A

REPORT

ON

“Procedures for Procurement

Of materials”

Submitted in partial fulfillment of the requirement for the award of eMBA for the year 2010-12

Under the guidance of:

Prof. L.N. Chopde

By:

Saylee Gandhi

Sneha Shriyan

Rasika Chavan

Harshada Dage

MET Institute of Management

Mumbai

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Certificate

This is to certify that,

Ms Saylee .M. Gandhi

Ms Sneha Shriyan

Ms Rasika Chavan

Ms Harshada Dage

of eMBA Div C Semester I of MET Institute of Management for

academic year 2010-12 has successfully completed the project on

“Procedure for Procurement of Materials” under the guidance of

Prof. L.N. Chopde.

Signature

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(Certificate from the Company)

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Preface

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ACKNOWLEDGEMENT

Our deepest sense of gratitude, profound respect and sincere thanks to

Prof. L. N. Chopde (faculty member MET) our project guide, for his

valuable assistance, keen interest at each step of the project. It would not have

been possible for us to reach this stage without his support & guidance.

He always had the answers to our queries, be it regarding any concept related

of accounts. His continuous interaction and support made it possible for the

successful completion of the project.

We would also take the opportunity to thank the institute for the

encouragement and facilities provided to us for the successful completion of

this project.

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Executive Summary

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TABLE OF CONTENTS

1. Procurement

a. Procurement - Introduction…………………………...…09

b. Common Terminologies in Procurement………………..09

2. Types of Procurement

a. Direct Procurement…………………………………….11

b. Indirect Procurement…………………………………...11

3. Types of Procurement Contracts

a. Fixed Price Contracts…………………………………..12

b. Cost Contracts……...…………………………………..13

c. Leasing Contracts………………………………………14

d. Regular Purchase Contracts...………………………….14

e. Installment Purchase Contracts………………………..14

4. Procedures of Procurement

a. Tendering…………….………………………………..15

b. Shared Services………………………………………..15

c. Selection in Planning (SIP)……………………………16

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d. Just in Time Approach (JIT)…………………………..16

5. Steps in Procurement of Materials……………………………18

6. Risk Management in Procurement

a. What is Risk Management………………………….....21

b. Types of Risks in Procurement………………………..22

7. Concepts

a. Green Procurement….………………………………...24

b. E-Procurement…………………………………….…..26

c. Public/Government Procurement…………………..…28

8. Bibliography………………………….………………….…29

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Procurement

Introduction

Procurement is the fancy word for "purchasing." The procurement

department within an organization manages all the major purchases.

Procurement is the acquisition of appropriate goods and/or services at the best

possible price to meet the needs of the purchaser in terms of quality and

quantity, time and location. Corporations and public bodies often define

processes intended to promote fair and open competition for their business

while minimizing exposure to fraud and collusion.

Almost all purchasing decisions include factors such as delivery and handling,

marginal benefit, and price fluctuations. Procurement generally involves

making buying decisions under conditions of scarcity. If good data is

available, it is good practice to make use of economic analysis methods such

as cost-benefit analysis or cost-utility analysis.

Common Terminologies in Procurement:

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1) Procurement plan: The document that describes how procurement

processes from developing procurement documentation through contract

closure will be managed.

2) Make or Buy Decision: A business decision that compares the costs and

benefits of manufacturing a product or product component against purchasing

it.

3) Contract Administration: The process of managing the contract and the

relationship between the buyer and the seller, managing contract related

changes and, when appropriate managing the contractual relationship with the

outside buyer of the project.

4) Invitation for Bid: Refers to the method of soliciting offers and are used

when negotiations are not anticipated. Bids are typically read aloud in public

at the time and place specified in the solicitation.

5) Request for Proposal (RFP): A type of solicitation that is used typically for

large amount of contracts when negotiations are anticipated. Offers in

response to RFPs can be accepted without negotiations and become legally

binding.

6) Contract: A contract is a mutually binding agreement that obligates the

seller to provide the specified products or services - obligating the buyer to

pay for them. Contracts are used because they are legally binding, there is

more accountability.10

7) Statement of Work (SOW): A narrative description of products, services to

be supplied.

