Procurement contracts can become a headache for any fast-growing business. How can legal and business teams work together to make sure procurement contracts, and the processes that govern them, scale with the business?
In this Juro deep-dive, we’ll explain what procurement contracts are, how they’re managed and how contract management software can improve procurement contract management processes in your business.
What is procurement?
Before we can delve into the specifics of procurement contract management, we first need to understand what procurement actually entails.
Put simply, procurement is a term used to describe the sourcing, negotiation and purchasing processes undertaken when businesses obtain goods or services for their operations. It encompasses everything from locating certain materials, supplies, and equipment to negotiating the terms for these and actually purchasing them.
It requires a firm understanding of supply chains and the ability to develop lasting relationships with reliable suppliers. But as with almost all business transactions, it also requires contracts - and lots of them.
What is a procurement contract?
Procurement contracts are legal agreements used to govern transactions between parties whereby goods or services are being obtained for business purposes. Also known as purchase contracts, this type of business contract is used to create a legally binding relationship between the business that’s purchasing the goods and the party that’s selling them, and protect these parties’ interests. If you're looking for a basic procurement contract, grab this free purchase order template.
Importance of procurement contracts
Procurement contracts are important for a lot of reasons. For a start, the contract purpose is akin to most other contracts: to formalize and finalize the terms of a new business relationship.
By doing this, they provide security for both the vendor and the buyer. This confidence is critical in procurement relationships since most transactions will require involving third parties to purchase materials and fulfill delivery obligations. Without this security, vendors could be contracting for materials and resources that may not end up needing, but will still have to foot the bill for themselves.
Similarly, as procurement contracts are often used within competitive markets (for example, from a supplier agreement template), businesses need the assurance that suppliers will fulfill their obligations and meet the demand that’s been created. After all, time is money, and without a robust contract in place, receiving compensation for unfulfilled promises can be near impossible.
Ultimately, procurement contracts are distinct from many other commercial contracts in the sense that they often rely on a chain of different interactions, transactions, and stakeholders in order to be fulfilled. Naturally, this makes them far riskier than some other commercial transactions, and a contract is a perfect mechanism for reducing this risk.
Lastly, procurement contracts serve as an effective tool for ensuring that the relationships developed between vendors and buyers are long-lasting. By providing clarity to these relationships, contracts help to prevent misunderstandings and establish the obligations owed by each party with certainty. As a result, having procurement contracts in place can prevent relationship breakdown and also hopefully reduce the risk of churn.
Types of procurement contract
Since procurement is a broad business function, there are numerous different types of procurement contracts your business might encounter. These include:
1. Fixed-price contracts
Under a fixed-price contract, the seller has promised to sell and supply a certain product or service for a set price. A fixed-price contract establishes the details of a good or service being provided when the transaction will happen, and the price the buyer is expected to pay.
Since these details are agreed in advance, a fixed-price contract offers more protection for buyers than some other procurement contracts. This is because this type of contract establishes the payment terms in advance and if the costs of supplying the goods or services increase, this won’t be reflected in what the buyer pays.
One of the biggest advantages of fixed-price contracts is that they clearly define the roles and obligations involved in the completion of a contract, which reduces the risk for both parties.
But not all fixed-price contracts are born equal. There are three different subtypes of this procurement contract to consider:
Firm Fixed Price (FFP)
Firm Fixed Price contracts are used in situations where the buyer pays the seller a fixed amount, regardless of whether extra costs are incurred or more resources are required in the course of the transaction.
Fixed Price Incentive Fee (FPIF)
A Fixed Price Incentive Fee contract is another type of Fixed Price Contract, but under this type of procurement contract, a seller is eligible for a bonus or ‘incentive’ if they deliver on the promises of a contract early and exceed certain expectations, like quality or delivery ahead of schedule.
Fixed Price with Economic Price Adjustment (FP-EPA)
A Fixed Price with Economic Price Adjustment contract operates on the basis that a buyer pays the seller a fixed fee, but with allowance for price adjustment in certain situations. These situations include market fluctuations and other events that are out of the seller’s control.
2. Cost-reimbursable contracts
Often known as a cost-plus contract, cost-reimbursable contracts are contracts whereby a contractor is paid a set fee for their work but is also reimbursed for any additional materials or costs incurred when executing the contract. The costs often cover expenses both directly and indirectly incurred.
For this type of procurement contract, a total cost estimate will be established before the contract is agreed, and this enables the parties to allocate an appropriate budget and establish a reimbursement limit. These types of contracts are most appropriate when the costs associated with a transaction are predictable.
3. Time and materials contracts
Time and materials contracts are legal documents that seek to reimburse a vendor for the materials used when fulfilling the contract and the time they spent working on that particular project. This type of procurement contract is particularly common amongst developers and other professionals that focus on delivering a service, as there are often not many materials involved in the fulfillment of these contracts, and the value being delivered is often quantified as time.
The only difficulty with this type of procurement contract is that it can be difficult to manage, particularly when the time required to deliver a service is uncertain, as this can make it difficult to provide a good level of certainty as to price within the contract.
Procurement contract management process: challenges and solutions
1. Choose vendors and establish contract requirements
🔃 The process:
In a typical procurement contract process, the contract manager is responsible for communicating with the project manager about the specific deliverables required, including but not limited to which items and services are to be purchased, how they’re to be quantified, and when to deliver them.
⛔ The challenges:
The difficulty with procurement contracts is that these discussions typically require input from a wide range of different departments, which can complicate who is responsible for approving which terms and values later in the contract workflow. In a manual contract lifecycle, this often results in contracts being sent for signing before certain terms have been approved, which can add risk to these transactions.
✅ The solution:
The best way to respond to these challenges is to implement a contract tool that enables users to set up approval workflows for certain procurement contracts, or even establish these approval workflows at template level.
By implementing software like Juro, users can add conditional approvers to contracts and ensure specific contract stakeholders are asked for their approval if there’s any deviation from standard or pre-approved terms. Alternatively, users can set up sequential approval workflows to ensure all teams have approved the contract terms before the agreement gets sent out for signing.
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