MANAGEMENT OF PROCUREMENT CONTRACTS
Definition of terms in contracting.
Contract – a contract is a legally binding agreement between two or more parties that is enforceable by the law in which a consideration is given after fulfilment of the promise made. Procurement Contract – This is a document containing the legally binding agreement between the procuring entity and contractor agreeing to undertake a specific contract in exchange for consideration. Duties and responsibilities for both parties must be clearly stipulated in this document.
Procurement file – a file that contains all details of processing the procurement before contract award, it contains, procurement requisitions, bid documents, evaluation reports, etc.
Contract file – This is a file containing all documents for specific contracts, duties and responsibilities of each party of the contract and details of execution of the contract e.g., inspection reports, any correspondence, payment agreements, etc. It is very important to store the file for audit trails.
Contract administrator – This a person who has been given the responsibility to manage and supervise a contract by the procuring entity. He oversees all that pertains to that contract. He is at times called the project manager.
Contract management plan – is a document that outlines how a specific contract/project will be carried out or administered.
Award – This is the process of notifying a contractor/supplier that they have been successfully selected for a tender.
Contract management involves negotiation of terms and conditions of governing a contract and ensuring adherence to the terms and conditions. Any changes to the contract should be well documented and properly communicated to the parties involved. All procurement agreements should be finalized with contract so as to mitigate any risks that may be a hindrance in achieving the contract objectives and create strategic relationships. Contract management has helped increase suppliers’ productivity. Its good practice to automate contract management so that managing many contracts does not become time consuming.
Purposes of contract management and contract administration.
Contract management is the process of managing contract creation, execution, and analysis to maximize operational and financial performance at an organization, all while reducing financial risk. Organizations encounter an ever-increasing amount of pressure to reduce costs and improve company performance. Contract management proves to be a very time-consuming element of business, which facilitates the need for an effective and automated contract management system.
It involves preparing procurement documentation, processing the documentation and giving approvals where necessary, monitoring the contract all through till the end, administering variations and modification of the contract if necessary and also terminating or cancelling of the contracts if not being handled well by the contractor.
Poorly administered contracts can give way to corrupt practices. A contract should be well administered to ensure the vendor delivers according to specifications to avoid substantial losses. Similarly, variations that may lead to large deviations, undermine the purpose of competition mostly if large volumes are involved.
Both the public and private sector have the pressure to reduce cost and improve profitability and business operations. This creates the essence of good contract management. Contractual processes need to be automated and completely compliant to structured contract management procedures.
The contractor has to perform his duties and responsibilities as per the agreed terms and conditions of the contract. The procuring entity has the duty to pay the contract as per the agreed terms.
Contract management can help achieve higher quality and productivity, creation of value and compliance.
This file is very important in contract management. It is used in preparation of the procurement before the award of the contract. The procurement file contains the following information on procurement requisition, bidding documents, bidding documents received, evaluation report, information on contract award, correspondence on the procurement.
In the public sector, it is a requirement in the law, that subject to all approved procurement plan, all procurements must start with a requisition.
A requisition is a request from the user that orders the goods or services or works required. It becomes an order only when accompanied with the confirmation on the source of funds or account to be charged. The procurement unit must be satisfied that the intended amount to be paid, given the estimated value does not exceed the funds authorized in the requisition.
b. The Specifications
The user unit must also provide specifications for the goods, services and/ or works required. Without specifications, nobody can guarantee the quality. Provision of specifications is important because a supplier who fails to supply as per the specifications has not fulfilled part of her obligations. Unless there are conditions to the contrary, supplies not meeting the specifications should be rejected and returned to the supplier at the supplier’s expense.
c. Procurement Implementation plan
This plan includes the procurement method to be applied in that specific procurement.
From the method, the procurement unit identifies all the steps in the procurement process and the respective timelines. Without this, the exact time will be compromised
d. Bid documents
Standard copy of the bid document
Copy of the advert whether sent normally or electronically by advertising this is an invitation to treat
f. Bid opening
Bid opening report and minutes if any. Bids bid received are offers from potential suppliers.
g. Evaluation report
This is a very crucial copy which will be used to compare the bidders assessed capabilities and the actual performance of the winning bidder.
h. Professional opinion
In the public sector, this is compulsory under the law.
i. Award decision
The award or if rejected, the reason for rejection must be documented, acceptance of offer is at this stage.
