The Procurement of Equipment and Services
Key Concepts
The Nuances of Capital Equipment Procurement
Supply Management’s Role
Phase I: Build the Foundation
Phase II: Identify Objectives and Estimate Costs
Used Equipment
Estimating Acquisition Costs and the Total Cost of Ownership
Life Cycle Cost Analysis
Phase III: Develop Specifications and Initiate Sourcing, Pricing and TCO Analysis
Develop Updated Acquisition Cost and TCO Estimates
Phase IV: Sourcing Lease/Buy Analysis and Post Award Activities
Leased Equipment (See Addendum re. Leasing)
To Lease or to Buy?
Initiate Lease or Contract
Post-Award Activities
Summary
Purchasing Services
Key Concepts
Hidden Opportunities [to outsource services] at Polaroid
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The Statement of Work
Four Formats for Statements of Work
Planning the Statement of Work
Description of the work
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Service levels
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Supplier responsibilities
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Schedule
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Changes and modifications
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Buyer responsibilities
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Specifications and requirements
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Bonds
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Work approvals
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Quality requirements
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Charges and costs
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Use of subcontractors
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Performance measurements
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Project management
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Authorized personnel
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Deliverables
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Reporting requirements
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Exhibits, schedules, and attachments
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Delivery and performance schedule
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Safety
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Writing the Statement of Work
Tips on Writing an Effective S.O.W.
Selecting Service Contractors (Tips from a Professional)
The Ideal Services Supplier
Pricing Service Contracts
Contract Administration
Services Purchases and the Internet
Pricing Service Contracts
Pricing is constrained by three factors:
Conclusion: negotiation is usually best
Some Pricing Issues
Four Keys to Successful Service Contract Administration
Construction Services
Concluding Remarks
Purchasing Services and “Non-Traditional” Goods
Traditionally, purchasing and supply management professionals have been engaged in buying raw materials; subassemblies; supplies; maintenance, repair, and operating (MRO) items; and manufacturing-related capital equipment. Because of their increased involvement in the acquisition of various services, these professionals should demonstrate their capacity for enhancing profits in the private sector or benefits in the public sector through a better understanding of the methods and mechanics of purchasing services and nontraditional goods (SNG). The procurement of SNG demands greater appreciation for and comprehension of the generally labor-intensive nature of services, the technology and inherent training required for use of capital assets, and the market determinants involved in outsourcing and retailing. For example, purchasing and supply management professionals can apply opportunity-cost and benefit-cost analyses to the purchase of SNG by evaluating the return on investment or the return on assets from engaging a service provider, selecting a capital asset supplier, or favoring outsourcing over in-house production.
Types of Services and Kinds of Nontraditional Goods
Private and public sector organizations buy several types of services and kinds of nontraditional goods for use in their operations and administrative functions for the short- and long-term. A categorization of these services and goods can be found in the Consumer (CPI) and Producer (PPI) Price Indexes. These services are categorized as follows:
Similarly, nontraditional goods are categorized as follows:
These types of services and kinds of goods do not constitute an all-inclusive listing. For example, purchasing and supply management professionals may be asked to secure testing services and shop instrumentation for an organization.
Responsibility for Purchasing Services and Nontraditional Goods
Purchasing SNG requires familiarity with the nature and scope of different service types; comprehension of the technological characteristics of capital assets, including requisite training; and knowledge of the market mechanisms inherent in outsourcing and retailing. Usually the purchasing department depends on the expertise of individuals in the operating departments/divisions of an organization to identify competent sources for SNG as well as factors influencing the acquisition of resale items. These individuals support the mechanics of source selection and the decision to buy outsourced items or wholesale/retail items. In addition, they often participate in the evaluation of these providers of services or purveyors of nontraditional goods.
A 1995 study entitled Purchasing of Nontraditional Goods and Services by the Center for Advanced Purchasing Studies (CAPS) found that in the 116 organizations responding to its survey, individuals in the operating departments/divisions were responsible for spending 59% of the organizations’ total purchase dollars. This study examined the responsibility for acquiring such goods and services in three sectors (manufacturing, service, and government). Comparing the organizations’ total purchase dollars in each sector, this study revealed that the purchasing department accounted for 48% in the manufacturing sector, 22% in the service sector, and 49% in the government sector. This study also corroborates the higher rate of growth in the purchase of SNG throughout the various sectors of the U.S. economy. It can be inferred that purchasing departments can enhance profits in the private sector or benefits in the public sector through more effective involvement in the procurement of these services and goods.
