PROJECT PROCUREMENT, CONTRACT MANAGEMENT, AND ETHICS IN PROJECT MANAGEMENT:Procurement Cycles

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Project Management MGMT627

LESSON 45

PROJECT PROCUREMENT, CONTRACT MANAGEMENT, AND ETHICS IN

PROJECT MANAGEMENT

BROAD CONTENTS

Procurement

Procurement Cycles

Type of contract

Categories of Contract

Ethics in Project Management

45.1. Procurement

Procurement can be defined as the acquisition of goods or services. Procurement (and contracting) is a

process that involves two parties with different objectives who interact in a given market segment. Good

procurement practices can increase corporate profitability by taking advantage of quantity discounts,

minimizing cash flow problems, and seeking out quality suppliers. Because procurement contributes to

profitability, procurement is often centralized, which results in standardized practices and lower

paperwork costs.

All procurement strategies are frameworks by which an organization attains its objectives. There are

two basic procurement strategies:

Corporate procurement strategy: the relationship of specific procurement actions to the corporate

strategy

Project procurement strategy: the relationship of specific procurement actions to the operating

environment of the project

Project procurement strategies can differ from corporate procurement strategies because of constraints,

availability of critical resources, and specific customer requirements. Corporate strategies might

promote purchasing small quantities from several qualified vendors, whereas project strategies may

dictate sole source procurement.

Procurement planning usually involves the selection of one of the following as the primary objective:

· Procure all goods/services from a single source.

· Procure all goods/services from multiple sources.

· Procure only a small portion of the goods/services.

· Procure none.

Another critical factor is the environment in which procurement must take place. There are two

environments: macro and micro. The macro environment includes the general external variables that

can influence how and when we do procurement. These include recessions, inflation, cost of

borrowing money, and unemployment. As an example, a foreign corporation had undertaken a large

project that involved the hiring of several contractors. Because of the country's high unemployment

rate, the decision was made to use only domestic suppliers/contractors and to give first preference to

contractors in cities where unemployment was the greatest, even though there were other more

qualified suppliers/contractors.

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The microenvironment is the internal environment of the firm, especially the policies and

procedures imposed by the firm, project, or client in the way that procurement will take place.

This includes the procurement/contracting system, which contains five cycles:

Requirement cycle: definition of the boundaries of the project

Requisition cycle: analysis of sources

Solicitation cycle: the bidding process

Award cycle: contractor selection and contract award

Contract administration cycle: managing the subcontractor until completion of the contract

There are several activities that are part of the procurement process and that overlap several of the

cycles. These cycles can be conducted in parallel, especially requisition and solicitation.

45.2.

Procurement Cycles

The first step in the procurement process is the definition of project, specifically the requirement.

This is referred to as the requirement cycle and includes the following:

Defining the need for the project

Development of the statement of work, specifications, and work breakdown structure

Performing a make or buy analysis

Laying out the major milestones and the timing/schedule

Cost estimating, including life-cycle costing

Obtaining authorization and approval to proceed

The SOW is a narrative description of the work to be accomplished and/or the resources to be

supplied. The identification of resources to be supplied has taken on paramount importance during

the last ten years or so. During the 1970s and 1980s, small companies were bidding on mega jobs

only to subcontract out more than 99% of all of the work. Lawsuits were abundant and the solution

was to put clauses in the SOW requiring that the contractor identify the names and resumes of the

talented internal resources that would be committed to the project, including the percentage of their

time on the project. Specifications are written, pictorial, or graphic information that describe, define,

or specify the services or items to be procured. There are three types of specifications:

Design specifications: These detail what is to be done in terms of physical characteristics. The risk

of performance is on the buyer.

Performance specifications: These specify measurable capabilities the end product must achieve in

terms of operational characteristics. The risk of performance is on the contractor.

Functional specifications: This is when the seller describes the end use of the item to stimulate

competition among commercial items, at a lower overall cost. This is a subset of the performance

specification, and the risk of performance is on the contractor.

