Procurement

Management

Prepared by CE 4CM4 Group 13
Group members: Paul Jarzecki (0565931) Jeffrey Nie (0755306) YiLiu (0847832) Jun Xing (0744657) Duo Huang (0864908) Date: March 23, 2012

ABSTRACT
The procurement report outlines the close relationship between project management and the procurement process. The report will demonstrate procurement in five steps: Initiation, Planning, Execution, Control and Closeout. Roles and responsibilities of department and managers will be investigated and explained. Governing procedures that is both globally and internally will be outlined. Supply chain management and how they interact with contractors, sub-contractors and suppliers, etc will be discussed in detail. Vendor selection will also be further described within the supply chain process. Monitoring of supplies from suppliers and how they affect receiving dates will be included along supply chain management. It is also important for supply chain to keep record of item stocks and how supplies should be recorded and stocked. Over stock and "just in time" stocks will be compared and valued according to their benefits and disadvantages. Method of payment and when the payment should be made, along with contract agreement from suppliers will be discussed. Internally within a company, how supplies stored within the facility would affect the outcome of a project will be discussed.

TABLE OF CONTENT

ABSTRACT ........................................................................................................................................... 1 CHAPTER 1 INTRODUCTION ........................................................................................................... 3

1.1 History of Procurement ................................................................................................................... 3 1.2 Procurement Factors ....................................................................................................................... 3 1.3 Key Players involved in Procurement .............................................................................................. 4 1.4 Direct and Indirect Procurement ..................................................................................................... 4

CHAPTER 2 CONSTRUCTION PROCUREMENT PROCESS ........................................................... 5

2.1 Procurement Planning ..................................................................................................................... 5 2.2 Solicitation Planning ........................................................................................................................ 6 2.3 Solicitation ....................................................................................................................................... 6 2.4 Source Selection .............................................................................................................................. 7 2.5 Contract Administration .................................................................................................................. 7 2.6 Contract Closure .............................................................................................................................. 7

CHAPTER 3 PROCUREMENT COST CONTROL ............................................................................. 8 CHAPTER 4 PROCUREMENT RISK MANAGEMENT ..................................................................... 9 CHAPTER 5 CASE STUDY .............................................................................................................. 11
5.1 Case Study#1: Performance Information Procurement System .................................................... 11 5.2 Case Study#2: Sustainable Procurement ....................................................................................... 13

CHAPTER 6 CONCLUSION ............................................................................................................ 14 REFERENCES ...................................................................................................................................... 15

CHAPTER 1 INTRODUCTION
Procurement is the acquisition of goods and services. In order to ensure that what is being acquired is done so at the best possible quality without interfering with the budget and schedule it is critical that the procurement is dealt with proficiently, and this is where procurement management comes in.

1.1 History of Procurement

Although gathering materials has always been a concern for construction, procurement as a field of expertise has never really been considered. The railway industry considered it an important aspect since before 1900 but it never really gained importance until World War I and World War II when it became critical that goods and services would be supplied to keep factories operational for the war effort. Following the wars, purchasing became more professional and procurement began coming into its own as a science. In 1983, Peter Kraljic had an article on purchase strategy published in the Harvard Business Review that is often referred to as the beginning of looking at procurement as a business. The article, along with new software that automated the procurement process, gave way to the birth of a dedicated position in many companies in the 1990s the Chief Procurement Officer (also known as the Head of Procurement). The recession that began in 2008 has placed procurement as a vital factor in an effective business strategy, with Chief Procurement Officers recognized as business leaders. Procurement Management is an extremely important aspect of construction when handled correctly it can keep a project under-budget and on-schedule.

1.2 Procurement Factors

There are many factors that must be considered in procurement such as delivery and handling, marginal cost and benefit, and searching for the best price in a fluctuating market. Procurement generally involves the management of many aspects: 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
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9. Supply contract administration 10. Inventory control 11. Disposal (and related functions) Procurement may also involve bidding. Sometimes known as tendering, companies often state the required product or service and receive price quotes from various competitors. In general, unless the supplier is found to be unable to properly provide the product or service, the company will select the lowest bidder.

1.3 Key Players involved in Procurement

In general, key players involved in procurement are Owner, Contractor, Design Professional and Purchasing Agent. Their main responsibilities are listed as following: Owner: determine budget, scope and schedule of purchase Contractor: provide goods and services Design Professional: determine material quantity and quality based on national codes and relevant standards Purchasing Agent: negotiate to get the best price while ensuring that all contract requirements are met For everyone who is involved in procurement, he/she has to be made accountable and responsible in order to improve efficiency of procurement and minimize cost and risk.

