SUBJECT NAME: PROJECT MANAGEMENT AND FINANCE CREDITS: 3

SUBJECT CODE: 1150MG101 HOURS: 3

UNIT – IV: PURCHASING, CONTRACTING, NETWORK MODELS
Introduction – Purchase cycle – Contract Management – Procurement process – Development
of Project Network – Time estimation, Determination of the critical path – PERT Model –
Measures of variability – CPM Model – Network cost system.

PURCHASE MEANING:
 To buy a product or service
 A product or service that has been bought by an individual or business.
PROCUREMENT MEANING:
The act of obtaining or buying goods and services. The process includes preparation and
processing of a demand as well as the end receipt and approval of payment. It often involves
(1) purchase planning,
(2) standards determination, 
(3) specifications development, 
(4) supplier research and selection, 
(5) value analysis, 
(6) financing, 
(7) price negotiation, 
(8) making the purchase, 
(9) supply contract administration, 
(10) inventory control and stores, and 
(11) disposals and other related functions. 

The process of procurement is often part of a company's strategy because the ability to
purchase certain materials will determine if operations will continue.
A business will not be able to survive if it's price of procurement is more than the profit it
makes on selling the actual product.
STEPS IN THE PROCUREMENT PROCESS:
Aligning your procurement function with your corporate strategy is only one part of
the ultimate goal of procurement. Goods and services also need to be purchased.
The process of purchasing these good and services is known as the Procure-To-Pay Cycle.
The entire Procure-To-Pay Cycle can be an involved process with numerous steps:

Identification of Requirement
Authorization of Purchase Request
 Approval of Purchase Request
Procurement
Identification of Suppliers
Inquiries Receipt of the Quotation
Negotiation
Selection of the Vendor
Purchase Order Acknowledgement
Advance Shipment Notice
Goods Receipt
Invoice Recording
3 Way Match (The goal of three-way matching is to highlight any discrepancies in three
important documents in the purchasing process – purchase orders, order receipts/packing slips,
and invoices – in order to save businesses from overspending or paying for an item that they did
not receive.)
Payment to Supplier

Although this list is extensive, the nature of your specific business will determine the extent of
the Procure-To-Pay cycle you use. For example, if your work in a large, multinational
corporation, you may have to undergo a more involved “Identification of Requirement” phase.
On the other hand, if you work in a small firm, that stage may be quick and simple. Understand
the scope of your business and tailor as needed.

PURCHASE VS PROCUREMENT:
Procurement involves the process of selecting vendors, establishing payment terms,
strategic vetting, and selection, the negotiation of contracts and actual purchasing of goods.
Procurement is concerned with acquiring (procuring) all of the goods, services, and
work that is vital to an organization. Procurement is, essentially, the overarching or
umbrella term within which purchasing can be found.
PURCHASE CYCLE:
14 STEPS FOR PURCHASING CYCLE WITH TENDERS:

1. The Need
In this case, the need usually goes through a business case and is then tightly defined
and specified.
2. Financial Authority
This usually happens at a higher level and includes the management of the department
that requires the goods.
3. RFP
A Request for Proposal (RFP) is written, in which the need is highly specified.
4. Invite Tenders
This is always done formally, usually by posting the request in trade magazines and
appropriate web sites. Government projects are posted on government web sites.
5. PQQ
A Pre Qualification Questionnaire (PQQ) is sent out to likely suppliers in order to select
a short list of appropriate potential suppliers.
 6. Tenders
The tenders are sent in from the qualified suppliers.
7. Qualifying
A number of meetings are held to clarify any questions that suppliers may have.
8. Evaluation
This is the most exciting part of the purchasing cycle and can take many weeks for a big
tender. All the tenders are evaluated and the requirement awarded to the winning
bidder.
9. Negotiation
The fine print of the terms and conditions are negotiated with the chosen supplier. The
price is fixed at the bid price.
10. Contract Award
In a very short time, the contract is awarded to the chosen bidder.
11. Manage Contract
This is the period in the purchasing cycle when the goods are delivered.
12. Approval And Payment
If the contract is carried out completely then full payment is made. If there are
problems, there may be a damage request.
13. Sign Off
At the end of the contract work and deliveries, the contract is signed off and all
relationships with the supplier are finished.
14. Update Of Records
The purchasing ledger and stock records are updated. This is automatically done by
many purchasing computer systems.

