Wednesday, July 20, 2011

Differences between production procurement and project based construction procurement

In a recent web post an individual asked whether contracts within project-based sectors such as mining & construction differ from traditional supply chain contracts.  I've worked in both construction and production procurement and they clearly are different. There are different costs and risks involved. In project related contracts there is a start and a clear finish, so there may be less of a focus on on-going relationship management.  Problems you encounter in a project based activity usually impact only the one activity, where as problems that occur in traditional production contracts can affect a huge number of products. While both may have many of the same risks, the frequency and magnitude of the risks will be different.

To briefly explain the differences I’ve created two tables. The first is a comparison based on traditional contract terms.  The second table lists the differences based upon specific issues.

Term of Contract
Supply chain view
Project based view
All changes require mutual agreement
May contain rights to direct changes to the drawings and specifications
Unit based
Traditionally based upon the completed project
Payment terms
Based on delivery of product
Usually milestone or percentage of completion with retainage held.
Delivery terms
May be agreed by the parties
Has to be the location of the project
Warranties and Representations
Will contain many warranties about the product.
Provides service warranties that work is done in a good work person like manner. Equipment warranties are passed through from suppliers
Limitations on liability
Important, usually concerned with the overall value of the purchases over time
Important. Usually tied to the project value
Basic requirement are similar
May require additional insurances such as on completed work or errors and omissions if contractor does any portion of the design
Termination rights
Termination for convenience usually allowed upon payment of certain costs.
Switching suppliers mid-project is difficult and costly. May instead include rights to suspend the work.
Frequently a competitive concern.
Usually not a concern unless the project involves construction for a sensitive or new process
Breach events
Material breach
Same, although switching supplier is costly so many times will complete work with the Supplier
Dispute management
May include process for management escalation.
Usually will include escalation process
Indemnifications for injury or property damage
Important for injuries caused by defective or unsafe product.
Important because of the nature of the business.
Intellectual Property Indemnifications
Important because of the potential magnitude (could affect huge number of products.
Less important because use is less and getting license for limited use should not be expensive
Governing law
Parties can agree to whatever law they want.
Same, although usually apply the location of the project.
Entire Agreement or Merger provisions
Included as there may have been discussions prior to agreement about the supplier’s product.
Les important as the project will be constructed in accordance with the Buyer’s drawings and specifications
Severability of clauses
Important for interpretation
Time of the essence provisions
Important for managing delivery or breach for failing to deliver on time
Not important as end performance date is the critical date and late delivery is usually tied to liquidated damages rather than termination rights
Order of precedence
Important for conflicts between documents.
Needs to address the precedence between drawings and specifications
Survival provision
Key to identify terms that will survive termination or expiration of the contract
Key to identify the terms that survive the completion of the project.
Waiver Requirements
Need to define what actions constitute a waiver of rights.
Slightly less important as the activity is not-repetitive in nature.
Catch-all provisions for performance of work or services
Usually not included
Frequently included – for example supplier shall provide all plant, labor, equipment and materials to provide ….
Rights to equitable remedies
Force Majeure
Probably more important was work is subject to more force majeure causes such as weather
Assignment rights
Usually prohibit assignment

