PM0018 Book

PM 0018

Contracts Management in Projects

Contents

Unit 1

Introduction to Contracting 1

Unit 2

Project Procurement Management 21

Unit 3

Overview of Construction Contracts 40

Unit 4

Contracts Management 61

Unit 5

Procurement Processes as per PMI 81

Unit 6

Methods of Procurement for Works and Goods 103

Unit 7

Procurement and Supply Cycle for Goods and Services 123

Unit 8

Types of Contracts for Works and Goods 143

Unit 9

Contracting Process for Works and Goods 163

Unit 10

Procurement of Consultants for Professional Services 183

Edition: Spring 2010

BKID – B1347 5th

Jan. 2011

Unit 11

Contract Management Skills 206

Unit 12

Contract Performance Management 226

Unit 13

Dispute Resolution and Mediation Procedures in

Contracts 249

Unit 14

Other Issues in Contracts Management 269

Unit 15

Mergers and Acquisitions 289

Dean

Directorate of Distance Education

Sikkim Manipal University

Board of Studies

Chairman Mr. Pankaj Khanna

HOD Management & Commerce Director

SMU – DDE HR, Fidelity Mutual Fund

Additional Registrar Mr. Shankar Jagannathan

SMU – DDE Former Group Treasurer

Wipro Technologies Limited

Controller of Examination Mr. Abraham Mathew

SMU – DDE Chief Financial Officer

Infosys BPO, Bangalore

Dr. T. V. Narasimha Rao Ms. Sadhna Dash

Adjunct Faculty & Advisor Ex-Senior Manager, HR

SMU – DDE Microsoft India Corporation (Pvt.) Ltd.

Prof. K. V. Varambally

Director, Manipal Institute of

Management, Manipal

Content Preparation Team Content Review:

Team Triumph Ms. Garima

Triumph India Software Services Pvt. Ltd. Lecturer, SMUDDE–EduNxt, First Floor

Bangalore – 560 094 Manipal Towers, 14-Airport Road

Instructional Designing Bangalore – 560 008

Team Triumph Language Editing

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Curriculum Revised : Spring 2010

Printed : January 2011

This book is a distance education module comprising of written and compiled

learning material for our students.

All rights reserved. No part of this work may be reproduced in any form by any

means without permission in writing from Sikkim Manipal University of Health,

Medical and Technological Sciences, Gangtok, Sikkim.

Printed and Published on behalf of Sikkim Manipal University of Health, Medical and

Technological Sciences, Gangtok, Sikkim by Mr. Rajkumar Mascreen, GM, Manipal

Universal Learning Pvt. Ltd., Manipal – 576 104. Printed at Manipal Press Limited,

Manipal.

SUBJECT INTRODUCTION

Contracts Management in Projects (PM 0018)

Contracts management is a process that helps to control and monitor the

project to bring it to a successful completion. Managing a construction

project requires lot of planning, co-ordination and control. All three i.e.

planning, co-ordination and control should happen from the phase of

inception to completion so as to achieve functionally and financially viable

project that can be completed on time within estimated cost. Contract plays

an important role in such projects.

This course will start by introducing you to the contracts along with reasons

that are essential for you to adopt any contracts. It covers various methods

along with types of contracts. This course covers the process to achieve

contracts management along with the pre requisite for the same. This

course will introduce you to different process of contracting for works and

goods. It will also introduce you to controls and flexibility that can help you to

minimise risks and disputes. This course will also cover how to resolve the

disputes arising in the process of contracts management and the arbitration

act that helps to solve issues without following the judicial course. The

procedure of the arbitration tribunal will also be dealt within.

This course will deal with the importance of project procurement. The

phases of procurement for projects i.e. planning, conducting, administering

and closing of contracts are dealt in detail. This course will help you

understand about various types of procurements and the process involved

in procurement. This also will deal with the activities required before the

actual procurement activity.

In this course will include various characteristics of mergers and

acquisitions. It will cover the motives for acquisitions and the alignment of

acquisitions with the corporate strategy. This course teaches the process

and constraints for a merger.

Unit 1: Introduction to Contracting

This unit introduces you to contracting and its definition. We will analyse the

factors which drive contracting. We will learn the laws of contract, that is

private and public laws. We will also discuss the role of competition in terms

of quality and competition. We will take a glimpse on to the historical

evolution of contracting.

Unit 2: Project Procurement Management

In this unit we will learn about project procurement management which

includes the processes necessary to purchase or acquire goods, services

and results of a project from an external source. We will study various

processes in project procurement. And also we will analyse the procurement

process on each step. We we also discuss about public procurement in

India and also the concept of e-procurement.

Unit 3: Overview of Construction Contracts

In this unit we will understand project contract. We will learn the

methodologies for construction contracts along with types of contract. We

will also understand few standard conditions like FIDIC, PMBoK, Works tax

contracts that should be implemented in contracts for work.

Unit 4: Contracts Management

In this unit we will learn about the contract management process cycle, step

by step. We will learn about the pre requisites for contract process. We will

study about various types of contracts along with their features.

Unit 5: Procurement Processes as per PMI

In this unit we will learn about the importance of project procurement. We

will learn procurement in four phase i.e. planning, conducting, administering

and closing contracts. In each of these phases we will learn about the legal

consideration, inputs and outputs along with the required tools and

technique.

Unit 6: Methods of Procurement for Works and Goods

In this unit we will study the various methods of procurement of works and

goods required for a developmental project. We will learn about various

methods of procurement for a project. We will discuss about the feature and

requirement along with their suitability about each method of procurement.

Unit 7: Procurement and Supply Cycle for Goods and Services

In this unit, we will have an insight into the various activities involved prior to

launching the procurement cycle, like development for a product,

preproduction stages, and processes and so on. We will learn about various

processes like Bill of material, purchase request, purchase quote and other

terms related to procurement in contract management.

Unit 8: Types of Contracts for Works and Goods

In this unit we will study various types of contracts along with each of their

salient features. We will learn the situation where each of the contracts can

be applicable along with their advantages and disadvantages.

Unit 9: Contracting Process for Works and Goods

In this unit we will learn the about the process of contracting based the

selection of contracting methods. We will learn about the specification of

good, designs, BOQ’s and INCO terms. We will also learn about the various

other processes like invitation for bids, evaluation for bids and so on. This

unit will cover the entire process in a step by step manner.

Unit 10: Procurement of Consultants for Professional Services

In this unit we will study the need for consulting services and the process for

the procurement of consultants. We also will learn methods of selection of

consultants along with the selection of appropriate type of contract for the

various types of assignments.

Unit 11: Contract Management Skills

In this unit we will discuss the skills required for finalisation of contracts. We

will also discuss the terms that need to be drafted for effective contracts

along with the negotiations skill required. We will learn about the

communication skill essential for contract management.

Unit 12: Contract Performance Management

In this unit we will learn contract performance management as a subset of

project management. This unit we will learn about the controls and flexibility

in contracts. We will learn about monitoring and controlling the contract

performance. We will learn about risks, incentives and penalties in

managing contracts. We will under condition for termination and termination

of contracts

Unit 13: Dispute Resolution and Mediation Procedures in Contracts

In this unit we will learn about the cause and dispute resolution process. We

will learn the causes for disputes and how to minimise the causes. We will

learn about the arbitration act and the procedures of an arbitration tribunal.

We will also learn about few international arbitration protocols like

UNCITRAL, ICCA, AAA and so on.

Unit 14: Other issues in Contracts Management

In this unit we will discuss about the legal and constitutional requirements in

the formation of contracts and their management. We will learn about

private and public laws and their differences. We will study about the Indian

contract act and articles instituted by Indian constitution.

Unit 15: Mergers and Acquisitions

In this unit you will learn about various characteristics of mergers and

acquisitions. We will learn about the motives for acquisitions and the

alignment of acquisitions with the corporate strategy. We will learn the

process and constraints for merger. We will touch upon the advantages and

disadvantages of merger

Objectives of studying the subject

After studying this subject, you should be able to:

Determine the factors driving contracting

Determine the make or buy decision

Describe project procurement management

Discuss the Public Procurement in India

Discuss e-procurement

Explain the types of contract for construction

Explain works contracts tax in India

List the salient features of FIDIC

Explain various methods for procurement

Describe Project Procurement Management process

Explain the terms and standard for drafting contracts

Explain the requirements for a bidding document

Outline the constitutional requirements of public contracts in India

Select the codes, manuals and GFR which presents the procurement

procedure

List the needs for procurement law

Define merger and acquisition.

Contracts Management in Projects Unit 1

Sikkim Manipal University Page No. 1

Unit 1 Introduction to Contracting

Structure:

1.1 Introduction

Objectives

1.2 Definitions of Contract

1.3 Evolution of Contracting

1.4 Make-or-Buy Decisions

1.5 Factors Driving Contracting

1.6 Law of Contract

1.7 Role of Competition

1.8 Summary

1.9 Glossary

1.10 Terminal Questions

1.11 Answers

1.12 Caselet

1.1 Introduction

Contract is a legal agreement between two or more parties. The number,

size and degree of complexity of the contracts vary widely depending on the

project.

Contract management is the management of these contracts. It is

considered as the backbone of a successful project implementation. The

general steps in contract management include planning, designing and

commissioning the project. Many project management professionals believe

that project management is nothing but contract management. Hence, the

project manager of any enterprise needs to view contract management as

one of the critical tasks for implementing the project. This unit introduces

you to the subject of contracting for purchases of goods and services for

projects.

We begin with the various definitions of contract, and then move on to the

historical development of contracting. We will also analyse the factors

driving contracting. We will learn about the laws of contract, that is private

and public laws. We will also discuss the role of competition in contracting.



Objectives:

After studying this unit, you should be able to:

define contract

explain the history of contracting

discuss about the make or buy decision

determine the factors driving contracting

discuss laws of contract: private and public

discuss the role of competition

1.2 Definitions of Contract

Let us look at some definitions of contract given by some of the well known

sources:

Webster’s New World College dictionary (4th edition):

“An agreement between two or more people to do something, especially one

formally set forth in writing and enforceable by law; compact; covenant”.

Webster Dictionary, 1913:1:

“The agreement of two or more persons, upon a sufficient consideration or

cause, to do, or to abstain from doing, some act. It is an agreement in which

a party undertakes to do, or not to do, a particular thing; a formal bargain; a

compact; an interchange of legal rights”.

Cambridge Dictionary of American English:

“A legal document that states and explains a formal agreement between two

people or groups, or the agreement itself.”

The Business Dictionary.com:

“A voluntary, deliberate and legally enforceable agreement between two or

more competent parties”. Here:

Agreement implies evidence of mutual accord between two or more

legally competent parties about their relative duties and rights regarding

current or future performance.

Legally competent party implies party having the required legal capacity

to enter into a binding contract. This legal capacity is the power provided

to the party under law to enter into binding contract and to sue and be

sued in its own name. The following persons are incompetent to enter

into a contract:

o Minors.



o Persons of unsound mind.

o Persons disqualified by law to which they are subjected.

Duty implies the accountability owed to someone who has the

corresponding right to demand satisfaction of an obligation.

Basic elements of contract

Now that we have learnt the definitions of contract, let us now learn about

the basic elements of contract. We must note that for an agreement to

become a contract, it must enclose an offer, acceptance, consideration, and

an objective to create legal relations.

The basic elements of a contract are shown in figure 1.1 and explained

thereafter:

Figure 1.1: Basic Elements of Contracting

Offer: An offer is proposal or a statement by one party to another,

manifesting the intention to enter into a contract on certain terms. For

example, suppose you want to sell a book, and you tell your friend that

he could buy it for Rs.200. In this case you offer to sell your book for

Rs. 200, without which you cannot develop a contractual relationship

with your friend.

The offer that you make must be clear in a manner capable of

acceptance without anything further required by the other party.

Acceptance: To create a contract, the party to whom you make an offer

must accept it, without which no contract exists. For example, if your



friend agrees to buy the book, then he has accepted your offer and a

contract is created between you and your friend.

An acceptance of the offer results in a meeting of minds. Acceptance can be

in oral, or in writing.

Consideration: It is the key element of a contract. It is the thing for

which the parties have bargained. It may be a promise or payment of

money. This promise is to perform the intended task. In our example the

consideration is both Rs. 200 and the book itself. You bargain for the

money and your friend bargains for the book.

Intention to create legal relations: The parties in agreement can

decide if they intend to make their contract a legal agreement that is

enforced by law. This involves terms and conditions for performance;

including fulfilling promises. For example, a major producer of

automobiles enters into an agreement with a service company to service

its automobiles.

A contract can be written or oral, but oral contracts are difficult to prove. A

contract can also consist of a series of letters, offers, counter offers and

orders. Some types of contracts are:

Conditional contract (that is. it depends on an event that affects legal

relations).

Joint contract (that is. when several parties combine to make a joint

promise to perform; however, each is responsible).

Implied contract (that is. a legal contract which arises due to some

relationship among the intermediate parties).

In reality, there are innumerable variations of contract. The types given

above are only some examples.

Contracts are agreements but it is not necessary that all the agreements are

legally enforceable. We address contract by comprehending the legal

effects of agreements as falling into four categories:

Valid contract: A valid contract is an enforceable contract. This contract

has a proper offer and acceptance. Legally valid consideration is given

and received. The parties have the legal capacity to enter into the

contract and the contract is completely under law.



Void contract: This is an illegal contract which means that the

agreement does not meet the contractual requirements. The parties

involved in such a contract are not entitled to any legal remedies

because the contract is not legal.

Voidable contract: Unlike the void contract, this type of contract is valid

unless one of the parties declares the agreement as invalid due to legal

reasons.

Unenforceable contract: This is a valid contract, but this cannot be

enforced because of a subsequent change in the law. For example,

when a contract may exist in which one party has failed to meet the

contractual obligations, and by the time the aggrieved party sues the

other party, the time limit to sue has expired.

Self Assessment Questions

1. According to Webster‟s New World College dictionary contract is used

to set forth in writing and enforceable by _______, ________ and

_______.

2. A valid contract is an enforceable contract. (True/False)

3. The key element of a contract for which parties have bargained

is ___________.

4. A contract can be written or oral, but oral contracts are easily proved.

(True/False)

Activity 1

XYZ, a major car manufacturer gets into an agreement with ABS

Company, which is a medium sized car service company. XYZ had

advertised for car service companies in different media and then it had a

formal agreement signed with ABS. Due to some reasons ABC felt that

some of the clauses set by XYZ were not agreeable. Hence ABC closed

the contract with XYZ. Identify the type of contract that XYZ signed with

ABS and the list out the reasons for the same.

Hint: Refer types of contracts

1.3 Evolution of Contracting

In the previous section we learnt the definition of contract and the basic

elements of contract. Let us now see the evolution of contracting.



Contracts have evolved over centuries. It is a lawful binding relation

between two or more parties. The contractual relationships can occur – from

a small project to a corporate takeover or treaty between nations. These are

specific tangible elements and codes that are structured according to the

laws of the country in which they are written.

In some countries, contracting parties like to meet with a verbal and

handshake agreements for informal promises or trades of goods and

services.

During the past few decades, contracts have undergone many changes

because of globalisation in our economy, outsourcing, deregulation and the

types of competitors. The mode of contracting has become easier because

of the usage of Internet.

With all these changes, agreements written a decade ago seem simple in

comparison to present agreements. This revolution in the contract structure,

content and format has occurred because of the changing roles of contracts

in today‟s business world.

Contracts have evolved from a simple document to a dynamic and powerful

tool with far-reaching implications for long-term business and personal

relationships.

Let us see an example of the development of contracting taken from the

article „An Unlikely History of Contracting‟ by Gary L. Sturgess published in

the Journal of International Peace Operations.

Two hundred years ago, British and Irish convicts were transported to

Australian colonies by private contractors. In 1787, Australia‟s first convict

fleet contract was won by a naval contractor, William Richards following a

public tender. Richards supplied six ships and he had to make provision for

food for about 800 convicts and their guard of marines for a period of eight

months. Richards was paid a flat rate per month for each ton of shipping

and another separate rate per convict-day for food provisions. This was

similar to the contracts the Navy Board had developed for the shipment of

troops to various parts of the world.

The second contract was rewarded in 1789; this time with the objective of

minimising costs. The contract marked a flat rate which transferred the risk

of delay. The mortality rate of convicts was high enough to attract the

attention of the authorities which received complaints of negligence. To



prevent further negligence of such kind by the contractor, there was an

enquiry and criminal prosecution, and the Home Department argued that the

contractor should be paid for the number of convicts actually landed rather

than taken on board. Hence the payment was modified. A bottleneck faced

in implementing this mode of payment was that the contractors were not

prepared to accept the complete transfer of outcome risk to them.

This kind of contract dropped the morality rate of the contractors

substantially. The only danger that the governing authority or the contractor

faced, comprised certainties of ocean travel, thus minimising the probability

of ill treatment of persons on board by the contractor. The example

explained was a performance based contracting.

Thus, we can conclude that the following actions need to be incorporated for

successful contracting:

Good contract design.

Selection of a socially responsible provider.

Sound contract management by public officials.


5. The contractual relationships can occur from a ________ project to a

corporate takeover or treaty between nations.

6. In ________, Australia‟s first convict fleet contract was won by a naval

contractor.

1.4 Make-or-Buy Decisions

In the previous section we learnt how contracting came into existence and in

this section let us look into the fundamental issues involved in make or buy

decision. Make or buy decision is a strategic decision that any organisation

has to make, between producing an item internally and buying it externally.

With the changes in the approaches of contracts, the issues related to make

or buy decisions have also started increasing. Make or buy decision is a

fundamental issue to be addressed by any company. The competition is

increasing globally; as a result the manufacturing companies are re-

evaluating their existing processes, technologies, manufactured parts and

services in order to focus on strategic activities.

There are finite resources in the company which makes the company

incapable of affording all the activities in house. In the PMBoK, make-or-buy



decision is an output of the plan procurement process which is then used as

an input to the conduct procurement process. So the organisation must

decide to make or buy the product or service which are cost effective. The

decision can be made at the individual resource level, or for an entire

deliverable or for the project itself. The last option is decided right at the

conception stage of the project.

The cost evaluation technique used for the make or buy decision should be

based on both direct and indirect costs. Direct costs include goods,

materials, equipment, facilities and employee salaries. Indirect costs (some

of which tend to get missed in the evaluation) include training costs,

management costs, administrative overheads, and on going maintenance

costs.

Even though cost evaluation is the fundamental issue, there are other

considerations in make or buy decision which include:

Capacity: Can the company take on a product or service of this scale?

Skill level: Do the persons involved in the project posses the skills

required or do they need any additional training based on the project?

Trade secrets: The company should maintain the secrets of a magic

formula for a product or service but if this is not disclosed, then the

product or service cannot be outsourced.

Staff availability and existing workload: If the staffs engaged in the

project are already working on another priority project, then they cannot

be available for this project.

Strategic level analysis and operational level analysis

The make-or-buy decision must be the most cost effective and efficient

decision for the organisation. Make-or-buy decision should be analysed both

at strategic level and operational level. In the book „World Class Supply

management – 2003‟ edition by David Burt, Donald Dobler, Stephen

Starling, it is recommended that the strategic level analysis and the

operational level analysis should adopt the respective Rule of Thumb as

under:

Strategic level analysis: Items that fall under one of the following

categories should be manufactured/produces internally, without being

outsourced:

o Items those are critical for the success of the product, including

customer perception of important product attributes.



o Items which require specialised design and manufacturing skills or

equipment, and for which the number of capable and reliable

suppliers is extremely limited.

o Items that fit within the firm‟s core competencies or within those the

firm must develop to fulfil its future plans.

Operational analysis: Items that fit into one of the following categories

should be produced internally that is. should not be outsourced. When:

o The item‟s in house cost of making is less than the cost, if it is

outsourced.

o In house manufacture makes productive use of excess plant

capacity, thus helping the firm to absorb fixed overheads.

o In house manufacturer can achieve better quality control.

o Design secrecy is to be ensured to protect proprietary technology.

o External suppliers of the product are unreliable.

o Union pressure exists to manufacture in house.

o The firm desires to maintain a stable work force.


7. Even though Cost Evaluation is the fundamental issue, there are other

considerations in make or buy decision which include capacity ______,

___________ and staff availability and existing work load.

8. The cost evaluation technique should be based on both _______ and

_______ costs.

9. The analysis of make or buy decision should be based on _________

level and ________ level.

Activity 2

Silicon Ltd is a calculator manufacturing company. They have accrued a

new project where the company has to manufacture 200 calculators in 15

days. Each calculator has three components: base, electronic cartridge

and top cover. The company can manufacture the base, cartridge and

the cover for 200 calculators in 5, 12 and 8 days respectively. The

company takes 12 days only to assemble these components together.

Based on these data the company decides to outsource the

manufacturing of the electronic cartridges.

How did the company decide which component it would outsource?

Hint: Refer strategic and operational analysis



1.5 Factors Driving Contracting

In the previous section, we reviewed the basis for arriving at a make or buy

decision for a specific work or service. In this section let us try to analyse the

factors which drive contracting decisions. Here, the buy mode is referred as

contracting, subcontracting and outsourcing. Even in a „make‟ mode, some

contracting is involved. For example if a firm desires to manufacture a part

in its own shop, it has to purchase the material from an outside agency; it

may outsource the rough cutting operations to an outside agency; it may

even employ an outside agency like a laboratory to inspect the material for

quality before the material is taken to its shop. This outsourcing is

elementary and we will not consider this as part of outsourcing as this is part

of the „make‟ mode in contracting.

Lets us now see the factors which drive the contracting decisions:

Companies require efficient contractors in place, so that they can carry

out their business operations without any trouble. This is a big

advantage to the company owners because, a general contractor will be

available to him and the business owner can concentrate, his time,

money and energy on his core competence of running his business.

Similarly, general contractors make a living, working with known

subcontractors.

An efficient general contractor will have an established relationship with

specific project he is presently engaged in.

If the project is completed on time or even before, this enables the

business owner to realise his revenues early.

Contracting lowers (sometimes may increase due to various other

reasons) the overall cost of the service to the business owner by

reducing scope, defining quality levels, re-pricing, and re-negotiation.

Contracting reduces the ratio of fixed costs to variable cost by offering a

move from fixed to variable cost and also by making variable costs more

predictable.

Business owners will focus on improvement of quality, so they ensure

that the contractor is capable of ensuring quality during process of

specific work.



Business owners will focus on contractors who have wider experience,

access to intellectual property and the knowledge of contractor

specialised in the work.

Contractor must be capable of developing a product in a much faster

way with the additional capacity brought by the supplier.

Risk management is one of the main benefits of contracting especially in

large, complex projects where the risks are distributed to parties most

capable of managing the risks applicable to the work of each party.

Contracting for low cost labour, for example is Research and

Development projects which are outsourced by the high labour-cost

countries to expertise available in low labour-cost countries like India

and China.

The term „subcontracting‟ implies to the next level of contracting resorted to

by a general contractor. If a contracting firm takes up the total project of

constructing a building, the firm itself may have the core competence of

carrying out the civil works, but it will usually award subcontracts for

components of the total work like electrical works, air-conditioning works,

fire protection system works and so on. However, the contracting firm is

responsible for book-keeping the performance of total work.

Since the 1980‟s, the term „outsourcing‟ has also come into use. It implies

essentially the same as contracting or subcontracting. Outsourcing is the

transfer of management and day-to-day execution of a specific business

function to an external source provider. Business segments that are

outsourced are:

Information Technology (IT).

Computer Aided Design(CAD) drafting.

Facilities management.

Accounting.

Human Resource (HR).

Market research.

Manufacturing.

Designing.

Web development.

Content writing.

Engineering.



Outsourcing or subcontracting helps the organisation to perform the task in

an easy manner with division of labour, whereby each agency executes a

part of the total project requiring specific skills applicable to that part.

The other recent term which is used is off-shoring, in which the buyer

organisation belongs to another country. As an extension of this usage for

the term, even if the work is not outsourced that is. the work stays within the

same corporation/company, the transfer of an organisational function to

another country is now considered as off shoring. The distinction between

outsourcing and off shoring will soon become lesser over time, because of

increasing globalisation of outsourcing companies. Outsourcing involves

contracting with a supplier, which may or may not involve some degree of

off shoring.

Disadvantages of contracting

As we saw some of the factors that drive a contracting decision, now let us

understand the disadvantages or criticisms associated with contracting in

the following areas:

Quality: The quality of work carried out by a contractor/subcontractor

can turn out to be unsatisfactory. This can happen if there is poor buyer-

supplier communication or when the buyer makes a wrong assessment

of supplier‟s capability.

Public opinion: The public may perceive that the practice of

outsourcing damages local labour market and can lead to

unemployment.

Language skills: Call centres often face complaints of low quality

service. The complaints usually arise because of linguistic features such

as accents; words used and so on which make call centre agents

difficult to understand.

Exploitation of work: Benefits such as medical assistance and

retirement are not offered to workers in companies taking up outsourced

work.

Staff turnover: This generally happens in call centres where agencies

keep changing frequently. This inhibits the pile up of employee

knowledge and reduces the performance and quality.



Productivity: Companies which solely outsource their project for the

purpose of saving cost can have negative influence on the productivity

of the company. When work is outsourced by a developed country to a

developing country, and the workers use hand tools in lieu of the

advanced computer controlled machine tools used by workers in the

developed country. Hence, the productivity of the offshore workers is

lower in reality, although it appears to be higher simply because of the

lower wages paid to them in dollars. This gives rise to the perception

that the developed country only gains non real productivity by hiring

fewer people locally, rather than investing in technology to improve

productivity.

We can conclude that contracting does have many benefits which are

mentioned below:

Division of labour.

Synergy of expertise.

Sharing of risks.

To avoid the negative aspects of contracting closed attention must be given

to the following:

Selection of efficient contractors.

Clear evaluation of bids.

Accurate measurement and control of contract performance.


10. Only the general contractors are necessary for carrying the business

without any trouble. (True/False)

11. __________ is the transfer of management and day-to-day execution

of a specific business function to an external source provider.

12. The contracting firm is responsible for ___________ the performance

of total work.

1.6 Law of Contract

In the previous sections we learnt the factors driving the contracting

decisions. In this section let us learn about Indian laws of contract.

The law of contract is a set of rules that govern the relationship, content and

validity of an agreement between two or more parties regarding the sale of



goods, services or results of project. While this is a wide definition it does

not cover the full ambit of situations in which contract law will apply. Hence,

we can say that contract law is a promise or set of promises which the law

will enforce.

As we have seen, a contract may arise in many situations; from buying a

loaf of bread in the shop next to your house, to selling of a house. It is

therefore unsurprising that certainty is needed, before the courts can

intervene to enforce any agreement. The law of contract confirms the basic

foundation of any contract, regardless of its complexity and substance.

The Indian contract law is based on the English contract law. In India,

contracts are governed by the Indian Contract Act ever since 1872. It

extends to the whole of India, except Jammu and Kashmir. This act governs

entering into contract, execution of contract, and the effects of breach of

contract.

The law is generally categorised as Private law and Public law, which are

explained below:

Private law: It is that part of the legal system that involves interrelation

between individuals who voluntarily enter into the system of transactions

of one sort or the other. It is the law which exists without the

interventions of the state or central governments.

Public law: It that part of the legal system that involves the government

and the general public. It is governed by a government body.

Contracts play a vital role in today‟s business environment. By contracting,

the companies can delivery their product or service on time. Central and

state government firms make extensive use of private firms which provide

facilities, firms and services. Government contracts vary a lot when

compared to other office supplies. Government contracts are usually for a

long period of time. Hence, complex and long term arrangements are

prepared which provide complete service.

The government contracts are regarded as traditional approach which is

similar to ordinary private law arrangements. Although, the traditional

approach is followed, the law of contracts applies to both private and public

law.



The need for Law of Contract

We saw different laws of contract above but the question which arises is

why we need the law of contract. If the law of contract are not taken into

consideration there cannot be uniformity and it may result in obligations. An

agreement which is free from law can be affected by misinterpretation. The

law of contracts help us to decide whether an agreement is legally enforced.

A court will apply the rules and principles of the law of contract to decide

this. Organisations must be aware of these laws before they sign or create

an agreement. The reasons to have a law of contract are because:

Contracts are present in day to day situations.

Modern society and globalisation operates by exchanging products and

services.

They are used to resolve issues or solve problems of misunderstanding

the contract.

It is part of private and public law. So it is concerned with relationships

between parties.

We can get a thorough idea of a valid contract. Not only the principles

and rules but also emphasis on remedies because law of contract is also

concerned with remedies.

It helps us to decide whether the contract is valid or not.

It helps us resolve issue if the other party in the contract does not keep

to the agreement.


13. The Indian contract law is based on the ______________ law.

14. The________ law is the law which exists without the interventions of

the state or Central Government.

15. The Public law is that part of the legal system that involves the

__________ and the ________.

Activity 3

Create a PPT about outsourcing laws followed in India.

Hint: Visit http://www.madaan.com/investing.htm and

http://www.outsource2india.com/why_india/articles/legal_aspects_outsou

rcing.asp



1.7 Role of Competition

In the previous sections, we understood the different laws of contract. In this

section let us discuss the competition in contracting. Ever since the 18th

century, contract is based on tendering which is a competitive basis. The

consequence of competition in contracting is reduction in the cost of the

product or service provided by the contractor. The results of a survey

conducted in UK to reveal the competition in tendering, showed that local

government and health services reduced cost by 20 percent, but at a severe

cost cut in terms of service quality. This clearly means that the government

must signal its intention to use competition and contracting to improve

service standards.

In USA, competition in contracting act was enforced in 1984 which sets a

standard of competition for federal contracts. This Act is implemented in the

Federal acquisition Regulations (FAR), Part 6. The Act establishes

competition as a norm for federal contracts, and directly affects every

federal contract awarded by establishing both policy and procedural

requirements that must be followed. This Act sends a clear message to both

federal procurement personnel and industry that in buying goods and

services, the Government will procure through competition.

There are seven exceptions which are allowed to the requirement of

competition. The approval levels for authorising these exceptions are also

specified in the Act. The seven exceptions to competition are:

Only one responsible source.

Unusual and compelling urgency.

Industrial mobilisation, engineering development and research

capability.

International agreement.

Authorised or required by statute.

National security.

Public interest.

Benefits of competition

Some of the benefits of competition are:

With the help of competitive binding cost savings can be obtained.

Quality can be ensured as mentioned in the bid document.



Contractors show more interest and put in lot of efforts better than their

competitors.

The customer can obtain enhanced level of service or product because

customer has the option of selecting the best contractor.

Competition permits fairness and openness. Openness is especially

important in government since it is the key to earning public trust.

Publication of the contract by the government creates openness.

Effective design and planning must be ensured in the design of contract

which results in greater advantage.


16. Since 18th century the contract is based on _________ which is a

competitive basis.

17. In USA, competition in contracting act was enforced in 1985 which sets

a standard of competition for federal contracts. (True/False)?

18. An effective planning and design in contract increases the advantages

in competition. (True/False)?

1.8 Summary

In this unit, we started with the definition of contract management for

implementing project. We understood that it is an agreement between the

client and the project manager and it is viewed as one of the critical tasks for

implementing the project. We discussed the various definition of contracts,

and also basic elements of contract. The basic elements are offer,

acceptance, considerations and intention to create legal relations.

We discussed about the four types of contracts: valid, void, voidable and

unenforceable contracts. Valid contract is the agreement signed by both

parties that meets the requirement of state law. Agreements which have

unlawful object are considered as void contract. Voidable contract is the

agreement entered between two parties where in it can be declared as

invalid by one party for any kind of legal reason. Unenforceable contracts

are valid contracts but they are not enforced in court.

We also discussed the origin of contracting. Contracts were developed from

one of the laws of Hammurabi, the ancient Babylonian conqueror. At the

end of 18th century tendering was started which is a competitive basis.

Then by latter part of 19th century, Associations of Builders, Architects and



other professionals were formed. By the 20th century this was named as

design and construct delivery method.

We analysed the fundamental issues involved in make or buy decision. This

mainly includes the cost evaluation technique based on direct and indirect

cost. We also analysed the factors which drive the contracting decisions.

Companies give contract to an efficient general contractor so that they can

do their business operations without any trouble. The disadvantages of

contracting are found in areas of quality, public opinion, language skills, staff

over, and exploitation of work.

We also discussed about the law of contract. There are two laws: private

and public law. Private law is the law which exists without the interventions

of the state or government. Public law is governed by a government body.

We have also discussed the competition in contracting. As contracts are

awarded on the basis of tender, contractors reduce their quoted rated in

order to gain the contract. In some cases this price reduction may also lead

to deteriorated quality of the service/product.

1.9 Glossary

Term Description

Book-keeping The job of keeping the exact record of the money that has been spent or received by a business or other organisation.

Tender A written or formal offer to supply goods or do a job for an agreed price.

Convict To decide officially in a court of law that someone is guilty of a crime.


1. What is contract management?

2. Explain the different categories of contract.

3. Explain the make or buy analysis.

4. Why do we need a Law of Contract?

5. What are the benefits of competition?



1.11 Answers


1. Law, Compact and covenant

2. True

3. Consideration

4. False

5. Small

6. 1787

7. Skill level, Trade secrets

8. Direct and indirect

9. Strategic and operation

10. False

11. Outsourcing

12. Book keeping

13. English contract

14. Private

15. Government, general public

16. Tendering

17. False

18. True

Terminal Questions

1. Refer section 1.1 Introduction.

2. Refer section 1.2 Definition of Contracts.

3. Refer section 1.4 Make-or-Buy Decisions.

4. Refer section 1.6 Law of Contract.

5. Refer section 1.7 Role of Competition.

1.12 Caselet

Nirman Ltd, a medium sized company was awarded a government grant

to complete the research and development and proof of concept for a

new product over a period of 15 month. The company signed a contract

for providing all the reporting requirements for the R&D and Proof of

Concept deliverables. The challenge was to meet milestones in terms of

time, cost and quality and also identifying, managing and solving issues

that need to be addressed.



The company used the following measures to overcome its problem. It:

Developed a review of contract management methods and a wide

range of tools such as project management, time management,

contract management software, and so on.

Developed and executed centralised administration for handling such

agreements, including compliance tracking and reporting.

Developed a training team who could guide the team on tools.

Developed real time task and team management software to manage

the R&D.

Tasks were completed on time, and the company profited from this

project.

Question:

How did Nirman Ltd solve the problem?

Hint: Solutions, which company undertook.

References

Sir William Reynell Anson, Anthony Gordon Guest, Principles of English

Law of Contracts.

Frank P. Saladis, Harold Kerzner, Project Management Book of Guide.

http://en.wikipedia.org/wiki/Pricing_strategies

http://www.businessdictionary.com/definition/void-contract.html



Unit 2 Project Procurement Management

Structure:

2.1 Introduction

Objectives

2.2 Overview of Procurement Management

2.3 Basic Steps in Procurement Process

2.4 Public Procurement in India

2.5 E-Procurement

2.6 Summary

2.7 Glossary


2.9 Answers

2.10 Caselet

2.1 Introduction

In the previous unit, we studied how contracts originated and the different

definitions of contracts. We also understood the factors driving contracting

decisions and also the law of contracts. We learnt how the business owners

outsource the project based on tendering, which can be cost effective to

organisation. A project is contracted if the organisation lacks in-house

resource.

In this unit we will learn about project procurement management which

includes the processes necessary to purchase or acquire goods, services

and results of a project from an external source. The organisation can either

be a buyer or a seller of goods or services based on the role it plays in the

procurement management process. Project procurement also includes

managing and abiding to the contract issued by an outside organisation that

is acquiring the project.

We will study various processes in project procurement. And also we will

analyse the basic steps in the procurement process, then, we will elaborate

on each step. We we also discuss about public procurement in India and

also the concept of e-procurement.



Objectives:


describe project procurement management.

explain the basic steps in procurement process.

discuss the Public Procurement in India.

discuss e-procurement.

2.2 Overview of Procurement Management

Let us start our discussion with an overview of project procurement

management. Procurement management is an important knowledge area in

project management and it is a formal process by which many organisations

acquire their goods and services from outside body. Hence, project

procurement management involves getting work done by people outside the

project organisation. It includes the management of purchasing or acquiring

of product, services, or projects.

According to PMBoK1 “project procurement management includes the

processes necessary to purchase or acquire products, services, or results

needed from outside the project team”. The organisation can be either buyer

or seller of the products, services, or results of a project”.

Project procurement is mostly managed by project managers and

specialists. Project procurement process includes the following processes

(as per PMBoK):

1. Plan procurement.

2. Conduct procurement.

3. Administer procurement.

4. Close procurement.

1 A Guide to the Project Management Body of Knowledge.



The table 2.1 shows the key deliverables in each of these processes.

Table 2.1: Project Procurement Processes

Project procurement Process

Process Project Phase Key deliverables

Plan procurements Planning

Procurement management plan

Conduct procurements

Execution Selected sellers list, procurement contract award

Administer procurements

Monitoring and Controlling Change requests

Close procurements Closure Closed procurements

These processes interact with each other and involve efforts from a group or

person involved in the project. The processes also interact with processes in

the other knowledge areas. We must note that all these processes occur at

least once in the life cycle of every project and may occur in one or more

phases of the project. Although the processes look as different components

but they overlap and interact with each other in real time.

The project procurement management involves legal documents signed

between the buyer and the seller. This includes terms and conditions

incorporated by the buyer depending on what the seller would perform or

provide. The project management team is responsible to make sure that all

procurements meet the project needs while adhering to the organisational

procurement policies. The project management team may seek support

from experts in contracting, purchasing law, and technical disciplines to

ensure that all the project needs are met, while the organisational

procurement policies are adhered. The activities involved in procurement

processes form the life cycle of contracting. By continuously managing the

contract life cycle the project management team can avoid some

unidentified risks.

If the project is large, then the buyer-seller relationship exists at different

levels and so the co-ordination must be maintained at each and every level

correctly. Depending on the application area we can call the seller as

contractor, subcontractor, vendor, service provider, or supplier. Depending

on the buyer’s position in the procurement cycle, we can name the buyer as



client, customer, prime contractor, service requestor, governmental agency,

or purchaser.


1. The project procurement management consists of _______________

signed between a buyer and seller.

2. The Project Procurement processes also interact with the processes in

the other knowledge areas. (True/False)

3. The activities involved in procurement processes form the __________

of a contract.

4. Project procurement is always managed by team memebers.

(True/False)

2.3 Basic Steps in Procurement Process

As we have understood that project procurement management includes the

processes necessary to acquire goods and services from external

organisation. This involves documenting the procurement plan, planning and

solicitation of goods and services, selecting suppliers, administering the

contract and closing the contract.

The PMBoK mentions four processes for procurement of goods and

services, which are here under:

Plan procurement

Plan procurement is a process for determining what goods and services to

purchase and when, how and from where to purchase them. This process

includes the documenting the purchasing decisions, selecting the approach

and identifying potential sellers. This process involves the following

activities:

1. Performing a make or buy decision: When a company decides to

complete a project, it also decides if they would complete the project

themselves or outsource the work. The company identifies those project

needs which can be met by acquiring from outside the project team

versus those project needs which can be accomplished by the project

team. The make or buy decisions are done based on the cost involved in

managing procurement and the direct cost of the product and services to

de procured.



2. Creating a procurement management plan: Once the make or buy

decision is made, the project manager should create a plan to manage

these procurements. The procurement plan will describe how to execute

procurement, control and close the procurement process.

3. Creating a procurement statement of work: The project manager

must determine the scope of the procurement. This can be done by

breaking down the project scope into the work done by the projet team

and the work that will be purchased. The work to be done by each

procurement is called the “procurement statement of work”. The

procurement statement of work must be clear, complete and detail. It

must clearly describe all the activities to be performed by the seller.

4. Selecting a contract type: There are different types of contracts that

can be chosen to acquire goods and services required for the project.

Contracts can be categorised into:

○ Fixed price: In this contract a fixed price will be ensured for

products and services to be provided. This contract incorporates

financial incentives for better product production and also exceeding

selected project objectives.

○ Cost reimbursable: This contract involves payments for actual cost

of the product and fee indicating seller profit. There is also an option

of cost reimbursement to the seller’s if the price falls below the

defined objectives

○ Time and material: This is a blend of both cost reimbursable and

fixed price contracts. They are often used for staff allocation, and

any support from outside.

The contract type can be selected on the basis of the what is being

purchased, the scope of work, marketplace and economy, level of expertise

of the seller and industry standards.

5. Creating the procurement documents: Once the contract type is

selected and the procurement statement of work is created, the project

manager can create the procurement document which decribes the

procurement requirements to the seller. Following are some of the types

of procurement documents:



○ Request for Proposal (RFP): It is an invitation for suppliers,

requesting for detailed proposal on how the work will be

accomplished, company experience, price, and so on.

○ Invitation for Bid (IFB): It is a request for the total price to do the

work.

○ Request for Quotation (RFQ): It is a request for the price quote per

items.

6. Determining the source seletion criteria: The source selection criteria

is included in the procurement documents to give the seller a clear

understanding of the project requirement. The source selection criteria

includes:

○ Number of years in business.

○ Understanding of requirements.

○ Price or life cycle cost.

○ Technical ability.

○ Quality of past performance.

○ Ability to complete the work on time.

Conduct procurement

After the procurement plan is prepared, then it needs to be executed. Let us

look into the next process of procurement which is conduct procurement.

Conduct procurement is the process of distributing the RFP, soliciting

responses from potential suppliers and then narrowing the choice and

selecting one seller and awarding a contract. In this process the bids and

proposals that fit the organisational needs and which are cost effective are

chosen.

The procurement plan acts as an input to the conduct procurement process

which describes how the procurement processes are managed from the

plan procurement til the closure of procurement. The procurement

documents and the source selection criteria also act as inputs to this

process.

The shortlisted seller sends the seller proposal with the price quote to the

project manager. The seller proposal is usually the reponse to a RFP, RFQ

and the IFB. The seller proposal represents an official offer from the seller.

The projetc manager (or a committee) then reviews this proposal using the



source seletion criteria identified in the plan procurement process to assess

the seller’s ability to provide the requested product and services.

The project manager uses a screening sytem to eliminate sellers who not

meet the minimum requirement of the source seletcion criteria. The project

manager can then negotiate with the seller for price reduction. The

negotiation should be healthy and help to achieve the objectives of

negotiation, that is,

Obtain fair price and reasonable price.

Develop a good relationship with the seller.

Negotiation can vastly vary depending on what is pruchased. When the

negotiations are complete, the procurement contract is awarded to the

selected seller.

Administer procurement

After conducting procurement it is time to administerprocurement.

Administer procurement process involves managing the buyer seller

relationship and ensuring that the performance of both the parties meet the

contractual requirements.

The administer procurement process ensures that the seller’s performance

meets procurement requirements and that the buyer performs according to

the terms in the legal contract. Administer ptocurements also include

application of appropriate project management processes to the contractual

requirements. This process also includes monitoring payments to the seller

which involves ensuring that the payment terms defined in the contract are

followed.

In this process the project manager (or procurement manager) monitors and

documents the seller’s performance. This performance review may be

considered as a measure or the seller’s competancy for performing in future

projects.

The contract can be modified at any time prior to the closure, as per the

change control terms of the contract. Sometime such modifications may not

be beneficial to both the buyer and seller.

As per the contract, the buyer can terminate the contract with the seller, in

case the seller breaches the contractual terms.



Close procurement

Close procurement involves completing each process mentioned in

procurement plan. In this process buyer must ensure that all deliverable by

the supplying agency is acceptable. The activity of closing a contract is also

part of this process. If there are any claims against the seller then necessary

action can be taken. Clauses like “with cause” and “without cause” are

written to ensure systematic closure of procurement actions. The primary

aim of closing the document is to get the product, the component or the

services required by the project team into their hands in time.

Close procurement involves administrative activities like finalising open

claims, updating records to final result and archiving such information. The

close procurement process is part of the project closure phase of project

management. The procurements ar closed when:

A contract is completed.

A contract is terminated before the work is completed.

Early termination of a contract is a special case of procurement closure due

to mutual consent of both the parties. This happen because of breach of

contract by the seller or for the convinence of the buyer.

The close procurement is a way to accumulate some added benefits such

as lessons learnt. It provides value to both the buyre and the seller and

should not be omitted under any circumstances.


5. The ______________ will describe how to plan, execute, control and

close the procurement process.

6. The company identifies those project needs which can be met by

acquiring from outside the project team versus those project needs

which can be accomplished by the project team. (True/False)

7. Close procurement involves completing each process mentioned in

procurement plan. (True/False)

8. _______________ is a request for the total price to do the work.

9. The procurement plan acts as an input to the ___________ process.

10. The performance review may be considered as a measure or the

seller’s competancy for performing in future projects. (True/False)



11. The ________ process is part of the project closure phase of project

management.

12. The buyer cannot terminate the contract with the seller, even if the

seller breaches the contractual trems. (True/False)

Activity 1:

Consider that you are a project manager in computer hardware

manufacturing company. You are required to manufacture different

hardware components for 200 computers in a very short duration of time.

Hence you decide to buy certain components from outside. Develop a

procurement plan to do the same.

Hint: Refer plan procurement

2.4 Public Procurement in India

After learning the steps in procurement process, let us now discuss the

public procurement in India.

In India, public procurement is governed by both central and state

Governments. The legislative functions of the central, union and state

governments are governed by three important lists, that is, the Union List,

the State List, and the Concurrent List. State procurement does not figure in

any of the lists as a distinct subject. Hence the Union Parliament has the

power to make any laws on procurement. As the parliament has not enacted

any specific legislation on procurement, public procurement in India is

performed through Government policies. We now review the scenario of

public procurement in India.

The Legislative framework

According to constitution of India, the executive powers are in the hands of

president of India. Government of India (GOI) (Allocation of Business)

Rules, 1961 and Government of India (Transaction of Business) Rules,

1961 assigns responsibilities by vesting financial powers of the Government

in the GOI Ministry of Finance. These are in turn assigned under authorities

of GOI General Financial Rules, 1963 (GFRs). GFRs provide greater

flexibility to the Executive in transacting government business, while

ensuring accountability and responsibility. They are similar to the US

Federal Acquisition Regulations (FARs). Rule 137 of the GFRs articulates



the fundamental principles of public purchasing that Government Ministries

and Departments provide. They are:

Adequate information and announcement.

Non-discriminatory practices to provide equality of opportunity,

transparency in bidding, as well as in the evaluation process.

Accountability.

Non-restrictive bidding conditions to unlock the particular market.

As one procurement law is not possible for the whole country, each

purchasing organisation has a set of documented policy guidelines

regarding purchase. These guidelines contain detailed purchase

procedures, policy guidelines and delegation of powers in the form of

procurement manuals.

The tendering process

There are three important tendering processes:

Advertised Tender Enquiry (ATE) or open tenders: ATE is the most

common mode of tendering, where bids are invited from the general

public on an unlimited basis and wide and adequate publicity is

provided. The logic behind open tendering is to increase competition

that will lead to reduction in price. Open tendering contains the following

elements:

○ Advertising showing project particulars and requesting contractors to

apply for the tender documents.

○ Tender documents are released after initial deposit by the

contractors.

○ Contractors submit their bid and are selected on the basis of lowest

bid.

Limited Tender Enquiry (LTE): This type of tendering fundamentally

different from open tendering. This mode of selecting contractors refers

to inviting tenders from only a limited numbers of bidders. Since

tendering is limited to only a few bidders it is presumed that the bidders

are well known to the purchaser for their capability. LTEs are issued in

such a way that sufficient competitive quotations are received from the

bidders. LTE is adopted for estimated value up to 2.5 million Indian

Rupees. All procurement agencies are expected to regularly identify

suitable vendors and periodically update vendor lists (performance



criteria being quality, delivery, price, response, product support and any

other specific consideration). Thus we can say that a selection of a

vendor for LTE is done to ensure that:

○ The firms are financially and technically sound.

○ The past performance of the firms with regard to quality, price and

adherence to time schedule has been acceptable.

○ The supplier has successfully made the last supply.

Single Tender Enquiry (STE): STE is permitted only when the

concerned competent authority/procurement agency can provide

detailed justification that no reasonable alternative or substitute exists.

STE refers to issuing tender enquiry to only one firm that is. to single

firm. It happens usually when:

○ Only when there is only one supplier licensed (proprietary item) in

respect of goods sought to be procured.

○ Only in exceptional circumstances such as natural calamities and

emergencies.

The time frame for the bids under any of these routes is determined by the

relevant procuring agency, but is usually at least 45 days.

Selection and award criteria for procurement of goods and services

These are generally governed by financial rules, which are contained in

subordinate legislation prescribing detailed selection criteria. Bid documents

are developed and tailored to the needs of the concerned government

office, and they will contain technical requirements, qualification of bidders,

and their expertise/experience. The tender will also state whether it is a

local, national or international tender depending upon the procurement item.

All tenders are generally displayed on the relevant procurement agency’s

website.

The lowest evaluated tender is the primary award criterion. This criterion is

arrived at by considering the tender price, the cost of operating, maintaining

and repairing the goods or construction, the terms of payment and all

guarantees (example payment, performance and other security) in respect

of goods or construction.



Checks and balances

These checks and balances are taken into consideration at each level of

government to ensure transparency in the procurement process.

Comptroller and Auditor General (CAG) and Central Vigilance Commission

(CVC) are two centres which have been constituted to ensure such

transparency.

CAG, who is constitutionally appointed by the GOI, oversees the accounts

of the Union and the States. The reports of the CAG, which also cover

procurement, are presented to each house of the Parliament and the

Legislature of the relevant State.

The CVC is now a statutory body established under the Indian Central

Vigilance Commission Act, 2003 and supervises investigations under the

Indian Prevention of Corruption Act, 1988 and the vigilance administration of

the Central Government. State Vigilance Commissions also have been set

up in some States. Some guidelines given by CVC for public procurement

are:

Public announcement of tenders should be made through print media

and applicable websites.

Unambiguous qualifications and other conditions are a must.

No alteration or amendment of qualifying requirements is permitted post

facto.

Negotiations are permitted only with lowest valid price and only if

unavoidable.

Sufficient time for bidders to assemble and submit bids must be

provided upfront.

Clarification, if any, must be uniformly issued to all bidders.

Types of contracts

The types of contract selected depend on the needs of the relevant

contracting authority. The GOI DGS and D (Directorate General of Supplies

and Disposals) is the central purchasing organisation of the Government of

India. It is responsible for the procurement and purchase of supplies

required by the Ministries of Defense, Indian Railways and other

government organisations. The types of contract prevalent are:

Rate contract: It is called the Rate Agreement. It is a contract for the

supply of goods at a specified rate during the period of the contract. No



quantity is mentioned and the contractor is bound to accept any order,

which may be placed on it. It is used for bulk procurement. The

advantages of rate contract are:

○ Facility of bulk rate at lowest competitive price.

○ Saves time and effort in tedious and frequent tendering at multiple

user locations.

○ Enables buying as and when required.

○ Just in time availability of supplies reduces inventory carrying cost.

○ Availability of quality goods with full quality assurance back up.

Running contract: It is a contract for the supply of an approximate

quantity of goods at a specified price and for a certain period of time.

Repair contract: This contract is a maintenance contract used for

computers, equipment and machinery and which is entered into for a

period of one year, initially after the expiration of the warranty/guarantee

period. If the service is found satisfactory, the existing contract may be

renewed for an additional period of one or two years without requiring

the formalities of a new contract.


13. STE refers to issuing tender enquiry to only one firm. (True/False)

14. According to constitution of India, the executive powers are in the

hands of _________ of India.

15. The _________ is the contract for the supply of goods at a specified

rate during the period of the contract.

Activity 2:

You as a procurement manager of a company, plan to purchase some

goods required for a project from outside vendors. You find out that there

are very few vendors in market for the item that you plan to purchase.

What type tendering process will follow?

Hint: Refer the tendering process

2.5 E-Procurement

In the last section we discussed about public procurement in India and in

this section let us discuss about E-procurement.



Globalisation has made public procurement a specialised function. Today’s

business environment calls for efficient, responsive and transparent

procurement procedures. As Information Technology (IT) has become a

possible solution for many administrative problems in the public sector, it

has also converged in almost every area of public procurement and has

revolutionised the process of public buying known as e-procurement.