1.4 Direct and Indirect Procurement

Procurement is generally split into two categories: direct, production-related procurement and indirect, non-production-related procurement. Direct procurement is only ever involved in manufacturing and includes all items that are part of finished products such as raw materials, components, and parts. In general direct procurement is on a large scale, using high quantities of goods and services very often. An example of a product used in direct procurement is crude oil in the petroleum industry. It is in high demand so it is procured often and at high value. Indirect procurement is about the maintenance, repair, and operating supplies that a company purchases to facilitate its operations. It is generally in low quantity but done very often, tactically replacing and resupplying parts that are needed for the core functions of an operation. Indirect procurement covers a wide variety of products and services, from smaller parts like lubricants and spare parts to extremely complex and expensive products and services like heavy machinery and financial or technical consulting.

CHAPTER 2 CONSTRUCTION PROCUREMENT PROCESS

Procurement management is a form of management that helps an organization to plan the acquiring process to ensure things run smoothly, as well as to save cost when purchasing goods and services from other companies. It is important to understand these processes of procurement management because it will minimize cost, risk, and delay of schedule for the entire project. As shown in Figure 1, the procurement management involves six steps: Procurement Planning, Solicitation Planning, Solicitation, Source Selection, Contract Administration, and Contract Closure. These processes interact with each other and each process may involve endeavor from one or more individuals based on the expectations of the project.

Procurement Planning

Solicitagon planning

Solicitagon

Source Selecgon

Contract Administragon

Contract Closure

Figure 1: Construction Procurement Process

2.1 Procurement Planning

Procurement planning is the process to identify what products or services are needed, and when they will be needed. The process involves determination of whether or not to procure, what to procure, how to procure, how many to procure, and when to procure a product or service. There are three methods for procurement planning: 1. Make-or-Buy Analysis The make-or-buy analysis can be used to determine whether the cost of a certain or service is efficient. This cost includes both direct costs (e.g. market price of a product) and indirect costs (e.g. costs of managing the purchasing process). This method can also represent the perspective of a company as well as the expectations of their project. 2. Expert Judgment The expert judgment could be provided by consultants, professional and technical associations, and also industry groups. This method requires detailed information regarding the project, such as scope statement, product description, market conditions, and constraints of the project.
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3.

Contract Type Selection Contract types can be classified based on different types of purchases. The most common categories of contracts are Fixed Price Contracts (or Lump Sum Contract), Cost Reimbursable Contracts, and Unit Price Contracts. The Fixed Price Contracts can be risk if the product is not well defined since additional costs may be required during the procurement process. The Cost Reimbursable Contracts involve payment to the seller for actual costs of a product or service. Moreover, the Unit Price Contracts is a function of the quantities required to complete the project.

Lastly, a procurement management plan and a statement of work can be concluded from the Procurement Planning process. The procurement management plan indicates how the remaining processes will be managed, such as the types of contracts that will be used, how multiple providers will be managed, and so on. The statement of work should be highly detailed so that the sellers could decide if they are capable of providing the products or services that the project requires.

2.2 Solicitation Planning

The Solicitation Planning is the process of creating requirements for all products and services that a project needs, as well as identifying potential sources. The procurement management plan and statements of work from the previous step, Procurement Planning, are required for this process. Other documents will be needed in this process are standard contracts and standard descriptions of procurement items. The outputs of Solicitation Planning process are procurement documents and statement of work updates. The procurement documents are used to solicit proposals from potential sellers, and are consist of relevant statement of work, description of the desired form of the response and requirements of contractual provisions. The procurement documents should be rigorous but also flexible with suggestions from sellers to satisfy the project requirements in better ways. One of important parts of procurement documents is a statement of evaluation criteria, which specifies limitations, such as purchase price, technical capability, etc. that will support the integrated evaluation of proposals from sellers. Finally, the old statements of work will be updated based on results from Solicitation Planning process.

2.3 Solicitation
The Solicitation process involves obtaining quotations, bids, offers, and appropriate proposals from prospective sellers. A list of qualified sellers needs to be developed so that the procurement documents can be sent to the prospective sellers. The Solicitation process can be executed through Advertising and Bidder Conferences. The list of potential sellers can be expanded by placing advertisements in the media so that better sources could be chosen. The Bidder Conferences are generally meetings with prospective sellers to ensure that they understand all requirements of the procurement for the project, the potential sellers will come up with proposals in accordance with the procurement documents after the
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Solicitation process which describe their capability and willingness to provide the requested products or services for the project.