There are always options in the way the end item can be obtained. Feasible procurement alternatives

include make or buy, lease or buy, buy or rent, and lease or rent. Buying domestic or international is

also of critical importance, especially to the United Auto Workers Union. Factors involving the

make or buy analysis is shown below:

· The make decision

· Less costly (but not always!!)

· Easy integration of operations

· Utilize existing capacity that is idle

· Maintain direct control

· Maintain design/production secrecy

· Avoid unreliable supplier base

· Stabilize existing workforce

· The buy decision

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Less costly (but not always!!)

Utilize skills of suppliers

Small volume requirement (not cost effective to produce)

Having limited capacity or capability

Augment existing labor force

Maintain multiple sources (qualified vendor list)

Indirect control

The lease or rent decision is usually a financial endeavor. Leases are usually longer term than

renting. Consider the following example. A company is willing to rent you a piece of equipment at a

cost of $100 per day. You can lease the equipment for $60 per day plus a one-time cost of $5000.

What is the breakeven point, in days, where leasing and renting are the same?

Therefore, if the firm wishes to use this equipment for more than 125 days, it would be more cost

effective to sign a lease agreement rather than a rental agreement.

Requisition Cycle

Once the requirements are identified, a requisition form is sent to procurement to begin the

requisition process. The requisition cycle includes:

Evaluating/confirming specifications (are they current?)

Confirming sources

Reviewing past performance of sources

Producing solicitation package

The solicitation package is prepared during the requisition cycle but utilized during the solicitation

cycle. In most situations, the same solicitation package must be sent to each possible supplier so that

the playing field is level. A typical solicitation package would include:

Bid documents (usually standardized)

Listing of qualified vendors (expected to bid)

Proposal evaluation criteria

Bidder conferences

How change requests will be managed

Supplier payment plan

Standardized bid documents usually include standard forms for compliance with EEO, affirmative

action, OSHA/EPA, minority hiring, etc. A listing of qualified vendors appears in order to drive

down the cost. Quite often, one vendor will not bid on the job because it knows that it cannot submit

a lower bid than one of the other vendors. The cost of bidding on a job is an expensive process.

Bidder conferences are used so that no single bidder has more knowledge than others. If a potential

bidder has a question concerning the solicitation package, then it must wait for the bidders'

conference to ask the question so that all bidders will be privileged to the same information. This is

particularly important in government contracting. There may be several bidders' conferences

between solicitation and award. Project management may or may not be involved in the bidders'

conferences, either from the customer's side or the contractor's side.

Solicitation Cycle

Selection of the acquisition method is the critical element in the solicitation cycle. There are three

common methods for acquisition:

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Advertising

Negotiation

Small purchases (i.e., office supplies)

Advertising is when a company goes out for sealed bids. There are no negotiations. Competitive

market forces determine the price and the award goes to the lowest bidder.

Negotiation is when the price is determined through a bargaining process. In such a situation, the

customer may go out for a:

· Request for information (RFI)

· Request for quotation (RFQ)

· Request for proposal (RFP)

The RFP is the most costly endeavor for the vendor. Large proposals contain separate volumes for

cost, technical performance, management history, quality, facilities, subcontractor management, and

others. The negotiation process can be competitive or noncompetitive. Noncompetitive processes

are called sole-source procurement.

On large contracts, the negotiation process goes well beyond negotiation of the bottom line.

Separate negotiations can be made on price, quantity, quality, and timing. Vendor relations are

critical during contract negotiations. The integrity of the relationship and previous history can

shorten the negotiation process. The three major factors of negotiations are:

· Compromise ability

· Adaptability

· Good faith

Negotiations should be planned for. A typical list of activities would include:

· Develop objectives (i.e., min-max positions)

· Evaluate your opponent

· Define your strategy and tactics

· Gather the facts

· Perform a complete price/cost analysis

· Arrange ''hygiene" factors

If you are the buyer, what is the maximum you will be willing to pay? If you are the seller, what is

the minimum you are willing to accept? You must determine what motivates your opponent. Is your

opponent interested in profitability, keeping people employed, developing a new technology, or

using your name as a reference? This knowledge could certainly affect your strategy and tactics.