Preparation for Purchasing of Services and Nontraditional Goods
Because the influence of service delivery and nontraditional goods utility can exceed the impact of the dollars spent, purchasing and supply management professionals should demonstrate the necessary credentials and qualifications to identify, select, and evaluate sources for these services and goods. These credentials and qualifications should permit them to thoroughly understand the essence and extent of the services to be purchased; the technology, coupled with the necessary user training, intrinsic to the efficient application of acquired capital assets; and the market factors encouraging the outsourcing of certain services or items and the retailing of select OEM products. Moreover, these professionals should be completely familiar with the execution of applicable financial analyses and relevant operations management methods employed in the decision to secure certain services, select specific capital assets, or subscribe to outsourcing or retailing rather than in-house production. Purchasing and supply management professionals should exhibit the necessary capacity and credibility preparatory to their assuming a leadership role in the selection of SNG.
For many organizations, the majority of total SNG purchases were not made by the purchasing department, as indicated by the chief executive officers and agency heads, in the 1995 CAPS study. These officials should provide the proper environment for SNG acquisitions, and seek the proactive involvement by the purchasing department. A collaborative approach, specifically the use of cross-functional teaming and strategic partnering, should be implemented to purchase services and nontraditional goods. This approach allows the purchasing department to effectively gain the integrative support of an organization’s operating departments/divisions, especially in making award decisions. With this support, purchasing can complement its capability and confidence in the identification and selection of responsible and competent sources for the purchase of SNG as well as the recognition of those market determinants affecting the acquisition of resale items. Moreover, the purchasing department can choose those strategic partners that will improve the organization’s profits or benefits, contingent on sector identity.
Process for Purchasing Services and Nontraditional Goods
The employment of cross-functional teaming permits each team member from the stakeholder operating departments/divisions of the organization to offer his/her discipline expertise to ascertain whether selecting specific providers of services or purveyors of nontraditional goods is proper under current budgetary or qualified source constraints. If such constraints exist, these team members can use their expertise and familiarity with competent professionals or firms to improve the possibility of mitigating these constraints. Prior to developing a request for proposal (RFP) along with its statement of work (SOW) or product specifications, however, the typical cross-functional team should carefully define any prerequisites for identifying, qualifying, and selecting competent service providers or goods purveyors. Some of these prerequisites include:
After delineating these prerequisites, the team members responsible for identifying, qualifying, and selecting these competent service providers or goods purveyors should:
Subsequent to taking these steps, the cross-functional team can begin identifying, qualifying, and selecting a competent provider or purveyor.
Regardless of their familiarity with responsible and competent providers or purveyors, team members should begin a thorough search of various sources from whom to solicit a proposal. Locating these suppliers involves:
After identifying potential service providers or goods purveyors, the cross-functional team can start qualifying those suppliers that have been found.
The qualifications of each provider or purveyor will form the basis for selecting the most appropriate supplier to satisfactorily resolve the key business issue or problem in collaboration with core staff in the stakeholder departments/divisions. In the qualification process, team members should:
After the completion of the qualification process, the cross-functional team can start the selection process. Team members should use their collective proficiency to craft a detailed RFP and SOW addressing the nature and scope of the key business issue or problem and defining the performance criteria, quality specifications, budgetary ceiling, and delivery schedule requirements.
The RFP should include clearly defined specifications, performance expectations, and acceptance criteria to ensure that all parties, particularly responding providers or purveyors, have an understanding of the complete requirements for the acquisition. Failure to adequately define these specifications, expectations, and criteria may result in the buying organization paying too much or not securing the appropriate services or nontraditional goods for the intended applications. Moreover, inadequate specifications can lead to restraint of competition, technological innovation, and quality improvements.
The most important part of the RPF is the SOW (the specifications). As with design or performance specifications used in the purchase of commodities, a SOW can be design- or performance-based. A design-based SOW states not only what is required but also how that requirement will be fulfilled. It is used when the buying organization wants strict control over the particular methodology used in performance of the work specified in the SOW. This control, however, can contribute to higher direct costs, restrictive competition, and higher indirect (administrative) costs associated with compliance monitoring. Conversely, a performance-based SOW describes the nature and scope of the issue or problem as well as the preferred outcome resulting from the performance criteria, quality level, budgetary restraint, and delivery schedule frequency. It allows the provider or purveyor the maximum flexibility to select the most cost-effective and efficient methodology to accomplish the work.