Types of Procurement

Procurement is broadly categorized in two types as follows.

Direct procurement and indirect procurement

 

TYPES

Direct procurement

Indirect procurement

Raw material and production goods

Maintenance, repair, and operating supplies

Capital goods and services

F E A T U R E S

Quantity Large Low Low

Frequency High Relatively high Low

Value Industry specific Low High

Nature Operational Tactical Strategic

ExamplesCrude oil in petroleum industry

Lubricants, spare partsMachinery, computers

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Based on the consumption purposes of the acquired goods and services,

procurement activities are often split into two distinct categories. The first

category being direct, production- related procurement and the second being

indirect, non-production- related procurement.

Direct procurement occurs in manufacturing settings only. It encompasses all

items that are part of finished products, such as raw material, components and

parts. Direct procurement, which is the focus in supply chain management,

directly affects the production process of manufacturing firms. In contrast,

indirect procurement activities concern “operating resources”

that a company purchases to enable its operations. It comprises a wide variety

of goods and services, from standardized low value items like office supplies

and machine lubricants to complex and costly products and services like

heavy equipment and consulting services.

Types of Procurement Contracts

Procurement contracts can be categorized into 5 main areas such as:

1. Fixed-Price Contracts

2. Costs Contracts

3. Leasing Contracts

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4. Purchase Contracts

5. Installment-Purchase Contracts

1) Fixed price contracts: Under fixed price contracts there are following sub-

categories:

a) Firm-fixed price contract:

It is used when a fair and reasonable price can be established at the outset. The

firm pays the negotiated amount regardless of the contractor’s real cost.

b) Fixed-price incentive contract:

It is used when the parties can negotiate a target cost, target profit and a

ceiling price that provides for the contractor to assume an appropriate share of

the risk. E.g. Fixed Price Plus Incentive Fee (FPIF) – 10000/- is paid plus

for every month the work finished earlier than schedule 1000/- will be paid

more and also Fixed Price plus Award fee (FPAF) – 10000/- plus every

month performance exceeds planned value 1000/- is awarded with the max

award of 10000/-

c) Fixed price with economic price adjustment contract:

It is used to protect the parties against significant economic fluctuations

material costs during the period of contract performance (rise since last

financial recession) recommended for all food commodities buyers. E.g.

Fixed Price Economic Price Adjustment – 10000/- year plus a price will

increase based on Consumer Price Index.

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2) Costs Contract: It is used when there are enough uncertainties involved in

contract performance to use a fixed price contract taking into consideration

limitation of costs. Under costs contract there are following sub- categories:

a) Cost Contract: Seller receives no profit. Used by non profit organizations.

b) Cost Plus Fees (CPF) or Cost plus Percentage of Cost (CPPC): Cost plus

10% as fees.

c) Cost plus Fixed fee (CPFF): E.g. Cost plus 10000/- in fees.

d) Cost plus Incentive Fee (CPIF): Cost plus variable fee. Original estimate is

done (target cost) and target fee is determined. The seller gets percentage of

saving if actual cost is less than target cost.

e) Cost plus Award Fee (CPAF): Cost plus fee plus award based on

performance.

f) Time and Material: Contract is based on the time consumed and materials

used. E.g. Rs.100 /hr plus cost.

3) Leasing Contracts: Contracts are leased as per the requirements of both

the parties for specific period of time. Such types of contracts are usually used

in construction industry for procurement of materials.

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4) Regular Purchase Contracts: Such contracts are ordinary contracts and

are generally used for procuring commodities.

5) Installments Purchase Contracts: Such contracts are ordinary contracts

and are generally used for procuring commodities on installment basis. Terms

and conditions of installments are decided by the buyer and the seller parties.

