Emphasis in project supply contracts.

Your organisation has decided to buy a new ‘something’ (factory, distribution centre, IT system) that will cost a lot of money. Where should the emphasis be placed when negotiating supply contracts for the new project?

Good advice has come from the head of technical information for Crossrail, the new underground east-west rail line across London, due to open in 2018. Based on their learning from contracts to date, Crossrail should have been more prescriptive about the outcomes required. This includes providing contractors with more detailed information about the project’s long-term maintenance requirements.

Although the Crossrail maintenance philosophy is ‘repair or replace before failure’, it was found that designers had only paid ‘lip service’ to the philosophy. And, because maintenance engineers are not high in the structure of the organisation, they unfortunately did not push their requirements hard enough when developing the specifications.

Where the money is spent

In typical projects, the capital costs will be about 30 percent of the lifetime costs; the other 70 percent are costs incurred for through-life support. But, the design decisions and actual operational maintenance will likely be widely spaced apart in time and the original negotiators and decision makers long departed for other jobs.

The challenge is that although substantial money will be spent on through-life support, less than 50 percent of the support decisions will have been made at the specification stage. For this reason, it is preferable to negotiate contracts based on a performance based specification (PBS). As the Crossrail professional says, “take the time and effort to identify the outcomes required, then rely on the knowledge and capabilities of suppliers to propose cost effective solutions”.

But why is it that highly experienced project professionals would only realise when the contracts were being implemented that maintenance requirements had not been fully considered? One reason is that organisations increase the risk of incorrect assumptions being made through employing specialist buyers; for example, using qualified and experienced IT people to buy IT equipment, software and services. Because the buyer assumes (and the employer also assumes) they know all about IT and communications, the ‘silly and dumb’ questions are not asked internally and of suppliers and subsequent problems arise through a lack of adequate supply market research.

This situation was illustrated by a recent job advertisement for a deputy director responsible for IT purchases in a State Government. The advertisement required capability in category management and spend analysis, but also extensive IT project experience. As this was a re-advertisement, it is evident the government (which currently has an anti-corruption investigation into IT procurement) has a problem obtaining the desired mix of skills.

What can often be lost when thinking about Procurement is that the role is one of developing commercial relationships, not technical expertise. When technical advice is required, that should be through a contract with a firm that demonstrates competence in the technical discipline.

Rather than using specialists who ‘know’ the supply market for particular items, a different approach is to employ commercial Procurement professionals willing to access a Supply Market Intelligence (SMI) database and technical specialist firms for knowledge. Establishing this process does not automatically reduce procurement risks, but is more likely to provide Procurement professionals with accurate and current information to assist their understanding of supply markets. This has to improve outcomes when negotiating with potential and current suppliers.

A commercial approach to Procurement

Rather than base decisions on industry ‘knowledge’, Procurement professionals will adopt a structured information and analysis approach to the markets. This will include the development of:

• Supplier Capability statements: These require two stages:

1. Understand the supply market for a category (identified as a supply industry or a process technology)
2. Research the supply base for sub-categories that are purchased by the organisation

Supplier Capability statement will include commercial aspects, such as:

1. The share of the supplier’s total business to be taken by the current or proposed contract and the associated risks if the percentage is high or if the supplier has major contracts with other organisations (which could be cancelled)
2. Financial strength of the supplier to deliver on the contract, together with the risk of default: This can be due to the buying organisation’s lack of knowledge about a supplier’s financial situation, not whether a supplier will fail

• Life Cycle Costing (LCC) approach (similar to Total Cost of Ownership (TCO)): to establish the lifetime costs of capital (or investment) purchases. An LCC statement accounts in a buy for the costs of installation, implementation, training, replacement parts inventory, maintenance and disposal. The approach includes identifying the environmental (including safety) risks that are part of the total cost of a purchased item

The Supplier Capability and LCC statements are but two factors which illustrate that commercial skills are the main requirement for Procurement professionals. So, expect your Procurement professionals to be the commercial specialists; able (and encouraged) to call upon technical advice when required.