ENGR 510

Engineering Project
Management
LECTURE 9 – CONTRACT MANAGEMENT
(REFER TO KERZNER’S BOOK CHAPTER 19)
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 on 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.

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Procurement Strategies
 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.

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Procurement Objectives
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 of the goods/services.

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Procurement Management
 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

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Procurement Planning
 The first step in the procurement process is the planning for purchases and acquisitions,
specifically the development of a procurement plan that states what to procure, when, and
how. This process 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

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Specifications
 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.

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Conducting the Procurements
 Once the requirements are identified and a procurement plan has been prepared, a
requisition form for each item to be procured is sent to procurement to begin the
procurement or requisition process.
 The process of conducting the procurements includes:
 Evaluating/confirming specifications
 Confirming sources
 Reviewing past performance of sources
 Producing solicitation package

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Solicitation Package
 The solicitation package is prepared during the procurements planning process but utilized
during the next process, conduct procurements. In most situations, the same solicitation
package for each deliverable must be sent to each possible supplier so that the playing field
is level.
 A typical solicitation package would include:
 Bid documents
 Listing of qualified vendors (expected to bid)
 Proposal evaluation criteria
 Bidder conferences
 How change requests will be managed
 Supplier payment plan

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Solicitation Cycle
 Selection of the acquisition method is the critical element to request seller responses.
There are three common methods for acquisition:
 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.

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Negotiation Processes
 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)
 Invitation for bids (IFB)

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Negotiation Processes (Cont’d)
 The RFP is the most costly endeavor for the seller. Large proposals may contain separate
volumes for cost, technical performance, management history, quality, facilities,
subcontractor management, and others. Bidders may be hesitant to spend large sums of
money bidding on a contract unless the bidder believes that they have a high probability of
winning the contract or will be reimbursed by the buyer for all bidding costs.
 Using the IFB process, only selected companies are allowed to bid. Either all or part of the
companies on the buyer’s preferred contractor list may be allowed to bid.
 In government agencies, IFBs are used in sealed bidding procurements. The competing
offerors submit priced bids in response to IFBs. These IFBs contain all of the necessary
technical documents, specifications, and drawings needed for a bidder to develop a priced
offer. There are no discussions or negotiations, and the contract is always awarded to the
lowest acceptable offer using a firm fixed-priced contract.

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Negotiation Planning
 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

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Contract Negotiations
Requires Knowing
When To Speak And
When To Be Quiet.

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 Research Your
Customer Before
Entering Into Contract
Negotiations

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Award Cycle
 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.

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Contracting Elements
 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.
 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.

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Contract Forms
 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.

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Contract Selection Criteria
 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?)

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Types of Contracts
 There are generally five types of contracts to consider:
1. Fixed-price (FP),
2. Cost plus-fixed-fee (CPFF), or cost-plus-percentage-fee (CPPF),
3. Guaranteed maximum-shared savings (GMSS),
4. Fixed-price-incentive-fee (FPIF), and
5. Cost-plus-incentive-fee (CPIF) contracts.

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There are several other types
of contracts available. They
may be derivatives of these
contracts, combinations, or
simply special contracts for
special circumstances.

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Incentive Contracts
 Clients, especially the government, have been placing incentive objectives into their
contracts. The fixed-price-incentive-fee (FPIF) contract is an example of this.
 The essence of the incentive contract is that it offers a contractor more profit if costs are
reduced or performance is improved and less profit if costs are raised or if performance
goals are not met.
 Cost incentives take the form of a sharing formula generally expressed as a ratio. For
example, if a 90/10 formula were negotiated, the government would pay for 90 cents and
the contractor 10 cents for every dollar above the target cost.
 Thus it benefits both the contractor and the government to reduce costs, because the
contractor must consider that 10 percent of every dollar must be spent by the company.
Expected profits can thus be increased by making maximum use of the contractor’s
managerial skills.

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Contract Type Versus Risk
 The amount of profit on a contract is most frequently based upon how the risks are to be
shared between the contractor and the customer.
 For example, on a firm-fixed-price contract, the contractor absorbs 100 percent of the risks
(especially financial) and expects to receive a larger profit than on other types of contracts.
 On cost, cost-plus, and cost-sharing contracts, the customer absorbs up to 100 percent of
the risks and expects the contractor to work for a lower than expected profit margin or
perhaps no profit at all.
 All other types of contracts may have a risk sharing formula between the customer and the
contractor.