Hygiene factors include where the negotiations will take place. In a restaurant? Hotel? Office?

Square table or round tables? Morning or afternoon? Who faces the windows and who faces the

walls? There should be a postnegotiation critique in order to review what was learned. The first type

of postnegotiation critique is internal to your firm. The second type of postnegotiation critique is

with all of the losing bidders to explain why they did not win the contract. Losing bidders may

submit a "bid protest" where the customer may have to prepare a detailed report as to why this

bidder did not win the contract. Bid protests are most common on government contracts.

Award Cycle

The award cycle results in a signed contract. Unfortunately, there are several types of contracts. The

negotiation process also includes the selection of the type of contract.

There are certain basic elements of most contracts.

Mutual agreement: There must be an offer and acceptance.

Consideration: There must be a down payment.

Contract capability: The contract is binding only if the contractor has the capability to perform the

work.

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The objective of the award cycle is to negotiate a contract type and price that will result in

reasonable contractor risk and provide the contractor with the greatest incentive for efficient and

economic performance.

Legal purpose: The contract must be for a legal purpose.

Form provided by law: The contract must reflect the contractor's legal obligation, or lack of

obligation, to deliver end products.

The two most common contract forms are completion contracts and term contracts.

Completion contract: The contractor is required to deliver a definitive end product. Upon delivery

and formal acceptance by the customer, the contract is considered complete, and final payment can

be made.

Term contract: The contract is required to deliver a specific "level of effort," not an end product.

The effort is expressed in woman/man-days (months or years) over a specific period of time using

specified personnel skill levels and facilities. When the contracted effort is performed, the

contractor is under no further obligation. Final payment is made, irrespective of what is actually

accomplished technically.

The final contract is usually referred to as a definitive contract, which follows normal contracting

procedures such as the negotiation of all contractual terms, conditions, cost, and schedule prior to

initiation of performance. Unfortunately, negotiating the contract and preparing it for signatures

may require months of preparation. If the customer needs the work to begin immediately or if long-

lead procurement is necessary, then the customer may provide the contractor with a letter contract

or letter of intent. The letter contract is a preliminary written instrument authorizing the contractor

to begin immediately the manufacture of supplies or the performance of services. The final contract

price may be negotiated after performance begins, but the contractor may not exceed the "not to

exceed" face value of the contract. The definitive contract must still be negotiated.

The type of contract selected is based upon the following:

Overall degree of cost and schedule risk

Type and complexity of requirement (technical risk)

Extent of price competition

Cost/price analysis

Urgency of the requirements

Performance period

Contractor's responsibility (and risk)

Contractor's accounting system (is it capable of earned value reporting?)

Concurrent contracts (will my contract take a back seat to existing work?)

Extent of subcontracting (how much work will the contractor outsource?)

45.3. Types of Contracts

Before analyzing the various types of contracts, one should be familiar with the terminology found

in them.

The target cost or estimated cost is the level of cost that the contractor will most likely obtain under

normal performance conditions. The target cost serves as a basis for measuring the true cost at the

end of production or development. The target cost may vary for different types of contracts even

though the contract objectives are the same. The target cost is the most important variable affecting

research and development.

Target or expected profit is the profit value that is negotiated for, and set forth, in the contract. The

expected profit is usually the largest portion of the total profit.

Profit ceiling and profit floor are the maximum and minimum values, respectively, of the total

profit. These quantities are often included in contract negotiations.

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Price ceiling or ceiling price is the amount of money for which the government is responsible. It is

usually measured as a given percentage of the target cost, and is generally greater than the target

cost.

