Business Needs in

Procurement and Supply

Diploma in Procurement and Supply
What are business needs?
• An organisation needs certain inputs in order to
perform its activities and pursue its objectives
• The planners of business activities, and the users of
inputs, typically notify the procurement function of
these requirements, in various ways
• The task of procurement is to fulfil the input
requirements, by achieving what are often called the
five rights of procurement
Development of procurement
• Passive (no strategic direction, reacts to requests, mainly
clerical.
• Independent (adopts latest techniques n processes, focus
on functional efficiency, contribution is measured on cost
reduction and supplier performance)
• Supportive (supports firm’s competitive strategy, only
facilitates the firm strategy)
• Integrative (cross-functional collaboration, info exchange
n understanding, it is measured by strategic contribution)
A generic procurement cycle
Type of purchase
• Straight re-buy of items already sourced from a supplier
• Modified re-buy, where some of the requirement has
changed or supplier has been changed.
• New buy, where the requirement has not previously been
specified or sourced
Note: Call off Order are order that are meant to cover
multiple supplies from a single supplier, the supplier has
all the details of the need, there estab relationship, there
o further information requirement or negotiation etc.
Capital procurements
• Systematic appraisal of the benefits, costs and risks of the
investment, and likely ‘payback’ period of the investment
• Balancing the whole life costs and performance, functionality
and quality of the asset
• Negotiation, specification and contracting with the chosen
supplier for a total ‘package’ of benefits sought over the
asset’s lifecycle
• Analysis and management of lifecycle costs
• Management and maintenance of the asset in such a way as
to prolong its useful life and maximise its residual value on
disposal
The Kraljic procurement portfolio
matrix
The business case process
• Fostering strategic, business-focused thinking
• Improving the efficiency and quality of decision-making
• Enabling management to evaluate proposals for feasibility,
suitability and acceptability
• Enabling management to compare alternatives and options
• Establishing measurable yardsticks by which the subsequent
performance, deliverables or outcomes of projects can be evaluated
• Is the project or asset achieving the business case benefits
anticipated?
• Are the assumptions made in the business case turning out to be
accurate?
• Is the business case justification for the project still valid?
Informal business case structure
Introduction/ • Overview of the business need
background • Priority of the need or issue (eg using Kraljic analysis)
• The current situation
Options • Options considered (if any), with reasons for rejecting or carrying forward each
option
Business benefits • Expected outcomes of the proposed solution, and their associated business
benefits
• Alignment of the proposed solution with business objectives, strategies, policies
and values
Costs and risks • Estimated costs of the proposed solution
• Anticipated risks of the proposed solution
• Anticipated impacts on activities and relationships
• Anticipated risks and costs of not pursuing the proposed solution (or doing
nothing)
Recommendation • Net (on-balance) cost/benefit assessment
• Return on investment or payback period (if data is available)
KPIs (if data is • Target costs and results which will be used to evaluate performance
available)
Elements of a comprehensive
formal business case
• Executive summary
• Reference
• Context
• Value proposition
• Scope
• Deliverables
• Impacts
• Work planning
• Resource requirements
• Risk management and contingency plans
• Commitments
Business benefits
• Fulfilment of a specific business objective
• Increased revenues
• Reduced costs
• Enhanced profitability
• Enhanced value for money
• Enhanced shareholder value
• Competitive advantage
• Leverage of key resources
• Increased capacity, capability or flexibility
• Improved brand or reputational equity
Specimen cost benefit analysis
Costs £
Computer equipment:
8 PCs @ £1,000 8,000
  1 server @ £1,200 1,200
  2 printers @ £400  800
  Installation and technical support 1,800
  Purchasing management software 3,200
Staff training:
  Introductory computing (6 people × £200) 1,200
  Purchasing management system (8 people × £400) 3,200
Other costs:
Lost time (20 person days @ £100 per day) 2,000
  Cost of errors/wastage through initial inefficiencies (estimate) 5,000
Total cost 26,400
Benefits (estimate, per year) £
Improved efficiency of ordering and expediting 20,000
Improved supplier selection and management 10,000
Improved planning and control through supply information 15,000
Total benefit (per year) 45,000

Benefit/cost ratio: 45,000/26,400 = 1.70 (positive)

Payback time: 26,400/45,000 = 0.59 year = approximately 7 months
The lease or buy decision
ADVANTAGES OF OUTRIGHT PURCHASE DISADVANTAGES OF OUTRIGHT PURCHASE
Total cost is low, compared to rental High initial expenditure ties up capital
The user has total control over the use of the asset User bears all costs and risks of maintenance,
operation and disposal
The asset may have residual re-sale value at the end Risk of technological obsolescence
of use
Capital allowances may be set against tax, and Wasteful, if equipment is needed only for a short
government grants may be available period (eg a particular project)
ADVANTAGES OF LEASING DISADVANTAGES OF LEASING
No initial investment to tie up capital Long-term commitment to pay instalments
Protects against technological obsolescence User does not have total control of asset
Costs are known and agreed in advance Total cost may be higher than purchase
Fewer complex tax and depreciation calculations Large organisations may get better terms by securing
their own finance to purchase (benefiting from capital
allowances)
Hedge against inflation, as payments are made in Contract terms may favour the lessor (eg limitations to
‘real’ money terms use, liability for risks and costs)
Links between corporate and
purchasing objectives
BUSINESS OBJECTIVES PURCHASING OBJECTIVES
Maintain or increase market share Provide supplies to match customer needs; assure
quality; reduce delivery lead time; reduce cost
Improve profits, cashflow, and return on capital Reduce stocks; improve reliability; more frequent
deliveries
Shorten time to market Early supplier involvement
Eliminate non-core activities Develop effective make-or-buy policy; integrate
purchasing and capacity planning
Introduce continuous improvement Reduce supplier base; partnership approaches;
reduce product complexity; increase accuracy and
reliability
Become world class supplier Work with suppliers to establish world class
standards; improve flexibility of response to
market conditions; liaison with technological
sources
Alignment with tactical objectives
and timescales
For a business case to be made, the proposal must, for
example:
• Secure supply within the timescales required by wider
production, marketing or project plans
• Secure adequate levels of performance and process control
within the timescales required by wider organisational and
project plans
• Be feasible within existing resource constraints
• Be capable of fulfilling agreed specifications and achieving
agreed objectives, standards, targets and KPIs
Market data on costs and prices
• Price is what a seller charges for a package of
benefits offered to a buyer.
