Case study on Procurement strategy
A contract is a “legal agreement between two or more people for an exchange of goods or services (Contracts Management, 2011)." A contract is important in governing the understanding between the parties. To a business, it presents an opportunity to acquire goods and services used in the business process. Nevertheless, they present a critical risk of liability. Unforeseen costs arise during implementation and new insight may need an accommodation. Prudent judgment is therefore critical in procurement contracts.
Forms contract evaluated
Firm fixed price
With firm fixed contacts the supplier of specified goods/service is paid a fixed amount of money by the buyer after delivery of the service. This contractual arrangement benefits the buyer with fixed cost figure that can be budgeted for. It is appropriate in cases where accurate cost estimations in a project can be determined beforehand (Contracts Management, 2011). Nevertheless, in case of new insight, the rigid terms bar the buyer from adjusting a project without the agreement of the buyer. In some cases, it could cost the buyer more if the supplier doe not compromise in a renegotiation.
Fixed price with targets
A fixed price contract with targets is fundamentally a fixed price contract. The targets are a form of incentive paid to the supplier to motivate economical efficiency. The supplier is paid the costs they save on a project as profit (Expert Program Management, 2011). For example, suppose there is contract has a target cost of $ 1 million; a target profit of $ 0.2 million and a price ceiling of $ 1.5 million. Should the supplier perform in cost less than $ 1 million, the profit increases to receive a maximum $ 1.5 as calculated using profit adjustment formula.
Fixed price at cost
This is a modified fixed cost contract. Within the specifications, it allows an adjustment of the price if the cost of were to change due to a macro factor like inflation. This is applicable contracts for critical services which need safeguarding by the buyer (FARSite, 2011).
Time and materials
In this contract, the supplier/seller is paid a determined value of their time and materials in a project (Tutorials Point, 2011). Time has to be in hours of direct labor that include wages and profit. Materials cover the acquisition cost and handling cost. In this contract, much risk is minimized on both the buyer and the seller. Time and material agreements are practiced where both parties are keen on to engage in long-term business. Implementation is in short cycles where estimates are reworked afresh.
Cost plus reimbursement plus profit
In this contractual agreement, “all the costs that the seller incurs during the project are charged back to the buyer, and thus the seller is reimbursed costs (Expert Program Management, 2011)." In the contract ‘allowable’ cost is defined so that only the agreed costs are claimed. In addition, an incentive fee is paid to the seller “for exceeding the performance criteria specified in the contract (Expert Program Management, 2011)." This profit incentive can save costs for the buyer when performance improves. Like other all cost-reimbursable contracts, this agreement offers flexibility on the scope of an ongoing project. This is appropriate in projects with uncertain aspects of the deliverable.
In this agreement, an agreed portion of allowable cost is reimbursed to a supplier of a service/good. There is no other fee paid to the supplier. In sharing the cost, the buyer anticipates a benefit in an exploratory project (US General Services Administration, 2011).
From analysis of different types of contract, it is clear that they present competing advantages and risks. The strategy is therefore to divide the contract into independent parts that will maximize on the benefits of each contact mode. It is prudent in this case where there is a mix of goods and services to procure. Justification is informed by varying risks. An estimate the price of computer hardware is achieved to high accuracy from market prices. Similarly, the training in 60 days can be determined using labor rates from the market (FARSite, 2011). On the contrary, disposal of obsolete software is not clear-cut issue. To leverage on these benefits, items will be procured independently. This does not necessarily mean that all contractors have to be different for each unit; rather, terms for each unit are negotiated separately.
Factors to consider
Risk is the main factor to be considered. Risk is liability that the business is likely to incur in acquisition/supply of services/goods as additional costs that could not be determined accurately in advance .When the degree of certainty in the estimation is low, there is a higher risk and vice versa (US General Services Administration, 2011). The motive of a business is minimizing the risk.
Time period to accomplish procurement is another factor. If the delivery of the service is urgent, the time of performing the contract should be shortened. Even in non-urgent matters, economic factors such as inflation raise the costs over longer periods. In cases where firm fixing of price is not feasible, incentive to the supplier is good strategy. It means that the supplier increases their efficiency to gain the profit incentive (Expert Program Management, 2011).
The third consideration is the opportunity to earn revenue. Acquisition of a service/good at times requires partial or complete interruption of ongoing business processes. Installations and testing of new cash registers require cash sale billing be stopped or be substituted with inefficient manual system. Although it may not be completely eliminated, supplier can be motivated with an incentive by saving time or reducing interruption with efficient techniques (Expert Program Management, 2011).
The forth important factor is flexibility on the business. While a firm is keen to keep costs to certain by fixing the contractual price, a degree of flexibility is rewarding (FARSite, 2011). The firm should aim for flexibility in complex projects and those that take longer periods of implementation.
Acquisition of computer software (includes the scheduling tool) hardware will be considered firm-fixed contract. These items have determinable prices with least risk. Software installations and training of staff will be awarded under time and materials contact. In these services, these tasks are fairly regular to determine standard labor rates. In addition not much material is expected to offer loophole for the contactor to inflate their costs. Finally, disposal of the software will be considered under cost-plus incentive contract. This service carries a great risk in estimation of costs to fix a price. It is in best interest the business to pay for only the costs realized. The disposal is critical to full allow full and timely adoption of the new system (Wallace & Webber, 2006 p. 243). There is an opportunity cost associated with delayed switch to the new system. To achieve efficiency on time, the contactor will be motivated with the incentive to earn a profit should they complete work ahead of deadline.
The use of different contract forms poses administration difficulty. Separation is motivated by two main reasons. The first one is a desire to minimize potential risks to the business. It is economical when the independent segments cumulatively save greater cost that that of the whole project. Another common motivation is applicable in projects that require varied expertise. However, monitoring the implementation of the different parts may commit extra staff to oversee.
The second challenge is the lack of motivation offered to the contactor in delivering time-and material service. When provided, an incentive motivates the contractor to increase their time efficiency completing. A related difficulty is verification of ‘training’ as a deliverable. As a new field, the staff may not reliably determine the extent of their learning.
Solutions to potential challenges
In the cost plus profit contract to remove the obsolete system, an audit of the contractor’s accounts is necessary. The profit accompanying reimbursement of costs is considered an incentive improves the efficiency of performance in urgent projects. However, there is a possibility of the contractor inflating costs to a greater value than the profit. Thus, their cost estimations need an audit.
It is admissible that the contractor who is not motivated by time or profit efficiency may drag their performance to earn more (FARSite, 2011). In this case study, time-and-materials contract have been recommended in procurement of services that have determinable routines and regular labor rates. However, there is a strategy to safeguard potential drag. The staff under training will be required to maintain progress reports to act as checklist in course objectives. Secondly, the staff will be assessed in regular practical to test assimilation of knowledge.
Difficulty in administering different contracts is expected. A suitable solution is sequencing the various processes in a logical flow. Acquisition of computer hardware will be carried out first followed by installations of the software. Training of the staff in the use of the tool can happen concurrently with disposal of old system. This is actually a benefit of leverage in separated the contract items.
In this procurement case study, a well considered decision has been discussed. An analysis of alternative forms of contracts identified their varying risks and benefits. Division of various contract items and awarding respective contracts will achieve the greatest benefit to the business.