Puchasing & Supply Management: Contracting (Part 2 : Contract types)

Summary

In this detailed lecture on contracting, Professor Finn Winstar from Rotterdam School of Management covers essential contract types used in purchasing and supply management. The video explores key mechanisms like fixed price, cost reimbursable, and unit rate pricing, alongside how these mechanisms impact both buyers and suppliers. The lecture further delves into the allocation of activities, especially in project-based capital expenditures, and highlights various contract structures such as Design and Build and EPC contracts. This content is a must-watch for those interested in optimizing supply chain contracts and understanding the intricacies of contract management in purchasing and supply management.

Takeaways

• 😀 The lecture discusses the importance of contracting in purchasing and supply management, focusing on contract types.
• 😀 Contracting is part of the broader sourcing process in supply management, following tendering and supplier selection.
• 😀 The main focus of the lecture is on two types of purchases: physical products and services/capital expenditures.
• 😀 For physical products, fixed unit price contracts are common, but they can suffer from the issue of double marginalization, which reduces supply chain profits.
• 😀 Buyback contracts, revenue sharing contracts, and quantity flexibility contracts help mitigate double marginalization by sharing risks between the buyer and supplier.
• 😀 For capital expenditure and services, contracts vary depending on the project, such as the construction of a factory or acquisition of office supplies.
• 😀 Contracts can involve three main mechanisms: pricing, payment, and activity allocation, each with different alternatives.
• 😀 The pricing mechanisms include fixed price, cost reimbursable, and unit rates, each with its advantages and disadvantages for both parties.
• 😀 Payment mechanisms include full payment upfront or installment-based payments, often tied to project milestones, which is common in long-duration projects.
• 😀 The activity allocation mechanism involves different contract types like construct, design and construct, and EPC, with increasing responsibilities for the supplier.

Q & A

What are the two main groups of purchases with respect to contracts mentioned in the lecture?

The two main groups of purchases are physical products (finished products, components, or raw materials) and services and capital expenditures.

What is the main issue with contracts based on fixed unit prices for physical products?

The main issue is 'double marginalization,' where the supply chain margin is divided between the two parties, each considering only its own margins, which reduces overall supply chain profits.

What is a buyback contract, and how does it benefit the supply chain?

A buyback contract allows a retailer to return unsold inventory at an agreed-upon price, reducing the retailer's risk and promoting better inventory management.

How does a revenue-sharing contract work, and what is its advantage for the retailer?

In a revenue-sharing contract, the manufacturer charges a low wholesale price and shares a percentage of the retailer's revenue. This reduces the retailer's initial cost, aligning their interests with the manufacturer's success.

What is the difference between fixed price and cost reimbursable pricing mechanisms?

In fixed price contracts, the supplier is paid a predetermined amount regardless of the resources required, whereas in cost reimbursable contracts, the supplier is compensated based on the actual resources used, such as time and materials.

What are the key features of unit rate pricing?

Unit rate pricing involves paying a fixed rate for a specified amount of output. It is commonly used for standardized activities where the quantity is not predetermined, such as in construction or oil and gas industries.

What is the primary benefit of milestone payments in long-duration projects?

Milestone payments help manage the financial flow during long projects, providing the supplier with funds as the project progresses and reducing the buyer's financial risk.

How do activity allocation mechanisms influence capital project contracts?

Activity allocation mechanisms determine the division of responsibilities between the buyer and the supplier. These mechanisms vary from simple construct contracts to more complex contracts like EPC (Engineering, Procurement, Construction) or DBFM (Design, Build, Finance, Maintain) contracts.

What is the purpose of using a fixed price contract with an economic price adjustment clause?

A fixed price contract with an economic price adjustment clause allows for price fluctuations in specific materials (e.g., steel) due to market changes, ensuring the supplier is not unfairly burdened by external factors.

When are cost reimbursable contracts typically preferred over fixed price contracts?

Cost reimbursable contracts are preferred in situations with high uncertainty or when the supplier market is not very competitive, as they reduce the financial risk for suppliers and encourage more bidders.