Maximum and minimum fees are percentages of the target cost and establish the outside limits of

the contractor's profit.

The sharing arrangement or formula gives the cost responsibility of the customer to the cost

responsibility of the contractor for each dollar spent. Whether that dollar is an overrun or an under-

run dollar, the sharing arrangement has the same impact on the contractor. This sharing arrangement

may vary depending on whether the contractor is operating above or below target costs.

The production point is usually that level of production above which the sharing arrangement

commences.

Point of total assumption is the point (cost or price) where the contractor assumes all liability for

additional costs.

At one end of the range is the cost-plus, a fixed-fee type of contract where the company's profit,

rather than price, is fixed and the company's responsibility, except for its own negligence, is

minimal. At the other end of the range is the lump sum or turnkey type of contract under which the

company has assumed full responsibility, in the form of profit or losses, for timely performance and

for all costs under or over the fixed contract price. In between are various types of contracts, such as

the guaranteed maximum, incentive types of contracts, and the bonus-penalty type of contract.

These contracts provide for varying degrees of cost responsibility and profit depending on the level

of performance. Contracts that cover the furnishing of consulting services are generally on a per

diem basis at one end of the range and on a fixed-price basis at the other end of the range.

Because no single form of contract agreement fits every situation or project, companies normally

perform work in the United States under a wide variety of contractual arrangements, such as:

· Cost-plus percentage fee

· Cost-plus fixed fee

· Cost-plus guaranteed maximum

· Cost-plus guaranteed maximum and shared savings

· Cost-plus incentive (award fee)

· Cost and cost sharing

· Fixed price or lump sum

· Fixed price with re-determination

· Fixed price incentive fee

· Fixed price with economic price adjustment

· Fixed price incentive with successive targets

· Fixed price for services, material, and labor at cost (purchase orders, blanket agreements)

· Time and material/labor hours only

· Bonus-penalty

· Combinations

· Joint venture

At one end of the range is the cost-plus, a fixed-fee type of contract where the company's profit,

rather than price, is fixed and the company's responsibility, except for its own negligence, is

minimal. At the other end of the range is the lump sum or turnkey type of contract under which the

company has assumed full responsibility, in the form of profit or losses, for timely performance and

for all costs under or over the fixed contract price. In between are various types of contracts, such as

the guaranteed maximum, incentive types of contracts, and the bonus-penalty type of contract.

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These contracts provide for varying degrees of cost responsibility and profit depending on the level

of performance. Contracts that cover the furnishing of consulting services are generally on a per

diem basis at one end of the range and on a fixed-price basis at the other end of the range.

There are generally five types of contracts to consider:

· Fixed-Price (FP),

· Cost -Plus-Fixed-Fee (CPFF), Or Cost-Plus-Percentage-Fee (CPPF),

· Guaranteed Maximum-Shared Savings (GMSS),

· Fixed-Price-Incentive-Fee (FPIF), And

· Cost-Plus-Incentive-Fee (CPIF) Contracts.

Each type is discussed separately.

Fixed-Price (FP)

Under a fixed-price or lump-sum contract, the contractor must carefully estimate the target cost.

The contractor is required to perform the work at the negotiated contract value. If the estimated

target cost was low, the total profit is reduced and may even vanish. The contractor may not be able

to underbid the competitors if the expected cost is overestimated. Thus, the contractor assumes a

large risk.

This contract provides maximum protection to the owner for the ultimate cost of the project, but has

the disadvantage of requiring a long period for preparation and adjudications of bids. Also, there is

the possibility that because of a lack of knowledge of local conditions, all contractors may

necessarily include an excessive amount of contingency. This form of contract should never be

considered by the owner unless, at the time bid invitations are issued, the building requirements are

known exactly. Changes requested by the owner after award of a contract on a lump sum basis lead

to troublesome and sometimes costly extras.