Procedures of Procurement

a. Tendering:

Procurement may also involve a bidding process i.e., Tendering. A company

may want to purchase a given product or service. If the cost for that

product/service is over the threshold that has been established (e.g.: Company

X policy: "any product/service desired that is over Rs.10,00,000 requires a

bidding process") depending on policy or legal requirements, Company X is

required to state the product/service desired and make the contract open to the

bidding process. Company X may have ten submitters that state the cost of the

product/service they are willing to provide. Then, Company X will usually

select the lowest bidder. If the lowest bidder is deemed incompetent to

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provide the desired product/service, Company X will then select the submitter

who has the next best price, and is competent to provide the product/service.

2) Shared Services:

In order to achieve greater economies of scale, an organization’s procurement

functions may be joined into shared services. This combines several small

procurement agents into one centralized procurement system.

Shared Services is an organizational best practice for procurement. Most

global companies have multiple purchasing departments resulting in

disconnected processes and individuals all trying to accomplish the same

function.

Each organization executes transactions differently, resulting in fragmented,

inconsistent processes with no internal control over the information,

presenting control and compliance issues. For Procurement to scale operations

in a central Shared Service Center, organizations can consolidate suppliers,

improve operational efficiencies, strengthen internal service for customers,

strengthen internal controls and facilitate the compliance process.

3) Selection in Planning (SIP):

There are several alternatives to tendering which are available in formal

procurement. One system which has gained increasing momentum in the

construction industry and among developing economies in the Selection in

planning process which enables project developers and equipment purchasers

to make significant changes to their requirements with relative ease. The SIP

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process also enables vendors and contractors to respond with greater accuracy

and competitiveness as a result of the generally longer lead times they are

afforded.

4) Just-in-Time Approach (JIT):

Another common procurement issue is the timing of purchases. Just-in-time is

a system of timing the purchases of consumables so as to keep inventory costs

low. Just-in-time is commonly used by Japanese companies but widely

adopted by many global manufacturers from the 1990s onwards.

Just in time approach says to keep no or zero inventory. These means the

material has to supplied only when it is needed. This not only applies to the

raw materials but also to finished goods. The philosophy of JIT approach is

not to waste money on keeping the inventory. This approach leads to

minimizing storage costs and any taxes that may be applicable. However

having a JIT approach being followed is very difficult and companies need lot

of investment to be made.

This investment is not only monetary but also includes employee training,

system installations, maintenance and other factors. But when once JIT is

successfully installed it helps companies to substantially reduce the cost of the

product.

The system is said to be developed by Toyota to decrease their cost of

inventory. The largest chain of the world, Wal-Mart is successfully following

this approach and thus they are in the position to offer the product at lower

cost as compared to other retail chains.

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This is also popularly known as "Pull system" in production. In other words it

is reverse chain of production, where customer places the order and

accordingly the product is manufactured. For implementation of JIT, proper

correspondence between customer and supplier has to be maintained.

Steps in Procurement of Materials

1. Make purchase decisions – Planning:

Purchase decisions follow from project planning and analysis. Project needs

are analyzed and compared with available resources and skills.  Anything the

organization cannot provide must be procured.

2. Prepare bid documents:

These documents include a SOW statement (Statement of Work), general

terms and conditions, bid response instructions, and an explanation of how

proposals will be evaluated (source selection criteria).

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3. Distribute bid packages to potential vendors:

Potential vendors can be identified through advertising, the internet, or

through an organization’s qualified vendors list.

4. Bidder’s conferences:

Bidder or vendor conferences are used to efficiently deliver detailed

information to potential vendors.  The events offer an opportunity for vendors

to ask questions and to hear questions posed by other potential vendors.

5. Receive responses from bidders:

A suitable time-frame must be given for vendors to prepare bids.  Additional

information and clarifications are often required by vendors.

6. Evaluate proposals:

After all bids have been received, they are evaluated on the basis of a

predetermined scoring system referred to as ‘source selection criteria’.

The comparisons are typically performed by experts from various disciplines

related to the type of procurement.

7. Interview bidders:

Short-listed bidders are interviewed to discuss details of their offers and to

ensure a good fit with the purchasing organization.

8. Conduct negotiations:

The leading candidate is invited to discuss (negotiate) contract details.  The

issues that generally require clarification include such things as delivery date,

shipping costs, warranty, and support.