CONTRACT MANAGEMENT:
MEANING:
Contract management or contract administration is the management of contracts made
with customers, vendors, partners, or employees. The personnel involved in
contract administration required to negotiate, support and manage effective contracts.
TYPES OF CONTRACT:
A contract is an agreement between two entities or individuals, which serves as legal
protection for both parties involved in a potential business deal. There are different types of
contracts, and each determines the rights and duties of both sides. A specific type of contract
regulates the risks and expenses for the contractor.
Two different kinds of groups of contracts are fixed price contracts and cost-
reimbursement contracts. Different types of contracts, which are contained within each of
these two types of groups, may be used separately or in combination with one another.
FIXED PRICE CONTRACT or LUMP SUM CONTRACT:
Contract that provides for a price which normally is not subject to any adjustment
unless certain provisions (such as contract change, economic pricing, or defective pricing) are
included in the agreement. These contracts are negotiated usually where reasonably definite
specifications are available, and costs can be estimated with reasonable accuracy. A fixed price
contract places minimum administrative burden on the contracting parties, but subjects the
contractor to the maximum risk arising from full responsibility for all cost escalations. Also
called firm price contract.

COST – REIMBRUSEMENT CONTRACT:

A cost-reimbursable contract is a variant of a contract that involves making a payment
from the buyer to the seller in reimbursement for the seller’s actual costs. Added to that is a fee
that typically represents the seller’s profit. When analyzing costs they are typically broken
down into two categories. Those categories are direct costs and indirect costs. Direct costs are
defined as the costs that have been incurred only for the purpose of the project. One example
of this type of cost can be the salaries of the full time staff members, or equipment purchased
exclusively for use in the project. Indirect costs represent costs that refer to more general,
more broad types of costs, such as administrative costs and general overhead costs. Cost-
reimbursable contracts often contain incentive-based contracts in which the seller will receive
a bonus payment or incentive if the seller meets or exceeds a series of pre-determined target
objectives, such as meeting a particular schedule or keeping the activity below a certain cost.
This term is defined in the 3rd and the 4th edition of the PMBOK.

OTHER TYPES OF CONTRACT:

A contract is a written or oral legally-binding agreement between the parties identified
in the agreement to fulfill the terms and conditions outlined in the agreement. 
Contracts can be of many types, e.g. sales contracts (including leases), purchasing
contracts, partnership agreements, trade agreements, and intellectual property agreements.

 A sales contract is a contract between a company (the seller) and a customer where the
company agrees to sell products and/or services and the customer in return is obligated to
pay for the product/services bought.
 A purchasing contract is a contract between a company (the buyer) and a supplier who
is promising to sell products and/or services within agreed terms and conditions. The
company (buyer) in return is obligated to acknowledge the goods / or service and pay for
liability created.
 A partnership agreement may be a contract which formally establishes the terms of a
partnership between two legal entities such that they regard each other as 'partners' in a
commercial arrangement. However, such expressions may also be merely a means to
reflect the desire of the contracting parties to act 'as if' both are in a partnership with
common goals. Therefore, it might not be the common law arrangement of a partnership
which by definition creates fiduciary duties and which also has 'joint and several' liabilities.

AREAS OF CONTRACT MANAGEMENT:

The business-standard contract management model, as employed by many organizations,
typically exercises purview over the following business disciplines:

 Authorizing and negotiation

 Baseline management
 Commitment management
 Communication management.
 Contract visibility and awareness
 Document management
 Growth (for Sales-side contracts)
 Contract compliance/governance

PHASES OF CONTRACT MANGEMENT:

Contract management can be divided into three phases namely

 pre- contract phase

 contract execution phase
 post award phase (often referred to as contract compliance/governance)

TO MANAGE A CONTRACT:
At the start of the procurement process, a contract is created that outlines the
operational, functional and business objectives which will be met as a result of the agreement.