Cost -Plus-Fixed-Fee (CPFF), Or Cost-Plus-Percentage-Fee (CPPF)

Traditionally, the cost-plus-fixed-fee contract has been employed when it was believed that accurate

pricing could not be achieved any other way. In the CPFF contract, the cost may vary but the fee

remains firm. Because, in a cost-plus contract, the contractor agrees only to use his best efforts to

perform the work, good performance and poor performance are, in effect, rewarded equally. The

total dollar profit tends to produce low rates of return, reflecting the small amount of risk that the

contractor assumes. The fixed fee is usually a small percentage of the total or true cost.

The cost-plus contract requires that the company books be audited. With this form of contract the

engineering-construction contractor bids a fixed dollar fee or profit for the services to be supplied

by the contractor, with engineering, materials, and field labor costs to be reimbursed at actual cost.

This form of bid can be prepared quickly at a minimal expense to contractor and is a simple bid for

the owner to evaluate. Additionally, it has the advantage of establishing incentive to the contractor

for quick completion of the job.

If it is a cost-plus-percentage -fee contract, it provides maximum flexibility to the owner and

permits owner and contractor to work together cooperatively on all technical, commercial, and

financial problems. However, it does not provide financial assurance of ultimate cost. Higher

building cost may result, although not necessarily so, because of lack of financial incentive to the

contractor compared with other forms. The only meaningful incentive that is evident today is the

increased competition and prospects for follow-on contracts.

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Guaranteed Maximum-Shared Savings (GMSS)

Under the guaranteed maximum-share savings contract, the contractor is paid a fixed fee for his

profit and reimbursed for the actual cost of engineering, materials, construction labor, and all other

job costs, but only up to the ceiling figure established as the "guaranteed maximum." Savings below

the guaranteed maximum are shared between owner and contractor, whereas contractor assumes the

responsibility for any overrun beyond the guaranteed maximum price.

This contract form essentially combines the advantages as well as a few of the disadvantages of

both lump sum and cost-plus contracts. This is the best form for a negotiated contract because it

establishes a maximum price at the earliest possible date and protects the owner against being

overcharged, even though the contract is awarded without competitive tenders. The guaranteed

maximum-share savings contract is unique in that the owner and contractor share the financial risk

and both have a real incentive to complete the project at lowest possible cost.

Fixed-Price-Incentive-Fee (FPIF)

Fixed-price-incentive-fee contracts are the same as fixed-price contracts except that they have a

provision for adjustment of the total profit by a formula that depends on the final total cost at

completion of the project and that has been agreed to in advance by both the owner and the

contractor. To use this type of contract, the project or contract requirements must be firmly

established. This contract provides an incentive to the contractor to reduce costs and therefore

increase profit. Both the owner and contractor share in the risk and savings.

Cost-Plus-Incentive-Fee (CPIF) Contracts

Cost-plus-incentive-fee contracts are the same as cost plus contracts except that they have a

provision for adjustment of the fee as determined by a formula that compares the total project costs

to the target cost. This formula is agreed to in advance by both the owner and contractor. This

contract is usually used for long-duration or R&D type projects. The company places more risk on

the contractor and forces him to plan ahead carefully and strive to keep costs down.

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45.4. ETHICS

Ethical Origins

Societal Ethics: Standards of Members of Society use when dealing with each other Based on

"Values & standards"

Societal Ethics: Found in Society's Legal Rules, Norm, & Mores. Codified in the "Form of Law" &

Society Customer.

Norms dictate how people should behave. Societal ethics vary based on a given Society. Strong

beliefs in one country differ elsewhere.

Professional Ethics: Professional Ethics are the Values & standards used by Group of Managers in

workplace. They are applied when decision not "Clear-Cut Ethically". Some examples are the

practices of Physicians/Lawyers Professional Associates (PMA, Bar Council)

Values: are an individual's basic convictions of what is "Right & Wrong". They are the basic beliefs

about what one should or should not do? & what is & is not important?

