A construction company’s purchasing policy is based on a combination of five overall objectives (Palmer et al., 1995): (1) price, (2) quality assurance, (3) delivery schedule, (4) vendor responsibility and (5) quantity control. Some of these factors relate directly to the material suppliers, while others, such as quantity control, are matters the contractor’s firm must manage. Tradeoffs among these objectives are a constant challenge. For example, it may be best to pay a higher price for some item in exchange for the assurance of no delays in delivery or higher quality.
Figure 5.23 Jobsite layout plan. From Construction Jobsite Management, 1st edition, by W.R. Mincks and H. Johnston © 1998. Reprinted with permission of Delmar, a division of Thomson Learning. Fax 800 730–2215.
One interesting policy issue affecting both the individual project and the contracting firm is whether material procurement should be a function that is centralised in the home office or carried out entirely at the jobsite. A contractor with a regional or nationwide range of operations that takes on relatively large projects will establish large project offices capable of conducting most or all of the procurement function. The advantages of carrying out local, or jobsite, buying are the positive relationships such purchases are likely to engender in the local community and the probable better service in case of mistakes or emergencies. On the other hand, centralised buying tends to result in lower prices because larger quantities can be procured at one time, long-term, high-volume customers tend to be favoured in times of shortages, excess materials on one project can be more easily utilised on other projects and better financial control of the purchasing function can be achieved (Palmer et al., 1995).
The materials procurement process consists of several interrelated steps, as follows: receipt and evaluation of offers, purchasing or placement of the purchase order, approval by the owner or owner’s representative, expediting or contact with the supplier to assure timely delivery, fabrication, shipping, delivery and inspection. For relatively minor items, many of these steps may be extraneous: the contractor may purchase small quantities of nails or bolts by sending a truck driver to the local hardware store with a purchase authorisation; provided these materials meet the technical specifications, the procurement process will be completed when they arrive back at the jobsite. For most materials, however, especially those manufactured specifically for the particular project, all of the listed steps will be followed. The first two take place during or prior to project mobilisation; we shall describe the remaining steps during our consideration of the project operations phase in Chapter 6.
In the process of compiling its cost estimate for the tender, the contractor can expect to receive, by post, fax, telephone or e-mail, offers from material suppliers. The management of the receipt and evaluation of the offers requires organisation and skill in ascertaining exactly what is being offered. Among the questions the astute estimator will want to ask are the following: Does the offer meet the plans and specifications? Is a substitution being offered? Will these materials come from inventory or from special order? What is the supplier’s manufacturing capability? Can the supplier meet the required delivery schedule? Are delivery costs included in the offered price? Are taxes included? Does the offer include the cost of loading and unloading the materials?
It is likely that offers will not have been received for all materials during the tendering process; in that case, the estimator will have made a ‘best guess’ of the cost, based on prior experience and judgment. Now, during mobilisation, all materials must be purchased. A process for soliciting offers for materials not previously offered and for confirming the most favourable offers previously received will lead to decisions to purchase. Except for the smallest of projects, whose purchase arrangements may be made by telephone or by simply visiting the supplier, the terms of each purchase are incorporated in a purchase order, which is a contract between the contractor and the supplier. The simplest purchase might use a form like that from a mail order catalogue; for more complex materials and equipment, the purchase order will incorporate detailed plans and technical specifications. Purchase orders are intended to do four things (Palmer et al., 1995):
1 Establish the responsibility for buying the things that are needed and only those things.
2 Tell the supplier in writing exactly what has been ordered; how, when, and where it is to be shipped and billed; how much the company expects to pay for it; and any other information necessary to fill the order promptly and accurately.
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3 Provide an internal check on purchasing, on receiving, and on the payment of money for items purchased.
4 Under the Uniform Commercial Code [in the US, and similar laws in other countries] fix certain of the terms of the contact of purchase and sale.
No matter how complex the transaction, a purchase order will contain five basic elements (Halpin and Woodhead, 1998): quantity or number of items required, item description, ranging from a standard description and stock number from a catalogue to a complex set of drawings and specifications, unit price, special instructions and signatures of agents empowered to enter into a contractual agreement. Purchase orders are numbered sequentially, with numbers strictly controlled. In addition to the original that is sent to the supplier, the contractor keeps copies for use by those who prepare vouchers for payment, who receive the order at the jobsite and who are responsible for expediting. Many of these ‘copies’ may be electronic, as many contracting firms conduct much of the communication regarding the procurement function via e-mail and the Internet. A typical purchase order is shown in Figure 5.24, which shows information about each item ordered plus instructions about how the shipment is to be marked for shipping, as well as various conditions governing the order.
One important aspect of any purchase that must be clearly defined is the point at which title of the purchased materials passes to the contractor. Consider a purchase made in Seattle, Washington, USA for use at a construction project in Fairbanks Alaska, 2450 km north by air and longer by sea or road. If the materials are damaged during their transport from Seattle to Fairbanks, which party will initiate a claim for compensation? The answer is the party who owns the goods at the time they are damaged. The purchase order must answer that question clearly. An extensive body of law has developed over questions related to shipping. We mention only a few aspects.