A clear, accurate, and thorough SOW will determine, to a great extent, the potential for a provider or purveyor to satisfactorily complete the objectives of the resultant purchase order or contract. Further, it will provide the expectant emphasis on price, quality, and delivery in addition to technical or professional excellence, supplier-furnished creativity, and timeliness of reporting interim progress or final delivery of the SNG. When crafting the SOW, the team members should have a complete understanding of all factors influencing the execution of this SOW together with the precarious balance between protecting the buying organization’s interests and promoting supplier creativity during the critical proposal preparation and post-award performance periods. Moreover, the team should be aware of possible misinterpretation of the SOW by all affected parties, and take the proper measures to solicit feedback from these groups. After the RFP with its SOW has been “approved” by all affected parties, the proposal package is ready for submittal to the provider(s) or purveyor(s). Contingent on the buying organization’s requirement for soliciting competitive proposals, the RFP will be conveyed to the select recipient(s).
Following receipt of these proposals, these team members employ their expert knowledge and considerable experience to examine each proposal for the most technically sound and innovative approach to resolve the organization’s key business issue or problem, consistent with the provisions stated in the RFP. The team can make an informed recommendation to the purchasing department of the best source for contract award. Then, purchasing can begin the analysis/confirmation process by using the same methodologies associated with commodities or product source selection, with some modifications. This process includes the utilization of as many analytical techniques as are practical for the specific procurement. The following analyses can be employed.
After conducting the appropriate analyses, the purchasing department, in collaboration with the cross-functional team members, makes the overall final contract award decision, consistent with the RFP’s SOW and other stated requirements. This fulfills the buying organization’s objective of providing the greatest expected value for the organization from selection of the most responsible and competent provider of services or purveyor of nontraditional goods.
Subsequent to choosing the most appropriate provider or purveyor, the cross-functional team should recommend that senior management consider establishing a strategic partnering agreement with the chosen supplier. Such an agreement would meet the organization’s immediate needs and also provide the organization with competent, long-term support for its specific issues or problems. Further, a strategic partnering agreement would create an interdependent and mutually beneficial business relationship conducive to meeting the organization’s profit or benefits objectives.
Many major organizations, even those in the public sector, are reducing the number of service providers and goods purveyors with whom they do business. Several of these organizations are developing strategic partnering agreements with one or a few suppliers. Credibility and continuity of support are joining price as important factors in choosing providers of services or purveyors of nontraditional goods. As these providers or purveyors demonstrate their concern for their buyers’ best interests, the price for their services or goods becomes less a factor than trust and commitment as a strategic partner. Establishing a partnering agreement with the most appropriate supplier involves:
The resultant agreement or alliance should demonstrate a strong commitment to achieving mutual benefits to both parties, based on open communication, reciprocal support, and trust. Moreover, this agreement or alliance should show an appreciation for the operational advantage available to each partner and the bilateral support for any adjustments to the underpinnings of the agreement or alliance.
The purchasing department should employ a logical purchasing process for the procurement of SNG. In the context of creating strategic partnering agreements or alliances, purchasing should eschew, whenever possible and permitted by governing law or regulations, competitive bidding and espouse negotiated procurements, especially through the use integrative or win-win negotiation, to secure such services or goods. For example, when purchasing professional services, the comparison of professional service quality and expertise is not amenable to price competition, and the delivery of these services does not exhibit the same characteristics as those for commodities or products. On the other hand, certain types of services or kinds of nontraditional goods can be purchased through competitive bidding. These include custodial and uniform services, capital equipment, and resale items. Typically, the choice between competitive bidding and negotiated procurements can depend on:
Given a good competitive market, however, a negotiated procurement usually permits the productive application of good business judgment coupled with a focused analysis of pricing. Nevertheless, purchasing should be cognizant of the possibility and desirability of engaging in strategic partnering, obviating the use of competitive bidding, with providers of these types of services and purveyors of kinds of nontraditional goods.
Purchasing and supply management professionals should pursue establishing blanket orders, open-end orders, or systems contracts as the appropriate vehicles for acquiring SNG. Other similar vehicles (i.e., consulting services contracts and standardized industry contracts) may be used for this purpose. Releases against these blanket orders, open-end orders, or systems contracts permit individuals from the user departments/divisions to initiate a procurement action without involving the purchasing department. Purchasing, however, retains the responsibility and authority to make any modifications to these orders or contracts. These procurement vehicles allow the purchasing department the time to demonstrate its professionalism in source selection and contract negotiation and administration. Ultimately, the type and scope of service delivery or the kind and volume of capital/outsourced goods will determine the choice of the most appropriate buying vehicle.