E-procurement has emerged as an innovative alternative to achieve a

better, cost-efficient system. E-procurement is the also known as supplier

exchange. This is a system which uses internet technology to streamline the

purchases of goods and services to reduce cost. Here, management of

purchasing and procurement are activities are carried out via internet. If a

system is managed correctly it helps to connect companies and their

business processes directly with suppliers.

We can say that e-procurement is the use of electonic means to improve the

procurement of goods and services, both in private and public sectors.

E-procurement helps in improving the working of the acquistion proces and

the communication along the supply chain.

Some of the benefits of E-procurement are:

Reduces tender processing time.

Reduces cost for government.

Transparency of tendering process.

Increase in average number of bidders per tender.

Helps in decision making process.

Helps in keeping the information neatly organised and time stamped.

Transactions are standardised and are also track able.

Reduces inventory levels.

Helps in content gathering for the buyers (Contents like product number,

bid prices, and contract points).

E-procurement encompasses a wide variety of tools, including purchase

card, online catalogues, electronic payments and so on. E-procurement is

done with a software application that includes features for supplier

management and complex auctions.



We can categorise e-procurement into seven types:

Web-based ERP (Enterprise Resource Planning): This is used for

creating and approving purchasing requisitions, placing purchase orders

and receiving goods and services by using a software system.

e-MRO (Maintenance, Repair and Overhaul): It is similar to the web-

based ERP except that the goods and services ordered are non-product

related MRO supplies.

e-sourcing: This helps in identifying new suppliers for a specific

category of purchasing requirements.

e-tendering: This helps in sending requests for information and prices

to suppliers and receiving the responses of suppliers.

e-reverse auctioning: This involves using Internet to buy goods and

services from a number of known or unknown suppliers.

e-informing: This helps in gathering and distributing purchasing

information both from and to internal and external parties using Internet.

e-market sites: This is an expansion of the web ERP. Buying

communities can access preferred suppliers' products and services, add

to shopping carts, and perform all the buying procedure online.

The number of people buying online is growing rapidly in repetitive and it

also is a low cost transaction. Such transactions are enabled in high

volumes through e-procurement systems. It is therefore necessary for

today’s and future procurement managers to develop their skills with the

latest technologies of Internet and electronic communication. However, in

project contracting, contract management skills involving people skills and

negotiation skills will continue to play a very important role.

Activity 3:

Consider that you are a procurement manager of a company and you

plan to improvise the procurement process by implementing an

e-procurement system. How will you convince your management to

implement the e-procurement system?

Hint: Refer benefits of e-procurement under E-procurement




16. E-procurement is the also known as supplier exchange. (True/False)

17. E-procurement reduces costs for the government. (True/False)

18. Low cost transactions are enabled in high volumes through

___________.

2.6 Summary

We have discussed the standards of project procurement management.

Project procurement deals with the processes necessary to acquire goods,

services, or results from an external resource. This includes administering

the procurement so that it is carried effectively and completed on time. We

also understood that project procurement management involves

documenting the procurement plan, planning and solicitation of goods and

services, soliciting suppliers for goods and services, selecting suppliers,

administering the contract and closing the contract.

We then analysed the four processes (as per PMBoK) of procurement

management in detail. We learnt that the plan procurement process is a

process of determining the goods and services to be purchased. This

process also includes documenting the purchasing decisions, selecting the

approach and identifying potential sellers.

We learnt that the procurement plan acts as an input to the conduct

procurement process, which is the next process after plan procurement. We

also learnt that the conduct procurement process describes how the

procurement processes are managed from the plan procurement til the

closure of procurement.

In the admister procurement process, we learnt that this process involves

managing the buyer seller relationship and checking if the performance of

both the parties meet the contractual requirements. We also studied that this

process also includes monitoring payments to the seller.

We have understood that the close procurement process is the last process

and it involves administrative activities like finalising open claims, updating

records to final result and archiving such information.

We have also discussed about the public procurement in India, India is a

federal constitution and public procurement is governed by both central and



state Government. We reviewed public contracting under legislative

framework, tendering process, award criteria, checks and balances, and

types of contracts scenarios.

We have discussed about E-procurement which provides advantages such

as reduced tender time process, reduced costs for government, and

transparency of tendering process.

2.7 Glossary

Term Description

Bidding To offer a particular amount of money for something which is for sale.

Incentive Something which encourages a person to do something.

Procurement List of obtaining the supplies.

Reimbursement Expenses given back for the money spent for any official work.


1. What is procurement management?

2. Explain the plan procurement project process.

3. Explain the close procurement project process.

4. Explain the administer procurement project process.

5. What is E-procurement?

2.9 Answers


1. Legal documents

2. True

3. Life cycle

4. False

5. Procurement plan

6. True

7. True

8. Invitation for Bid

9. Conduct procurement

10. True

11. Close procurement



12. False

13. True

14. President

15. Rate

16. True

17. True

18. E-Procurement

Terminal Questions

1. Refer section 2.2 Overview of procurement management.

2. Refer section 2.3 Basic steps in procurement process.



5. Refer section 2.5 E-procurement.

2.10 Caselet

E-Procurement system

Chroma is one of the largest manufacturers of nitrogenous fertilizers in

the world. Chroma had a manual procurement system but it was plagued

by problems of inefficiency. Vendors from distant locations were finding it

difficult to contact Chroma, collect bid documents and submit quotes on

time. Many a time, local vendors like transport contractors or local service

vendors, material handling contractors and local service vendors did not

allow other vendors to collect tender document, submit quotes or

participate in the bid opening and finalisation process. To tackle this

problem, the procurement manager of Chroma decided to put together an

e-procurement system.

The whole process of e-procurement was new to vendors, partners and

even internal users. Many of them were not computer savvy and some

have not even used computers earlier. The whole legality of the process

was under a cloud

For the smooth rollout of the e-procurement system, he setup help desks

at Chroma’s corporate office, plants and major marketing offices to

address the queries of vendors. The management was not sure if e-

procurement was the right way forward. The procurement manager

explained the entire process to the management, and told them about its



benefits. The management agreed, but added a clause stating that the

system should be audited by an internal audit.

He zeroed up on a leading e-procurement vendor and implemented the

e-procurement system for the company. Thus, the e-procurement system

increased the efficiency of vendor management.

After implementing the e-procurement system Chroma saves on cost of

printing, dispatch, human resource, and filing, while vendors save on cost

of travelling, preparation of bid and dispatch.

Questions:

1. Why did the procurement manager decide on implementing the e-

procurement system?

2. How did Chroma benefit from the e-procurement system?

References

Fourth Edition - A guide to the Project Management Body of knowledge

http://en.wikipedia.org/wiki/Pricing_strategies

http://www.allbusiness.com/legal/contracts-agreements/734-1.html

http://www.businessdictionary.com/definition/void-contract.html



Unit 3 Overview of Construction Contracts

Structure:

3.1 Introduction

Objectives

3.2 Understanding Project Contracts

D-B-B

D-B (Design and Build)

3.3 Types of Construction Contracts

Lump-sum contracts (also called Lump-sum fixed price or Fixed

price contracts)

Cost-reimbursable contracts

Unit rate contracts

3.4 Standard Conditions in Construction Contracts

3.5 Summary

3.6 Glossary


3.8 Answers

3.9 Caselet

3.1 Introduction

In the previous unit you learnt about the procurement management. You

understood the steps for procurement process along with public

procurement in India. You also understood e-procurement.

Project contracts involving setting up any physical facility will always involve

construction. Construction can be undertaken only when the designs and

drawings of the facilities are available and the equipment and materials

required for the facilities are procured. Hence construction contracts

invariably involve varying degrees of design scope and procurement scope.

In this unit we will discuss the methodologies for construction contracts

along with types of contract. We will also discuss few standard conditions

that should be implemented in contracts for work.

Objectives:


explain board methodologies for project contracts.



explain the types of contract for construction.

explain works contracts tax in India.

list the salient features of FIDIC.

3.2 Understanding Project Contracts

Project contracts invariably involve construction and therefore we will

discuss contracts necessarily involving construction in this section. In

addition to construction, other areas of work like design, engineering and

procurement are involved in project contracts, but all these up front areas of

work have to be followed by construction and subsequent commissioning of

the project. In this section we will discuss about contracts combining some

or all of these areas. Units 4, 5 and 8 deal with project contracts in much

greater detail.

A construction contract between Principal and Contractor can be formed by:

Negotiation.

Competitive tendering.

Combination of both.

Mode 1 contract is formed by direct negotiation by the principal with one

contractor. This mode is adopted only when work is very urgent, or when the

principal believes that only one contractor is capable of building the project,

or when the principal believes that time and money spent on tendering is

wasteful. This is practically non existent in government contracts, but can

occur, although rarely, in private industry.

Mode 2 competitive tendering is inviting for bids from several contractor to

extract the best performance from the contractors. Competitive tendering

exists invariably in public contracting.

Mode 3 is an approach to negotiate with two or three bidders for securing

the best possible price. When this is a post-bid negotiation, there is a

danger that the lowest price bid agreed in the contract may not be realised

on account of the contractor as he may have been coerced to accept a low

price for getting the contract. The danger is that the cost risk gets

transferred either to the principal through claims under the contract or to

subcontractors.



Whatever be the mode of contracting adopted, we will now discuss

contracts from the viewpoint of the scope of design and construction. When

the two areas of work that is, design and construction is involved in a

project, a third dimension of work viz. coordination necessarily arises. This

combination means that the project manager must thoroughly understand

the contracting strategies that can be adopted to ensure the ultimate

achievement of the project deliverables.

We discuss two broad methodologies in this section viz D-B-B (Design, Bid,

Build) and D-B (Design and Build)

3.2.1 D-B-B

This methodology separates the design and construction functions. In this

method you as an employer hire a designer to provide the complete set of

drawing required for construction. This drawing approved by you is then

passed to a contractor for executing the project. Figure 3.1 depicts the D-B-

B set up with several construction contractors.

Figure 3.1: D-B-B Set up with Several Construction Contractors



Figure 3.2: explains D-B-B set up with a general contractor.

Figure 3.2: D-B-B set up with one General Contractor

The responsibility for design and construction are spread between more

than one entity in both these D-B-B set ups. The project is split into work

packages (one work package given to one contractor). Interface needs to be

maintained between the designer and each contractor as well as between

the contractors. You (through the Engineer) should take responsibility for

coordinating these work packages for example in a hydroelectric project, the

designer, the civil and electrical contractors should be in coordination. The

designer should plan the building with the required set of specification for a

turbo generator and the civil engineer should understand the special design

and use the right material that can withstand the vibrations of the turbo-

generator.

In the D-B-B mode, it is also possible to award the construction contract to

one general contractor who in turn will award subcontracts for works in

specific areas. For example, in a building contract, the general contractor

may be essentially a civil works contractor who will award subcontracts to

an electrical subcontractor, ventilation and air-conditioning subcontractor,

fire protection system subcontractor, lifts subcontractor and so on.



Following are the advantages of D-B-B mode:

This mode is impartial to the construction contractors as they are

selected by competitive bidding. It protects the interests of the owner

(you), since the design details would have been substantially finalised

before awarding the construction contracts.

Incomplete, incorrect or missed items in the design will surface during

comparative evaluation of bids and can be corrected.

Quality of work is improved because of competitive bidding.

Following are the disadvantages of D-B-B mode:

The design team is responsible for cost estimates for the project with

break ups for different areas and if the estimation is not up to date, the

project cost will be increased.

The general contractor gets involved only in post-design phase. Hence

his inputs will have severe constraints to incorporate.

If the general contractor hires subcontractors, he may possibly sacrifice

quality in order to bid low for the project (this applies to mode shown in

figure 3.2).

3.2.2 D - B (Design and Build)

This is also called the Turnkey method. This places the entire responsibility

for the project that is. both design and construction on the Design and Build

contractor. The turnkey method is often also called EPC (Engineer, Procure

and Construct) .In this method you look no further than the D and B

contractor for the accountability as to performance and quality. You neither

get involved in any phase of the project nor coordinate.

Following are the advantages of D-B mode:

It minimises project risk for the owner.

The general contractor retains the design phase thus reducing project

delivery schedule.

You (owner) need not get concerned with arguing whether a defect that

is observed is due to design or workmanship because single point

responsibility is on the contractor.

Constructability is taken into consideration in the design phase in an

effective manner when design and construction are performed by the

same entity.



Following are the disadvantages of D-B mode:

The cost estimate can be premature, since D-B contracts are often

written keeping allowance for unexpected situations.

Regulatory review can lead to design changes resulting in change

orders in project since both design and construction are being performed

in parallel.

If the D and B contractor resorts to short-cut design methods, the project

scope gets ill-defined.

You are distanced from the design aspects and hence it is difficult to

exercise variation power.

World Bank invariably suggests two-stage bidding (techno-commercial,

which is unpriced bids are evaluated first, and priced bids are called only

after completion of this evaluation). This is suggested in order to avoid the

temptation of accepting bids based on price rather than quality of design.

However, D-B contracts are extensively adopted today, especially in USA. A

common example of D and B contract in India is implementation of thermal

power plant projects, wherein the size/nature of the plant desired as well as

the operational output/consumption of consumables to reach that output are

committed by the D and B contractor under penalties for non performance.


1. One of the disadvantages of a D-B mode of contract is that, the cost

estimate can be _____________, since they are often written keeping

allowance for unexpected situations.

2. The advantage in D-B-B mode of contract is that, the quality of work for

is improved because of __________.

3. The disadvantage of D-B-B mode of contract is that, the general

contractor gets involved only in __________ phase. Hence his inputs

will have severe constraints to incorporate.

Activity 1:

You are constructing a multiplex with multiple cinema halls. You need

good acoustic to the building. What methodology of the contract do you

think will suit you and why?

Hint: Refer section 3.2



3.3 Types of Construction Contracts

In the previous section we understood the broad classification in a

construction contract type. In this section we will discuss contract from a

standpoint of project cost.

We noted two broad types of construction contracts viz. D-B-B and D-B. For

a project to be implemented, the work scope can be any combination of the

following scope elements:

Design (basic design and detailed design).

Procurement (goods and services).

Construction (includes installation and commissioning).

Plant operation after commissioning.

The primary deliverables of a construction project are completion schedule,

as-built cost and quality .First we will analyse the possible contracting

modes from the viewpoint of controlling project cost. From this viewpoint, we

need to look at two ends of the spectrum viz. Lump-sum (fixed price)

contract and Cost-reimbursable contract.

One of the most important tasks in procurement planning is the selection of

the appropriate pricing strategies for major contracts. This task should be

accomplished in the early phases of the project. The pricing strategies

selected should balance the risks between the contracting parties. These

strategies will have a considerable impact upon the organisation and

management of control systems required for a project.

The selection of an inappropriate approach will have a negative impact on

the quality, cost and schedule of the work performed.

3.3.1 Lump-sum contracts (also called Lump-sum fixed price or Fixed

price contracts)

In a lump-sum or fixed price contract, the prime contractor agrees to

complete the project, as described in the contract documents, for a fixed

price. For rigid fixed-price contracts, once a contract is in place the

contractor is responsible for any cost-overruns. In this case, the buyer is

responsible for providing a complete definition of what is required and

schedule for delivery. The price provided by the seller is going to include an

estimate of its costs and its profit.



Fixed-price contracts are effective when the scope of work is well-defined.

Fixed-price contracts shift at least some of the uncertainty associated with a

project to the contractor. The evident advantage of a Fixed-price contract is

that it encourages efficiency in the contractor‟s work since the level of profit

realised depends on a contractor's ability to control costs. However, they are

inflexible to modification in project activities once work has commenced as

per the contract.

Variations of fixed price contracts

Other forms of fixed-price contracts allow variances or change orders if

conditions are significantly different from what the original statement of work

described. A portion of the fixed price applied for items of work that cannot

be quantified in the beginning can adopt this mode of Unit prices. This is

discussed later in this section under the heading „Unit Price Contracts‟.

Another variation is that if a project has a long duration, the fixed price

contract might include an allowance for future labour and material escalation

costs. Some public sector undertakings in India (example, Nuclear Power

Corporation of India Ltd.) allow escalations for projects having a completion

period of longer than twelve months, and do not allow escalation if the

period is less than twelve months. It must be noted here that theoretically,

the escalation can result in either an increase in the fixed price or a

decrease in the fixed price depending on how the indices vary.

EPC contracts

EPC refers to Engineer, Procure and Construct, which implies that the three

scope elements viz. design, procurement and construction are in the EPC

contractor‟s scope. D-B contracts have the nature of EPC contracts except

that financing is invariably involved for the contractor in the case of EPC

contract. Also EPC contracts are usually of the Lump-Sum Turn Key type

(LSTK).

Lump-Sum Turn Key type (LSTK) contract

Lump-sum turnkey (LSTK) EPC contracting is now popular world-wide as a

project delivery system for large process and power facilities. Examples are

steel mills, LNG facilities, petroleum and petrochemical facilities and power

plants. It is also being adopted for large infrastructure developments such as

airports, water treatment facilities and telecommunication systems. While

the term LSTK implies a fixed price for the whole contract, you must



understand that several variations of the EPC mode of contracting are in

vogue. The contract price issue can however vary from „fixed price‟ to a

„hybrid price‟.

LSTK EPC contracts offer the following benefits:

It fulfils the primary expectation of a single point of responsibility (SPR)

for all facets of project. You (owner) can transfer more risk to the EPC

contractor, understanding that this risk allocation carries a higher price

tag. Examples of some risks that can transferred to contractor in a EPC

contract are:

o Contractor should account for existing site conditions (including sub-

surface conditions).

o Even risk for some force-majeure conditions can be transferred to

contractor.

If the scope of the contract is well defined, the potential for significant

changes is very low. Without the risk of significant changes, the

schedule for performing the work is unlikely to change. In this case, a

fixed-price contract is usually the best approach.

The drawbacks of the LSTK EPC contract are:

It provides less incentive for a contractor to minimise schedule duration

than in the case for reimbursable contracts.

Fixed-price suppliers and contractors often minimise quality

management activities in order to reduce costs.

Renegotiations of the price might delay the schedule as the fixed-price

contractors are reluctant to proceed with any work associated with a

change request before resolving the cost of the change.

We will now review few noteworthy characteristics and legal issues

concerned with LSTK EPC contracts, the understanding of which is

necessary in order to reap the benefits of this project delivery system.

Characteristics and legal issues of LSTK EPC contracts:

Design: In a LSTK EPC contract, the responsibility for basic and

detailed design rests with the contractor. You give the design criteria

and contractor gives his price based on his basic and detailed design. If

you give very clear design criteria, you become responsible for design

deficiencies. If your design criteria are ambiguous, then the contractor



should clarify this ambiguity prior to submitting his price. If the design

criteria are critical to the project, contractor should ensure that it is made

part of the contract. Otherwise, different interpretations of the design can

lead to disputes affecting both the schedule and cost of the project. This

can only be prevented by pre-contract negotiations, scope review and

clarification sessions, agreement on preliminary P and I d s (Process

and Instrumentation diagrams) and design drafts.

Changes or variations: Even when design criteria are clear, EPC

contracts allow for variations (see note on FIDIC in this section). The

impact that a change will have on the project will depend on the timing of

the change, example, a change in the P and I d at the design stage will

have less adverse impact than at the construction stage. This means

that changes should be addressed early.

Schedule delay: You regard schedule as contractor‟s responsibility in a

LSTK EPC contract. However, for you to claim compensation for

schedule delay from the contractor, you must prove that the contractor

delayed a work on the critical path of the schedule. Similarly, the

contractor should also keep producing a time-impact analysis of each

delay throughout the project in order to claim any extension in the

project completion schedule as well as financial compensation that he

may desire from you.

Force majeure: These are occurrences beyond the control of either you

or contractor for example war, terrorism, labour strikes, radiation and so

on. However, precise terms regarding force majeure conditions should

be included in the contract. These terms should also address whether

only time extension will be given for such events or whether financial

compensation will also be allowed.

Owner controlled activities: Despite the single point responsibility by

the LSTK EPC contractor, you are also responsible for contractor‟s

action, some of which are:

Adequate site access.

Assurance that basic design issues are addressed.

Facilities for commissioning like raw material feed, water, power and

other utilities as applicable which are usually in your(owner‟s) scope.



Payment and performance assurances: EPC contractor is customarily

bound for satisfactory performance by a Bank guarantee of the project

for a period (usually one to one and a half years) termed as the Defect

Liability Period. This is a help mechanism for you to recover any defects

even post project delivery.

In some contracts, contractor can get his payment assurance for work done

when you give an open letter of credit in favour of the contractor. However,

this is usually for delivery of costly equipment or imported equipment.

Insurance: Insurance companies offer several options to both owner

(you) and contractor. Examples are LD insurance, cost over-run

insurance, insurance for even some force majeure items and so on.

Insurance is an important risk mitigation mechanism that should be

adopted in EPC contracts.

EPC projects offer a mutually beneficial and exciting form of project delivery

for you as well as the contractor. However, you should not mistake the

LSTK EPC approach as a license to do anything you want without the threat

of increase in project cost or delay in project schedule. You must discharge

your responsibilities without hindering the work of the contractor. You must

realise that the goal of LSTK EPC contract is to allow the work to proceed

without disruption due to changes throughout the implementation of the

project. Otherwise many of the benefits of this mode of project delivery will

not be realised.

3.3.2 Cost-reimbursable contracts

In the previous section you learnt that Lump sum contracts are suitable for

well defined project with little variation in design. You learnt various

characteristics of a LSTK EPC contract.

In cost-reimbursable contracts you pay the contractor the costs necessarily

incurred in the construction plus a fee. The latter portion viz. the fee can be

fixed in a number of ways which we will discuss later in this section. The

main reasons for adopting this mode of contracting are:

At the time of contracting, the scope of the work is indeterminate or

highly uncertain and the kind of labour, material and equipment needed

are also uncertain.

At the time of contracting, you are unable to finalise the plans and

specifications for the project.



At the time of contracting, you are not certain whether the construction

project will be completed in full.

Cost-reimbursable contracts offer an easy response to unexpected

conditions arising during project implementation.

Under this arrangement complete records of all time and materials spent by

the contractor must be maintained. (These types of contracts are also called

Time and Material contracts or Cost-plus contracts). Evidently the risk of

cost increase in the project depends entirely upon you.

The most important question that should be resolved for finalising cost-

reimbursable contracts is to identify the following costs:

Reimbursable costs (costs that are reimbursable to contractor that is.

costs that are necessarily incurred in the performance of the work).

Non-reimbursable costs (costs that are not reimbursable to contractor).

Costs that are included in the base figure which is agreed as the basis

for determining the fee.

Typically these costs comprise the following elements:

Reimbursable costs (that is. costs that are necessarily incurred in the

performance of the work), which includes:

o Wages, payroll taxes and fringe benefits.

o Cost of all materials, supplies and equipment including the costs of

transportation, unloading thereof.

o Payments to subcontractors.

o Rental and maintenance charges for all equipment, trucks and hand

tools.

o Cost of salaries of all contractor‟s staff stationed at the field office.

o Cost of salaries of contractor‟s staff utilised for expediting of

supplies, supervising of transportation and so on calculated for time

specifically spent on the project.

o Cost of travel and travel incidentals of contractor‟s staff directly

incurred on the project.

o Premiums of all bonds and insurances incurred by contractor for the

work.

o Permit fees.

o Cost incurred for communication that is, telephone, electronic

communication and so on and for stationery at site.



o Cost of temporary site facilities like removal of debris.

o Losses and expenses not compensated by insurance which result

from causes other than the fault or negligence of the contractor.

Non-reimbursable costs which includes:

o Salaries or other compensation for the contractor‟s officers and

employees while working at the contractor‟s main office or branch

offices.

o Expenses of the contractor‟s principal or branch offices other than

the field office.

o Any capital expenses including interest on the contractor‟s capital

and any additional capital required to perform the work.

o All general overhead expenses.

Costs due to negligence of the contractor, subcontractors, or anyone

directly employed by the contractor.

While the above list is typical, there can be some variations to the list

depending on the agreement between owner and contractor. But the

contract should make these costs clear in order to avoid disputes.

Types of cost-reimbursable contracts are:

Cost Plus Fixed Fee contract (CPPF): Compensation is based on a

fixed sum independent of the final project cost. The customer agrees to

reimburse the contractor's actual costs, regardless of amount, and a

negotiated fixed fee in addition.

Cost Plus Fixed Percentage contract (CPFP): This is the same as

CPFF with the difference that the fee is a negotiated percentage of the

cost.

Cost Plus Fixed Fee with Guaranteed Maximum Price contract: The

fee is a negotiated fixed sum of money. The contractor quotes a

maximum contract price. If price exceeds this maximum, the contractor

has to bear the overrun. The contractor agrees to quote the guaranteed

maximum only when he is confident of determining it from the plans and

specifications available.

Cost Plus Fixed Fee with Bonus contract: In addition to fixed fee, a

bonus is given if the project finishes below budget, ahead of schedule

and so on.



Cost-reimbursable contracts are used mainly for R and D projects and are

rarely used in construction projects – the main reason being that assigning

responsibility to an entity for meeting the performance parameters and

controlling the performance parameters makes it very complex to the entity

to handle. Incorporating guaranteed maximum price and bonus clauses can

facilitate better control to some degree.

3.3.3 Unit rate contracts

In a unit-rate contract, the seller commits to providing each unit of work

defined by a buyer for a fixed price per unit of each work item.

Engineered materials are procured with unit-rate contracts when the design

is not complete. Service contracts can use unit rate pricing provided the

scope of work lends itself to the unit-rate approach.

Unit-rate contracts are appropriate when the units of work can be well

defined but the total quantities are uncertain. Certain standard materials that

are procured in large quantities are provided under unit-rate contracts.

This type of contract also requires an accurate definition of when the units of

work will be delivered or installed, unless the contract contains an escalation

clause. Unit-rate contractors are usually reluctant to increase personnel,

overtime and shift work to accelerate the schedule of their work.

In this scenario, the seller carries the risk of the cost per unit, and you

should assume the risk of quantity growth in the number of units.

Unit prices are fixed for normal duration contracts, but for linger duration

contracts (say 2 years or more), contracts usually permit variation due to

escalation based on published indices incorporated in an agreed escalation

formula. Another reason for variation in unit rates that may be permitted is

variation greater than (plus) or (minus) a certain percentage (say + or –

20%) in the final contract price compared with the estimated grand total

contract price.

You must not view unit rate contracts identical to cost reimbursable type

since, in unit rate contract the unit rate for all work items are fixed based on

the description of the work and only the quantity is subject to variation.



Also, when using unit-rate contracts, you should remember that:

Unit-rate and cost-reimbursable work should not be included in the same

contract.

Unit-rate contracts require an accurate method of reporting completed

work units.

If the scope of a contract is well defined, stable, and the schedule for

performing the work is unlikely to change, a fixed-price contract is the best

approach. If the units of work can be well defined, but the total quantities are

uncertain, a unit-price contract is the best approach.


4. All fixed price contracts do not allow any variation whatsoever in the

fixed price (True/False)

5. A unit rate contract is a fully cost-reimbursable contract (True/False)

6. R and D contracts are usually awarded on a cost-reimbursable mode

(True/False)

Activity 2:

You are working in a public sector and you have to construct 23 schools

in the next one year. Which type of contract will you adopt and why?


3.4 Standard Conditions in Construction Contracts

In previous section we learnt about various types of contract and how they

can be suitable to your project. In this section we will learn about the

standard conditions in a construction contract.

Practice in India

Project firms in India develop their own general conditions of contract. For

construction contracts, the following documents are prepared as forming

part of the contract:

1. General conditions of contract.

2. Technical conditions of contract.

3. Special conditions of contract.



The format for a contract document will have following in order:

Document 1 is the standard template of the firm consisting of normal

clause applicable for all contracts.

Document 2 is prepared specifically for each contract.

Document 3 is also specifically prepared for each contract to override or

modify some of the clauses in document 1.

Federation Internationale Des Ingenieurs Conseils (FIDIC)

FIDIC is an organisation founded in 1913 by three countries France,

Belgium and Switzerland. It is well known in the consulting engineering

industry for its work in defining conditions of contract for the construction

industry worldwide. It‟s „Conditions of Contract for EPC turnkey projects‟

otherwise known as Silver book is popular internationally for EPC contracts.

The salient features of the Silver Book are:

Responsibility for design lies with contractor.

Employer‟s requirements usually a „performance specification‟

(functional basis).

Contractor carries out all engineering, procurement, construction, ready

for operation at the „turn of a key‟.

No Engineer – instead the Employer.

Lump Sum Contract Price (but adjustments in limited specified cases).

Testing procedures to demonstrate achievement of specified end result.

Contractor carries majority of risks, so Employer pays more.

Final price and time should be more certain.

Small number of tenderers with negotiation.

Contractor is given freedom to use own methods.

Contractor has to prove reliability and performance.

Although FIDIC is yet to become a widespread practice in the Indian

construction industry for EPC contracts, it is internationally accepted as a

document which is fair to both the owner and contractor for EPC contracts.

Project management Book of Knowledge PMBoK

The Project management Book of Knowledge of Project Management

Institute, USA covers construction contract management in its chapter 12

titled „Project Procurement Management‟, which is one of the nine

Knowledge Management areas described in the book. Construction



contracts also form part of this knowledge management area in PMBoK.

The relevant definitions given therein are as under:

Quote for contract [Output/Input]: A contract is a mutually binding

agreement that obligates the seller to provide the specified product or

service or result and obligates the buyer to pay for it.

Contract administration [Process]: The process of managing the

contract and the relationship between the buyer and seller, reviewing

and documenting how a seller is performing or has performed to

establish required corrective actions and provide a basis for future

relationships with the seller, managing contract related changes and,

when appropriate, managing the contractual relationship with the outside

buyer of the project.

Contract closure [Process]: The process of completing and settling the

contract, including resolution of any open items and closing each

contract.

Contract management plan [Output/Input]: The document that

describes how a specific contract will be administered and can include

items such as required documentation delivery and performance

requirements. A contract management plan can be formal or informal,

highly detailed or broadly framed, based on the requirements in the

contract.

Each contract management plan is a subsidiary plan of the project

management plan.

Works Contracts Tax (WCT) in India

Construction contracts are contracts for works that is. „Works contracts‟ –

however sale of goods is also involved in these contracts to varying degrees

depending on the scope of work (including supplies by contractor) contained

in a particular contract. The introduction of the 46th amendment in the

Constitution of India in 1987 led to an important change in the statutory

sales tax regime of the states of India.

Prior to the 46th amendment, under sales tax laws, sales tax was applicable

only on „normal sale‟. After the 46th amendment, the states were

empowered to levy sales tax on „deemed sale‟ also. We examine the

difference between these two categories of sale as under.



Normal sale: Here there is transfer of property indefinite or ascertained

goods.

Deemed sale: Here the goods that are delivered and goods after the

execution of works are different for examples cement, steel, sand, electrical

fittings, plumbing fittings and so on (all in the supply scope of the agency

executing the works contract), whose form is deemed to have changed after

incorporating them in the project. Because of the incidence of deemed sale

in works contracts, these contracts are also called indivisible works

contracts or composite contracts.

Examples of contracts which involve deemed sale are building works,

erection of plant and machinery, processing jobs, job works, repair jobs,

annual maintenance contracts and so on.

It is to be noted that the sales tax for such deemed sale can be levied only

on the „material value‟ portion of the contract. While it is not in the scope of

this unit to enumerate the details of arriving at the Woks contract tax to be

paid to the state, we will note a few salient points as under:

Sales tax in India is now replaced by VAT (Value added tax) in a

majority of the states. Hence in these states, there is no WCT

transaction but the tax is now a VAT on the works contract transactions.

Supreme Court has stipulated guidelines for arriving at the material

value component of works contracts. Each State has formulated rules in

line with these guidelines.

Self Assessment Question

7. „Normal sale‟ and „Deemed sale‟ imply the same. (True/False)

8. The sales tax for deemed sale is levied only on the „works value‟

portion of the contract. (True/False)

9. The book for Conditions of Contract for EPC turnkey projects is

otherwise known golden book. (True/False)

10. Construction contracts form part of the Knowledge Area of „Project

Procurement Management‟ in PMBoK of PMI, USA. (True/False)

Activity 3:

Find out more details on “Lump Sum Contract Price (but adjustments in

limited specified cases)”

Hint: www.fidic.org



3.5 Summary

Construction is a major scope element in the implementation of projects and

hence construction contracts require careful attention in planning the

contracting strategy for a project.

We discussed that the two board methodologies for construction contract

are D-B-B (Design, Bid, Build) and D-B (Design and Build). The advantages

and disadvantages for each of the above were also discussed.

The various types of contracts for works are lump sum, cost reimbursable

and unit rate contracts. The Lump-Sum Turn Key type (LSTK) contract is

suitable for well defined project without much variation. Cost reimbursable

contracts are suitable for not so well defined project along with uncertainties.

Unit rate is suitable the work is well defined but there is uncertainty about

the quantity.

We discussed that certain conditions are standard to be implemented in

contract. The standard condition are mentioned in FIDIC and PMBoK

An important tax component which must be included in the costing for

construction contracts is the works contract tax or VAT whichever is

applicable.

3.6 Glossary

Term Description

Force majeure

A common clause in contracts that frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties occur.

Standpoint A position from which things are considered or judged

Escalations Is the phenomenon of something getting more intense step by step.

Enumerate To ascertain the numbers.


1. Enumerate the characteristics and legal issues of LSTK EPC Turnkey

contracts.

2. Bring out some factors which lead to price variation even in „fixed-price‟

contracts.



3. Explain the typical reimbursable cost elements and the non-

reimbursable cost elements in cost-reimbursable contracts.

4. Bring out some drawbacks that can occur in a lump-sum EPC turnkey

contract, and also discuss how the adverse implications of such

drawbacks can be minimised.

5. State the salient features of FIDIC contract (Silver book).

3.8 Answers


1. Premature

2. Competitive bidding

3. Post-design

4. False

5. False

6. True

7. False

8. False

9. False

10. True

Terminal Questions

1. Refer section 3.3.1 Lump-sum contracts (also called Lump-sum fixed

price or Fixed price contracts).



3. Refer section 3.3.2 Cost-reimbursable contracts.



5. Refer section 3.4 Standard conditions in construction contracts.



3.9 Caselet

Lump Sum contract

In 1998, Finland‟s first five, three-year area maintenance contracts was

performance-based contracts. This was followed by another five

contracts in 1999. This experiment established that the price was 20%

cheaper than in the traditional contracts, negotiated with another

contractor.

The experiment made the Finnish Road Administration (Finnra) achieve

good value for money spent, it was productive and innovative, optimised

risk allocation between the client and the contractor, contractor flexibility,

and better customer service.

With this success in mind, Finnra outsourcing maintenance services

through competitive bidding for maintenance contracts in 2001.

Bidding Process

The bidder selection is based both on price and non-price criteria. The

price accounted for 75%. The non-price criteria include references,

personnel, and competence; depots, and quality plan and so on. Bids

also included a 10% annual bonding requirement.

As 78% of the contracts were won by the FRE, Finnra created incentives

for the private sector to continue participating in the bidding process.

Results of PBC program

The Finnra saved 7-10% due to performance-based contracting. Its price

level went down by 50 to 40% when maintenance works were executed

by Finnra by its own labour and equipment.

Seven-year contracts were recognised more beneficial than three-year

contracts, with savings of over 13%.

Question:

1. What criteria did the Finnra use in the selection of bidder?

Reference:

World Bank Consultancy Manual.



Unit 4 Contracts Management

Structure:

4.1 Introduction

Objectives

4.2 Contract Management Process Cycle

Project process cycle

Contract process cycle

4.3 Types of Contracts

Fixed price contracts

Cost reimbursable contracts

Partially defined contracts

Letter contracts

4.4 Other Types of Contracts

4.5 Summary

4.6 Glossary


4.8 Answers

4.9 Caselet

4.1 Introduction

By now you must be familiar with the types of contracts and the features of

the different types of construction contracts. The various types of contracts

include lump-sum contracts, Engineering Procurement and Construct (EPC)

contracts, cost reimbursable contracts, unit rate contracts, and a choice of

contracts for a particular project.

At this juncture, it is imperative that we get familiarised with the various

conditions of contract that are normally adopted. Unit 3 also details us about

FIDIC conditions of contract, which are environment friendly as they have

minimum environmental impact on pollution, noise and so on. We also got

an insight into construction contract management as per the Project

Management Book of Knowledge (PMBOK) in the earlier unit.

Contracts management is an important part of business for companies that

engage in transaction based processes. In this competitive world of

manpower shortages, price competition and limited capital resources plays

a crucial role. Effective management of contracts can improve operational



efficiency, improve profitability, and make contracts more viable in the

organisation. An organisation can manage and streamline the processes

involved in procuring contracted supplies and labour by implementing a

contracts management framework. Implementing a contracts management

framework in an organisation, amplifies the operational efficiency.

In this unit, we will learn about the contract management process cycle.

Contract management can be an important means of successfully achieving

organisational goals.

A contract is a legal agreement between two or more parties for the

exchange of goods or services. Contracts are enforceable by contract law.

There are different types of contracts and they vary with industry and

according to the type of goods supplied or services rendered. We will study

about some of the types of contracts in this unit. Contracts are usually

categorised according to the type of payment but can be customised to

incorporate common elements from several different contract types.

Objectives


define contracts management, its application in project management

cycle sequentially.

explain the prerequisites that effectively drive the contract process for

successful execution of planned objectives.

discuss the various types of contracts that are universally applied in

execution of the projects and their features.

4.2 Contract Management Process Cycle

Contract management is a part of the project management. To execute any

type of project, it is important to study the phases involved in project

management. These phases form the prerequisites to the contract process.

Let us now discuss these phases in detail.

4.2.1 Project process cycle

Any project professionally planned will target specified goals within the

framework of time with available resources. The project passes through the

following six phases for achieving the desired tasks:

1. Conceptualisation: The conceptualisation stage gives a broad outline

of project, its purpose and budget estimates for the same.



2. Project definition: A project, post conceptualisation enters this stage if

it is technically feasible. This phase defines the project in detail,

develops the project description and determines time schedules, mode

of accomplishment of work and resource estimates.

3. Planning: This is a crucial phase of any project since the success of the

project totally depends on the professionalism built in this stage.

Planning takes care of creating the organisation to manage the project,

developing detailed plans, identifying tasks, budget and resources. This

should also define how the various tasks and activities in the project will

come together to complete the task.

4. Preliminary studies: This stage involves a review of planning done in

the previous stage before execution of the project begins. In this phase,

the assumptions made in project plans are validated through various

modes like data collection, discussions with experts, and so on.

5. Performance: This phase entails execution of the project as per the

plan. The project manager will use all the project control tools and

techniques in executing the project. This activity consumes the longest

time and large resources compared to other phases of the project.

6. Post completion: In this stage, the project manager evaluates the

results and confirms that the results meet the expectations of the

management. The project teams meet to discuss the strengths and

weaknesses of the project, the effectiveness of the systems and

procedures for future reference. This is followed by reassignment of

project personnel to other projects. All other activities like restoration of

equipment, facilities and so on are also taken care of in this stage.

Documents connected with the project are filed systematically for future

reference.

We must note that the contract process cycle begins with the initial stages of

the project process. Hence, documentation process can be effectively

managed if the phases of the project are systematically planned and

adhered to.

4.2.2 Contract process cycle

Contract process goes through the following stages to complete the contract

documentation cycle:

Pre tender documentation stage.

Approval of project manager for inviting tenders.



Tendering documentation.

Contract documentation.

Amendments to contract.

Closing of contracts.

Pre tender documentation stage: All the pre tender preparations are

carried out in this stage. This involves collecting technical documents like

detailed drawings, specifications, schedule of work and so on for civil,

mechanical, electrical, hydraulic, pneumatic systems required for the

project. Documents covering commercial clauses and statutory guidelines to

be followed by the contractors also need to be prepared. These documents

form a part of tender documents, which involves interaction with various

agencies including both internal and external. The documentation personnel

involved should be familiar with the nature of the project and its intricacies

so that they can adopt a comprehensive approach to this activity.

Approval of project manager for inviting tenders: The personnel

handling contract should obtain an approval from the project head or project

manager prior to issuing the tender notification. This is essential as the

project manager is the overall coordinator for the entire project and he will

be executing the functions of planning, organising, directing and

coordinating all the individual functions of the project. Any amends in the

programme in terms of change in design, budget and so on may be

incorporated in the tender documents in this stage of tendering. Slippages if

any in parameters of the project plan will weigh heavily in terms of process

time and project cost in this stage.

Tendering documentation: Issue of tender notice is the first activity in this

stage of contract documentation. The notices are published in news papers,

trade journals and portals based on the practice in vogue.

Of late e-tendering has taken off in a big way. There are websites meant for

tendering notices of various values and types of contracts. Tenderers can

also respond to notices through electronic media. There are many

advantages to this method like responding at short notice and eliminating

the use of paper promoting environment friendliness.

The following are essentials of the tendering documents to ensure flawless

and smooth documentation process:

Schedule of tender documents.



General conditions of tender (project completion schedule, method of

payments, cancellation of tender and so on).

Statutory guidelines to be followed (labour laws, safety laws and others).

Required form of tender.

Detailed drawings and specifications of the project.

Last date for submission of tenders.

Action on late submission of tenders.

Arrangement for site inspection by tenderers.

Deposit with tender documents, if any.

Contact person details for clarifications.

Criteria used to evaluate tenders.

Contracting documentation personnel should also make necessary

arrangements to facilitate tendering and finalisation of tenders like:

Forming evaluation committee for tenders received.

Opening of tenders and evaluating the same.

Taking action on late tenders.

Negotiating with tenderers.

Contract documentation: The evaluation committee finalises the bidder

based on standard practices prevailing in the company. After the bidder is

finalised, the contract documentation personnel will initiate the

documentation of contract. However, this needs the combined skills of a

legal expert depending on the nature of project.

Contract documentation begins with an offer. Offer is a proposal given by

the offeror to the offeree with certain terms and conditions mentioned prior

to the agreement. Once the offeree or the contractor accepts the offer, the

parties discuss the terms and finalise it by signing the contract. The offer

becomes a contract when the offeree sends the acceptance to the offeror

(contractee).

Amendments to contract (if any): There are instances wherein a contract

finalised and issued after all the formalities, needs to be amended for

various reasons. The change in many instances may be on request by the

contractor that may have to be adhered to considering its implications on

project. Contract documenters resort to this act only on consultation with the

project manager.



Sometimes, the amendment may be required after the commencement of

project or in the closing end of the project necessitated due to minor

changes in the implementation stage. All the amendments however have to

be executed with the concurrence of the project manager.

Closing of contracts: The contract documentation completes its cycle on

execution of the project followed by initial trials and handing over the same

to the project authorities. Project manager subjects the works or job

executed to a final check by the concerned authority before accepting the

same. All the contract documents and other relevant files are properly filed

and preserved for future reference.


1. Contracts are usually categorised according to the

______________but can be combined to incorporate common

elements from several different contract types.

2. ________is very crucial phase of project since the success of the

project totally depends on this.

3. _________ activity consumes the longest time and large resources

compared to other phases of project.

Activity 1:

Consider yourself to be the project manager of the construction of a road.

You are about to sign a tender with another company. What are the steps

involved in the contract process?

Hint: Refer section 4.2.2

4.3 Types of Contracts

There are two broad types of contracts, namely, fixed price and cost

reimbursement. Within each of these groups, there are variants of these

contracts that can be used individually or in combination.

There are no formulae that can automatically choose a contract type to suit

a circumstance and safeguard the interests of the project. While considering

the importance and magnitude of the planned contract, it is essential to have

a judgement. Usually, a person who is familiar with the influencing factors

provides the judgement. It is necessary to make an intelligent selection of a

specific or combination type of contract to fulfil a specific need. To make the

selection, the contracting personnel must know and understand each of the



types of contracts available. The personnel must also know the benefits and

limitations of each type of contract in a given situation, the requirements of

the project, and the types of risks involved.

4.3.1 Fixed Price contracts

Fixed price contracts have a preset price that the vendor must adhere to in

performing the work and in providing materials. There are different types of

fixed price contracts. They are:

Firm-fixed-price (FFP): This type of contract requires delivery of a

product or service at a specified price, fixed at the time of entering into

contract, and not subject to any adjustment. Here, the products are “off-

the-shelf” commercial products for which sound prices can be

developed. The following are the advantages of this contract:

Possesses definite design and performance specifications.

Establishes fair and reasonable price due to adequate competition.

Places full responsibility and risk on the contractor.

Encourages contractor competition, efficiency and economy.

Possesses minimum administration.

One of the constraints about pricing is the lack of flexibility in pricing and

performance.

Fixed price with economic price adjustment: This type of contract

provides upward and downward revision to the contract price within the

limits, which are contractually stipulated due to contingencies.

There are three general types:

Adjustments based on established prices.

Adjustments based on actual costs of labour or material.

Adjustments based on cost indexes of labour or material.

An example of a contingency is the rise or fall in unit rate costs for

specified labour or material utilised for the supply item. This pricing helps

in extending production life contracts that involves market or labour cost,

which can be isolated. These pricings are subject to hourly pay or unit of

sale rate fluctuations. With this pricing, the contractor must validate all

claims for price adjustments and certify the correctness and

completeness of all invoices.



The features of this contract are as follows:

It eliminates contingency allowances from contractor‟s basic price to

incorporate economic price adjustment provision.

It is applicable if instability of market and/or labour is expected over

an extended period.

It possesses specific criteria for determining acceptability of wage

and material rate fluctuation, that is, a Government order, union

contract, prices published in specified newspaper, trade publications

and so on.

One of the constraints of this type of pricing is that it transfers part of

price risk to the project, thereby increasing administrative cost and

burden to the project. It restricts adjustment to general contingencies

beyond the control of the contractor. Also, the adjustment applies only to

specific wage or material cost rates. The upward adjustment will not be

applied due to non-excusable fault of contractor.

Fixed price incentive contracts (FPI): This contract provides incentive

for efficiency and economy in performance using the following:

High profit for outstanding performance.

Modest profit for mediocre performance.

Low profit or loss for below average performance.

This contract is applied when a firm-fixed-price is not suitable. There is

also a possibility of cost reduction. Incentives will likely result in savings

and better performance. Achievable incentives must be identified and

criteria established for evaluation of performance to determine if

performance are met. These incentives must be objective. This type of

pricing motivates contractor efficiency and economy. As the contractor

performance increases, the profit also increases as profit is directly

related to contractor performance. In this contract, performance and

delivery incentive provisions may be added to cost incentive. Billing

price flexible within ceiling limits is also established at the time of award

as interim basis for payment. The limitation of this contract is that it is

difficult to evaluate performance.

Funds are obligated for the target price and there are two types. They

are:

Fixed-Price Incentive (Firm Target).



Fixed-Price Incentive (Successive Targets).

Fixed price incentive (Firm Target): In this type of incentive, the

parties agree on possible range of cost of performance and

negotiate initially. This is applied whenever a firm target and formula

for establishing final price is negotiated. This incentive provides a fair

and reasonable incentive and confidence in achieving high

performance. It also helps in identifying technical and cost

uncertainties. Contractor has full liability for all incurred costs beyond

the price ceiling. The benefits of this incentive are as follows:

It provides timely and positive incentive to the contractor to

control costs.

It enables the contractee to obtain material and/or services at a

lower cost than what is normally expected.

This has several limitations such as it requires establishing realistic

target cost where there is equal probability of an under-run or over-

run. Within limit of price ceiling, the contractee shares cost of over-

run with the contractor. Unrealistic target price can invite reversing

the goal of the incentive provision, that is, cost over-run may not be

reflective of lack of cost control by contractor, nor cost under-run

reflective of outstanding cost control by a contractor.

The contractor‟s accounting system is adequate for a firm target cost

to be negotiated prior to negotiating firm target profit or share

formula.

Fixed price incentive (successive targets): In this type of

incentive, the parties agree on possible range of cost of performance

and negotiate at outset. The contract includes: an initial target cost,

profit, ceiling price, a formula for fixing the firm target profit and a

specified production point incident to the contract to apply the

formula. When the production point is reached, the firm target cost is

negotiated, considering experience and cost and then the formula is

applied to obtain the firm target profit. The formula, including the

profit ceiling and floor may then be retired. The original price ceiling

set for the initial target price may be sustained or adjusted downward

as per negotiation. If the firm target price is considered reasonable

and provides normal risk for the contractor, a FFP may be



negotiated. If this is felt inappropriate, parties may negotiate a

formula for establishing final price (by negotiation on completion of

the contract) using the firm target price as a guide.

This is applied when the available pricing data at the outset is not

sufficient to permit the negotiation of a firm target price. When we

are sure that additional reliable costing data will be available at an

early point in the performance of the contract, we can either use a

FFP or firm targets to permit negotiation. Although used infrequently,

its main usage has been on second production contracts of newly

developed items where the contractor is still pursuing the first

production contract. This type of pricing enables application of profit

motive through economic incentive under circumstances that

preclude firm target incentive at the outset.

The disadvantages of this type of approach are that it increases

administrative burden and cost to both contractee and contractor.

Cost or pricing information must be adequate to establish a

reasonable firm target cost at an early point in contract performance.

Also, there is a possibility that the contractor may not maximise

economic potentials during the initial target period in order to keep

the firm target cost high.

Fixed price with prospective price re-determination: This facilitates

FFP for an initial period as long as it allows fair and reasonable pricing

at outset. Re-determination periods are generally at least 12 months,

expressed in terms of units delivered or as calendar date and can adjust

price up or down. Ceiling price is optional, applied to total contract, or

alternatively, a ceiling amount stipulated for each or any re-

determination. Level of ceiling price should reflect reasonable sharing of

risk. In this, negotiation of re-determined price applies to all cost factors,

including profit. This is appropriate for a long term, quantity production

contract for which a FFP can be agreed upon for only part of the

contract period. This can eliminate or reduce charges for contingencies.

When parties lack adequate long range cost data, and accurate cost

computation, escalation is not appropriate. The benefits of this approach

are that it:

Provides means of eliminating contingencies.



Provides protection to contractee and contractor where specs are

not definite enough to allow firm and accurate cost estimates.

Allows contracting officers to adjust profit in relation to the degree of

efficiency, economy and overall quality of contractor performance.

The limitations of this contract are as follows:

Transfers part of risk to the contractee.

Requires contractor accounting system to be adequate for re

determination of prices.

Burdens the administration as It is of relatively high cost.

Prolongs the period of funding obligation before correct and final

funding need is known. It cannot be used unless FFP contract is

inappropriate.

Cannot be used if administration of the re-determination clause

would cost more than allowing on contingencies.

Cannot be used as a substitute for intelligent and timely initial

analysis and negotiation of price.

Fixed price with provision for re-determination: This contract

provides for a price ceiling and retroactive re-determination upon

completion of the contract. It also includes fair and reasonable billing

price for interim payments and price ceiling that reflects reasonable risk

by contractor. This is applicable where a fair and reasonable FFP cannot

be negotiated, and the amount of money involved is small or the time for

performance is so short that use of any other type contract is

impracticable. The most important benefit it has is same as for fixed

price with re-determination.

The limitation of this contract is that it provides minimal incentive to

contractor to control costs.

4.3.2 Cost reimbursable contracts

These contracts involve payments to sellers for all the cost incurred to

complete the work, plus a fee representing seller profit.

Cost reimbursable contracts are negotiated at the time of award. This

contract is applied when fixed price contract is not possible because of

uncertainties in performance magnitude. The benefit of this contract is that it

is economical if contractor is efficient and conscientious in performance. It



has several limitations as it has heavy technical administration monitoring.

In this, ceiling amount cannot be exceeded without contracting officer

approval and contractee pays only incurred costs. Contractee surveillance

during performance will provide reasonable assurance that efficient methods

and effective cost controls are used.

Cost sharing: This is called share-in-savings wherein the contractor

provides service or product with little or no upfront funding by the agency. It:

Helps in sharing cost in lieu of full reimbursement of cost.

Helps in payment of costs only.

Cost share agreement is reached prior to award. This is applicable only

when there is a high probability that the contractor identifies substantial

benefits such as savings, revenue, or improved efficiency. It benefits both

contractor and contractee.

The cost reimbursable contracts are of the following types:

Cost-plus-fixed-fee (CPFF) contract: In this type of contract, estimated

cost and fixed fee are negotiated at the time of award. Costs are

reimbursed up to the estimated cost (limited), and specified fee paid.

