.
    • Cost Plus Incentive Fee Contract (CPIF): A CPIF contract is a risk-sharing contract between the buyer and the seller. All CPIF contracts share one common quality known as the sharing ratio. The sharing ratio can be expressed as 70/30 or 60/40 or 50/50, but is always expressed as buyer share/ seller share. You may see questions in the exam that indicate that you have a CPIF contract and you have a 70/30 sharing ratio and then proceed to ask you who has the 30 percent share. The answer in this case would be the seller, because 30 is the second part of the ratio.
  • Unit Price Contracts: A unit price contract is really a derivative of a fixed price contract. The unit price follows fixed pricing but just on a unit-by-unit basis and not the sum total of a number of units. In this case, we are looking towards a fixed price for a single unit of an item or service. The unit price will be fixed, but it is fixed for each particular unit of goods or service that we want to acquire. For example, we are setting up a new office and we need to buy some desktop computer systems. We can go to suppliers and tell them that we need 1,000 computers. We can also give them the specifications in terms of the specific hardware requirements for each computer. We can tell suppliers that we want a fixed price for a particular quantity of a product or service and we can collect bids and we will generally select the supplier who has the lowest price and conforms to the specifications. This is an example of fixed price. Let us say that we have acquired the 1,000 computers and we realize that we need a few more computers but this time we’re not exactly sure how many computers to obtain. We might just want to buy them two or three at a time. In this case, we would like to get a unit price for each computer. This is an example of unit price.

Comparing Cost Plus and Fixed Price Contracts

In cost plus contracts, all of the allowable fixed costs of the seller will be covered in the contract. When it comes to a fixed price contract, all of the allowable costs may not be covered because the seller might exceed what was allowed under the ceiling price of the FP contract. A tip for candidates to identify incentive contracts such as fixed price incentive or cost plus incentive based contracts is to look for terms such as ‘target costs’; ‘target price’; or ‘sharing ratio’ which will denote that the question is referring to an incentive based contract.

Additional Incentives

There are additional incentives that have not been discussed as yet when it comes to contracts. These incentives need not always be financial. These incentives can be thought of as benefits that the buyer will give to the seller or Organization performing the work if they can complete the work ahead of schedule or below costs.

Solicitation Planning

Solicitation planning comes after procurement planning. At this point, we want to take our SOW and other procurement documents and go to the outside world and start obtaining bids and proposals for our work.

We need to solicit bids and proposals from a number of suppliers and we are interested in putting a procurement package together to help potential sellers or vendors. We have a particular process and we need to structure this process in a standardized way that will be easy to follow and well known for potential sellers.

Contract Origination

There are various accepted ways for an organization to go about looking for potential vendors to fulfill their requirements.

  • Unilateral Contract: A purchase order is a good example of a unilateral contract. One party signs the contract. Typically there is no negotiation required and the contract is of low monetary value. We are looking at standardized solicitation and we are buying commodity items. A good way to look at what might be a unilateral contract is to ask yourself if you can send something via a fax. If you have the ability to send a contract via fax and not expect any reply and just expect work to be done after it is sent, then you can look at this document as a unilateral contract.
  • Bilateral Contract: Bilateral contracts are more conventional and have a tendency of being a lot more involved. There are 3 basic forms of bilateral contracts.
    • Invitation for Bid (IFB): An invitation for bid is a form of contracting which is appropriate for routine items. The primary objective as a buyer is to find the best price. The buyer is able to clearly describe what it is that he or she wants and is able to identify the completed product or service when a potential seller presents it to the buyer. There is typically no negotiation involved in this process and the buyer is usually looking for the lowest price. When you see an IFB, the buyer is not looking for any extra qualities aside from what is described in the initial specification.
    • Request for Quote (RFQ): Requests for Quotes are used for generally low monetary purchases of commodity items. Essentially a certain number of items and exact specifications are known to the buyer and the RFQ is going to be sent out to a few pre-selected and pre-qualified suppliers and the objective is to find the best price.
    • Request for Proposal (RFP): The Request for Proposal is generally used for complex or non-standard items. The monetary value of procurement in this case is going to be higher than in an RFQ or and IFB. What distinguishes and RFP from an RFQ or IFB is that there is going to be some discussion between the buyer and the seller. The buyer will attempt to describe what he wants in the clearest terms that he or she possibly can. The buyer is very interested in not only receiving proposals from vendors but also interested in talking to sellers about his or her needs. The seller might have a better idea of how the work can be performed.

For example, if you are involved in a complex software development project for your Organization, you would be issuing an RFP and not an RFQ or IFB. In this particular case, the buyer wants to meet with different sellers and determine from them the best approach to take in order to write the software, implement it and train the people on how to use it.

Proposal evaluation techniques

At the end of the solicitation process, the buyer would have received responses back from interested sellers and we are now interested in putting these responses through some kind of evaluation criteria. The evaluation criteria can be objective or subjective. There may be metrics to measure the different proposals, or sometimes the buyer will simply want to get a feel for how the contractor will meet the requirements of the contract.

Common evaluation criteria are listed below:

  • Management approach
  • Financial health
  • Contractors understanding of buyers requirements
  • Overall/lifecycle costs of proposed solution
  • Type of contract which should be used

Solicitation

Once a number of responses from respective vendors have been received, it is now time to identify which parties to send the solicitation to. Sometimes, it is hard to pick, it is hard to find the right vendors. It is hard to find out who or where you go looking for vendors. You can go looking for a variety of sources. The project manager is heavily involved in this process. The project manager is not working alone in this task, but is instead working with contracting staff. PMI is looking at this from a centralized contracting perspective.

When it comes to solicitation and source qualification, we’re looking in catalogs; we’re looking in contacts, talking to other suppliers, looking at trade journals. We’re looking at anybody that might be able to meet this particular need. The solicitation is issued with the help of the contacting staff.

  • Source Selection: Once we go through the solicitation, we then go through the source selection where we pick those vendors who responded to our original solicitation itself. There are a variety of issues associated with evaluating these contractors. As we evaluate perspective contractors, the PMBOK talks about a number of different ways to do this.
  • Evaluation criteria: We are going to apply our evaluation criteria to the proposals. We are going to use a weighting system.  A weighting system is a method for quantifying qualitative data to minimize the effect of personal prejudice. For example, imagine a group of three to five people sitting around a table and looking at various proposals from a number of vendors. We are attempting to apply our evaluation criteria to the vendors such that we come up with a  number using a scoring system of some type. We are trying to assign numbers to our various evaluation criteria and we are going to weight our criteria. This means that certain criteria would have more importance to us than other criteria.
  • Screening System: According to PMI, we establish minimum performance requirements for one or more of our evaluation criteria. A common example would be that one of the criteria we have in a project is to require a project manager who has significant project management credentials and inexperience in the field. Using the screening system in our criteria, we can say that the project manager that is offered by the vendor must have a PMP or a master’s degree in a relevant profession. If that project manager does not have a PMP or the relevant master’s degree, then we can rate that particular contractor low or kick them out of the whole process.
  • Team aspect of solicitation: All of the above screening criteria work under the premise that everyone is going to be focused on working together to come up with one solution. Sometimes we don’t have the time to sit around and sort through all of the vendors. Sometimes we delegate the task to one person who can do the job and do it well.

Sole Sourcing

Is there ever a time when we skip to the chase and cut out the entire process and simply hire somebody? There are cases where we know that competition is good and competition keeps prices low but we just know at the outset that we have one supplier in mind and we know that because they are so uniquely qualified that we can’t find anyone else to do the job, so why waste all of the time to look for vendors. There are also times where we can go to one contractor which is known as sole sourcing. Or sole source where we might have the in-house expertise to evaluate the contractors for reasonableness and accuracy.  In other words we have significant expertise and we know if the contractor is going to be good for this job and we really don’t need to have multiple vendors come in and give us prices.