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9. Award contract:

A contract is awarded for each procurement.  The contract is a legal document

that clarifies the responsibilities and relationships between the buyer and

seller.

10. Determine work start date:

Work cannot begin until after the final contract has been signed by senior

management of both the buying and selling organizations.  Delays in

obtaining final signatures can result in delays to the start of work.

11. Manage contracts:

‘Managing contracts’ is the supervision of actual procurement activities

from both an administrative and a practical perspective.  Responsibility for

ensuring that the right work gets done at the right time is typically left to the

project team.  Administrative responsibility remains with the procurement

department.

12. Review performance (extend or terminate):

Throughout the life of the ‘delivery’ of goods and services, the performance

of the delivering organization (vendor) must be constantly reviewed and

compared with contract terms.  A detailed SOW is a critical component of

effective performance analysis.

If vendor performance falls below a specified standard, (such as schedule or

quality) then the contract may be terminated according to terms established in

the contract.  (Of course every effort should be made to correct the situation

through negotiations and discussions before considering termination.)

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13. Claims administration:

Claims administration involves the management of conflicts between the

buyer and seller.

How claims are administered is determined by the procedures set out in the

contract.  When the remedies specified in the contract are insufficient to

resolve conflicts, the issue may ultimately end up being settled in court.

14. End contracts:

After all work is complete, or if the contract is terminated, the contract is

formally ‘closed.’

Contract closure involves the formal notification of all parties regarding the

status of the contract.  In addition, a contract archive is created that documents

exactly what work was completed and what payments made. Records are kept

of all correspondence generated during the life of the contract.

15. Lessons learned:

An important part of helping an organization to avoid repeating mistakes is

the gathering of ‘lessons learned.’  This includes an analysis of what went

according to plan, what went wrong, and what should have been done

differently.

16. Ongoing claim administration – litigation:

Conflicts between the buying and selling organizations can continue long after

a project is formally completed.  An organization’s legal and procurement

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departments take responsibility for ongoing claims administration, which can

take years to be resolved.

Risk management in Procurement

1. What is Risk Management?

Risk management can be defined as the culture, processes and structures that

are directed towards effective management of potential opportunities and

threats to the organization achieving its objectives.

Risk management is an essential part of good procurement. An officer who

manages procurement risk well is more likely to achieve the objectives set in

the business case.

It is important to recognize that risk management covers all aspects of

procurement. The following diagram illustrates the hierarchy of risk.

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2. What are the types of risk associated with procurement?

There are three main risk areas:

Strategic Risk – Long-term adverse impacts from poor decision-making or

poor implementation.

Strategic risks threaten to damage the reputation of the Company, result in

loss of public confidence, and in extreme cases may result in external

intervention.

Programme Risk – Failure to comply with procurement legislation, or

internal procedures (the procurement code of practice or contract procedure

rules) or the lack of documentation to prove compliance (i.e. a clear audit).

Programme risks can exposure the Company to challenge, judicial review,

employment tribunals, increased government inspection, or inability to

enforce contracts.

Project or Operational Risk – Poor contract management, inadequate terms

and conditions, failure to deliver services effectively & on time,

malfunctioning equipment, hazards to service users, the general public or

staff, or damage to property.

Such risks are often the result of inadequate contract management processes,

and can result in insurance claims, disputes, poor user satisfaction, and

ultimately, litigation.

For example, a programme risk could be the awarding a contract without

appropriate terms and conditions and lack of contract management, resulting

in confusion as to contract requirements and outcomes.

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Procurement risk can be minimized by the following means:

1) Elimination – The circumstances from which the risk arises are identified

and removed so that the risk no longer exists.

2) Reduction – Control measures are implemented to reduce the impact

and/or likelihood of the risk occurring.

3) Transfer – The financial or delivery impact of a risk is passed to others.

4) Acceptance – Documenting a conscious decision after assessment of areas

where the risk can be accepted as having little or no material impact, or is

unavoidable.

Concepts

Green Procurement:

A. Definition

Green procurement is the purchase of environmentally friendly products and

services, the selection of contractors and the setting of environmental

requirements in a contract.

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B. Main Features

Green procurement steams from pollution prevention principles and activities.

Also known as green or environmental purchasing, green procurement

compares price, technology, quality and the environmental impact of the

product, service or contract. Green procurement policies are applicable to all

organizations, regardless of size. Green procurement programs may be as

simple as purchasing renewable energy or recycled office paper or more

involved such as setting environmental requirements for suppliers and

contractors.

"Green" products or services utilize fewer resources, are designed to last

longer and minimize their impact on the environment from cradle to grave. In

addition, "green" products and services have less of an impact on human

health and may have higher safety standards. Whilst some "green" products or

services may have a greater upfront expense, they save money over the life of

the product or service.

Before a green procurement program can be implemented, current purchasing

practices and policies must be reviewed and assessed. A life cycle assessment

of the environmental impacts of products or services is required and a set of

environmental criteria against which purchase and contract decisions are made

has to be developed. The outcome is a regularly reviewed green purchasing

policy that is integrated into other organizational plans, programs and policies.

Green procurement policies and programs can reduce expenditure and waste;

increase resource efficiency; and influence production, markets, prices,

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available services and organizational behavior. They can also assist countries

in meeting multi-lateral requirements such as the Kyoto Protocol.

International Standards Organisation and other bodies have established

guidelines for green procurement programs.

Obstacles to implementing a green procurement program include:

1. lack of readily available environmental friendly products;

2. expensive or zero environmental alternatives;

3. inaccurate studies;

4. lack of organizational support;

5. Inaccurate or unsupported environmental claims by manufacturers and

suppliers.

C. Examples

1. Fujitsu

Fujitsu Japan has a green procurement policy that selects materials; parts;

products; and production equipment based on price; environmental impact;

quality; and delivery. Environmental considerations include: avoidance of

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toxic substance during production and disposal; resource and energy

conservation; recyclibility; and ease of disassembly for processing and

disposal.

E- Procurement:

E-procurement is the business-to-business purchase and sale of supplies and

services over the Internet. An important part of many B2B sites,

e-procurement is also sometimes referred to by other terms, such as supplier

exchange. Typically, e-procurement Web sites allow qualified and registered

users to look for buyers or sellers of goods and services. Depending on the

approach, buyers or sellers may specify prices or invite bids. Transactions can

be initiated and completed. Ongoing purchases may qualify customers for

volume discounts or special offers.

E-procurement software may make it possible to automate some buying and

selling. Companies participating expect to be able to control parts inventories

more effectively, reduce purchasing agent overhead, and improve

manufacturing cycles. E-procurement is expected to be integrated with the

trend toward computerized supply chain management.

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E-Procurement delivers significant decreases in purchasing cycle times,

increased compliance with corporate purchasing policies and better

purchasing decisions. These efficiencies optimize operations, enabling a

Shared Service Center to create further efficiencies by managing a company’s

total procurement budget and process.

Benefits of E-procurement:

Lower Costs – Automation enables buyers to process more bids and

speeds purchasing, freeing time for more important activities such as

price negotiation, spending analysis and finding better suppliers.

Improved Purchasing Decisions – With more information readily

available, buyers can make better decisions on selecting suppliers,

negotiating prices and settling contract terms.

New Savings and Improvement Opportunities – Finance managers

can monitor performance quickly with analytical reports and realize

buying power by consolidating purchasing volumes.

Faster Purchasing Cycles – The elimination of document rerouting

and paper chasing speeds the purchasing process; no searching for lost

or misfiled documents.

Improved Supplier Relationships – Self service capabilities enable

suppliers to access information online, reducing calls to Purchasing.

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Faster Communication – The real-time exchange of documents and

monitored workflow speeds communications with business managers

and suppliers.

Improved Visibility into Purchasing Processes – Finance has a “clear

line of sight” into the end-to-end procure-to-pay process, making it

easier to detect bottlenecks, identify inefficiencies and eliminate

unnecessary spending.

Easier Auditing – Complete capture of all purchasing content and

workflow steps combined with instant online access makes integrated

auditing easier for both internal and external auditors.

Public/Government Procurement:

Bibliography:

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