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What is a Procurement Contract?

December 10, 2020 4 min read

For enterprise business, procurement lies at the heart of the organization’s actions and purpose. Companies need to purchase materials, supplies and services cost-effectively and reliably. For sellers who provide products or services, knowing that the buyer will fulfill their end of the bargain — including paying invoices and abiding by all agreed-upon terms and conditions — is crucial. 

Procurement contracts — often called purchase contracts — are contracts that establish a legally binding relationship between buyers and sellers that protects both entities throughout the procurement process. 

Establishing the foundation of the business relationship, procurement contracts set forth the parameters of the deal, including:

  • Vendor selection
  • Product selection
  • Vetting
  • Payment terms and conditions
  • Contract negotiation
  • Product management (ordering, payment and delivery) 

And set the stage for a mutually satisfying business relationship. 

The significance of the procurement contract

The old adage, “time is money,” is at the heart of the procurement contract. To maximize profits and survive in a competitive marketplace, businesses need to be able to rely on their suppliers. Conversely, suppliers need to be able to trust that if they meet their end of the bargain, they will receive the agreed-upon compensation. 

An effective procurement contract solidifies business relationships by protecting both the buyer and seller. 

By including agreed-upon details — including the quality of the materials to be used, the parameters of the services to be provided, delivery times, fees, costs, etc. — procurement contacts provide a solid blueprint that allows both parties to collaborate confidently. In addition, procurement contracts allow businesses to diversify and use resources more effectively. Companies can outsource specific actions and processes to vendors who can fulfill their needs more cost-effectively by using procurement contracts. 

Vendors often produce products more cheaply and provide more comprehensive service at a better price because they operate on a larger scale through their agreements with similar businesses. For example, a company can outsource customer service to a third-party vendor who can fulfill that need at a lower cost because that vendor already has the customer-service infrastructure in place and supplies similar services to other businesses. 

The procurement contract process

Procurement contracts are usually generated by the buyer. At the start, the project team communicates with the buying department to establish what will be needed for a project, including materials, services, staffing, technical specs and other requirements. 

From there, the procurement team takes over, using this information to solicit bids from various vendors. Once a proposal is selected, the buyer uses the information gleaned from the buying department and project team to create the procurement contract.  Contract management for procurement contracts requires managing vendor relationships and coordinating across the different parties at every step of the process.

Types of procurement contracts

Procurement contracts can cover several different aspects of the buyer-seller relationship. The contract terms included in your procurement contract create the most beneficial relationship for both parties. 

The main types of procurement contracts include: 

  1. Fixed price contracts
  2. Cost-reimbursable contracts
  3. Time-and-materials contracts 

Fixed price contracts 

A fixed-price contract, also called a “lump-sum contract,” sets the terms of the project, establishes the good or service provided, when, and what price the buyer pays. The advantage of a fixed-price contract is that both parties have clearly defined roles and responsibilities. The seller knows exactly what they are required to supply, and the buyer knows exactly how much to pay once the contract is complete. Fixed-price contracts are straightforward and easy to manage and are the most common type of procurement contract. 

Cost-reimbursable contracts 

In a cost-reimbursable contract — sometimes called a cost-control contract — the buyer pays for the actual cost of the work completed. Here, the buyer agrees to cover the expenses not just for materials and equipment but also for indirect costs (like salaries and utilities) that go into creating the product or service. In return, vendors will be awarded either a fixed fee or a percentage of the profit over the cost price. 

Cost-reimbursable contracts place much of the risk on the seller, who initially bears the work’s cost and will only receive payment once all expenses have been verified and reconciled. In addition, if the scope of the work changes, the seller bears the responsibility for absorbing any additional costs those changes may trigger. To mitigate these risks, sellers build in additional fees for changes beyond the basics to discourage costly adjustments and improve their bottom line.

Time-and-materials

Finally, vendors can request a time and materials contract, which reimburses them for materials used while also including payment for the amount of time (days or hours) spent on a project. Typically, software developers request this time of contract because the bulk of what they provide falls into the services rather than the materials category.

In this type of contract, the vendor functions like a contract or third-party employee, with most of the cost attributable to the service or work being provided rather than a physical product. This type of procurement contract is best when a project’s parameters are harder to quantify because it allows more flexibility and the ability to change mid-course if needed. On the flip side, these types of procurement contracts generally require more oversight so that the project stays on track and on budget. 

The power of the procurement contract

Many organizations treat procurement as a “set-it-and-forget-it” operation. But a hands off approach to procurement can trigger disruptive and costly consequences. When a complication arises, the project will succeed or fail based on the strength and comprehensiveness of the original procurement contract.  

The elements in a successful (and functional) procurement contract include:

  • Full consideration of all sourcing processes
  • Robust and comprehensive negotiations
  • Detailed project management requirements
  • Precise definitions of key contract terms
  • Essential KPIs with specific contractual aspects included
  • Stakeholders being  aware of all terms and conditions.
  • Strategies for ongoing contract management once the bid is completed and the project is underway.

By making sure every role and eventuality is defined and assigned beforehand, you create a procurement contract that will protect your business and allow your vendor relationships to grow and thrive. 

Learn more about how to fast-track your procurement contracts and manage every step of the process in one place with a digital contracting platform.

About Ironclad

Ironclad is the #1 contract lifecycle management platform for innovative companies. L’Oréal, Staples, Mastercard, and other leading innovators use Ironclad to collaborate and negotiate on contracts, accelerate contracting while maintaining compliance, and turn contracts into critical carriers of operational business intelligence. It’s the only platform flexible enough to handle every type of contract workflow, whether a sales agreement, an HR agreement or a complex NDA. The company was named one of the 20 Rising Stars on the Forbes 2019 Cloud 100 list, and is backed by leading investors like Accel, Y Combinator, Sequoia, and BOND. For more information, visit www.ironcladapp.com or follow us on LinkedIn and Twitter.

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