Purchasing’s proactive involvement in the areas of SNG acquisitions is affected by myriad laws and regulations applicable to the purchase of various types of services and kinds of nontraditional goods. The legal aspects relating to the execution of a purchasing and supply management professional’s responsibilities are more clearly visible in the public sector, which relies on the Federal Acquisition Regulations, state statutes, and local ordinances in formulating any one of the previously mentioned acquisition vehicles, including the terms and conditions stated in the boilerplate of each procurement. In the private sector, however, the Uniform Commercial Code (UCC) applies to contracts for the purchase of goods (primarily commodities and products) but does not pertain to contracts for services. Service contracts are governed by the body of common law. In mixed contracts, such as the purchase of nontraditional goods, the applicable law is determined by the predominant purpose of the contract. For example, the UCC applies to the purchase of capital equipment but does not apply if the major focus of the contract is the procurement of installation services. Here, common law would apply.
Especially in specific types of services, certain federal legislation may affect a contract for service delivery. Some of the major applicable acts include:
Other legislative and regulatory provisions that may affect a contract with a service provider or goods purveyor include:
Purchasing and supply management professionals should research and be familiar with considerations involved in the development of specific procurement vehicles to ensure that all applicable laws and regulations have been included. They should request a legal review of all contracts before finalizing them with either a service provider or goods purveyor.
Unlike traditional supplier evaluation methods, evaluation of the performance of services providers or goods purveyors should employ the same collaborative approach, using cross-functional teaming, involved in the process for purchasing SNG. This approach does not rely on establishing performance-rating standards but applies well-defined performance criteria, already established in the qualifying process prior to contract award, as the basis for such an evaluation. Team members provide input to the determination about each provider’s or purveyor’s conformance with such criteria.
Performance should be monitored at periodic intervals, and appropriate action taken to resolve significant issues identified during the period of performance. Previous performance history, either with the particular organization or others that may have offered a reference, can provide tangible guidance in the conduct of an objective evaluation. To the extent practicable, such evaluations should be quantified primarily for two reasons: (1) these evaluations are usually more objective and precise and (2) the feedback to the provider or purveyor is typically more meaningful and motivating. Regardless of the quantitative or qualitative nature of the evaluation method, scheduled performance evaluations are an important part of the post-award administration of a services contract. These evaluations typically contribute significantly to the maintenance of good supplier relationships, which in turn promote efficient and effective service delivery or nontraditional good utility.
Purchasing and supply management professionals have a distinct opportunity to demonstrate their competence and capabilities in buying SNG. Through the use of cross-functional teaming, they can enhance their visibility and credibility among the various departments/divisions of the organization and assume the responsibility for spending a larger percentage of the total purchase dollars.
Business Equipment: Buying vs. Leasing
Decide whether to lease or buy by learning about the pros and cons of each.
Should your business lease or buy equipment? The answer depends on your situation. Leasing equipment can be a good option for business owners who have limited capital or who need equipment that must be upgraded every few years, while purchasing equipment can be a better option for established businesses or for equipment that has a long usable life.
Each business is unique, however, and the decision to buy or lease business equipment must be made on a case-by-case basis. Here's a look at both options.
Leasing Equipment
Leasing business equipment and tools preserves capital and provides flexibility but may cost you more in the long run.
Advantages of Leasing Equipment
Less initial expense. The primary advantage of leasing business equipment is that it allows you to acquire assets with minimal initial expenditures. Because equipment leases rarely require a down payment, you can obtain the goods you need without significantly affecting your cash flow.
Tax deductible. Another financial benefit of leasing equipment is that your lease payments can usually be deducted as business expenses on your tax return, reducing the net cost of your lease.
Flexible terms. In addition, leases are usually easier to obtain and have more flexible terms than loans for buying equipment. This can be a significant advantage if you have bad credit or need to negotiate a longer payment plan to lower your costs.
Easier to upgrade equipment. Leasing also allows businesses to address the problem of obsolescence. If you use your lease to obtain items that may be outdated in a short period of time, such as computers or other high-tech equipment, a lease passes the burden of obsolescence onto the lessor. You are free to lease new, higher-end equipment after your lease expires.
Disadvantages of Leasing Equipment
Higher overall cost. Leasing an item is almost always more expensive than purchasing it. For example, a 3-year lease on a computer worth $4,000, at a standard rate of $40/month per $1,000, will cost you a total of $5,760. If you had bought it outright, you would have paid only $4,000.