• Cost is what the buying organisation pays to acquire
the goods or services purchased. This may be much
more than just the purchase price paid to the seller.
Primary sources of market data on
costs and prices
• Communication with suppliers
• The buyer’s database of market data
• The marketing communications of suppliers
• Online market exchanges, auction sites and forums
• Advisory and information services
• Trade fairs, exhibitions and conferences
• Informal networking and information exchange
Secondary sources of market data
on costs and prices
• Financial and trade or industry press
• Published economic indices
• Published and online market analysis
• Published statistical surveys compiled by the
government
• Price listing and price comparison websites
Factors in supplier pricing decisions
External factors Internal factors
• Prices charged by competitors • Costs of production and sales
• Extent of competition (market structure) • How badly the supplier needs the
• The nature of competition in the market business
• Market conditions • Risk management
• Customer perceptions of value • How attractive a particular customer is
• Price elasticity of demand • Financial position and product portfolio
• What a particular (desirable, powerful) • Where the product is in its ‘lifecycle’
customer is prepared to pay • Shareholders’ expectations and
• Environmental factors affecting the cost managerial objectives in regard to profit
of raw materials margins
• Environmental factors affecting demand • The strategic objectives of the
and affordability organisation
Supplier pricing strategies
Cost-based pricing
• Full-cost pricing (total costs + mark up)
• Cost-plus or mark-up pricing (amount to cover direct costs)
• Marginal pricing (achieves predetermined profit)
• Rate of return or ‘target return’ pricing (aims to achieve
desired return on investment)
• Contribution pricing (aims to cover variable costs to keep the
plant running)
Supplier pricing strategies
Market-driven pricing
• Price volume (volume discounts as incentives)
• Market share pricing (or penetration pricing):
• Market skimming (premium pricing to cover costs early then
price is lowered later,new product at early stage
• Current revenue pricing (or contribution pricing)
• Promotional pricing (aims to clear product, increase sales etc.
• Market segment pricing (also called differential pricing or price
discrimination)
• Competition pricing (or dynamic pricing)
Components of the cost base
• Raw materials (and/or components, subassemblies
and consumables)
• Labour
• Overheads
Total costs
Fixed and variable costs
Lifecycle costing
Total cost of ownership includes not just the price of the
items being purchased, but also:
• Various transaction costs
• Finance costs
• Acquisition costs
• Operating costs
• Costs of storage and other handling, assembly or finishing
required
• Costs of quality
• End of life costs
The price-cost iceberg
Benefits and limitations of WLC
Benefits Limitations
• Enabling the fair (like-with-like) • It is not an exact science, and future
comparison of competing options cost estimates are subjective
• Enabling realistic budgeting over the • Many costs are incurred through the
life of the asset life of a product or asset, and not all
• Highlighting, at an early stage, risks of these will be easy to forecast
associated with the purchase • A wide range of intervening factors
• Promoting cross-functional may affect costs over the lifecycle of
communication on cost and asset a product or asset
management issues, and improving • A systematic WLC exercise can be
awareness of total costs time-consuming, labour-intensive
• Supporting the optimisation of value and costly
for money
Statistical forecasting techniques
• Simple moving average
• Weighted average (or exponential smoothing)
• Time series (trend) analysis
• Regression analysis
Estimating or predicting costs
• What are the direct or variable costs of sales?
• What are the indirect or fixed costs or overheads?
• Premises costs
• Labour and staff costs
• Utilities
• Printing, postage and stationery
• Equipment costs
• Fleet and vehicle costs
• Advertising, promotion and sales activities
• Financing costs
• Legal and professional costs (including insurance)
• What are the one-off capital costs for the period or project?
