Project Management – Kerzner – Chapter 19 – Contract Management

Contract introduction
[Page 975-976]
– One of the most important factors in preparing a proposal and estimating the cost and profit of a project is the type of contract expected
– The confidence by which a bid is prepared is usually dependent on how much of a risk the contractor will incur through the contract
– Certain types of contracts provide relief for the contract since onerous (unfair risks that the contractor may have to bear) risks exists
– The cost must therefore consider how well the contract type covers certain high- and low-risk areas
– Because of the risk factor, competitors must negotiate not only for the target cost figures but also for the type of contract involved since risk protection is the predominant influential factor
– To select the optimum arrangement for a particular project the following has to be recognized and carefully evaluated: size and experience of the client’s own staff; urgency of completion; availability of qualified contractors; and the advantages and disadvantages of all basic contractual agreements
[Page 976-978]
– Is 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
– Is often centralized, which results in standardized practices and lower paperwork costs

All procurement strategies are frameworks by which an organization attains is objects; the two basic procurement strategies are:
– Project procurement strategies can differ from corporate procurement strategies because of constrains, availability of critical resources, and specific customer requirements

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 source
– Procure only a small portion of the goods/services
– Procure none of the goods/services

Another critical factor is the environment in which procurement must take place; there are two environments:
– Macro: includes the general external variables that can influence how and when we do procurement which are: recessions, inflation, cost of borrowing money, whether a buyer or seller’s market exists, and unemployment
– Micro: the internal procurement processes of the firm, especially the policies and procedures imposed by the firm, project, or client in the way that procurement will take place; includes the procurement/contracting system which contains four processes: plan, conduct, administer, and close procurements

– In certain environments such as major projects for the Department of Defense (DoD), the contracting process is used as the vehicle for transitioning the project from one life-cycle phase to the next
– As the project progresses from one phase to the next, and additional project knowledge is acquired through each completed phase, the level of uncertainty (and risk) is reduced
– The reduction in project risk allows the use of lower-risk contract throughout the project life cycle
– During higher-risk project phases such as conceptual, development, and testing, cost-type contracts are traditionally used
– During the lower-risk project phases such as production and sustainment, fixed-priced contracts are typically used

– Contract management is defined as “art and science of managing a contractual agreement throughout the contracting process”
– Contracts involve at least two parties: the buyer and the seller (contractor); the seller’s contract management processes, which correspond to the buyer’s processes, consist of the following activities:

Plan procurements
[Page 978-981]
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
– The process includes the following:
[REFER TO PAGE 978-979]

– There could be separate and different statements of work for each product to be procured
– The statement of work (SOW) is a narrative description of the work to be accomplished and/or the resources to be supplied
– There are clauses in the SOW that require that the contractor identify the names and resumes of the talented internal resources that would be committed to the project, including the percentage of their time on the project
– In addition to SOW, organizations also use statements of objectives (SOOs) for projects that are designed as “performance-based” effort
– SOOs are used when the procuring organization wants to leverage the advanced technologies, capabilities, and expertise of the potential contractors in the marketplace

Specifications are written, pictorial, or graphic information that describe, define, or specify the services or items to procured
– There are three types of specifications:

– Feasible procurement alternatives include make or buy, lease or buy, buy or rent, and lease or rent
– Factors involving the make or buy analysis are shown below:
– The lease or rent decision is usually a financial endeavor
– Leases are usually longer tern than renting

– Procurement planning must address the risks on the contract as well as the risks with procurement

Conducting the procurements
[Page 981-982]
– 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 procurement includes:
– The solicitation package is prepared during the procurements planning process but utilized during the next process, conduct procurements
– A typical solicitation package would include:
– The solicitation package describes the manner in which solicitation questions will be addressed, namely bidder conferences
– Bidder conferences are used so that no single bidder has more knowledge than others
– The solicitation package usually provides bidders with information on how the bids well be evaluated
– Contracts are not necessarily awarded to the lowest bidders and some proposal evaluation scoring models assign point in regard to each of the following, and the company with the greatest number of points may be awarded the contract:
Conduct procurements: Request seller responses
[Page 983]
– Selection of the acquisition method is the critical element to request seller responses

There are three common methods for acquisition:
– Advertising: when a company goes out for sealed bids
– Negotiation: when the price is determined through a bargaining process
– Small purchases (i.e., office supplies)

In such as situation of negotiation, the customer may got out for a:
– Request for information (RFI)
– Request for quotation (RFQ)
– Request for proposal (RFP): most costly endeavor for the seller
– Invitation for bids (IFB): during this process, only selected companies are allowed to bid

– Large proposals may contain separate volumes for cost, technical performance, management history, quality, facilities, subcontractor management, etc.

Conduct Procurements: Select sellers
[Page 983-987]
– Part of source selection process includes the application of the evaluation criteria to the contractor’s proposals
– The evaluation criteria reflect the selected contract award strategy, which is typically either a price-based award strategy or best-value award strategy
– The price-based award strategy is used when the contract will be awarded to the lowest priced, technically acceptable proposal
– The best-value award strategy is used when the contract may be awarded to either the lowest priced, technically acceptable offer or a higher-priced proposal offering a higher level of performance
– During a best-value source selection, the procuring organization conducts trade-offs among price, performance, and other nonprice factors to select the proposal that offers the overall best value to the buyer
– Most common criteria = time, cost, expected management team of the project (i.e., quality of assigned resources), and previous performance history

Additionally to the evaluation criteria, a negotiation process can be part of the selection process because the buyer may like several of the ideas among the many bidders and then may try to have the preferred seller take on added work at no additional cost to the buyer
– Separate negotiations can be made on along with their factors and a list of activities:
– The negotiation process also includes the selection of the type of contract, and the final type of contract may be different than what was identified in the solicitation package

– The objective of the conduct procurements process is to negotiate a contract type and price that will result in a reasonable contractor risk and provide the contractor with the greatest incentive for efficient and economic performance

There are some basic contractual terms that should be understood before looking at the various contracts. These include:
[REFER TO PAGE 985-986]

– The final contract is usually referred to as a definitive contract, which follows normal contracting procedures such as the negotiation of all contractual terms, condition cost, and schedule prior to initiation of performance
– If the customer needs the work to begin immediately or if long-lead procurement is necessary, then the customer may provide the contractor with a letter contract or letter of intent
– The letter contract is a preliminary written instrument authorizing the contractor to begin immediately the manufacture of supplies or the performance of services

The type of contract selected is based upon the following:

Types of contracts
[Page 987-991]
Before analyzing the various types of contracts, one should be familiar with the terminology found in them:

No single form of contract agreement fits every situation or project; therefore, companies normally perform work under a wide variety of contractual arrangements, such as:

– At one end of the range is the cost-plus: a fixed-fee type of contract where the company’s profit, rather than price, is fixed and the company’s responsibility, except for its own negligence, is minimal
– At the other end of the range is the lump sum or turnkey type of contract under which the company has assumed full responsibility, in the form of profit or losses, for timely performance and for all costs under or over the fixed contract price
– Various types of contracts provide for varying degrees of cost responsibility and profit depending on the level of performance

There are five types of contracts to consider: Fixed-price (FP); Cost-plus-fixed-fee (CPFF) or the Cost-plus-percentage-fee (CPPF); Guaranteed maximum-shared savings (GMSS); Fixed-price-incentive-fee (FPIF); and Cost-plus-incentive-fee (CPIF)
– Discussed in detail: [REFER TO PAGE 988-990]

– The type of contract that is acceptable to the client and the company is determined by the circumstances of each individual project and the prevailing economic and competitive conditions
– It is important that you use an adequate and realistic description of the work to be undertaken and a careful evaluation and pricing of the scope of the work to be performed and the responsibilities and obligations assumed
– The preparation of a proposal requires a clear understanding between the client and your company as to the rights, duties, and responsibilities of your company
– The proposal defines what it intends to do and can do, what it neither intends doing nor is qualified to undertake, and the manner and basis of its compensation
– Thorough analysis of these matters before, not after, submission of the proposal is essential