2.4 Source Selection

Source selection is the process of receiving and assessing proposals from sellers based on evaluation criteria, and further select providers of products and services that the project needs. The proposals are often divided into two sections: technical approach and commercial price; each section will be evaluated separately. Several techniques will be used for Source Selection. The first one is Contract Negotiation, which involves a clearly explanation of all essential prerequisites, terms, and conditions. Moreover, Compensation, Acknowledgement of procurement schedule, and statement of potential risks and liabilities are also included in Contract Negotiation. Another commonly used method is Weighting System. The basic idea of Weighting System is to quantifying qualitative data in order to simplify the evaluation process. Normally, numerical weights will be assigned to evaluation criteria and the overall score can be compute by the weight and rating of each criterion that a seller proposed. Other methods, Screening System and Independent estimates, can also be used to help select efficient sources of products and services for the project. Finally, the most efficient proposal from one or more sellers will be selected after assessments of all the proposals from sellers, and a contract will be established which obligates the relationship between buyer and sellers.

2.5 Contract Administration

The main purpose of Contract Administration process is to manage the relationships with providers. This process requires performance reports, changes requests of contract, and also seller invoices of every payment request. The performance reports provides information of how effectively the seller is to achieving the contractual objectives, such as the quality of products and services from sellers. A contract change control system will be involved in Contract Administration process since there might be modifications of the contract based on descriptions of products and services required as well as satisfaction of work done by sellers. Furthermore, a payment system will be used to help manage and review the expenses of procurement.

2.6 Contract Closure

The final process of procurement is Contract Closure, which involves product verification and administrative closeout. To ensure the quality and quantity of products or services that sellers provide and also update both information of the products or services and sellers
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records for future use. Procurement Audits is a structured review of all successes and failures during the entire procurement process. At the end of the Contract Closure process, the organization that is responsible for contract administration will provide a formal notice to sellers of the completion of the contract.

CHAPTER 3 PROCUREMENT COST CONTROL

Majority organizations manage their costs savings by focusing on finding lower price suppliers. However, it is surprised that the actual cost on supplies is less than 50% of the procurement total cost. Industry studies points out that the processing steps related with procurement activities account for around 120% of the total cost of the real product. These processing steps are illustrated in Figure 2, and they are more specific compare to generalized procurement process in Chapter 2.

Figure 2: The Procurement Process and Total Cost of Supplies Therefore, the improvement of procurement process will eventually not only lead to cost reduction, but also increase the project efficiency. Currently, there is lots of research and consulting firm associated with procurement process improvement. Lean Construction perspective will be introduced here in order to have a better understanding about how to improve the procurement process. This methodology consists of five phases to diagnose, evaluate, and finally improve the procurement process. First phase is a characterization of company, project and procurement process. This will be a starting point for a formal application. Then, the general diagnosis phase will be followed. The next phase will be performance indicators. These indicators help in the detection of improvement opportunities. Afterwards, the fourth phase evaluation of the procurement process analyses the waste identified according to variety of
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sources. At end, the fifth phase instruments and strategies for improvement comes up the new strategies and design the improvement for procurement process. Traditionally, the procurement process control criteria are usually too general. These leading project management systems do not have a clear view regarding the way the procurement process being developed. The methodology above identified key areas of the procurement process. This will eventually improve the procurement process efficiency and reduce the cost during the process. Not limited by the methodology above, requiring procurement department or organization to participate employee training is always a good idea to keep company have most recently knowledge to manage the procurement under certain economic circumstance. In addition to this, using e-software to improve procurement process is another model way to increase the management efficiency. This will also benefit company by saving unnecessarily employee cost. In conclusion, procurement cost control cannot only focus on externality such as finding lower price suppliers. Improvement of procurement process has a much more significant effect on procurement cost control.

CHAPTER 4 PROCUREMENT RISK MANAGEMENT

Procurement organizations have traditionally underestimated the effect of risk on their performance. However, helped by the economic downturn, procurement risk management has brought to attention. Organizations started to realize that how dramatically procurement risk can affect them. Nowadays, Organizations procurement communities understand that uncertainty in product demand, component price and component availability results in significant procurement risks. Therefore procurement risk management approach is involved in order to minimize the uncertainty lost and unnecessary spending. The processes in the procurement risk management are the identical with other risk management as followed. Risk identification Risk analysis and evaluation Risk treatment and control Successful developing procurement risk management will directly lead organization to benefit from several ways. An example from HP is illustrated in order to provide practical results.
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The First benefit is material costs savings. HPs procurement risk management lowers the supplier demand risks by dealing with quantity commitments. Meanwhile, suppliers are also enabled to cut costs from more efficient planning and production processes. Some of this value is shared between HP and suppliers by discounting on material costs. As a result of this, HP has achieved up to 5% incremental material cost discounts for standard components, custom components, indirect cost and services procurement. Secondly, dealing with specific pricing terms allows HP to manage the cost uncertainty proactively. HP used procurement risk management deals to procure a significant portion of memory. This enables HP to obtain cost predictability required to protect margin on large customer deals. Assurance of supply is the third key objective for procurement risk management at HP. Assurance of supply has been improved for many commodities even under an industry-wide shortage conditions. For instance, a HP particular business unit executed the procurement risk management deals to make sure that 100% of demand from suppliers obtained during the industry-wide memory shortage period one year ago. Moreover, by using procurement risk management software, the measurement of demand uncertainty was obtained precisely. This leads HP optimized inventory levels both externally and internally at supplier sites. In consequence, several percentage points of inventory driven costs have been cut by this optimization for commodities. Implementing the procurement framework reduces significant inventory cost.

Figure 3: HP annual spend impacted by PRM process

Figure 3 shows the impact of procurement risk management on HPs spending over the past years. Implementing procurement risk management leads an over $100 million incremental savings for HP. Furthermore, the procurement risk management also substantially benefited suppliers as well.
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CHAPTER 5 CASE STUDY

5.1 Case Study#1: Performance Information Procurement System

5.1.1 Introduction Performance Information Procurement System (PIPS) is initially developed by Performance Based Studies Research Group at Arizona State University. The goal of the system is to transfer risk to the contractors and allow them to minimize the risk through quality control and preplanning. The City of Miami Beach has been integrating principles from the best value Performance Information Procurement System into their Capital Improvement Program (CIP) since 2006. Challenges and benefits are discovered through the transition of infusing PIPS concepts into the existing Best Value Selection process at CIP. 5.1.2 What is PIPS? In general, Performance Information Procurement System is a risk management system that creates an information environment where participants can quick identify where the problem was and are motivated to solve the problem. PIPS consists of three phases. Phase One is the Selection Phase, Phase Two is the Preaward Phase and Phase Three is the Risk Management and Quality Control Phase. In Phase One, the best value vendor or contractor is identified based on past performance information. In Phase Two, interviews and prioritization are conducted between owners and contractors. Communication is enhanced between different parties and potential risks are preplanned and addressed. In Phase Three, risk assessment plan and quality control program are established by the contractor in order to minimize risk and ensure safety. Throughout the PIPS process, risks are transferred to the vendor and they are forced to preplan and minimize risk. 5.1.3 Existing Problem 1. The procurement department was predominately buying the lowest price instead of the best value construction option 2. Although the City of Miami Beach already had a procurement code that allowed the award of contracts to the lowest and best option, they were having difficulty in
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3.

establishing a sustainable process. The procurement department was not efficiently transferring risk and control to vendors

4. Project Management department and Code Regulation department were having a difficult time partnering due to points of contention between the groups.

5.1.4 Previous Solution Regarding to the existing problems listed in 5.1.3 on page 11, the City of Peoria used design-build delivery method and construction management at risk to force the efficient transfer of risk and control because price was not a consideration in the delivery process. The results are quite positive. Most test projects were completed on time, on budget, minimized change orders, and met the expectations of the client. However, there was potential risk associated with this solution. The client could not hold the contractor accountable because they do not use an information environment. Therefore, inadequate information could lead client to subjective decision. 5.1.5 Apply PIPS

Figure 4: PIPS Self Regulating Closed Loop System As shown in Figure 4, Performance Information Procurement System is a closed loop system. Only one vendor at a time can that has completed its risk management plan and weekly risk report can move into the pre-award phase. Therefore, it minimizes subjective decision making of the client's experts by forcing the vendors to compete based on value, quality and risk management. In conclusion, PIPS optimizes procurement process by minimizing the need of manage, direct, and control, increasing quality, and transferring risks to vendors.
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5.2 Case Study#2: Sustainable Procurement