Differences on specific issues:
Supply chain view
Project based view
Acceptance, acceptance criteria
Based upon complying with the product specification.
Based upon complying with the drawings and specifications. May include additional test and acceptance criteria for major systems or subsystems similar to capital equipment
Acceptance or rejection of non-conforming work
Requires return to the supplier.
Requires correction at the product location
Accept Conforming Purchase Orders
May be important term for continuity of supply.
Not important as contract is for the project.
Access To future Products
May be important.
Not important.
Allocation Of Supply
Important activity to address especially if single sourced.
May be cause for supplier requesting a change of design or specification to use alternative.
Required to make any changes.
Buyers may use change orders to specify change to the work where the agreement authorizes their use (which is common).
Auto Liability
Really only important is supplier will use vehicles in performance of the work.
Important as project will require substantial deliveries of materials and equipment.
Availability of Spare Parts, Repairs, Support
Important to protect the life cycle cost of the purchase or to provide customer support.
Buyer needs to negotiate that with equipment suppliers for the project.
Not commonly used.
Buyers may require performance bonds to pay for added cost to complete the work if the supplier fails or payment bonds to protect against subcontractor liens resulting from supplier non-payment.
Buyer's Responsibility For Instructions
Usually not an issue unless specific instructions are included in the agreement.
More frequently a problem if the Buyer or a Buyer representative such as an architect or engineer instructs the supplier on how to perform the work.
Buyer’s right to make changes To Specifications
Cancellation Rights 
Requires mutual agreement
Frequently included where there is a pre-agreed formula for compensation of such changes to allow for immediate action.
Carrier selection
Important for any non DDP delivery terms.
Not important. It’s supplier’s responsibility to get to project site.
Claims of infringement
Protection is important as claims can impact production and sales.
Slightly less important. Impact is not the same. Courts would not traditionally require removal and would allow for continue use with license fee.
Claims from Supplier Employees
Traditionally not a large concern as employees work at Supplier site.
Major concern as employees work on customer premises where injuries can be sustained.
Claims for delays, extra costs
Less frequent
More frequent as there may be more interdependence during performance.
Claims For Misappropriation of trade secrets
Important to manage if you will learn technical trade secrets of the Supplier
Less important as work is not being performed in a supplier controlled environment.
Compliance with laws, regulations or ordinances
Can impact the ability to sell or use the product.
Can impact the ability to use the premises
Comprehensive General Liability Insurance
Important for product liability lawsuits
Important for damages or injuries that could be sustained from the work operation.
Conflict Between Documents 
Addresses priority between various document including P.O’s
Needs to address priority between drawings and specifications
Continuity Of Supply
Very important, especially if you are single sourced.
Only important to capital equipment that will need parts and service over useful life.
Contract Term
A defined period of time.
Contract has a period for performance, but doesn’t end until all work is complete
Cost reductions
Frequently used for long term relationships.
Seldom required. Focus is more on value engineering to help reduce cost.
Coordination of work
Not important  if supplier performs all work at supplier site.
Important to avoid conflicts with buyer operations, and other suppliers that have access to the site.
Parties can agree to whatever currency they want (subject to local laws to the contrary).
Usually the site of the project. Main exception would be if major materials and equipment were coming from another country and there was concern about currency fluctuation between the site location currency and the material and equipment source currency
Damages to supplier's property on Buyer's site
Seldom applies unless supplier loans property to the buyer.
Common issue.
Delivery Flexibility
Needed to deal with changes to demand
Only applies to final completion date.
Delivery performance,
Measured for each delivery.
May be measured against milestones and final completion.
Delivery Term
Is the project location
Drawings and Specifications
Frequently are based upon supplier’s standard product specification.
Are unique to the Buyer’s requirements
Early Shipments
Frequently a problem for buyers.
Only problem with early completion is payment may be early.
Epidemic Defects
Major concern to deal with cost that occur in the field and rework to correct problem.
Not an issue as work has to be corrected by the contractor at the project site.
Errors and omissions insurance
Seldom used. Reliance is placed more on indemnifications and insurance to protect against risk
Common requirements for the company that performs the design for the Buyer.
Forecast responsibility
Key issue in supply chain management.
Does not apply to work. May have applied to the design requirements.
How promises are backed up.
Suppliers may want payment assurance and Buyer’s traditionally rely upon damages for non-performance
Buyers may require bonds or other financial guarantees for performance.
Supplier may place liens against the premises to protect interests.
Invoicing requirements
Tied to deliveries
Tied to either monthly progress or completion of milestones.