Incentive contracts
[Page 991-994]
– To alleviate some of the previously mentioned problem areas, clients, especially the government, have been placing incentive objectives into their contracts
– The fixed-price-incentive-fee (FPIF) contract 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
– In this contract, the contractor agrees to perform a service at a given fixed cost
– If the total cost is less than the target cost, then the contractor has made a profit according to the incentive-fee formula
– If the total cost exceeds the target cost, then the contractor loses money

– When the contract is completed, the contractor submits a statement of costs incurred in the performance of the contract
– The costs are audited to determine allowability and questionable changes are removed, which determines the negotiated cost
– The negotiated cost is then subtracted from the target cost and then multiplied by the sharing ratio
– If the number is positive, it is added to the target profit; if it is negative, it is subtracted
– The new number, the final profit, is then added to the negotiated cost to determine the final price, which never exceeds the price ceiling

– In the cost-plus-incentive-fee (CPIF), the contractor is reimbursed 100% of the costs; however, there is a maximum fee (i.e., profit) of $1,350 and a minimum fee of $300
– Because there appears to be more financial risk for the customer in a CPIF contract, the target fee is usually less than in an FPIF contract, and the contractor’s portion of the sharing ratio is smaller

Contract type versus risk
[Page 994-995]
– 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
– On a firm-fixed-price contract, the contractor absorbs 100% 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% of the risks and expects the contractor to work for a lower than expected profit margin or perhaps no profit at all
Contract administrator
[Page 995-998]
– 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

The functions of a contract administrator include:
[REFER TO PAGE 995-996]

– 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 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:

An ambiguous contract will be interpreted against the party who drafted the document; however, there is an offsetting rule called Patent Ambiguity that includes the following:

The majority of the contract administrator’s time is spent handling changes
– The following definitions describe the types of changes:
[REFER TO PAGE 966-997]

Typical causes of constructive changes include:

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:
– The following are reasons for determination for default due to contractor’s actions:
– If the contract is terminated due to default, then the contractor may not be entitled to compensation of work in progress but not yet accepted by the customer

The contract administrator is responsible for performance control, which 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:

Contract closure
[Page 998]
– 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 by with administrative closure, which includes:
– The seller also performs administrative closure once contractual closure is recognized
– For the seller, an important subset of administrative closure is financial closure, which is the closing out all open charge numbers
– If financial closure occurs before contractual closure, then the PM runs the risk that the charge numbers may have to be reopened to account for the cost of repairs or defects
Using a checklist
[Page 999-1000]
– To assist a company in evaluating inquiries and preparing proposals and contract, a checklist of contract considerations and provision can be helpful in the evaluation of each proposal and form of contract to insure that appropriate safeguards are incorporated
– It is also used for sales letters and brochures that may promise or represent a commercial commitment
– Its primary purpose is to remind users of the legal and commercial factors that should be considered in preparing proposals and contracts

The following contract provisions will minimize risk, and should be included in proposals and contracts:
[REFER TO PAGE 999-1000]

– Because of the variations among proposals and contracts, it is not feasible to prepare material specifically suited for each situation
– It is also not practical to establish a standard form of contract or standard provision to be included in a contract

– It would be valuable to maintain a summary of commercially oriented company policies for reference in reviewing a client’s contract provisions

– It is not uncommon in industry for prospective projects to be canceled because of lack of funks, disagreements in contract negotiations, or changing of priorities

Proposal-contractual interaction
[Page 1000-1003]
– It is critical during the proposal preparation stage that contract terms and conditions be reviewed and approved before submission of a proposal to the client
– The contracts (legal) representative is responsible for the preparation of the contract portion of the proposal
– The contract representation determines or assists with the following:

– The sales department, through the proposal group, has the final responsibility for the content and outcome of all proposals and contracts that it handles
– In general, contract agreements should be reviewed by the following departments:

– Responsibility for collecting and editing contract comments rests with the proposal manager
– In preparing contract comments, consideration should be given to comments previously submitted to the client for the same form of agreement, and also previous agreements signed with the client
– The burden of proof that a contract change is required rests with the company; therefore each comment submitted must have a good case behind it
– Normally, when submitting a proposal for such work, a company does not have sufficient definitive information to establish its position relative to how it would like to handle taxes; that is:

– The legal department should be advised of information pertinent to its functions as promptly as possible as negotiations develop
– Proposal personnel should be familiar with the standard contract forms the company uses, its contract terms, and available conditions, including those developed jointly between sales and the legal department, as well as the functions, duties, and responsibilities of the legal department
– Key areas that are normally negotiated should be discussed so that proposal personnel have a better understanding of the commercial risks involved and why the company has certain positions

– Proposals should send all bid documents, including the client’s form of contract, or equivalent information, along with the proposal outline or instructions to the legal department upon receipt of documents from the client
– The instructions or outline should indicate the assignment of responsibility and include background information on matters that are pertinent to sales strategy or specific problems such as guarantees, previous experience with client, etc.

– The legal department reviews the documents and prepares a memorandum of comment and any required contract documents, obtaining input where necessary or advisable
– The purpose of the memorandum is to alert the proposal department to the issues and suggest solutions, usually in the form of contract comments

– Proposals is responsible for providing information to, and getting comments from, others, such as purchasing, engineering, and estimating; therefor it is necessary for them to review the documents and advise the legal department of any pertinent issues known by or determined by proposals

– Normal practice is to validate proposals for a period of thirty to sixty days following date of submission
– The validity period is especially important on lump sum bids because the validity period must be consistent with validity times of quotations received for major equipment items; if these are not consistent, additional escalation on equipment and materials may have to be included in the lump sum price, and the company’s competitive position could thereby be jeopardized

– One area that is critical to the development of a good contract is the definition of the scope of work covered by the contract; this is of particular importance to the proposal manager, who is responsible for having the proper people prepared for the scope of work description
– The degree to which the project scope of work must be described in a contract depends on the pricing mechanism and contract form used

– A contract priced on a straight per diem basis or on the basis of reimbursement of all costs plus a fee does not normally require a precise description of either the services to be performed or the work to be accomplished
-A contract priced by other methods, especially fixed price, cost sharing, or guaranteed maximum it is essential that considerable care be taken to set forth in the contract documents the precise nature of the work to be accomplished as well as the services performed

– The proper preparation of the description of the work as well as the evaluation of the requirements demands coordination among sales, administration, cost, and technical personnel both inside and outside the organization
– Technical personnel within the organization or technical consultants from outside must inform management whether there is an in-house capability to successfully complete the work
– Determination also must be made of whether suitable subcontractors or purchase orders can be awarded
– Technical projections must be effected relative to a host of problems, including delivery or scheduling requirements, the possibility of changes in the proposed scope of work, client control over the work, quality control, and procedures

– An inadequate or unrealistic description of the work to be undertaken or evaluation of the project requirements marks the beginning of an unhappy contract experience

Guidelines to aid a company in preparing its proposals and contracts and administering operations:
[Page 1003-1004]
While it is essential that companies obtain good contracts with a minimum of risk provisions, it is equally important that those contracts be effectively administered.

– Use of the checklist in the preparation of all proposals and contracts
– Evaluation of risks by reference to the suggested contract provisions wherever appropriate
– Review by the legal department prior to submission to the client of all major proposals and contracts and of other contracts with questionable provisions
– Appropriate pricing and insuring of risks under the contract
– Improving contract administration at appropriate levels
– Periodic review and updating of the entire contract procedure including basic risk areas, administration, and so on

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