In business, the role of procurement is often confused with the act of purchasing since the purpose of both is the securing of goods or services. Though the two are certainly related, they are different processes and understanding that difference helps build a foundation of knowledge around the role of procurement contracts in commercial operations.
Purchasing is the function of buying goods or services and, as such, serves short-term goals. It is a transactional process that involves ordering, payment and receipt. By contrast, procurement is relational and serves longer term goals. It involves all activities pertaining to the sourcing and acquisition of goods and services, including due diligence, tendering and the building of productive commercial relationships.
It is these aspects of the process that make contracts such a vital part of any procurement system. While purchasing involves a form of legal agreement – the agreement to provide goods or services for an agreed price – these contracts are limited in scope and timescale. Procurement deals with more lasting agreements and so the area of procurement contracts requires specific management to contribute to overall business success.
The Purpose of Procurement in Contract Management
All Contract Management serves to reduce risk and keep costs down by ensuring a proactive approach to the control of requirements and obligations. Procurement Contract Management is no exception in that it establishes bespoke legal frameworks for potentially repetitive transactions, to protect all parties. The point here is that effective management strategies in the procurement contract area are designed to accommodate the specifics of the procurement process, as opposed to the processes used in other areas.
Procurement is a clearly defined cycle involving the following stages:
- Market research
- Identification of possible suppliers
- Background checks
- Approved vendors list compilation
- Identification of need
- Purchase order creation
- Tendering and supplier selection
- Receipt of goods or service and quality control
- Contract monitoring
- Invoice approval and payment
- Relationship management
Each of these stages includes elements of Risk Management which lend themselves to the overall purpose of the Procurement Contract process. This purpose is not only to set out expectations and requirements, but also to reduce the likelihood of delay, conflict, and penalty. Since procurement focuses on longer term goals of supplier and vendor relationships, this Risk Management element is a high priority for the ongoing success of the business.
The Main Types of Procurement Contracts
Time and Materials
A Time and Materials contract sets out the terms under which payment is agreed in exchange for time spent and materials used. It is often used within the fields of construction and product development, with the request and negotiation stages of the contract lifecycle focusing on hourly or daily rates of labour in addition to cost of materials. This type of contract applies when various project elements – including overall timescale - cannot be accurately estimated or are likely to be subject to change.
As the name suggests, purchase orders are closely aligned with purchasing. These are the documents that set out the specific business requirement and are then sent to the supplier. This document controls the purchasing process by ensuring that all parties are clear on what is needed, when it is needed, and how much will be paid for it. Once it is accepted by the supplier or vendor, it functions as a contract within the procurement process. The purchase order protects all parties by virtue of being a statement of obligations within a specific scope.
When a project is predictable in terms of scope and duration, a fixed price contract is appropriate. These are agreements that set out clearly defined terms, including the timescale and delivery schedule for the project. It has the benefit of enabling the buyer to know exactly what the cost will be, when it will be completed, and when payments are due. The bulk of the risk therefore falls to the supplier or vendor, because they have committed to fulfilling their obligation in a specific timeframe, for a specific price. Any work completed outside that scope will remain unpaid. There are two possible variations on the fixed price contract model:
Fixed Price with Economic Price Adjustment – When a project is predictable, but a particularly lengthy duration is anticipated, then it can be appropriate to agree a fixed price with a percentage increase after a specified period. This ensures that the cost reflects potential increases in inflation, with the percentage agreed being aligned with the Consumer Price Index.
Fixed Price Incentive Fee – When a project is predictable, but the client would benefit from earlier or better completion, then a financial incentive can be included as recognition of higher-than-average quality, or faster delivery.
With any variation of the fixed price contract model, monitoring is imperative – especially for lengthy projects. This allows for early identification of issues and potential delays.
A cost reimbursable contract is used when the duration of a project is likely to change. It meets the actual costs incurred by the supplier or vendor, and then adds a fee to cover profit – but payment is made after project completion. Incentive fee variations and additional percentage variations are also possible with a cost reimbursable contract model, which can potentially increase profit for the supplier or vendor.
Procurement Management Basics
So, with a clearly defined procurement contract lifecycle, and a clearly defined set of procurement contract types, it is possible to lay out the basic principles of Procurement Contract Management. The fundamental principle is the implementation of a Contract Management Software solution that encompasses all the tools necessary to successfully handle the procurement contract process, alongside all other business contracts. The Contract Management platform devised and designed by can help businesses to bring procurement contracts under greater, more stringent control with cutting edge Contract Management features.
Centralized repository – Effective management of documentation is only possible when that documentation is stored in an organized and accessible fashion. By centralizing procurement contract data, along with all other business contracts, the collection of documentation becomes a searchable data pool that is instantly located. When used in conjunction with an agreed policy for the application of metadata and data tagging, the speed at which valuable information can be surfaced and utilized is greatly increased.
Risk Management suite – Contract Management Software enables business to perform comprehensive background checks on organizations and individuals as part of a thorough program of due diligence. This means that procurement decisions and contracts are based on verifiable fact, as a risk mitigation measure. These tools include links to all leading databases, including Dow Jones, Dun & Bradstreet, LexisNexis and Refinitiv. Also, and in conjunction with the centralized repository, the platform allows for the design and publishing of intelligent questionnaires, to gather further information about suppliers and vendors.
Standardization facilities – The centralized repository includes facilities for building a library of standardized clauses and language. When used in combination with standardized metadata and data tagging, this ensures that contract creation and storage is standardized across the business. For procurement contracts, this brings control and efficiency to the process, while also ensuring that it is aligned with agreed business goals and objectives.
Customizable reporting – Powerful customizable reporting tools transform the accumulated, centralized contract collection into a valuable source of actionable data. With the consistent application of standardized metadata and data tagging, and stringent categorization of documentation, contracts can be filtered at all levels of granularity, with all types of information surfaced. This allows for fully informed decisions moving forward with new procurement relationships, and a full and frank assessment of existing relationships.
Automated workflows – In terms of Contract Management, the introduction of a high degree of automation allows for increased efficiency and productivity. When AI is applied to workflow management, the results are the significant reduction of human error. Tasks are flagged up to the right person at the right time and the risk of delays and bottlenecks is minimized. This allows for a truly proactive approach to be established, making the entire procurement process far more cost-effective.
Cloud technology – The use of cloud technology makes collaboration on contract processes and documentation much quicker and easier. A browser-based design means that authorized personnel can access the system from any web-enabled device in any internet-connected location. This reduces the time taken in due diligence and approvals, thereby speeding up the procurement process. Valuable resources are freed up at a greater frequency, to progress further procurement. The electronic signature facility is an important part of this equation, adding to speed and efficiency, and further boosting the green credentials of the system by significantly reducing the carbon footprint of the business.