Objectives of preparing a budget
• To express organisational objectives as operational targets
• To communicate plans and targets to stakeholders
• To motivate people to attain performance and cost targets
• To motivate managers to identify risks and problems
• To measure unit or project performance
• To help evaluate managerial performance
• To pre-authorise estimated levels of expenditure for
procurement activities
• To co-ordinate operations
• To control procurement activities and costs
Corporate budget preparation
Types of budget
•Incremental budget
•Zero-based budget
•Rolling budget
•Fixed budget
•Flexible
Note the ones in red are added from the Assessor
Report of D2 Nov 13
Actual income entries
• Entering actual income or revenue figures against
estimates
• Analysing the reasons for lower than expected
turnover
• Analysing the reasons for higher than expected
turnover
• Taking action to prevent further shortfalls, or revising
the budget to reflect more realistic expectations
Actual cost entries
• Entering actual costs or expenditures as they occur
against the budgeted amounts
• Analysing how fixed costs differed from the budgeted
amount
• Verifying that variable costs were in line with the budget
• Analysing any reasons for changes in the relationship
between costs and turnover
• Analysing any differences in the timing of actual and
budgeted expenditures
Operating the cash budget
• Forecast sales
• Forecast the time-lag on converting debtors to cash
• Determine purchase requirements
• Forecast the time-lag on paying suppliers
• Incorporate other cash payments and receipts
• Collate this information so as to find the net
cashflows
Cash outflows
• Purchases
• Staff salaries or wages and benefits, rents and daily
operating expenses
• VAT, National Insurance contributions, corporation
tax and similar payments
• Loan repayments
The role of a specification
• To define the requirement
• To communicate the requirement
• To provide a means of evaluating the quality or
conformance of the goods or services supplied
Drawing up specifications
Product • Performance objectives: functionality, outputs, outcomes
• Process needs and input parameters
• Features
• Aesthetics
• Compatibility
• Reliability
• Durability
• Maintainability
• Ease of use
Price • Purchase price
• Life time costs (maintenance, operating, disposal)
Quantity • One-off or scheduled on going requirement
• Forecast demand: supplier production and delivery capacity to supply
Quality • Desired level of quality
• Acceptable tolerances (range of variance)
Timing • Time-phased requirements (daily, weekly or monthly schedule)
• Acceptable tolerances (range of variance)
Place • Delivery address(es)
• Delivery requirements (e.g breaking of bulk, or consolidation)
• Packaging requirements
• Transport requirements (mode preference, special conditions)
Zero defects
• Specifications
• Supplier pre-qualification, selection and appraisal
• Quality control
• Costs
• The buyer’s quality management
Advantages of using specifications
• The process of drawing up specifications is a useful
discipline
• If items are to be purchased from more than one
source, the use of conformance specifications may be
essential to ensure uniformity
• Specifications provide useful criteria for measuring
the quality and acceptability of purchases once
delivered
• Specifications provide evidence, in the event of a
dispute, as to what the purchaser required
Disadvantages of using specifications
• Detailed specification is an expensive and time
consuming process
• The costs of inspection and quality control are
greater for complex specifications than if simple
specification is used
• Specifications can become too firmly embedded
• Specifications can create a temptation to over-
specify, adding cost and increasing stock
variation and proliferation
Types of specification
Conformance specification Performance specification
The buyer details exactly what the The buyer describes: what it expects a
required product, part or material part or material to be able to achieve,
must consist of. This may take the in terms of the functions it will
form of an engineering drawing or perform and the level of performance
blueprint, a chemical formula or it should reach; or what outputs or
‘recipe’ of ingredients, or a sample of outcomes (results) it expects to be
the product to be duplicated, for delivered by a service. It is up to the
example. The supplier may not know supplier to furnish a product or service
in detail, or even at all, what function which will satisfy these requirements:
the product will play in the buyer’s the buyer specifies the ‘ends’, and the
operations. The supplier’s task is supplier has relative flexibility as to
simply to conform to the description ‘means’ of achieving those ends.
provided by the buyer.
Technical or design specifications
• The scope of the specification (its objectives and content)
• Definitions: explanation of any technical or specialised terms used
• The purpose of the equipment or material that is the subject of the
specification
• Reference to any related documents (such as standards or legislation)
which apply
• Materials requirements, properties, tolerances and permissible variability
• Desired appearance, texture and finish requirements of the finished
product
• Drawings, samples or models of the required product (where available)
• Conditions under which the item or material is to be installed, used,
manufactured or stored
• Maintenance and reliability requirements
• Specification of packaging and protection
• Information to be provided by the supplier for users
Types of conformance
specifications
• Technical or design specifications
• Specification by chemical or physical properties
• Specification by brand
• Specification by sample
• Specification by market grade
• Specification by standards
Performance specifications
A performance specification would typically include:
• The functionality, performance, capabilities, outputs or outcomes to be
achieved, within specified tolerances
• The key process inputs which will contribute to performance
• The operating environment and conditions in which the performance is to
be achieved (and extreme or unusual conditions in which it is not
expected)
• How the product is required to interface with other elements of the
process
• Required quality levels (including any relevant standards)
• Required health and safety levels and controls
• Required environmental performance levels and controls
• Criteria and methods to be used to measure whether the desired function,
performance or outcomes have been achieved
Developing specifications
ITEM CONTENT
Identification Title, reference number, authority, designation, issue number and date
Circulation Distribution list of the specification
Contents List of parts, clauses, illustrations and annexes
Foreword Reasons for writing the specification
Introduction Summary of the business need and technical aspects of objectives
Scope Range of objectives and content
Definitions Terms used with special meanings in the text
Main body of the Requirements, guidance and methods
specification
Annexes Additional detailed technical information and examples
Index Alphabetical index
Bibliography Details of internal and external standards and publications referred to in
the specification
