PMP Project Management Professional Study Guide, Third Edition (Certification Press)

Procurement planning should be done early in the planning processes, with certain exceptions. As needs arise, as project conditions change, or as other circumstances demand, procurement planning may be required throughout the project. Whenever procurement planning happens early in the project, as preferred, or later in the project, as needed, a logical approach to securing the proper resources is necessitated.

Determining to Make or Buy

The decision to make or buy a product is a fundamental aspect of management. In some conditions it is more cost effective to buy-while in others it makes more sense to create an in-house solution. The make-or-buy analysis should be made in the initial scope definition to determine if the entire project should be completed in-house or procured. As the project evolves, additional make-or-buy decisions are needed.

The initial costs of the solution for the in-house or procured product must be considered, but so too must the ongoing expenses of the solutions. For example, a company may elect to lease a piece of equipment. The ongoing expenses of leasing the piece of equipment should be weighed against the expected ongoing expenses of purchasing the equipment and the monthly costs to maintain, insure, and manage the equipment.

For example, Figure 12-1 shows the mathematical approach to determining the whether it is better to create a software program in-house or buy one from a software company. The in-house solution will cost your company $25,000 to create your own software package and, based on historical information, another $2,500 per month to maintain the software.

Figure 12-1: Make-or-buy formulas are common question topics on the PMP exam.

The development company has a solution that will cost your company $17,000 to purchase, but the development company requires a maintenance plan for each software program installed, which will cost your company $2,700 per month. The difference between making the software and buying the software is $8,000. The difference between supporting the software the organization has made and allowing the external company to support their software is only $200 per month.

The $200 per month is divided into the difference between creating the software internally and buying the software-which is $8,000 divided by $200-40 months. If the software is to be replaced within 40 months, the company should buy the software. If the software will not be replaced within 40 months, it should build the software.

There are multiple reasons why an organization may choose to make or buy. Here are some common examples or reasons for making and buying:

Exam Watch

You may be presented with one or two questions on make versus buy. On the exam, as in the preceding example, you won't be confronted with tax benefits of make versus buy-though in your job as a project manager you may be. For the exam, focus on determining which is the most cost effective, fair solution.

Using Expert Judgment

Procurement planning can rely on expert judgment. It may be beneficial to rely on the wisdom of others-those in the performing organization or subject matter experts-to determine the need for procurement. Expert judgment for procurement management planning can come from the following:

• Units or individuals within the performing organization

• Consultants and subject matter experts

• Professional, trade, or technical associations

• Industry groups

Determining the Contract Type

There are multiple types of contracts when it comes to procurement. The project work, the market, and the nature of the purchase determines the contract type. Here are some general rules that PMP exam candidates, and project managers, should know:

• A contract is a formal agreement between the buyer and the seller. Contracts can be oral or written-though written is preferred.

• The United States backs all contracts through the court system.

• Contracts should clearly state all requirements for product acceptance.

• Any changes to the contract must be formally approved, controlled, and documented.

• A contract is not fulfilled until all of the requirements of the contract are met.

• Contracts can be used as a risk mitigation tool, as in transferring the risk. All contracts have some level of risk; depending on the contract type, the risk can be transferred to the seller. If a risk response strategy is to transfer, risks associated with procurement are considered secondary risks and must go through the risk management process.

• There are legal requirements governing contracts. In order for a contract to be valid, it must:

  • Contain an offer

  • Have been accepted

  • Provide for a consideration (payment)

  • Be for a legal purpose

  • Be executed by someone with capacity and authority

• The terms and conditions of the contract should define breaches, copyrights, intellectual rights, and force majeure.

Fixed-Price Contracts

Fixed-price contracts (also known as firm-fixed-price and lump-sum contracts) are agreements that define a total price for the product the seller is to provide. These contracts must clearly define the requirements the vendor is to provide. These contracts may also provide incentives for meeting or exceeding contract requirements-such as meeting deadlines-and require the seller to assume the risk of cost overruns, as Figure 12-2 demonstrates.

Figure 12-2: FIxed-Price Contracts transfer the risk to the seller.

Exam Watch

Force majeure is a powerful and unexpected event, such as a hurricane or other disaster.

Cost-Reimbursable Contracts

These contract types pay the seller for the product. In the payment to the seller there is a profit margin-the difference between the actual costs of the product and the sales amount. The actual costs of the product fall into two categories:

• Direct costs costs incurred by the project in order for the project to exist. Examples include equipment needed to complete the project work, salaries of the project team, and other expenses tied directly to the project's existence.

• Indirect costs costs attributed to the cost of doing business. Examples include utilities, office space, and other overhead costs.

Cost-reimbursable contracts require the buyer to assume the risk of cost overruns. There are three types of cost-reimbursable contracts:

• Cost plus fixed fee

• Cost plus percentage of costs

• Cost plus incentive fee

Time and Materials Contracts

Time and Materials (T&M) contracts are sometimes called Unit Price contracts. They are ideal for instances when an organization contracts out a small projector for instances when smaller amounts of work within a larger project are to be completed by a vendor. T&M contracts, however, can grow dangerously out of control as more work is assigned to the seller. Figure 12-3 is an example of how T&M contracts can pose risk for the buyer.

Figure 12-3: Time and Materials contracts must be kept in check or expenses can skyrocket.

Summary of Contract Types

On the PMP examination you can anticipate a few questions on contract types. Familiarize yourself with the following table: