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Contract Management 101 - Purchasing and Project Procurement, fixed-price, cost based, and T&M - YouTube
Channel: Americo e-Learning
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Why and when do companies need contracts in purchasing management?
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What are the main contract types used by companies?
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What are the advantages and risks of each contract type?
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Would you like to understand contract management in corporations?
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If yes, keep watching.
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Get better marks, be ready for job interviews,
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and excel in work meetings.
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We are here to help you!
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Subscribe Americo e-Learning!
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Welcome to supply chain management lessons
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my name is Americo Cunha!
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Learn fast, solve problems, and make good decisions!
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In this lesson, we will be exploring 3 questions about contracts in purchasing management.
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Why do companies need contracts?
When is a contract is needed or not?
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What are the most common contracts?
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What are advantages and risk of each contract type?
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How to choose the best contract type for the company鈥檚 needs?
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Let's get started!
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Why do companies need contracts?
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Well, sometimes they need, sometimes they don't.
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A contract is better when: the company needs a continuous supply,
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of products with complex requirements,
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of customized solution, with significant information sharing
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for a medium/long term commercial relationship.
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When a contract is not required:
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in discrete or one-time purchasing
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to fulfill an occasional short-term need
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in a simple buyer-seller transaction
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when there is no process integration
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A contract is a good tool to define
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what is being bought and its cost
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operations processes for ordering, shipping, and receiving
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to define quality and acceptance criteria
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to establishes payment and warranty procedures
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With contracts, companies manage
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1) information flow: the contract
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establishes the communication process
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Who sends/receives information, at what time
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in what form.
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Also, how communication systems will be integrated,
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what information will be transferred
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through electronic data interfaces (EDI)
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2) the goods flow: the contract defines
defines
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how materials will be ordered, how materials will be ordered,
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transported, delivered, received, and accepted
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3) In the Financial flow: contracts describe
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how and when payments will be made.
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4) commercial relationship,
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contracts specify the point of contact
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who is responsible for what
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and the escalation procedure
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in case of problems
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What are the main contract types companies use?
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There are 3 main contract types:
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fixed price, time and materials, and cost based contracts
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Almost all purchasing contracts are based on some form of pricing mechanism
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and can be categorized as a variation of
two main types:
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fixed-price or cost-based
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Fixed-price is a contract in which the price of the product or service is fixed
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during the contract duration.
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In this contracts, buyer and seller
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should know very well the specifications
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and therefore, the cost can be better estimated
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In a cost-based contract, the buyer agrees
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to reimburse the supplier for the expenses incurred
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and, of course, plus a dollar amount of profit.
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To protect against cost overruns,
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some companies define the maximum cost
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the supplier cannot exceed.
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In Time & Material (T&M) contract,
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cost unit rates are predetermined,
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but the labour and material quantity can vary.
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Therefore, the total cost is not fixed
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although unit cost is predetermined.
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It is a kind of hybrid contract.
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In this small example, the brick
and the labor rate have a fixed cost,
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the total price will depend on the amount of the material used and hours worked.
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Fixed-price contracts may have problems to handle changes and quality assurance.
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There are small modifications that can be implemented
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to reduce the most common risk.
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The main varieties are intended to provide
provide
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formal mechanisms to change prices
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and to provide incentives for quality.
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The major challenge is cost-based contracts
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is the risk of cost overrun.
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Sometimes is nice to change some aspects
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to motivate contractors to keep the costs low.
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Financial incentives are usually very effective.
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What are the advantages and risk each contract type?
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Cost overrun
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The risk that the cost exceeds the contract budget
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estimated cost, or target value,
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is much higher in cost-based
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To mitigate the risk, the buyer should
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put additional effort in the contract administration, expenses control,
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maybe include saving incentives for the supplier.
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Low quality in fixed-price contracts
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the potential for low quality is higher
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Because the price is fixed, the vendor/contractor may be forced to reduce costs
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what may affect product/project quality.
To mitigate this risk, the buyer should
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have well know specifications
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and include quality standards and expected performance in the contract.
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Depending on the supply condition,
one contract type may be
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more suitable than the other.
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For instance, every time that
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there is a high level of uncertainty,
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it is almost impossible to develop
detail specifications.
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therefore fixed-price contract is not recommended.
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Long-term contracts also bring
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changes naturally due to its duration.
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Therefore fixed-price should be avoided.
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In case the company has an in-depth knowledge
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and experience about the product,
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and are able to develop very well detailed specs,
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fixed-price is a good alternative.
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On the other hand, the cost-based contract
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can be more suitable when there are
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high uncertainty and long durations.
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The Time and Materials contracts
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are an intermediate solution that combines elements
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of fixed-price and cost-based.
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It has fixed-price for work-units and materials,
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but also accommodate changes in the scope and workload.
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In this video, we presented the main concepts of contract management.
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To check your learning, try to answer
the following questions?
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Why and when do companies need contracts?
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What are the main contract types used by companies?
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What are the advantages and risks of each contract type?
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What are the best scenarios to use fixed-price or cost based contract?
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We work hard to help you to get better marks
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be prepared for job interviews and excel in work meetings
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you can send your questions in the comment area below
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I'll be pleased to answer all of them
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Thanks for watching
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and don't forget to subscribe
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