All bidders whether successful or not must be notified of their results. This is the stage of communicating the offer.
k. Letter of acceptance
This comes from the supplier
l. Signed Contract
A contract is signed if there is no appeal. Where there is an appeal the details of the same is part of the procurement process and remains with the procurement file. Ones the appeal process is over, then the decision of the quasi – judicial or judicial process is implemented.
Eventually, a contract is signed.
Where there is a separate procurement and contract files, then a copy of the signed contract will be availed in both files.
The public procurement and asset disposal act states that no contract is formed between the vendor and the procuring entity unless they enter into a written contract. The contract file for either goods, works or services is opened after the contract is signed and is usually opened by the contract administrator. The file is used for keeping a record of the actual performance of the contract. It usually contains the following:
a. Appointed contract implementation team is filed here.
b. Contract document – this outlines the duties of various parties, the terms and conditions, the applicable penalties when obligations are not fulfilled or adequately done, the breaches, the timelines, the expected quality standards and so on.
c. Contract implementation schedule at the procurement stage, the procurement implementation plan shows the timelines with specific actions, likewise, in the contract management, the project implementation schedule is summarized version of the bill of quantity (BQ’s) with timelines to be observed.
d. Minutes of review meetings – these are commonly known as site meetings. Usually are held at the contract site, and sometimes called site meetings because the project is being constructed at the desired place, then the issue of the right price was sorted out at the procurement stage. During implementation, its other aspects are paid according to quotation in the BQ’s.
Site meetings may address any issue concerning the project, but concentration is on the remaining three rights, namely Quality, Quantity and time.
Where there is incomplete or non-conformity, there would be Snag list with suggestions and/or directives on how to have them sorted out within the timelines.
e. Payments details – payments so far made, and those withheld and reason thereof, retained payments, taxes deducted. Whether subcontractors are paid directly or through the main contractors and so on are included here.
f. Completion Certificate – all copies filled here.
g. Disputes if any and how they are resolved are recorded here both in process and conclusion.
h. Contract closure and project handling over.
In a nutshell, the contract file should have; a copy of any performance security required, payment documents or records for the contract, information of the performance of the vendor for that contract, the original signed procurement contract, any modifications to the contract signed by relevant authorities, minutes of any meeting held pertaining the contract, correspondence between parties pertaining the contract, any correspondences for the contract, reports of the project progress from management, any other relevant information.
Types of contracts.
The contract between suppliers and customers should define how the relationship will be managed taking into account the supply chain objective of ensuring system-wide performance, lowering of transactional costs, risk sharing and healthy business partnership arrangements.
The interactions between parties of either side of the divide is premised on the need for coordination through provision of appropriate information and incentives, which ultimately calls for governance through formal contracts.
Supply chain contracts should essentially cover three flows namely material, information and financial flows. This leads to classification of contracts in relation to specification of decision rights, pricing, minimum purchase commitments, quantity flexibility, return policies, allocation rules, lead time, quality, horizon length, periodicity ordering, and information sharing.
There are various types of contracts in supply chain including the following:
1. Quantity flexibility contracts
The Quantity Flexibility (QF) contract is a method for coordinating materials and information flows in supply chains operating under rolling-horizon planning. (The rolling horizon solution framework involves successively solving each scheduling sub-horizon and carrying over any unsatisfied demand to the following sub-horizon. In principle, this approach produces feasible planning and scheduling solutions with a significant reduction of the computational requirements.)
It stipulates a maximum percentage revision in each element of the period-by-period replenishment schedule is allowed per planning iteration. The supplier is obligated to cover any requests that remain within the upside limits. The bounds on reductions are a form of minimum purchase commitment which discourages the customer from overstating its needs.
Allows the buyer to modify the order (within limits) because demand visibility increases closer to the point of sale
This contract allows for better matching of supply and demand. It also offers increased overall supply chain profits if the supplier has flexible capacity and it lowers levels of misleading demand information than either buyback contracts or revenue sharing contracts
For example, consider a supply chain consisting of two independent agents, a supplier (e.g., a manufacturer) and its customer (e.g., a retailer), the retailer is in turn serving an uncertain market demand. To reconcile manufacturing/procurement time lags with a need for timely response to the market, such supply chains often must commit resources to production quantities based on forecasted rather than realized demand.
If the customer (retailer) provides a planning forecast of their intended purchase (which does not entail commitment), they benefit from overproduction while not bearing the immediate costs, the customer (retailer) thus has incentive to initially overforecast before eventually purchasing a lesser quantity. The supplier(manufacturer) must in turn anticipate such behaviour in its production quantity decision. The result is, the supplier (manufacturer) requires the customer (retailer) to order a minimum number of items e.g. 1000 pieces and then promises to fulfil any extra orders that may arise in future.
