MSc International Logistics & SCM / MSc Strategic

Procurement Management

Commercial Relationships

Using relevant course material and broader research, critically evaluate what could be
considered to be the most critical and appropriate contractual, legislative or regulatory
arrangements that are involved in the procurement and supply of goods and services for an
organization in 2020?
Table of Contents
INTRODUCTION...........................................................................................................................................2
AN OVERVIEW ON PROCUREMENT.............................................................................................................4
RISK IN PROCUREMENT OF GOODS AND SERVICE.......................................................................................5
CONTRACTUAL ARRANGEMENT IN PROCUREMENT OF GOODS AND SERVICE...........................................6
Fixed-Price Contracts...............................................................................................................................7
Cost-Reimbursable Contracts..................................................................................................................8
REGULATORY ARRANGEMENT IN PROCUREMENT OF GOODS AND SERVICE............................................10
SUSTAINING PROCUREMENT PROCESS.....................................................................................................11
CONCLUSION.............................................................................................................................................12
References.................................................................................................................................................13
INTRODUCTION
Every functional area of a company contributes to the success of the business. Nevertheless, the
commercial role has the distinctive characteristics being in constant interaction with the client.
The future of an organization depends on the efforts of those carrying out commercial functions,
know-how, and success in completing their responsibilities. It depends upon personal conduct of
business and how ethics, principles, and value is perceived. It is critical for an organization on
how commercial relationship is handled. Management of commercial relationships is related to
the efficient management of contract, implementation, and assessment of relational performance.
Good contract management leads to the maintenance of a better association with the fewer
dispute. Good management contracts improve understanding among parties and can be easy to
work with. Business involves various types of short-term & long-term agreements, and managing
contract can offer great clarity in performance and financial obligation. Procurement is an
integral part of commercial relationship management. An efficient management of the
procurement helps in in improving commercial relationships.
AN OVERVIEW ON PROCUREMENT
In a business, procurement refers to the process of purchasing products or services. It can be day
to day part of daily business in a small organization.  In a large organization, the procurement
process can be complex functions requiring considerable resources. Procurement is the process
of receiving of goods through leasing, hiring, purchasing, and borrowing [ CITATION Ken06 \l
1033 ]. It relates to more proactive, strategic, relational, and integrated roles of an organization.
An individual department devotes its function in procurement activities across a large
organization. The procurement process is performed under organization policies and procedures.
An effective procurement involves getting the right product at the right price. An organization
needs to monitor the procurement process for mitigating fraud risk and corruption risk. It is
based on fairness, cost-effectiveness, transparency, and probity. The application of procurement
methods varies from organization to organization and from one country to another.

Table 1: Objectives of procurement system

Objectives of procurement systems

1) Accountability
2) Value for money
3) Integrity
4) Fair treatment
5) Equal opportunities
6) Opening of markets for international trade
7) Proficiency in the procurement process
8) Effective implementation of environmental, social and industrial objectives
RISK IN PROCUREMENT OF GOODS AND SERVICE
Risk is a circumstance that can hinder procurement from achieving financial and non-financial
objectives[ CITATION Rus08 \l 1033 ]. Every type of organization experiences some risk at
different points of business. Risk is involved in procurement and supply partnership. It is viewed
as an essential part of the organization in enhancing value.  The critical risk involved in the
procurement are:

Fraud Risk
TYPES Quality Failure Risk
OF Supplier Failure Risk
RISK Currency Risk
Information Risk
Figure 1: Types of risk in procurement

(i) Fraud Risk: Fraud occurs from the presentation of a false document in the
engagement process. The consequence and probability of fraud are high on the
quality of goods. It happens through the supply of inferior material and the
submission of a false bill memo.
(ii) Supplier Failure Risk: It results from poor financial supplier's health. Suppliers
encounter an issue such as labor dispute, natural calamities, and unforeseeable
incidents. These issues affect the process of supply of goods and services in the
market. Reliance on a single supplier leads rise to such risk.
(iii) Quality Failure Risk: It is a risk related to failing to meet quality. The fundamental
factor affecting quality are market, capital, and management.
(iv) Currency Risk: It includes quote prices and foreign tenderers. Generally, the rise in
price leads to currency risk. Higher risk involves in international procurement.
 (v) Information Risk: Lack of protection and low reliability is the major factor causing
information risk. The procurement process is highly vulnerable to it and has high
negative consequences.