Specifying a service
The ‘Triple Bottom Line’ concept
• Economic sustainability (Profit)
• Environmental sustainability (Planet)
• Social sustainability (People)
Types of specification by industry
sector
TYPE OF SPECIFICATION SECTORS IN WHICH COMMONLY USED
Blueprint/design Engineering, projects, construction
Brand name Small businesses, consumers
Sample Textiles, commodities
Market grade Commodity trades
Standards Engineering, manufacturing
Performance/functional Manufacturing, electronics and most sectors
Chemical/physical properties Chemical engineering, engineering, construction
Outcome Services, projects
Outputs IT, consultancy and projects
Drafting specifications
An effective specification is one that is:
• Clear and unambiguous as to what is required
• Concise
• Comprehensive
• Compliant with all relevant standards, and health, safety
and environmental laws and regulations
• Up-to-date
• Expressed in terms which can be understood by all key
stakeholders
• Value-analysed
Cross-functional contributions to
specification
The contribution of procurement professionals:
• Supply market awareness
• Supplier contacts
• Awareness of commercial aspects of purchases
• Awareness of legal aspects of purchases
• Purchasing disciplines
Approaches to specification
development
• Early buyer involvement (EBI)
• Formal committee approach
• Early Supplier involvement (ESI)
• Informal approach
• Purchasing co-ordinator approach
The buyer’s role in specification
• Understanding the needs of users
• Liaising with users
• Minimising tolerances
• Understanding the legal implications of specification
Purchasing experts may provide
the following contributions:
• Input to make/do or buy decisions
• Policy formulation for supplier involvement and internal purchasing
• Monitoring of supply markets
• Pre-selection of suppliers
• Supplier relationship management
• Ordering and expediting of samples and prototypes from suppliers
• Information on new products and technologies
• Suggestion of alternative suppliers, products or technologies
• Evaluation of product designs
• Promotion of standardisation, variety reduction and simplification
Technical requirements
• Intended function or performance
• Conditions under which the product or service will be
required to operate, be transported, handled and stored
• Measures of quality and performance
• Tolerances for reliability, quality, dimension, strength and
other key properties
• Features: texture, colour, aesthetics, finishing and other
external properties
• Durability and serviceability
• Information provided with the product or service
Company policy
The buying organisation may have a wide range of
policies embracing areas such as:
• Its intention to comply with all relevant laws, regulations,
standards, codes of practice and best practice benchmarks
• Its aspirations for environmental sourcing and manufacture
• Its aspirations for corporate social responsibility and ethical
trading
• Sourcing policies
• Quality, cost and pricing policies
Standardisation
Standardisation is a voluntary process, based on
consensus among different stakeholders such as:
• National and international standardisation organisations, led
globally by the International Standards Organisation (ISO)
• National public authorities
• Industry and business associations, including representatives
of SMEs
• Non-governmental organisations (NGOs)
• Scientific and academic organisations
Unnecessary stock proliferation
• Unnecessary stockholding and handling costs, as
additional variants are stocked
• Unnecessary specification costs and transaction costs
• Multiple small orders of variant items
• The risk of lower quality
• The risk of waste
Benefits of standardisation
• Specification
• Purchasing
• Transport
• Inventory
• Quality management
Environmental criteria
• Location in relation to the buyer and lower tiers of supply
• The use of less, and ‘greener’, materials and packaging
• ‘Green’ design and innovation capability; reverse logistics
and recycling capability; and so on
• The development and enforcement of strong
environmental policies
• Robust environmental management systems
• Compliance with environmental protection and emissions
law and regulation in the country of operation
CSR and social sustainability
criteria
• The development of robust CSR policies and ethical codes
• Location in relation to the buyer
• Evidence of responsible and ethical labour policies and practices
• Evidence of, and commitment to, conformance to relevant
legislation and regulations
• Compliance with International Labour Organisation standards
• Evidence of ethical trading policies and practices
• Compliance with Fair Trade standards, or membership of the Ethical
Trading Initiative
• Commitment to transparency and improvement, in collaboration
with the buyer
The UK waste hierarchy
Reduce • Ensure products are definitely needed
• Ensure products are fit for purpose to avoid wasteful mistakes
• Ensure products are durable and covered by a long warranty
• Ensure packaging is the minimum necessary for protection
• Avoid disposable products designed for single use
Re-use • Check for redundant equipment that could be redeployed
• Specify goods that are repairable and easily upgraded
• Specify goods with clear and comprehensive maintenance, repair and operating instructions,
supported with guaranteed stocks of parts
• Give preference to suppliers that operate take-back schemes for end of life equipment and
packaging
Recycle • Specify products made from recovered or recyclable materials
• Purchase products on which the materials are identified for ease of recycling
• Minimise mixed-material products which are more difficult to recycle
Rethink • Re-evaluate precedents and assumptions
• Consider and evaluate options and alternatives
• Consider consortium buying, if required, to gain sufficient buying power to promote
sustainable performance among suppliers.
Sustainable specification across
sectors and industries
• Vehicles Fuel efficiency
• Paper Recycled, chlorine-free, sustainable forestry
management
• Office Energy efficient, clean manufacturing processes,
equipment safety, end-of-life take-back
• Energy Renewable
• Food and Organic, fresh or seasonal, hygienic processes,
beverage minimised packaging, sustainable water
management
What is information assurance?
• Corporate governance: regulatory standards
compliance, internal controls and auditing in regard
to data protection, IT systems and fraud prevention
• Contingency, business continuity and disaster
recovery planning in relation to key systems risks
• Strategic development and management of IT
systems to fulfil the current and future needs of the
organisation (and supply chain)
Information-related risks
• Risks to the organisation’s intellectual capital
• Risks to the integrity and security of data
• Risks to the integrity and value of specification data
• Risks and inefficiencies in the design and implementation of
management information systems, specifications databases,
inventory systems, extranets and other relevant systems
• Turnover of key personnel and loss of their intellectual
property and/or knowledge of the organisation’s procurement
needs, supply market, stock or technical specifications
• Loss of organisational knowledge, information and capabilities
What is performance
measurement?