When our project is under extreme pressure for time and the procurement process and the planning involved as well as the other steps requires time that we are is short supply of. There are occasions where we simply don’t have time and there are situations where we know of a contractor and we’ve used him before and he has a great track record and for the sake of the project and the sake of the client we are going to go to that contractor and negotiate a price and move forward. So we are going to sole source you need to know that term for the exam. Sole source means going to a vendor without considering other vendors.

Procurement Negotiations

When we get into a lot of these environments to meet with contractors, it very often involves contract negotiation. We need to be comfortable with the contract negotiation process. One of the issues here is that PMI has changed terminology over time and we need to know a variety of terms for the different issues associated with contract negotiation.

There is a series of steps and you can never afford to jump over a step regardless of how the questions in the exam might try to convince you of otherwise.

  1. Protocol or Rapport Setting: Introductions are made and the atmosphere is set and we are trying to get ourselves organized for discussing the pros and cons of working with one vendor and taking a look at their prices and trying to get an understanding from them whether they truly understand the work that we would like to have them do.
  2. Probing: Probing is where we go in and we are trying to ferret out what the contractor is after and what are we after and what we are able to share with them and that they are actually interested in and what they are going to be able to share with us.
  3. Hard-core Bargaining or Scratch Bargaining: This is where we’re starting to make our concessions and both parties are trying to give and we are trying to come up with a good mutual agreement for a situation that both the buyer and the seller are basically unhappy with in some ways and we are both satisfied that we are basically starting to move forward and that each party has gotten what it thinks it needs to move forward. The buyer has gotten the right price and the seller says yes, I am going to benefit by this particular relationship.
  4. Getting to Yes: PMI is pretty big on the concept of getting to yes they are looking for win-win situations when we get into a contract. And if you have a question in negotiations and it implies that your opponent is trying to crush you like a grape and you decide that you are here to try to get to yes. Trying to achieve a win-win situation, this is what PMI wants you to be thinking
  5. Closure: Closure occurs where we are summing up our positions and most times when you go through a negotiation you’ll often get to closure and find that you didn’t understand what they thought they said that they didn’t understand what they thought you said and you’re back into hard-core bargaining. Again,
  6. Agreement: The important thing about this last stage is that it is documented and the parties sign a document and by their signing indicate that yes, they have complete understanding of this particular relationship

Negotiation Tactics

As you go through negotiation, there are many strategies that can be applied. We will look at a situation where a real-estate broker is trying to sell you a house.

  • Deadline strategy: The broker walks up and says that if you sign this deal by 5 o’clock tonight, I am willing to sell the house for this price. If you come back after this time, then the offer price is no longer valid.
  • Surprise: The broker might mention late in the contract that the house comes with gold-plated fixings in all bathrooms in order to lure you into closing the deal.
  • Limited authority or missing man strategy: This is the most ubiquitous tactic. The broker will tell you that he has to go talk to the owners or some higher power in the universe before he can get back to you.
  • Fair and reasonable: Sometimes you will meet brokers who are honest and trustworthy and when you come together they tell you that they are offering you a fair and reasonable price and that they are trying to come up with an agreement.
  • Reason together: Both parties, in this case, the buyer and the representative for the seller or the sellers themselves would sit down and try to come up with a reasonable price that will result in both parties with a win-win strategy
  • Fait accompli: This refers to a done deal. In this instance, the broker acts surprised, indicating that he was under the impression that the deal was agreed upon is surprised that it wasn’t so.

The End of Negotiations

This refers to the moment in negotiation where we have signed the contract, both parties are in obvious agreement and there are a few things that we want to keep in mind at this stage. Our objectives in reaching the end of contract negotiations are to obtain a fair and reasonable price while still trying to get the contract performed within certain time and performance limitations. We also want to ensure that there is a good relationship between the buyer and seller after the contract is sealed and signed. This makes sense because the buyer and sellers may have a relationship over a long period of time and we want to ensure that the working relationship between both parties is good.

Administer Procurements

This is where the work actually gets done. This is where the Project Manager along with the contracting staff watches performance of the vendor to keep the project moving forward. Our focus shifts from finding and selecting a seller to making sure that the seller is performing the work in accordance with the contract specifications.

