What is a Procurement Contract ?
A procurement contract is a legally enforceable agreement between a buyer and a vendor. Usually accompanied by volume discounts, the seller commits to making goods available to the buyer or engaging in the buyer’s project, satisfying particular criteria, and providing a defined price.
The buyer promises to either repay the cost of producing the supplies or take delivery of and pay for a designated volume of the seller’s supplies.
Eliminating uncertainty, a procurement contract lays the foundation for developing and maintaining the customer-vendor relationship. To handle suppliers effectively, we have put together a strategic sourcing guide. Download it right now to enhance cost savings and supplier relationships.
What is included in a Procurement Contract ?
A procurement contract is a means of clearly defining the terms governing the relationship between the buyer and the seller. In other words, the procurement contract specifies what both the buyer and the seller are expected to deliver, thereby guiding their expectations of one another.
A procurement contract mostly consists of the following :
Control of Performance and Observation
This process covers contract efficiency, procurement relationship management, required repairs and adjustments, and closing out of contracts.
Monitoring and performance control guarantees that every party satisfies their contractual responsibilities, thereby safeguarding their rights; it also ensures that every party gains from the deal.
Receiving, Checking, and Approval
Once the seller’s materials arrive, the inventory must be checked to guarantee it meets the agreed-upon standards. The purchase contract lays forth how it will be handled.
Contract Termination
Should at any point both sides of a procurement contract discover their differences irreconcilable, the contract specifies conditions under which it will be void, thereby guiding both sides forward.
Alternative Dispute Resolution
A procurement contract might specify how disagreements will be resolved to ensure that any problems that might arise during the buyer-supplier relationship will have a pattern for resolving them, thereby avoiding taking problems to court which often benefits only the attorneys.
Financial Control and Payment
This defines how preferences, invoicing, payment conditions, and methods of management of financial affairs will be handled. Should the conditions of the contract be satisfied, a procurement contract makes it abundantly clear how the money will be transferred.
Performable Securities
A procurement contract ensures a performance level that both the buyer and the seller are obliged to expect and thereby produce over their working relationship.
Models of Procurement Agreements
Your scenario, desired outcome, and degree of risk tolerance will determine the several purchase contracts you can accept from your suppliers. Furthermore, a contract is essentially a risk management tool providing expected performance the other can guarantee for both sides.
These are the three basic forms of procurement contracts that are available; together, they comprise several branches.
Fixed-Price Agreement
Provided the customer orders a minimum required quantity of inventory, a fixed-price contract ensures that a buyer will get specific pricing for goods or services.
For necessary goods that are vital to the buyer’s supply chain, fixed-price contracts are perfect since they bind the buyer into an agreement guaranteeing them supplies at an affordable cost, provided they follow the conditions of the contract.
A fixed-price contract, then, ensures supplies in return for a predetermined minimum order quantity.
Three key niches divide fixed-price contracts:
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Official Fixed Price
- A firm fixed price in the most basic fixed-price contract guarantees that between a customer and a supplier, the latter will make a minimum order volume and the seller will supply them at a designated cost.
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Fixed Price & Incentive Fee
- Under an FPIF procurement contract, the buyer pays a set price for a minimum order quantity of supplies and an incentive if the supplier meets and surpasses the requirements of the contract.
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Fixed Price with Economic Change Adjustment
- Under an FPEPA contract, the buyer agrees to purchase a specific volume of supplies and the seller agrees to deliver them at a fixed price—provided the cost of manufacturing the good or service in question remains the same. If supplier production costs rise, the supplier has flexibility to make suitable adjustments to safeguard their margins.
Contract for Cost Refund
A fixed-price contract guarantees both buyer and seller to be bound to:
- As long as the customer follows through with the minimum necessary order, the seller will offer an ideal price for them.
- The buyer will make a minimal volume of orders from the seller.
Conversely, a cost-reimbursement contract states that the buyer will reimburse whatever the capital cost a seller pays into creating a good, service, or project.
There are three primary groups into which cost reimbursement agreements fit:
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Cost Plus a Fixed Price
- Under the CPFF approach, the seller provides a quotation for the project, good, or service the customer wants. Quantity and quality requirements are laid down, and the seller is required to pay for running the project from inception to conclusion. After completion, the customer pays the seller back the costs spent during order delivery plus a specified bonus—say, a percentage of the total value the order brought about.
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Plus Incentive Fee for Cost
- The seller commits to footing the cost of producing the ordered purchase using the CPIF model. Once the order is fulfilled successfully, the buyer is obliged to reimburse the seller any cost associated with the project as well as an agreed incentive fee for effectively executing the order. If the seller falls short in meeting the conditions of the contract, a Cost Plus Incentive Fee contract calls for the buyer and seller to share the expense of the failing project.
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Plus Award Fee for Cost Plus
- A CPAF contract is set up such that the seller supplies the goods and services, or carries out the project as decided upon with the buyer. Once finished, the buyer pays the supplier back for expenses and an award fee at their discretion. The award fee can be as little as the buyer wants or as great as necessary.
Cost reimbursement contracts shift the capital cost for generating and delivering the buyer’s order on the seller while requiring the buyer to reimburse the seller with interest should the conditions of the contract be fulfilled. These contracts can come into play when a buyer is looking to purchase a custom good or service or when a seller is working on a project that will need continuous effort to finish instead of only collecting payment and forwarding them to the buyer.
Contractual Agreements on Time and Materials
Under a time and material contract, the buyer promises to pay for the time and resources committed to the desired good or service. In exchange, there is a legally enforceable agreement stating that the time and resources will not surpass a given volume in order to maintain acceptable expenses and prevent fraud.
One clear instance of this would be in the digital services sector, where a freelancer may quote 100 hours to produce a newly created website. Priced at $100 per hour, the company bargains for the website development process to not surpass 80 hours. The project can start when both sides agree. The web developer can also forward an invoice for the hours worked plus extra material charges, including web hosting, premium themes, SaaS subscriptions (Cloudflare, etc.), and business email setup when the website project is totally delivered.