Supplier performance measurement is the assessment and
comparison of a supplier’s current performance against:
• Defined performance criteria
• Previous performance
• The performance of other comparable organisations (eg other
suppliers) or standard benchmarks
Quantitative and qualitative
measures: characteristics
QUANTITATIVE MEASURES QUALITATIVE MEASURES
Easier to establish KPIs KPIs likely to be subjective
Easier to monitor over time Monitoring over time is subjective
Focus on efficiency Focus on effectiveness
Particularly suitable for purchase of Particularly suitable for purchase of
products services
Examples include prices, delivery Examples include management
performance, financial performance, capability, staff issues, technological
reject rates development, willingness to
collaborate closely
SMART performance measures
With the possible addition or
substitution of:
• Specific • Stretching
• Measurable • Sustainable (or Responsible)
• Attainable • Agreed
• Relevant • Rewarded
• Time-bounded • Reviewed
Developing key performance
indicators
Four types of benchmarking:
• Internal benchmarking
• Competitor benchmarking
• Functional benchmarking
• Generic benchmarking
The benchmarking process
Supplier scorecard
FACTOR WEIGHTING MAXIMUM MEASUREMENT CRITERION
(%) SCORE
Quality conformance (0.7)
Quality  30 1.50
Reject frequency (0.3)
Delivery  25 1.25 On-time-in-full delivery (1.0)
Quality management systems,
Support systems  15 0.75
eg ISO 9000 (1.0)
Cost savings (0.7)
Commercial  30 1.50
After-sales support (0.3)
Total 100 5.00
Weighted points system
FACTORS MAXIMUM RATING SUPPLIER SCORE
(WEIGHT)
Technical:
 Understanding of problem 10  9
 Technical approach 20 19
 Production facilities  5  4
 Operator requirements  3  2
 Maintenance requirements  2 2
Totals      40      36
Ability to meet schedule      20      20
Price      20      16
Managerial, financial and technical
capability      10      10
Quality management processes      10       9
RATING TOTAL     100      91
Supplier performance measures at
different levels
STRATEGIC LEVEL TACTICAL LEVEL OPERATIONAL LEVEL
• Lead time against • Efficiency of purchase • Delivery performance
industry norm order cycle times (OTIF – on-time-in-full)
• Quality status and • Booking in procedures • Quality conformance;
aspirations • Cashflow management service level
• Cost saving initiatives • Quality assurance agreements
and potential methodologies • Responsiveness
• Supplier pricing • Capacity flexibility • Technical support level
against market prices • Future growth potential
• Risk assessment and
compliance
KPIs as statements of
performance
PERFORMANCE PERFORMANCE INDICATOR
CRITERION
Quality Management systems and processes are clear and
documented
Cost management Consumable purchasing rates are benchmarked for value
for money
Timeliness Service is delivered within the agreed periods of availability
Quantity Stocks are maintained to appropriate levels to ensure
continuity of service
Compliance Corporate policies and procedures are adhered to
Measures of quality
• Performance
• Features
• Reliability
• Durability
• Conformance
• Serviceability
• Aesthetics
• Perceived quality
Benefits of effective SLAs
• The clear identification of customers and providers, in relation to specific services
• The focusing of attention on what services actually involve and achieve
• Identification of the real service requirements of the customer, and potential for
costs to be reduced by cutting services or levels of service that (a) are unnecessary
and (b) do not add value
• Better customer awareness of what services they receive, what they are entitled to
expect, and what additional services or levels of service a provider can offer
• Better customer awareness of what a service or level of service costs, for realistic
cost-benefit evaluation
• Support for the ongoing monitoring and periodic review of services and service
levels
• Support for problem solving and improvement planning
• The fostering of better understanding and trust between providers and customers
Contents of an SLA
• What services are included
• Standards or levels of service expected from the provider
• Other expectations of the supplier
• The allocation of responsibility for activities, risks and costs
• How services and service levels will be monitored and
reviewed, what measures of evaluation will be used, and how
problems (if any) will be addressed
• How complaints and disputes will be managed
• When and how the agreement will be reviewed and revised
Developing and implementing SLAs
General examples of purchasing
service KPIs
• Number of complaints made to purchasing by internal
customers, external customers or suppliers (and found to have
merit)
• Number or proportion of supply orders delivered on-time-in-
full and of specified quality
• Number of stockouts reported
• Value of cost reductions or savings achieved per period
• Number of projects completed to customer satisfaction
• Lead times to fulfil the purchase cycle
• Qualitative assessments of desired values
What is a contract?
A contract is basically a statement of:
• Exactly what two or more parties have agreed to do or
exchange
• Conditions and contingencies which may alter the
arrangement
• The rights of each party if the other fails to do what it has
agreed to do
• How responsibility or ‘liability’ will be apportioned in the
event of problems
• How any disputes will be resolved
Implied terms
Terms may be implied into a contract by virtue of:
• The nature of the contract
• The need for business efficacy
• Statute law
• Custom of the trade
General contract structure
The agreement Names and signatures of the parties to the contract
Definitions Definition of names and terms, to avoid repetition of long sentences in the
body of the contract.
General terms • General agreements clause
• Changes, alterations and variations clause
• Notice clause: how and by what method any notice relating to the
contract is to be sent
Commercial Rights and obligations of the supplier and of the purchaser. Standard terms
provisions of purchase, for example, might include:
•Passing of title/ownership
•Time of performance
•Inspection/testing
•Delivery/packing
•Assignment
•Liability for damage or loss in transit
•Rejection
•Payment terms
General contract structure (cont.)
