Introduction

If you are a beginner in supply chain management or buying, then you will find this chapter an important building block for understanding the rest of the chapters of this book; experienced procurement professionals will find this chapter to be a refresher of knowledge previously gained.

This chapter covers the following topics:

• Definitions
• Project Stages
• Procurement Life Cycle and Importance in Project Management
• Types of Procurement
• Budgets and Reserves

1.1 Definitions

It is important to begin with an understanding of the terms related to buying. Reading these terms carefully will go a long way in any attempt at making a career in buying, from junior buyer up to supply chain head of organizations, so let us have a look at some of these important definitions.

1.1.1 Purchase Requisitions

Purchase requisitions are formal requests raised by the department that is requesting the supply chain department to outsource goods and/or services.

1.1.2 Procurement

Procurement is an all-inclusive function that describes the activities and processes used to acquire goods and services. Importantly, and distinct from purchasing, procurement includes the activities involved in establishing fundamental requirements; sourcing activities, such as market research and vendor evaluation; and negotiation of contracts. In short, purchasing is a subset of procurement functions.

1.1.3 Project Procurement

A project-specific procurement function is referred to as project procurement. In the past, procurement was a decentralized function because it was understood as a support function rather than a specialized job. With the increase of competition and organizational complexity, project procurement was made a centralized function, requiring experts to deal with ever-changing conditions and keep track of the market at all times. However, this was also not very helpful, as organizations buying everything with the same standard specifications (that do not conform to client or end customer requirements) resulted in organizations becoming less cost beneficial. As organizations started losing orders, the need for setting up a project procurement department was felt; however, experts added this function based on particular project requirements rather than for the purposes of providing a high-quality end product.

1.1.4 Purchasing

The term purchasing refers to the process of ordering and receiving goods and services. It is a subset of the procurement process, as explained above. Generally, purchasing refers to the process involved in ordering goods such as the request, approval, or creation of a purchase order (PO) record, and the receiving of goods. Therefore, in simple words, purchasing is a subset of procurement and is part of procurement functions.

1.1.5 Auction

An auction is a sort of public bidding system, where the bids can be submitted repeatedly any number of times until a decided end time—or earlier if somebody has won the deal.

1.1.6 E-Auction

An electronic way of negotiating a contract or an agreement is known as an e-auction. E-auctions can be conducted in a number of formats, such as a reverse auction, Dutch auction, English auction, and so forth. It is important to understand the basis of choosing a particular type of e-auction method. Although we will learn more about this in Chapter 6, popular electronic auctions are introduced and briefly described as follows.

• Dutch auction

  A Dutch auction is a method of reducing prices until a buyer is found. This type of auction starts with the highest possible price at which the selling organization wants to sell their goods and/or services, and in the case that no buyer is ready to accept the selling organization price, then the selling organization reduces the price. This is an iterative process, as the seller keeps on reducing the selling price until the buyer accepts the offered selling price. Dutch auctions are not popular with project organizations, as project organizations buy material based on competition among different sellers.

• English auction

  An English auction is a type of forward auction, where the seller sets the reserve price and then the price is incremented until the highest price is received. This is a traditional method of auction. For example, when somebody wants to sell a painting with the lowest price set at US$1 million and the price is increased by US$200,000 with every new bid. In such an auction, the bidder with the highest price gets the painting.

• Reverse auction

  A reverse auction is way of agreeing on a contract, where competing suppliers keep on reducing the prices at which they are ready to provide the goods and/or services to the buyer. The lowest bidding supplier wins the contract.

1.1.7 Logistics

This term was first used by the military for all the activities of armed-force units in support of war units, including transport, supply, communications, medical aid, and personnel. In the business context, this is used for handling the complete operation, from picking up the material from the agreed-upon place through the time period of the material being stored at the required destinations.

1.2 Project Stages

It is ideal for readers to understand the various project stages and the role to be played by the procurement team during each stage. Procurement has an important role to play within the business unit. Figure 1.1 illustrates that procurement can support the tendering team in preparing an offer. Also, once the offer is submitted by the sales team to the customer, the customer can request further discounts; procurement/tendering can rework the costing for revision of the offer. During execution, procurement has an active role to play and has to support the project management team to ensure the business unit has set up a project margin.

Most organizations make the mistake of acknowledging the role of procurement during the tendering stage, which leads to less business and higher risks during execution.

1.2.1 Marketing and Tendering

Marketing and tendering is an important phase; normally both are understood to be the same thing, but they are, in fact, entirely different. Marketing is about marketing an organization's products and searching for potential customers. Once the potential customers start finding interest in an organization's products, the sales and tendering people pitch in. Sales teams mark a particular customer as an opportunity, whereas tendering teams start working on the estimates, costs, and prices to be offered to the customer.