CONTRACTUAL ARRANGEMENT IN PROCUREMENT OF

GOODS AND SERVICE
Contractual arrangements refer to mutual agreements written between two or more parties,
enforceable by law, and both parties have equal duties and responsibility [ CITATION See93 \l
1033 ]. Organization signs arrangements with the other entities to provide products or services.
It involves various types of contracts, like offering the party for using goods as well as requiring
the party to maintain procurement activities. The same nature of the contractual arrangement is
found across many countries.  Procurement contracts are arrangements for the use of
certain goods and services. Usually the forms of procurement contracts either are fixed-price or
cost-refundable. Some deals on a single contractual agreement can contain more than one of the
many payment structures. The procurement management process facilitates to find suitable
suppliers for goods and services. Using the correct type of contractual agreement could have a
considerable impact on the success of an organization since there are real advantages and
disadvantages with the selection of each procurement contract. The structured procurement
process must be understood by both buyers and sellers within an organization. It is used in every
company and industry. While private businesses have flexibility in procurement, government
agencies have to comply with specific rules and regulations.
Table 2: Types of contractual arrangement

TYPES OF CONTRACTUAL ARRANGEMENT

i. Fixed-Price Contracts

ii. Cost-Reimbursable Contracts

Fixed-Price Contracts
It is a legal arrangement between the company and an agent to provide products or services at a
price agreed upon. The contract typically specifies the quality of the product and the cost of
products being provided. If the supplier is responsible for all costs into an agreed price, it can be
referred to as a fixed –price contract. The fixed-price contract has different variations. It provides
a stable cost for materials and goods and services in which the work scope is very
straightforward and also not expected to be influenced[ CITATION Cor04 \l 1033 ] . It is the supplier
who is responsible for overseeing the job to meet the needs of the client. The supplier
team tracks the consistency and schedule progress and ensure the suppliers are fulfilling the
needs. The risks involved are the costs of modifying the supply process.  The price of the change
in the procurement is very costly to an organization. Even if the price for changes is included
with the original agreement, adjustments to a fixed-price contract can generate higher overall
procurement costs than other types of deals as much of the cost risk is passed to the organization.
Most organization uses a contingency plan to cover the additional risk. It includes the provision
of at least two or more suppliers with the experience and performance records to guarantee that
the organization's requirements can be met. The other prerequisite is a scope of procurement that
most probably won't alter. Good information, creation of a list of highly qualified suppliers, and
development of a clear contract reflect a good fixed-price contract. The buying
organization assumes the risks associated with unforeseen rises in labor and resources needed to
deliver the product and resources on time [ CITATION Tir09 \l 1033 ].
The price-adjusting fixed-price contract is used for exceptionally long procurement and supply of
goods that last years. Inflation-adjusted price is used in such conditions. The cost of procurement
materials is highly affected by currency fluctuation in the local and international
markets.  During times of high inflation, the company assumes the risk of increased costs due to
inflation, and then the contract price is adjusted to the inflation index. Within a price-adjustment
contract, the uncertainty of other goods may also be compensated. For example, oil price
significantly affects the cost of procurement. The oil price volatility risk can be included in the
contract allowing for adjustment in the contract price. The fixed-price contract plus incentive fee
offers an opportunity to perform on the procurement contract over the contract baseline amount.
The agreement may provide an opportunity for the contractor to complete the work on a
significant milestone. It involves the penalty cost clause if the procurement contract is not
performed under to contract.
Table 3:Types of fixed-price contract

Type Share of Risk Known Scope Predictability of An incentive for

cost meeting
milestone
Fixed unit price Mostly High High Low
organization
Fixed total cost All parties Very High Very High Low
Fixed fee with Mostly High Medium Low
price adjustment organization
Fixed price with Mostly High Medium-high High
 an incentive fee organization

Cost-Reimbursable Contracts
The organization offers to pay the supplier for the cost of delivering the goods. It is widely
known as cost-plus contracts. It is most frequently used when the cost of doing the task is not
well known.It is used by an organization to pay the supplier for the contract performance related
to the supply of goods. Since procurement costs are reimbursable, the organization has less risk
with an increment in price [ CITATION Kim16 \l 1033 ]. It reduces the money bidder places to
account for the potential risk of the rising cost when the procurement cost is not known. The
supplier feels demotivated in reducing cost unless the incentive exists for the supplier after the
procurement of goods. To guarantee that the supplier is paid for the services done and to ensure
that the organization does not pay for anything that has not taken place, it needs proper reporting
of the costs incurred. An additional payment is also paid to the supplier above the expenses.
There are various ways to make up for the contractual agreement between suppliers and the
organization. A cost-reimbursable contract with a fixed price pays the supplier a charge, or
benefit sum, which is decided at the outset of the agreement but does not adjust. A cost-
refundable contract with a percentage fee charges the supplier for expenses plus a percentage of
the costs, like 8% percent of the total permissible costs. The supplier is paid a fee and is
reimbursed for costs incurred.
Similarly, A cost-refundable contract with an incentive fee is often used to promote efficiency in
areas of procurement criticality. The procurement contract also aims to encourage suppliers and
organizations to save costs. Reimbursable contract with an incentive fee is another way of
facilitating cost-reduction. A cost-refundable contract with a reward fee reimburses all allowable
expenses to the company plus a price dependent on performance requirements. Usually, the cost
is based on more arbitrary objectives or targets. The decision on the amount to be paid to
suppliers for goods rest on the hand of an organization. This amount includes an extra amount set
aside for the procurement to motivate suppliers.

Table 4:Types of cost-reimbursable contract & risk

Cost Share of Risk Known Scope Predictability of An incentive for

Reimbursable Cost meeting
milestone
C.R. with Mostly Medium Medium-High Low
percentage fee organization
C.R. with a fixed Mostly Medium Medium-High Low
 fee organization
C.R. with an Mostly Medium Medium Low
incentive fee organization
Time and Both parties Low Low High
Materials
C.R. with award Mostly Medium Medium Low
fee organization

The selection of contracts is based on the degree of risk, the scope of uncertainty, meeting of
milestone dates, and the need for a predictable cost. Fixed cost is a significant factor affecting the
range of procurement. Each of these types of contracts has its own advantage and limitation.
Although fixed-price contracts set price per unit, it is difficult to know exact numbers. A fixed
price with an incentive contract provides rewards for the completion of procurement on time.In
the same way, fixed price with adjustments supports increment or decrement with the change in
cost and other risk factors. Similarly, a cost-reimbursable contract relates to payment for actual
cost compared to cost plus fixed fee whereby the fee of a deal is assured. Likewise, a huge
difference exists in other types of contracts in terms of pricing.

The existence of various types of contractual arrangement raise challenges to organization in

selection of right agreement. Likewise, the increasing complexity in contractual terms has also
affected the very process of contractual arrangement in procurement process.
REGULATORY ARRANGEMENT IN PROCUREMENT OF GOODS
AND SERVICE