Secondary • Confidentiality and intellectual property protection (where relevant)
commercial • Indemnity
provisions • Guarantee clause
• Termination
• Arbitration
Standard clauses These may include:
•Waiver
•Force majeure
•Law and jurisdiction
Model form contracts
• CIPS has published a range of model form contracts and contract
clauses
• The Freight Transport Association has developed a model form of
conditions of carriage, for carriage of goods by road in the UK
• The Chartered Institute of Building has developed a model form
contract for the commissioning of facilities management services
• The Joint Contracts Tribunal (JCT) publishes a Standard Form of
Building Contract
• The Institute of Civil Engineers (ICE), the Association of
Consulting Engineers and the Federation of Civil Engineering
Contractors issue standard forms for civil engineering
Advantages and disadvantages of
model form contracts
ADVANTAGES DISADVANTAGES
Helps reduce time and costs of Terms may not be as advantageous to
contract development a powerful buyer as if contract was
negotiated
Avoids ‘reinventing the wheel’ Terms may not include special clauses
Industry model forms are widely Legal advice is still required if
accepted significant amendments or variations
are to be made
Designed to be fair to both parties Costs of training buyers to use model
forms
Interpreting key terms
• What type of clause they are and what they are
designed to achieve
• The legal and operational effects or implications of
the clause for the buyer and the supplier
• Whether the example clause, as given, expresses the
buyer’s requirements (and best interests) clearly
A breach of contract occurs:
• When a party fails to perform an obligation under the
contract: is in breach of a condition; improperly
repudiates (ends) the contract; or prevents completion of
the contract on his own side or by the other party, during
performance. These are examples of ‘actual breach’.
• When, before the time fixed to perform an obligation, a
party expressly or by implication repudiates the
obligations imposed on him by the contract: ie shows an
intention not to perform. This is called ‘anticipatory
breach’.
Examples of ‘frustration’
• Destruction of the contract subject matter
• Non-occurrence of the event on which the contract
was based
• Incapacity to provide personal performance
• Extensive interruption which makes further execution
of the contract impracticable or different from that
originally agreed
Insurances
• Employer’s liability insurance
• Public liability insurance
• Professional indemnity insurance
• Product liability insurance
Ethical sourcing and supply
• The promotion of fair, open and transparent competition in sourcing
• The use of sourcing policies to promote positive socio-economic goals
• The specification and sourcing of ethically produced inputs
• The selection, management and development of suppliers in such a
way as to promote ethical trading, environmental responsibility and
labour standards at all tiers of the supply chain
• A commitment to supporting the improvement of working terms and
conditions throughout the supply chain
• A commitment to supporting sustainable profit-taking by suppliers
• Adherence to the ethical frameworks and codes of conduct of relevant
bodies
• A commitment to compliance with all relevant laws and regulations for
consumer, supplier and worker protection
What is the ‘right price’?
The ‘right price’ for the supplier or seller to charge
(the sales price) will be:
• A price which ‘the market will bear’
• A price which allows the seller to win business, in competition
with other suppliers
• A price which allows the seller at least to cover its costs, and
ideally to make a healthy profit
What is the ‘right price’?
The ‘right price’ for the buyer to pay
(the purchasing price) will be:
• A price which the purchaser can afford
• A price which appears fair and reasonable, or represents value
for money, for the total package of benefits being purchased
• A price which gives the purchaser a cost or quality advantage
• A price which reflects sound purchasing practices
Pricing arrangements (showing
risks to the buyer)
Reasons for cost/price variations
• Under-estimation of costs at the forecasting stage
• Price inflation, escalating materials costs
• Wage inflation, escalating labour costs
• Commodity and energy price fluctuations
• Exchange rate fluctuations
• Overtime or incentive payments required to ‘crash’ the
schedule
• Failure costs incurred by unforeseen quality problems
• Changes in the scope of the contract
• Unforeseen contingencies
Indexation and price adjustment
formulae
The calculation of average changes in the price or cost of an
item or group of items over a period of time can be used to:
• Estimate the current average prices or costs of a product, by
using price/cost data for similar items at a previous ‘base’ date
• Eliminate the effects of inflation or deflation when analysing
price and cost trends
• Allow for currency fluctuations
• Compare the cost performance of different suppliers
• Identify and define average price/cost changes
Cost-plus pricing
• A cost plus fixed fee (CPFF) contract includes
payment of allowed costs plus a pre-determined fixed
amount, as the fee for doing the work
• A cost plus incentive fee (CPIF) contract includes
payment of allowed costs plus a higher fee for
meeting or exceeding performance or cost targets or
KPIs
• A cost plus award fee (CPAF) contract includes
payment of allowed costs plus a fee (bonus) based on