Terms of the contract

There are a variety of specifications that would define how the work gets performed in a contract. The most commonly used features in contracts are listed below and these are the things that the project manager and the project team should look out for as they are administering the project.

  • Delivery schedule
  • Handling of changes
  • Warranties
  • Inspections
  • Subcontracts

Clauses

You should be familiar with common clauses found in contracts.

  • Standard Clauses: First and foremost we look at our standard clauses to see how much of the work is covered. If there are gaps, then we should proceed to develop some new clauses ourselves. We take a look at the standard clauses first, because typically, this project will not be the first work that you have done before and therefore you have a lot of information written down to your standard clauses so far. Many organizations also prefer to standardize the standard terms and clauses of their contracts.
  • Change clauses: This is one of the clauses that you can expect to see tested in the exam. This gives us some sense of who initiated the change, where the changes come from, how the changes are  going to be funded, what some of the approval authorities are going to be from. Some of the configuration management issues are going to be addressed in the change control clauses.
  • Pricing Change: This also refers to how we are going to deal with change especially when it comes to the pricing of the contractor.  PMI prefers that we use lump sum or Firm Fixed Price changes. PMI suggests that we use lump sum prices for changes even if we have a cost plus basic contract. This might not have any real practical applications, however, we need to understand the exam from PMI’s perspective.
  • Express warranties: An express warranty is explicitly written out and we have an understanding of exactly what the functions or features a product or service should have.
  • Implied warranty: There are a couple of terms used such as merchantability and fitness of use. For example if we look at a desk that we are sitting at, we will realize that the desk came with an implied warranty. The implied warranty is that the table should be sturdy enough to serve it’s purpose as a desk and that we are going to use this desk is going to hold objects that desks usually hold. For example, if we buy this desk and we put our stationery and notepads on it and the desk collapses, we bought it under the assumption that the desk was going to be strong enough to hold notebooks, which is a reasonable assumption. We don’t need to have an explicit description of that warranty. This desk has collapsed and it obviously isn’t fit for use and we can go and get a replacement for the desk.
  • Doctrine of Waiver: This refers to the fact that if we fail to exercise our contract rights, we lose them. This is a legal doctrine that has a lot of practical applications especially when it comes to the issues of change control. If we do not enforce the change control process, we might not have the change to exercise the change control process.
  • Delays: We need to look at who caused the delays as well as the nature of the interruption and the impact of the delays.
  • Performance Bond: The performance bond secures the performance and fulfillment of the contract for the buyer. In other words, we want to make sure that if we hire a contractor, they are able to do the job and if they cannot do the job, then the bonding company is going to step in and do the necessary work to complete the job.
  • Payment bond: There is guaranteed payment to sub-contractors and laborers by the prime contractor. In many situations, the buyer may pay the prime contractor for the work and the prime contractor may be paying sub-contractors for a former job that the subcontractor had performed for the contractor prior to this contract. We want to ensure that the prime contractor will use our payments to pay the sub-contractor because we want to make sure the sub-contractors and laborers are being paid to do the work and will not walk off due to some issues with the prime contractor.
  • Basic Breach: This is an important issue when it comes to contract administration. Breach of contract says that if it is just a basic breach where we have somehow violated some part of the contract, but this doesn’t mean that the entire contract is invalid.
  • Material Breach: This type of breach is a lot more serious. It means that the breach is so bad that the contract expires at that point in time. Usually, a material breach occurs in a situation where the work to be performed is time sensitive. The buyer needs a particular product or service by a specific date. If he gets the product or service after that date, then he has no more need for that product or service.Therefore, if there is no delivery by the date specified in the contract, the contract is breached.

Summary

  1. Procurement Planning
  2. Types of Procurement
  3. Contract Types
  4. Vendor Selection process
  5. Contract Negotiation process
  6. Contract Clauses

Conclusion

In this section on Project Procurement Management, we identified various types of contracts and common clauses of contracts. We also identified the common sequence of procurement activities, to go from procurement planning to solicitation and vendor selection and finally procurement administration.