At this stage of the contract management process, both parties agree on

relevant Service Level Agreements (SLAs) and Key Performance Indicators (KPIs). These
let the supplier know what is expected of them and provide a framework for both parties to
measure how successfully the terms of the contract are being met.
Once these terms have been agreed, the focus then shifts to the day-to-day management of the
contract, which includes:

 Ensuring the delivery of products as and when they are ordered

 Managing the ongoing dialogue between buyers and suppliers to make sure that
agreed deadlines are met
 Throughout the process, seeking improvements which will drive efficiencies and
increase profits
 Regular assessment to ensure that the terms of the contract are adhered to and key
milestones are met

SLA:
It includes;
 A description of the service being provided
 Reliability
 Responsiveness
 Procedure for reporting problems
 Monitoring and reporting service level
 Consequences for not meeting service obligations
 Escape clauses or constraints

KPI:
It is a measurable value that demonstrate how effectively a company is achieving key
business objectives. Organization use KPI at multiple levels to evaluate their success at
 reaching targets. High level KPI’s may focus on the overall performance of the enterprise ,
while low level KPI’s focuses on processes or employees in department such as marketing,
sales and call center.

DEVELOPMENT OF PROJECT NETWORK: PERT AND CPM:

 Program Evaluation and Review Technique (PERT)
 Critical Path Method (CPM)
Common terms in Network Analysis:
a) NETWORK: It is a graphical representation of a project plan showing inter relationship
of the various activities.
b) PROJECT: It is a combination of inter related activities, all of which must be executed in
a certain order to achieve a set goal.
c) ACTIVITY: An activity is any portion of a project which consumes time or resources and
has a definable beginning and ending.
d) EVENT: The beginning and ending points of activities are called events. An event is an
instantaneous point in time. The event are shown by nodes. There are three types of
events namely burst event, merge events and dual events.
e) ES- Early Start, LS- Latest Start, EF- Early Finish, ES- Early Start
f) TF- Total Float, FF- Free Float, IF- Independent Float
g) to – Optimistic time, tm- Most likely time, tp- Pessimistic time
FLOATING:
 TOTAL FLOAT: It is the amount of time by which the completion of activity could be
delayed beyond the earliest expected completion time without affecting the overall
project duration time.
(TF = Lf – Ef) or (TF = Ls-Es)

 FREE FLOAT: It is the amount of time by which the completion time of an activity can be
delayed beyond the earliest finish time without affecting the earliest start of the
succeeding activity.
(FF = Total float – Head event slack)

 INDEPENDENT TIME: The time which an activity can be rescheduled without affecting
the preceding or succeeding activities.
(IF = Free float – Tail event slack)
THREE TIME ESTIMATION:
CPM is considered as Deterministic approach. Whereas PERT is considered as
Probabilistic in nature. Hence, Probabilistic consideration are incorporated while obtaining
time durations of the activities in a project. The following three estimates are used:
 Optimistic time – notations: (to) (a)
 Pessimistic time – notations: (tp) (b)
 Most likely time – notations: (tm) (m)
  The optimistic time is a time estimate if the execution goes extremely good.
 The pessimistic time is a time estimate if the execution goes very badly.
 The most likely time is a time estimate if execution is normal.
The probabilistic data for project activities generally follow beta distribution. The formula for
mean (µ) and variance (σ2) of the beta distribution are given below:
µ = a+4m+b / 6
σ2 = ( b-a / 6 )2
For this, the beta distribution is approximated to standard normal distribution whose statics is
given below:
Z=x-µ/σ

Question and Answers:

Different between PERT and CPM:

1. What is the significance of Critical path in network analysis?

Critical path in a network requires much more attention because
 There is no time gap between starting and completion time.
 Necessary resources should be kept ready to carry out the activities that lie in the
critical path.
 Any delay in the critical path may lead to procrastination of the entire project or the
stoppage of the project.

2. Define critical and non-critical activity.

The activities that fall in the critical path are known as critical activity. The activities which fall
apart the critical path are known as non-critical activities.
 3. List the applications of network techniques.
 Construction of buildings
 Commissioning of a factory
 Fabrication of boilers
 Shut down maintenance of major equipments
 New product launching
 Conducting national level election.

4. Define the term activity and event. Differentiate

The starting point or the end point of an activity is known as event. Starting point is called tail
event. End point is called is head event. Activity is the entire performance of an specific task.

Reference book for Problems, Problem formula and Terminologies.

1. Operations Research – S. Bhaskar
2. Operations Research – T. Veerarajan
3. Operations Research – R. Panneerselvam