2. Revenue sharing contracts
Under a revenue-sharing contract, a retailer pays a supplier a wholesale price for each unit purchased, plus a percentage of the revenue the retailer generates. Such contracts have become more prevalent in the videocassette rental industry relative to the more conventional wholesale price contract.
The buyer pays a minimal amount for each unit purchased from the supplier but shares a fraction of the revenue for each unit sold.
Decreases the cost per unit charged to the retailer, which effectively decreases the cost of overstocking.
It may be misleading for the supply chain as it reacts to (inflated) retail orders, not actual customer demand
3. Buy-back contracts
Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price It increases the optimal order quantity for the retailer, resulting in higher product availability and higher profits for both the retailer and the supplier
Most effective for products with low variable cost, such as music, software, books, magazines, and newspapers.
The downside is that buyback contract results in surplus inventory for the supplier that must be disposed of, which increases supply chain costs.
It may be misleading for the supply chain as it reacts to (inflated) retail orders, not actual customer demand.
4. Sales rebate contracts
It is a contract in which the manufacturer makes a payment to the retailer for each sold item to the final consumer. Rebates are used to receive money back after making a purchase. Rebates are opposite of coupons.
5. Wholesale contracts
When the supplier and retailer use a wholesale price contract, the supplier charges the retailer a per-unit price and has no further obligation after selling to the retailer; profits are independent of the realized consumer demand.
6. Cost-reimbursement contract
With a cost-reimbursement contract, the final total cost is determined when the project is completed or at another predetermined date within the contract’s time frame. Before the project is started, the contractor will create an estimated cost to give the buyer an idea of the budget. They will then provide payment for the incurred costs to the extent that has been described in the contract.
The purpose of setting this expectation with cost-reimbursement contracts is to establish a ceiling price that the contractor shouldn’t exceed without the approval of the buyer. At the same time, if that ceiling is reached, the contractor can stop work.
Contract administration responsibilities.
The contract administrator has the following responsibilities:
a. Monitoring performance of the contractor according to the set standards.
b. Making sure the contractor submits all required documents and correspondence regarding the contract.
c. Ensuring the procuring entity pays the contractor on time and according the set provisions in the contract.
d. Making modifications to the contract where needed and making sure he signs them for them to be valid.
e. Ensuring the contract is completed before closing the contract file and that it is completed in time.
f. Ensuring all the contract administration records are properly stored and are up to date.
g. Handling any other issue pertaining the contract as long it’s in his jurisdiction.
Procurement contract management plan.
The contract management plan is usually prepared by the project manager and usually contains information on how the project will be administered. It focuses on the key areas of the contract. It usually contains the following information.
a. Background information on the project/contract.
b. Names of the contract management team.
c. Duties and responsibilities of both the parties, i.e., contractor, contract manager, procuring entity, etc.
d. Any provisions regarding the contract.
e. Mode of communication to be used in the project.
f. How to prepare contract review reports.
Maintenance of risk registers.
A risk register is a document used as a risk management tool and to fulfil regulatory compliance acting as a repository for all risks identified and includes additional information about each risk.
Most risk registers will contain he following information:
• Identifier: a unique code to refer to the risk
• Description: an explanation of the risk, including the trigger and consequences
• Probability: a qualitative or quantitative estimate of the risk likelihood
• Impact: a qualitative or quantitative estimate of the consequences if the risk is triggered
• Risk level / risk rating / risk score: this is calculated by multiplying the probability by the impact
• Author: the person who raised the risk
• Owner: the person responsible for managing the risk
• Treatment: a strategy for dealing with the risk
• Residual risk: the level of risk that remains after the treatment is applied
At the outset of the contract period, the parties will populate the risk register with the risks identified in the contract data. The risk register is likely to expand over time as new risks are identified. Both the contractor and the procuring entity are required to notify the other as soon
as either become aware of matters that could impact the time or cost of completing the project, or the use of the completed works.
The contractor may also notify the procuring entity of matters that are likely to increase the contractor’s total cost.
Both parties have an incentive to give early warnings as soon as possible. The contract manager is interested in avoiding additional cost and/or delay to the contract. Meanwhile, if the contractor fails to give an early warning, it will not be entitled to recover the costs it incurs by failing to do so.
The contract manager will revise the risk register and issue it to the contractor.