The Legal Service Act U.K. defines regulatory arrangements as a set of all rules, regulations, and
other designs which apply to regulated persons and organization [ CITATION PRO15 \l 1033 ]. The
procurement of goods and services has to go through many regulatory processes. Public
Contracts Regulations 2015, Concession Contracts regulation 2016 and Utilities Contracts
Regulation 2016 are the legal frameworks for procurement in the UK. The procurement rules
must be followed by all the organizations. There exist many limitations and issues in the
procurement law concerning the treatment of the arrangement of goods/services in various types
of industries. The organization follows different forms of the procurement process to take
advantage of economies of scale. The approach to a difference in procurement in the public
sector and private sector makes even for complicated in adherence to procurement laws. The
principle of transparency plays a significant role in procurement in private organizations.
Procuring suppliers are provided with various types of discretion and leave room for close
relationships with the organization. Although formal competitive procedures are the norms
guiding the selection of suppliers, the favoring of specific suppliers has hurt the regulatory
arrangement. For example: Although the UK government has robust control over procurement
policy, but is neither enforced nor agreed by the organization. These are augmented by internal
rules and policies of organizations. Different rules are necessary for effective management of
procurement system. However, the procurement rules are often criticized by various
organizations in spite they set universally accepted principles and laws for governing the
procurement system. The moral ground of procurement system lacks on adherence to traditional
procurement rules and regulation. Transparency and competition is the principle found in the
regulatory system of procurement. All types of organizations involving in the procurement
system must achieve these principle objectives. However, the principle has been rarely defined
and articulated in an organization. The complex nature of legislative and regulative framework
ha stood as a threat to the organization. It has resulted in a lack of trust in procuring
firms[ CITATION Sch06 \l 1033 ]. Non-supportive policies act as a barrier in the process of
procurement of goods and services. This issue has centrally affected many organizations across
the world. With the ongoing changes taking place in global business environment the
procurement laws is likely to be less accepted and followed by organization.
SUSTAINING PROCUREMENT PROCESS
It is the responsibility of an organization to integrate the procurement process with the
objectives of an organization. It involves monitoring supply trends in the market, interpreting
the trend and supporting organizational needs for a competitive procurement base [ CITATION
Rob09 \l 1033 ]. Organization is highly surrounded by many issues leading to incompetence in a
selection of the right supplier and also leading to untrustworthiness. An underlying issue in the
contractual arrangement and the regulatory arrangement has also raised the problem for an
organization. The existence of different forms of contractual arrangement makes it hard in the
selection of the right types of contracts for procurement with suppliers. In the same way,
inconsistency in the laws set for procurement has hindered the legal framework guiding the
procurement process. The unprofessional practice badly disrupts relation with suppliers down the
supply chain procurement stream. The stage in the procurement of goods involves placing an
order to the final consumption of goods by customers. An unprofessional executed procurement
affects customers and goodwill of the company. Lack of corporate governance leads to
mismanagement and negatively affects the overall process of procurement and organization
success. Vroom’s expectancy theory states that an effort to satisfy needs depends upon a
person’s perception and effort to achieve certain desirable outcomes [ CITATION Mai11 \l 1033 ] .
Thus the procurement function of an organization needs to interrelate with the organization
other’s function for the success of the firm.
CONCLUSION
Inevitably rising challenges in procurement in a private organization have led to the development
of many exciting issues among the business organization. An understanding of the extent of such
an issue is essential for navigating the increasingly complex procurement world. An organization
cannot evaluate procurement in the modern world. It needs to maintain a strong relationship
with suppliers to become successful. Supplier relation is very critical for a profit-driven
organization. The selection of a supplier’s directly affects the financial and non-financial
performance. It impacts on the delivery of goods, customer relationship and goodwill.
Therefore, an organization should spend on the development of the procurement system by
investing in newer technology, training of employees and learning of different types of
procurement systems. In general, the procurement process in small and large organizations varies
highly. The selection of the right procurement system is most for overcoming any type of issues
and conflict of interest. Failure of the various small organizations from understanding the
suitable procurement system has often articulated the problem. Therefore, it is necessary to apply
a suitable strategy for the procurement of goods and services. Performing a risk assessment is
one of the most widely used processes by an organization. Likewise, and increasing the use of
procurement software provides a way for quickly unraveling issues. The organization must make
sure that all the details related to procurement are read and understood by both parties before
proceeding into the procurement process.
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