the contractor’s performance
Alternative arrangements
• Cost without fee, for non-profit-making providers
• Cost sharing, where the supplier stands to benefit
from its own work
• Time and materials, for contracts (such as repair
services) where the precise work to be done cannot
be predicted in advance
Target cost with maximum price
Target price: £10 (including £1 profit)
Ceiling price: £12 (no profit)
Cost savings: shared in the ratio 80: 20
(supplier: purchaser)

Cost (£) Profit (£) Price (£)

11.00 – 11.00
10.00 1.00 10.80
9.00 2.00 10.60
8.00 3.00 10.40
Target cost without maximum price
Target cost per item: £10 (plus £1 profit)
Cost variations above or below this target cost to be
shared in the ratio 50: 50 (supplier: purchaser)
Cost (£) Profit (£) Price (£)
10.00 (target) 1.00 11.00
11.00 1.00 11.50
9.50 1.50 10.75
Payment methods
• Payment in advance (or payment with order)
• Payment on delivery
• Open account or credit
Statutory remedies for an unpaid
seller
An unpaid seller’s remedies against the goods include:
• The right of seller’s lien (ss 41–43 SGA 1979)
• The right of stoppage in transit (ss 45–46)
• The right of resale (s 48)
Factors in make/do or buy
decisions
FACTORS SUPPORTING MAKING/DOING FACTORS SUPPORTING BUYING IN
Opportunity to extract value from otherwise Quantities required are too small for
idle capacity and resources economic production
Potential for lead time reduction Avoid costs of specialist machinery and
labour
Cost of work is known in advance Reduced inventory costs
Desire to exert direct control over Financial risk shared with supply chain
production and/or quality
Protection of confidentiality and intellectual Access to contractor’s specialist research,
property expertise, technology, patents, designs and
so on
Less supply risk and supplier risk Augmented production capacity
Desire to maintain a stable workforce Desire to maintain a stable workforce
Supply chain management
• ‘The management of upstream and downstream
relationships with suppliers and customers to deliver
superior customer value at less cost to the supply chain
as a whole’ (Christopher)
• ‘The integration and management of supply chain
organisations and activities through co-operative
organisational relationships, effective business processes,
and high levels of information sharing to create high-
performing value systems that provide member
organisations a sustainable competitive advantage’
(Handfield & Nichols)
Terminology
DEFINITION EXPLANATION
A service contract is a supply contract concerned with Company A wishes to purchase a service, and enters
sourcing a service rather than a tangible product. into a contract with a selected supplier (Company B)
to have the service performed on agreed terms.
Subcontracting is the use of an outside organisation Company A contracts Company B (the main
to do work that the buying organisation cannot do contractor) to perform certain work, such as cleaning
itself, because of a temporary shortage of resources services. Company B lacks capacity to perform all the
or lack of capacity. work itself. In order to meet Company A’s
requirements, B subcontracts some of the work to
Company C, if permitted to do so by its contract with
Company A.
Outsourcing is the strategic contracting out of major The outsourcer (Company A) will draw up a long-term
work, previously carried out in-house, to an external contract specifying the work to be performed and the
service provider. service levels to be achieved by an outsource provider
(Company B). The outsourcer retains responsibility for
satisfactory completion of the work, but delegates all
day-to-day operations to the outsource provider.
Insourcing is the opposite of outsourcing. The organisation previously outsourced the work, but
now decides to bring it in-house.
Managed services in the
construction industry
Drivers for outsourcing
• Quality drivers
• Cost drivers
• Business focus drivers
• Financial drivers
• Relationship drivers
• Human resource drivers
Advantages of outsourcing
Supports organisational rationalisation and downsizing
Allows focused investment of managerial, staff and other resources on the organisation’s
core activities and competencies
Accesses and leverages the specialist expertise, technology and resources of contractors
Access to economies of scale
Adds competitive performance incentives
Leverages collaborative supply relationships, and can support synergies (2 + 2 = 5)
Cost certainty for activities where demand and costs are uncertain or fluctuating
Disadvantages of outsourcing
Potentially higher cost of services (including contractor profit margin), contracting and
management
Difficulty of ensuring service quality and consistency and corporate social responsibility
Potential loss of in-house expertise, knowledge, contacts or technologies in the service
area
Potential loss of control over key areas of performance and risk: over-dependence on
suppliers
Added distance from the customer or end-user, by having an intermediary service provider
Risks of ‘lock in’ to an incompatible or under-performing relationship: cultural or ethical
incompatibility; relationship management difficulties; contractor inflexibility, conflict of
interest, complacency or loss of client focus
Risks of loss of control over confidential data and intellectual property
Ethical and employee relations issues of transfer or cessation of activities
Potential risks, costs and difficulties of in-sourcing if the outsource arrangement fails
Why does it go wrong?