Contract performance measurement.
The key contract performance drivers are speed, cost and quality.
Cost and timeliness are identified as separate metrics, while quality address various aspects of quality, value, suitability to circumstances, and realization of contract goals.
a. Time is the amount of time required to negotiate and administer the contract, including the time required to handle disputes and litigation.
b. Cost is the total cost of negotiation and administration, including expenses related to disputes and litigation.
c. Value is the economic value of the consideration received over the lifespan of the agreement.
Contract Performance Measures
Second, for each quantitative measure, we can identify some of the component elements and measures.
1. Time Factors
• Drafting and negotiation time
• Number of versions or negotiation iterations
• Contract administration time
• Disputes and settlement time
2. Cost Factors
• Drafting and negotiation cost
• Number and type of professionals required
• Contract administration cost
• Disputes and settlement cost
3. Quality/Value Factors
• Degree of consistency: more consistent portfolio of agreements will likely be less expensive to administer
• Degree of conformity to standards: degree of correspondence to business standards, including completeness, standards, accuracy, and auditability.
• Realization of contract goals and objectives: whether the contract meets business goals, including: availability, capacity, reliability, flexibility, and responsiveness.
Contract review and reporting.
In large procurements, there should be slots for review meetings in the contract management plan. Review meetings are very crucial as they allow the project management team to have face to face communication with the vendor pertaining contract performance and any other necessary thing regarding the project. The supplier should be given enough time to read and understand the review report and if any modifications should be in writing and be justified. The supplier can also propose changes to the contract and the procurement unit should review the changes to make sure they do not conflict with the original requirements of the contract. After holding a review meeting, a status report for the project should be prepared. The project status report contains the following:
a. Executive summary for the contract.
b. Performance reports for the project performance and budget.
c. Environmental issues regarding the contract.
d. Performance rating of the contractor.
e. General observation of the contract.
f. Timeliness of contract performance.
g. Risk analysis of the contract.
h. Performance and quality cost of the project.
It very important for the contract administrator to report outcomes of the review meeting to the management of the procuring entity for them to be fully aware of the happenings of the project. The reports will provide lessons for the procuring entity and project management team on how to carry out future projects.
Payments to contractors.
It is very crucial that the contractor performs according to the specifications of the contract. The procuring entity also need to pay the contractor according to the terms agreed and the payments should be timely.
It is the duty of the contractor to submit his invoice for payment to be made. Payment should not be made to the contractor unless he has submitted the invoice and it should be in accordance to the provisions of the contract.
Failure to pay the contractor in the agreed period of time, this will give the procuring entity a bad name. If a debt becomes a pending bill, the procuring entity may be forced to pay the debt amount plus interest which is determined by the prevailing commercial bank rates.
All invoices should be paid thirty days after submission.
Contract termination and exit strategies.
A dynamic operating environment and growing supplier dependency have combined to make contract exit strategies far more relevant and important than they were in the past.
The drivers for contract exit may be planned or unplanned. They range from factors such as financial distress or reputational risk, through to changes in market conditions or disinvestment. Contracts have always had termination provisions, typically allowing early exit for non- performance and increasingly perhaps including some form of ‘termination for convenience’. The extent to which specific consequences of termination were spelt out has tended to vary, however, modern contracts are likely to have specific obligations or survival clauses.
An exit strategy is a planned approach to terminating a situation in a way that will maximize benefit and/or minimize damage.
It is generally, agreed that the consequences of exit – whether voluntary or involuntary – have become far more significant today, due to the heightened dependence on key suppliers. However, exit activities still tend to be handled on an ad-hoc basis, rather than through a well- defined or consistent process.
In general, suppliers are not averse to discussing exit plans and this is a significant factor to consider in supplier selection.
There may exist different levels of terminations; they may cover only part of the relationship, or they may result in a phased wind-down of service. It may also be possible to transition the supplier to a different project, thereby alleviating resistance and financial implications. These factors significantly affect the nature of any negotiation at the time of an exit.
Another influence that was discussed was the impact of a mutually agreed exit, versus a contentious exit; in the latter case, the plan should allow for the need to switch the relationship management and performance teams, since they will rarely have positive views of each other and cooperation (which will be crucial to smooth transition) is unlikely to be achieved.
Overall, when implementing exit strategies organisations should seek to:
• record and document lessons learned
• have more in-depth planning for key strategic relationships
• review plans and update them annually
• include exit planning in risk management and mitigation
• include checklists of key points to consider