Planning & Managing Procurement

Procurement management involves acquiring goods and services from external sources. Understanding contract types and their risk implications is critical for the PMP exam and effective project management.

Procurement Management Processes

---

Make-or-Buy Analysis

Make-or-buy analysis determines whether to produce goods/services internally or purchase from external sources.

Factors to Consider

Cost Comparison Example

Decision: Buy is more cost-effective in this example.

Beyond Cost

Consider non-financial factors:

• Quality: Which option delivers higher quality?
• Risk: What are the risks of each option?
• Control: How important is control over the work?
• Capability Development: Is this a skill we should develop?
• Confidentiality: Are there proprietary concerns?

---

Contract Types

Contracts are categorized by how risk is allocated between buyer and seller.

Risk Spectrum

BUYER RISK          ←——————————————→          SELLER RISK
     ↓                                              ↓
Cost-Reimbursable    Time & Materials    Fixed-Price
(CPPC → CPFF)           (T&M)           (FPIF → FFP)

---

Fixed-Price Contracts

In Fixed-Price contracts, the seller agrees to deliver for a set price, assuming most of the cost risk.

Types of Fixed-Price Contracts

Firm Fixed Price (FFP)

• Most common contract type
• Seller agrees to a specific price regardless of actual costs
• Maximum incentive for seller to control costs
• Best for: Well-defined scope, low uncertainty

Fixed Price Incentive Fee (FPIF)

• Base price with performance incentives/penalties
• Includes a price ceiling - costs above ceiling are seller's responsibility
• Formula: Final Price = Target Price + [(Actual Cost - Target Cost) x Buyer Share Ratio]

Example:

• Target Cost: $100,000
• Target Profit: $10,000
• Target Price: $110,000
• Price Ceiling: $120,000
• Share Ratio: 80/20 (Buyer 80%, Seller 20%)

If Actual Cost = $105,000:

• Cost Overrun = $5,000
• Buyer Pays Additional: $5,000 x 80% = $4,000
• Final Price = $110,000 + $4,000 = $114,000

---

Cost-Reimbursable Contracts

In Cost-Reimbursable contracts, the buyer reimburses the seller's costs plus a fee, assuming most of the cost risk.

Types of Cost-Reimbursable Contracts

Cost Plus Fixed Fee (CPFF)

• Buyer reimburses all allowable costs
• Seller receives fixed fee (not affected by actual costs)
• Fee calculated as percentage of estimated costs
• Best for: Undefined scope, high uncertainty

Cost Plus Incentive Fee (CPIF)

• Buyer reimburses costs plus incentive fee
• Fee based on achieving specified objectives
• Cost savings/overruns shared between buyer and seller
• Best for: When performance targets can be defined

Cost Plus Percentage of Costs (CPPC)

• Fee is percentage of actual costs
• Worst for buyer - seller has incentive to increase costs
• Prohibited for US government contracts

---

Time and Materials (T&M) Contracts

T&M Contracts combine elements of both fixed-price and cost-reimbursable:

When to Use T&M

• Scope cannot be fully defined
• Need quick start while scope is clarified
• Short-term or staff augmentation needs
• Work of unknown duration

T&M Risk Mitigation

To limit buyer risk, add:

• Not-to-exceed (NTE) clause: Maximum total cost
• Time limit: Maximum duration
• Progress milestones: Regular checkpoints

---

Contract Type Comparison

---

Source Selection Criteria

Criteria for evaluating and selecting vendors:

Common Selection Criteria

Weighted Scoring Example

Selected: Vendor A (highest weighted score)

---

Procurement Documentation

Key Documents

---

Key Takeaways

• Make-or-buy analysis compares in-house vs. outsourced options
• Fixed-Price contracts put risk on seller; Cost-Reimbursable on buyer
• FFP has maximum seller risk; CPPC has maximum buyer risk
• T&M shares risk and is best for undefined scope
• Source selection criteria should be weighted and used objectively
• CPPC is prohibited for US government contracts