• The organisation fails to distinguish correctly between core and non-
core activities
• The organisation fails to identify and select a suitable supplier
• The organisation has unrealistic expectations of the outsource
provider
• The outsourcing contract contains inadequate or inappropriate
terms and conditions
• The contract does not contain well defined key performance
indicators or service levels
• The organisation lacks management skills to control supplier
performance and relationships
• The organisation gradually surrenders control of performance to the
contractor
Key sourcing issues
• The need for the outsource decision to be based on clear
objectives and measurable benefits, with a rigorous cost-
benefit analysis
• The need for rigorous supplier selection
• Rigorous supplier contracting
• Clear and agreed service levels, standards and key
performance indicators
• Consistent and rigorous monitoring of service delivery and
quality
• Ongoing contract and supplier management
• Contract review
Advantages of internal supply
• The transaction costs are low
• The relationship between ‘customer’ and ‘supplier’ is
likely to be long-term and stable
• There is (usually) no profit motive within the internal
supplier
• Customer and supplier are part of the same
organisation, meaning that they should share the
same culture and values
Competencies and contractor
competence
When procurement should be
outsourced
CIRCUMSTANCES WHAT ACTIVITIES TO OUTSOURCE
Procurement (or ‘purchasing’) is a peripheral • Purchase orders
rather than a core activity (low or generalised • Locally and nationally procured needs
skill requirements, internally focused • Low-value acquisitions
responsibilities, well-defined or limited tasks, • Brand name requirements
jobs that are easily separated from other tasks) • Call-offs against framework agreements
• Administration and paperwork associated
with purchasing needs
The supply base is small and based on proven • Well-defined or limited tasks
cooperation, and there are no supply • Jobs that are easily separated from other
restrictions tasks
• Jobs that have no supply restrictions
The supplier base is small, providing non- • Outsource purchasing to specialist
strategic, non-critical, low-risk items purchasing and supplier organisations, or to
buying consortia
The business case for outsourcing
The main criteria for making a business case for any
procurement proposal are:
• Costs and benefits
• Evaluation of options
• Alignment with organisational needs and timescales
Operational arguments for
outsourcing
• The outsourcer may be unable to keep up with the
pace of technological change in a particular activity
• The outsourcer may simply lack capability or capacity
to perform the activity competitively
• The outsourcer may be able to transfer the resources
used to make/do to another activity which will save
cost or increase revenue
Consideration of options
• Produce the goods or services in-house (if this can be
done competitively)
• License the technology or designs to external producers,
to make or deliver under licence or franchise
• Buy from a qualified external supplier
• Establish a joint development project with another
organisation
• Enter a long-term development or supply partnership
• Acquire a world-class supplier (backward integration)
The outsource procurement process
The outsource procurement process
The ‘10 Cs’ model
• Competence (or capability)
• Capacity
• Commitment
• Control
• Cash
• Consistency
• Cost
• Compatibility
• Compliance
• Communication
Post-contract management
• There will be obligations and actions to be followed up on either
side
• If risk events or contingencies arise, the contract may (or may not)
lay down how they should be handled
• If the outsource supplier shows signs of struggling to conform with
contract requirements, agreed standards or service levels, remedial
or corrective action may have to be taken
• If performance fails to conform to agreed terms and standards,
there will be a variety of options for pursuing and escalating the
dispute, enforcing the terms of the contract or gaining remedies
• Circumstances and requirements will often change over the life of a
long-term services contract, and terms may have to be re-
negotiated, agreed and amended accordingly
Key elements of contract
management
• Contract development
• Contract communication
• Contract administration
• Managing contract performance
• Relationship management
• Contract renewal or termination
Transfer of assets
Contract terms should clearly establish:
• The value (or valuation) of assets transferred to the outsource
provider, and how depreciation or appreciation in value will be dealt
with
• Arrangements for the return to the outsourcer, or other disposal, of
assets transferred to the outsource provider, upon termination of
contract
• Arrangements for the return of files, data and proprietary
information to the outsourcer, upon termination of contract
• Ownership of assets developed or created in performance of the
contract
• Responsibilities for insurance, maintenance and management of the
assets
Employment terms of transferred
staff
Express provisions should be made for the disposal of
existing staff providing the service:
• Establishing any undertaking by the outsource provider to
adopt the contracts of existing staff
• Reminding both parties of their obligations under the Transfer
of Undertakings (Protection of Employment) Regulations 2006
(TUPE)
Performance management clauses
• A rights of inspection clause
• A schedule performance clause
• Penalties for specific non-performance, and
incentives for performance or improvements
Transfer of employment contracts
• The new employers must take over the contracts of employment of all
employees
• They cannot dismiss employees because of the transfer unless there is a sound
economic, technical or organisational (ETO) reason entailing changes in the
workforce
• If a dismissal on ETO grounds takes place immediately before the transfer, any
liability remains with the transferor
• The new employers take over and are bound to honour all rights and
obligations arising from the employment contracts, except some provisions for
old age and invalidity, and the pre-existing debts to employees of an insolvent
transferor
• The Regulations provide some freedom for either party to agree variations to
contracts of employment before or after a transfer, where the sole or principal
reason for the variation is a reason unconnected with the transfer, or a reason
connected with the transfer which is an ‘economic, technical or organisational
(ETO) reason entailing changes in the workforce’
Consultation and notification
The Trades Union and Labour Relations (Consolidation) Act
1992 (TULCRA) places a duty upon the employer to consult
with representatives of employees to be affected by
redundancy. The consultation must include such matters as:
• Reasons for the proposed redundancies
• Number of employees involved
• Proposed methods of selecting those to be made redundant
• Timing of the dismissals
• Ways of avoiding redundancy
Alternatives to compulsory
redundancy
• Natural waste
• Retraining or relocation and redeployment of staff
• Loaning or seconding staff to other units or
organisations with labour or skill shortages
• Incentives to take voluntary redundancy or early
retirement
• Revised working arrangements
Contractual provisions for review
and non-renewal
Provisions for renewal of contract may include:
• The initial duration of the contract
• The availability of an extension period, if any
• Criteria for qualifying for extension
• Procedures for terminating the contract
• Procedures for handing over to a new provider
Risks of contractor switching
The new supplier may fail to perform
Process incompatibility
Cultural or inter-personal incompatibility
Loss of knowledge
Learning curve: time for the new provider to achieve peak performance,
teething problems
Exposure of intellectual property, confidential data
Problems of adversarial hand-over from the old provider to the new
De-stabilisation of the workforce, through multiple transfers of service
provision
Costs of contractor switching
Identifying and qualifying alternative providers
Initiating and administering tendering exercises or other sourcing and
contracting processes
Settlement of work in progress projects with the outgoing provider;
settlement of outstanding claims; payment of ‘exit’ (eg early cancellation)
fees
Change of internal systems and processes to align with the new provider
Familiarising and training the new provider in policies and requirements
Contract development and contract management (often with more
intensive monitoring and contact in the early stages of the relationship)
Risk mitigation measures (eg insurances) and corrective measures (eg re
teething problems)