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Contract Administration Cycle
 The contract administrator is responsible for compliance by the seller to the buyer’s
contractual terms and conditions and to make sure that the final product is fit for use.
 Contract administrators can shut down a manufacturing plant by allowing the seller to make
late deliveries.
 Although a contract administrator is a member of the project team for project reporting
purposes, the contract administrator can report to a line function such as corporate legal
and may even be an attorney.

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Contract Administration Cycle (Cont’d)
The functions of the corporate administrator
include:
 Change management
 Contract breach
 Specification interpretation
 Resolution of disputes
 Adherence to quality
 Warranties  Project termination

 Subcontractor management  Payment schedules

 Production surveillance  Project closeout
 Waivers

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Order of Precedence
 The larger the contract, the greater the need for the contract administrator to resolve
ambiguity in the contract. Sometimes, large contracts that are prepared by teams of
attorneys contain an order of precedence clause.
 The order of precedence specifies that any inconsistency in the solicitation of the contract
shall be resolved in a given order of procedure such as:
A. Specifications (first priority)
B. Other instructions (second priority)
C. Other documents, such as exhibits, attachments, appendices, contract date
requirements list [CDRL], etc. (third priority)
D. Contract clauses (fourth priority)
E. The schedule (fifth priority)

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Type of Changes
Perhaps the majority of the contract administrator’s time is spent handling changes. The
following definitions describe the types of changes:
 Administrative change: A unilateral contractual change, in writing, that does not affect the
substantive rights of the parties (i.e., a change in the paying office or the appropriation
funding).
 Change order: A written order, signed by the contracting officer, directing the contractor to
make a change.
 Contract modification: Any written change in the terms of the contract.

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Type of Changes (Cont’d)
 Undefinitized contractual action: Any contractual action that authorizes the
commencement of work prior to the establishment of a final definitive price.
 Supplemental agreement: A contract modification that is accompanied by the mutual
action of both parties.
 Constructive change: Any effective change to the contract caused by the actions or inaction
of personnel in authority, or by circumstances that cause a contractor to perform work
differently than required by written contract.

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Causes of Constructive Changes
 Defective specification with impossibility of performance
 Erroneous interpretation of contract
 Over-inspection of work
 Failure to disclose superior knowledge
 Acceleration of performance
 Late or unsuitable owner or customer furnished property
 Failure to cooperate
 Improperly exercised options
 Misusing proprietary data

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Reasons for Termination for Convenience
of the Customer
 Based on the type of contract, terms, and conditions, the customer may have the right to
terminate a contract for convenience at any time. However, the customer must compensate
the contractor for his preparations and for any completed and accepted work relating to the
terminated part of the contract.
 The following are reasons for termination for convenience of the customer:
 Elimination of the requirement
 Technological advances in the state-of-the-art
 Budgetary changes
 Related requirements and/or procurements
 Anticipating profits not allowed

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Reasons for Termination for Default Due
to Contractor’s Actions
The following are reasons for termination for default due to contractor’s actions:
 Contractor fails to make delivery on scheduled date.
 Contractor fails to make progress so as to endanger performance of the contract and its
terms.
 Contractor fails to perform any other provisions of the contract.

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Contract Administration Rights
The contract administrator is responsible for performance control. This includes inspection,
acceptance, and breach of contract/default. If the goods/services do not comply with the
contract, then the contract administrator has the right to:
 Reject the entire shipment
 Accept the entire shipment (barring latent defects)
 Accept part of the shipment

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Contract Closure
The contract administrator is responsible for verification that all of the work performed and
deliverables produced are acceptable to the buyer. Contractual closure is then followed up with
administrative closure, which includes:
 Documented verification that the output was accepted by the buyer
 Debriefing the seller on their overall performance
 Documenting seller’s performance (documentation will be used in future source selections
when evaluating contractor’s past performance)
 Identifying room for improvement on future contracts
 Archiving all necessary project documentation
 Performing a lessons-learned review
 Identifying best practices

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END OF LECTURE 9

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