You don't own it. In addition to the higher cost, you don't build equity in the equipment. Unless the equipment has become obsolete by the end of the lease, this lack of ownership is a significant disadvantage.
Obligation to pay for entire lease term. Another downside to leasing is that you are obligated to make payments for the entire lease period even if you stop using the equipment. Some leases give you the option to cancel the lease if your business changes direction and the equipment you leased is no longer necessary, but large early termination fees always apply.
Buying Equipment
Ownership and tax breaks make buying business equipment appealing, but high initial costs mean this option isn't for everyone.
Advantages of Buying Equipment
Ownership. The most obvious advantage of buying business equipment is that you gain ownership of it. This is especially true when the property has a long useful life and is not likely to become technologically outdated in the near future, such as office furniture or farm machinery.
Tax incentives. Section 179 of the Internal Revenue Code allows you to fully deduct the cost of some newly purchased assets in the first year. In 2007, you can deduct up to $112,000 of equipment (subject to a phase-out if you placed more than $450,000 of equipment in service in any one year). For example, if you are in the 25% tax bracket and you purchase $100,000 in business equipment this year, the net cost to you is only $75,000.
Possibility of depreciation deduction. Although not all equipment purchases are eligible for Section 179 treatment, you can still receive tax savings for almost any business equipment through depreciation deductions. (Some assets that don't qualify for the Section 179 deduction are real estate, inventory bought for resale, and property bought from a close relative.)
Disadvantages of Buying Equipment
Higher initial expense. For some people, purchasing business equipment may not be an option, because the initial cash outlay is too high. Even if you plan on borrowing the money and making monthly payments, most banks require a down payment of around 20%. Borrowing money may also tie up lines of credit, and lenders may place restrictions on your future financial operations to ensure that you are able to repay your loan.
Getting stuck with old equipment. Although ownership is perhaps the biggest advantage to buying business equipment, it can also be a disadvantage. If you purchase high-tech equipment, you run the risk that the equipment may become technologically obsolete, and you may be forced to reinvest in new equipment long before you had planned to. Certain business equipment has very little resale value. A computer system that costs $5,000 today, for instance, may be worth only $1,000 or less three years from now.
When deciding whether to buy or lease a particular piece of business equipment, try to figure out the approximate net cost of that asset. Be sure to factor in tax breaks and resale value when making this calculation. After determining which option is more cost-effective, consider other intangibles such as the possibility that the product will become obsolete (if you are considering purchasing) or that your need for the product will expire before the lease does (if you are considering leasing).
Types of Leasing Arrangements
Tax Lease Purchase ("TLP"): A TLP is a tax lease designed to allow for the ultimate purchase of the equipment at a pre-agreed date (window) for a stated value by the lessee. In many ways, it's the best of both worlds. Typically, high value equipment fits best into this kind of lease. A careful balance must be maintained to comply with both Tax and Accounting rules. A normal circumstance would involve equipment with a 60 month depreciable life but a value at 60 months of 25% or more. The "window" would allow for purchase of the equipment by the lessee during the 48 the month for an amount agreed upon at the onset of the lease (approximately 40% of initial cost). Up to that point, the depreciation would be declared by the lessor and the lease should be able to be carried off-balance sheet by the lessee. If the lessee decides not to purchase the equipment at the "window", then the lease continues to maturity. At that time, the lessee may elect to purchase the equipment for its then fair market value or may simply "walk away." If the sum of the lease payments, up to and including the purchase amount at the window, are used to calculate the effective interest cost, it will be found to be very competitive.
True / Operating Lease: A true lease is a "walk away" tax lease. The lessor buys the equipment and leases it to the lessee for an agreed upon term and then sells the equipment for fair market value and the end of the lease. This kind of lease is most popular for equipment with low future value due to use or technological change. True leases enable companies to acquire the most technologically up-to-date equipment with fixed monthly payments, but also enables them to pass on the risk of obsolescence to the lessor. The lessor has all the rights to the depreciation benefits and bears the risk of residual value. A true lease is usually an off balance sheet lease. Typically this lease will meet FASB 13 accounting rules.
Lease Purchase: A lease purchase is designed for ultimate ownership by the lessee. Because the residual is a specific dollar amount (typically a nominal figure when compared with the actual value of the equipment at the time of exercise of the option) this is not a tax-oriented lease. All depreciation belongs to the lessee and the asset must be shown on the lessee's balance sheet. Advantages of a lease purchase include paying sales tax overtime and a low initial "down payment." Lease purchase transactions are flexible by design and can usually be tailored to suit the special needs of the lessee.