Fee is not changed unless there is a change in work or term of the

contract. Its application is such that use of any fixed price contract is

inappropriate. The benefits of this contract are that it may proceed with

general scope and indefinite specifications. Its constraints are that it

provides minimum incentive to contractor for cost control. Contractee

monitoring during performance will provide reasonable assurance that

the contractor uses efficient methods and effective cost controls. In this

contract, a renewal for further performance under the term is considered

as a new procurement and involves new fee and cost arrangements.

Cost-plus-incentive-fee (CPIF) contract: In this type of contract, the

following are negotiated at the time of award:

Target cost, target fee, minimum and maximum fee, and fee

adjustment formula.

Delivery, performance or cost incentives – individually or a

combination of both are negotiated at time of award.

The formulae are then applied subject to the minimum and maximum fee

limits after completion.



Fee is adjusted as increased from target for cost under run and

decreased for cost over run. Performance objectives are known.

Confidence in achieving objectives is also high.

Probability of large cost variance does not dictate use of this contract

type in lieu of a fixed price, that is, incentive. The benefit of this contact

is that it encourages economic, efficient and effective performance when

cost reimbursement type of contract is necessary. The disadvantage of

this contract is that it keeps heavy burden on both contracting and

technical personnel to administer.

Cost-plus-award-fee (CPAF) contract: This combines characteristics

of CPFF and CPIF contracts. All allowable costs are reimbursed;

contractor‟s performance will be measured against an award fee plan

that contains evaluation criteria. The government establishes specific

times for evaluation of performance to determine the quality of the effort

and the amount of fee earned. This contract is applicable when another

type of contract cannot be used because definite milestones, targets, or

goals to measure contractor performance cannot express performance

objectives. The advantage is that it provides more incentive for

contractor economic efficiency than a cost-plus-fixed-fee where use of a

cost plus-incentive- fee is not feasible. The constraints are that it has

significant emphasis on contract monitoring and administration. This

system must not be used:

To avoid cost-plus-fixed-fee (CPFF) when the criteria for a CPFF

contract applies.

To avoid the effort of establishing objective targets so a cost-plus-

incentive fee contract can be used.

To procure engineering development or operational systems

development which have undergone contract definition (Once the

development has been completed and the requirement defined, then

a Firm Fixed price contract would be more appropriate).

These types of contracts are not suitable when the contract amount,

period of performance or the benefits expected are insufficient to offset

the additional administrative effort or cost. In this, performance is

affected by inefficient contractee administration action. Timeliness of

periodic evaluation reports is also critical for proper administration. The



statement of work should indicate precisely what results the contractee

expects. The amount of the award fee that is actually paid is determined

by the contractee‟s evaluation of the contractor‟s performance in terms

of criteria stated in the contract.

4.3.3 Partially defined contracts

Partially defined contracts 1are agreements where either the specific

goods/services, the delivery schedule, or the quantity is unknown at the time

of contract execution. Partially defined contracts are of the following types:

Firm-fixed-price level of effort term (FP/LOE): This is applicable to

cases where work cannot be defined clearly. The level of effort desired

can be identified and agreed upon at the time of award. This is useful in

research and exploratory development. It requires expenditure of a

specific number of labour hours during a stated period of time. It

describes the scope of work in general terms (usually investigation or

study). The contractor is required to submit reports which show the

results achieved with the level of effort. The payment is based on effort

expended and not on results. The benefits of this contract are that under

FP/LOE contract, the contractor must perform without increase in price

and level of effort. The level of effort desired must be identified with

reasonable assurance that the results desired could not be achieved by

fewer labour hours. Heavy technical administration burden is required to

assure that contractor makes best possible effort to achieve desired

results within specified level of effort. The constraints are that there is no

guarantee that results will be achieved. It should be used only when the

work to be performed cannot be defined clearly.

Indefinite-delivery/indefinite-quantity contracts: This contract does

not fully specify the time of delivery and/or the quantity to be delivered.

However, it provides an estimate with a minimum and maximum number

of the requirements to be ordered. It contains terms and conditions that

will apply to future contracts (orders) during a specific period of time. It

provides description of supplies or services (as specific as practicable)

and identifies methods for pricing, issuing of orders, and delivery terms.

1 Enterprise Contract Management: A Practical Guide to Successfully Implementing an ECM Solution, by

Anuj Saxena, 2008



Its benefit is that it saves time in negotiation. Its constraints are that

terms and provisions of an agreement may be changed only by

modification of the agreement and not by a contract incorporating the

agreement. It will not imply agreement to place future contracts and shall

not be used to avoid competition.

4.3.4 Letter contracts

Letter contract is a legal, preliminary, negotiated contract that authorises

contractor to start work pending negotiation of a definitised contract, which

may be of any type, or combination of types. It offers maximum liability of

the contractee (amount estimated to be necessary to cover performance

until definitised), and the type of contract anticipated to be negotiated. Its

application must be in emergencies only. An immediate binding agreement

is required so that performance can start. Its benefits are that it expedites

the procurement process; contractor begins performance on urgent

requirements prior to completion of procedural requirements. Its constraints

are that there is no incentive for cost control by the contractor. The

contractee will be in a very weak bargaining position at the time the contract

is definitised. A letter contract may be used only after the head of the

contracting activity determines in writing that no other contract is suitable.

This can easily result in the contractee paying more for less, or ending up in

a dispute, which is a manpower intensive procedure for both contracting and

technical personnel.

The following are few factors that must be avoided while using letter

contracts:

Commit the contractee to a definitive contract in excess of the funds

available at the time the letter contract is executed.

Be entered into without competition.

Be amended to satisfy a new requirement unless that requirement is

inseparable from the existing letter contract.


4. There are two broad types of contracts known as _________ and

_________.

5. ___________ is a legal, preliminary, contract that authorises contractor

to start work pending negotiation of a definitised contract.



6. Effective management of contracts can improve operational efficiency

and improve profitability. (True/False)

7. Firm-fixed-price contracts can be used for Exploration contract.

(True/False)

8. Fixed price incentive (FPI) contracts are for contractor motivation.

(True/False)

9. Cost contracts are for payment of cost only. (True/False)

10. Cost-plus-incentive-fee (CPIF) are for cost reimbursement only.

(True/False)

11. Cost-plus-fixed-fee (CPFF) is a fixed price contract. (True/False)

12. Letter contracts are used for emergencies only. (True/False)

13. Conceptualisation is a first step in project management. (True/False)

14. Cost sharing is a cost reimbursable contract. (True/False)

15. A contract once entered into can never be amended. (True/False)

Activity 2:

Consider yourself to be the sponsor who has assigned a university a

fixed sum to complete a particular job for a fixed price within a stipulated

time. Assess the type of contract which both of you can sign.

Hint: http://www.sps.arizona.edu/handbook/typesofagreements.htm

4.4 Other Types of Contracts

There are other types of contracts than the contracts that are discussed in

the previous section. They are as follows:

Performance based contracts: This type of contracting emphasises

that all aspects of an execution be structured around the purpose of the

work to be performed and not to the manner in which the work has to be

performed. It is designed to ensure the following:

Contractors are given freedom to determine how to meet the

contractee‟s objectives.

Appropriate quality levels are achieved.

Payment is only made for services that meet these levels.

This can be used with various types of contracts.



Definite-quantity contracts: This contract provides for supplies or

services of definite quantity at fixed prices within stated limits during a

definite period. The features of this contract include:

Minimum and maximum quantities for individual orders.

Delivery orders issued for specific quantities.

Time and materials (T and M) and labour hour (LH): This contract

provides for payment of labour hours at specified fixed hourly rates, and

material at cost. This requires a price ceiling, which contractor may not

exceed except at own risk. In this contract, labour hour (variant) may

provide for payment of labour hours only.


16. ______________ can be used with various types of contracts.

17. Performance based contracts are designed to ensure that contractors

are given freedom to determine how to meet the contractee‟s

objectives. (True/False)

18. _____________ provides for supplies or services of definite quantity at

fixed prices within stated limits during a definite period.

4.5 Summary

We have understood that developing contracts management and working

towards performance improvement should be the key objective of every

company. Contract management and development includes many more

allied activities of sourcing management, supplier identification, contract

negotiation, service ordering, tracking vendor equipment, monitoring and

analysis of vendor performance, forecasting need, aligning procurements

with business objectives, and securing advantageous rates for products and

services.

We have also understood that although contract management generally

points to engineering and construction industry, one should acknowledge its

application in various other fields like finance contracts, project management

contracts , sales contracts business contracts, procurement contracts and a

host of other specialised fields after due customisation.

We have discussed the two broad types of contracts: fixed price and cost

reimbursement contracts. Within each of these groups, there are variants of

these contracts, which can be used individually or in combination.



We also discussed the other types of contracts that include: partially defined

contracts, performance based contracts, definite-quantity contracts and time

and materials (T and M) contracts and labour hour (LH) contracts.

4.6 Glossary

Term Description

Conceptualisation Mental formulation of an idea. Here the word is used with relation to the conceptualisation of project.

Statutory guidelines Rules mandated by statute that are punishable for Violation. Here the word is used in relation to the guidelines regarding the document.

Commercial clauses Commercial rules. Here the word is used in relation to the rules with regard to the business in the document.


1. Explain Pre tender documentation stage.

2. What are the advantages of firm fixed price contracts?

3. Describe performance based contracts.

4.8 Answers


1. Mode of payment

2. Planning

3. Performance

4. Fixed price, cost reimbursement

5. Letter contract

6. True

7. False

8. True

9. False

10. False

11. False

12. True

13. True

14. True

15. False

16. Performance based contracts

17. True

18. Definite-quantity contract



Terminal Questions

1. Refer section 4.2.2 Contract Process Cycle.

2. Refer section 4.3.1 Fixed Price Contracts.

3. Refer section 4.4 Other types of Contracts.

4.9 Caselet

Effective Contract Management

IBMS was an event management firm which has about ten years of

industry experience in the field. The organisation had plenty of offices all

over the world. They realised the essentiality to have a unified and

centralised contract management system which increases their control

over the documents. The team IBMS sought a user friendly and flexible

system to manage their contracts in a more efficient manner so that they

could get best value from their customers.

They searched the market intensively for a solution and got a system

known as „Framework‟ which is developed by Software Europe. They found

that „Framework‟ is user friendly and flexible. The organisation was quite

impressed by the interface. The organisation was ensured of the

authenticity of the information and helped them to capture the details

specific to their business. They found that it provides better control and

compliance of all the agreements and ensures that the organisation does

not ignore any renewal or auto renewal dates. The interface sends e-mail

notifications regarding specific dates. It reminds them of important dates

and sends a cancellation notification.

The „framework‟ enables them to update the crucial information and keeps

track of the variations of each contract. This system has helped the firm to

establish a control procedure. It has reduced the telephone calls within the

organisation regarding tracking of information. The organisation can also

find out the location of hard copies of the original contracts. The

accessibility to all the updated information helped them to increase their

efficiency.

As a result of this, the organisation could get better control of their

agreements and contracts. They are expecting to deploy the framework all

over the business and hope to meet the other global locations by 2011.

Question:

What was the reason for IBMS to search for a centralised contract system?



References

Anuj Saxena, „Enterprise Contract Management – A Practical Guide to

Successfully Implementing an ECM Solution.

Akhileshwar Pathak, Contract Management: Understanding Business

Contracts‟.

www.emarketingpapers.com/whitepaper9470

http://law.jrank.org/pages/5688/Contracts-Types-



Unit 5 Procurement Processes as per PMI

Structure:

5.1 Introduction

Objectives

5.2 Plan Procurement Management

Legal considerations of procurement

Plan procurement inputs

Plan procurement tools and techniques

Plan procurement outputs

5.3 Conduct Procurements

Conduct procurements inputs

Conduct procurements tools and techniques

Conduct procurements outputs

5.4 Administer Procurements

Administer procurements inputs

Administer procurements tools and techniques

Administer procurements outputs

5.5 Close Procurements

Close procurement inputs

Close procurement tools and techniques

Close procurement outputs

5.6 Summary

5.7 Glossary


5.9 Answers

5.10 Caselet

5.1 Introduction

By now you must be familiar with contract management process and its

types. This unit deals with the project procurement management as per the

Project Management Body of Knowledge (PMBOK).

In unit 4, we have learnt about procurement in detail. Managing

procurement is the most critical phase in a project as this leads to timely

delivery of project and reduces considerable amount on cost. The

Procurement Management process includes four processes namely,



Planning, Conducting, Administering and Closing procurements. Planning

procurements refers to the establishment of the concrete plan for the

project. Conducting procurement involves obtaining seller responses,

selecting sellers and awarding contract. Administering procurement is the

process of monitoring the process and ensuring that the supply takes place

at the right time. Closing procurement ensures that the procurement is

completed.

We will discuss each of these processes in detail in this unit.

Objectives:


define Project Procurement Management process.

explain the inputs, tools and techniques, outputs of the various

processes.

discuss the importance of Project Procurement.

5.2 Plan Procurement Management

Plan Procurement is the first step towards the Procurement Management. It

is the process which helps you to acquire products or services from the

external suppliers. Careful planning of your procurement provides an

opportunity to buy the right products at the right time. Procurement planning

is vital for the success of any project.

Let us now understand some of the uses of the Procurement Plan. It:

Helps to define the procurement requirements.

Helps to identify the items you need to accumulate.

Helps to create a sound financial justification for acquiring items.

Helps to list out all the tasks related to procuring your products.

Helps to schedule those tasks by allocating necessary timeframes and

resources.

Develops a dynamic project procurement process for your business.

5.2.1 Legal considerations of procurement

Procurement is a transaction with external or third party organisation where

the suppliers are given full freedom to charge for their goods and services.

In other words, we can say that the suppliers are self interested when they

are given such an opportunity. However, they cannot be trusted to act in the



preeminent interest of the purchasing organisation. It is the responsibility of

the purchasing organisation to protect from potential harm caused by

dealing with outside organisation pertaining to costs, scope, schedule, and

the organisation liabilities.

To protect from the potential harm, purchasing organisations enforce

controls on purchases that seek to:

Minimise the cost.

Ensure the meeting of the requirements.

Reduce the liability.

Help prevent miscommunication.

5.2.2 Plan procurement inputs

A set of inputs have to be considered while planning procurement, which at

the minimum includes, the scope baseline and the requirements document.

These define the project necessities in a comprehensive manner. The other

inputs such as the teaming agreements, the risk register and the risk related

contract decisions have a tendency to cover up proceedings against risks.

The time and cost parameters of the project are covered by project

schedule, activity resource requirements and the cost performance baseline.

This also helps in establishing the procurement actions. The other important

inputs are the organisation’s environmental factors that establish the

framework in which most decisions are made. The organisational process

assets correspond to the collective learning of the organisation and

determine many of the appropriate formats of documentation and

parameters of pertinent decisions.

We will now discuss these inputs in detail:

Scope baseline: The performance of the complete project is measured

against the scope baseline, which includes the scope, schedule and cost

baselines. Therefore, scope baselines are considered as performance

measures. They determine whether or not the project is on track, during

the execution of the project. The scope baseline makes use of the scope

statement, the Work Breakdown Structure (WBS) and the relevant WBS

dictionary to identify the mandatory components required to complete

the project activities. It helps in identifying the needs, deliverables, and

the requirements of the project. On conformance of the deliverables with

the scope statement, they have to be developed into a WBS in which the



deliverables are broken down.. The deliverable WBS forms the scope

baseline and has the following elements.

o Scope statement: The most significant document in the project plan

is the scope statement. The scope statement acts as a basis for the

rest of the project and provides a common agreement among the

stakeholder regarding the scope. The following needs to be

incorporated in the scope statement:

Business needs and business problem.

Project objectives, stating what problems may occur in the

project, and the solution for that business problem.

Benefits of completing the project as well as the justification for

the requirement.

Project scope stating the deliverables to be included or excluded

from the project and so on.

o Work Breakdown Structure (WBS): WBS manages the total scope

of the project as well as the organisation. The WBS breaks down the

project work into smaller modules, each representing an increasingly

complete definition of the project work. It also represents the work

specified in the current approved scope statement.

o WBS dictionary: The description of the components contained in a

WBS, including work packages and control accounts, are described

in the WBS dictionary. The WBS dictionary includes entries for each

WBS components that briefly describes the statement of work,

defines deliverables, and contains a list of associated activities and

so on. The project management should consult WBS dictionary for

the following reasons:

Scheduled start and end dates.

Required resources.

Estimated cost of project.

Requirements documentation: The requirement documents contain

the project scope and project objectives that are applicable to the

project. Requirements may contain contractual and legal needs, which

include health, safety and security that must be met.

Teaming agreements: The contracts that establish a joint venture,

offering business advantages for two or more parties are termed as



teaming agreements. This agreement defines the buyer-seller

relationship for each party. Understanding teaming agreement acts as

an important input in planning procurements.

Risk register: This register contains information related to risks such as

its impact, risk response, risk owner and feedback plans.

Risk-related contract decisions: Risk related contract decisions

include agreements such as insurance. It specifically outlines buyer-

seller responsibilities as they relate to risk response activities.

Activity resource requirements: Activity resource requirements

include information related to specific needs such as people, equipment

or location for the project.

Project schedule: Project schedule contains information related to

planned start and end date for each activity in the project.

Activity cost estimates: This cost estimate includes evaluation of bids

and proposal from the sellers.

Cost performance baseline: The cost performance baseline contains

information on the planned budget over time.

Enterprise environmental factors: The environmental factors that

have a direct impact on plan procurement process are marketplace

conditions, products, and services that are available in the marketplace,

suppliers including past performance or reputation and so on.

Organisational process assets: The source of existing policies,

processes, organisational data and knowledge are specified in

organisational process assets. These assets comprise the total

collection of formal and informal methodologies, policies, procedures,

plans, and guidelines, as well as the organisation's "knowledge base,"

The “knowledge base” includes historical performance data, labour

information, service and maintenance history, issue and defect history,

project files, and financial data.

5.2.3 Plan procurement tools and techniques

The tools and techniques under the plan procurement are: make or buy

decisions, expert judgement that helps to make decisions and the various

types of contracts that have to be as appropriate as possible. This section

gives an overview on the tools and techniques of the process:



Make-or-buy decisions: It is a general management technique, which

determines if the organisation should make or perform a particular

product or services within the organisation or buy from outside

organisation. It often involves a budget constraint. Here, the experts

including both internal and external, provide valuable inputs in

procurement decisions.

Expert judgement: It is based on the experience and knowledge of the

subject matter experts. Expert judgement is used to assess the inputs

needed to develop the project character. Therefore, the judgement and

expertise is applied to any technical and management details during this

process.

Contract types: Contract is a legal agreement between the buyer and

the seller. The type of contract depends on various factors such as

organisational policies and the amount of risk and uncertainty in the

procurement need. The broad categories of contracts are already

explained in unit 4.

5.2.4 Plan procurement outputs

The outputs of plan procurement are procurement management plan,

procurement statements of work, make or buy decisions, procurement

documents, source selection criteria and change requests. This section

provides an overview of these outputs:

Procurement management plan: It describes the means by which the

procurement processes will be managed, from developing

documentation for making outside purchases or acquisitions to contract

closure. The procurement management plan can include guidance for:

o The type of contract to be used.

o The management of risk related issues.

o The decision whether the independent estimates will be used and if

they are needed as evaluation criteria.

o The management of multiple suppliers.

o The procurement management plan is the component of project

management plan.

Procurement Statements of Work (SOW): The SOW is the description

of the work required for the procurement. The procurement SOW

describes the procurement items, which will help the prospective

suppliers to determine if they are capable of providing the products and



services. The procurement SOW has to be written in an understandable,

short and complete manner.

Make-or-buy decisions: These decisions indicate if a product is

purchased from outside organisation or manufactured within the

organisation. The make-or-buy decisions document can be as easy as a

record that includes a short justification for the decisions.

Procurement documents: These documents refer to the collection of

printed materials that provide the likely sellers with all the information

they need to develop and submit a bid or proposal. Request for

Information (RFI), Invitation for Bid (IFB), Request for Proposal (RFP),

Request for Quotation (RFQ), tender notice, invitation for negotiation

and invitation for sellers initial response are some of the types of

procurement documents.

Source selection criteria: These selection criteria are used to evaluate

and assess bids and proposals. It can be based exclusively on price for

commodity-type of materials, but it often includes a host of further

subjective factors. In case the procurement item is readily available from

a number of acceptable sellers, then the selection criteria will be limited

to the purchase price. The purchase price in this context refers to the

cost of the item as well the additional expenses such as delivery.

Change requests: The plan procurement process may result in change

requests to the project management plan, its subsidiary plans and other

components.


1. Plan Procurements is the process which helps you to acquire products

and services from the _______.

2. The _______ acts as a basis for the rest of the project and provides a

common agreement among the stakeholder about the scope.

3. Risk register contains information related to risks such as its impact,

risk response, risk owner and feedback plans. (True/False)

5.3 Conduct Procurements

Let us now look at the next process of procurement, that is, conduct

procurement. It is the process of finding and selecting a suitable seller,

finding responses and finalising a contract with the seller in order to deliver



the item on time and with acceptable quantity. The outputs that must be

generated by the complete process include a range of documents and

document updates that ensure all of the above. Here, the overall process of

requesting responses from the seller and evaluating those responses can

be repeated. Based on the preliminary proposal, a list of prospective sellers

is shortlisted. A more detailed evaluation can be carried out based on the

specific and the comprehensive requirements document requested from

shortlisted sellers.

5.3.1 Conduct procurements inputs

The inputs consists of a large set of documents that help to define what has

to be procured, how to procure them and how to close the process using a

particular type of contract. The various inputs are as follows:

Project management plan: It is the source document against which

everything needs to be decided. It defines the way in which the project is

monitored, executed and controlled. The purpose is to outline the

approach used by the project team to deliver the anticipated project

management scope of the project.

Procurement documents: The explanation is similar to the outputs of

plan procurement process, refer section 5.2.4.

Sources selection criteria: The explanation is similar to the outputs of

plan procurement process, refer to section 5.2.4.

Qualified seller list: This is a list of sellers who have been pre-scanned

for their qualification and past experience, so that procurements are

directed to those sellers who are ready to take up any type of contract.

Seller proposals: These proposals are the basic set of information that

the evaluation body uses for the selection of one or more successful

sellers.

Project documents: These include project documents such as contract

related documents, risk register and so on.

Make-or-buy decisions: The explanation is similar to the outputs of

plan procurement process, refer to section 5.2.4.

Teaming agreements: In a teaming agreement, the roles of the buyer

and the seller are already decided by the executive management. The

buyer and the seller are actively involved in preparing a procurement



statement of work that will satisfy the requirements of the project. The

parties will then negotiate a final contract for award.

Organisational process assets: The elements of organisational

process assets that influence the conduct procurements process are: list

of prospective and previously qualified sellers as well as information on

past experience with sellers, both good and bad.

5.3.2 Conduct procurements tools and techniques

The organisation can employ some standard tools and techniques to bring a

closure to the conduct procurement process. The process progressing by

locating some of the potential sellers, finding if they are interested in

bidding, getting bids, and evaluating them. Finally, some suppliers are

shortlisted and one among them is selected and awarded the contract. This

section gives an overview on the tools and techniques of the process:

Bidder conferences: It is a tool that helps to clarify issues between the

buyer and all prospective sellers prior to the submission of a bid or

proposal. The aim is to ensure that all prospective sellers have a clear

understanding about the procurement and that no bidders receive

preferential treatment. The corrections to the procurement document are

made after the clarification.

Proposal evaluation techniques: These techniques should be clearly

set up. Usually, we have a scoring system, which is used to survey the

proposals submitted by the sellers and come up with the overall scores.

The scoring would be done by the committee. After the shortlist of

qualified sellers, you need to make the assessment of acquisition costs,

which is often against a benchmark. Independent estimation, provide a

way for cost benchmark. The estimates can be arrived at by in-house

experts or by external experts.

Independent estimates: The procurement department might conduct

independent estimates or cost estimates of the proposals. These costs

will be compared against the vendor prices. If there is a large difference

in cost estimates, it indicates that the SOW or the terms of the contract

are not clear or the seller has misunderstood or failed to fulfil the

procurement requirements of the SOW.



Expert judgement: Expert judgement is used to evaluate seller

proposals. The evaluation of proposals is done to assess the expertise

of the seller in area covered by the procurement document.

Advertising: It is the method of announcing to potential sellers that

Request for Proposal is available. The company’s website, professional

journals, or newspapers are few examples where advertising might take

place.

Internet search: The Internet has a strong influence on most project

procurement and supply chain acquisitions in organisations. Internet

searches have several useful features in this process. Internet searches

can be used to find sellers, perform research on their past performance

and compare prices. You cannot rely on Internet search while

conducting high-risk or complex procurements.

Procurement negotiation: In procurement negotiation, it is seen that

both the parties come to an agreement regarding the contract terms.

The negotiation skills of both the buyer and seller are put into practice

here as the details of the contract are being decided between both the

parties. The complexity of the contract will determine how extensive the

contract negotiation will be. Simple contracts may be predetermined,

nonnegotiable elements requires only seller acceptance. Any number of

elements may be included in the complex contract, including financial

options, overall schedule, proprietary rights, service level agreements,

technical aspects, and more. In either case, once agreement is reached

or the negotiation are finished, the contract is signed by both seller and

buyer and is executed.

5.3.3 Conduct procurements outputs

Conduct procurement is all about finding a suitable seller. After the

selection, the next step is to finalise a contract to deliver the item on time

with an acceptable quality. The output obtained from the complete process

includes a range of documents and document updates which include:

Selected sellers: The list of selected sellers is the most important

output of the conduct procurement process. The sellers are selected

based on the bid evaluation. These selected sellers are likely to be a

prospective seller. The final selection of the seller is done by the senior

management in the organisation.



Procurement contract award: A procurement contract is awarded to

the selected seller. This marks the completion of the conduct

procurement process. The contract can be in the form of a simple

purchase order or a complex document that includes legal documents

that bind the seller to supply the product and services, and the

compensation of the buyer agreeing the terms and conditions. The

major components of a contract document usually contains: SOW,

schedule baseline, performance reporting, roles and responsibilities,

payment terms, warranty, penalties, insurance, termination mechanism

and other.

Resource calendars: The resource calendars consists availability of

specific resources on specific dates.

Change requests: Change requests in the project management plan

and its subsidiary plans are processed and reviewed through the

performance integrated change control. .

Project management plan updates: The necessary updates in the

project management documents have to be documented without fail.

These updates include the schedule baseline, cost baseline, scope

baseline, and project management plan and so on. The procurement

costs must be documented if the actual procurement changes in the

planned numbers due to the changes in the planned schedule of

procurement. Scope baseline can vary as a direct result of some of the

make or buy decisions to be made in course of procurement.

Project document updates: Some of the project documents will also

need updates including requirements documents, requirements

traceability documentation and the risk register. The various factors in

the procurement operation will directly impact the requirements

documents. Also, depending on the availability one can enforce changes

to the documents. The requirement traceability document will also

undergo changes when there is a change in the requirement. In addition,

risks may occur due to the variances in actual procurement from the

plan, resulting in changes to be made in the risk register.


4. Based on the ______ proposal a list of prospective sellers is short

listed.



5. Advertising is the method of announcing to potential sellers that

____________ is available.

6. The resource calendars consists availability of project plan on a

specific dates. (True/False)

Activity 1:

Consider that you are the procurement manager of a manufacturing firm

and your firm decides to purchase some goods from an outside

organisation. You are given the task of planning the procurement. What

tools will you use to plan the procurement?

Hint: Refer section 5.2.3

5.4 Administer Procurements

Administer procurement is the process of nurturing the process, making

sure that the contractual terms are observed and the supply happens on

time. Typically, in any organisation, buyers want to make sure that the

suppliers meet the contract terms and sellers need to guarantee that their

legal rights are protected. In other words, both the buyer and the seller

follow the same procedure to make sure that the opposite party is meeting

their legal responsibility and the contract performance is as per the

requirements of the contract.

Despite the fact that there can be deviation in the process depending on the

organisation and the type of contract, the typical processes involved in

administering the procurement include the following:

Managing project execution process actions that are required to

authorise the seller’s outputs at the correct time.

Reporting structure which ensures that procurement performance is

evident to the project management team.

Performing quality control so that the sellers’ product meets the

requirements of the project as specified.

Performing integrated change control to manage the changes that occur

in the procurement process. Also, all change requests must be approved

and communicated to relevant people.

Monitoring and controlling to ensure that risks are mitigated.



5.4.1 Administer procurements inputs

Administer procurement is an ongoing process that involves a diverse set of

documents. The set of inputs to this process defines the work assigned to

the seller, the performance reports and the project management documents.

The contract document has to be consulted first. The project management

plan becomes the master reference for most of the documents. The two set

of performance reports namely the seller performance report and work

performance report are necessary. The inputs in the process are as follows:

Procurement documents: The complete set of supporting records

required for the administration of the procurement process is contained

in the procurement documents. The procurement documents in addition

with the SOW define what was intended to be procured. The reference

document contains the proposal as submitted, along with the changes

made to it due to any negotiation.

Project management plan: The overall plans needed for the

procurement process is managed by the project management plan. It

acts as a master reference describing the way the procurement process

should be conducted. The seller evaluation to be undertaken is guided in

the master plan.

Contract: A contract is a buyer-seller relationship with a legal

agreement indicating the terms and condition agreed by both the parties.

There are few differences between a contract and agreement. A contract

is enforceable, whereas agreement is difficult to enforce. Also, a

contract cannot be used for illegal activities. For further explanation on

types of contract refer unit 4.

Performance reports: These reports give detailed information of the

performance of the seller in the past with respect to a particular

procurement action. It also provides technical documentation and other

deliverable information, which is given in terms of the contract as part of

arriving at the selection and award of the contract. In general, the

performance of the seller can be measured and corrected.

Approved change requests: Change requests that have been

accepted are added to the set of fundamental inputs. These may contain

references to changes in terms and conditions, such as relaxations in



some acceptance criteria or changes in the description of the product

and service.

Work performance information: This includes information on the

quality standard satisfied, cost incurred/committed and the seller

invoices that have been paid.

5.4.2 Administer procurements tools and techniques

Administering procurement is about supervision of the buyer seller

relationship, measuring the contract performance periodically and making

the changes that are necessarily suitable to on-going changes incident in

the process. The tools and techniques used to ensure this are as follows:

Contract change control system: The contract comprises the

procedures decided ahead by the seller and buyer for introducing,

reviewing, and approving or denying contract change requests. The

project contract change control system is an element of integrated

change control, and it ensures that paperwork, tracking, communication,

and approval processes are completely followed and included with the

overall project change control system. The terms in the contract

including scope, technical, payments, schedule, financial terms, or

service changes are related to the requested contract changes. The

contract change control system protects both the buyer and the seller.

Procurement performance reviews: These are the structured reviews

where the seller’s performance is compared with the contract statement

of work including a broad range of evaluation like quality, price, plan,

process effectiveness and contract compliance. The main aim of

performance review is to evaluate the sellers overall ability in performing

the work as stated according to the procurement SOW. Such reviews

turn out to be a part of the project status reviews which include the key

suppliers.

Inspection and audits: During the execution of the project, audits and

inspections will be carried out as stated in the procurement contract. It is

required and supported by the seller to ensure the compliance of the

seller’s work progress.

Performance reporting: The progress of procurement action is

governed by providing information to the management. It is the

evaluation of the seller’s performance with the aim of producing the



deliverable as mentioned in the contract. In addition, the quality, cost

and schedule performance associated with the outcome have to be

assessed. These measurements are taken out periodically and driven by

the procurement plan. Very often it is based on the results found in

inspection and audits undertaken by the buyer at the seller’s premises

Payment system: It is one of the essential requirements of the

procurement administration. To maintain a good buyer-seller

relationship, it is necessary that the payments are made quickly without

any delay. The payment is usually done through the accounts payable

system of the buyer. The documentation of the payment is also

important. Many a times the seller enforces conditions stating that the

unpaid sum will be added with a definite amount of interest when

delayed beyond the period agreed to. When there are periodic

payments, the seller may put forth a condition stating that the next set of

work or outcome may be withdrawn unless the payment on the earlier

invoice is not received.

Claims administration: It is essential to maintain an efficient claim

administration in order to maintain a good relationship and avoid

proceedings with any outstanding claims. In the life span of the

procurement action, two changes, that is, contested changes and

potential constructive changes can take place. The changes that are

agreed by either party become the constructive change. The contested

changes are termed as claims, disputes or appeals. Claims are

documented, processed, monitored and managed well throughout the

existence of the procurement action. If the claim is unable to be resolved

between the two parties, then it might be handled in accordance with

Alternative Dispute Resolution (ADR) where the procedures of the

contract are followed. Further, the ideal method is to resolve the claims

and disputes through compromise.

Record management system: It is the part of the project information

system that helps to collect, manage and find the right procurement

documents quickly and easily. A definite set of processes, control

processes that administer these and an information tool jointly represent

such a system. The system must have a vault that records all the

procurement documents and correspondence. An easy recovery, based



on refined search criteria, is a necessary feature required of such

systems.1

5.4.3 Administer procurements outputs

The changes to the procurement document become crucial during the

procurement. The procurement documents become the typical outputs of

the process. The updates that is done on the organisation process assets

and project management plan are the outputs of the administer procurement

process. Change requests are a set of new documentation that is another

output of this process.

Procurement documents: In the record management system, any

supplementary information to be added to the procurement document,

along with contract records are collected during procurement

administration. All the approved changes need to be updated in these

documents. The contract document, all its schedules, requested and

unapproved changes, and approved changes are part of this output.

Project documentation also includes technical documentation of sellers

and work performance reports gathered during the project execution.

The work performance information includes deliverables, seller

performance reports, warranties, invoices, payment records and so on.

Organisational process assets updates: These updates are provided

through the administer procurement process. It is essential to update the

documents as the knowledge updates enclosed in these documents are

refereed throughout the process. The following are the elements of the

process assets that are affected:

o Correspondence, which is a set of documents that will be affected

through this process. These details may include warnings from a

buyer about unsatisfactory performance. The buyer as well as the

seller needs to preserve the chain of correspondence so that actions

that lead to a result can always be established legally.

1 Taken from Administer procurements Just PM blog



o Payment schedules and requests should be made according to the

terms of the contract.

o Seller performance evaluation documents should be maintained.

Change requests: The explanation is similar to the outputs of conduct

procurement process, refer to section 5.3.3.

Project management plan updates: There are two categories that are

covered by project management plan updates. The occurrence of

changes in the procurement plan due to approved change requests

need to be updated. This may also affect the cost or schedule. Baseline

slippages that may impact the project performance should be updated.

5.5 Close Procurements

Close procurement is the notification to the seller that the procurement

action is formally closed. It supports the close process in the project as it

involves the confirmation that all work and deliverables were acceptable.

Finalising open claims, ensuring that all the deliverables have been

accepted and updating the record to reflect the final results are the usual

activities associated with the closing procurement processes. There are

possibilities that the outstanding claims and pending negotiations are

present at this stage. The contract would have given solutions to deal with

these circumstances.

5.5.1 Close procurement inputs

The close procurement has two inputs, which are project management plan

and procurement documentation.

Project management plan: The explanation is similar to the inputs of

administer procurement process, refer to section 5.4.1.

Procurement documentation: It includes the contract itself and all the

supporting documents that go along, which might include things such as

the WBS, the project schedule, change control documents, technical

documents and so on. This information plus the additional information

gathered throughout the project is closed so that anybody considering a

future project of similar scope can refer to what was done.



5.5.2 Close procurement tools and techniques

The various tools and techniques of this process are as follows:

Procurement audits: These audits are performed to check if they are

meeting the right needs and are being performed according to the

standard. The procurement audits are concerned with the procurement

process, starting from the plan to administer procurement process.

These audits aim to determine the areas to be improved in the

procurement process and to identify the faulty process and procedures.

It can be used by either the buyer or the seller, or by both, as an

opportunity for improvement.

Negotiated settlements: The negotiated settlements occur while using

an ADR technique due to disagreements about deliverables, payments,

performance, and so on. The most approving method to resolve the

dispute is through the aid of ADR techniques.

Records management system: The explanation is similar to the tools

and techniques of Administer Procurement Process, refer to section

5.4.2.

5.5.3 Close procurement outputs

The outputs of close procurement are a set of two documents where one

has the details of completed procurements and the other set has updates to

the organisation process assets.

Close procurement: One of the purposes of the close procurements is

to present official notice to the seller, which is typically in written form

representing that the procurement is complete. The output of close

procurements that deals with this is termed as closed procurements.

Most of the time, the stipulation for formalising acceptance and closing

the procurement are given in the procurement document.

Organisational process assets updates: These are the set of

documents in which several parts of the organisational assets may need

updates. The necessary updates depend on the particular needs of the

project and can also vary depending on the organisation. These include

procurement file, deliverable acceptance and lessons learned. The

procurement file provides complete details of the project. A formal notice

is given to the seller indicating that the deliverables is accepted or

rejected. The contract would specify how to deal in case of rejection.



The experience with the procurement, emerging of process

improvement recommendation and so on are included in the lessons

learnt which will be helpful for future use on similar projects.2


7. The set of inputs to the Administer procurements defines the _____ to

the seller, the performance reports and the project management

documents

8. The procurement _____ are concerned with the procurement process,

starting from the plan to administer procurement process.

9. A formal notice is given to the seller indicating that the _____ is

accepted or rejected.

Activity 2:

Imagine you are a project manager of an organisation that has purchased

some goods from a seller. The seller now requests for some change in

the contract. How will you control this change requested by the seller?

Hint: Refer: Administer procurements tools and techniques

5.6 Summary

In this unit, we started our discussion with the definition of procurement

which refers to the transaction with the other organisation to acquire the

goods and services. The project procurement management deals with four

processes namely, plan, conduct, administer and close procurement.

We learnt that the procurement plan defines the products and services that

have to be acquired from the external organisation. The outputs of this

process include a procurement management plan, statement of work, make

or buy decision and many more.

We also studied that the conduct procurement consists of large set of

documents as inputs describing the procurement. The outputs include the

selected sellers, procurement contract award and many more.

We also understood that a list of activities in the administer procurement

process are proposed in order to ensure that all parties accomplish their

contractual obligations. The main outputs are the procurement

documentation and organisation process updates.

2 Taken from Project management professional exam study guide



The close procurement is the process of completing all the project

procurement, where the output consists of closed procurement and

organisational process assets updates.

All the four processes discussed in this unit have several inputs and various

other tools and techniques.

5.7 Glossary

Terms Description

Pre eminent It refers to the greatest of importance or achievement.

Deliverable A report or document which forms the building block of the project.

Pertinent Having precise and logical relevance to the matter in hand.

Outsourcing It is the process of contracting a third party.


1. Explain the Plan Procurement process with its inputs and the tools and

techniques used.

2. Explain the outputs of Conduct Procurement process and Administer

procurement process.

3. Explain the Close procurement process

5.9 Answers


1. External suppliers

2. Scope statement

3. True

4. Preliminary

5. Request for proposal

6. False

7. Work assignment

8. Audits

9. Deliverables



Terminal Questions

1. Refer 5.2 Plan Procurement process.

2. Refer 5.3 and 5.4 Conduct Procurement process and Administer

Procurement process.

3. Refer 5.5 Close Procurement.

5.10 Caselet

A new Advance to IT Procurement

A fresh approach to the procurement of IT infrastructure services has

offered a project with some distinctive and worthwhile opportunities. By

introducing succeeding evaluation processes, Project now has the

following:

Greater efficiency in its procurement process

Well-organised procurement outcome

Objectives of IT infrastructure services are met

High quality is delivered.

Previous Procurement Process

In the previous procurement process, the project followed conventional

and less efficient tendering method. As a result, the outcome was not up

to the mark.

Changed procurement process

Changed Procurement Process focused on the positive relationship

between vendors and agencies.

Under the new system, only suppliers who attended a mandatory pre-

tender briefing were able to take action to the tender. It helped the project

to control the release of responsive information and make sure that each

respondent received the same message about the intention and purpose

of the tender and project’s required outcomes.

The supplier presentation step was eliminated and non-negotiable

contractual requirements were acknowledged early in the process, and

removed from negotiations.

The key player of the new strategy was the adoption of the Discovery

Workshop evaluation method, a practical addition to the conventional

desktop evaluation process.



Benefits

By revolutionising the tendering process, particularly the evaluation

component, project has the following benefits:

Produced final outcome as per the customer requirements.

Created better intensity of understanding from the tender evaluation

process.

Reduced the period and difficulty in negotiation

Distributed a product based on the delivery of a quality service, in line

with the agency requirements.

Question:

1. Define plan procurement process.

Hint: Refer 5.2. Plan procurement process.

References

Kim Heldman, PMP Project Management Professional Exam Study

Guide.

Kathy Schwalbe, Information Technology Project Management.

Kathy Schwalbe, Introduction to Project Management.



Unit 6 Methods of Procurement for Works and Goods

Structure:

6.1 Introduction

Objectives

6.2 Bidding

International/Global Competitive Bidding (ICB)

Limited International Competitive Bidding (LIB)

National Competitive Bidding (NCB)

6.3 Shopping

6.4 Direct Contracting

6.5 Force Account

6.6 Summary

6.7 Glossary


6.9 Answers

6.10 Caselet

6.1 Introduction

In the previous unit, we have learnt about the contracting strategies. We

understood the importance of project procurement. We learnt how to plan,

conduct, administer and close contracts. In this unit, we will study the

various methods of procurement of works and goods required for a

developmental project.

Procurement processes are continuously developing due to the increase in

interest for sustainability, be it government or business industries. The

procurement of goods, works, and services has a major impact on the

successful execution of a project. Hence, application of sound policies and

practices characterised with right planning and coordination of procurement

is indispensable for the adequate execution of any project. Choosing

appropriate methods of procurement becomes important for various

packages of works and goods by considering their values.

The various methods of procurement are bidding, shopping, direct

contracting and force accounting. You will learn about them in detail in this



unit, which will help you to choose the correct method of procurement for

any project.

Objectives:


explain various methods for procurement.

choose the best method for procurement.

explain the requirements for various procurement methods.

6.2 Bidding

Bidding is a process in which you quote money in exchange of goods or

services through an auction. They are two types of auctions: open auction

and silent auction. In an open auction, interested parties compete for

acquisitions by offering a higher bid than the offer that is currently on the

table and higher than the competitive bidders. In silent auction, there is no

quote on table; the quoted bid is the maximum price that the bidder is willing

to pay for the goods or services.

The most widely used methods of bidding are as follows:

International/Global Competitive Bidding (ICB).

Limited International Competitive Bidding (LIB).

National Competitive Bidding (NCB).

6.2.1 International/Global Competitive Bidding (ICB)

In the previous section, we have defined the term bidding and have also

discussed the two types of auction. Let us now learn about the types of

bidding. The first is International Competitive Bidding.

International competitive bidding is a process that governs procurement,

which involves World Bank funding for your projects. As the name suggests,

this bidding happens internationally. The funding for such projects happens

through World Bank. Hence, you have to globally advertise about the project

for which you seek funds. In ICB, bids are open for works and goods

through advertisements in electronic and print media. ICB is best suited for

a large contractor or supplier, whose scale of operations and high level of

expertise is expected to result in most economic and efficient procurement

resulting in economical growth. Hence, it is also called Global Competitive



Bidding. The contractors and suppliers can submit bids in internationally

convertible currency and they get paid in the same currency. Bids will

normally be requested from several firms or organisations in writing.

Conditions for adopting ICB

We should adopt International Competitive Bidding (ICB) in the following

conditions:

The value of the package of works and goods are high or the

works/goods are complex in nature. Currently, for work contracts,

estimated cost must be crores of rupees or more while it is lakhs of

rupees for goods contract.

High degree of mechanisation is involved for execution of the project

work. For example, an atomic power generation unit has to be set up

with high degree of precision tools and machines.

Irrespective of value, supplies need to be imported and entail payment in

foreign currency.

No local bidder is available to fulfil the requirements.

Requirements of ICB

Let us now look at the requirements of ICB:

Advertisement: You have to publish the invitation for pre-qualification of

works/Invitation for Bids (IFB), or supplies, in frequently visited websites

such as United Nations development Business online (UNDB online),

and in the Development Gateway’s Market in order to attract the

attention of the foreign contractors and suppliers.

We should also publish the Invitation for pre-qualification/Invitation for

Bids in national news papers having wide circulation in metros, in

principal cities, and also in the region where the procurement is being

made.

º The invitation for Bid pre-qualification/IFB should also be published

in appropriate Trade Journals published in the country. These

actions will ensure adequate publicity and we can expect better

competition and thus, economic and efficient procurement.

º Copy of the Invitation for pre-qualification/IFB should also be sent to

the Embassies and Trade representatives of the countries from

where active participation in the bid is expected.



Pre-qualification document (for works): The pre-qualification

document should include sufficient details regarding eligibility, method of

submission of pre-qualification documents, details of documents/

information to be furnished, qualification criteria, evaluation

methodology, preparation of the list of pre-qualified applicants, and

notification of the list of approved pre-qualified bidders.

Period for submission of pre-qualification documents: The pre-

qualification submission period is counted from the date of publication of

the invitation for pre-qualification in the press, or the date of making

available the document for sale (whichever is later). The period that we

are considering must be sufficiently large. Depending on the size and

complexity of the contract, a submission period between 45 to 60 days

is considered reasonable for the submission of pre-qualification

documents

Bidding document (for works and goods): The bidding document

should include sufficient details regarding eligibility, method of

submission of bids, bid security (amount and currency), period for

submission, qualification criteria, evaluation methodology, securities to

be submitted, award of contract, and so on. It should also include

internationally accepted Conditions of Contract, such as those

developed by Federation Internationale Des Ingenieurs-Conseils (FIDIC)

and Institution of Engineers, United Kingdom.

Bidding period (for works): The bidding period begins from the date of

publication of pre-qualification, or the date of availability of bidding

documents (whichever is later) to the last date of submission of bids. It

should be sufficiently large in order to enable the prospective bidder to

obtain the bidding document, study the same, work out the reasonable

rates and then submit meaningful bids. A period between 45 to 60 days,

or even more in case of large and complex contracts, is considered

reasonable bidding period for goods.

Bidding period (for goods): The bidding period is the period from the

date of issue of the bid document to pre-qualified bidders, to the last

date stipulated for the submission of the pre-qualification document. This

should also be sufficiently large to enable the prospective bidders to



obtain the bidding document. A period between 45 to 60 days is

considered as a reasonable bidding period for works.

Steps involved for ICB

Now that we are aware of the requirements of ICB, let us understand the

steps involved in ICB. There can be two ways an ICB can be executed. One

is with the pre qualification and another without pre qualification.

ICB for services with pre-qualification

As an employer, you have to take the following essential steps:

1. Notify and advertise for submission of pre-qualification applications.

2. Issue/sale of pre-qualification documents to prospective bidders.

3. Collect pre-qualification applications from the prospective bidders.

4. Open pre-qualification applications.

5. Evaluate pre-qualification applications.

6. Prepare the list of pre-qualified bidders.

7. Issue the bidding document to the pre-qualified bidders.

8. Collect bids from pre-qualified bidders.

9. Evaluate the bids.

10. Select the lowest evaluated responsive bid.

11. Award the contract and sign the contract with the contractor.

12. Contract is accomplished by the Contractor.

ICB for goods and services without pre-qualification

As the employer/purchaser, you have to take following essential steps:

1. Notify and advertise.

2. Issue/sale of the bidding document to the prospective bidders.

3. Collect the bids from prospective bidders.

4. Evaluate the received bids.


6. Award and sign the contract with the contractor/supplier.

7. Contract accomplished by the contractor/supplier.

6.2.2 Limited International Competitive Bidding (LIB)

You learnt that projects of higher value or tougher execution are executed

through ICB bidding process and it is done at an international level. In

Limited Competitive Bidding (LIB) method, bids are invited for goods from



selected suppliers, who are the only known manufacturers or suppliers for

the required goods. In this case, no advertisements are issued through

press or any other means. Since the bidding is open for a few selected

manufacturers, no domestic preference is allowed. Similar to ICB, in this

type of bid also the bidders can submit their bid in any internationally

convertible currency and they are paid in the same currency.

Condition for adopting LIB

You can use Limited International Competitive bidding for procuring goods

only, and this cannot be applied to procure services. We should adopt

Limited Competitive Bidding (LIB) when:

The cost of goods to be procured is small.

There is limited number of suppliers already listed.]

There are few situations in which ICB cannot be adopted. In such cases,

we may use LIB.

Requirements of LIB

Let us now look at the requirements of LIB:

Potential supplier: Since you invite the bids from limited number of

potential suppliers, advertisement as in the case of ICB is not required. You

have to ensure that the list of potential suppliers is broad enough to ensure

receipt of competitive bids.

Bidding document: You have to prepare the bidding document with all the

details similar to ICB.

Bidding period: The bidding period is similar to that in case of ICB.

Steps for LIB

Now that we are aware of the requirements of LIB, let us understand the

steps involved in LIB.

As this method is particularly used for procuring goods, you should follow

the following essential steps:

1. Issue/sale of the bidding document to the potential suppliers.

2. Collect the bids from the potential suppliers.





5. Award and sign contract agreement with the supplier.

6. Contract accomplished by the supplier.

6.2.3 National Competitive Bidding (NCB)

You have learnt that LIB can be applied while selecting preferred bidders,

but this cannot have domestic preferences (domestic bidders).

In National Competitive Bidding you as an employer or purchaser, invite

bids for works and goods through advertisement in electronic and print

media within the country. However, foreign firms can participate in the

bidding process, provided they accept the bidding conditions. The bidders

have to submit their bids in national currency only and payment would also

be made in national currency.

Conditions for adopting NCB

You can choose NCB method of procurement for goods and services under

the following circumstances:

Contract values are lower than that fixed for ICB.

Where the works are spread out geographically (for example different

villages or towns in a district), or it has staggered period of starting time,

may be due to the lack of availability of land or financial resources.

Where the works are labour intensive (that is, deployment of huge

labour force is necessary, which may not interest a foreign contractor).

Where the goods are available nationally at prices below the

international market because of high transportation costs.

Where foreign firms are not likely to be interested to take up the works or

make supply.

Requirements of NCB

Let us now look at the requirements of NCB:

Advertisement: The Invitation for pre-qualification/IFB should be published

in national news papers having wide circulation in metros, in principal cities,

and the region where the procurement is being made.

We should also publish the Invitation for pre-qualification/IFB in appropriate

Trade Journals depending on the value of proposed procurement. These will

ensure adequate publicity and we can expect better competition.



The invitation that you place for pre-qualification/IFB should contain details

regarding the scope of the NCB, the address and telephone numbers of the

officer from whom details could be obtained (or the pre-qualification/ bidding

documents are available).

On the website, you should include a detailed invitation for pre-

qualification/IFB and pre-qualification/bidding documents, the last date and

time of submission, and the place for submission of the pre-qualification

applications/bids.

Pre-qualification document (for works): The pre-qualification

document should include sufficient details regarding eligibility, method of

submission of pre-qualification documents, details of documents/

information to be furnished, qualification criteria, evaluation

methodology, preparation of the list of pre-qualified applicants, and

notification of the list of approved pre-qualified bidders.

Period for submission of pre-qualification documents: The pre-

qualification submission period, that is the period from the date of

publication of the invitation for pre-qualification in the press or the date

of availability of pre qualification documents (whichever is later) to the

last date of submission of bids. Just like in the other bids, the

submission period must be sufficiently large depending on the size and

complexity of the contract, in order to enable the prospective applicants

to obtain the pre-qualification document, study the field conditions,

collect field data, compile the qualification and other required information

and then submit pre-qualification applications. A period between 30 to

45 days depending on the size and complexity of contracts is considered

as reasonable for submission of pre-qualification documents.

Bidding document (for works and goods): The bidding document

should include sufficient details regarding eligibility, method of

submission of bids, bid security (amount and currency) to be furnished,

period for submission of bids, qualification criteria, evaluation

methodology, securities to be submitted, award of contract, and so on. It

should also include simplified Conditions of Contract, such as those of

Institute of Civil Engineers, United Kingdom.



Bidding period (for works): The bidding period, is the period from the

date of issue of the bid document to pre-qualified bidders to the date of

the bid submission. It should be adequate depending on the size and

complexity of the proposed contract to enable the prospective bidders to

obtain the bidding document, study the field conditions, collect field data

and then submit meaningful bids. A period between 30 to 45 days or

even more in case of large and complex contracts is considered as a

reasonable bidding period for works.