Individual Ethics: are the values of an individual resulting from their family & upbringing.

Ethics codes & policies provide sign of top management's desires in project based organizational

culture. Project manager should behave ethically to avoid harming others. Managers responsible for

"protecting & nurturing resources" in their charge. Leadership, Culture and Incentive Compensation

Plans help Shape "Individual Ethical behavior" in project management promoting ethics. There is

strong evidence showing that ethical managers benefit in the longer run. Firms increasingly seek to

make good ethics part of norm & organizational culture. Ethical decisions involve normative

judgment implies "something is good or bad, right or wrong, better or worse." Some examples are:

Should you pay compensation pay to lay off workers?

Should you buy goods from overseas firms that hire children? (If you don't Children may not earn

enough money to eat)

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Views of Ethical Decision-Making

Figure 45.1: Views of Ethical Decision Making

Code of Ethics:

Professional organizations such as the Project Management Institute are taking a serious look at

developing the requirements for a professional project manager. In a paper by Ireland, Pike, and

Schrock, this subject was described by an ethics obligation matrix and a code of ethics.

Figure 45.2: Ethics Obligation Matrix

Code of Ethics for Project Managers

Project Managers, in the pursuit of their profession, affect the quality of life for all people in our

society. Therefore, it is vital that Project Managers conduct their work in an ethical manner to earn

and maintain the confidence of team members, colleagues, employees, clients and the public.

Article I: Project Managers shall

· Maintain high standards of personal and professional conduct.

· Accept responsibility for their actions.

· Undertake projects and accept responsibility only if qualified by training or experience, or

after full disclosure to their employers or clients of pertinent qualifications.

· Maintain their professional skills at the state -of-the-art and recognize the importance of

continued personal development and education.

· Advance the integrity and prestige of the profession by practicing in a dignified manner.

· Support this code and encourage colleagues and co-workers to act in accordance with this

code.

· Support the professional society by actively participating and encouraging colleagues and

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coworkers to participate.

Obey the laws of the country in which work is being performed.

Article II: Project Managers shall, in their work:

· Provide the necessary project leadership to promote maximum productivity while striving to

minimize costs.

· Apply state-of-the-art management tools and techniques to ensure schedules are met and the

project is appropriately planned and coordinated.

· Treat fairly all project team members, colleagues and co-workers, regardless of race,

religion, sex, age or national origin.

· Protect project team members from physical and mental harm.

· Provide suitable working conditions and opportunities for project team members.

· Seek, accept and offer honest criticism of work, and properly credit the contribution of

others.

· Assist project team members, colleagues and co-workers in their professional development.

Article III: Project Managers shall, in their relations with employers and clients:

Act as faithful agents or trustees for their employers or clients in professional or business

matters.

Keep information on the business affairs or technical processes of an employer or client in

confidence while employed, and later, until such information is properly released.

Inform their employers, clients, professional societies or public agencies of which they are

members or to which they may make any presentations, of any circumstances that could

lead to a conflict of interest.

Neither give nor accept, directly or indirectly, any gift, payment or service of more than

nominal value to or from those having business relationships with their employers or

clients.

Be honest and realistic in reporting project cost, schedule and performance.

ARTICLE IV: Project Managers shall, in fulfilling their responsibilities to the community:

Protect the safety, health and welfare of the public and speak out against abuses in those

areas affecting the public interest.

Seek to extend public knowledge and appreciation of the project management profession

and its achievements.

How Firms Can Improve Their Social Responsiveness (Ethical Performance)

Establish and publish their own Code of Ethics

Ombudsmen - (committee, task force) to review the corporate past behavior

Protect whistle-blowing - when an employee discloses an illegal, immoral, or unethical

action committed by a member of the organization

Training programs - ethical sensitivity training

Controlling compliance - corporate social audit (or ethics audit)

Leadership - demonstrate commitment from leaders

Involve personnel at all levels

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