1.2.2 Sales

The sales team works based on the leads generated by the marketing team, and once agreeing on the bid/no bid, they request tendering to prepare the offer based on the customer's requirements. The sales team meets with the customer several times before the customer makes a decision to go with the supplying organizations for the customer's project requirements of goods and/or services.

1.2.3 Project Execution

Once the sales team has secured the project order from the customer, it hands the project order over to the project execution team during the formal project kick-off meeting. These kick-off meetings are important since they define the deliverables in detail as well as other critical factors. After the project kick-off meeting, the contracting organization starts working on a detailed project schedule and project plan. This is the phase where project execution delivers what was agreed upon with the customer, whether this includes products, services, or both. If the customer is satisfied with what they have appointed the organization to provide, they sign the provisional acceptance/project handover formally. This is an important stage after which the warranty period starts, and will be discussed below.

1.2.4 Warranty

The customer has taken over the project delivered by the contracting organization by signing the project handover or provisional acceptance of works. Because every product has a life, and based on the returns on investment, if anything goes wrong, the contracting organization has to repair any defects or replace the products as agreed upon under the contract with the customer. Normally, the contracting organization has a clear idea about their own product reliability and shelf life, so they have nothing to lose by agreeing to warranty terms. In spite of product life, the contracting organization keeps a 3% to 5% budget for any uncertainties. After successful completion of the warranty phase, contracting organizations are not bound to make any rectification, even if any condition arises. However, the customer can ask the organization to make corrections at additional costs and expenses, which is a normal practice across the globe until or unless the products or services become obsolete.

1.3 Procurement Life Cycle

Understanding the procurement life cycle can change the way you do it. Procurement generally starts with planning what to buy, where to buy, when to buy, and how much to buy, and then concludes with closing the contract.

Figure 1.2 shows that before transforming the requirements into finished products, services, or results, there are several steps to be taken that may fall into one of the illustrated areas.

1.3.1 Plan Procurement

This is about the planning of procurement, which covers what to buy, when to buy, how and how much to buy, and what contract type to be used.

1.3.2 Conduct Procurement

Conduct procurement is about finalizing the order award. This covers the steps involved in making requests for quotes, conducting bidder's conferences and strategic negotiations, and awarding the contract.

1.3.3 Administer Procurement

This is where the contract is being administered against the contract requirements, and only the appropriate changes to the contract order are being discussed for further approval from the change control board or approval committee.

1.3.4 Close Procurement

This is the final phase in the procurement—the time to formally close the order and settle all possible claims. However, it should be noted that even if there are unsettled claims, the phase needs to be completed.

1.4 Sector-Based Procurement

Doing procurement can be defined in many ways, which vary from organization to organization, and country to country. We should keep our focus on the ways in which it is being handled generally. Sector-based procurement can be divided broadly into two categories, government sector and private sector.

1.4.1 Government Sector

Government sector utilities and public-private partnership companies must follow the guidelines laid down by the respective regulators (if appointed). Otherwise, all cases need to follow the guidelines of a central vigilance commission, or any other circulars or amendments being issued by the competent authority.

1.4.2 Private Sector

The private sector is highly dependent on the type of sector and the organization's internal policies. In the case of regional organizations or small entities, you may not even find any policies; such organizations follow the instructions of the entity's head in all cases. However, in the case of multinational companies, there are usually established processes and guidelines inherited from their headquarters with alignment to local and international rules and regulations.

1.5 Budgets and Reserves

If you are working for an organization that is more dependent on external projects, or projects coming from outside customers or clients, then knowledge of the following types of budgets is critical.

Every organization during the sales phase keeps some documentation on perceived risks and profits. So, when one organization makes an offer to another organization, it is not only the cost of the raw material plus the profit margin, it is also dependent on the style of the organization to bid for external customers. Despite the fact that different organizations can have different ways of arriving at project costs, they will keep following types of reserves in addition to other projects costs to meet any unforeseen costs, which otherwise impact the complete profit margin.

1.5.1 Management Reserves

The management reserves are generally the reserves that every organization keeps based on future uncertainties from any of its projects or from some external factor(s). The important point to remember is that management reserves are not in the hands of the project manager, and in case of project cost overruns, the project manager has to request top management to release additional budget funds from this reserve. Whether to continue the project with such a loss or just terminate it is, again, solely the decision of top management. These may be understood as “known cost provisions for unknown risks.”

1.5.2 Contingency Reserves

Every project should have a contingency reserve, which should be decided on in the very initial stages, preferably while bidding, but not later than accepting the order from the external customer. This is also known as “provisions created for the known risks,” which if they pop up, will have to be mitigated with additional costs. In other words, we may say that these are the known cost provisions for known risks.