Bidding period (for goods): It should be sufficient depending on the

size and complexity of the proposed contract to enable the prospective

bidder to obtain the bidding document, study the same and then submit

meaningful bids. Here also a period between 30 to 45 days is

considered as a reasonable bidding period for goods.

Steps for NCB

Similar to ICB, we have two ways involved in NCB: one with pre-

qualification, another without prequalification. Steps for NCB are essentially

the same as of ICB and are reproduced hereunder.

Works with pre-qualification

The following are the essential steps:

1. Notify and advertise for submission of pre-qualification applications by

the prospective bidders.

2. Issue/sale of pre-qualification documents.

3. Collect pre-qualification applications by the prospective bidders.

4. Open the pre-qualification applications.

5. Evaluate the pre-qualification applications.

6. Prepare the list of pre-qualified bidders.

7. Issue of the bidding document to the pre-qualified bidders.

8. Collect bids by pre-qualified bidders.



11. Award and sign contract agreement with the selected contractor.

12. Contract accomplished by the Contractor.



Works and goods without pre-qualification

Following are the essential steps that you must follow:

1. Notify and advertise.

2. Issue/sale of the bidding document to the prospective bidders.

3. Collect bids by prospective bidders.

4. Evaluate of the bids.

5. Select lowest evaluated responsive bid.

6. Award and sign the agreement with the selected Contractor/ Supplier.

7. Contract accomplished by the Contractor/Supplier.


1. In addition to the national news papers we should publish the invitation

for bids in ___________ and _________ and send copies to

__________ to ensure wide publicity

2. The bidding period for works and goods in case of ICB is usually

_______ to ________ days.

3. We adopt ICB for value of packages which are ______ in value and the

works or goods are _____ in nature.

4. In LIB, IFB is not required to be published in electronic or print media

as the bids are invited from selected known manufacturers/suppliers.

(True/False)

5. In LIB, domestic preference is allowed while evaluating the bids, as in

the case of ICB. (True/False)

6. In LIB, except for advertisement, all the other steps are the same as of

ICB. (True/False)

7. In NCB, foreign contractors/suppliers are not allowed to participate.

(True/False)

8. In NCB, the bidders can quote in any internationally convertible

currency and payment is also made in the same currency. (True/False)

9. The essential steps for procurement under ICB are almost the same as

in the case of ICB. (True/False)

10. The bidding period in the case of NCB could be shorter than in the

case of ICB. (True/False)



Activity 1:

Consider that you are constructing a power house in India and are

looking for World Bank funding. How do you gain the attention of supplier

or contractors across the Globe?

Hint: Refer Section requirements for ICB.

6.3 Shopping

Shopping is a term often used in our daily life. In terms of contract

management, this term is adapted for procurement of certain special

requirements. As a first step, various contractors or suppliers are enquired

and a procurement date is obtained from them. This procurement date is

based on the requirements of your project. The date collected from various

suppliers by enquiring is compared, and then based on the output,

procurement is made. Since procurement is critical, we follow a definite

procedure for procurement.

Shopping is a popular method of procurement in which the quotations are

invited from pre-selected contractors or suppliers for procurement of small

quantity of service, or goods. Shopping can either be national or

international. In the case of national shopping, the currency of quotation and

payment is in national currency. In international shopping, currency of

quotation and payment can either be national or international.

Conditions for adopting shopping

We should adopt shopping when:

It is an appropriate method for execution of works of small value in a

short period of time. In the case of goods, it is appropriate method for

procuring readily available, off the shelf goods.

In cases where more than one source is present for the standard

specification commodities of small value.

Requirements of shopping

Let us now look at the requirements for shopping:

The value of the work or goods should be of a lesser value and the

nature of business should be urgent. You can also consider this as a

parameter to adopt shopping.



Material or goods which are readily available. (The materials are readily

available in the market or within your organisation).

A competitive market is present. You can also consider this as a

parameter to adopt shopping as this gives you an edge on price.

Pre-selected list of qualified contractors and suppliers are prepared for

different categories of works/goods.

Steps for shopping (works/goods)

Now that we are aware of the requirements for shopping, let us understand

the steps involved in shopping:

1. Issue requests for quotation (RFQ) to selected contractors/suppliers.

2. Collect quotations by the selected contractors/suppliers.

3. Public opening of quotations.

4. Evaluate quotations by preparing comparative statement as per

method of evaluation given in RFQ.

5. Select lowest responsive and qualified contractor/supplier.

6. Issue of work order (for works)/supply order (for goods).


11. In shopping method we invite open quotations for execution of works or

supply of goods. (True/False)

12. Shopping is best method of procuring readily available goods.

(True/False)

13. Shopping is not an appropriate method for procuring standard

specification commodities. (True/False)

Activity 2:

You are running a car assembly unit in India for an international car

manufacturer X from Germany. You need to import engine from X only,

what kind of bidding process will you adopt and why?

Hint: Refer the section bidding

6.4 Direct Contracting

You learnt that shopping can be adopted for urgent works and readily

available products with enough competition in market.



Direct contracting is another procurement method that is used under a

limited number of exceptional circumstances. In Direct contracting method,

contract for works or supply is made with a pre-identified contractor or

supplier, who is considered capable of performing the contract satisfactorily.

In this method, we do not invite open bids or quotations. It is best suited

when there cannot be any delay in project or material required. For

example, when there is an unexpected leak in a dam, we would want it to be

fixed immediately. In such cases, we hand over the work to a pre-identified

contractor as this is an emergency situation.

Conditions for adopting direct contracting

We should adopt direct contracting when:

Extension of existing contracts for works or supply of goods is justifiable

on economic grounds. For example, there is an existing contract

(awarded through NCB) for the construction of 20 kilometres road by the

Public Works Department (PWD). While the construction is in progress,

PWD decides to construct a bye-pass road of length1.5 kilometres of the

same specifications. Rather than inviting fresh bids for 1.5 kilometres of

road (for which the mobilisation costs would be high), this length of road

could be awarded at the same rates as of 20 kilometres road to the

existing contractor on a direct contract basis.

We standardise equipments. We can illustrate this with an example; let

us consider that an organisation has 200 passenger cars of specific

model of a particular manufacturer. The organisation wants an additional

10 passenger cars for new recruits. If the organisation chooses to go for

procurement by open bids for these additional cars, they may end up

procuring cars of a different model and different manufacturer. This will

lead to maintaining different inventory and different service engineers,

which is not in the best interest of the company.

Proprietary equipment (those equipments which are known to be

manufactured by a single manufacturer only, for example, a scientific

equipment of a particular specification which is manufactured by a

particular manufacturer only) and spares of that equipment are already

with the purchaser (to achieve optimum operation efficiency).



There is a need for early delivery to avoid costly delays (as in the case

of breakdown of equipment resulting in heavy operational losses).

Exceptional cases like natural disaster such as flood, earthquake, and

so on occur.

We purchase books, periodicals from publishers; software from the

developers or producers, and works of art.

We purchase published data (such as meteorological data, satellite

imageries, and so on) from a Government agency.

Contracts awarded to NGOs in the interest of project sustainability,

achieve certain social objectives of project, utilisation of local know-how

and materials.

Requirements for direct contracting

Let us now look at the requirements for direct contracting:

The requirement of direct contracting should be such that it can be

justified on economic grounds.

No purpose would be served by inviting quotations as comparison is not

possible.

Avoid losses in operation of a production unit or a project by making the

equipment or material available.

Non-availability of a competitive market.

Existing Cooperative agreement between the parties involved.

Steps for direct contracting

Now that we are aware of the requirements for direct contracting, let us

understand the steps involved in direct contracting:

1. Invite short period quotation/proposal except in the case of natural

disaster.

2. Examine quotation/ proposal.

3. Issue work order/purchase order.

4. In case of items on Directorate General of Supplies and Disposals

(DGS and D) rate contract and other rate contracts, place orders on the

rate contract holder as per terms and conditions of the rate contract.




14. Direct Contracting is another procurement method that is used under a

limited number of ____________ circumstances.

15. ___________ refers to goods or services for which any slight delay will

result in the imminent loss or damage to valuable properties.

16. Non-Competitive market for performance or price is available means

minimum requirement of _________ for bidding is non-existent.

17. Direct contracting method, contract for works or supply is made to a

pre-identified contractor or supplier considered qualified to perform the

_________.

6.5 Force Account

You have learnt that direct contracting is used under a limited number or

exceptional circumstances without inviting any open bids.

Force account is to make use of your own personnel and equipment, or to

do the work or procure goods without prior agreement as required for lump

sum or unit price. For example, when you have skilled labour for execution

of certain components of the work, you need not call for bids for completing

the work. However, you should justify this on economic grounds.

Conditions for adopting force account

List of the situation where you can utilise force account is mentioned below:

Works are small or in remote locations where mobilisation costs for the

contractors would be unreasonably high and they would quote

unreasonably high rates.

Works cannot be carried out without disrupting the progress of on-going

operations.

To bear risks of unavoidable interruptions (a contractor or supplier

cannot sometime quantify the losses).

Emergencies needing proper attention, such as repairs or restoring of

railway track washed away by floods to restart rail communication.

Items of work that cannot be measured, such as dressing of roads,

watering of plants and so on.



Requirements for force account

Let us now look at the requirements for force accounting:

Force account should be justifiable as to why competitive bids cannot be

invited. The reason for not inviting bids could be either due to the nature

of the work or exigencies.

Losses of work or supplies related to projects that cannot be quantified.

When the work is remote and the contracting will be more expensive

than the actual cost.

Steps for force account

Now that we are aware of the requirements for force account contracting, let

us understand the steps involved in force account contracting:

1. Establishing the need with justification.

2. Mobilising the requisite labour, equipment and materials.

3. Deploying resources for the work.

4. Monitoring the progress.

5. Financing till the work is complete.


18. Direct contracting is adopted when the works are small and scattered

or in remote locations where mobilisation costs for the contractor would

be unreasonably high. (True/False)

19. Force Account is adopted when the works are to be carried out without

disrupting on-going operations. (True/False)

20. In Force Account method of construction the materials and equipment

are provided by a contractor. (True/False)

Activity 3:

You own an oil digging company and you are planning to set up a new

unit in the middle of an ocean. You currently buy equipments from a

company in Korea and you know that they are best in such equipments.

What kind of procurement method will you adopt and why?

Hint: Refer to section direct contracting.



6.6 Summary

Let us now sum up few points that we learnt in this unit:

There are various methods available to us for procuring works and

goods. You have to select an appropriate method for various packages

of works and goods by considering the value of the packages, need to

ensure economy and efficiency, availability of contractors/suppliers,

importance of the procurement, availability of the goods, amenability of

the procurement to competition and so on.

We discussed that International Competitive Bidding (ICB), requires

inviting open bids for works or goods through wide range of advertising.

It is the most efficient and economic method of procurement for high

value packages of works and goods and those which are complex in

nature. We learnt that the bidders may bid in an internationally

convertible currency and get paid in the same currency. For works, we

usually pre-qualify the bidders. We studied that the standard bidding

documents with internationally accepted conditions of contract are used.

It takes a relatively longer time for procurement. We discussed that to

safeguard the interests of domestic bidders; a certain amount of

preference is given to domestic contractors and suppliers.

We discussed that Limited International Bidding (LIB) is usually adopted

for procurement of goods. Bids are invited from known, pre-selected

bidders where you need wide publicity. Domestic preference is not

given. We learnt the other requirements of LIB and discussed the steps

of procurement which are the same as that of ICB.

We studied that National Competitive Bidding (NCB) is adopted where

ICB/LCB is not expected to result in economic and efficient

procurement. We discussed that the invitations for bids are notified/

advertised in national media and the currency of bid and payment is the

nation’s local currency. However foreign contractors/suppliers can

participate if they agree to the NCB terms and conditions. We also

discussed the steps for procurement, which is essentially the same as

that of ICB.

We learnt that shopping is an appropriate method of procurement for

small value packages of works and goods. We discussed that this is a

quick method of procurement of small value goods, which are readily



available off the shelf items, or standard specification commodities of

small values. We can invite quotations from pre-selected

contractors/suppliers and then evaluate the quotations as per normal

commercial practices and work/supply order is issued to the lowest

responsive offer.

We discussed that direct contracting is placing of work/supply order for

works/goods on a contractor/supplier without inviting competitive bids or

receiving quotations. This is done only in an exceptional condition;

where other methods of procurement are not economically reasonable.

This process is for quicker project competition or goods procurements.

We learnt that force account is a method executing work by using

employer’s own resources such as labour, equipment and materials. It is

adopted where other methods of procurement are impracticable, or

feasible, or for emergency operations resulting from natural disaster.

6.7 Glossary

Term Description

Sustainability A term used to describe the capacity to endure without

giving way or yielding.

Journals Periodical presenting articles on a particular subject: for

example a medical journal.

Embassies A body of persons entrusted with a mission to a

sovereign or government, especially an ambassador

and his or her staff.

Exigency A term used to describe the condition of urgency.

Indispensable A term used to describe something absolutely

necessary, essential, or requisite.


1. Compare ICB and NCB.

2. What are the suitable circumstances to adopt direct contracting?

3. Explain the requirements for a LIB?

4. Explain where force account is best suited and list out the requirements

for the same.

5. List out requirements for Shopping.



6.9 Answers


1. Widely seen websites, trade journals, embassies

2. 45, 60

3. High, complex

4. True

5. False

6. True

7. False

8. False

9. True

10. True

11. False

12. True

13. True

14. Exceptional

15. Genuine exigency

16. Three quotations

17. Contract satisfactorily

18. False

19. True

20. False

Terminal Questions

1. Refer section 6.2.1 and 6.2.3 International/Global Competitive Bidding

(ICB) and National Competitive Bidding (NCB).

2. Refer section 6.4 Direct Contracting.

3. Refer section 6.2.2 Limited International Competitive Bidding (LIB).

4. Refer section 6.5 Force Account.

5. Refer section 6.3 Shopping.



6.10 Caselet

Diagnosis Related Groups contract in HPS

A health care provider network, HPS in a Western state of India, was

looking for contracting opportunities with major employers in the region.

The group already had an infrastructure of contracts and a sophisticated

financial system from which service-line costs could be derived. The

network was also able to deliver a full array of services to its customers.

HPS worked with the three largest employers in the State and put in place

a data analysis process which demonstrated that significant savings for the

employers could be achieved while meeting the health system’s financial

requirements. HPS was then able to negotiate contracts based on

Diagnosis-Related-Groups which resulted in a projected savings of over 2

crore rupees per year for the employers. In exchange for favourable

pricing, this was demonstrated to achieve cost-plus results; the health

system looks forward to significantly increase the patient volume at

network facilities and an evolving relationship with the employers as part of

a three year commitment.

Question:

1. Analyse why the employers in the region gave the contract to HPS?

References

http://siteresources.worldbank.org/INTPHILIPPINES/Resources/Procure

ment.pdf



Unit 7 Procurement and Supply Cycle for

Goods and Services

Structure:

7.1 Introduction

Objectives

7.2 Production Process

7.3 Production and Development Process

7.4 Bill of Materials

7.5 Purchase and Buy Decision

7.6 Purchase Request

7.7 Request for Quote

7.8 Negotiations

7.9 Purchase Order/Contract

7.10 Terms Related to Procurement in Contract Management

7.11 Summary

7.12 Glossary


7.14 Answers

7.15 Caselet

7.1 Introduction

In the previous unit, we learnt about different types of bidding and its

implementation. We learnt about shopping, force account and also the steps

and requirement for it. In this unit, we will have an insight into the various

activities involved prior to launching the procurement cycle, like

development for a product, preproduction stages, and processes and so on.

In this unit, we will study the process involved in identifying the list of parts

for a project and categorising them into make or buy groups. We will discuss

methods to organise a project to manufacture it in house or source them

from reliable suppliers.

To familiarise you with the live situation of procurement and supply cycle,

various stages of procurement, from receipt of purchase request, down the

line to issue of a purchase order/contract to ensuring supplies, accounting

for the same and paying suppliers are covered in this unit.



Learning objectives


define production and development process.

explain purchase request and buy decision.

elucidate negotiations and the steps involved in it.

describe purchase order.

discuss the terms related to procurement.

7.2 Production Process

Let us begin our discussion with the production process. The production

process for any project begins soon after the research and development

department finalises the design/development of the product. The project

under reference may be any one of the following types or combination of

any of them:

Collaborative project: In this type, the project collaborator will arrange

to provide the complete know-how to the project producer/contractor.

The transfer of know-how will be in the form of detailed technical

drawings, processes, technology, equipments used and so on, for the

producer to manufacture the equipment and market the same directly or

through the collaborator. Transfer of technology in case of complex

projects takes place in phases, spread over a period to facilitate

organising/absorption of the same by the recipient. On many occasions,

the producer develops a part of the equipment or units and the

collaborator develops a part of it .The project shapes to total equipment

for an application after integration. This normally happens when a

project design involves a multidisciplinary technology, where each one

of the company is specialised in their field. The benefits of collaborated

projects are easy availability of technology for projects with no

development hassles at a cost of course. However, the

producer/marketer should hasten up to absorb the technology, produce

and market the same to get returns to cover up investment before it is

outdated.

Total in house development project: In this type of project, the project

is totally developed in house with each Research and Development (R &

D) group specialising in their own field and developing their part of the

equipment. The development cycle for the project takes its own toll due



to the cycle time, with the result that only companies existing in the

product field can afford to take up.

Integrators: In the present age of high tech equipment for complex

projects, companies resort to design a system with bought out units and

sub unit from different manufacturers specialised in each of them. The

system designer integrates these units, tests them and conducts field

trials before installing the same to complete the project. Any new

product has to go through the product life cycle of introduction, growth,

maturity and decline. Time scales in each of these stages vary

depending on the nature of the project, the technology involved in it and

so on. Projects of certain nature like drugs and pharmaceuticals involve

a long cycle and extensive field trials before the approvals by statutory

authorities prior to release.

Product development cycle

All products under development typically follow the cycle of market_place-

to-market_place. The development starts with identification of a product in

market place, followed by market research for this product to confirm its

potential, expected price range, features and so on, to ensure economic

viability. Product design takes off at this stage followed by process design

and operations. Subsequently, the product is ready for consumption and hits

the market at a suitable time. The product designer should ensure that

quality tag is inbuilt in each stage to provide a reliable, easily maintainable,

cost effective and visually attractive product to the consumer. Post sales

warranty and service support will add a feather in the supplier customer

service.

There are few production processes followed by organisations. The

organisation prepares a strategic business plan, which defines the major

goals and objectives of the company. An effective planning is always

required to implement any process or model in an organisation. Let us

discuss this in the next section.

Steps in production process

A project whether it is the development of Fast Moving Consumer Goods

(FMCG) product, a Parma product or any other product, generally follows

the standard model with customisation for specific industry depending on its



nature. It is a statement of the broad direction of the firm, kinds of business

and product lines it proposes to take up.

There are various stages involved in it. They are illustrated in the figure 7.1:

Figure 7.1: Steps in Production Process

Let us now discuss each of these stages in detail.

1. Stage 1 - Planning: The objectives mentioned in the strategic plan, act

as a guideline for preparation of production plans. The production

management prepares plan for quantities of each product group,

resources of equipment, labour and material required and the availability

of resources. Planning gives the long-range forecast and general

directions as to how the company plans to achieve its objectives. It is

prepared with the participation from marketing, finance, production and

engineering teams. This plan is prepared for a time horizon of a year

without many details.

2. Stage 2 - Preparation: It is of master production schedule. This is a

plan for production of individual items at component level. This is

prepared based on sales orders, inventories and existing capacity.

Manufacturing and purchase lead times are important considerations in

preparation of master production schedule. The planning horizon for this



plan could extend beyond a financial year as the product mixes do not

undergo a drastic change over this period.

3. Stage 3 - Preparation of Material Requirement Plan: Here, the actual

quantities to be produced are decided with minute details. The role of

manufacturing and purchase lead times is an important consideration

here. The planning horizon for this activity generally extends from 3 to

18 months.

4. Stage 4 - Implementation: Purchasing and production activity controls

the implementation phase of a production system. Purchasing takes

care of all raw material and purchase part supplies to the plant, thus

ensuring uninterrupted supply. Production activity controls the

manufacturing activity within the plant. This ensures free flow of Work In

Progress (WIP) ensuring steady supply of inputs, at assembly stage for

uninterrupted despatch of finished goods to customers. The planning

horizon in this stage is very short and could be as small as days.

All these activities integrated with sales and operations planning need to

handle large amount of data involving a number of calculations. Thus, the

strategic business plan incorporates marketing, finance and production.

Manufacturing should meet the required demand, financing should concur

with other functions from financial point of view, and marketing must ensure

that its plans are achievable. The result of integrated approach for all these

was the evolution of manufacturing planning and control system, which

interacts with all the related functions in the system. This integrated planning

and control system is called manufacturing resource planning-MRP II to

distinguish it from materials requirement plan.


1. The transfer of know-how will be in the form of detailed_______,

processes.

2. All products under development typically follow the cycle of ________.

3. Planning gives the long-range _______ and general directions as to how

the company plans to achieve its objectives.

4. The planning horizon for material requirement plan is generally from ___

to _________ months.



Activity 1:

Consider that you are a production manager in a FMCG organisation.

Your organisation manufactures dairy products. It decides to diversify its

business into beverages. What steps will you implement in the production

process?

Hint: Refer section 7.2.1: Steps in production process.

7.3 Production and Development Process

After learning the production process and the steps involved in it, we will

now discuss about the production and development process.

The traditional approach to product development stresses on a rigid

sequence of steps. Usually R&D engineers exclude the manufacture

process and purchase process during the product design stage. R&D

engineers normally assume that process engineers/manufacturing

engineers could develop the processes required for a new product. The

prototype model of the new product under development goes through the

universal production process to prove the concept, and for initial trials,

without using the mass production techniques, tools, and fixtures. As a

result, the process time for manufacturing is extended and the expenses

also increase.

After the completion of design, to prevent high cost and long time consumed

in development, a system of concurrent activity of production and

development is created. In this system, the designer and processor work in

close coordination with each other, which results in considerable reduction

in the development cycles.

This has gained high level of importance in the present scenario of high

costs and severe competition. It is called as simultaneous engineering or

concurrent engineering. The traditional approach of sequential activity of

product and process design is replaced by concurrent operation of

development and design, by cross-functional teams consisting of

representatives from product design, process design, quality, production

planning and so on. The results of simultaneous engineering are reduced

time to market, reduced product cost, and better quality.



7.4 Bill of Materials

Bill of Materials (BOM) is an important document for any project, production

before launching or material requirement planning process.

The American Production and Inventory Control Society (APICS) defines a

BOM as “a listing of all sub assemblies, intermediates, parts and raw

materials that go into making the parent assembly showing the quantities of

each, required to make an assembly”.

BOM serves the following purposes:

It specifies the components required for a project.

It provides a platform for recording the engineering changes in parts

consequent to change in design.

It is a ready beckoner for purchase parts and manufactured parts for the

end product.

It provides a list of parts required to make a subassembly, assembly and

final product.

It can participate as costing a tool.

Identification of parts is an important requirement in preparation of BOM.

Each part that goes into a product is identified by unique part number, which

is not assigned to any other part. A part with the same material, shape, but

with different finish, like painting instead of plating, is assigned a different

number. In conclusion, BOM can be described as a summarised parts list

for making one set of complete assembly.

BOM is further exploded to arrive at the total quantitative requirement of a

part/component for batch quantity. If the part under reference has multiple

uses in different products, that is, in manufacture of variants of the same

product, then the requirement is assessed across the variants to arrive at a

quantity. The quantity thus arrived is termed as gross requirement. In a

project running continuously over a period, the situation is highly dynamic as

a few numbers of this part may be available in stock within the plant and few

pieces ordered earlier may be in pipeline (that is in transit). Hence, all these

quantities are taken into consideration before arriving at net requirement for

either manufacture or supply.




5. Bill of material is a ready beckoner for purchase parts for a project.

(True/False)

6. The _______ of sequential activity of product and process design are

replaced by concurrent operation of development and design.

7. BOM can be described as a _______ list for making one set of complete

assembly.

7.5 Purchase and Buy Decision

The project manager or the production manager of a project has to decide

whether to buy or make a part, so that it is available at the right schedule to

ensure continuity in manufacturing/work process, as all these activities are

highly time bound. Any delays in schedules will cause a cascading effect on

overall project resulting in cost overruns. There are no universal rules

applicable across projects. It varies widely from project to project.

For a manufacturing project, the factors favouring in house manufacture are

as follows:

In house cost less than supplier cost

Capacity utilisation in house in terms of machine hours and man-hours.

To retain process confidentiality.

To retain high level of quality.

To keep up schedules particularly if long process cycles are involved

post this part.

The factors favouring buy out are as follows:

Elimination of capital expenditure.

Utilisation of specialist facility.

Lesser buy out costs than in house cost.

Focus on one‟s own area of specialisation.

7.6 Purchase Request

In the previous section, you learnt about purchase and buy decision where

the production manager decides the right part so that it can be used

effectively. Now let us discuss about purchase request.

The activities of purchasing starts with the receipt of a document called

purchase request by the purchase manager. This document is an authority



to proceed with procurement action for materials. The purchase manager is

responsible for arranging material supplies required for the project. The

purchase department ensures that the following factors are taken care of:

Studying and analysing the purchase request from project manager.

Identifying the potential suppliers.

Completing the purchase cycle.

Ensuring payment to suppliers

Assessing the supplier.

Purchase plays a vital role in any type of project. It keeps up supply lines

alive by planning to issue purchase orders, following supplies, and ensuring

the availability of right quality of material at right time at right price, which

adds to the revenues considerably. The objectives of purchase are to:

Ensure goods and services of quality and right quantity.

Obtain goods and services at the most competitive price.

Ensure prompt delivery of goods and services.

Maintain supplier relations and develop potential suppliers.

Purchase cycle covers the following steps:

1. Receipt and analyses of purchase request.

2. Select potential suppliers for materials in purchase request.

3. Issue request for quotation.

4. Analyse quotations received.

5. Determine the right price.

6. Negotiate with the suppliers.

7. Issue purchase orders/contracts.

8. Secure commitment from suppliers or enter into contract.

9. Follow up with suppliers/contractors to ensure timely execution.

10. Arrange to receive the goods.

11. Arrange for quality check of goods.

12. Ensure that the supplies reach the consumer.

13. Approve suppliers invoice for payment to supplier/contractor.

The material requirement planning, issues a purchase request covering the

following information:

Originating department and project.

Material part number with full specification/detailed drawing.

Quantity required and unit.



Delivery schedule and point of delivery.

Suppliers‟ part number if the material is a catalogued item.

Any other special instructions.

Selection of potential suppliers

This is an important function of the purchase department. If the material

under reference is a standard item covered by company standards, then the

standards will have a list of approved suppliers for the item under reference.

This item would have been approved after due analysis of samples and

ensuring its compliance with national or international standards. If the

material/component under reference is a mechanical item/equipment, list of

suppliers for this type of item may be identified based on historical data.

In case items under reference are first buy category, suppliers‟ catalogue or

trade journal directory will be of use.

Number of potential suppliers depends on factors like value, importance of

the part and so on.

The sources of specifications are:

Standards.

Buyer specification.

Engineering drawing.

Suppliers catalogue.

Miscellaneous like part sample.

Procurement is the sourcing process that a company uses to get the goods

and services it requires.

Sourcing: There are three types of sourcing:

o Sole source for proprietary items.

o Multiple sources for general/off the shelf items to get price

competitiveness.

o Single source, as decided by organisation for critical items.

Contract buying: Material requirement planning sometimes encounters a

situation wherein it needs a few items of general nature in small

quantities at short notice. The shortage would have occurred due to

some unforeseen circumstances in supply chain. We can deal with this

type of buying at planner level in material requirement planning. The



purchaser sometimes issues the raw material for such requirement on

chargeable basis.

After selecting the potential suppliers, buyers may request bids and quotes.

It is generally termed as Invitation. Let us learn about quotes in detail in the

next section.


8. The _______ or the production manager of a project has to decide

whether to buy or make a part, so that it is available at the right

schedule.

9. Procurement is the sourcing process a company uses to get the goods

and services. (True/False)

10. The purchaser sometimes issues the raw material for contract buying

requirement on _____ basis.

Activity 2:

Consider that you are a purchase manager in an organisation. Few new

employees have joined your organisation. Prepare a Power Point

Presentation for them in which the objectives for purchase request are

given.

Hint: Refer section 7.6: Purchase Request.

7.7 Request for Quote

Request for Quote (RFQ), is a standard business process to invite suppliers

into a bidding process to bid on specific products or services through

Invitation for Bid (IFB). A RFQ seeks information like unit price for the

product/material, delivery schedule, payment terms, quality level and special

instructions like packing type, packing unit and so on during the bidding

process.

An RFQ should always contain/request the following information:

The price requirement that includes the fixed price and slab price in

some cases.

The quantities or volumes required.

The delivery date or the completion date for the goods or services

required.



The confirmation that the supplier can fully comply with the

specifications of the items or services.

The confirmation of compliance with any standards.

The terms and condition of purchase.

Terms of payment.

RFQ is a very important document while purchasing goods and services.

Hence, it should cover all the necessary items by including all the relevant

drawings, specifications, description of services, and so on. Therefore, RFQ

for contracts should elaborate all terms and conditions of contract, both

commercial and statutory, in an enclosure attached to the tender forms. The

bidders sometimes offer alternative solutions to the specifications tendered,

hence they should be invited during the process. The suppliers may have

alternative solutions, which will meet the requirements at a lower price. The

lead-time of RFQ should be high so that the negotiation process has

sufficient time run. A minimum of 3 to 4 potential suppliers will receive the

RFQ. A predetermined date must be selected for receipt of quotation, which

should be specified in the RFQ.

The evaluation process will proceed once the quotations are received. This

is followed by a discussion on the technical capabilities or to note errors in

the proposal. Multiple rounds of negotiations may follow with an aim to

generate the best market price. You should make it a point to respond to all

the bidder questions without any delay. RFQ‟s are standardised/customised

to products and services as far as possible, to facilitate computerisation and

automation of transactions. An RFQ provides an opportunity to different

contractors to provide a quotation, among which the best will be selected.

Although RFQ for imported material/equipment covers all the parameters

listed above, it will have certain unique parameters as it is an overseas

transaction.

7.8 Negotiations

One of the most important activities performed by the supply managers is to

negotiate agreements or contracts with the suppliers. Although supply

management is definitely not the single group in the organisation that

negotiates, negotiation is a fundamental part of every sourcing process.



Negotiation is the best way to employ the supply management strategies

and plans that a business unit develops.

Material inputs account for more than 60% of sale value for any project.

Hence, cost saving at this stage will contribute to direct profit for the

company.

Triangle Talk is the simple negotiation tool, which can help the negotiator to

begin the initial preparation for a forthcoming negotiation.

The figure 7.2 shows the set of steps followed in Triangle Talk:

Figure 7.2: Steps in Triangle Talk

Let us now discuss these steps in detail:

Step 1: Triangle Talk is a tool used to determine and formalise the

negotiators precise goals and objectives for the forthcoming negotiation.

By being precise with ones expectation and noting down the points, the



negotiators remain fixed on their predetermined priorities during the

negotiation. Writing down the points to be negotiated allows the

negotiator to refer back to them during the course of the negotiation. If

the negotiators are clear about their priority, they are more likely to

achieve it in the final agreement.

Step 2: In this step, the needs of the negotiators counterpart is

determined. It is difficult to conclude without understanding the needs of

the other party. The needs or wants of the other party, their underlying

interests have to be determined in advance. However, the negotiator

cannot automatically assume that the other party thinks in the same way

that they do. The negotiators are free to raise open-ended probing

questions to confirm if their preliminary analysis of the other party is

right. In addition, the negotiator should develop a strategy and

associated tactics that will satisfy the needs of the other party. This

allows us to step into step 3 of the Triangle Talk.

Step 3: In this step, the negotiators own requirements are analysed

along with the requirements of the other party. In this way, the proposals

and counterproposals can be offered. They take both sets of

requirements into account and are framed in such a way that the other

party agree to the negotiators‟ demands. The decisions of the negotiator

and the other party should remain flexible and reasonable so that both

can work on the similar agreement, while acknowledging the other

party‟s concerns. The negotiators can bring about this by negotiating

about those needs first, while framing their proposals. At times,

negotiation becomes a lengthy and cumbersome process. Hence, it

requires tactful and careful planning.

We will discuss about negotiation in detail in Unit 11.


11. Request for Quote (RFQ), is a standard business process to invite

______ into a bidding process to bid on specific products or services.

12. The evaluation process will proceed once the quotations are received.

(True/False)

13. Triangle Talk is the simple negotiation tool, which can help the

negotiator to begin the initial preparation for a forthcoming negotiation.

(True/False)



7.9 Purchase Order/Contract

In the previous section, we have discussed about negotiation. Let us now

discuss about the purchase order.

A purchase order/contract is issued to the supplier/contractor. The offer

once accepted by the supplier/contractor becomes a legal contract by which

the supply must supply the goods as per the terms of contract. The

purchase order covers all the essential data indicated on purchase request,

RFQ, quotation and subsequent updated points, and finalised during

negotiations. Many companies have pre-printed general conditions of

contract, which is enclosed to purchase order.

Even in the case of contracts, the contractor gets an offer covering the

points quoted above, along with general conditions of contract and the

statutory guidelines to be followed at site during execution.

The copies of purchase order/contract are sent to finance, inward goods and

the project manager after it is approved.

A purchase order/contract offered by the purchaser needs to be accepted by

the supplier/contractor through an acknowledgement, to mature into a

legally binding agreement.

Although purchase order for imported material/equipment covers all the

parameters listed above, it will have certain unique parameters as it is an

overseas transaction.

7.10 Terms Related to Procurement in Contract Management

There are few procurement related terms in contract management, let us

learn about them.

Supplies

The supplier is responsible for the delivery of goods/services that are

ordered/contracted to him as per the order. However, purchaser has to

ensure the goods are delivered on time. In case there are apprehensions

about this purchase, the purchaser should try to assist the supplier to clear

impediments if any, like amendment to purchase order, modifying the

delivery schedule and so on. On many occasions the supplies have to be

accelerated due to change in consumption patterns which needs

intervention by purchase. In case of contracts, the project manager/site



engineer plays a major role along with the contracts manager in timely

execution of projects.

Inward goods

The goods are delivered at the inward goods stores of the company/plant

with necessary documents like delivery challans and suppliers invoice.

These documents will have the details such as purchase order number, part

number, quantity, unit price, total invoiced value, statutory duties and so on.

Personnel operating inward goods stores accept the supplies after verifying

that the entries in documents tally with the actual delivery of goods. They

also conduct visual inspection of the same to ensure that the materials

received are free from physical damages during transit. The supplies are

subjected to inspection by quality department before they are accepted on

records. In some cases, the goods are sent to user department for user

acceptance.

IG accounting

The inward goods personnel accept the goods supplied on clearance by

quality department and send report to purchase department. Discrepancies

if any like short supplies, rejections in quality and so on are brought to the

notice of purchaser, who promptly takes action to rectify. The goods are

tagged for identification and are handed over to project group for storing.

Binning

The goods on receipt are received by personnel at the project stores,

verified and then accepted. The goods are stored properly following store

procedures, in bins/store trays or customised holders depending upon the

design of the goods, with necessary care. The conventional practice of bin

cards are still followed in many stores.

Release to production

The goods received in stores are released for consumption to the user as

and when indented, following proper procedures.

Payment to suppliers

The purchase manager approves release of payment to the supplier based

on the report sent by inward goods personnel.




14. The supplier is responsible for delivery of goods ordered as per

schedule. (True/False)

15. The goods are arranged to be delivered at the _______ stores of the

company /plant with necessary documents.

16. The goods on receipt are received by the project stores verified and

accepted. (True/False)

17. The goods received in stores are released for________ to the user as

and when indented by them following proper procedures.

Activity 3:

Consider that you have recently joined an organisation. Your manger has

asked you to prepare a document on steps to negotiate. Create a power

Point Presentation for it and upload it in your official website.

Hint: Refer section 7.8: Negotiations.

7.11 Summary

In this unit, we have had a walk through of the entire purchase cycle. We

have understood that issues of a purchase request from material

requirement planning triggers purchase cycle. We have discussed how a

purchaser verifies the purchase request and initiates a request for quotation

to short listed suppliers. The suppliers respond to this with quotations

indicating the price and stipulating their clauses in quotes within a stipulated

deadline. The quotes are then scrutinised and a comparison statement is

prepared. Successful bidders are identified from this statement.

We also studied that negotiations are conducted before a purchase

order/contract is offered .The supplier/contractor responds to this with an

acknowledgement resulting in a contract.

We have also understood that the goods are received at inward goods

stores of the plant. The stores personnel check the goods for quality after

initial inspection. Inward goods personnel send reports of receipt and quality

checking. Based on this, purchaser initiates action for release of payment to

the supplier. The accepted goods are handed over to the project manager

and are stored properly before releasing to production/manufacture.



7.12 Glossary

Term Description

Collaboration A company working together on a project.

Comply To act in accordance with another's command, request, rule or wish.

Customer An organisation or individual that receives a product or service from the company.

Supplier An organisation that provides a product to another organisation. Products are often passed in a chain, from the supplier to the organisation to the customer.


1. List the Sources of specifications.

2. What are the objectives of purchasing?

3. List the essentials of RFQ.

4. How is bill of material useful?

5. Explain the steps involved in Triangle Talk.

7.14 Answers


1. Technical drawings

2. Market_place-to-market_place

3. Forecast

4. 3, 18

5. True

6. Traditional approach

7. Summarised parts

8. Project manager

9. True

10. Chargeable

11. Suppliers

12. True

13. True

14. True

15. Inward goods

16. True

17. Consumption



Terminal Questions

1. Refer section 7.6.1 Selection of potential suppliers

2. Refer section 7.2.1 Steps in production process

3. Refer section 7.7 Request for quote

4. Refer section 7.4 Bills of Materials

5. Refer section 7.8 Negotiation

7.15 Caselet

Implementation of Contract Management

The Company

Post World war, Golden Paradise, an Indian organisation was practicing

older concepts of system to manage the negotiation techniques. As a

result, a barrier of mistrust, individualism, and non-involvement of

different levels of work force and management had cropped up between

the important sections of the organisation. Hence, by introducing modern

concepts of negotiation in the organisation, employees at the grassroots

level had the opportunity to perform effectively and meshing well with the

activities of other levels.

The Challenge

In 2006, the organisation, wanted to start a new branch in Noida. They

had to buy raw materials from the suppliers. The supply managers had

to negotiate with their suppliers. Triangle Talk, which is the simple

negotiation tool, helped the supply manager to begin the initial

preparation for negotiation.

The Solution

The organisation followed a negotiation technique that included:

Raising open-ended probing questions to confirm the other party‟s

requirements.

Developing a strategy and associated tactics that will satisfy the needs

of the other party.

Analysing the needs and wants of the organisation, with the needs and

wants of the other party.

In this way, proposals and counterproposals were offered. The manger



took both sets of requirements into account and framed the proposal in

such a way that the other party agrees to their demands .The decisions

of the supply manager and the other party remained flexible and

reasonable and both worked on the similar agreement. This helped the

organisation to buy raw materials in a reasonable rate. They could also

start their organisation in Noida.

The Benefits:

Rapid deployment.

Set up of the new branch within 5 weeks.

Cost savings.

Question:

1. What steps did „Golden Paradise‟ implement to negotiate with

suppliers for their new branch in Noida?

References

Thomas E. Usher and Philip Davenport, Fundamentals of Building

Contract Management.

Anuj Saxena, Enterprise Contract Management: A Practical Guide to

Successfully Implementing an ECM Solution.

Jack Sternbach, Contract Management Systems.



Unit 8 Types of Contracts for Works and Goods

Structure:

8.1 Introduction

Objectives

8.2 Factors Influencing Types of Contracts

8.3 Lump Sum/All inclusive/Fixed Price Contracts (Works)

8.4 Item Rate/Unit Rate Contracts (Works and Goods)

8.5 Percentage Rate Contract (Works)

8.6 Cost Plus Fee Contracts (Works)

8.7 Supply and Erect/Install, Commission, and Test Contracts

(combination of supply of Goods and Works contracts)

8.8 Design and Build Contracts (Works)

8.9 Turnkey Contracts (combination of supply of Goods and Works

Contracts)

8.10 Management Contracts

8.11 Public Private Participation Contracts

8.12 Summary

8.13 Glossary

8.14 Terminal Question

8.15 Answers

8.16 Caselet

8.1 Introduction

In the previous unit you learned about production and supplies. We learnt

that there are different processes in production as well as purchase. We

also discussed the concept of Inward goods, IG accounting and binning.

In this unit you will study various types of contracts along with each of their

salient features. You will learn the situation where each of the contracts can

be applicable along with their advantages and disadvantages.

Objectives:


discuss the factors influencing the types of contracts.

explain different types of contract.

identify the advantages and disadvantages of various contracts.



8.2 Factors Influencing Types of Contracts

There are various types of contracts that are suitable for different situations.

Contracts are required for both project developments as well as for

purchase of goods. The type of contract that you choose can be suitable

only for works or goods or both, depending on the requirement and on the

complexity of the works and goods. The type of contract chosen will affect

the subsequent steps of procurement.

Some of the factors that enable you to select the type of contracts suitable

for your works or goods are as follows:

Nature and complexity of the works/equipment (example, building,

highway, flyover, industrial plant and so on).

The size and duration of the contract (example, primary health centre,

primary school, major hospital, feeder roads, expressway, pumping unit

supply and installation, urban water supply, and others).

The degree of the definition of the works and the element of

risk/uncertainty.

The status of design of works or framing of specifications for goods and

so on. (Preliminary or final).

The technical capability for design, framing of specification, preparation

of drawings, and supervision of works/installation of equipment.

The financial resources available and/or budgetary constraints, if any.

The previous experience in awarding of the type of contract and its

management.

8.3 Lump Sum/All inclusive/Fixed Price Contracts (Works)

After knowing the factors influencing your choice to pick a suitable contract,

let us learn more about different types of contracts. In this section, we will

learn about Lump sum/all inclusive/fixed price contracts.

This type of contact is typical used for small projects that can be executed in

a small duration. You should use this type of contact for only works. Typical

examples of lump sum contracts is culverts, small bridges, primary schools,

health clinics, bus shelters, transmission towers, and so on.



Features

Let us look at the salient features for lump sum contracts:

You find bidders who offer a fixed sum for execution and completion of

the work, in accordance with the designs, drawings and specifications,

within the stipulated time.

Your work must be defined accurately, specifications should be

complete, and the site conditions must be fully explained to avoid

disputes.

Quantities are not usually given for small works. However, for large

works, the quantities of major items are indicated to enable rational bid.

Payments schedule should be linked to the completion on stages of

work and should be a percentage of the contract price for each of the

stages.

Modifications to the lump sum price should be appropriately

incorporated in the contract to account for quantity variations and price

adjustments.

Conditions for adopting

The lump sum/all inclusive/fixed price contracts are best suited for the

following situations:

You should use it for small works with short (less than a year) duration

for completion. For example, buildings, schools, and so on.

You should use it for works which are unlikely to change in quantity and

specifications.

You should use it where there are no unforeseen problems. For

example, you buy a half constructed house and plan to complete it as

you got it in a better price. After buying, you call for contract to complete

the house. While work is in progress you come to know that there is a

problem in the foundation and you cannot complete the project as per

plan and have to spend more.

Advantages and disadvantages

Every contract has its advantages and disadvantages. Let us take a look at

advantages of the lump sum/all inclusive/fixed prices contracts:

As you are aware of the fixed price (variation and price adjustment being

minimal), it is helpful for budget forecasting to be precise.



You find it easy to administer the payment process, since payment is

made on completion of each stage that involves minimal measurements.

You require very less documentation, as there is practically no bill of

quantities.

Let us now look at the disadvantages of lump sum/all inclusive/fixed prices

contract:

It is inflexible to design changes. You cannot do any major variations as

it becomes difficult to manage.

It is difficult to foresee potential future risks and changes. In such case

the bidders may increase their prices to cover future risks which may

result in paying more price than the original.


1. In lump sum contracts the bidder offers a _______ sum for the

execution of the works

2. Lump sum contracts are appropriate only for _______ Contracts.

3. In lump sum contracts, payment schedule is linked to completion of

_____ of work. Payment is usually a _______ of the contract price.

4. Lump sum contracts are ______ for design changes.

8.4 Item Rate/Unit Rate Contracts (Works and Goods)

In the previous section you understood that lump sum/all inclusive/fixed

price contracts are beneficial for small projects that do not have changes

during the execution phase. Let us now learn about the item rate/unit rate

contracts.

This is the common form of contract for execution of simple, small/large

value infrastructure works or for supply of goods (including equipment) for

public sector across the world.



Features

Let us look at the salient features of item rate contracts:

Bidders are allowed to quote unit rates1 for carrying out various items of

work or required goods.

Detailed measurements of all items of work executed by the contractor

are recorded and payments are made to the contractor as per the

quoted rates.

In the case of goods, the bid price is the product of required quantities of

items of supply with the respective unit rates.

The unit rates are fixed for short duration contracts (usually less than

one year) or adjusted for variations in the indexed price of inputs for

longer duration contracts.


Following are the situation where you can use item rate/unit rate:

For supply of goods and works, in public-sector across the world.

For works that are under moderate perceivable risk in sectors such as

transportation, power, irrigation, water supply and sewerage, and so on.


As mentioned earlier every contract has both advantages and

disadvantages, you must be aware of them for optimum benefits. The

advantages item rate/unit rate contracts are:

It provides flexibility for the contracting parties in handling variations and

extra items of work. For example, you give orders to buy ten units of

computer for your new office. Later, you come to know that two units are

required for your old office to replace existing system. It will be easy to

buy them as item rate contract provides you the flexibility to do so.

It provides regular process payments for the works completed or the

supplies made, which gives a good income to the contractors/suppliers.

1 The unit rates are inclusive of all related inputs such as labour, materials, equipment usage and a

proportion of overheads and profit.



It provides reasonably accurate cost estimates of works. Thus, employer

can expect only minor discrepancies between the estimate of cost and

the lowest bid as well as between contract price and the final basic cost

(without price adjustment).

Disadvantages

Let us now look at the disadvantages of item rate contract:

Involves bids containing unbalanced unit rates for some items of works.

It also includes filing rates in initial stages where the details deign is not

available, which create problems in comparison and evaluation of bids.

Involves higher cost of documentation, compared to lump sum contract,

in preparing the detailed bill of quantities.

Involves higher supervision cost, compared to lump sum contract, when

recording detailed measurements of work that are involved in various

items of work.


5. Item rate contracts are appropriate for both ______ and _______

contracts.

6. Item rate contracts are _________ for design changes.

7. In item rate contracts ______ measurement of each item is recorded

and payment made at the quoted rates.

8.5 Percentage Rate Contract (Works)

In the previous section, you learnt that item rate contract is used for supply

of goods and works, in public-sector across the world. They are used for

simple projects without many complications.

The percentage rate contract is generally used for works contracts. You

provide the bidders, all the items or materials required for the work. This

type of contracts is best used for public sector organisations.

Features

You have to consider few important features before you choose this

contract:

Provides a detailed estimate of the quantity of work to be carried out

along with the estimate rates to the bidders to quote their price.



Enables bidders to quote the amount in percentage above or below or at

Par for your estimation.


Let us see the suitability of percentage rate contracts;

It is widely used in public sector.

It is appropriate for small value contracts, where the items of work are

few and belong to the same category. For example maintenance works

leveling and storm water drainage, water supply and sewer lines, and so

on.


As you know that every contract has both advantage and disadvantage, lets

us look at the advantages of percentage rate contracts:

Simple to comprehend for the contractor and submit his bid.

Decision on the lowest bid can be taken immediately as no detailed

procedures are involved.

Possibility of unbalanced bid submission is eliminated as the percentage

of amount obtained above or below the estimate is applicable to all the

items of works.

Let us now look at the disadvantages of percentage rate contracts:

Two or more bidders may quote the same percentage making it difficult

for you to take a decision.

Quoting the same percentage rate above or below the estimate is

irrational since the prices of inputs will not change over a period of time.

Suppliers manipulate the items to obtain advantage of higher rates.


8. Percentage rate contracts are appropriate for small value ____

Contracts.

9. In percentage contracts, the bidder offers to execute the works at some

percentage above or below the _________ rates.

8.6 Cost Plus Fee Contracts (Works)

In the previous section, you learnt that percentage rate contract is suitable

for small value projects. Let us now discuss about the cost plus fee contract.



A cost-plus fee contract, also termed a Cost Reimbursement Contract, is a

contract where you pay the contractor for all set expenses plus an additional

payment as profit to him. This type of contract is also suitable for works. For

example you buy 3 tons of bricks from a contactor who is outside your city.

You pay him the manufacturing cost of bricks, transportation cost, labour

cost for loading and unloading, labour cost for manufacturing plus an

additional amount which is given as profit to him.

Features

As already told features are to be considered to pick the right type of

contract for your project. You need to reimburse the bidders periodically for

inputs such as labour, materials, equipment, spare parts, fuel, and so on,

with a fee to cover his overheads, management and profit. The fee may be

either:

A fixed fee that is independent of the total measured costs, or

A percentage of the measured costs, or

A variable (incentive) fee, which increases if savings are materialised in

an agreed estimate of the total contract payments or which reduces with

cost overruns.


Now that we know the features of this contract, let us analyse where we can

use this type of contracts:

They are appropriate for open ended emergency situations such as

structural collapse. For example, damage to buildings and bridges due

to flood, earthquake, and other natural calamities.

They are best suited for works with unquantifiable risks such as

unknown ground conditions which cannot be foreseen before the project

is started.

They help to select a known contractor who is very reliable to complete

highly remunerative projects such as hotels, casinos, and so on, where

the design and aesthetics are complex and innovative.

They are used in an innovative technical processing and manufacturing

plants, which are not completely designed.




Let us first look at the advantages of the cost plus contracts:

Emergency works are mobilised and started almost immediately without

finding bidders, calling for tenders, allotting tenders, which will consume

lot of time.

Payments are made for the actual expenditure incurred and hence can

be used for the works that are poorly defined and involve high risks.

Final cost may be less than a fixed price contract because contractors

do not have to increase the price to cover their risk and give the actual

price covered.

Let us now look at the disadvantages of the cost plus contracts:

Works are awarded on sole source basis with negotiations and hence

there is no competition.

Quality of work may be affected as bidder will have less incentive to

produce quality work or timely completion.

Bidder who gets the contract may use higher value material to increase

his incentives and not make it cost effective.

Additional supervisory staff is required to monitor and verify the actual

costs.


10. Cost plus fee contracts are appropriate for emergency works.

(True/False)

11. In cost plus fee contracts works are awarded on sole source basis and

hence there is no competition. (True/False)

12. In cost plus fee contracts, if the fee is fixed the contractor is likely to

produce quality works and ensure their early completion. (True/False)

8.7 Supply and Erect/Install, Commission, and Test Contracts

(combination of supply of Goods and Works contracts)

In the previous section, you learnt that the cost plus contract are suitable for

emergency projects as they can be allotted to contractor in a short time.

The supply and erect/install, commission, and test contracts are used when

there are projects involving the erection and testing of the equipment. The



contractors supply the required goods or equipments as well as set up the

equipments and check out for installations.

Features

Let us look at the salient features of this contract:

The supplied goods meet the specifications or are fabricated to the

design required on a lump sum basis.

Minor works are quoted lump sum based on the design of the supplier,

but the major works are normally undertaken to the design of the

employer on item rate basis.

Commissioning and/or testing of the completed work/plant become a

necessity before acceptance.


This type of contract is used when supply of manufactured or pre-

fabricated goods such as turbines, switch yards, transmission towers,

and telecommunication equipments will include installation and

commissioning. In such cases, the manufacturer will do the required

installation and commissioning which is a minor part in the project rather

than hiring a new contractor.


Let us first take a quick look at the advantages of this contract:

The contractor alone becomes responsible for the supply of the goods

and execution. This avoids conflicts and delays in the event of non-

compatibility.

Managing the project is simpler, as you do not get involved in any

stages or lengthy procedures.

The disadvantage of this contract is that there is no competitive bidding from

the contractor to procure equipments. He buys equipment from several

sources on sole basis, which increases the direct cost..


13. The supplied goods should meet the specifications or fabricated to the

design required on a percentage rate basis. (True/False)?

14. In supply and erect/install, commission and test contracts, the

responsibility for successful completion is shared by many contractors

and suppliers. (True/False)?



Activity 1:

You are an officer at the Public works department. The new township

outside Mumbai requires maintenance for water and sewage. Which kind

of contract will you opt for and why?


8.8 Design and Build Contracts (Works)

In the previous section you learnt that Supply and Erect/Install, Commission,

and Test Contracts are suited for both combination of works and goods.

Design and build contracts are also used for works. Sometime you may not

have the required skill set within your organisation for which you look for a

contractor on a competitive basis. You must find the most innovative

designs and the special skills of individual contractors. For example, you

need to install a transformer for a huge building. You do not have engineers

who can erect and install the transformer. Hence you try and get them from

contractor who can give you innovative design.

Features

Let us look at the salient features for design and build contracts:

Bidders have pre-qualification, which help them to easily select the

qualified combinations of Engineer/Architect and Contractor.

Comprehensive site and sub-soil survey are offered that include the

parameters of structural design and loading.

Bidders are allowed to provide competitive design and lump sum bids.

Bid evaluation includes design checks, the quantification of design

errors, time for completion, payment schedules, and so on. It also

includes an assessment of the aesthetics of different proposals.

Bidders are sometimes compensated on a sliding scale according to

merit for the preparation of responsive proposals.


It is appropriate for important buildings, major bridges, aqueducts, viaducts,

complex flyovers, navigation works, seaports, airports, and other major

infrastructure works.




The advantage of this contract is that, competitive proposals result in

economy and better design and aesthetics.

The disadvantages of this contract are none to mention.


15. The advantage of this contract is that, competitive proposals result in

economy and better design and aesthetics. (True/ False)

16. You must invite bidders for design and build who can provide

competitive design on percentage basis. (True/ False)

8.9 Turnkey Contracts (combination of supply of Goods and

Works Contracts)

In previous section, we discussed that a design and build contract is for

works and must be used when you do not have the required skill set within

your organisation.

The turnkey contracts are the combination of works and goods contracts.

Here, you will not be involved in any stages of projects. The contractor or

bidders will accomplish the project and give it to you after completion.

Features

Let us look at the salient features for turnkey contracts:

Bids are invited for alternative systems and processes to provide

satisfactory end product requirements. Thus, it is undesirable or

impracticable to prepare definitive designs and complete technical

specifications in advance.

Two stage bidding procedure is followed. The contactor first includes the

detailed designs, production process plant, equipment, related

construction, procurement licenses, guarantees, recruitment, training of

operating staff and commissioning. Then they hand over the key/project

to you.

The contract price is normally quoted full amount with periodic payments

against specific stages of partial completion.

Price adjustment is provided to the contracts of longer duration (say

more than one or two years).




It is appropriate for procurement of complex industrial process plants such

as steel mills, fertilizer plants, food processing plants, oil refineries, and so

on.


The advantage of the turnkey contracts is that the employer is able to

choose the best available processes and thus achieve a good position in

economy.

The disadvantages are none to mentioning.


17. The advantage of the turnkey contracts is that the employer is able to

choose the best available processes and thus___________.

18. The contract price is normally quoted _______with periodic payments

against specific stages of partial completion.

8.10 Management Contracts

In previous section you learned that the turnkey contracts must be used

when you do not want to involve in any phase of the project. Turnkey

projects are used for a combination of works and goods.

Management Contracts is a combination for supply of Goods and Works

Contracts. This is a third party contracts that are useful for huge public

sector projects.

Features

Let us look at the salient features for management contracts:

Allow you to hire consultation firm that act as contractor/supplier, but do

not usually perform construction work/supply goods directly. They

manage the work of other sub-contractors and suppliers. The firm bears

full responsibility and risk for price, quantity and timely performance of

the contract.


It is appropriate for major infrastructure projects such as airports, seaports,

expressways, townships, power projects, telecommunication projects, and

so on.




Now let us look at the advantages and disadvantages for the management

contracts.

The advantages of management contracts are:

It helps you to lower the project costs, related to goods and services or

running ancillary business operations.

It reduced any risk involved, as the consulting firm will be responsible to

handle risks.

The disadvantages of management contracts:

You need to give up a considerable amount of control over the services

that will be provided.

You cannot ensure the quality of material or goods which may lead to

loss in quality.

You may not be able to modify or change design in the process.


19. A management contract helps you to lower the project costs.

(True/False)

20. You can ensure the quality of material or goods which may lead to loss

in quality. (True/False)

Activity 2:

You have shifted from London to Delhi. You have bought a house that

needs renovation. You are not aware of the hidden issues in that house

are. What kind of contract will you opt and why?


8.11 Public Private Participation Contracts

In previous section we learnt that management contracts are best suited for

major infrastructure projects. Now let us learn about Public Private

Participation (PPP).

PPP contracts are usually based on Build, Operate and Transfer (BOT)

concept with many variations. PPP contracts are concessionary turnkey

type of contracts, which include financing, design, construction, operation

and maintenance of public and private revenue earning projects and so on.



Features

Let us now take a look at the salient features of a PPP contract:

Total costs and risks are borne by the private BOT investors over the

yielding period, which may be between 10 to 20 years.

The employer from a public sector is the public authority, responsible for

a PPP contract. The contract is transferred to the employer at the end of

the concessionary period.

PPP contracts are of different types. There is little variation among these

types. The only source of revenue to the BOT investors is the tariff

imposed on users of this facility, during bid evaluation.

Other variants include

o Build, Own, Operate and Transfer (BOOT).

o Build, Own and Operate (BOO) without any obligation for Transfer.

o Build, Rent and Transfer (BRT).

o Build, Lease and Transfer (BLT).

o Build, Own, Operate, Subsidise and Transfer (BOOST).

o Build and Transfer (BT) immediately, possibly subject to instalments

payments of the purchase price.


It is best used for profit earning projects such as power generation and

distribution, port facilities, toll roads and bridges, water supply, and so on.

Thus it provides income when you have limited budget and/or borrowing

capacity.


Let us look at the advantages of the PPP contracts:

PPP contracts are a way for overcoming the borrowing capacity,

budgetary constraints to acquire the much needed infrastructure for

growth.

PPP contracts provide significant additional functions in financial

resources, while achieving overall cost savings from efficiency in design,

construction and operation.

Let us now look at the disadvantages of the PPP contracts:

They are highly complex from both a legal and financial point of view.

They require potential sponsors to spend millions of rupees in

development.



They require to present issues for host Government/implementing

agencies about the proper allocation of risks and rewards among

parties.


21. PPP contracts are a way for overcoming the borrowing capacity,

budgetary constraints to acquire the much needed infrastructure for

growth. (True/False)

22. In a PPP type of contract the total costs and risks are borne by the

Public sector over the yielding period. (True/False)

Activity 3:

You are constructing a movie theatre with aesthetics of high order. You

have highly defined concepts with clear specification. This project will

take eight months of duration with no unforeseen issues. What kind of

contract will you adopt and why?


8.12 Summary

Let us sum up the points that we learnt in this unit.

In this unit, we have discussed various types of contracts used for works

and goods. You have to select any contract only after considering various

factors as it affects the type of projects or purchase of goods both in

monetarily as well in execution part. The right choice of contract will help

deliver quality project on the right time.

We learnt the several factors such as nature and complexity, size and

duration, degree of definition, status of design and financial resources

influence the selection of the type of contract for execution of works or

supply of goods.

We discussed few common types of contracts. The common types of

contracts are Lump Sum; Item Rate; Percentage Rate; Cost plus Fee;

Supply, Erect and Install; Design and Build; Turnkey; Management; Public

Private Participation.

We also learnt that each of these contracts has different features, has

definite advantages and disadvantages as well as their use in different

situations and circumstances.



Public Private Participation contracts are nowadays being adopted in large

numbers because of constraints of budget and the need to provide large

number of infrastructure works.

8.13 Glossary

Term Description

Aesthetics An artistically beautiful or pleasing appearance.

Viability Capability of any work being done in a practical and useful way

Inflexible Incapable of being changed or unalterable.

Turnkey A project or service which can be implemented or utilised with no additional work required by the buyer.

Concessionary period A term used for yielding period.

Subsidise Monetary assistance granted by a government to a person or group in support of an enterprise regarded as being in the public interest.

8.14 Terminal Question

1. Explain the factors which generally affect/influence the selection of the

type of contract for a package of works/goods.

2. List the features of Item Rate contracts and demonstrate how they are

different from Lump Sum contracts.

3. Where is a Percentage Rate contracts suitable and List its features.

4. Explain the features of Turnkey contracts.

5. What are PPP contracts and List the advantages and disadvantages of

the same.

8.15 Answers


1. Fixed

2. Works

3. Stages, percentage

4. Inflexible

5. Works, goods

6. Flexible

7. Detailed

8. Works



9. Estimated

10. True

11. True

12. False

13. False

14. False

15. True

16. False

17. Achieve economy

18. Lump sum

19. True

20. False

21. True

22. False

Terminal Questions

1. Refer section 8.2 Factors Influencing Types of Contracts.

2. Refer section 8.3 and 8.4 Lump sum/All inclusive/Fixed Price Contracts

(Works) and Item Rate/Unit Rate Contracts (Works and Goods).

3. Refer section 8.5 Percentage Rate Contract (Works).

4. Refer section 8.9 Turnkey Contracts (combination of supply of Goods

and Works Contracts).

5. Refer section 8.11 Public Private Participation Contracts.

8.16 Caselet

The Cape Town Street Lights- A Case Study

This case study is considered as one of its kind till date for a Public

Private Participation (PPP) type of contract.

The City of Cape Town is split into three controlled supply areas, that is,

City of Cape Town

Provincial Administration

ESKOM

ESKOM was maintaining street lights in the areas that were allocated to

them in a day to day basis. They called for contract only when something

failed. They felt this was not effective and they started looking for an

alternative pro-active solution. They decided that the maintenance of the



ESKOM supply areas should be the responsibility of the City of Cape

Town. As they did not have the resources to maintain these areas, the

City invited tenders.

Total Facility Management Company (TFMC) had the commercial

potential of maintaining the street lighting for a city like Cape Town. But

TFMC did not have the specific expertise in this niche market to provide

street-lighting maintenance work in-house. They then entered into an

Operational Partnership with Light-Be, a company with the necessary

expertise.

TFMC's then placed a tender with Cape Town. The tender was

successful, largely on the basis of its track-record, its professionalism, its

recognised experience and expertise in contract management. TFMC's

has a call centre which is 24/7, played an important positive element.

Services provided

Service Level Agreements (SLA) were agreed upon with the City of Cape

Town and a back-to-back agreement between TFMC and Light-Be was

entered thereafter. As mentioned in the contract, they conducted an audit

of the areas to be maintained. And it was agreed with the City of Cape

Town that initially, a total of 31,000 units would be maintained.

The next step was to divide the ESKOM supply area into smaller

operational areas and eventually standardise the light fittings per area,

making them easier to maintain.

This project was completed on 31st August, 2006. A total number of

34100 units were accounted for within the agreed areas.

As additional areas being built, these new areas are handed over to

TFMC for maintenance. The company also provides a day-to-day service

through its Contact Centre, enabling the general public to report faulty

streetlights. These faults are channelled to Light-Be for repair. TFMC

ensures that the SLA’s are met at all times.

Contractually, the "Mean Time to Repair" (MTTR) faults is 7 days, 95% of

the time with the balance to be repaired within 14 days from date of

logging the fault. TFMC has to date continuously to achieve a MTTR of

less than three days. Some faults classified as "excusable delays" are



brought to the City of Cape Town's attention as and when they occur.

The duration of the repair work for these types of faults is mutually-

agreed upon with the City and is not measured according to the MTTR.

The initial period of the agreement is three years (July, 2005 to June,

2008), with the option to extend the agreement for a minimum of a further

five years. The extension of agreement is subject to TFMC's meeting the

performance criteria of 90%, during its audit.

Value-Added Achievements

Although the City of Cape Town operates on a run-to-fail basis, TFMC

operates on a scheduled routine maintenance strategy, i.e. all streetlights

are replaced every three years, reducing the failure rate.

To date, TFMC has consistently met the performance criteria of any

audit/monitoring exercise conducted by the City of Cape Town.

Question:

1. What is the MTTR according to TFMC’s? Explain in details how it

was achieved?

Hint: Refer the services provided by the TFMC.

References

Ministry of Statistics and Project Implementation, Government of India,

Standard Bid document.

Ministry of Finance, Government of India, Standard Bid Document.



Unit 9 Contracting Process for Works and Goods

Structure:

9.1 Introduction

Objectives

9.2 Process for Contracting

Specification for goods, delivery period and destination,

International Commercial Terms (INCO) terms

Design, Drawing and Bill of Quantities (BOQ) for works

Components in bid document for works and goods

Invitation of bids and bid publicity

Receipt of bids and bid opening

Evaluation of bids and determination of the lowest evaluated

responsive and qualified bidder

Negotiation

Award of contract

9.3 Summary

9.4 Glossary


9.6 Answers

9.7 Caselet

9.1 Introduction

In the previous unit you learnt about the factors that influence the choice of

contracts. We learnt the various types of contract and the situation they

must be used. We also learnt about the advantages and disadvantages of

each, to make the choice of the correct contract through a proper analysis.

In this unit you will learn the process of contracting. You will learn to prepare

the bidding documents and the difference in contracting process for works

and goods. Once the cost for the project is finalised and the procurement

plan is ready, you must select the types of contract as per the guidelines of

the various contract mentioned in Unit 8.

Learning Objectives:


list the process for awarding a contract.

list the required qualification for works and goods to invite bids.



explain the requirements for a bidding document.

list the requirement and specification to award a contract.

9.2 Process for Contracting

After deciding the type of contract (as explained in unit 8), the next step for

you is to start the procurement process for a given package of goods and

works. In the following sub-sections we will discuss in brief the steps to be

taken for contracting process.

We will select National Competitive Bidding (NCB), Post-qualification, single

cover and Item rate contract for our discussion in the following sub-sections

for both works and goods. The principles would more or less remain the

same but would differ in detail.

9.2.1 Specification for goods, delivery period and destination,

International Commercial Terms (INCO) terms

Let us discuss the various factors that we have to follow in awarding a

contract.

Specifications

Following are the various specifications that we need to apply while creating

contracts.

If the goods to be procured are covered under Bureau of Indian

Standards (BIS), then you should select specifications as framed by BIS.

If BIS is not available, you should frame the required specifications.

○ The specifications should present a clear statement of the required

standards of workmanship, materials and performance of the goods

to be procured. For example, you need to build an aircraft. You

require workmanships who are highly qualified engineers with

relevant experience of building aircraft. If you just mention as

engineer the right skill set may not be known.

○ The specifications should meet the actual and essential needs of the

project or goods. Over-specification will unnecessarily increase the

cost and may suppress competition.

○ The specifications should include the latest technology. This avoids

procuring obsolete items that increases the unnecessary cost.

○ Minimum functional specifications should be given as not to make it

restrictive and attract reasonable number of competitive bids.



Except in the case of proprietary purchase from a selected single

source, the specifications should not contain any brand name, make, or

catalogue number of a particular manufacturer. If the same is

unavoidable due to some compelling reasons, then the brand name of

manufacturer should be followed by your company’s brand name or

equivalent name.

All dimensions incorporated in the specifications should be indicated in

metric units. If due to some unavoidable reasons, dimensions in FPS

(foot pound second) units are to be mentioned, then corresponding

equivalents in the metric system should also be stated. The

specifications should use the words not less than or not more than

rather than fixed parameters.

The specifications for equipment should lay emphasis on factors like

efficiency, optimum fuel power consumption, use of environmental

friendly material, and low maintenance costs.

The specifications should have the requirement for warranty and Annual

Maintenance Contracts (AMC) requirements.

The specifications and the technical details must be expressed with

clarity. Where ever necessary, the specifications should be

supplemented with drawings/figures for additional clarity.

Delivery period

You learnt about the specifications that are to be well documented before

making a contract. Now, let us discuss about the delivery period involved in

a contract.

The delivery period is the time given to the supplier to deliver goods at the

destination. This period has to be reasonable to take care of manufacture,

transportation and inspection by the supplier. It should not be restrictive. For

example a car assembling company needs 500 diesel engines for its unit.

The company should consider the time required for manufacturing, the

number of goods required and the required test to check the perfection. It

must also consider the distance and mode of transport while fixing the date

of delivery.

The date from which the delivery period would be counted has to be

specified in the bidding document. The delivery date must be given from

taking into account one of the below:



The date of signing of the contract.

The date of supply order.

The date of payment of advance, if any.

Opening of the letter of credit.

There should be provision in the bid document to adjust the bid price, for a

delivery period longer than that specified in the bid document. The method

of adjustment, when there are any changes in the items, should also be

specified in the bid document.

Destination

While determining the delivery period, we should also consider the

destination.

Destination is a place where the ordered goods are to be delivered to the

specified consignee, within the stipulated delivery period.

INCO terms

You learnt that specifications, delivery period and destination are all

dependent factors on a particular project. Let us know about the

international standards set for any project.

The INCO terms (International Commercial Terms) is a universally

recognised set of definitions of international trade terms such as EXW (Ex

Works….named place), FOB (Free on Board… named port of shipment),

CFR (Cost and Freight…. named port of destination), and CIF (Cost,

Insurance and Freight…. named port of destination). The INCO terms are

developed by the International Chamber of Commerce (ICC) in Paris,

France.

For example, for national procurement the trade term often used is FOR

(Free on Rail), it defines the trade contract responsibilities and liabilities

between the buyer and seller. It is a cost saving tool. The exporter and the

importer need not undergo a lengthy negotiation about the conditions of

each transaction. Specifying the appropriate INCO TERM in the bid

document helps to arrange the responsibility of the seller, which enables

him to submit the bid accordingly.



9.2.2 Design, Drawing and Bill of Quantities (BOQ) for works

We discussed about INCO terms which are set standards for the project.

Now let us learn about other parameters for contract preparations.

For the works included in a package/project, you have to prepare the

design, drawings and specifications for incorporation in the bid document.

From the design and drawings, the cost estimate has to be prepared by

determining the quantities.

The BOQ gives the various items of work involved, brief specifications, unit

of measurement and the estimated quantities. It enables the bidder to offer

his unit rates (used in the Item Rate Contract) for the various items included

in the BOQ, the summation of which gives the bid price.

9.2.3 Components in bid document for works and goods

Bid document should furnish all information necessary for a prospective

bidder to prepare his bid for the goods and works. As already stated

complexity of the bidding documents vary with the size of project, method of

procurement and type of contract. We will discuss the bidding document for

NCB procurement with Item rate contract.

Bidding document for goods (item rate contract) include the following

sections

Invitation for Bid (IFB).

Instructions to Bidders (ITB).

Forms for submitting qualification information.

Form of fid and Form of contract.

General Conditions of Contract (GCC).

Special Conditions of Contract (SCC).

Specifications.

Drawings.

Schedule of requirements.

Qualification requirements.

Forms for various securities.

Form of manufacturer’s authorisation.

Bidding document for works (item rate contract) include the following

sections

Invitation for Bid (IFB).



Instructions to Bidders (ITB).

Forms for submitting qualification information.

Form of bid and Form of contract.

General Conditions of Contract (GCC).

Special Conditions of Contract (SCC).

Contract data.

Specifications.

Drawings.

Bill of Quantities (BOQ).

Qualification requirements.

Forms for various securities.

Standard Bidding Documents (SBDs) have been prepared by various

organisations such as FIDIC, World Bank (WB), Asian Development Bank

(ADB), Japan Bank for International Cooperation (JBIC) and other

multinational financial Organisations. The Government of India (GoI), State

Government and GoI Public Sector Organisations also provide SBDs. The

Multinational Financing Organisations have recently agreed for the use of a

single document and have issued harmonised bidding document for works

(large and small) and goods for various types of contracts. These

documents have all the essential sections as stated above, where the GCC

section varies to some extent. The documents are available on the website

of World Bank (www.worldbank.org). Government of India, Department of

Statistics and Program Implementation has issued a bidding document in

May 2005. This document is available on www.mospi.nic.in website.

Finance Ministry in India has also issued a bidding document for work in

2006. This document is available on the website of Finance Ministry.

Government of Karnataka (GoK) has also issued SBD’s for Works and

Goods and has mandated the use of these documents by all procurement

entities of State Government. These SBD’s are available on the website of

GoK Finance Department.

Preparation of bid documents

You learnt about the various sections that should be included in a bid

document for goods and work. Let us see how the bid document is

prepared.



You have to prepare the bid document for works and goods by making use

of the bid document formats, provided by standard organisation.

The Specification, Drawings, Schedule of Requirements/Bill of Quantities,

Contract Data, and other important sections should be correctly and

completely filled in the bid document.

Qualification criteria

We discussed how to prepare the bid documents. Let us now see what

criteria should be considered to qualify a bidder.

You will have to open bidding to receive competitive bids. Your intention is

to award the contract to a well qualified bidder who can be expected to

perform the contract satisfactorily.

In order to provide transparency in the contract award process, you should

pre-disclose the minimum qualification criteria (that the bidders have to meet

for award of the contract) in the bidding document.

The minimum qualification criteria for works related bid document should

include the following:

Bidder’s annual return must be at least twice the estimated annual

payment which is mentioned in the contract. This annual return must be

maintained for the last five years by the bidder’s company.

Bidder must have completed at least one work of similar category for

which the bid is invited. For example, if you have called bids for malls

the bidder must have at least constructed one mall during the required

period. The cost of project that they have completed must at least be

50% of the estimated cost of the work for which the bid is invited.

They should have executed specified quantity of selected items of work

during the past five years (usually not less than 80% of the expected

peak rate of construction).

The bidders should have specified liquid assets for ensuring

uninterrupted progress of works (usually not less than three months

requirement during peak period).

The bidders should have specified number of critical equipment needed

for ensuring quality and progress of work.

The bidder should have specified number of technical and management

personnel to ensure successful implementation of contract.



In case you invite bids for several packages in one invitation, a situation

may arise, where a bidder may become lowest in some of the packages. He

than has to satisfy the stipulated qualification criteria for each of the

package for which he is the lowest bidder. Then you can award more than

one contract to the same bidder. In such an event the bidder may not be

able to execute all the works simultaneously, since he does not have the

needed resources. In such cases, before awarding the works, you need to

check whether the bidder satisfies the aggregate of the required minimum

qualification criteria for all the packages for which he is the lowest bidder.

Contracts should be awarded to the packages to the extent that satisfies the

aggregate qualification criteria only. Such a stipulation should be pre-

disclosed in the bidding documents to have a clear idea of contract

awarding process.

The minimum qualification criteria for goods bid document should include

the following:

The bidder should be a manufacturer, who must have manufactured,

tested and supplied the equipment up to specified percentage (usually

not less than 80%) of the quantity. The equipment produced must be of

similar type and size as specified in Schedule of Requirements.

The equipment offered for supply must be of the most recent series

models. These models must have capacity to incorporate any new

improvements in design. The equipments that are supplied must provide

satisfactory operation for a specified duration.

Bidders who are authorised representative or agent of a manufactures

should submit bids only if they meet the above stipulated criteria

requirements.

The bidders selected as authorised agents must have supplied,

installed, commissioned the equipments or requirements similar to that

of requirements specified in the Schedule of Requirements. These

equipments must provide satisfactory operation for a specified duration.

Available bid capacity

We saw the criterion that qualifies the bidder. Now we will learn about the

bid capacity.

There are chances that a bidder might acquire more contracts by meeting

the qualification criteria for several packages and then fail to complete these



contracts. Hence, the available bid capacity is evaluated before the

contracts for several packages are assigned to the same bidder.

The assessment has to be made in a manner which is not subjective and

must be a transparent process. An end qualification criterion should include

a pre-disclosed method for computing available bid capacity. The available

bid capacity for works is calculated as:

Assessed available bid capacity = (A*N*1.5-B), where,

A = Maximum value of works executed in any one year during the last five

years, taking into account the computed as well as works in progress.

N= Number of years prescribed for completion of the package of works for

which bids are invited.

B = Value of existing commitments and on-going works to be completed

during the next “N” years.

The manufacturers who satisfy the qualification criteria should have

available bid capacity more than the required supply, which will be

calculated as below:

The assessed available bid capacity is (A*N-B) where,

A = Licensed Annual capacity for the item of supply.

N= Number of years prescribed for completion of the supplies for which the

bids are invited.

B= Number as per existing commitments to be supplied during the next N

period.

9.2.4 Invitation of bids and bid publicity

In previous sub section we learnt how the bid capacity for works and goods

are calculated. We discussed how to prepare the bid documents, criteria

that are required to qualify a bid, as well the calculation for bid capacity.

Here we will learn how to invite bids.

Invitation of bids

You can issue the invitation for bids after the preparation of bid document

and after getting it approved from competent authority.

The Invitation For Bids (IFB) should contain the following details:

The name, designation and address of the officer (you) inviting bids



The name of the project or program that you are procuring.

The date up to which and place from where the bid documents should

be obtained.

The amount of bid security payable.

The last date and time for receipt of bids must be mentioned.

The date, time and place for opening of bids that has been received.

And any other information that you feel important or relevant before

inviting bids.

Bid publicity

You learnt what an IFB should contain. Let us now discuss how we can

publish the bid.

You should make arrangements for wide national publicity by having the IFB

published in newspapers. You should also publish the IFB in appropriate

Trade Journals depending on the value of the procurement. These kinds of

publicity will ensure better competition.

9.2.5 Receipt of bids and bid opening

We discussed how to prepare the bids and to publish them in the earlier sub

section. Now let us see how to receive and open bids.

To receive bids you should:

Make adequate arrangements for the proper receipt and safe custody of

the bids. Other communications are also made regarding the time and

place for the receipt of bids, as specified in the bid documents.

Permit the submission of bids by post or courier.

Extend the last date and time for receiving bids, after giving adequate

notice to all intending bidders in cases where:

○ The publication of the IFB has been delayed.

○ The communication of changes in the bid documents to prospective

bidders took time.

Bid opening

You must receive the bids within the stipulated time on the date of last

submission. The bid box should be sealed and opened at the stipulated time

(usually half an hour later than the time stipulated for submission of bids).



At the time of bid opening you should:

Count all envelopes containing the bids, irrespective of any deficiency.

Open all bids received in time; delayed bids (on what ever account)

should not be opened.

Maintain a record of the corrections noticed at the time of tender

opening.

Read out and record the names of the bidders and the rates quoted by

them for each of the item(s) in figures and words.

Read out and record the details of the bid security deposit such as

amount, form and validity.

Read out and record the validity period of bids, warranty and any other

conditions/reservations given.

Read out and record discounts offered if any.

Record the details of the bid opening by incorporating the above criteria.

9.2.6 Evaluation of bids and determination of the lowest evaluated

responsive and qualified bidder

You learnt how to receive and open bids in the previous sub section. Here

you will learn the criteria that you should consider while evaluating the bids.

After opening the sealed bids as per procedure outlined above, you have to

evaluate the bids as per procedure given in the Instructions to Bidder (ITB)

of the bid document.

You may do the evaluation yourselves or take the assistance of a Technical

Evaluation Committee (TEC) as per requirements of the procuring

organisation.

You should carry out initial examination to determine substantial

responsiveness by taking the factors such as:

Whether the bidder meets the eligibility criteria laid down by you in the

bid document.

Check whether the critical documents such as Bid Form, Price Schedule

and so on have been duly signed by the bidder.

Whether the requisite bid security of stipulated amount, form and validity

has been furnished.

Whether the bid security, if furnished in the form of bank guarantee, is

conditional or otherwise.



Check whether the bid is valid for the required period.

Check whether the bidder (if he is not a manufacturer) has furnished the

Manufacturer’s Authorisation in the stipulated form.

Check whether the bidder has any reservations to crucial clauses of

conditions of contract such as warranty, security deposit, force majeure,

AMC, and so on.

Check whether the bid is substantially responsive to the specifications

required.

After the initial examination and preparation of a list of responsive bidders,

you should take up detailed evaluation of these bids. The evaluation is done

as per the evaluation criteria stipulated in the bid document.

The bid costs are worked out by following the steps:

The bid price should be corrected for any arithmetical errors.

In case of discrepancy between the prices quoted in words and figures,

the prices in words must be considered1.

If there is discrepancy in the computed total amount for an item, the

quoted rate should be considered and the total amount must be

corrected.

The bid price should be adjusted for deviations in the commercial

conditions such as delivery schedule, minor variations in payment terms

and other variations as stipulated in the bid document. These variations

are quantifiable but deemed to be non-material in the context of the

particular bid – to the extent stipulated in the bid documents.

Compute the present value of the future Average Manufacturing Cost

(AMC) payments at the specified discount rate and add to the cost of the

equipment if stipulated in the bid document.

Include all central duties such as custom duty, central excise duty, local

taxes, VAT, or ST2 as per stipulations in the bid document.

In case of purchase of equipment, the operation and maintenance cost,

cost of spares for appropriate period, after sales service facilities and

other factors and method of quantification as specified in the bid

document should be evaluated and added to the equipment cost.

1 This is the international practice. However in case of Tamil Nadu and Karnataka transparency Acts, the

lower of the two i.e. figures and words shall be considered. 2 In the case of external agency financed contracts, VAT or ST is not considered for evaluation of prices.



The cost of incidental services such as installation of equipment, training

of personnel, providing operation manuals, and so on should be verified.

After arriving at the evaluated costs of each of the responsive bidder, we

should select the bid with the lowest evaluated cost.

You should then check whether the lowest evaluated responsive bidder, as

selected above, meets the specified minimum qualification criteria. If the

criteria meet, then you can award the contract. If not, check for the second

lowest evaluated bidder and see if he meets the specified minimum

qualification criteria. If the criteria meet, then you can award the contract to

the second lowest evaluated bidder.

An evaluation report must be prepared with detailing the entire process of

evaluation and selection of the lowest evaluated responsive bidder, which

has met the specified minimum qualification criteria.

9.2.7 Negotiation

In previous sub section you learnt how to evaluate the bids. You can also

negotiate with the bidders based on the requirements as mentioned below.

You can negotiate only with the lowest evaluated responsive and qualified

bidder. Normally, you should not negotiate3, as this sets a bad precedent for

the bidders, who then initially raise the prices and may reduce the prices

marginally on negotiations, which may still be more than the reasonable

costs/prices. Thus, negotiations may lead to corruptive practices. However,

negotiations may have to be conducted under the following circumstances:

When you find that the lowest evaluated responsive and qualified bid for

works or for items of goods are substantially more than the updated cost

of works or items of goods.

When the procurement for works or goods is of an urgent nature and

rejection of bids and re-invitation of fresh bids will adversely affect the

schedule for completion of the project.

The Chief Vigilance Commissioner, GoI has issued detailed guidelines4 on

the circumstances under which negotiations could be conducted. GoK has

3 External financing institutions such as World Bank prohibit negotiations. GoI and State Governments

permit negotiations under some special circumstances. 4 The Guidelines of CVC, GoI are available on the website of the CVC



also issued detailed guidelines as well as mentioned the procedure that has

to be adopted for conducting negotiations.5

9.2.8 Award of contract

In previous sub section you learnt in what situations you can negotiate. Now

let us discuss the procedure for awarding the contract.

Below are the steps for awarding the contract and signing them:

With or without negotiations you should award the contract to the lowest

evaluated responsive bidder who meets the specified minimum

qualification. The bidder must possess the bid capacity more than the

contract value.

The acceptance of contract is communicated to the selected bidder

within the initial validity period or within the mutually agreed extended

period.

You should request the bidder to deposit the requisite security deposit

such as the amount, form, validity, as required in the bid document,

within the stipulate period.

If the selected bidder fails to submit the security deposit within the

stipulated period, then his bid security is forfeited. You must then award

the contract to the next lowest evaluated responsive and qualified

bidder.

Signing of the contract

After the submission of the security deposit as detailed above, you can

conclude the contract by signing the completed Form of Contract.


1. Over specifications will _______ cost and may _______ competition.

2. Specification for goods should meet latest technology to avoid

procuring ________ items.

3. All dimensions incorporated in the specifications should be in _______

units.

4. EXW stands for ________________________

5. CIF stands for __________________________

6. If _____ is not available, you should frame the required specifications.

5 GoK has issued the Guidelines vide Finance Department Circular No.PWD 1359 SO/FC 2001(P-2)

dated 3-12-2002. The Circular is also available on the website of the Finance department, GoK.



7. Bidder’s annual return must be at least ______ the estimated annual

payment which is mentioned in the contract.

8. Bidder must have completed at least one work of ________ category

for which the bid is invited.

9. If the selected bidder fails to submit the security deposit within the

stipulated period, his bid security can be extended for a stipulated

period. (True/False)?

10. In case of discrepancy between the prices quoted in words and figures

in a bid, the prices in figures must be considered. (True/False)?

11. You should not evaluate the bid and always the assistance of a

Technical Evaluation Committee (TEC) for evaluation. (True/False)?

12. While opening a bid you should count all envelopes containing the bids,

irrespective of any deficiency. (True/False)?

13. The Chief Vigilance Commissioner, GoI has issued detailed guidelines6

on the circumstances under which negotiations could be conducted.

(True/False)?

Activity 1:

Find out details about a standard bidding document available online.

Hint: Visit the website www.worldbank.org and www.mospi.nic.in .

Activity 2:

You setup a call centre for a company B. You choose a bidder through

tender for supplying 400 landline phone connection. But the supplier is

not able to deposit the required security in stipulated time. What action

will you take?

Hint: Refer section Award of contract.

6 The Guidelines of CVC, GoI are available on the website of the CVC



9.3 Summary

In this unit, we learnt that after selecting the type of contract, we start the

contracting process for a given package of goods and works., by following

the steps given here under:

You have to prepare the specification, fix the delivery period, and decide

the destinations by understanding the INCOTERMS for goods

procurement.

You have to prepare the designs, drawings, bill of quantities for works

procurement.

You have to choose the appropriate bid document, conditions of contract

for works and goods procurement.

You have to prepare the bid document; incorporate appropriate

qualification criteria to select a bidder who can perform the contract

satisfactorily.

You have to issue invitations for bid with wide publicity.

You have to receive the bids and open them publicly to ensure

transparency.

You have to evaluate the bids and select the lowest evaluated

responsive bidder who meets the specified minimum qualification

criteria;

You can negotiate with the lowest evaluated responsive and qualified

bidder if considered very necessary and permitted by following the

guidelines stipulated by the organisation.

You have to award the contract to the selected lowest evaluated

responsive and qualified bidder with or without negotiations.

You can sign the contract with the selected bidder after obtaining the

requisite security deposit in the amount, form and validity as stipulated.

9.4 Glossary

Term Description

Force majeure A clause in contracts that frees both parties from liability or obligation in an extraordinary event or circumstance beyond the control of both the parties.

Obsolete No longer produced or used; out of date.

Stifle A term used instead of “to stop”.



Letter of credit A formal letter from a bank stating that the buyer can pay the money to a seller on time

Incidental Likely to occur as an unpredictable or minor accompaniment.

Marginally Only to a limited extent.

Consignee A person or firm to whom the shipment is to be delivered to whether by land, sea or air.

Obligations The requirements which must be fulfilled.


1. Explain the steps that you should follow while evaluating the bids

document.

2. Explain the process for opening a bid.

3. List out the requirements for inviting bid as per IFB.

4. List the minimum qualification criteria for works bid document.

5. List the specifications that are required to make a contract.

9.6 Answers


1. Increase, stifle

2. Obsolete

3. Metric

4. Ex. Works …. Named place

5. Cost Insurance Freight ….. named port of destination

6. Bureau of Indian Standards (BIS)

7. Twice

8. Similar

9. False

10. False

11. False

12. True

13. True



Terminal Questions

1. Refer section 9.2.7 Evaluation of Bids and Determination of the Lowest

Evaluated Responsive and Qualified Bidder.

2. Refer section 9.2.6 Receipt of Bids and Bid Opening.

3. Refer section 9.2.5 Invitation of Bids and Bid Publicity.

4. Refer section 9.2.4 Preparation of Bid Documents, Qualification

Criteria, Available Bid Capacity.

5. Refer section 9.2.1 Specification for goods, Delivery Period and

Destination, International Commercial Terms (Inco) terms.

9.7 Caselet

TransMilenio Bus Rapid Transit System in Bogota (Colombia)

TransMilenio (TM) Bus Rapid Transit System was developed in the year

2000 to upgrade and operate the Bogota bus transport system through a

partnership between the public sector and a number of private

companies.

A state of art infrastructure was planned involving a network of bus stops,

pedestrian bridges, terminals, and transfer stations. The overall project

was to be executed over 15 years and would include 22 exclusive

corridors covering about 400 km with a capacity to transport 5 million

people daily.

A new public owned company, TransMilenio SA, was set up to manage

the project. The TransMilenio SA developed the planning and

contracting. It conducted tendering to select private partners that would

build infrastructure and operate the main routes, the feeder routes, the

ticketing system, and the payments system.

The TM contracts entitled TransMilenio SA to undertake monitoring and

verification activities in order to ensure quality performance and customer

service. In this regard, a system of fines was implemented to penalise the

private partners failing to comply with their contractual obligations,

responsibilities and investment requirements.

Financing

In the TM project, there was a clear distinction between activities to be

financed by the public-sector party and those to be financed by the

private partners.



Activities and risk allocation

As was mentioned above, the TM project was a partnership between the

public sector and many private partners that required complex

contractual arrangements to coordinate the building and operation

activities.

To build the infrastructure, the public-sector party contracted with private

constructors selected on a competitive basis.

To conduct the operation activities, the public-sector party contracted

with different partners and unbundled the operation of buses, the

collection of revenues, and the distribution of revenues among the bus

operators.

The existing bus companies awarded concessions through competitive

bidding to operate the bus routes. The award criterion was based in a

system of points in which bidders received points according to their

experience, bus quality, and emission levels. Thus, TM encouraged the

bus operators to provide an efficient, modern, and non-polluting vehicle

fleet. The bus operators had to invest in new buses, so financial risk was

transferred to them.

Two different private companies were selected by competitive bidding to

collect fares and to distribute revenues among the bus operators. One

company invested in ticket machines and managed the ticketing system.

The other company, a financial service provider, managed the trust fund

where fare revenues were deposited and the payments system to

distribute the revenues.

Out come

Soon after the TM project was launched, significant improvements were

achieved in terms of the efficiency, safety, and environmental impact of

the system.

One year after the TM project was launched, an evaluation was done and

the results are as below:

Journey times were reduced 32%, implying an equivalent to a one

hour/day saving for the average passenger,

Average speed in the main routes was much higher than before. Pollution

levels in Bogotá resulting from the bus transport system dropped,



The number of accident fatalities decreased.

Question:

What criterion do you think TM gave those points to the bidding bus

companies before awarding the contract?

Hint: Refer "Activities and risk allocation" paragraph.

References

Standard Bid Documents of World Bank (harmonised).

Ministry of Statistics and Project Implementation, Government of India

Standard Bid document.

Ministry of Finance, Government of India, Standard Bid Document.

Karnataka Transparency in Public Procurements Act 1999 and Rules

2000 and the circulars, notifications and orders.



Unit 10 Procurement of Consultants for

Professional Services

Structure:

10. 1 Introduction

Objectives

10.2 Consultants and Need for Consulting Services

10.3 Types of Consulting Services

10.4 Steps Involved in the Procurement of Consultants

10.5 Methods of Selection of Consultants

Quality and Cost based Selection (QCBS)

Quality Based Selection (QBS)

Selection under a Fixed Budget (FBS)

Least Cost Selection (LCS)

Selection Based on Consultant’s Qualifications (CQS)

Single Source Selection (SSS)

10.6 Prepare the Terms of Reference (TOR)

10.7 Advertise and Prepare the Shortlist

10.8 Consulting Organisations versus Individual Consultants

10.9 Types of Consultancy Contracts

Lump sum contract

Time based contract

Percentage contract

Indefinite delivery contract

10.10 Request for Proposal (RFP)

10.11 Negotiations and Award of Contract

10.12 Contract Performance

10.13 Summary

10.14 Glossary


10.16 Answers

10.1 Introduction

In the earlier units (units 6 and 8) you have learnt about various methods of

procurement and different types of contracts. You also learnt how to select a

contract based on the type of procurement required. We further discussed



the step by step process for awarding a contract (refer unit 9) for works and

goods.

Present day developmental projects are very complex and involve

specialised services. The expertise required for all these assignments will

not be available in-house in every organisation. Hiring the services of

specialist consultants is a cost effective and efficient method, since these

specialised services would be for limited period without any obligations of

permanent employment.

In this unit we will study the need for consulting services and the process for

the procurement of consultants. You also will learn methods of selection of

consultants along with the selection of appropriate type of contract for the

various types of assignments.

Objectives:

After studying this unit, you should be able to

explain the various processes in selection of consultants.

adopt the appropriate method to select consultants.

list the features of each type of contract.

10.2 Consultants and Need for Consulting Services

Consultants are professionals with required skill, who can be employed on

project basis. Growth of consultant profession is of recent origin in India.

The procedures to choose a consultant is laid down by external financial

institutions particularly, the World Bank (which have been adopted by other

financial institutions also).These procedures are also being widely followed

for procuring services of consultants employed on Government of

India/State financed assignments also.

Consulting services refers to services of a professional nature provided by

consultants using their skills to study, design, organise and manage

projects. Any organisation with the responsibility of project implementation

may not have the skills required for various specialised services required for

the project. Hence it will be cost effective to hire the services of specialised

consultants as and when required since the consultants would be employed

for limited period without any obligation of permanent employment.



Requirements to select a consulting service

Now that we know why consulting services are required in the

implementation of a project, let us now see how to select a consulting

service.

When you select a consulting service, they should normally satisfy the

following requirements:

Meet high standards of quality.

They should be impartial (that is, a consultant should act independently

from any affiliation, economic or otherwise, that may lead to conflicts of

interest).

They should be capable of high planning, should have been awarded,

for previous assignments, administered reputed project, and performed

according to ethical standards.


1. The procedures to choose a consultant are laid down by external

financial institutions particularly _______.

2. Any organisation with the responsibility of project implementation may

not have skill required for the various _________ required for complex

project.

10.3 Types of Consulting Services

In previous section you learnt why we need to hire consulting services. IIn

this you will learn about various types of consulting services.

There are various types of consulting services and you have to distinguish

between professional consulting services and other types of services.

Some of the services such as maintenance and upkeep of a utility, security

services, providing man power, and so on are services of a routine nature

and thus cannot be classified as professional consulting services. These are

called non-consultant services. There is other type of services that involves

physical component as crucial element. These services often involve

equipment intensive assignments using established technologies and

methodologies that have measurable physical outputs, for example, field

investigations and surveys such as topographical surveys, cartography,

aerial surveys, drilling, satellite mapping, and so on. These services are not



classified as professional services and are usually procured following good

and works procurement procedures.

The professional services that are usually required for a developmental

project vary from simple to highly specialised and complex assignments.


3. Conducting aerial surveys is classified as professional services

(True/False)

4. Hiring for maintenance and upkeep of a facility is a non-consultant

service (True/False)

10.4 Steps Involved in the Procurement of Consultants

You learnt about the types of consulting services in the previous section. Let

us discuss the process to procure a consultant.

Once you identify the assignment and decide to procure the professional

services for the assignment, you should take the following steps (these

steps depend on the method of selection which will be discussed further in

this unit. The following steps are for Quality and Cost Based selection

(QCBS):

Prepare the Terms of Reference (TOR) for the assignment.

Prepare the cost estimate or budget for the assignment.

Advertise and invite the Expression of Interest.

Prepare the Shortlist of Consultants.

Prepare the Request for Proposals (RFP).

Issue the RFP to the shortlisted consultants.

Receive the proposals from the shortlisted consultants.

Evaluate the technical proposals – Quality evaluation.

Evaluate the financial proposals – Cost evaluation.

Evaluate the combined proposals and select the winning proposal.

Negotiate with the selected consultant.

Award the contract to the selected consultant after negotiations.

We discuss the above steps in greater detail in the following paragraphs.



10.5 Methods of Selection of Consultants

We discussed about the steps involved in the procurement of consultant in

previous section. We will now discuss the methods of selecting consultants.

The methods of selecting a consultant are designed to achieve the

objectives of quality, efficiency, fairness and transparency in the selection

process and to encourage competition. Hence it becomes critical for you to

select the consultant through a proper method.

10.5.1 Quality and Cost based Selection (QCBS)

You understood that the selection method is crucial for a successful

implementation of project in the previous section. We will now learn about

the features of QCBS.

QCBS is a method based, both on the quality and the cost of the services

provided. It is the most commonly used method of selection for services.

Under QCBS the technical and financial proposals are submitted

simultaneously in separate sealed envelopes. Evaluation of the proposals is

done in two stages-quality and cost. You have to open the technical

proposals first and evaluate and notify the technical scores publicly. The

financial proposal of those consultants qualifying the stipulated minimum

requirement is then evaluated. The technical and financial scores must be

combined and you should select the consultant obtaining the highest

combined score.

Where appropriate

You should adapt this method when:

The type of services required is common and not too complex.

You can define the scope of the work with precision and the TOR is

clear and well specified.

You as well as the consultant can estimate with reasonable precision the

staff time, the assignment duration and all other inputs with respect to

cost.

The risks of estimated are quantifiable and manageable.

To ensure receipt of responsive proposals, the RFP under QCBS should

indicate the level of key staff inputs (in staff time) estimated by you (the

client) to carry out the assignment or the estimated cost of the services, but

not both.



Type of assignments for which this method of selection is adopted

You should use QCBS for the following assignments:

When the assignment is simple and well defined with proper feasibility

study.

Preparation of bidding documents and detailed designs.

Supervision of the construction of works and installation of equipment.

Technical, financial or administrative services of noncomplex nature.

Procurement and inspection services.

QCBS may not be appropriate for complex or specialised assignments in

which the scope of the assignment is not well defined and staff time are

difficult to estimate.

10.5.2 Quality Based Selection (QBS)

In the previous section you learnt that QCBS is used for common and not

too complex project where both technical and financial proposals are

considered.

QBS is based on the evaluation of the proposal quality without any initial

consideration of cost. In QBS the quality and technical aspects are very

important.

Because the TOR of the assignments under QBS is generally more complex

and less defined, contract negotiations with the winning consultant may be

lengthy and complicated.

Where appropriate

You should adapt QBS method when:

The downstream impact will be very large hence the quality of services

is of prevailing importance for the success of the project.

The scope, the duration, and the TOR require flexibility because of the

complexity of the assignment. Hence the need is to select among

innovative solutions, or other factors.

There may be significantly different ways to execute the assignments

where cost proposals may not be easily or necessarily comparable.

You have a need for an extensive and complex capacity building

assignment.



The RFP under QBS should also indicate the level of key staff inputs (in

staff time) estimated by the client to carry out the assignment or the

estimated cost of the services, but not both.

Type of assignments where this method of selection is adopted

You should use QBS when the assignment is of:

Complex sector for example chemical industry and complex nature for

example manufacturing industry.

Importance and far reaching strategy studies.

Pre-feasibility and feasibility studies or design of large and complex

projects.

Consultant with different cost structures (for example traditional

consultants, nongovernmental organisations (NGOs)) are required to

compete.

Strong uncertainty or risk for the project.

Selecting consultant through Design Contests (DC). DC is a process

where you provide a concept to various consultants and select them

based on the best design. For example you want to construct a Railway

station or Rehabilitation of large and abandoned structures. You call for

a design contests and select the consultant.

10.5.3 Selection under a Fixed Budget (FBS)

In the previous section, you learnt that QBS is used for complex sector and

the quality of the project is of utmost importance. So the financial proposal is

not considered initially in QBS.

In FBS method, the available budget is disclosed in the RFP to the invited

consultants and the consultants who apply should be able to perform within

the budget.

You cannot alter the financial proposals. Any proposal that exceed the

indicated budget should be discarded and the consultant who has submitted

the highest ranked proposal within the budget should be selected.

Where appropriate

You should adapt this method when:

The budget cannot be exceeded.

The objective and the TOR including the scope of work are very

precisely defined.



The time and the staff effort required can be assessed.

Capacity building is limited to a simple nature where estimation is easy.

Negotiations

Because the budget is fixed, the consultant’s TOR cannot be changed

substantially and technical negotiations cover only minor aspects.

Type of assignments for which this method of selection is adopted

FBS is likely to result in better quality proposals than under QCBS, because

it is easier for consultants to maximise quality under a fixed budget than

under simultaneous quality and cost competition.

FBS requires the TOR to be consistent with the established budget and to

contain a well specified scope of work. .The main risk of using the FBS is

discouraging good consultants from participating.

10.5.4 Least Cost Selection (LCS)

In the previous section you learnt that FBS is used when the budget is fixed

hence the consultant who has submitted the highest ranked proposal within

the budget is selected.

Under LCS a minimum qualifying mark for quality is fixed and indicated in

the RFP. Shortlisted consultants are requested to submit their proposals

(technical and financial) in two separate envelopes. Consultant who has

scored the required technical score with the lowest price is selected. LCS is

not a substitute for QCBS because quality is to be ensured in LCS.

Where appropriate

You should adapt this method only for small assignments of a standard or

routine nature wherein the intellectual component is minor.

Type of assignments for which method of selection is adopted

You should use LCS when the assignment involves:

Simple audits

Engineering designs or supervision of simple projects.

Repetitive operations, maintenance work and routine inspections.

10.5.5 Selection based on Consultant’s Qualifications (CQS)

In the previous section you learnt that LCS is beneficial for simple projects

with ensured quality.



Under CQS, you first request expression of interest (EOI) and qualification

relating to the experience and competence of the consultants relevant to

your assignment. You then evaluate the information, shortlist and select the

firm with the best qualifications. You then send the RFP to the selected

consultant and negotiate the contract.

Where appropriate

You should adapt CQS method when:

Assignments where only the cost selection procedure would not be

justified.

Past qualifications and experience of the consultant are crucial because

technical proposal itself is not likely to reveal the suitability of the

consultant.

CQS method can substantially reduce the process cost for us as well as the

consultants and the time required to hire a consultant as well.

Type of assignments for which this method is adopted

You should use CQS when the assignment involves:

Evaluation studies at every critical point in the project such as review of

alternative solutions with large downstream effects.

Executive assessments of strategies and programs.

High level, short term expert advice.

Participation in project review panels.

10.5.6 Single Source Selection (SSS)

In the previous section you learnt that CQS method helps to reduce cost,

time and this method should be adopted when only cost based selection

process cannot be justified.

Under the SSS method, you request the already identified consultant to

prepare technical and financial proposals which are then negotiated.

Where appropriate

When there is no competition, you should use this method. You can adopt

this method when it offers obvious advantages over a competitive method,

as in the following cases:

The assignment is a continuation of a previous one awarded

competitively and the performance of the consultant is good.



The consultant’s prompt availability is essential (for example in

emergency operations following a natural disaster).

The contract value is very small.

Only one consulting organisation has the qualifications required to carry

out the assignment.

Type of assignment for which this method of selection is adopted

Good or excellent performance in the first assignment has to be a

precondition for contract continuation. In such cases, we should weigh the

importance of continuing with the same technical approach, the experience

acquired and the continued professional liability of the incumbent consultant

against the benefits of competition, such as fresh technical approaches and

competitive remuneration rates. In these cases we have to consider and

account for the time and cost of a competitive round, because it may weigh

considerably on our decision.

SSS should not normally be adopted when the downstream assignment is

substantially larger in value than the initial one.


5. If the downstream impact of an assignment is large, we use ________

method of selection.

6. For design contests we use ________ method of selection.

7. For procurement and inspection services we use ________ method of

selection.

8. For repetitive operations, maintenance work and routine inspections we

use ________ method of selection.

Activity 1:

You want to construct a small primary school building that does not

require much complex design but the quality must be of good standards.

Which method of procuring consultant will you use and why?


10.6 Prepare the Terms of Reference (TOR)

In the previous section you understood the types of selection methods for

procuring a consultant, their features and also which type should be adopted

for different type of assignments. Let us now learn how to prepare a TOR.



TOR forms are an important document of the RFP. It helps reduce the risk

of ambiguities during the preparation of the consultant proposals, contract

negotiations and execution of the services. It reduces the risk of

unnecessary extra work, and additional expenditure for you.

TOR should generally include the following:

Project and assignment background information.

Precise statement of the objectives.

Outline of the tasks to be performed by the consultant.

Schedule for the completion.

Data, services and facilities to be provided by you.

Final outputs (reports – inception, progress reports, interim report, draft

final and so on) that would be required of the consultant.

Composition of the review committee and the review procedure of the

outputs delivered by the consultant.

List of key personnel who’s resume would be evaluated.


9. TOR reduces the risk of unnecessary_____, and ________for us.

10. TOR helps reduce the risk of ________ during the preparation of the

consultant proposals, contract negotiations and execution of the

services.

10.7 Advertise and Prepare the Shortlist

In the previous section we discussed that TOR forms are an important

document of the RFP. Here we will learn how to advertise for inviting

proposals.

As opposed to open bidding for goods and works, proposals for consultants

are invited from a shortlist of selected consultants. Open invitation will be

time consuming as you have to evaluate each proposals. Similarly open

invitation of proposals will incur lot of expenditure to the consultants. To

avoid this, you should invite bids from a shortlist of selected consultants,

usually not less than three and not more than six to ensure adequate

competition.



Seeking Expression of Interest through Advertisement

For small consulting assignments1 you can prepare a shortlist of well

performing consultants and if there are more number of consultants, you

should seek expressions of interest by advertising in the press. You have to

give details of the assignment and request the consultants to furnish

organisation details, qualifications and experience of the key staff,

qualifications towards assignment, similar assignments performed, financial

standing of the firm and so on. This will provide equal opportunities for all

interested consultants to get shortlisted.


11. For consultancy assignments we invite open bids from consultants as

in the case of goods and works. (True/False)

12. Open invitation of proposals will incur a lot of expenditure by the you in

preparing proposals. (True/False)

13. We prepare a shortlist from those consultants who have expressed

interest in the assignment. (True/False)

10.8 Consulting Organisations versus Individual Consultants

In the previous section we discussed how to advertise and seek expression

of interest from the consulting organisations. In this section we will learn

how to choose consulting organisation or individual consultants based on

the situation.

Individual Consultants

We should engage individual consultants for which:

The experience and qualifications of the individual are important as in

the case of advisory service.

No support from the head office is required.

Team work or a multidisciplinary approach is not necessary.

1 The threshold for small assignments changes with the financing agency for the assignments. World

Bank and other external financial agencies consider the consultancy assignments costing less than US$100,000 as small while GoK considers consultancy assignments less than Rs.20 lakh as small.



Consulting organisation

On the other hand, you engage a consulting organisation when integrated

technical work and collective responsibility for the consultant’s output (say

preparation a study report) is required.

We should engage a consulting organisation, so that the organisation is

responsible for:

Identifying best experts.

Ensuring cohesiveness.

Providing back up support and transparent administration.

Professional liability for the end deliverable/output.

Selection

We have discussed the various methods of selection for a consulting

organisation In the case of individual consultants, you need not ask them to

submit proposals. You select them by comparing the qualifications and

experience of candidates who have expressed interest in the assignment.

We can also engage an individual consultant on single source basis in

exceptional cases such as:

A task that is a continuation of a previous works that the consultant has

carried out.

A short term assignment (say less than six months).

An emergency situation such as a natural disaster.

The individual is the only consultant qualified for the assignment.

10.9 Types of Consultancy Contracts

In the previous section you learnt various situations where to hire individual

consultant or a consulting firm. In this section we will discuss about various

types of contract that can be adopted while procuring a consultant.

General considerations

The following considerations determine the type of contract to be adopted:

The nature of the assignment.

The distribution of risks between the client and consultant.

The level of capacity of the client in contract management and

consultant supervision.



We discussed the general consideration for a contract now we will study in

detail the types of contracts.

10.9.1 Lump sum contract

Under Lump sum contracts you pay to the consultant a fixed sum of money

for the services given such as study report, project design and so on to be

delivered within a specified period. The risks of cost overruns are borne by

the consultant.

Where best suited

This contract is best suited for assignments where the content and duration

of the services and the expected output of the consultants are clearly

defined such as:

Planning and feasibility studies

Environmental studies

Detailed design of infrastructure

Cases of sophisticated and clear cut assignments of short duration in

which external factors generally are not expected to influence (delay or

substantial change) the outcome.

10.9.2 Time based contract

You learnt that the lump sum contracts are beneficial when the scope is well

defined. Under the time based contract, the consultant provides services on

a timed basis according to quality specifications, and the consultant’s

remuneration is based on:

Agreed staff month remuneration rate multiplied by the actual time of

deployment of staff on the assignment.

Reimbursable expenses using actual expenses or agreed unit rates.

Cost risk which will be transferred to you. Hence the consulting firm

would be keen to deploy staff for more periods.

Where best suited

Time based contracts are usually adopted for the following type of

assignments:

The nature and scope of the services cannot be precisely incorporated

in the TOR, since the assignments are complex for example

management of complex institutions or studies of new approaches.



The duration and quantity of resources depend on variables that are

beyond the control of consultants.

The output required of the consultants is difficult to assess in advance

(example, technical assistance, organisation development and others).

Capacity building program forms part of the assignment.

Examples of this type of contract are preparation and compilation of data,

complex studies, supervision of contract, training, advisory services and so

on.

10.9.3 Percentage contract

In the previous section you learnt that the time based contract is beneficial

for complex projects. In the percentage type of contract, consultants receive

an agreed percentage of the actual project cost as their fees for their

services

Where best used

It is mostly used for architectural services and engineering services. The

drawback of this type of contract is that there is no incentive to lower the

cost of the project as the higher the cost more will be the consultant fees. It

may encourage the consultants to adopt more expensive design solutions to

increase their fees.

10.9.4 Indefinite delivery contract

In the previous section you learnt that the percentage contracts are best

suited for architectural and engineering services.

Indefinite delivery contract is used for procuring the services of individual

consultants or a consulting firm to provide the services over a specified long

period of time, say three to five years at mutually agreed rates to undertake

the tasks as and when needed.

Examples of the services for which this type of contract is appropriate are

for on-call services of advisors for complex projects.


14. Under Lump sum contract the risk of cost over run is borne by __

______.

15. Architectural services and engineering services mostly use ______

contract.



16. When the nature and scope of the services cannot be precisely

incorporated in the TOR we use ________ type of contract.

17. Indefinite delivery contracts are usually used for _______ advisory

services.

Activity 2:

You need a house that has to be completed with in a stipulated period.

The assignment is simple and well defined. Which selection method will

you use to select a consultant?


10.10 Request for Proposal (RFP)

In the previous section we discussed various types of contracts and their

suitability. Let us study in detail about the RFP document and the evaluation

criteria.

The RFP document for procurement of consultant is similar to tender

document for procurement for works and goods. RFP provides all the

instructions and information necessary for the shortlisted consultants to

prepare their proposals. RFP includes the following:

Letter of Invitation (LOI) (providing the information of name of

Client(you), source of fund, names of shortlisted consultants, name of

the consulting assignment, method of selection, dates by which the

proposals are to be submitted and so on).

Instructions to the consultants (including evaluation process, evaluation

criteria and sub-criteria and their relative weights).

Standard forms for submission of Technical Proposal.

Standard forms for submission of Financial Proposal.

Terms of Reference (TOR)

Standard form of contract either Lump sum or Time Based or

Percentage or Indefinite Delivery and so on with appendices.

Government of India has prepared a model RFP document along with form

of contract which is available on the website of Ministry of Finance. The

model RFP documents have also been framed by World Bank and other

financing institutions and are available on the websites of those institutions

for different forms of contract.



You have to incorporate the evaluation criteria to evaluate the technical

proposals in the Section of Instructions to the consultants provided in the

RFP. The evaluation criteria generally should be adopting the following:

Specific experience of the consultants relevant to the assignment.

Adequacy of the proposed methodology and work plan.

Key professional staff qualifications and competence.

Suitability of the transfer of knowledge (training) program.

Now that we are aware of the necessary inputs for a RFQ document, let us

now learn about preparation, submission and evaluation of proposals.

Preparation of proposals

The consultants should go through the RFP documents and prepare the

technical as well as financial proposals as given in the TOR by making use

of the standard forms. A pre-proposal conference with shortlisted

consultants can be called for, in order to explain the TOR, the standard

forms and clarify any query. If any clarifications are to be issued, you must

issue it in the form of pre-proposal conference minutes and amendments if

any required are issued later.

Submission of proposals

The consultants should submit the technical and financial proposals in two

covers together before the last date and time fixed. Proposals received after

the deadlines for submission are rejected and returned unopened. The

consultants should use the standard forms contained in the RFP and should

provide all information and documentation requested.

Evaluation of the proposals

You should have an evaluation committee consisting of three or four

members who are well qualified and well versed with the assignment. The

technical evaluation report is prepared by the committee and the

recommendations are accepted after review by the officer competent to

accept the contract. The financial proposals of the technically qualified

consultants are opened based on the procedure applicable for the particular

method of selection. Based on the method of selection a combined

evaluation report is prepared and action taken for acceptance. The selected

consultant is then notified and requested to come for negotiations.




18. A RFP document for procurement consultant is what a ________

document is for goods and works.

19. The consultants should use the ________contained in the RFP and

should provide all information and documentation requested.

20. Based on the method of selection a combined ________is prepared

and action taken for acceptance.

Activity 3:

Find on internet few samples of LOI (Letter of invitation) for RFP.

Hint: http://mohfw.nic.in/Final%20%20RFP%20-%20PC.htm

http://mprdc.nic.in/Consultants-%20MPSRSP-II.pdf

10.11 Negotiations and Award of Contract

In the previous section we discussed about RFP, the selection criteria, and

also the preparation, submission and evaluation of proposals. In this section

let discuss how we could negotiate with the consultants.

We should negotiate with the selected consultant with the objective of

arriving at a mutually satisfactory contract. We should discuss the technical

proposal submitted by the consultant and agree on the following:

Scope of work

Technical approach and methodology.

Work plan and activity schedule.

Organisation and staffing plus time schedule for the key staff.

Deliverables/output

Data, facilities and inputs to be provided by us.

Contract special conditions.

Staff unit rates and reimbursable expense unit rates (where price is not

a factor for evaluation).

Tax liabilities of the consultant.



Award of contract

After negotiations are concluded we should prepare the contract containing:

Negotiated TOR, including the scope of the work of the services, agreed

methodology, organisation chart, and program of activities.

List of reports indicating format, frequency, content, submission dates

and approval procedures.

Job description of key personnel and the staffing schedule.

List of services, facilities to be made available by the client (you) and

also the timing for which they are available.

Estimated contract amount in specified currency indicating staff man

month rates and reimbursable expenses.

Detailed capacity-building program if this is a specified requirement.

After the signing of the contract, the contract is awarded to the consultant.

10.12 Contract Performance

In the previous section we understood the situation where we can negotiate.

Here let us see the final stages of completion of a contract.

Monitoring

You should closely monitor the performance of the consultant. This could be

done by keeping track of the submission of deliverables. The reports

submitted by the consultants should be reviewed by a specially constituted

review committee which will review and forward the approval/comments

(soon after the receipt of the same) to the consultant for compliance and

resubmission if needed.

Amendments

You can amend the contract promptly as mutually agreed by modifications

in the TOR, or scope of work or contract value.

Disputes

You can make sufficient effort to resolve the disputes amicably. Unresolved

disputes shall be treated as per provisions in the contract.

Poor performance

In case of poor performance by one or more or all of the key staff of the

consultant, you can take action as per provisions in the contract. You should

not allow poor performance to continue beyond a certain point and inform



the consultant so as to improve the performance and/or replace the key staff

member(s) as per contract. If the consultant does not comply or improve his

performance adequately, you can terminate the contract.

Delays

In case the consultant is unable to complete the assignment within the

stipulated period due to any reason what so ever, the consultant should

requests for extension of time and or increase in cost. You should review

the request immediately and if satisfied with the request, you can amend the

contract either by increasing the cost or extension of time.

Completion of Assignment:

You should review the draft deliverables/outputs as per contract and

promptly communicate approval/comments to the consultants. The

consultants should promptly comply with the comments without extra cost

and submit the final deliverable/output. After receipt the same, final

payments should be made and the contract is closed.


21. Consultant contract performance should be monitored by keeping track

of the submission of ________.

22. If any of the key staff members of the consultant does not perform

satisfactorily you should ask the consultant to ________ the key staff

member.

10.13 Summary

Let us sum up what we have discussed in this unit.

You learnt that hiring of consultants for assignments that are complex and

requires specialised services is a cost effective and efficient utilisation of

available resources;

Once you identify the consultancy for your assignments, you should prepare

the TOR and cost estimate; decide on the method of selection; advertise

seeking expression of interest and prepare shortlist; prepare the RFP and

issue the same to the shortlisted consultants; receive the proposals and

evaluate the same by following the procedure and criteria as given in the

RFP; select the winning proposal, negotiate and award the contract; and

monitor the contract performance;



We discussed the various methods of selection of the consultants which are

designed to achieve the objectives of quality, efficiency and economy,

fairness and transparency in selection process and encourage competition.

In QCBS we consider both the quality and cost scores, in QBS the quality is

given more importance, In FBS method the budget is fixed, in LCS we give

importance to technical aspect, in CQS we shortlist and seek consultant’s

interest and in SSS we identify a consultant based on certain specified

requirements

TOR form is an important document of RFP. It should be drafted carefully so

that it reduces the risk of ambiguities

There are several types of contract such as Lump sum, Time based,

Percentage, Indefinite delivery available to us. We select the type based on

the nature of assignment, distribution of risks, and our capacity to manage

the contract performance.

RFP document for consultancy assignment is what a tender document is for

goods and works. RFP document includes Letter of invitation, Instructions to

consultants, Standard forms for submission of proposals, TOR and

Standard form of the selected type of contract.

10.14 Glossary

Term Description

Topography Is the study of earth’s surface.

Cartography A study and practice of making maps.

Downstream A term referring to the completion point.

Ambiguity Is a condition where information can be interpreted in more than one way.


1. What is the need for consultancy services?

2. List the steps which are involved in the procurement of consultancy

services in respect of QCBS.

3. Discuss the importance of TOR and what should be contents of TOR

and the importance of each.



4. Explain the evaluation criteria that we incorporate in RFP.

5. Describe the procedure for preparation, submission and evaluation of

the consultancy proposals.

10.16 Answers


1. World Bank

2. Specialised services

3. False

4. True

5. QCBS

6. QBS

7. QCBS

8. LCS

9. Extra work, additional expenditure

10. Ambiguities

11. False

12. False

13. True

14. Consultant

15. Percentage

16. Time based

17. on call

18. Tender

19. Standard forms

20. Evaluation report

21. Deliverables

22. Replace

Terminal Questions

1. Refer section 10.2 Consultants and need for Consulting Services.

2. Refer section 10.5 Methods of Selection of Consultants.

3. Refer section 10.6 Prepare the Terms of Reference.

4. Refer section 10.10 Request for Proposal (RFP) Documents.

5. Refer section 10.11 Preparation, Submission and Evaluation of

Proposals.



References

World Bank Guidelines for procurement of Consultants.

World Bank Consultancy Manual.

GFR of Government of India (2005).



Unit 11 Contract Management Skills

Structure:

11.1 Introduction

Objectives

11.2 Drafting Contract Terms

Writing a contract

11.3 Negotiation Skills

Reasons for a negotiation

Planning for negotiations

Develop negotiating strategy and tactics.

Power positions in negotiations

11.4 Conducting Negotiations

Guidelines for conducting a competitive negotiation

Executing the agreement

11.5 Communication in Negotiations

Verbal communication

Understanding body language

11.6 Summary

11.7 Glossary


11.9 Answers

11.10 Caselet

11.1 Introduction

In earlier units (8 and 9) you have learnt about the various types of contract

and contracting process. You studied that selecting the right kind of contract

is very essential for successful completion of project economically.

Contract management includes finalisation of contracts that is later followed

by monitoring and control of the contract execution.

In this unit, we will discuss the skills required for finalisation of contracts. We

will also discuss the terms that need to be drafted for effective contracts

along with the negotiations skill required. We will learn about the

communication skill essential for contract management.



Objectives


explain the terms and standard for drafting contracts.

adopt negotiation skills required for negotiating competitive contracts.

plan strategically for negotiation.

explain the importance of communication skills.

11.2 Drafting Contract Terms

In the previous units, we have discussed the methods followed to finalise a

bidder. The first step after finalising the bidder is to draft the contract so that

you finalise the terms and condition. The contract must be effective and

flawless.

Let us now discuss the methods involved in writing a contract.

11.2.1 Writing a contract

Most commonly used contracts are developed from earlier contracts that are

subsequently modified to fit the situation in hand. Organisations usually

have a standardised template, which they mould as per the requirement..

Using standard forms or previous contract documents substantially reduces

administrative effort or „reinventing the wheel‟ for much of the word content

of your contract. Reference must be made only to those portions of the

previous documents that are relevant to the current transaction.

Firms have realised that the organisation which writes the first draft of a

complex contract has the advantage of shaping the course of negotiations.

While writing the drafts they can include clauses that suits them, and

structure the deal in their favour.

In contract for project works, the contract draft is prepared by the project

owner and it is invariably adapted by the contractors. This is because the

contractors‟ bids are received against a bid (tender) document, which is

issued to them by the project owner for bidding. Project contracts are of the

following types:

Supply contract.

Installation contract.

Civil works contract.

Supply-cum-installation contract.



The project firms have developed different standard templates for each of

these contract types. For supply of standard products, the supplier also has

his own template of terms and conditions, which you may have to accept

and agree mutually.

„Boilerplate‟ is a term adopted by lawyers to describe parts of a contract that

are “standard text”. You need to consult a good business lawyer to prepare

boilerplates. The standard text may seem less important, but can end up

being tremendously important in the event of a dispute.

Examples of key boilerplate terms are given hereunder:

The prevailing party in any dispute will be awarded its attorney fees.

The contract includes all representations, warranties and agreements of

the parties (the integration clause).

Ambiguous language in the contract shall be interpreted as to its fair

meaning, and not strictly for or against a party.

Disputes will be resolved by binding arbitration, not litigation. The clause

will also state the rules and venue of arbitration.

Time is of the essence of the contract.

Entire agreement

The entire agreement clause must state that the contract is the final,

complete, and total expression of the parties' agreement. Such an

agreement helps in preventing a party from claiming that there are other

promises or terms to the deal that are not explicitly set forth in the written

contract, such as oral representations, e-mails or memoranda, and other

documents.

Modification of agreement

The modification of agreement clause should state that the contract may

only be modified in writing and signed by all parties. This is done in order to

prevent either of the parties from saying that the terms of the written

agreement were verbally changed.

Standard conditions

The following are the standard conditions that must be included in project

construction contracts:

Terms of payment.

Liquidated damages.



Escalation provisions.

Variation of unit rates with variation in the estimated Bill of Quantities.

Compensation basis for extra works.

Force majeure.

Suspension.

Termination.

Bank guarantees.

Statutory variations in taxes/duties.

Works contract tax.


1. The party which prepares the first draft of a complex contract and

sends it to the other party has the advantage of shaping the course of

negotiations. (True/False)

2. Escalation clause is allowed in all construction contracts as a statutory

requirement. (True/False)

3. Boiler plate refers to a document containing standard text for inserting

terms and conditions which are common in _________ contracts.

4. The modification of agreement clause should state that the contract

may only be modified verbally. (True/False)

Activity 1:

Find more boiler plate terms on Internet.

Hint: http://images.jw.com/com/publications/204.pdf

11.3 Negotiation Skills

In the previous section, you learnt what standard terms should be included

in contract and how they should be drafted. In this section, let us discuss the

requirements and importance of negotiation skills.

Negotiation is an interactive process between two or more parties seeking to

find common ground on an issue or issues of mutual interest. Negotiation is

also useful in disputes where the involved parties seek to make or find a

mutually acceptable agreement that will be honoured by all the concerned

parties.

In its simplest form, it involves two or more people/organisations coming

together to seek and arrive at a mutual agreement on one party purchasing



goods or services offered by another party. It is a vital part of the

purchasing/contracting process.

While relationship between the organisations is important for negotiations,

managing personal relationships is equally crucial in negotiations.

Negotiation involves skills which individuals with proper training and

experience can learn and improve upon. Although some are born with good

negotiation skills, it can be developed or enhanced through practice. More

than ever, negotiation today is becoming a group activity rather than an

individual activity. So, in addition to the knowledge and skills required to be

an effective negotiator, while negotiating you must learn to work as a team.

In the book „Purchasing and Supply Chain management‟ 2002 edition by

Robert Monzka, Robert Trent and Robert Handfield, the authors identify five

phases in the negotiation process. They are as follows:

Identifying the product or service to be procured/contracted.

Determining if negotiation is required.

Planning for negotiation.

Conducting negotiation.

Executing the agreement.

We will discuss phases 2, 3, 4 and 5 in this section, since these are critical

to the success of the negotiations.

11.3.1 Reasons for a negotiation

As we now aware that negotiation is a process, we will now learn the

reasons for which the negotiation plays a crucial role.

Detailed negotiations may not be warranted for standard products or

services of low value and those which are widely available or have

established standards. For such requirements, the competitive bidding

process is invariably adequate. When issues other than just price and

delivery time become important in a project, receiving and reviewing

competitive bids will need to be followed up with competitive negotiations.

The other issues may pertain to some of the following:

Quality of the deliverable – stage wise and final inspection of the

deliverable before accepting the deliverable.

Technology support and assistance.

Mode of shipping/transportation and responsibility for the same.



Transit insurance, project insurance.

Non-performance penalties.

Protection of proprietary information.

Payment terms.

Warranties and performance guarantees.

Resolution mechanism for contract disputes.

Progress reporting methodology.

11.3.2 Planning for negotiations

In the previous sub-section you learnt the reasons for which the negotiations

can be conducted. Now let see how to plan for negotiations.

A complex negotiation requires specific planning to be successful. Without

planning, a negotiator cannot possibly have the information required to

effectively argue with a strong stand in a complex negotiation. Sufficient

time needs to be committed upfront to the planning for a complex

negotiation. Planning negotiation includes:

Establishing specific objectives and also the range of those

objectives. Objectives may need to be categorised as „must have‟ and

„would like to have‟. Although building relationship is important, the

parties should not be afraid to isolate the most important objectives and

areas of concern, and put them on the table for discussion at an early

stage. After the objectives have been stated, you have to make sure that

they remain the primary focus of the negotiations. You should avoid

getting lost in details and contractual languages, and should be flexible

enough to consider alternative methods for achieving objectives and

overcoming concerns. Nothing brings negotiations to halt faster than one

partner‟s proposal of final plans or offers that, at least in the eyes of the

other partner, must either be accepted or rejected without much

discussion. Failure to do this will lead to agreeing to something that is

not in your company‟s best interest, or delaying the negotiation process.

Ensuring the right people are negotiating. Participants involved in the

negotiation process should include all persons who will have substantive

responsibilities in executing the relationship, as well as representatives

of senior management with authority to make commitments on behalf of

each party. It is also wise to pay careful attention to the rank and status

of negotiators for the other side.



Analysing the other party’s strengths and weaknesses as well as

your own. This will help you to formulate convincing arguements or

support for your arguements. You should also identify areas of flexibility

within the arguement points. Gathering sufficient information about the

other party is very important. This may not be difficult for items which

you are already purchasing. Otherwise, you must peruse trade journals,

government reports, annual reports, commercial databases, Internet or

resort to direct enquiries to supplier‟s personnel.

Understanding the other party’s needs for example, if supplier desires

market share and volume, he will want the whole contract and not part

contract. If supplier is supplying for your business for the first time, it

would be preferable to create a small contract with an eye on future

business.

Differentiating between facts and issues. Facts are reality or truth

which cannot be negotiated about. Issues are items or topics to resolve

during a negotiation and are to be identified in advance.

Establishing a position on each issue. The negotiator should develop

a range of positions on an issue – a minimum acceptable position, a

maximum or ideal outcome, a most likely targeted position. Figure 11.1

and figure 11.2 illustrate this with an example.

Figure 11.1: Non-Negotiating Condition



Figure 11.2: Negotiating Condition

11.3.3 Develop negotiating strategy and tactics

In the previous sub-section we discussed how to plan for negotiation, here

we will discuss the ranges for a negotiation.

These are two dimensions of the negotiating process. They are:

Strategy: It has a long term focus. It is a predetermined approach or a

prepared plan of action to achieve a specific goal or objective to

potentially find and make an agreement/contract in a negotiation with

another party or parties.

Tactics: It refers to the art or skill of employing available means to

accomplish an objective or strategy. Tactics should support the strategy.

Tactics can also be viewed as the detailed method employed by

negotiators to gain advantage over other parties. Tactics should support

the strategy.



It is important to brief about the strategy and tactics to be used in the

organisation to other personnel who are participating in the negotiations as

well as those who are affected by the negotiations. Briefing prevents

unwanted surprises during face-to-face negotiations. Holding a mock or

simulated negotiation may also help substantially for a complex and

competitive negotiation.

11.3.4 Power positions in negotiations

After learning about the strategies for negotiation and about ways to apply

tactics that support your strategy in good negotiation, now we will discuss

about who will be the right person or authority to negotiate.

Power is simply the ability to influence another person or organisation. X

has power over Y if X can get Y to do things that directly benefit X.

We classify the sources of power as follows:

Informational power: This comes from access to facts, data and other

arguements. This power relies more on persuasion.

Reward power: Here, the party is in a position to offer to the second

party something that the second party considers a reward. For example:

award of a large value contract by the first party. One drawback of this

power is that the second party may get conditioned to rewards.

Coercive power: If A can give something to B, A can also take away

something from B. One fall out of this power is that this can lead to

retaliation from B when the power structure shifts. Hence, prior to using

this power, the buyer must consider the willingness of the supplier to

comply.

Legitimate power: This power stems from the position held by the party

for example ministers, political office holders and prominent companies.

This power relies more on persuasion.

Expert power: This power stems from the expertise of a person. Non-

experts will not challenge an expert in the subject. This power also relies

more on persuasion.

Referent power: This stems from the personal qualities and attributes of

an individual, such as honesty, charisma, friendliness, sensitivity can be

strong sources of power. This power can be used when referent is

aware that a counterpart has an attraction to the referent.




5. Tactics refer to the ____ or _______ of employing available means to

accomplish an objective or strategy.

6. Analyse the other party‟s Strengths and Weaknesses will help you to

formulate convincing ________ or support for your positions.

7. ________ are items or topics to resolve during a negotiation and are to

be identified in advance.

8. Negotiation is an _________ process between two or more parties

seeking to find common ground on an issue.

9. Sufficient time needs to be committed upfront to the planning for a

_______ negotiation.

Activity 2:

Find the benefits of using strategy and tactics for negotiating.

Hint: http://ezinearticles.com/?Negotiation-Strategy-Vs-

Tactics&id=1504682

http://www.au.af.mil/au/awc/awcgate/fai/negotiation_strategy.pdf

11.4 Conducting Negotiations

In the previous section, we learnt about the different elements to plan before

a negotiation, here we will learn how to conduct a negotiation.

11.4.1 Guidelines for conducting a competitive negotiation

The most important rule in conducting a complex negotiation is that you

should have done the planning for it and you should feel confident about

your plan. Advances in electronic communication such as video-

conferencing may have reduced the frequency of face-to-face meetings, but

for a complex and competitive negotiation, no other mode of communication

has yet replaced the face-to-face meeting. Broadly, the face-to-face

negotiation comprises four sequential phases.

The opening phase consists of cordial greetings, introduction of

participants, and review of the meeting agenda followed by fact-finding

between the parties.

The second phase is a recess for both parties to internally review and

reassess their positions.

The third phase is the crucial meeting between the parties to narrow the

differences on all the agenda issues.

The fourth is to seek an agreement and conclusion to the negotiation.



As you begin to interact with the other party on the issues specific to the

negotiation, you must recognise that everything you do and every decision

you make is part of the negotiation.

Let us review some questions that as a negotiator you can face while

conducting a negotiation and the considerations to find answers to these

questions:

Framing the opening conversation: A tough opening position sets a

firm tone and the counterpart probably will have to make deep

concessions to win an agreement. It is a take-it-or-leave-it approach.

You can adopt this when you are sure that the other party needs to

close a deal with you. The pitfall of this approach is that the other party

may reject your position if he has good alternatives.

Getting better information and setting the tone: Negotiations

commence with exchange of pleasantries. At some point of time one has

to make the first offer. The significance of the first offer stems from two

reasons – it gives a lot of information to the other party to size your offer

against his own target; the other party can adjust his own opening offer

to be more or less extreme than planned. It makes sense to let the other

party make the first offer if you are unfamiliar with the negotiating.

Concessions: Concessions are trade-offs that a party is willing to make,

usually with the expectation that the other side will respond kindly and in

the same degree. Figure 11.2 is an example of this. However, price is

not the only issue in most negotiations. Several issues may be involved.

Very competitive negotiators tend to negotiate one issue at a time by

pushing for the best deal in that issue and only then move to the next.

More talented and cooperative negotiators seek to package issues

together, because in the end, it is the whole deal that is important and

not the best deal on each issue. This is called „packaging the

concessions‟. Concessions affect both tangible and intangible

outcomes – the intangible outcomes being reputation and esteem. Even

if you are winning the overall negotiation, it is easier to maintain your

reputation and image if you manage to give the other party some wins to

go with, which gives him the feel-good factor.



Rules of thumb for a competitive negotiation:

Stick to your planned target and walk away points.

You are likely to get a better overall deal if you make a larger number of

concession moves, but smaller in magnitude.

Do not reveal your target until you reach close to it during the

negotiation.

Never reveal your walk away point.

Get the other party to make big concessions.

Keep your concessions few, slow and small. This calls for patience of

the negotiator.

Manage the other party‟s impressions of your concerns. If you are liberal

in showing your big concerns, your position becomes weaker. Hence,

conceal your greatest concerns, and divert attention to lesser concerns

as you negotiate.

We noted in this section that effective negotiators are not born and learnt

their skills through experience and training. As an effective negotiator you

should have very clear goals, but should also compromise or revise your

goals in the light of new information. You should learn to view issues

independently without linking them in a sequence. Linking can undermine a

negotiation if an impasse is reached on one issue. Instead of taking a single,

rigid position on an issue, you should review many more options for a

position compared with an average negotiator.

Some detailed important do‟s and don‟ts while conducting negotiations are

given hereunder.

Do’s:

Know your authority as a negotiator and that of your counterpart.

Get the other side to commit first.

Prepare a memorandum of what happened after each negotiation. Also

prepare interim summaries as agreement is reached on individual

issues.

Use your team of experts.

Be patient. Remember the 80-20 rule. 80% of the concessions are given

in the last 20% of the negotiations.

Understand how to interpret body language.



Ask open-ended questions if you want information. Invariably, a question

which demands a „yes‟ or „no‟ answer cannot be followed up or

reopened for discussions.

Be an active listener.

Ask for more than you expect to get. It gives you more negotiating room.

Position the most difficult questions last. You are more likely to get

concessions as negotiations drag on.

Don’ts:

Never give up chunks of negotiating room upfront.

Never reveal your position, strategy or tactics to anyone outside those

who absolutely need to know.

Do not make concessions without getting something in return.

Do not try to become well liked or popular with the other side during

negotiations.

Never allow more than one person to talk at one time.

Do not allow your team to be separated even during breaks or lunch.

Never let the other side see disagreements among your team members.

Avoid entanglement on personal issues.

Do not go with your best offer upfront. By giving your best offer towards

the end of the negotiations, you raise the chances of the feel-good factor

in the other party.

11.4.2 Executing the agreement

Earlier in this unit, we discussed the drafting of a contract. A successful

negotiation leads to the signing of a contract by the parties after

incorporating all the mutual agreements reached during negotiations.

Execution of the agreement does not involve just the signing of the contract,

but it represents the beginning of the contract‟s performance for the

deliverables covered in the contract. Hence, a key part of executing a

contract (negotiated agreement) is providing performance feedback. Both

the contractor and the buyer have responsibilities as per the contract, which

they must discharge. Thus, both parties should build upon the success of a

negotiated agreement and reaffirm their commitment to pursue future

opportunities. Contract performance management will be dealt in Unit 12.

Here we review three categories of conclusion of negotiations between

parties:



Win-Win negotiation: This implies an integrated negotiated agreement.

In theory, it means the negotiating parties have reached an agreement

after fully taking into account each other‟s interests such that the

agreement cannot be improved any further by any other agreement.

Win-Lose negotiation: This is a distributive negotiation whereby one

party‟s gain is another party‟s loss. Both parties are competing to get the

most value from the negotiation. It is also known as Lose-Win

negotiation.

Lose-Lose negotiation: This is a negotiation where all the parties in a

negotiation fail to recognise or exploit more creative options that would

lead to a Win-Win negotiated outcome.


10. As a guideline for negotiation you should conduct a crucial meeting

between the parties to narrow the difference on all the _______ issues.

11. When there is a distributive negotiation whereby one party‟s gain is

another party‟s loss, it‟s a _________ negotiation.

12. A successful negotiation is signing of a contract after incorporating all

_________ reached during negotiations.

13. You should prepare a __________ of what happened after each

negotiation.

Activity 3:

Find out what other issues can be cause for negotiation apart from price.

Hint: http://www.au.af.mil/au/awc/awcgate/fai/negotiation_strategy.pdf

11.5 Communication in Negotiations

In the previous section, you learnt about guidelines for a good negotiation.

You understood the three categories of conclusion in negotiation.

In this section, we will analyse the importance of communication, both

verbal and non-verbal. Negotiators understand the importance of effective

communication while conducting negotiations. Both verbal and non-verbal

modes of communication need attention for conveying messages correctly

and effectively to the listeners. In this section, we will discuss about the

communication skills required during negotiations.



Effective communication (verbal and written/non-verbal and written) is the

key to conducting business successfully. The non-verbal communication

occurs by the advertent or inadvertent use of „body language‟, which is

equally important to convey the intended message. We review hereunder

the verbal communication and body language under separate headings.

11.5.1 Verbal communication

The verbal communication is split in three sections as under:

Grammar: Informal speech often uses abbreviations, contractions and

colloquialisms. For example, „hope‟ is less formal than „expectation‟; the

words „ooh‟, „oodles‟ and „oomph‟ are casual and used in conversations.

This only means that good communicators adjust the level of formality to

the context in which they are speaking or writing.

Tone of communication: The tone of a business communication is also

chosen with the objective of the communication in mind. The tone can

be considered as the third dimension of communication, the other two

being the business context and the level of formality. If the supplier

realises that he must maintain good relationship with a strategic

customer, his tone will be friendly. If the customer defaults on or delays

payments, the supplier‟s tone can vary from a friendly reminder to a

hostile demand.

Channel of communication: Different channels (media) of

communication are available today. Table 11.1 presents the advantages

and disadvantages of using the various channels available.

Table 11.1: Advantages and Disadvantages of Different Modes of

Communication

Medium Advantages Disadvantages

Face-to-face meeting

Promotes trust

Content and level of formality Can be adjusted during the meeting.

Disagreements can be negotiated further.

Expensive

Time consuming

Phone call Requires immediate response

Opportunity to restate or clarify if the listener does not understand

Can extend for a long time

No record

Hard to judge the emotional component.



Video-conference

Can be used for a „milestone‟ interaction

Relatively inexpensive compared to face-to face meeting.

Substantial organisation to arrange a video conference (especially across time zones.

Limited possibility of a breakthrough if participants have not previously met face-to-face.

11.5.2 Understanding body language

Body language implies non verbal communication that involves body

movements. What we try to deliver through verbal means may not be similar

to the one which we actually deliver through our body language.

Let us see few negative and positive signs that can be assessed through

body language:

Positive signs

Having eye contact with another person signifies self-assurance.

Hand movements made outward and upward express positive message.

A nod of head occasional by the listener is an indication that they are

listening and are interested.

Negative signs

Head lowered communicates acceptance of defeat.

Clearing the throat now and then is a sign of anxiety.

Looking around signifies that the person is bored.

Research findings show that as much as 90% of the meaning transmitted

between two people in face-to-face communication is non-verbal. This

means that as little as 10% of the verbal communication will have an impact

on the outcome of your negotiation. Therefore, studying what you and your

counterpart are not saying in the negotiation process is critical to achieving

a win-win outcome. As the emphasis in negotiation is on body language,

negotiation can be more effective in face to face meetings.


14. Video conference can be used for a _________ interaction.

15. Tone is considered as the third dimension of _________, the other two

being the business context and the level of formality.



11.6 Summary

In this unit, we discussed that the contract management includes finalisation

of contracts followed by monitoring and controlling of the contract execution.

We learnt the skills required for drafting contracts; we understood the term

boilerplate and some standard that needs to be followed for contracts in

works.

We also learnt that planning a negotiation is essential to succeed in a

negotiation process. Conducting the negotiations and concluding the

agreement closes in a signed contract. Negotiating skills play a significant

role both for the buyer and seller in concluding a contract.

We discussed the relevance of the target price, bargaining zone and the

walk-away point in price negotiations. We understood negotiation can be

done for several issues apart from price. The power positions impacting the

result of a competitive negotiation were discussed.

We discussed enumerated guidelines for negotiations in terms of do‟s and

don‟ts which should be observed. Communication – oral, written as well as

body language, all have impacts on the outcome of a negotiation.

11.7 Glossary

Term Description

Legitimate Being in compliance with the law.

Transit The act of passing over or passing through.

Advertent Giving attention to details.


1. List out the reasons for which negotiation is essential.

2. What are the categories of powers that can be used for negotiation?

3. List out standard conditions that must be included in project construction

contracts.

4. Write short note on body language.

11.9 Answers


1. True

2. False



3. Construction

4. False

5. Art, Skill

6. Arguments

7. Issues

8. Interactive

9. Complex

10. Agenda

11. Win lose

12. Mutual agreement

13. Memorandum

14. Milestone

15. Communication

Terminal Questions

1. Refer section 11.3.2 Reasons for a negotiation.

2. Refer section 11.3.5 Power positions for negotiations.

3. Refer section 11.2.4 Standard conditions that must be included in

project construction contracts.

4. Refer section 11.5.2 Understanding body language.

11.10 Caselet

Lessons from The United States-Singapore Free Trade Agreement

(USSFTA)

The USSFTA is taken as lessons for good negotiation. This happened

between the United States of America and Singapore. It is not about just

negotiation, it is about negotiating with American companies and

coordinating domestic policies within the United States of America and

Singapore.

The lessons have been drawn against the backdrop of economic model

of Singapore in particular. The strategies that are used by government

pursues in the absence of natural resources.

The negotiations with Singapore started when congress leader President

Clinton‟s government was coming to an end and the new US

Government under President George W Bush who is a republican.



The idea was mooted in 1998 when Clinton‟s administration considered

Singapore‟s economy as inefficient and wanted to implement the model

on the US-Jordan Free Trade Agreement with a modest scope. It was

thought that the negotiations could be completed before the new

administration was in place. However, the US legislative process was

sceptical and knew that it was near impossible that it could happen within

the specified time. Why?

It is because in the US, it needs to be ratified by Congress, both the

House of Representatives and the Senate. The process takes 60 to 90

days and requires lot of effort to persuade the congressmen to support

and vote for the agreement. So how did Singapore ensure that the

incoming Bush Administration will continue with the Free Trade

Agreement (FTA) negotiations initiated under the Clinton Administration?

A solution was found by the Singapore Trade Minister, Mr. George Yeo.

He convinced a joint agreement signed that captured the overall

approach to the FTA from the two administrations. Singapore could

successfully transit between the two Administrations because of the fact

that minister George Yeo had a good working relationship with the two

US Trade Representatives.

Lesson One: It is never too early to make friends and maintain good

relations.

When you are negotiating with the US, you only won half the battle when

you finish the negotiations. Getting the Agreement sanctioned is the other

half of the battle. To do this, Singapore formed two important groups to

help mobilise the FTA in the US business community and in Congress –

the Singapore Business Coalition and the Singapore Congressional

Caucus.

Singapore Business Coalition

Singapore Business Coalition role was to earn friends in the business

community. Three big US businesses – ExxonMobil, Boeing and UPS

agreed to co-chair the Coalition. This was not specified in USSFTA, thus

coalition for Singapore persuaded 100 over companies to join them and

support the FTA. The US-ASEAN Business Council was a key supporter



too. The coalition was important because when you put an agreement

before the Trade Promotion Authority (TPA), businesses would recognise

and argue for the benefits, instead of opposing it. If this was not done by

the Singapore government, they would have got stuck here. Hence, it

was important to sought out the support.

Singapore Congressional Caucus

The second group that helped Singapore‟s innovative effort is the

Congressional Caucus, made up of Congressmen from the Senate as

well as the House of Representatives. These congressmen would help

the Singapore government persuade their fellow congressmen to vote for

the FTA. Singapore had both a Democrat and Republican jointly co-chair

the Caucus to reach out to both the Democrats and Republicans. These

groups offered good advice along the way. Singapore‟s Ambassador

personally met 353 out of the 435 members of the House of

Representatives or their staff and 78 out of the 100 Senators or their staff

in Washington. She wore out many pairs of shoes in the effort!

Lesson two: Your best chance of success is to negotiate with your

friends but even among friends, there can be misunderstanding and lack

of information so information is also important.

Question:

How do you think the Singapore congressional Caucus helped complete

the negotiation?

Reference

Robert an Gilbreath, Managing Construction Contracts.



Unit 12 Contract Performance Management

Structure:

12.1 Introduction

Objectives

12.2 Control and Flexibility in Contracts

Flexibility in contracts

Control of contracts

12.3 Monitoring and Controlling Technical and Operational Performance

of Contracts (Contractors)

12.4 Controlling Risks

Risk classification based on where risk control lies

Areas of risk and causes of risk

12.5 Incentives and Penalties

Penalty

Incentives

12.6 Change Order Management

12.7 Termination of Contract and Conditions for Termination

12.8 Summary

12.9 Glossary


12.11 Answers

12. 12 Case let

12.1 Introduction

In the previous unit you learnt about contracts management skills. You

learnt how to draft a contract in detail. You also learnt about the

requirements for negotiations and negotiation skills. You learnt about the

importance of communication skills.

This unit deals with contract performance management as a subset of

project management. Since contract performance management begins right

in the contract formulation stage and continues up to the contract close-out

stage for each contract awarded in a project, the unit starts with guidelines

for you to achieve both control and flexibility in managing contracts.



Learning objectives


list the guidelines to achieve both executive control and flexibility in

contracting, as an owner of a project.

define the areas requiring attention in effectively monitoring and

controlling the technical factors.

determine the possible causes of risk events and strategies to mitigate

the adverse implications of risk events.

outline the incentives and penalties that can be incorporated in contracts

to motivate contractors to perform.

12.2 Control and Flexibility in Contracts

Contracts form the backbone of project management today. Project

management techniques have developed in response to severe pressures

such as unfavourable economic factors, inflation, uncertainties in the

magnitude and duration of construction projects, and often unpredictable

regulatory and environmental requirements. Executive control of a project

can therefore be achieved only by controlling the progress of contracts

entered into for the project.

Major projects involving substantial construction are exceptional, one-time

or at least infrequent. The popular mode is that you invest in capital works

and execute the project through a single entity created for the

implementation of the specific project.

The single entity is the project team, which in turn is led by a designated

project manager dedicated to the project. This team should be established

early in the development of the project concept and be given responsibility

for the complete project life cycle from feasibility; through schematics,

design, and procurement. In this way, managerial unity is established early

in the project.

The single entity model can be achieved in three different ways, each way

being a contracting mode for an entire project:

1. Award of a single contract (either Lump sum Fixed price or Engineering

Procurement Construction (EPC), which were discussed in unit 3) for



the implementation of the project after the basic design of the project is

finalised.

2. D-B (Design and Build) mode of contracting discussed in unit 3.

3. D-B-B (Design, Bid and Build) mode of contracting also discussed in

unit 3.

12.2.1 Flexibility in contracts

In the „1‟ and „2‟ modes, the single entity is the Lump Sum Turnkey Contract

(LSTK), EPC contractor and the D-B contractor respectively. In both these

modes, the contractor acts as a single point responsibility for the

implementation of the project i.e. the contractor accepts financial liability for

failure to meet any of the salient project deliverables of schedule, cost and

performance. The drawback in this model is that you cannot change design

or introduce new scope.

Mode „3‟ allows a good deal of flexibility to you, i.e. you will be able to

maintain both executive control and open options for as long as possible, to

respond to external conditions in this mode.

Theoretically, in mode „3‟, the single entity model can be achieved if you can

designate a project manager for in house project planning and project

engineering personnel can report for the duration of the project.

In such a case, this team should have certain features which set it apart

from the traditional function of a project company. For example:

A centralised clearing system should be established for timely project

decisions involving diverse interests.

The team should get directly involved in managing participation by

parties normally outside its direct control. The team should handle

diverse activities such as feasibility studies, changing requirements,

regulatory requirements, so on all of which are time-phased, and which

require coordinated planning, scheduling, and control.

Organisational conflicts are bound to occur which need to be dealt with

by top management.

The project staff hired will have to get back to their original function as

you may not hire them in near future.

Construction projects are one-time undertakings and they do not justify for

you to set up an in house staff, both from the viewpoint of efficient utilisation



of staff and lack of project management skills. Hence, for medium size and

big size projects, the project manager and the project team should be an

outside agency and you can nominate a representative to whom the outside

agency‟s project manager reports. The benefits provided by the outside

agency are that the agency‟s services are more flexible; the agency usually

has access to varied resources, and costs little in comparison to the total

project commitment throughout its life.

This outside agency is popularly known as Project Management Company

(PMC). You award the contracts for supplies and construction while the

entire coordination and interfacing of the project works are carried out by the

PMC.

In summary, you have understood that the degree of flexibility owned by you

is greater in the D-B-B mode of contracting compared with the LSTK EPC

mode of contracting. Some flexibility for changes can also be incorporated in

the LSTK EPC mode, for example, escalation formula for providing financial

compensation to contractor, mutually agreed basis for computing

compensation for marginal extra works i.e. works not envisaged in the

original contract. Generally, a LSTK contractor will be inclined to demand a

higher compensation and grant of longer time extensions for project

completion when faced with major extra works.

The degree of flexibility in the D-B mode would fall between that of D-B-B

mode and LSTK mode.

12.2.2 Control of contracts

The contract control process commences right at the beginning stage of bid

document preparation inviting contractors to bid, and proceeds through the

contract negotiation, contractor selection, monitoring and controlling of the

contractor‟s work and terminating the contract..

For effective control of the contracts in a project, the following areas need

attention:

Core competence of the project manager: The project manager must

have experience in planning and management of similar projects. While

he should be ready to refer to the individual specialists, he should be as

knowledgeable as anyone about the economic and regulatory



environment, engineering technology, project planning, scheduling and

cost accounting, as well as construction.

His focus throughout the project implementation should be on the key

criteria of scope, time, and cost and client satisfaction. He achieves this

by interpreting the requirements to the specialists and directing their

efforts to achieve the best combination of these four key criteria. His

core competences will be to resolve conflicts which invariably arise

between these four criteria. His objectives on the project are identical to

that of the client; however, he should be able and willing to argue a point

with the client when he feels it is necessary.

Requirements of the working system: For a competent project

manager to be effective, the following components of the working

system are necessary:

o The project manager must have the necessary managerial authority

to ensure response to his requirements from his team.

o All major technical, cost, schedule, or performance decisions should

be made only with the project manager's participation.

o He must be identified as the authoritative and single formal contact

in dealing with outside parties.

o The project manager should have a say in the assembly of the

project team, and personnel assigned to the project must be

competent.

o The project manager should have the authority to control the

commitment of funds within the prescribed limits of the project, for

which he liaises constantly with the owner‟s representative.

o Senior management must clearly demonstrate support for this

concept.

Use of Work Breakdown Structure (WBS): A complex project is made

manageable by breaking it down to smaller group to define task that can

be achieved independently of other tasks. A formalised WBS is essential

for effective control of contracts. A contract to be awarded on the project

is identified after deciding the work package units. Consultants and

contractors should confirm their agreement to the work package units for



which they are responsible. Thumb rules for finalising and controlling

work package units are:

o It should not be necessary for the project management team to

incorporate into the network schedule, information which is more

detailed than the work package level. Progress should be monitored

at this level and variances can be investigated through field reports.

o Work packages should be identified 2 to 6 months prior to

performing the work, and can only be revised with the approval of

the project manager and normally as a consequence of a change

order.

o A project should not be broken down to such an extent, or contain

work packages so small, that unnecessary administrative effort is

incurred in maintaining the information flow. For example on projects

up to, say, Rs.100 crores, a minimum work package value of, say,

0.1% is a good rule of thumb.

o For schedule control, an integrated network should be drawn to

monitor and forecast progress. This schedule should not be changed

unless:

A formal reprogramming of the entire project or major part takes

place.

The target schedule and the current schedule become so far

apart that recovery is impossible and target objectives become

meaningless.

Such changes are recognised and approved by top

management.

Recognising the limitations with flexibility: While the D-B-B mode of

contracting enables flexibility to make scope and design changes, it

must be constantly ensured that the detailed designs with reference to a

contract get substantially finalised prior to award of the contract.


1. When the project team is established early in the project and given

responsibility, _______ unity is established.

2. In the D-B mode of contracting, _______ contractor is the single entity

responsible.



3. Project manager is identified as the ______and _______contact in

dealing with outside parties.

4. Flexibility to make scope and design changes can be achieved in the

_____ mode of contracting.

Activity 1

Find out roles and responsibilities of a project manager for a construction

industry.

Hint: http://www.exforsys.com/career-center/career-tracks/the-role-of-a-

construction-manager.html

http://en.wikipedia.org/wiki/Project_manager

12.3 Monitoring and Controlling Technical and Operational

Performance of Contracts (Contractors)

In previous section you learnt about flexibility in contract and contract

controls that help in uninterrupted project execution.

Monitoring and controlling of a contract being executed by a contractor

should focus on the deliverables in regard to time, cost and quality. Projects

are invariably carried out by awarding several contracts and for each

contract, the same salient deliverables apply. In this section, we will focus

on the performance management of the contract from the owner‟s (your)

point of view since you are the direct beneficiary of the deliverables. You

should therefore focus on the monitoring and controlling of contractor‟s

deliverables as per the contract, as opposed to getting involved in the nitty-

gritty of the planning and implementation aspects which is the contractor‟s

scope of work.

Effective performance control of a contract encompasses both the pre-

contract award and the post-contract award phases. For the purpose of

discussion in this section, we refer to the pre-contract award phase as the

contract formation phase, and the post-contract award phase as the contract

administration phase (by administration, we mean monitoring and controlling

of project).

The administrator you choose for contract management must be involved

even at the stage of contract formation, so he is aware of all the aspects

affecting the contract implementation. In other words, contract



administration begins with signing of the contract documents, continues

throughout the performance period and ends with the formal termination of

the contractual relationship.

The areas to be considered while monitoring and controlling a contract are

wide spread. They are:

Physical mobilisation: In this stage, the contractor gathers people,

materials and equipment to begin his work. You should mobilise

personnel (contract manager), systems and equipment required to

manage the contractor‟s performance. This has to happen immediately

after contract award. The contract manager hired focuses on the

following in this stage:

o Initial set of contractor‟s submittals are received, reviewed and filed.

o Initial meeting between contract manager and contractor‟s job site

manager is conducted.

o System and facilities for maintaining contract records and conducting

contract related transactions are established.

Typical submittal comprises: This includes:

o Evidence of insurance coverage.

o Fabrication/installation procedures (rigging methods, weld

procedures and so on.), concrete placement schedules and soil

compaction methods.

o Quality assurance and control program documentation.

o Fabrication, supply and construction schedules.

o Detailed schedules for contractor‟s submission of technical

documents consisting of construction drawings, shop drawings,

detailed specifications of materials or sample products in contractor‟s

scope of supply, Operations and Maintenance (O and M) manuals

and so on in accordance with what is agreed in the contract.

o Signed bond forms.

You should realise importance of a good contract records, as these records

will greatly facilitate:

Technical and compliance by both parties.

Contract auditing.

Control of correspondence.



Change control.

To make progress payments and the final payment.

For quality control.

To operate the completed facility.

As a claims defence; the party which maintains the best

documentation prevails in the claims arena.

If personnel managing the contract can get shifted out of the

project, the past records assume great importance in such a

scenario.

Progress billings and payments: Payment is the valuable control tool

in your hands. You should ensure that progress payments are

determined objectively and designed to promote timely performance by

contractor. The key rules which apply here are:

o You should guard yourself against early payment and overpayment

as it is risky.

o You should not unreasonably delay or withhold earned payment

which will lead to risk of contractor‟s dissatisfaction which manifests

as quality compromise or time delay.

o Prompt and accurate contractor invoices and timely payments are

critical to the financial status of the contractor.

o It is prudent to involve both personnel responsible for contract

formulation and personnel responsible for contract administration in

designing payment terms. It should be noted that contracts invariably

stipulate percentage retention (usually 10% of progress bill value).

The purposes served by the retention are motivating the contractor

to complete the work; covering the risk of latent errors or omissions;

encouraging contractor to rectify deficiencies after a planned

demobilisation.

Claims: Claims can be initiated by both parties involved. Claims are

settled through negotiation, adherence to contract terms, or a mutually

agreed adjustment in the contract performance. The goals of both

parties should be to ensure that claims are justifiable.

The reasons for owner‟s claim can be the following:

o Defective work by contractor.

o Delays by contractor.

o As a claims defence.



The reasons for contractor‟s claims can be the following:

o Late or defective information by owner.

o Delay in or defect in free issue material by owner.

o Changes in regulatory requirements.

o Unknown site conditions.

o Restrictions imposed on work method, including restrictions which

cause delay or acceleration in contractor‟s work performance.

o Collateral work which leads to ripple effect for example concreting is

planned to be done during fair season is rescheduled to adversely

cold seasons (for reasons not attributable to contractor) which

require heating arrangements impacting cost.

A claim is different from a change order. A claim is a quotation by the

contractor requesting you to issue a change order. When you agree on the

quotation it becomes change order.

Back charging: Back charging the contractor arises when a certain

scope of work included in the contract is either not carried out or carried

out defectively. When such an event is identified, the first option for you

is to get the scope rectified by the same contractor. If the contractor is

unable to do so, you can retort to get it done by another agency and the

cost incurred is back charged by deducting it from the contractor‟s next

bill. For example if a pipe supplier has supplied pipes with unbevelled

ends while the purchase order called for beveled ends. You get the

beveling done by another agency and back charge the cost incurred to

the contractor.

Contract close-out: Contract close-out begins with checking for

physical completion, i.e., whether all services have been performed and

products delivered. Closeout of a contract is completed when all

administrative actions have been completed, all disputes settled, and

final payment has been made. Contract close-out comprises both

„physical close-out‟ and „financial close-out‟. Physical close-out is

achieved when contractor has completed all his physical work

obligations as per the contract including rectification of all

defects/deficiencies jointly identified by both parties.



Financial close-out is achieved when all amounts payable to and

recoverable from the contractor are reconciled and the final payment is

made to the contractor.

The amounts will cover many aspects like reconciliation of materials

issued to/returned by contractor, recoveries for back charges, Liquidated

Damages (LD) and so on. In summary, completion of all contractual

obligations needs to be agreed by both parties after which the contractor

submits the following certificates:

o Final discharge certificate.

o No lien certificate or an affidavit for lien.

In case dispute remains, the dispute is referred to arbitration in accordance

with the contract provision and contract close-out is made on the basis of

the arbitrator‟s award.


5. A claim and a Change order mean the same. (True/False)

6. The only method available to the owner for controlling contractor‟s

performance is to be involved in the nitty-gritty of contractor‟s planning

of the daily work. (True/False)

7. Back charging the contractor arises when the project is delayed beyond

the schedule. (True/False)

12.4 Controlling Risks

In previous section we discussed about the important areas for controlling

and monitoring a contract performance. In this section will discuss various

risk factors that need your intervention to control.

Risk management is not just providing for uncertainties – it is management

of risks considering the combination of the probability (extent to which the

risk event is likely to occur) and its consequence (severity of the outcome of

the event). The two principles in risk management are:

Principle of control: This suggests that the party which has the better

ability to control a risk should be given the risk.

Principle of capability: This suggests that risk should be transferred to

the party which is most capable to absorb it.

The two principles are not mutually exclusive and both principles should be

equitably applied in allocating risks in a construction contract document.



Two other characteristics of risk management are that:

It begins in the project conception stage and continues throughout the

execution of the project.

It results from the combined efforts of both owner and contractor.

Projects involving substantial construction are most prone to risks and

demand relatively the most elaborate attention to risk control. Handling of

risk in construction contracts varies considerably. This depends on the

nature and location of the work, the owner and contractor involved and the

prevailing contracting climate. Each of these varies over time and there are

may be other outside influences also such as banks, governments and the

insurance market.

12.4.1 Risk classification based on where risk control lies

From the point of view of where risk control lies, five classifications of risk

can be listed:

External risks which are unpredictable like acts of god, third party risks

and so on.

External risks which are predictable, but uncertain, like weather.

Internal risks of technical nature arising directly from the technology of

the project work, design, construction or operation of the facility.

Internal risks of non-technical nature. These are within control and arise

out of failure of the project team to achieve its expected performance.

These result in schedule delays, cost overruns or quality deficiencies.

4. Legal risks:

Relevant to civil law – like contract arrangements, patent rights.

Relevant to criminal law – like not adhering to statutes example Health

and Safety at Work Acts in UK.

12.4.2 Areas of risk and causes of risk

Below are mentioned few areas and causes of risk. The term „operator‟ used

in this listing means the owner (you) who awards the contract to the

contractor. The areas mentioned need attention in the contract that you

prepare for the project.

Contractual risks: The risks are:



o Operator group and contractor group property and personnel:

The contract should define the costs of loss of or damage to the

parties.

o Project works including both operator and contractor supplied

items: The contract should define the responsibility for loss of or

damage to the project works.

o Pollution: The contract should define responsibility for the effects of

pollution and contamination emanating from the contractor groups.

o Third parties: The contract should define the legal liability for third

parties‟ losses caused by each including in circumstances where a

contractor is required to perform work in an area of close proximity to

any existing facilities.

o Consequential losses: The contract should define the indemnities

for each party‟s group‟s respective indirect or consequential losses

howsoever caused or arising (including negligence) – whether or not

foreseeable at the date of the contract.

o Warranty obligations: The contract should define warranty

obligations and defective performance liabilities in terms of

magnitude, time and remedy.

o Unlimited liability/damages at large: The contract should define or

limit the contractor group‟s total cumulative liability to enable him to

assess his overall exposure resulting from, for example, liability for

delay, damage, rework, re-performance and so on.

o Insurance cover: The contract should define full details of the

insurance policy terms, conditions, limits and exclusions.

o Force majeure and suspension: The contract should define the

rights for both parties, if the condition exceed a specified time

because of force Majeure.

o Delay: The contract should define contractor‟s liability for delay and

liquidated damages both under contract and at law.

o Variation orders: The contract should define the contractor‟s

obligations to perform the variation orders taking into account other

existing commitments.



o Access to worksite: The contract should define the access to the

work site and remedies as a result of restricted access to the work

site by the operator or any party

o Intellectual property (IP) rights: The IP rights in terms of the party

who developed those IP before or during the project should be

clearly identified.

o Termination by operator for convenience: If the operator

terminates the whole or part of the work for his convenience then the

contract should define the entitlement to payment for all work

performed, materials including cancellation costs relating thereto and

termination fee.

o Operator’s obligation to pay contractor: Payment by the operator

to the contractor is a material term of the contract and time critical.

Performance risks: The risks are:

o Scope, nature and duration of work: This includes:

Lack of clear definition of scope, nature and duration of work in

bid document.

Insufficient time given to bidding contractors to understand and

quote.

Wrong information in bid document.

Scope outside the bidding contractor‟s knowledge.

o Schedule interactions: This includes owner initiated schedule

changes and contractor initiated schedule changes.

o Size: Large size of contract increases chance of the above two risks.

o Safety and environmental performance: Operator and industry

safety performance targets not defined in bid.

o Weather: If contractor is able to absorb this risk up to a limit, the

contract should specify this limit.

o Soil and foundations: Risk cannot be fully measured by contractor

prior to commencement of work. Hence risk should be generally

borne by owner.

o External influences: Risks which are outside contractor‟s control

like:

Access.



Interfaces with owner and other contractors.

Politics.

Risks of interference and disturbance.

o Owner and influences at time of bid: This includes:

Incomplete information at time of bid.

Contract being re-bid or renegotiated over an extended period of

time leads to lack of continuity in the bid process and amongst

personnel and these impact negatively on contractor‟s

performance.

Financial risks: Risk that needs attention in the area is the profitability,

value of contract – size, balance sheet debt, off balance sheet debt,

level of exposure, foreign currency exposure, terms of payment, owner

creditworthiness and insurance.

Political risks: Risk that needs attention in the area is the interference

by government, local disturbance, breach of confidentiality, delay in

permits and licenses.

Technical risks: Risk that needs attention in the area is the quality of

Front End Engineering Design (FEED) and understanding new

technology.

Geographical risks: Risk that needs attention in the area is the location

of the work, weather and soil and foundations.

Operator risks: Risk that needs attention in the area is the operator

areas of influence, insurance and problems which impact the operator

can impact the contractor.

12.5 Incentives and Penalties

The underlying principle of incentives and penalties incorporated in

contracts is “Punish bad behaviour and Reward good behaviour”. In

implementing penalties, you should not resort to the principle of imposing a

penalty as an excuse to pay less or as only a method of punishing.

12.5.1 Penalty

Penalties should aim at fixing a problem when it arises and ensuring that it

does not recur. Guidelines to note while stipulating penalties are:

Penalties should not leave scope for taking them lightly.



Penalties should act as a deterrent to shoddy work by being adequately

troublesome.

Penalties should increase with recurrence of the same transgression.

Penalties should be imposed immediately after failure occurs (say in the

next monthly bill payment). This forces contractor to take corrective

action immediately.

Penalties should be shaped around the most critical aspects.

12.5.2 Incentives

These are rewards given when vendor/contractor exceeds your expectation.

Incentives should increase contractor‟s profit. Incentives can be categorised

as:

Cost incentive: No incentive for the contractor can be structured. In a

contract where design and development are included, a value

engineering clause can be incorporated to motivate the contractor to

submit a proposal for cost reductions. The contractor gets the

opportunity to consider an extra profit for himself while quoting the price

reduction.

Technical incentive: These are incentives for quality and performance

of work. These can also be applied to contracts which include design

and development in addition to construction.

Schedule incentive: All construction contracts incorporate a Liquidated

Damages (LD) clause which refers to penalty for delay in time of

completion. Sometimes a Bonus clause for early completion is

incorporated. In such a case, the LD clause is called a Penalty clause.

Caution must be exercised while combining cost, technical and schedule

incentives in a contract to ensure that different incentives do not counteract

or conflict with each other. Also, when more than one contract is awarded,

one contractor who is given an incentive for early completion may complete

his work early but this will turn out to be a benefit only if you can ensure that

the following interfacing contractor can commence his work consistent with

the previous contractor‟s work completion.



12.6 Change Order Management

In previous section we learnt that incentives motivate and penalties keep a

check for faults that occur in a project. In this section we will understand

about a change order management.

A change order is order for work that is added to or deleted from the

original scope of work in a contract, which alters the original contract

amount and/or completion date. A contractor‟s claim for such an alteration

due to a work perceived by him as additional work remains as a claim until

the change order is resolved. A claim is a potential source of dispute. Hence

resolution of change order situations knowledgably, fairly and promptly

benefits both owner and contractor.

Change order is a component of the change management process in

contract management. The change management process should enable

implementation of changes in a system in a controlled manner by following a

predefined framework/model. Change order management is hence a critical

aspect of any construction job.

The rights of a contractor to a change order arise from the contract. If the

contractor‟s claim is not consistent with the contract, it will be denied, unless

you admit it by oversight.

Project construction contracts always incorporate a Changes clause which

provides allows you to order extra work without invalidating the contract or

make changes to the existing work by altering, adding to or deducting from

the work, with the contract sum.

The reasons this change clause is needed are:

Impossibility of perfect drawings and specifications: A fundamental

truth in the construction industry is that no design can be made perfect.

Impractical risk allocations: The fundamental principle of risk

allocation is to assign each risk to the party who is best able to control,

manage or absorb that risk, which is the way to achieve maximum

efficiency and economy. When contract for construction is taken up by a

general contractor, his tendency will be to shift the risks to

subcontractors and so on down the line leading to improper risk

allocation.



Contractor-suggested changes: In many project contracts, value

engineering proposals from contractor should be encouraged by owner.

Owner-suggested changes: You may discover obstacles or possible

efficiencies that require them to deviate from the original plan.

Other than the above reasons, incorrectly estimated work or failure to meet

commitments can lead to claims by contractor. Examples are:

Unforeseen adverse site conditions or actual site conditions being more

adverse than what is mentioned in the contract.

Failure to make the site available at the time and in the condition

required by the contract.

Failure to grant, or delay in granting, legitimate time extensions.

Unreasonable or mistaken inspection.

Although you can unilaterally order that changes be made, there is a

commensurate duty on you, to make adjustments in the contract sum or

contract time. Hence changes provisions in contract should typically provide

methods for making these adjustments.

Changes in contract sum or contract time are made on the basis of

negotiations between owner and contractor. The basis can be:

Unit prices for specific items of work.

Recognised mark-ups for contractor‟s work and subcontractor‟s work.

12.7 Termination of Contract and Conditions for Termination

One event which can arise in contract performance management is an

extreme non-performance by either contracting parties which may

necessitate or lead to termination of the contract.

Termination of contracts can be partial termination or entire contract

termination. Cancellation of a portion of work is called partial termination

while entire contract means an indivisible contract i.e. a contract in which

the obligations of the two parties are interdependent, and consequently non

fulfilment of significant obligations by one party makes it very difficult or

impossible for the other party to continue with the contract.

Contracts invariably have a termination clause incorporated. This clause

ensures that either or both parties have the right to terminate the contract



under certain circumstances. The termination clause describes the

following:

Breach of contract events that trigger the right to terminate the contract.

Methods of giving notice of the exercise of the termination right.

Whether the breaching party must be given an opportunity to cure the

breach before the other party can terminate the contract.

We will briefly discuss conditions in which a contract can be terminated as

under:

Natural course of events: This is a trivial condition wherein the contract

work has been completed, entire contract performance has been met,

final acceptance has taken place, the work has been paid for, and

contract closure has taken place.

Breach of contract: A breach of contract takes place when a party fails

to deliver on their contractual promises by failing to perform their

obligations completely.

Mutual agreement: Contracts may be terminated by mutual agreement

where the contract itself provides for the event (for instance upon 3

months notice); by the parties conduct; or where the parties enter into a

separate agreement to terminate the earlier agreement (for example, a

compromise agreement where there has been a dispute in respect to

the earlier agreement).

Frustration: Frustration is a basis upon which parties may be excused

from their obligations to perform as a result of events arising after the

contract has been entered.

Termination for convenience: Many construction contracts also

include a clause that allows the owner to terminate the contractor‟s

remaining work on the project at the owner‟s convenience. Such a

termination is not due to any fault on the part of the contractor.

Termination for convenience clauses are intended to provide the owner with

the option to terminate the remaining balance of the contract for work for a

reason other than the contractor‟s default - for example, owner being unable

to obtain additional financing to complete the work.

In addition to terminating the contract for cause or convenience, an owner

can also delete all or a portion of the balance of the remaining scope of



work. Should the owner make such a deletion at any time before or during

performance of the contract, the contractor must review the contract to

determine what his or her rights and obligations may be.

If the contract is terminated for convenience, the contractor will not earn the

profit that was anticipated when the contract was executed. If the contract is

terminated, the amount paid to the contractor may not recapture the

contractor‟s home office overhead that was allocated to the contract. While

on the face of it, this may appear unfair to the contractor, in every contract

there is an implied covenant of good faith and fair dealing.


8. A change order always means an increase in the scope of contractor‟s

work. (True/False)

9. Natural disaster is a controllable risk. (True/False)

10. A contract can be terminated by owner only when he proves that the

contractor is at fault. (True/False)

11. A cost-plus contract provides the maximum incentive to the contractor

to reduce the cost of the project. (True/False)

12. In risk management, the principle of control and the principle of

capability must be applied in a mutually exclusive manner while

allocating risks to parties. (True/False)

Activity 2

Find out risks for a construction project on internet apart from the list

mentioned in IMCA

Hint: http://www.misronet.com/risks.htm

12.8 Summary

You learnt that the contracts are backbone for any project, hence the control

over contracts are essential for a successful completion. Also a contract

must have enough flexibility to implement changes that may not be foreseen

in the initial stages.

Monitoring and controlling technical and operational performance of

contracts are characterised by salient areas like physical mobilisation,

typical submittal compromises, importance of records, progress billing and

payment, claims and back charging.



Controlling risk is task that needs to be immediately addressed for any

project. The risks are listed as contractual risks, performance risks, financial,

political, technical, geographical, and operators risks.

You learnt that incentives, penalties and change order are important clauses

in a contract. You also learnt that termination clause is also important in a

contract that can be exercised in various situations.

12.9 Glossary

Term Description

Entity Person, partnership, organisation, or business unit which has a legal existence.

Framework It is a concept or idea to serve as a guide to develop or create something.

Transgression A violation of a law.


1. Explain why flexibility in contractor is required for the owner and how a

degree of flexibility can be achieved maintaining executive control at

the same time.

2. Bring out the meaning of the principle of control and the principle of

capability applicable in risk management while awarding contracts.

3. Briefly explain the five classifications of risk from the viewpoint of where

the risk control lies.

4. Briefly describe five conditions for termination of a contract.

12. 11 Answer


1. Managerial

2. EPC

3. Authoritative, single formal

4. D-B-B

5. False

6. False

7. False

8. False

9. False



10. False

11. False

12. False

Terminal Questions

1. Refer section 12.2.1 Flexibility in contracts.

2. Refer section 12.4 Controlling Risks.

3. Refer section 12.4.2 Areas of risk and causes of risk

4. Refer section 12.7 Termination of Contract and Conditions for

Termination

12.12 Caselet

Technology Company expands control of their world wide contracts

WWW Technology Company is a leader in sales, consulting and support

solutions to its customer in most of the countries across the world.

Need of the company

This company wanted to control the contracts to reduce the cost and

improve efficiency.

The company decided to replace outdated legacy system and to organise

a contract management. It needed to establish standard, published

contracts and to more successfully support their non-standard contracts.

They wanted a centralised corporate control of their contracts, while still

allowing support to various languages, currencies and differences in

jurisdictions .With centralised control and regionalisation, company

wanted to establish a mechanism to make contract changes rapidly

throughout geography. It will standardise legal wording further, which

helps to reduce administration costs and improve their risk management

capabilities. They wanted a solution that could also update procurement

contract processes and all other areas in contract management.

Solutions

To find the best solution to meet their objectives, this company undertook

a global product search. After reviewing a large number of offerings from

vendors, it chose Upside Contract. This company worked with Upside

Software to specify their full requirements, some of which were new

features that would need to be added to the system. Newer software and

hardware to sink regionally was deployed.



Benefits

- Greatly improved efficiency in managing contracts.

- Improved stakeholder involvement.

- Very fast Return On Investment (ROI).

- Improved central control while supporting easy regionalization of

contracts.

- Reduced process time for new contracts

- Improved risk management.

- Easily scales as usage grows and additional operating units are added

– single deployment with global use.

- Rapid and extensive user adoption driven by value

- Multi-lingual (all major languages) and multi currency support in one

system

Question:

1. What were the benefits of using Upside software?

References

Gererd N, The Complete Project Management Methodology and Tool

Kit.



Unit 13 Dispute Resolution and

Mediation Procedures in Contracts

Structure

13.1 Introduction

Objectives

13.2 Disputes and Claims in Contracts

Usual causes of disputes

Actions for minimising the disputes and claims in contracts

13.3 Dispute Resolution Mechanisms in Contracts

Evolution of the Arbitration and Conciliation Act of India, 1996

Conciliatory mechanisms

Arbitration and Arbitration Act

13.4 Procedures of the Arbitration Tribunal

Determination of the rules of the procedure

Duties and responsibilities of the arbitrator

Arbitral Award

13.5 International Arbitration Protocols (UNCITRAL, ICCA, AAA, ICSID

rules)

Arbitration and Conciliation Act, 1996

United Nations Commission on International Trade Law

(UNCITRAL)

International Council for Commercial Arbitration (ICCA)

The American Arbitration Association (AAA)

International Centre for Settlement of Investment Disputes

(ICSID)

13.6 Summary

13.7 Glossary


13.9 Answers

13.10 Caselet

13.1 Introduction

In the previous units, you learnt about contract management skills and

contract performance management. You learnt how to draft the terms for a

contract and also to negotiate a contract. You also learnt about the controls

and flexibility in a contract that can be exercised to the best.



The contract documentation and management of contract includes lot of

legalities. The actions that are involved for this process will give raise to

disputes besides other causes encountered during the implementation of

contracts. Disputes and claims are common in the case of larger

infrastructure projects. In this unit we will learn about the cause and dispute

resolution process.

Learning objectives


list the disputes and claims in contracts and actions to minimise them.

describe the dispute resolution mechanism in contract.

explain the procedures of the Arbitration Tribunal.

identify the International Arbitration Protocols.

13.2 Disputes and Claims in Contracts

The word “dispute” implies the claim of rights by one party to the contract

and its denial by the other party. Normally, the claims made by either party

on the contract presume the existence of a dispute. Claims are broadly

classified as:

Objective claims (depending on the interpretation of contractual

provisions).

Subjective claims (arising from breach of contract).

Contractual claims (arising out of express provisions in the contract).

Extra contractual claims (damages for breach of contract).

Quantum merit claims (as much as the party that claims has earned)

Ex Gratia claims (out of kindness).

Disputes and claims are common in contracts. However, they are more so in

large contracts that involve major developmental projects involving various

types of contracts. We must be aware of the fact that almost all disputes and

claims arise due to the contractors/suppliers not getting enough payment for

the supplies made, services rendered or works executed along with

legitimate profits.

13.2.1 Usual causes of disputes

Some of the common causes for disputes and claims related to goods

contracts are as follows:

Inequitable contract conditions.



Inequitable sharing of risks between the purchaser and supplier.

Change in the scope of the contract.

Delay in releasing payments.

Delay in inspections.

Some of the common causes for disputes and claims related to works

contracts are as follows:

Inequitable sharing of risks between you and contractor by inserting

exemption clauses in the contract, stating that the contractor is

responsible and no claims shall be payable.

Conducting inadequate geological investigations and collection of

inadequate data.

Delay in obtaining permissions as required by legal authorities.

Delay in handing over the work site due to land acquisition problems.

Faulty designs.

Delay in providing detailed construction drawings.

Change in the scope of the contract.

Delay in decisions and approval of foundations.

Delay in giving instructions for carrying out the works.

Delay in giving permission for the employment of specialist sub-

contractors.

Delay in advance payment and payment for work done.

Alterations and omissions.

Delay in finalisation of extension of intended completion date, rates for

variations and so on.

Delayed and inadequate settlement of claims.

Delay in assessment and compensation of damages due to force

majeure conditions.1

13.2.2 Actions for minimising the disputes and claims in contracts

In the previous section, we discussed the most common causes of disputes

and claims. Now, let us discuss about the actions that can be used to

minimise the causes. You have to take actions in three phases that are

mentioned hereunder:

1 Refer: International Business Law and Its Environment By Richard Schaffer, Filiberto Agusti and

Beverley Earle



Phase I: Preparatory phase prior to invitation of bids

You should take the following actions to minimise the disputes and claims in

goods contracts:

Incorporate appropriate qualification criteria so that competition is

restricted to competent bidders (manufacturers) who can perform the

contract satisfactorily.

Adopt appropriate conditions of contract that will share the risks between

the purchaser and supplier (such as liquidated damages and proper

payment terms).

Provide realistic delivery period.

Provide detailed inspection procedures without ambiguity.

Define risks and obligations of both purchaser and supplier and allocate

the same equitably by adopting International Commercial Terms

(INCOTERMS).

Incorporate appropriate dispute resolution mechanism in the bidding

document.

You should take the following actions to minimise the disputes and claims in

works contracts:

Have a proper concept of the work with accurate planning and proper

design.

Carry out detailed geological and hydrological investigations including

identification of quarries for materials and take responsibility for the

same.

Acquire the site suitable for the work.

Obtain requisite permissions from statutory authorities.

Incorporate appropriate qualification criteria so that the competition is

restricted to competent bidders, who can perform the contract

satisfactorily.

Adopt appropriate conditions of contract with sharing of risks (such as

price adjustment, compensation events, liquidated damages, proper

provisions for payment of advances, payment for variations and extra

items).

Provide realistic completion period for the whole of the work as well as

intermediate milestones by taking into account the ground conditions,

climatic conditions, period required for mobilisation and so on.



Incorporate an appropriate dispute resolution mechanism (appointment

of mutually acceptable adjudicator).

Phase II: Submission and acceptance of the bids

A well balanced bid will go a long way in minimising the disputes and claims,

since it is a well known fact that a low bid quoted intentionally or

unintentionally is a fertile ground for disputes and claims.

You have to take the following actions in this phase to minimise the disputes

and claims:

Provide sufficient time to the bidders to study the site conditions and

other data before submitting the bids.

Examine the background of the supplier/contractor, his experience,

financial strength and reputation while accepting the bid to ensure that

the supplier/contractor is able to perform the contract satisfactorily.

Award the contract for supplies/works to the lowest evaluated

responsive bidder who fully meets all the specified qualification criteria.

Phase III: Execution of supply and works contracts

Completion of supplies/works of desired quality and specifications without

time and cost overruns and without major disputes and claims is the ultimate

aim of any contract. This will be possible by:

Careful planning and giving attention to details in all the aspects of

contract management and taking timely corrective measures within the

frame work of the contract.

Consistent review of progress and plans, co-ordination, close

monitoring, adherence to safety plans, tight operational management,

good industrial relations, and strict financial control.

Self Assessment Question

1. The usual cause for disputes and claims in works contracts is due to

_______ sharing of risks between the employer and contractor.

2. A _________ bid quoted intentionally or unintentionally is a ________

ground for disputes and claims.

3. Incorporation of an appropriate _________ mechanism is vital to ensure

speedy and successful implementation of a contract.



Activity 1:

You want to construct windmills in the desert. What will be your important

aspect to avoid or minimise dispute.

Hint: Refer section 13.2.1, usual causes for disputes.

13.3 Dispute Resolution Mechanisms in Contracts

In the previous section, we discussed the causes and the action that can

minimise disputes and claims. Let us now discuss few mechanisms that can

be utilised to resolve the disputes.

13.3.1 Evolution of the Arbitration and Conciliation Act of India, 1996

Contracting parties approached court for settling the cases. But courts were

already overloaded with disputes and were of less help to these contractors.

The parties to the contract preferred to settle their disputes out of court by

referring the disputes to persons other than the court. This came to be

called arbitration. Certain decisions by arbitrator were not accepted and

parties still went to court. The courts then formulated the general rule that if

the parties had settled on arbitration, the jurisdiction of the courts could be

expelled. However, there were several cases, where expelling of the

jurisdiction of the courts resulted in injustices to one party or the other.

Thus arbitration became a subject matter on its own through the Arbitration

Act of 1889 in England. India became a signatory to the General Agreement

on Tariffs and Trade (GATT) and World Trade Organisation (WTO) and

other international bodies. In view of this, arbitration in a country was not

only between two parties of a country, but also between a local party and

foreign party.

Thus, the global community became interested not only in standardising the

arbitration procedures, but also in facilitating the standardisation. The United

Nations Commission on Trade Law (UNCITRAL) created a model law. India

being a signatory to UNCITRAL enacted Arbitration and Conciliation Act

1996, based on the UNCITRAL model law. The awards made under the

Arbitration and Conciliation Act, 1996 bind on both the parties and cannot be

challenged in a court of law except on two grounds only. These would be

discussed in the later section (discussed in section 13.4.3).



13.3.2 Conciliatory mechanisms

Conciliatory mechanisms are actions such as appointment of

adjudicator/Dispute Resolution Board in case of Works Contracts.

Adjudicator: An adjudicator is a technical person well versed with the

nature of work for which the bids are being invited. The bidder reviews the

credentials of the proposed adjudicator and either he accepts your

nomination or else he can propose another adjudicator. The fees and other

expenditure of the adjudicator are to be shared between the parties. The

adjudicator continues as long as the contract period last. All disputes which

arise during the execution of the work are referred to the adjudicator.

Dispute Resolution Board (DRB): In case of large value contracts, in the

place of a single person adjudicator, a Board consisting of three persons is

appointed under the contract. One of the Board members is nominated by

the bidder; the second is nominated by the project owner (you). The third

member is selected and nominated by the two members of the Board. The

Board continues as long as the contract period last.

All disputes which arise during the execution of the contract are referred to

the DRB. As in the case of the adjudicator, the DRB visits the site, reviews

the documents, hears both the parties and gives its award which is normally

binding on both the parties. In case the parties to the contract do not agree

on the award and want to contest the same, they have to proceed as per

procedure given in the contract. The case is then referred to Arbitration

under the Act.

13.3.3 Arbitration and Arbitration Act

Arbitration is the reference of a dispute to a neutral (third) person(s) chosen

by the parties to the contract, who agree in advance, to abide by the

Arbitrator’s decision (known usually as award) given after scrutiny of

records, hearing both the parties and their witnesses. The Arbitrator’s award

is in most cases binding on the parties to the contract.

Disputes relating to engineering contracts involve highly technical matters

and such disputes are settled by an impartial technical authority.

The Arbitration and Conciliatory Act 1996 has been enacted to lend

assistance to the parties of the contract by ordinary mechanism of law to

enforce the award of the Arbitrator and attain the recognition it needs. The



Act of 1996 is applicable to all matters contained in the earlier Arbitration Act

of 1940.

The advantages of referring a dispute to arbitration are (compared to those

through the courts)

The time is lesser in conducting arbitration proceedings.

The cost of dispute resolution is less.

Convenience in fixing the hearing dates.

The informal atmosphere which prevails during hearings.

Option to select Arbitrators.

Availability of expertise in the Arbitrators particularly required for most

engineering contracts.

The privacy in the hearings, since court hearings are open to general

public.

The finality of award, as in most cases the decision of the Arbitrator is

binding.

Consent awards are possible with the consent of the parties to the

contract during the arbitration proceedings.

The presence of the arbitration clause is a safeguard for fair deal and

the bidder can offer most competitive bids.

Arbitration agreement

Arbitration can only take place if there is an agreement between the two

parties of a contract for settlement of disputes if any between them.

Section 7 of the Arbitration and Conciliation Act, 1996 deals with Arbitration

Agreement and provides as under.

Arbitration agreement means an agreement by the parties to the contract to

submit all or certain disputes to arbitration. The disputes would have arisen

or may arise between them in respect of a defined legal relationship,

whether contractual or not. Arbitration agreements:

May be in the form of an arbitration clause in a contract or in the form of

a separate agreement.

Shall be in writing.



Section 7 (4) of the Act further elaborates as under:

An arbitration agreement is in writing if it is contained in:

A document signed by the parties to the contract.

An exchange of letters, telex, telegram or other means of

telecommunication which provide a record of the agreement.

An exchange of statements of claims and defence in which the

existence of the agreement is alleged by one party and not denied by

the other party.

Section 7(5) of the same act states that, “the reference in a contract to a

document containing an arbitration clause constitutes an arbitration

agreement if the contract is in writing and the reference is such as to make

that arbitration clause part of the contract”.

Arbitration clause in a contract

The Indian Council of Arbitration has suggested model Clause of arbitration

that need to be incorporated in the bid documents. The Model Clause

includes:

The number of Arbitrators.

Qualifications and experience of the Arbitrators.

Methods of selection/nomination of the Arbitrators.

Limitations if any on the scope of the reference.

Payment of fees and expenses.

Place of hearing and meetings.

Whether practicing advocates are allowed to present the cases of the

parties to the contract.

Jurisdiction of the courts (at which place).

Appointment of arbitrators in vacancies created after first appointment.

Applicable Act.

Conditions precedent if any.

Appointment of arbitrators

The people(s) who are experts in the field of disputes should ordinarily be

chosen to effectively arbitrate. It is also desirable that the parties to the

contract should select an independent person as their arbitrator.




4. Adjudicator’s decision is binding on the parties and cannot be

challenged. (True/False)

5. The appointment of Adjudicator/DRB settles an appreciable number of

disputes. (True/False)

6. Arbitration can take place even though there is no arbitration

agreement. (True/False)

7. Adjudicator/DRB is usually technical people well versed with the works

being executed. (True/False)

Activity 2:

Find out more details about the Arbitration and Conciliation Act of 1996 –

India on Internet.

Hint: http://clwindia.gov.in/05_bfoaca_1996.pdf

13.4 Procedures of the Arbitration Tribunal

In the previous section, we discussed about the Arbitration and Conciliation

act of India 1996. Also the choice of adjudicator and DRB was dealt. Let us

now discuss about the procedure that is followed in Arbitration tribunal.

13.4.1 Determination of the rules of the procedure

There various sections that determines the procedure as given under:

Section 19 of the Act describes the procedure to be followed by the

arbitration tribunal. The Section at the outset, declares that the tribunal is

not to be encumbered with the procedural load of the ordinary court in

following the Code of Civil Procedure, 1908 or the Indian Evidence Act,

1872. In fact the parties to the contract are at liberty to specify the procedure

to be followed else arbitration tribunal can set its own procedure. While

doing this they have to keep in mind the other Sections of the Act.

Section 18 of the Act states that the parties to the contract shall be treated

with equality and each party shall be given a full opportunity to present his

case. Thus neither the parties nor the tribunal can set procedures where the

parties are not treated as equals or full opportunity is not given to them to

present their case.



As per Section 24, “unless otherwise agreed by the parties, the Arbitration

Tribunal shall decide whether to hold oral hearings for the presentation of

evidence or for oral argument or whether the proceedings shall be

conducted on the basis of documents and other materials, provided that the

Arbitrational Tribunal shall hold oral hearings, at an appropriate stage of the

proceedings, on a request by a party, unless the parties have agreed that no

oral hearing shall be held”.

13.4.2 Duties and responsibilities of the arbitrator

Arbitrator is in the position of a judge. The arbitrator neither observes the

ordinary rules of procedure applicable to judicial tribunals nor hears or

receives formal evidence. The arbitrator usually approves order on the

documents or statements of the case filed by both the parties and/or on

personal inspections. The arbitrators have power to view the subject matter

of the dispute with or without the parties or their agents.

The responsibilities of an arbitrator are mentioned below:

The arbitrator is neither bound to observe the rules of evidence or to

hear the parties nor precluded from doing so.

Arbitrator is unbiased and intends to do justice as a judge.

The arbitrator calls the parties and listen them as well as adduces

evidence on points of facts.

When points of law arise and the parties explain their case through

attorneys, there is no objection for the arbitrator to hear them. There is

absolutely no bar on the arbitrator to seek legal advice.

The very object of arbitration proceedings is to gain time and avoid

protracted litigation, as the work may be in progress. Normally, a period

of four to six months is provided for the conclusion of arbitration

proceedings.

While passing the award, the arbitrator takes every care to see that no

lacuna enters into it. The award should be clear and should not give rise

to further complications.

The courts have also laid down certain principles which the arbitrators

should follow in the process of arbitration. They are:

The arbitrators in their function which is quasi-judicial must act in the

judicial manner.



They should not simply make appearances of conducting enquiry

according to judicial procedure.

They should give notices; maintain proper records and notes.

They need not strictly follow the rules of procedure and evidence as the

Evidence Act does not apply to arbitration proceedings.

They should behave in a manner that brings importance to justice.

Any deletion from the fundamental rules of procedure and established

cannons of justice will violate their award, which is liable to be set aside

and the arbitrators will be held guilty of misconduct.

The arbitrators are not conciliators and cannot ignore the law or

misapply it in order to do what they think is just and reasonable.

The absence of any of the requirements relating to the award would

render the award a nullity.

13.4.3 Arbitral Award

Arbitral award is in the nature of a judgment. Section 31 of the Arbitration

Act details the Form and content of arbitral award. An arbitral award shall be

made in writing and shall be signed by the members of the arbitration

tribunal (If the tribunal consists of more than one member, the signatures of

the majority of the members shall be sufficient so long as the reason for any

omitted signature is stated).

The arbitral award shall state the reasons upon which it is based unless the

reasons that are mentioned in arbitral tribunal.

Recourse against arbitral award

Section 34 of the Arbitration Act deals with the circumstances in which an

arbitral award can be set aside by a court of law.

An arbitral award can be set aside by the court only if the party making an

application provides proof that:

A party was under some incapacity.

The arbitration agreement is not valid under the law to which the parties

have subjected it or failing any indication thereon, under the law for the

time being in force; or

o The party making the application was not given proper notice of the

appointment of an arbitrator or of the arbitral proceedings or was

otherwise unable to deliver the case dealt by arbitrator.



o The arbitral award deals with a dispute not contemplate by or not

falling within the terms of the submission to arbitration, or it contains

decisions on matters beyond the scope of the submission to

arbitration. If the decision on matters submitted to arbitration can be

separated from those not submitted, then only that part of the arbitral

award which contains decisions on matters not submitted to

arbitration may be set aside; or

o The composition of the arbitral tribunal or the arbitral procedure was

not in accordance with the agreement of the parties or was not in

accordance with the law of the country where the arbitration took

place.

The court finds that:

o The subject matter of the dispute is not capable of settlement by

arbitration under the law for the time being in force.

o The arbitral award is in conflict with the public policy of India.

An application for setting aside may not be made after three months

have elapsed from the date on which the party making that application

had received the arbitral award. If the court is satisfied that the applicant

was prevented by reasonable cause from making the application within

the said period of three months, it may entertain the application within a

further period of thirty days, but not thereafter.

Finality and enforcement of arbitral awards

An arbitral award shall be final and binding on all parties and persons

claiming under them respectively, subject to Section 34.

The arbitral award shall be enforced under the Code of Civil Procedure,

1908 in the same manner as if it were a verdict of the court.


8. When points of law arise and the parties explain their case through

attorneys, there is no objection to the Arbitrator to hear them.

(True/False)

9. Arbitration Tribunal cannot hold oral hearings. (True/False)

10. Arbitral award can be set aside by a court of law under some

circumstances. (True/False)



11. The arbitral award should always state the reasons upon which it is

based. (True/False)

Activity 3:

Find out details about the challenging the Errors in Arbitrators’ Awards

Hint: www.Ashurst.com

13.5 International Arbitration Protocols (UNCITRAL, ICCA, AAA,

ICSID rules)

In the previous section, we discussed about the procedure to be followed for

Arbitration tribunal. In this section, we will get familiar with some of the

International Arbitration protocols which are in current use.

13.5.1 Arbitration and Conciliation Act, 1996

The Arbitration and Conciliation is widely based on the model law of United

Nations Commission for International Trade Law (UNCITRAL). The

enforcement of certain foreign awards is dealt within Part II of this Act.

Below are the two treaties that deal with cross-border enforcement of

arbitration awards:

Chapter I deal with New York Convention Awards.

Chapter II deals with Geneva Convention Awards.

In Chapter I, “foreign award” means an arbitral award on differences

between persons arising out of legal relationships, whether contractual or

not, considered as commercial under the law in force in India, made on or

after the 11th day of October 1960:

In pursuance of an agreement in writing for arbitration to which the

Convention set forth in the First Schedule of the Act (Convention on the

Recognition and Enforcement of Foreign Arbitral Awards) applies.

In one of such territories as the Central Government, being satisfied that

reciprocal provisions have been made, may be by notification in the

Official Gazette declare to be territories to which the said Convention

applies.

The Chapter deals with power of judicial authority to refer parties to

arbitration, when foreign award is binding, evidence, conditions for



enforcement of foreign awards, enforcement of foreign awards, appealable

orders and so on.

In Chapter II, “foreign award” means an arbitral award on differences

relating to matters considered as commercial under the law in force in India

made after the 28th day of July 1924:

In pursuance of an agreement for arbitration to which the Protocol set

forth in Second Schedule of the Act (Protocol on Arbitration Clauses)

applies.

Between persons of whom one is subject to the jurisdiction of some one

of such powers as the Central Government, being satisfied that

reciprocal provisions have been made, by notification in the Official

Gazette, declare to be parties to the Convention set forth in the Third

Schedule of the Act (Convention on the Execution of Foreign Arbitral

Awards) and of whom the other is subject to the jurisdiction of some

other of the Powers aforesaid, and

In one of such territories as the Central Government, being satisfied that

reciprocal provisions have been made, by notification, declare to be

territories to which the said Convention applies and for the purposes of

this Chapter an award shall not be deemed to be final if any proceedings

for the purpose of contesting the validity of the award are pending in the

country in which it was made.

13.5.2 United Nations Commission on International Trade Law

(UNCITRAL)

UNCITRAL is a secondary body of the General Assembly of the United

Nations, which was established in 1966 with the general authorisation to

further the progressive harmonisation and unification of the law of

international trade. UNCITRAL has made a wide range of Conventions,

Model Laws, and other instruments dealing with the substantive law that

governs trade transactions or other aspects of business law which have an

impact on international trade.

UNCITRAL deals with the laws applicable to private parties in international

transactions. As a result, UNCITRAL is not involved with “State to State”

issues such as anti-dumping, countervailing duties, or import quotas.



13.5.3 International Council for Commercial Arbitration (ICCA)

ICCA is a worldwide non-governmental organisation dedicated to promoting

and developing arbitration, conciliation and other forms of international

dispute resolution. ICCA arranges conferences, produces leading dispute

resolution publications and works toward harmonisation of arbitration and

conciliation rules, laws, procedure and standards and practice. ICCA is not

an arbitral institution; it does not administer arbitrations or act as appointing

authority.

13.5.4 The American Arbitration Association (AAA)

AAA is a private enterprise in the business of arbitration, and one of several

arbitration organisations that administers arbitration proceedings. The AAA

also administers mediation and other forms of alternative dispute resolution.

The International Centre for Dispute Resolution (ICDR), currently updated in

2007(established in 1996), administers international arbitration proceedings

initiated under the institution's rules.

The AAA role in the dispute resolution process is to administer cases, from

filing to closing. The AAA provides administrative services in the U.S., as

well as abroad through its International Centre for Dispute Resolution®

(ICDR). The AAA's and ICDR's administrative services include assisting in

the appointment of mediators and arbitrators, setting hearings, and

providing users with information on dispute resolution options, including

settlement through mediation. Ultimately, the AAA aims to move cases

through arbitration or mediation in a fair and impartial manner until

completion.

13.5.5 International Centre for Settlement of Investment Disputes

(ICSID)

ICSID is an autonomous international institution established under the

convention on the settlement of investment disputes between States and

nationals of other States (ICSID or the Washington Convention), with over

140 member States. The Convention sets forth ICSID’s mandate,

organisation and core functions. The primary purpose of ICSID is to provide

facilities for conciliation and arbitration of international investment disputes.

The ICSID Convention is a joint treaty formulated by Executive Directors of

the World Bank. It was signed on March 18, 1965 and came into force on

October 14, 1966. The Convention attempted to remove major impediments



to the free international flows of private investment posed by non-

commercial risks and the absence of specialised international methods for

investment dispute settlement. ICSID was created by the Convention as an

impartial international forum, providing facilities for the resolution of legal

disputes between eligible parties, through conciliation or arbitration

procedures.

As evidenced by its large membership, considerable caseload, and by the

numerous references to its arbitration facilities in investment treaties and

laws, ICSID plays an important role in the field of international investment

and economic development. Today, ICSID is considered to be the leading

international arbitration institution devoted to Investor- State dispute

settlement.

ICSID does not conciliate or arbitrate disputes. It provides the institutional

and procedural framework for independent conciliation commissions and

arbitral tribunals, to resolve the dispute.


12. The primary purpose of ICSID is to provide facilities for _______ and

arbitration of international investment disputes.

13. The AAA role in the dispute resolution process is to ________ cases,

from filing to closing.

14. ICCA is worldwide non-governmental organisation dedicated to______

and _____ arbitration.

13.6 Summary

In this unit, we learnt that in today’s business environment it is inevitable

that disputes will arise. Most of the disputes and claims arise because the

contractor/supplier not getting adequate payment.

We can minimise disputes and claims to a considerable extent by taking

several precautionary actions in the three phases of a contract Phase I-

preparatory phase prior to invitation of bids; Phase II – Submission and

acceptance of bid; and Phase III- Execution of supply and works contracts.

We also learnt that the Arbitration was formed to solve disputes and claims

for a timely judgement or resolution. Several acts were formed and the first

act, The Arbitration Act 1940 was found, to deal with international

commercial cases as well as domestic large value disputes.



We discussed that after India became a signatory to WTO and GATT, in

order to cope up with such cases, and to ease the burden of courts, India

formulated and promulgated the Arbitration and Conciliation Act, 1996.

With a view to reduce the number of Arbitration cases, World Bank and

other international financing institutions incorporated the appointment of

single man Adjudicator/three man DRB acceptable to both parties for

settling disputes and claims to the advantage of both the parties and

reduced the number of cases referred to Arbitration.

In a dispute resolution mechanism you should be explicitly detailed in the

bid documents as per requirements of the Act. There are definite

advantages in Arbitration as opposed to settlement of disputes in courts.

We also discussed several international arbitration protocols such as

Arbitration and Conciliation Act 1996, UNCITRAL, ICCA, AAA and ICSID.

13.7 Glossary

Term Description

Adjudicator A person who studies and settles conflicts and disputes.

Arbitration Arbitration is alternative dispute resolution .It is a legal technique for the resolution of disputes outside the courts.

Adduce Means of proof in an argument.

Inequitable A term used for not equal or unjust or unfair.

Lacuna Lack of a law or legal source addressing a situation.

Milestone An important event.

Protocols A set of guidelines or rules.

Quasi-judicial An individual or organisation which has powers resembling those of a court of law or judge

Substantive Having a truly firm basis and therefore important.


1. List the actions that can be taken to minimise disputes and claims.

2. Describe the roles of Adjudicator/DRB and explain how they are useful?

3. Explain the importance of Arbitration Agreement.

4. Describe briefly the procedure for arbitration.

5. Write short notes on International arbitration institutions.



13.9 Answers Self Assessment Questions

1. Inequitable

2. Low , fertile

3. Dispute.

4. False

5. True

6. False

7. True

8. True

9. False

10. False

11. True

12. Conciliation

13. Administer

14. Promoting, Developing

Terminal Questions

1. Refer section 13.2.2 Actions for minimising the disputes and claims in

contracts

2. Refer section 13.3.2 Conciliatory mechanisms

3. Refer Section 13.3.3 Arbitration and Arbitration Act

4. Refer section 13.4 Procedures of the Arbitration Tribunal

5. Refer section 13.5 International Arbitration Protocols (UNCITRAL, ICCA,

AAA, ICSID rules)

13.10 Caselet

Quick dispute resolution because of arbitration

The ABC Condominium is a six storied building located in New Jersey.

The ABC Condominium Association is a non-profit corporation

established to provide the management, administration and maintenance

of the Common Elements of the Association and to promote the health,

safety and welfare of the unit owners of the Association.

Construction of the ABC Condominium was completed sometime in early

1992. Lookout Builders LLC was controlling the ABC condominium

because the majority units were owned by them until May, 2001. Lookout

sold all the remaining units it owned via a process known as transition

and turned control of the Board of Trustees of the Association.



The condominium had severe water intrusion problems from the date of

its completion. Unit owners suffered from water leaks and even after

repeated complaints from 1991 up to 2001, the water intrusion problems

were never addressed.

In 2001 independent unit owner were given control and the Board of

Trustees of the Association hired Stark & Stark (Arbitrators). Stark and

stark brought several engineering firms to investigate and diagnose the

water intrusion problems. These studies revealed multiple construction

defects and damages in the building.

Arbitration:

Stark & Stark’s filed suit on behalf of the ABC Condominium Association

in December of 2002. They pursued damages against responsible parties

for all construction defects. This quick resolution happened because they

used the arbitration method.

The result:

Stark & Stark’s settled the suit on behalf of the ABC Condominium

Association for a total recovery of $1,645,000.00. The recovery was used

by the Association to correct the damage to the building.

Question:

1. What did the Stark and Stark’s do to resolve the problem faced by unit

owners?

Reference:

Douglas A. Stephenson, Arbitration Practice in Construction Contracts.

Custodio O. Parlade, Construction Arbitration.

http://books.google.co.in/books?id=E9Krv_J6LCMC&pg=PA1920&dq=c

onstruction+arbitration&hl=en&ei=_0TFTICjCoW8vgOK7vDKCA&sa=X&

oi=book_result&ct=result&resnum=5&ved=0CEkQ6AEwBA#v=onepage

&q=construction%20arbitration&f=false

http://books.google.co.in/books?id=ZW-2Gk6FM4kC&printsec=front

cover&dq=construction+arbitration&hl=en&ei=_0TFTICjCoW8vgOK7vD

KCA&sa=X&oi=book_result&ct=result&resnum=4&ved=0CEMQ6AEwA

w#v=onepage&q&f=false



Unit 14 Other issues in Contracts Management

Structure:

14.1 Introduction

Objectives

14.2 Law of Contracts

Definition of law

Private and Public Law

Law of contracts

Indian Contract Act

14.3 Indian Constitution and Government Contracts

Indian constitution

Fundamental rights

Equality of opportunity in the matter of Government contracts

14.4 Codes, Manuals and Regulations, GoI GFR

Need for codes and manuals

Codes, Manuals for Works and Goods

Standard bidding documents

14.5 Need for Procurement Law

Need for procurement law

Objectives of procurement law

UNCITRAL Model Procurement Law

Status of enactment of Procurement Law in the world

Status of Enactment of Procurement Law in India

14.6 Cost of Contracting

Cost of contracting

Contract compliance

14.7 Contracting and Service Economy

14.8 Summary

14.9 Glossary


14.11 Answers

14.1 Introduction

In the earlier units we have discussed various aspects of contracting and

contracts management. We also discussed about the disputes and claims

that are general. We learnt how to minimise or resolve these issues.



There are certain codes and manual for the contracts documentation and

execution. But these codes and manuals are just guidelines and need not

be followed strictly by the parties involved. Any party who does not follow

them is not punishable by law. Hence, the parties always have a chance to

get away with misappropriations or faults leading to dispute and claims. In

this unit we will discuss about the legal and constitutional requirements in

the formation of contracts and their management. We will learn about

private and public laws and their differences. We will study about the Indian

contract act and articles instituted by Indian constitution.

Learning objectives:


explain the law of contracts both for private and public

outline the constitutional requirements of public contracts in India

select the codes, manuals and GFR which presents the procurement

procedure

list the needs for procurement law

explain outsourcing as service economy

14.2 Law of Contracts

Contract laws vary from state to state. This body of law addresses what

constitutes a contract and what remedies are available if a contract is

broken or "breached."

14.2.1 Definition of law

In its widest sense, the term law is used to denote any rule of action, i.e.,

any standard or pattern, or norm to which actions are required to conform.

Sir William Blackstone, an English jurist and professor who produced the

historical treatise on the common law called Commentaries on the Laws of

England states “law in its most general and comprehensive sense signifies a

rule of action and has applied indiscriminately to all kinds of action, whether

animate, rational or irrational”

In Civil Law or the law of the State or the land, we use the expression law to

signify a command from a superior authority, prescribing a course of action,

disobedience which would lead to punishment. Holland defines Law as a

“general rule of external human action enforced by a sovereign political

authority”.



14.2.2 Private and Public Law

We can categorise contract laws into two broad categorise: Private and

Public law.

Public Law deals with the constitutional and administrative powers of the

State and also certain relations between the State and the individual.

Private Law on the other hand deals with the rights of the subjects inter se.

The law of contracts forms part of the Private Law. Again Private Law may

be divided into Substantive Law and Adjective Law. Substantive Law deals

with rights which may be acquired by one citizen against another, for

example law of property, contracts, torts and so on. While the Adjective Law

deals with the law of procedure i.e. the process of litigation, the process

modalities which secure the compensation of grievances and the

mechanism by which rights can be enforced in a Court of Law.

The objective of law is to create and protect legal rights. It has been defined

by Holland as a “capacity residing in one person of controlling with the

assent and assistance of the State, the actions of others.” Law aims at the

creation and protection of legal rights to ensure order, peace and security in

the society and guarantee some degree of uniformity in the conduct of

human affairs.

14.2.3 Law of contracts

The law of contracts deals with rights in personam (a right for which the

corresponding duty is, not owed by the whole world, but by an individual or a

definite number or body of individuals) and forms a part of the law of

obligations. Frederick Pollock (Sir Frederick Pollock, 3rd Baronet PC1,

was an English jurist best known for his History of English Law, and his

lifelong correspondence with US Supreme Court Justice Oliver Wendell

Holmes) says “the Law of Contracts may be described as the endeavour of

public authority to establish a positive sanction for the expectations of good

faith which has grown up in the mutual dealings of men.” Sir William Anson

(Sir William Reynell Anson, 3rd Baronet PC, was a British jurist and

Liberal Unionist politician) says “the law of Contracts is intended to ensure

that what a man has been led to expect, shall come to pass; that what has

1 A member of the British order of honour; ranks below a baron but above a knight

of Her Majesty's Most Honourable Privy Council (PC)



been promised to him shall be performed”. No branch of the law has more

pervasive influence upon the affairs of the individuals than the law of

contracts.

14.2.4 Indian Contract Act

The Indian Contract Act came into being in 1872. The Act deals with all

aspects of contracts, including formation of contracts and damages in case

of breach of contract. The Act was drawn on practices prior to 1872. The

massive industrial and commercial developments in Europe and world over

were yet to happen. Thus, the organising principles of the contract were

simple. As trade and commerce developed significantly in the late 1800s,

new types of cases came before the courts, the lawyers and business

community. As a result, contracts increasingly came to be in writing and

included terms and conditions on a large number of issues. The courts in

turn came to interpret the provisions in the contracts and gave decisions on

them. Following this, each of the terms in a written contract was further

detailed. The business and law community, worldwide, has been very quick

to learn from one another. New clauses, following legal developments, got

quickly distributed and copied by others. As a result of this, contract

documents have become law-like, complex and dense. It is not surprising

that it appears intimidating. World Bank, FIDIC and other professional

bodies have developed standard conditions of contract for different types of

contracts.


1. The law of contracts forms part of public law. (True/ False)

2. Contract documents have become law-like, abstruse and dense.

(True/False)

14.3 Indian Constitution and Government Contracts

In the previous section you learnt about the definition of law and how the law

of contracts came into existence. In this section you will learn about few act

enforced by Indian constitution for contracts.

14.3.1 Indian constitution

The Constitution of a country describes the governing arrangements to be

followed in the country. Constitution constitutes the society and the

governing mechanism and thus is the basic law of the country. Indian



Constitution provides for the democratic function of the Government of India

(GoI). It is a written Constitution, adopted on the 26th November 1949 and

came into force on 26th January, 1950. The Constitution defines and

determines the relation between:

Various institutions and areas of government.

Executive, the legislature and the judiciary.

Central government, State governments and the local governments.

People and the government.

Political, social and economic issues.

14.3.2 Fundamental rights

The fundamental rights are freedoms guaranteed, but these freedoms are

not absolute, but are justifiable meaning judicially enforceable. The

fundamental rights are different from legal rights. Legal rights are protected

and enforced by ordinary law. On the contrary the fundamental rights are

protected and guaranteed by the Constitution. There are articles written for

every fundamental right.

Let us discuss some of the Articles of the Indian Constitution which affect

the formation of contracts and their management:

Article 12: “Unless the context otherwise requires, the „State‟ includes

the Government and parliament of India and the Government and

Legislature of each of the States and all local or other authorities within

the territory of India or under the control of GoI.” The definition of „State‟

is important as it refers to government and legislature of each state but

not the Governor. Fundamental Rights have been guaranteed against

the State.

Article 13: This Article declares that any law made by the State, which

takes away or abridges the Fundamental Rights is to be void. This

Article also gives a list of rules, notifications, ordinances, government

orders regulations and bye-laws.

Article 14: This Article declares that “the State shall not deny to any

person, equality before the law or equal protection of the laws within the

territory of India”. The courts in India have interpreted it to mean the right

to equal treatment in similar circumstances. Thus Article 14 has been



widely used by individuals or organisations wherever there has been any

discrimination by the State in the award of contracts.

Article 19(1) (g): This Article states that,” All citizens shall have the right

to practice any profession or to carry on any occupation trade or

business.” Thus all citizens have the right to practice contracting as a

profession. The provision of this Article has been qualified by Article 19

(6) which reads as follows;

○ “19(6): Notwithstanding in sub-clause 19(1) (g) shall affect the

operation of any existing law in so far as it imposes, or prevents the

State from making any law imposing, in the interests of the general

public, reasonable restrictions on the exercise of the right conferred

by the said sub-clause, and in particular, nothing in the said sub-

clause shall affect the operation of any existing law in so far as it

relates to, or prevents the State from making any law relating to:

The professional or technical qualifications necessary for

practicing any profession or carrying on any occupation, trade or

business.

The carrying on by the State or by a corporation owned or

controlled by the State of any trade, business, industry or

service, whether to the exclusion, complete or partial of citizens

or otherwise”

Article 298: Under this Article “The executive power of the Union and

each State shall extend to the carrying on of any trade or business and

to the acquisition, holding and disposal of property and the making of

any contracts for any purpose, provided that:

○ The said executive power of the Union shall, in so far as such trade

or business or such purpose is not one with respect to which

parliament may make laws, be subject in each State to legislation by

the State; and

○ The said executive power of each State shall, in so far as such trade

or business or such purpose is not one with respect to which the

State Legislature may make laws, be subject to legislation by

Parliament.”



Article 299: This Article reads as follows:

○ “All contracts made in the exercise of the executive power of the

Union or of a State shall be expressed to be made by the president,

or by the Governor of the State, as the case may be, and all such

contracts and all assurances of property made in the exercise of that

power shall be executed on behalf of the president or the Governor

by such persons and in such manner as he may direct or authorise.

○ Neither the President nor the Governor shall be personally liable in

respect of any contract or assurance made or executed for the

purposes of the Constitution, or for the purposes of any enactment

relating to the GoI heretofore in force, nor shall any person making

or executing any such contract or assurance on behalf of any of

them be personally liable in respect thereof.”

The Article 299 imposes the below rules:

○ Government contracts must be expressed as to be made by the

President or Governor.

○ They shall be executed by the competent person and in the

prescribed manner.

○ If the above requirements are not complied with, then:

Government is not bound by the contract, because Article 299 is

mandatory.

The officer executing the contract would be personally bound.

The Government, however if it enjoys the benefit of performance

by the other party to the contract, would be bound to give

recompense on the principle of quantum merit or quantum

valebat (service or goods received). This is on quasi-contract

(Sections 65 and 70 of the Indian Contract Act, 1872).

The doctrine of promissory estoppels may apply on the facts.

The freedom of the Government to enter into business with

anybody it likes is subject to the condition of reason and fair play

as well as public interest.

○ In the case of Government contracts and contracts of Government

Corporations, where certain formalities are required to be observed

under the Constitution or under the law, the doctrine of “indoor

management” cannot be applied. This helps to eliminate the need to



observe the formalities regarding formation of the contract or

essential terms of the contract.

Article 32: The remedy for a violation of the Fundamental Rights is

contained in Article 32. It provides “the right to move the Supreme Court

by appropriate proceedings for the enforcement of the rights conferred

by this Part is guaranteed”. In addition to this, Article 226, which defines

the powers of the High Courts, has provided for a direct access to the

High Courts for protection of the Fundamental Rights.

We now have a better understanding of the provisions on the Fundamental

Rights. These rights are available against the law-making powers of the

institutions of the State. The Fundamental Rights recognise the freedom and

liberty of individuals, but at the same time they are balanced against the

public good. Thus, when a case is brought before the High Court or

Supreme Court, the courts weigh the two sides of the scale. To put it

broadly, at this stage, if the demands of public good are heavier, the law is

declared valid. On the other hand, if the claims of individual freedom and

liberty are weightier, the law is declared to be void.

14.3.3 Equality of opportunity in the matter of Government contracts

After India attained independence in 1947, the State activity has increased

by leaps and bounds. Massive projects have produced a new class of

professionals, that is, the contractors. Taking Government contracts and

executing them is a professional occupation, where everyone has a

fundamental right to practice under Article 19(1) (g).The scope of this

fundamental right has assumed a new dimension and importance in the

present day activities of the State.

The extent of the duty to act fairly will vary from case to case. Broadly, the

grounds upon which an administrative action is subject to control by judicial

review can be classified as under:

Illegality: This means the decision maker must understand correctly the

law that regulates the decision making power and must give effect to it.

Irrationality, namely Wednesbury unreasonableness: It applies to a

decision which is so offensive in its defiance of logic or of accepted

moral standards, which is not accepted by any sensible person. The



decision is such that no authority will be properly directing itself on the

relevant law.

Procedural impropriety: It applies when the mandatory procedural

requirements are ignored. A breach in mandatory requirements will lead

to procedural impropriety.


3. Article 13 declares that any law made by the State, which takes away

or abridges the ___________ is to be void.

4. The fundamental rights are freedoms guaranteed but these freedoms

are not _________.

Activity 1:

Find what” Wednesbury unreasonableness” means on internet.

Hint:http://www.encyclo.co.uk/define/Wednesbury%20unreasonableness

14.4 Codes, Manuals and Regulations, GoI GFR

In the previous section we discussed about various articles meant for

contracts in the Indian constitutions. Let us now discuss about the codes

and manuals along with some standard documents meant for contracts.

14.4.1 Need for codes and manuals

In order to avoid the public funds from getting depleted by secret contracts

made by the public servant, (in exercise of the provisions contained in

Article 299 of the Constitution) there should be a definite procedure

according to which contracts must be made. Hence it is necessary to make

rules, which will regulate the selection of persons for awarding of contracts.

The rules should comply and not violate the constitutional requirements to

avoid striking down by the courts. The norms and procedures prescribed by

the Government and the court decisions have to be strictly followed by the

Government functionaries, while awarding the contracts. The Government

functionaries do not have an absolute discretion. Certain precepts and

principles have to be followed, which gives importance to public interest.



14.4.2 Codes, Manuals for Works and Goods

Central Public Works Department (CPWD) which is the premier organisation

for the construction of public works of the Union has issued Manuals for its

officers. These manuals detail the procedure to be followed for the award of

the contracts and also the Forms of Contract. The Director General of

Supplies and Disposals (DGS and D) which is the premier organisation for

procurement of goods and equipment has its own Purchase Manual. Based

on these manuals the Public Sector Undertakings (PSUs) of GoI have

issued their own Codes and Manuals. GoI issued the General Financial

Rules (GFR) in 1963 as a collection of instructions that act as guidance for

Central Government Officers dealing with matters of financial nature. This

GFR has been revised in 2005 to ensure transparency, accountability and

effectiveness. GFR 2005 incorporates instructions for guidance for officers

dealing with new areas of governance such as externally aided projects,

government guarantees, engagement of consultants, outsourcing of

services, and so on. These instructions were not included in the GFR 1963.

The system of procurement, accountability and disposal of goods has been

liberalised, bringing it inline with accepted international practices. These

instructions of GFR are applicable only to the Central Government

Departments and not for the multitude of GoI PSUs.

Each of the States of the Indian Union has issued their own Financial

Codes, Public Works Departmental Codes and Manuals, Store Purchase

Rules and Contract texts. The Public Sector Undertakings of the States and

the local administrations have issued their own codes, manuals, regulations

and contract texts, though they are similar in most of the cases.

14.4.3 Standard bidding documents

The Ministry of Statistics and Programme implementation, GoI made an

analysis of the Central Sector Projects and found that many projects suffer

from inadequacies in project formulation and implementation leading to time

and cost overruns. Inequity condition in construction contracts has been

identified as one of the major issues in project execution. Earlier, the

contract for all wings of Government, be it the Union Ministries, State

departments or even the Public Sector Undertakings, both at the Central as

well as the State levels, had the practice of writing their own contracts.

Several of these are not relevant or designed to meet the demands posed

by the complexities of present day contract management requirements. The



Ministry of Statistics and Programme Implementation took the initiative to

develop a harmonised and transparent Contract Management System. After

having consultations with major PSUs and Government Ministries/

Departments, the Ministry issued a Standard Bidding Document (SBD) for

execution of major domestic works contracts in May 2005.


5. Ministry of Statistics and Program Implementation GoI has issued the

SBD. (True/False)

6. GFR 2005 incorporates instructions for guidance of officers dealing

with new areas of governance. (True/False)

Activity 2:

Find out details on the purchase manual by Director General of Supplies

and Disposals (DGS and D) on Internet.

Hint: http://www.dgsnd.gov.in/

14.5 Need for Procurement Law

In previous section we learnt about the manuals and codes developed by

Indian constitution. We also learnt about the standard document created by

the GoI. In this section, let us look at the need of procurement law.

14.5.1 Need for procurement law

The Public Sector Units of the Centre and the States have issued their own

procurement guidelines, manuals, codes and Standard Bidding Documents

(SBDs). Thus, there is no uniformity across various Ministries, State

Departments and PSUs. They could be easily modified as they were issued

by the administrative Central Ministries and State Departments. Any

violation of the guidelines, manuals and codes does not attract any penal

action except departmental and in most cases are ratified/excused by the

administrative Ministry/Department. The provisions are in most cases

inadequate to meet the principles of public procurement and their

enforcement is very weak.

It is considered by legal experts that the guidelines, manuals and codes are

non-statutory in nature and are generally not enforceable. It is stated that a

policy is not a law. It is also considered that guidelines, manuals and codes



do not fall into the category of legislation. They have only an advisory role

and non-adherence to them is implicitly permissible.

Lot of developmental activity is being undertaken in the country.

Procurement of works, goods and services now-a-days accounts for more

than 80% of the public expenditure and the amount involved is very huge

with high stakes. Lack of discipline, loose enforcement of the procurement

rules will result in a lot of leakage of government funds and will become a

fertile ground for corruptive practices.

14.5.2 Objectives of procurement law

The procurement law regulates the procurement of goods, construction and

services so as to promote the objectives of:

Maximising economy and efficiency in procurement.

Fostering and encouraging participation in procurement proceedings by

suppliers and contractors, regardless of nationality, and thereby

promoting international trade.

Promoting competition among suppliers and contractors for the supply of

the goods, construction or services to be procured.

Providing for the fair and equitable treatment of all suppliers and

contractors.

Promoting integrity, fairness and public confidence in the procurement

process.

Achieving transparency in the procedures relating to procurement.

The procurement law should cover all aspects of procurement to achieve all

the above stated objectives.

14.5.3 UNCITRAL Model Procurement Law

UNCITRAL (United Nations Commission on International Trade Law) is an

organ of the United Nations general Assembly. It was established to

promote the harmonisation and unification of international trade law, to

remove unnecessary obstacles to international trade caused by

inadequacies and divergences in the law affecting trade. At its 19th session,

in 1986, UNCITRAL decided to undertake work in the area of procurement.

The UNCITRAL Model Law on Procurement of Goods and Construction,

and its accompanying Guide to Enactment, were adopted by the

Commission at its 26th session (Vienna, 5-23 July 1993).



The procurement of services was governed by different considerations from

those that governed the procurement of goods or construction. Thus, a

decision was taken to enlarge the scope of the Model Law to include

procurement of services. Accordingly, at the 27th session (New York, 31

May-17 June 1994) of the Model Law adopted the Model Law on

Procurement of Goods, Construction and Services (hereinafter referred to

as “Model Law”) without replacing the earlier text, whose scope was limited

to goods and construction. While sound laws and practices for public sector

procurement are necessary in all countries, this need is particularly felt in

many developing countries, as well as in countries whose economies are in

transition.

14.5.4 Status of enactment of Procurement Law in the world

Legislative texts are largely inspired by the UNCITRAL Model Law on

Procurement of Goods, Construction and Services.

In 2003, UNCITRAL launched a project to revise the Model Law. This aims

to update the Model Law to take account of new practical developments,

drawing on the early experience of States in dealing with these new

developments. In particular, it is proposed to include extensive new

provisions on electronic means in procurement, on the conduct of electronic

auctions and on framework agreements. In addition to existing, some

important changes are anticipated to some of the Model Law‟s key

provisions, such as those on bid evaluation and supplier remedies.

14.5.5 Status of Enactment of Procurement Law in India

In India, Tamil Nadu was the first State to enact “Tamil Nadu Transparency

in Tenders Act, 1998”. Karnataka was the second State to enact “The

Karnataka Transparency in Public Procurements Act 1999.” The Acts apply

to all government departments, state PSUs, universities, and local bodies.

Though these Acts were not as comprehensive as the UNCITRAL Model, it

provides a legislative and legal backing to the rules governing procurement

of goods and works. Karnataka Act provides penal action for violation of the

provisions of the Act and Rules. Karnataka, with the assistance of World

Bank, has issued amendments, enlarging the scope of the Act to include

two stage bidding consultancy services. It has also issued a number of

circulars, guidelines (2002-2006) regarding various aspects of procurement

such as negotiations, price adjustment, third party inspections,



measurement books, sale of tender documents and so on. Karnataka has

also issued and mandated a number of State Bidding Documents (SBDs) for

procurement of goods and works. It has also issued RFP documents for

different methods of selection and types of contracts (2005-2007).

Many of the other States in the Indian Union are proposing circulation of

Procurement Acts. GoI has not agreed till date to enact a Procurement Act,

but has issued revised General Financial Rules (GFR) in 2005 which include

some rules for the procurement of goods and works. GoI has also issued

SBD for Works in 2006.


7. Only two states of India, _____ and ______ have enacted

Transparency in Procurement Act.

8. The objective of procurement is to promote _____, ______ and

_________.

9. Karnataka Act provides ______ action for violation of the provisions of

the Act and Rules.

Activity: 3

Find the latest version in Model Law.

Hint: http://www.uncitral.org/uncitral/search.html?q=model+law

14.6 Cost of Contracting

In the previous section, we discussed the law of procurement. Now let us

discuss about various cost with regards to contracts.

14.6.1 Cost of contracting

The costs of contracting could be classified into Direct and Indirect costs.

Direct costs are those that are involved in the procurement process such as

preparation of estimates, designs, specifications and bill of quantities. It also

involves preparation of bid document including conditions of contract

(general and special), advertisement, receipt and opening of bids,

evaluation, award and preparation of contract. Part of the cost is recovered

by sale of documents, but this is a small percentage of the total cost

incurred up to the stage of contract award.



The indirect costs are the cost involved in monitoring the performance of the

contractor/supplier, taking remedial action for delays, making alternative

arrangements for meeting the needs, settling disputes and so on. In case of

public works contracts (say for infrastructure projects), delay in the

completion of works/supplies results in cost and time over runs of the project

and also results in the non-realisation of project objectives. This would in

turn affect the cost-benefit ratio and also decreases the economic rate of

return of the project. However, in case of business contracts, contracts

which are concluded by a production business organisation such as a

manufacturing entity, energy producing and retailing company or a public

utility like railways and telecommunication are difficult to synchronise.

Contracts with several terms and conditions, if not followed and monitored

properly can prove to be costly.

14.6.2 Contract compliance

The overreaching objective in delivering sustainable cost reduction in the

procurement function is to develop a program that eradicates contract

leakage, scope creep, delivery and quality failures, poor or perverse

incentives and bad planning. It also aims at eliminating ill-informed buying,

deliberate contract manipulation, general waste and miscommunication. To

attain this, it requires a systematic, top down program of ongoing analysis,

reporting, communication and training. Contract compliance cannot be a

one-time effort. There must be a long-term commitment, for major

companies that do business to ensure that the company utilises its

procurement contracts effectively- and its vendors and suppliers- adhere to

written agreements. But contract compliance looks like an unmanageable

activity to these companies. The resources required to monitor and maintain

compliance appear to be too great to make it worthwhile. But with the proper

focus, companies can prioritise their compliance efforts to get the most

return on their investment in time and effort. Procurement contracting

effectiveness needs to be evaluated and has to maintain compliance by

focusing on key compliance elements such as:

Is the contract being administered effectively?

Is there contract leakage?

Are there problems with payment/control weaknesses?



Finally, it is important to rank priorities and identify the action items to

determine:

The largest opportunities for savings.

The contract leakages that can be easily prevented or even recovered.

The operational issues that prevent the company from closely

monitoring their contractors.

These opportunities for substantial cost avoidance typically present

themselves easily once the review and analysis is completed. Contract

compliance efforts can provide companies the information they need to

show procurement staff and field personnel, the major disconnects between

their two functions.


10. The major cost to the organisation of contracting is the direct costs

(True/False)?

11. In case of public works contracts, delay in the completion of

works/supplies does not effect the non-realisation of project objectives

(True/False)?

14.7 Contracting and Service Economy

In the previous section we discussed about the direct and indirect cost

involved in contracting. Here we will study how contracting helps to

outsource a job.

Outsourcing

Outsourcing is subcontracting a service, such as product design or

manufacturing, to a third party company. The decision whether to outsource

or to do in-house is often based on achieving a lower production cost,

making better use of available resources, focusing energy on the core

competencies of a particular business, or just making more efficient use of

labour, capital, information technology or land resources. It is essentially a

division of labour. Outsourcing became part of the business lexicon during

the 1980s.

Organisations that outsource are seeking to realise benefits or address the

following issues:

Cost savings.



Focus on core business.

Cost restructuring.

Improve Quality, knowledge and contract.

Operational expertise.

Access to talent.

Capacity management.

Catalyst for change.

Enhance capacity for innovation.

Reduce time to market.

Risk management.

Venture capital.

Criticisms of outsourcing are:

Quality risks.

Quality of service.

Language skills.

Public opinion.

Social responsibility.

Staff turnover.

Company knowledge.

Qualifications of outsourcers.

Failure to deliver business transformation.

Productivity.

Standpoint of labour.

Security.

Research and Development

Competitive pressures on firms to bring out new products at a rapid pace to

meet market needs in Research and Development (R&D) are increasing. In

order to alleviate the pressure, firms have to either increase R&D budgets or

find ways to utilise the resources in a more productive way. There are

situations when a firm may consider outsourcing some of its R&D work to a

contract research organisation or universities. The key drivers for R&D

outsourcing are emerging mass markets and availability of expertise in the

field at a relatively lower cost.



Manufacturing

Often manufacturing companies will develop and market products but leave

the manufacturing to other companies that specialise in it. Thus, a factory

can do manufacturing for several companies and keep a large

manufacturing plant operating at nearly full capacity, when no individual

contract could justify the expense of maintaining the infrastructure. An

example of this would be Fabless semiconductor companies which do

design, but do not have their own extremely expensive, fabrication facilities.

Information Technology

Outsourcing in the Information Technology (IT) field has two meanings. One

is to commission the development of an application to another organisation

that specialises in the development of this type of application. The other is to

hire the services of another company to manage all or parts of the services

that otherwise would be rendered by an IT unit of the organisation. The

latter concept might not include the development of new applications.

14.8 Summary

Let us now sum up few points that we learnt in this unit:

You learnt that the object of law is to create and protect the legal rights

of citizens so as to ensure order, peace and security in the society, and

guarantee some degree of uniformity in the conduct of human affairs.

You learnt Private and Public law is a broad classification of law. Law of

contracts comes under Private law, which is again divided into

Subjective and Adjective law.

Most business contracts are written contracts. Indian Contract Act came

into being in 1872. It deals with all aspects of contracts including

formation of contract, breach of contract and damages in case of

breach.

You learn that all Public contracts made by the State shall have to

comply with the requirements of the Constitution, which stresses the

equality of opportunity in the matter of government contracts.

Central and State governments have prescribed procurement

procedures in the codes, manuals, GFR issued by them. However, each

Government department/PSU has issued their own codes, manuals and

SBD and hence there is no uniformity of approach and texts.



Procurement law promotes the objectives of maximising economy and

efficiency, encouraging competition, provide fair and equitable treatment

to all suppliers and contractors; achieve transparency. UNCITRAL has

prepared a model Procurement Law.

Outsourcing is in the fields of R&D, manufacturing and information

technology. Organisations that outsource are seeking to realise great

benefit. However, there has been bitter criticism for outsourcing,

particularly in U.S.A., where it became an issue in the Presidential

Elections of 2004.

14.9 Glossary

Terms Description

Exigencies A state of affairs that makes urgent demands.

Substantive Relating to, or containing, or being the essential element of a thing.

Quantum Specified quantity or portion.

Abstruse Hard to understand.

Inter se A legal Latin phrase meaning "between or amongst themselves".

Bye-laws A private law or regulation made by a corporation for its own government.

Quasi contracts It is not an actual contract, but is a legal substitute for a contract formed to impose equity between two parties.


1. Write short notes on any three articles by the Indian Constitution.

2. What is the need for Codes and Manuals? Briefly list few codes and

manuals for works and goods.

3. Explain the need of Procurement law and what are its objectives?

4. Write short notes on contract compliances.

5. What is outsourcing? What are its benefits and draw backs?

14.11 Answers


1. False

2. True



3. Fundamental rights

4. Absolute

5. True

6. True

7. Tamil Nadu, Karnataka

8. Integrity, fairness, public confidence

9. Penal

10. False

11. False

Terminal Questions

1. Refer section 14.3.2 Fundamental Rights.

2. Refer section 14.4.1 Need for codes and manuals and 14.4.2 Codes,

manuals for works and goods.

3. Refer section 14.5.1 Need for Procurement Law and 14.5.2 Objectives

of Procurement Law

4. Refer section 14.6.2 Contract compliance

5. Refer section 14.7 Contracting and Service Economy

References

UNCITRAL Publications.

Indian Contract Act.

GoI GFR 2005.

KTPP Act.

Tamil Nadu Transparency Act.



Unit 15 Mergers and Acquisitions

Structure:

15.1 Introduction

Objectives

15.2 Mergers and Acquisition

15.3 History of Mergers and Acquisition

15.4 Acquisition Motives

15.5 Aligning Mergers and Acquisitions with Corporate Strategy

15.6 Constraints to Successful Merger Integration

15.7 Acquisition Planning and Strategy

15.8 Advantages and Disadvantages of Mergers and Acquisition

15.9 Summary

15.10 Glossary


15.12 Answers

15.13 Caselet

15.1 Introduction

In the previous units, you have learnt about contracts and contract

management. In this unit you will learn a new concept i.e., mergers and

acquisitions that takes place in the cooperate world.

Times are tough today in the business world. Corporate restructuring is a

big part of the corporate finance world. One of the aspects of corporate

restructuring is mergers and acquisitions. Mergers and acquisition refers to

two or more companies coming together or one company taking over the

other. In this unit you will learn about various characteristics of mergers and

acquisitions.

Learning objectives


define merger and acquisition.

explain the history behind the merger and acquisition.

explain the acquisition motives and its planning and strategy.

define the merger process and the constraints to successful merger

integration.

state the advantages and disadvantages of mergers and acquisitions.



15.2 Mergers and Acquisition

Mergers and acquisitions (M and A) is a corporate finance strategy that

helps companies to attain their objectives and financial goals. It involves

selling or combining two diverse companies, usually with different value

system and culture. Merger and acquisitions assists, or helps a rising

company in a given industry to grow faster without having to create new

business entity. Merger refers to companies that come together to combine

and share their resources, be it human, capital or infrastructure, to achieve

common objectives. Acquisition is a process where one company takes the

controlling interest in another company. This is considered as takeover.

Mergers

Merger happens when two companies, mostly of the same size, agree to go

forward as a single new company in the best interest of both. The

shareholders of the involved companies often remain as joint proprietors.

Both company’s stocks are surrendered and a new company stock is issued

in its place. For example, both Daimler-Benz and Chrysler ceased to exist

when the two firms merged, and a new company, DaimlerChrysler, was

created. A merger can bear a resemblance to takeover, but results in a new

company name and a new branding.

There are different mergers based business structures. Here are a few

types:

Horizontal merger: This happens when two or more companies who

are in direct competition and share the same product lines and markets

merge.

Vertical merger: This happens between a customer and company or a

supplier and company. For example, a laptop company merge with the

processor company.

Market-extension merger: This happens between companies that sell

the same products in different markets.

Product-extension merger: This happens between companies selling

different but related products in the same market.

Conglomeration: This happens between companies that have no

common business areas.



Finance based mergers

There are two types of mergers based on the financing. Each has certain

implications for the investors:

Purchase mergers: This occurs when one company takes on another.

The purchase is made with cash or through the issue of some kind of

debt instrument.

Consolidation mergers: This occurs when two or more companies join

to become a completely new company.

Acquisition

An acquisition is slightly different from a merger. Unlike all mergers, all

acquisitions involve one company purchasing another - there is no

exchange of stock or consolidation as a new company. One company can

buy another company with cash, stock or a combination of the two.

Acquisition is likely to be friendly or hostile. In a hostile acquisition, the

company, which is to be bought has no information about the acquisition

and is taken by surprise. Usually, a company acquires another company

against the wishes of the company being acquired. In a friendly acquisition,

the companies cooperate with each other and go ahead with acquisitions. In

acquisition, normally a larger company buys a smaller company. In some

cases the minor company will acquire managing power of a larger company

and retain the larger company’s name. This is also well-known as reverse

takeover.

Following are the types of acquisitions:

Asset deals: Under an asset deal, specific assets of a business are

acquired to either wrap up its affairs or continue with another business

opportunity.

Stock deals: Under a stock deal, instead of purchasing specific assets

of the selling company, the stock or equity of the selling company is

purchased at fair market value with all assets being acquired along with

all their liabilities. The acquired company usually survives as a legal

entity and continues to operate as subsidiary of the acquiring company.

The advantages of acquisition are as follows:

It provides a high speed access to resources.

It avoids barrier to entry.

It involves less reaction from competitors.



It can also block the competitor.

It provides an asset evaluation.


1. When a minor company acquires a larger company and retains the

larger company’s name, it is known as _____________.

2. _______ merger happens between companies that have no common

business areas.

15.3 History of Mergers and Acquisition

In the previous section, we had an overview of merger and acquisition. In

this section we will cover its history. The understanding of the history of

mergers and acquisition helps us to understand the importance of mergers

and acquisitions in the world. If we take into account the detailed history, we

find that merger and acquisition started to take place in the world from very

early years. The emergence of U.S merger and acquisition took place in the

early 20th century. After that it continued to take place in cycle or wave.

During the cycle or wave, maximum number of mergers had taken place as

discussed here under:

The start of first wave merger: The first wave merger started from

1897 to 1904. During this wave, merger had taken place involving

different companies enjoying domination in railroads and electricity. In

this period, horizontal mergers occurred between heavy manufacturing

industries.

The end of first wave merger: Due to the decreased efficiency,

majority of the mergers that had started during the first wave ended up

in failure. This resulted in the slowdown of economy in 1903 and also

the crash of stock market in 1904. There was no supporting base for the

legal framework.

The start of second wave merger: The commencement of second

wave merger took place from 1916 to 1940, giving importance to the

mergers between the oligopolies to a certain extent than the

monopolies. Major technical development like the railroads and

transportation motor vehicles came into existence. The government

policy was passed in 1920s encouraging firms to work in harmony. The

second wave merger that took place was horizontal in nature. The



producers of primary metals, food products, transportation equipment

and chemicals were some of the industries that went for merger during

this wave. A number of investment banks helped in the process of

merger and acquisition.

The end of second wave merger: In 1920, the second wave merger

faced a major failure with the stock market crash. Again in 1940s, the

tax exemption encouraged conglomerates to involve themselves in M

and A activities.

The start of third wave mergers: The conglomerate mergers

developed during the period 1965 to 1969. The stern enforcement of

antitrust laws, interest rates, high stock price took place during the third

wave merger. The bidders of the third wave merger were minor than the

target firm. The role of investment banks were replaced due to the

funding from equities.

The end of third wave merger: In 1968, the split of conglomerate took

place that marked the end the third wave merger. One of the reasons

was the poor performance of the horizontal mergers. The INCO-ESB

merger; United Technologies and OTIS Elevator Merger are the merger

between Colt Industries and Garlock Industries were the most prominent

ones that set precedence in the 1970s.

The start of fourth wave merger: The fourth wave merger began in

1981 and ended by 1989 and was characterised by acquisition targets.

The mergers between the oil and gas industries, pharmaceutical

industries and various banking and airline industries had taken place.

The foreign takeover became more prominent. The result of anti

takeover laws, financial institutions reform and the gulf reason marked

the end of fourth wave merger.

The start and end of fifth wave merger: The commencement of fifth

wave merger was triggered by globalisation, stock market rise and free

enterprises. The fifth wave merger took place mainly in the

telecommunication and banking sectors. The mergers were driven long

term rather than short term profit motives. The burst in the stock market

concluded the fifth wave merger.

Therefore, we can assume that the growth of merger and acquisitions has

been long drawn. The economic factors characterised its development. As



far as the economic units of production exist, merger and acquisition would

last for an ever expanding economy.

The lessons from the history about merger and acquisition will give the

acquirer an idea of the right and wrong strategies used by these companies.

He may then use this information for planning a good strategy.

15.4 Acquisition Motives

In the previous unit you learnt about the history of M and A. All the

companies do not always have acquisition strategies, and not all companies

that have acquisition strategies will stick to them. In this section, we will

learn different motives for acquisitions.

Acquisition motives are mentioned hereunder:

Acquiring undervalued firms: An acquirer would want to buy a

company that is undervalued by financial markets. The difference

between the purchase valve and the true valve of the target company

give certain amount of profit to the acquirer. For this strategy to work,

three basic components are essential.

o A capacity to find company that is for sell than its true value:

This capacity would require either access to better information than

is available to other investors in the market, or better analytical tools

than those used by other market participants.

o Availability of funds needed for acquisition: The availability of the

required capital to carry out the acquisition when the company is

undervalued. Access to the capital depends on the size of the

acquirer.

o Skill in execution: The acquirer sometimes drives the stock price

up to and beyond the estimated value, where there will be no value

or profit from the acquisition.

Strategy of buying undervalued company always has a great deal of

spontaneous appeal, but it is daunting as well. Because, acquisition

happens publicly in efficient markets, where the premiums paid on market

prices very quickly eliminate the profit, when the market price goes up.

Diversifying to reduce risk: Another reason of acquisition is the belief

that buying companies and diversifying can reduce earnings volatility

and risks as well as increase potential value.



Diversification has its own benefits although the question is if it can be

accomplished efficiently by investors or the companies who acquire other

companies in the name of diversification.

Comparing the costs associated with investor with the cost associated by

the company getting into diversification, investors in most publicly traded

companies can diversify far more cheaply than acquirer.

Creating operating or financial synergy: Some companies operate

below their potential and become less efficient. Such companies are

likely to be acquired by another company. Synergy is the prospective

additional growth in terms of value obtained by combining two

companies. It is widely used and misused principle for mergers and

acquisitions.

o Sources of operating synergy: Operating synergies enable a

company to increase their operating income, increase growth or

both. The categorises for operating synergies are mentioned below:

Economies of scale arising from the merger, allows the

combined companies to become more cost-efficient and

profitable.

Greater pricing power arising from reduced competition and

increased market share, resulting in, higher margins and

operating income.

Combination of different functional strengths happens when

different skills set are merged. For example, a company with

strong marketing skills acquires one with a good product line thus

the marketing team upon merger will do the job essential to

promote the product with extra human resource.

Higher growth in new or existing markets arising from the

combination of the two firms of the same product line.

Operating synergies can affect margins and growth, which in turn affect the

value of the firms involved in the merger or acquisition.

o Sources of financial synergy: Financial synergies can happen

when the payoff takes the form of either higher cash flows or

discount rate. Below are mentioned few forms:

A combination of a company with extra cash but less projects

and a company with high-return projects but little cash can yield

a payoff in terms of higher value for the combined company.



Debt capacity will increase as two companies combine. Their

earning and cash flows will become more stable and predictable.

Tax benefits can be achieved from the acquisition by using tax

laws to reduce the taxes or by reducing operating cost to shelter

income.


3. An acquirer would want to buy a company that is undervalued by

financial markets for the _________

4. Strategy of buying under valued company always has a great deal of

_____________appeal.

Activity 1

Find out more details about M and A history on internet.

Hint:

http://ezinearticles.com/?Ten-Important-Lessons-From-the-History-of-

Mergers-and-Acquisitions&id=1486559

15.5 Aligning Mergers and Acquisitions with Corporate Strategy

In the previous section we learnt about the motives for acquisition. In this

section, we will learn how to align Mergers and Acquisitions (M and A) with

corporate strategy.

A successful M and A execution and integration is achieved only when the

M and A strategy aligns with the companies corporate strategy. These

corporate strategies may be varied including company’s growth, becoming

more competitive in market, product extension or risk reduction and so on.

Acquisition should satisfy the criteria or add valve to the corporate strategy.

Hence it should be aligned with the company’s strategy.

M and A is a strong strategic tool for a company. Successful M and A

includes multiple steps in an elaborate process, which is quite similar to the

corporate strategic planning. Acquirer should always consider how to

optimise the M and A in the framework of an overall corporate strategy. Let

us now review how merger and acquisitions create value in particular:

The existing company’s structure may be changed due to investment

structure. The investment structure usually gets altered by various



financing transaction in the event of acquisition with consequential

impact on the asset.

While making a horizontal or vertical acquisition, the existing company’s

image will be modified in the market place. Hence, the communication

strategies desired should to be adapted to enhance public perception in

a positive way.

Also, there will be change in operational performance of shareholders

value, which is the most obvious change.

There are numerous reasons for a company to peruse M and A. Some of

them are listed below:

The M and A are undertaken to achieve specific financial, business and

strategic objectives to strengthen current operations and spread into

new markets. These transactions can substantially change a company’s

income statement, balance sheet and public profile.

Executing on a set of corporate objectives is the most important

constituent of merger and acquisition whereas creating value with the

transaction is considered as additional gain. The key factor becomes the

pre and post merger integration.

Therefore, while individual considers mergers and acquisition as an

approach for growth, it is sensible to assess the potential transaction in the

perspective of the internal option. There are, however, a few typical M and A

drawbacks:

Many mergers failed due to an unclear or a wrong M and A strategy,

leading to over payment and time extension.

Due diligence is limited only to commercial financial data, which leads to

un-assumed problems.

Integration/separation environment are very uncertain after the deal is

closed.

The merger process

We learnt how to aligning M and A with corporate strategy. Now, let us study

how the merger process takes place. The merger process is carried out in

two ways. One is through the formation of a new company (NewCo). The

other one is the merging of one or many companies into another company,

with the effect that the acquiring companies keep hold of their uniqueness.

The principle of merger is of a financial or business nature. The merging of



two companies allows for the creation of cost synergies such as the

administration, production and listing costs. It also allows for a better

geological coverage with a positive impact on revenue and the likelihood of

additional development. The stages of the merger process are:

1. Planning.

2. Resolution.

3. Implementation.

Now let us go through in detail with the three stages of the merger process.

Planning: The most complex part of the merger process is planning which

involves analysis, action plan and negotiation with the parties involved in it.

The planning stage can take any amount of time, but after its completion,

the merger process is on the way. The planning stage also includes the

following:

The signing of the letter of intent that starts off the negotiation.

The appointment of advisors who take part in the role of consultants,

examining the strengths, weakness, opportunities and threats of the

merger.

The maintenance of deadline, conditions and type of transaction which

can be merger by integration or through the formation of a new

company.

The maintenance of export report based on the consistency of the share

exchange ratio, for the companies involved.

Resolution: The resolution stage needs the approval of the management

and the shareholders involved in the merger plan. The resolution stage also

includes the following:

The board of directors arrange meeting with extraordinary stakeholders’

whose item on the agenda is the merger proposal.

The extraordinary shareholders’ meeting is called to overtake a

resolution on the item on the agenda.

The opposition to the merger that comes from the creditors or

bondholders must be limited to within 60 days of the resolution.

The evaluation of the impact of the merger is undertaken by the Italian

Antitrust Authority, which imposes any requirement as a precondition for

approving the merger.



Implementation: It is the concluding stage of the merger process. This

includes the enrolment of the merger act into the company register. The

period of time occupied by the medium size or big mergers is one year from

the start up of the negotiation to the finish of transaction. This is because,

the issue relating to the share exchange ratio among the merger companies

is hardly accepted by the parties with no drawn-out negotiation. The

shareholders possibly will deal without constraint the new shares and

benefit from all rights.


5. Acquisition should satisfy the criteria but may not add valve to the

corporate strategy. (True/False)

6. Limiting due diligence only to commercial financial data leads to un-

assumed problems. (True/False)

7. The most complex part of the merger process is planning which

involves finance. (True/False)

Activity 2

Find out the latest merger between HP and Compaq on internet.

Hint: www.awpagesociety.com

http://www.hp.com/hpinfo/newsroom/press/2001/010904a.html

15.6 Constraints to Successful Merger Integration

Successful merger integration involves a number of constraints. Some of the

key constraints include maintaining vital managers and workforce,

resistance from key constituents including industry organisation, unions,

clients, suppliers, communities or regulators, set up a wrong benchmark for

achievement and varying the criteria for success once a transaction is

accomplished.

Some of the constraints that should be dealt in the process of M and A are:

People: The most fundamental limitation to M and A incorporation and

implementation is human resource. The support of people is very

necessary otherwise the buy-in transaction is destined to failure. The

input to each feature of a contract whether the preliminary valuation, the

due diligence or the integration should comprise of the management and

employees. Most of the time the companies are unaware of how the M

and A works can create a significant barrier to success. It is essential



that the key personnel be brought into position to guarantee their stay

during the transaction and are suitably recognised for their involvement

in the deal.

Other elements: suppliers, clients, unions and regulators: In

addition to people, there are other elements that can serve as a

constraint in a contract. These elements may range from the regulatory

agencies to clients, suppliers and to industry organisation as well as

unions. The maintenance of each entity should be handled with intense

care and brought into the information flow at the proper time. A

tremendous wisdom has to be used on paper and employees, during a

transaction. Acquirer and target company may buy into the transaction

logic, yet the transaction may alter in such a way that the justice

department intervenes. Therefore, it becomes essential to deal with

antitrust issues in the beginning. Also, employee union may get in the

way of a transaction providing some form of benefit to its union

members.

Providers of capital: The obstruction to transaction can also be raised

by the providers of capital finance in an acquisition. These constituents

may include commercial banks, public debts, equity holders and private

equity firms. It becomes necessary that the state of the capital market at

that time must be accomplished.

Competitors: A critical barrier to successful merger integration is

competition. The action by the competitors varies in a number of ways

ranging from objecting the deal to antitrust regulators or an attempt to

steal employees and customers. Thus, plan should be done accordingly

to pre-empt the behaviour of the competitors.

Ongoing review: Merger of two firms never ends on the closing of the

transaction nevertheless it ends when the firms are fully integrated. If

well planned and executed, the merging companies should be

supervised according to the targets and benchmarks recognised at the

start.


8. The support of people is very necessary otherwise the buy-in

transaction is destined to_______.



9. The ________ to transaction can also be raised by the providers of

capital finance in an acquisition.

10. A critical barrier to successful merger integration is __________.

15.7 Acquisition Planning and Strategy

In the previous section, we discussed about the constraints to successful

merger integration. In this section, we will learn how to plan a strategy for

acquisition. We have already learnt from the previous section that planning

is a key part of any successful acquisition.

Acquisition planning is the method of coordinating and integrating the efforts

of all those responsible for acquisition. The result of acquisition planning

normally leads to a comprehensive written plan. The overall strategy for

managing the acquisition is given in an acquisition planning that includes

administration of the contract.

The acquisition plan should be long enough to perform key business

consideration, attain competition, decrease price, administer the contract

and display the signatures of approving officials. It should be maintained by

the project officer. The responsibilities of the project officer include:

Coordinating acquisition plan with contracting officers, legal and finance.

Ensuring that plan captures key points of the business strategy.

Obtaining the required approval signatures.

Working with the concerned officer to maintain the acquisition plan,

including the milestone chart.

The acquisition approach used should be included in the acquisition plan.

The alternative acquisition approaches, budgeting and funding, contract

type, milestone and other technical information should also be considered.

The risk analysis of your acquisition should include:

Technical risks such as uncertain specifications.

Cost risks such as insufficiency of the funds.

Schedule risks which include untimely project completion.

In addition, the updates are necessary to the acquisition plan whenever the

circumstances change.



The acquisition strategy

The most important strategic consideration is the size of the acquisition. The

completion of smaller series should be considered in the beginning than the

larger ones. This will help the acquirer to be trained from each of the

successive acquisition so that he develops a significant experience. If the

acquirer starts with a number of smaller firms, he can work on its acquisition

skills remarkably.

The more liable strategic issue faced by the acquirer is the reactions of the

competitors to an acquisition. This does not mean that the acquirer should

back away from the acquisition because of the fears of competitors. The

acquirer must be conscious of how the transaction will guide to a

reformation of the aggressive environment in this industry. There are some

cases where the buyer will intentionally back away from an acquisition,

thereby leaving the competitor to acquire.

The value of merger and acquisition transactions lies in the execution. It

requires real experience, comprehensible strategic objectives, technical M

and A expertise and capable people who act as a strong base for M and A

program. Successful strategic acquirers use process and discipline to avoid

an M and A breakdown that will certainly impair and devastate shareholder,

customer and employee value.

The approach of M and A focuses on supporting clients in developing

efficient structure and discipline which include:

Providing a framework for the target screening, transaction execution

and combination phases.

Communicating a compelling strategy to the employees, else they will

resist the change process required for effective combination.

Considering the people, process and technology into the target

screening phase.

Using a well-defined structure with a unique combination.


11. The more liable strategic issues faced by the acquirer is the reactions

of the seller to an acquisition. (True/False)



12. The overall strategy for managing the acquisition is given in an

acquisition planning that includes administration of the contract.

(True/False)

Activity 3

Find details about Indian Merger and Acquisition.

Hint: http://www.economywatch.com/mergers-acquisitions/india.html

http://trak.in/tags/business/2007/08/16/indian-mergers-acquisitions-

changing-indian-business/

15.8 Advantages and Disadvantages of Mergers and Acquisition

In the previous section, we have learnt about the acquisition planning and

strategies. In this section, let us analyse the advantages and disadvantages

of M and A provided in the business environment. The following describes

the advantages of mergers and acquisition:

Mergers and acquisitions are capable of generating long term

productivity for the joint company in the case of a merger, or the

purchasing company in the case of an acquisition.

A merger may be proficient tax-free for the parties involved.

M and A can help a developing company through its expansion and

development or generate a smoother production process or functioning

system.

A merger assigns the shareholders of minor entities to possess a

smaller part of a larger pie, raising their general net value.

A merger between a public sector company and a private company

gives the smaller private company the status of the public sector

company.

A merger allows the seller to pass numerous expensive and prolonged

aspects of asset purchases, such as the assignment of leases and bulk-

sales notice.

A merger is of substantial significance. If there are marginal or fewer

stockholders, obtaining the votes for merger is easier. .The transaction

becomes effectual and the disagreeing shareholders are appreciative to

go along.



Let us have a look on some of the disadvantages of mergers and

acquisition:

Higher cost will be incurred for excessively large business.

The monopoly concerns in merger can have a negative impact on the

market.

Conflict among the altered types of business can occur, reducing the

efficiency of the integration.

Necessity of workforce redundantly, particularly at management levels,

will have a consequence on motivation.

Decisions are harder to make and cause disturbance in the

management of the business when diverse business combine.

Success is not always definite in merger. Sometimes there can be net

loss of value because of issues related to technological

inappropriateness, needless employees or poor supervision.

Company acquisitions or takeovers contribute to several of the

equivalent risks, where a company that acquires another company has

to reconfigure the employee atmosphere and operations amongst other

things.

Risks concerned with the purchased company such as precedent and

present debt, trouble, asset or liabilities that must be addressed by the

new owners and organisation.

15.9 Summary

We learnt that Mergers and acquisition (M and A) refers to a company

strategy of buying a new or taking over a target company. Combining of

diverse companies can assist, economics, or aid a rising company to grow

quickly without having to create a new business entity.

We learnt about few types of mergers which are horizontal mergers, vertical

merger, conglomerate merger, market extension and product merger.

The principle to successful M and A implementation and integration is

aligning M and A strategy with the companies’ largely corporate strategy.

A good knowledge on the history of M and A helps us to achieve this.



We also learnt that the arrangement of business activities of a company as

a whole with an aim to achieve some of the predetermined objectives at the

corporate level is termed as corporate strategy.

We now know that merger process include planning, resolution and

implementation. Successful merger integration involves a number of

constraints. These consist of maintaining vital managers and workforce,

resistance from key constituents including industry organisation, unions,

clients, suppliers, communities or regulators, set up a wrong benchmark for

achievement and varying the going in criteria for success once a transaction

is accomplished.

We also discussed about acquisition planning, which is a method of

coordinating and integrating the efforts of all those responsible for

acquisition. Mutually, mergers and acquisitions are capable of generating

long term productivity for the joint company in the case of a merger, or the

purchasing company in the case of an acquisition.

15.10 Glossary

Term Description

Benchmarks A standard by which something can be measured or judged.

Due diligence The process of investigation, performed by investors, into the details of a potential investment.

Liable Used with reference to an unfavourable outcome.

Monopolies It is a market in which there are many buyers but only one seller.

Oligopoly A market that is dominated by a small number of participants who have control over supply and market prices.


1. Give a brief introduction on mergers and acquisition.

2. Describe the merger process.

3. What are the necessary constraints for successful merger integration?

4. List the advantages and disadvantages of mergers and acquisition.

5. Explain the planning and strategy of acquisition.



15.12 Answers


1. Reverse take over

2. Conglomeration

3. Mis-pricing

4. Spontaneous

5. False

6. True

7. False

8. Failure

9. Obstruction

10. Competition

11. False

12. True

Terminal Questions

1. Refer section 15.2 Mergers and Acquisition

2. Refer section 15.6 The Merger Process

3. Refer section 15.7 Constraints to successful Merger Integration

4. Refer section 15.9 Advantages and Disadvantages of Mergers and

Acquisition

5. Refer section 15.8 Acquisition Planning and Strategy

15.13 Caselet

Merger of Arsis and Dwris

The merger between Arsis and Dwris took place in September 1989, and

the resultant company formed is Zodiac. Arsis founded in 1882 was

veteran in Russia. Dwris was established in 1891 in Switzerland. The

employ power of Arsis was likely around 6500 and that of Dwris was

8500. On the date of the merger it employed another 1500 people. The

operation of the newly formed company operated in 56 different

countries.

Before this large cross border merger, both the companies were major

competitors in the industry. Both the companies were equally competent

in power generation and distribution. Arsis had competencies mainly in

the power generation, varied products including steam turbines,



locomotives and application of electric power. The company had also

owned a Norwich company whose expertise used to be in air technology

and environment protection like electrostatic precipitators, industrial fans

and so on. Dwris had competence in power generation and distribution

and diverse production range from industrial electronics to industrial

robots. The objective of this merger for both was to become the single

most powerful leader in the power sector. After the merger between both

the companies in 1988, Zodiac acquired more then 32 companies all over

the world. The merger was done each holding fifty percent of the new

entity of Zodiac. The formation of a new parent and introduction of a

single class of shares was the ultimate step in fully integrating Zodiac.

After the merger the company faced a lot of confusions regarding the

managerial staff as who has to leave and remain in the organisation.

Over staffing had become a serious issue. The board of directors held a

meeting to overcome these problems. They distributed the staff members

in all the branches which they had acquired. The problem of over staffing

was solved in this way. There was a slow implementation of financial,

accounting within all the sectors. The mistakes that were faced by both

the companies in the past were analysed so that it would not repeat in

the future. The accountability of sales tax and excise duties were

undertaken. The employees of the merged company enjoyed equal rights

and benefits throughout.

Question:

1. Explain the merger process of Arsis and Dwris and the difficulties

faced.

References

Steven M. Bragg, Mergers and Acquisitions: A Condensed Practitioner's

Guide.

Edward P. Halibozek, Gerald L. Kovacich, Mergers and Acquisitions

Security: Corporate Restructuring and Security.

Jenny Davenport, Simon Barrow, Employee Communication during

Mergers and Acquisitions.

Robert E. Hoskisson, Michael A. Hitt, R. Duane, Ireland Competing for

Advantage.

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