Import, export
Can be major issue for international purchases
Contractors responsibility to manage import. There is no export.
Key issue in managing order issuance.
Non-issue. There is only the dates for completion of the work.
Seldom apply.
Frequently apply and need to be managed.
Limitation of Actions (aging claims)
Important as agreements can be extend over extended terms.
Less important as project has a final completion date.
Certain logistics such as VMI may be important.
Only address if the buyer makes advance purchases and needs to assign and novate those agreements to the contractor.
Long Term Support
May be required as long as the Buyer has support obligations to their customers.
Contractor traditionally has no obligations and support for capital equipment needs to be negotiated directly with the manufacturer or subcontractor that installed it.
Lot acceptance
May be important to reduce cost of inspection.
Not applicable. Other forms of testing will be specified and done to ensure both quality and compliance with the specifications.
Non-conforming work cost responsibility
As correction must be performed at the site, supplier bears the cost responsibility
On-time delivery
Important to manage to the production schedule.
Major key dates are final completion or when other contract performance is dependent upon completion b a specific date.
Packing And Packaging
Important to manage against potential damage if delivery term has you assume risk of loss.
Not an issue. Supplier has responsibility to get the material to the site.
Payment terms
Traditionally net terms X days after delivery.
Usually based upon milestones or percentage completion with retainage.
Performance improvement requirements
Important for longer term relationships.
Not important. One of activity.
Personal Injury.
Concern applies only to product liability or automobile caused injuries.
Concern applies to both auto liability, injuries that occur on site and injuries that result from defective performance of the work.
Concern is competitiveness of the product over the entire term of the relationship.
Initial price is the price unless there are built in adjust provisions for changes in underlying costs.
Price Changes
May occur at the end of the term before any new term or must be agreed by the parties
Price changes do not occur during the project unless there are provisions to allow for adjustments (such as changes to rates of union contracts).
Property Damage
Concern only with product liability and automobile liability
Concern with automobile liability, liability from operations, and liability resulting from defective work or design
Product Withdrawal - End-of-life
Issue if you don’t have a commitment to a term of availability with Supplier
Not a major concern as you have a one time demand for the item and don’t need it on a recurring basis.
Product Liability
Important concern to protect against.
Not an issue. Issue here is errors or omissions in design or defect in the work that cause injury.
Quality Levels & requirements
Important to manage on-going quality of production.
Not used here. Quality is managed by oversight of work, testing of elements. If correction is needed it will be done on site or a deduct to the price will be taken of agreed.
Remedies for late delivery
May include things like right to cancel order, require premium shipment etc.
Primary remedy used for late delivery here is liquidated damages.
Reschedule Orders
Important tool to manage supply versus demand.
Not a tool used here. May include rights to suspend the work.
Risk of loss or damage in transit
Depends upon agreed delivery point and term
Totally contractor’s responsibility to have items delivered to site.
Subcontractor use, responsibility, approval and changes
Important as part of managing quality.
Supplier Changes
Depends upon the terms you negotiate.
May allow supplier to make changes to materials and equipment specified to meet the schedule provide that the new materials are equal to the substituted material
Supplier Claims
Usually based upon buyer changes – to volumes, schedule, requirements etc.
Based more on buyer directed changes to the specifications, buyer or buyer subcontractor cause delays or damage to the work. May also include claims for costs based upon differing site conditions where what was represent by topographical maps, soil samples and borings do not accurately represent what’s there.
Taxes and Duties
Dependent upon where title to the product passes.
Duties will be contractor responsibility.  Taxes will be based upon the location of the project
Technical Support needs.
May be required for determining root cause of problems experienced.
Contractor is usually not involve and support comes from manufacturer or subcontractor that installed the item,
Third Party Claims
Major risks are for infringement and personal injurty
Major risk is personal injury
Total life cycle cost
Concerns about life cycle cost involve warranty term and what’s included in the warranty. It also includes the cost of maintenance, spare parts or repairs.
Life cycle cost is driven by the buyer provided specifications and drawings.
Warranty Redemption, RMA processes
Important process to ensure you get committed warranties
All warranty correction must be performed on buyer’s site. There are no buyer returns or return processes.
Workers' Compensation Or Employer's Liability Insurance
Real importance is for situations where the Supplier personnel perform work on the Buyer’s site and could be injured and make a claim against the Buyer.
Very important as most work will be performed on the Buyer’s site

1 comment:

  1. Hi John,

    Fantastic and detailed post! You have exceeded my expectations and I really appreciate your efforts. Thanks for the sharing.