Sustainable procurement is integrated with the three vital points of sustainable development - Social, environmental, and economic factors. Three very similar sustainable procurement elements are thus developed: strong economy, healthy environment, and social well-being. 5.2.1 Background Read Construction is a construction firm located in north-east Wales. Read Construction employs 87 people and has annual sales of 16 million pounds. 75% of Read's sales come from public sectors and the remaining from private sectors. Public buildings in education such as schools are on of Read Construction's specialties. The company started becoming aware of sustainable procurement in 2005. 15 million pounds from a 5 year contract was lost because the client felt Read's softer aspects of construction such as a sustainability was not good, even though they are known for producing high quality buildings. Read Construction has transformed ever since then to a market aware and much more professional company. 5.2.2 Sustainable Path Forward PQQ (Pre-Qualification Questionnaires) Read was questioned with the following questions in their initial phase of transformation: Do you have a written environmental policy? Do you have an environmental management system (EMS)? Do you have a health and safety policy? Do you comply with the disabled persons employers act? Although such paperwork shows the company's direction towards sustainable procurement, it often does not have much actions involved. Read was introduced with documents that must be filled prior to work begins such that it directly impacts the materials used for the work. For example, the scope document for bidding for constructing a new school includes optimization of energy, high levels of insulation, recycling sensitive, locally sourced material and their environmental impacts and life expectancy, and a "very good" rating from the BREAM (most widely used environmental assessment method for buildings) assessor. 5.2.3 Subcontractors When selecting contractors/subcontractors, the following sustainable procurement values are used along with economical and quality aspects to determine the most suitable contractor/subcontractor: Choice of materials specified in the project design for their
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durability, sustainability, availability and cost. In order to ensure that subcontractors practice the same sustainable methods within their supply chain, Read Construction invested 10,000 pounds to setup a program that provided workshops on a better performing construction industry. Weekly meetings between Read Construction managers and subcontracts are required in order to help reduce unnecessary waste. These actions have reduced supply chain cost by 150,000 pounds. 5.2.4 Audits Read Construction has been taking environmental audits and sustainability review from Cheshire County Council's Eco Audit 21 program and the SynnwyrBusnes - Business Sense Sustainability Appraisal from the University of Wales. Continuation of education through construction sustainability courses further enriched the company's sustainable procurement process. The company is working hard towards various accreditation and their long term goal is to be obtaining ISO 14001 accreditation. 5.2.5 Discussion Read Construction high recommends investing in sustainability as it is an investment in the future. As Read Construction has demonstrated through their workshops, which more money is saved than spent in setting up the programs. Sustainability criterion is likely to become stricter as time goes on. Therefore, industries with a lead in sustainable procurement are likely to keep up the pace and become more attractive in the bidding process.

CHAPTER 6 CONCLUSION
Procurement management is an extremely valuable tool to modern businesses. One large company was able to cut 15% off its annual expenses of $10 billion by properly managing its buying power of all worldwide divisions (Epiq Technologies, 2010). In addition to saving a significant amount of money, procurement management can also save time and streamline the workforce. With proper analysis it is generally found that many of the steps required for purchasing are either redundant or can be automated. Similarly, it is often found that many companies have multiple staff members doing the exact same job in different locations these redundancies can be eliminated by centralizing all procurement to a single department or firm, allowing the liquidation of excess office space and equipment. As witnessed in the sustainable procurement case study, putting resources into sustainable procurement is an investment in the future. In the long run the savings outweigh the capitol put into starting the program.

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REFERENCES
1. AAA Business Supplies & Interiors. (n.d.). What's Your True Cost? Retrieved from AAA Business Supplies and Interiors: http://www.aaasolutions.com/prowheel.htm

2. AntiClue. (2010). Project Procurement Management Processes. Retrieved from AntiClue: http://www.anticlue.net/archives/000823.htm

3. Billl, H. (2012). Allocating and Managing Procurement Risks. Retrieved from McMillan: http://www.mcmillan.ca/Upload/Publication/allocating%20and%20managing%20procu rement%20risks%20bill%20hearn%200104.pdf

4. Defense Acquisition University. (2012). Standard Procurement Systems. Retrieved from Defense Acquisition University: http://www.dau.mil/default.aspx

5. Epiq Technologies. (2010). Procurement Management. Retrieved from Advanced Supply Management: http://www.epiqtech.com/Purchase-Procurement-Management.htm

6. Luis, F. A. (1999). Evaluation and Improvement of the Procurement in Construction Projects. University of Berkely.

7. Project Management Institute. (2008). A Guide to the Project Management Body of Knowledge (PMBOK Guide) - Fourth Edition. Project Management Institute.

8. Tutotials Point. (2010). Procurement Management. Retrieved from Tutorials Point: http://www.tutorialspoint.com/management_concepts/procurement_management.ht m 9. Venu, N. (2010). Procurement Risk Management. Retrieved from drk Research: http://www.drkresearch.org/contact_us/risk_roundtable/hpprocurement.pdf

10. Kenneth Sullivan, Dean Kashiwagi. (2007). Case Study:Minimization of Best Value Issues in the Procurement of Construction Services at the City of Miami Beach. Retrieved from ASU Research: http://pbsrg.com/publications/papers/case-study-minimization-of-best-value-issues-in- the-procurement-of-construction-services-at-the-city-of-miami-beach/

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