If delivery and payment take place concurrently, the transaction is called a cash sale and title passes when payment and delivery occur. If the purchase order requires the seller to deliver the materials personally to the buyer’s location, the seller owns the materials until they are delivered. The most complicated situation is that in which the materials are shipped by common carrier; in that case, the general rule is that title passes to the buyer when the seller delivers the goods to the carrier for subsequent transport. As with most general rules, there are exceptions! A purchase order that specifies a ‘free on board’ (FOB) location means that the seller is required to deliver the materials to a common carrier and pay for transportation costs to the FOB location at no cost to the buyer, with title passing to the buyer only when delivery is completed. Thus, our purchase order might specify ‘FOB Jobsite Fairbanks Alaska’, in which case the materials would be owned by the seller until delivered to the Fairbanks project location. A variant is the ‘cost, insurance, freight’ (CIF) arrangement, under which title passes when the materials are delivered to the common carrier but the price paid includes the cost of the materials, usual insurance and freight to the buyer’s location. Further discussion of title of purchases in construction can be found in Clough and Sears (1994). The general ideas apply to shipping of all kinds of goods throughout the world; a standard reference on international shipping is CIF
and FOB Contracts: British Shipping Laws by Sassoon and Merron (1995).
Subcontracting
The contractor’s other major responsibility under ‘buying out the job’ is to arrange subcontracts for those portions of the work the contractor will not perform itself. First, the contractor must
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decide which work will be subcontracted, a decision that is made, for most subcontracts, before the project mobilisation phase. Then, proposals will be received and analysed. Finally, negotiations lead to finalising the subcontracts.
To subcontract or not?
Subcontracting has its advantages and disadvantages. Subcontractors maintain organisations of personnel with special skills that often allow the work to be performed better and less expensively than the general contractor could do it. In addition, it may not be economical for the general contractor to acquire and maintain the special equipment needed for certain work. The skills provided by electricians, for example, are more likely to be found in an electrical subcontractor’s organisation than in that of a general contractor. Likewise, general contractors often subcontract earthmoving work on building projects so as to avoid having to provide the required equipment. Furthermore, subcontracting allows the contractor to unload some of the risks and financial burdens of a large project onto other organisations. It is common practice among some general contractors, when preparing tenders, to add smaller margin percentages to work that will be subcontracted than to that which they will do themselves, in recognition of this reduced risk.
On the other hand, the contractor relinquishes some degree of control over the work by subcontracting. If delays occur or other difficulties arise, the contractor’s task of responding and making corrections is more complicated because of this lack of direct control. Although the contractor has potentially less risk in such an arrangement, a subcontractor that proves to be financially unstable can leave unpaid obligations for which it has already been paid and the contractor may face a legal process and loss of considerably more than the profit expected from the project.
It is common practice that certain types of work will be subcontracted. General contractors that are preparing tenders and are on the planholder’s list will automatically receive proposals from some speciality contractors without soliciting them. In building construction, subcontracts are likely to include electrical, mechanical and painting work. In highway construction, steel bridge erection, painting of roadway markings and installation of guiderails are commonly subcontracted. Nonetheless, the contractor will still have to weigh the advantages and disadvantages of subcontracting as it decides which portions of the work to turn over to these specialists.
Subcontract proposals
As noted in the previous section on material procurement, most initial proposals for materials and subcontracts are received by the contractor during the estimating and tendering process. Proposals for subcontracts, especially the larger ones, are likely to be received within a few days or even a few hours before the time when tenders are due and the natural activity and confusion inherent in tender day makes it a challenge to evaluate these proposals properly. Just as for material proposals, the contractor must be prepared to ask a series of questions of subcontractors, but it will want to know about both the subcontractor’s organisation (unless that information is already known) and the proposed work. The contractor will want to know the subcontractor’s experience, expertise, personnel, current workload and financial status. With regard to the proposal to provide subcontracting services, the contractor will require information about the particular specification sections that would be covered, with any proposed exceptions,
whether the proposal is to furnish, unload and/or install, whether freight, insurance and taxes on furnished materials and equipment are included, how long the performance of the work is expected to take and whether the effort can fit into the master programme, what lead times will be required for shop drawings, manufacturing and delivery and whether the subcontractor intends to utilise its own equipment, storage facilities and office space or rely on the general contractor for these support services.
The following is a direct quotation from a proposal from a mechanical subcontractor; to save space, several of the exclusions are omitted here.
Quotation for: Division 15 – Mechanical complete except for items specifically excluded below.
Exclusions:
Excavation/backfill/compaction Exterior utilities
Pipe bedding/dewatering/shoring
Concrete sawing/removal/core drilling/patching Debris removal
... ... ...
Cost of bond/builders risk insurance Division 13900 Sprinkler
Inclusions:
Materials and equipment Installation labor
Supervision One year warranty Freight to jobsite
Red-lined as-built drawings Fuel gutter
Total price ... ... ...
With statements such as these and answers to such questions as suggested above, the contractor must compare the offers and decide which is the most favourable to include in its tender price. As one example, suppose proposals are received from two electrical subcontractors. Electrical subcontractor A proposes to install foundations for electrical equipment with its own forces, subcontractor B states that it will not do this foundation work. Both proposals are otherwise equal in terms of work to be provided and the proposed price from contractor A is US$ 12 000 higher than that from contractor B. In evaluating the two proposals, the general contractor must decide whether it can do the foundation work itself for no more than US$ 12 000 in direct costs and other expenses and impacts.
Like material procurement, some subcontracted work may not be solicited until after the contract is awarded. The contractor may not have received subcontract proposals during the tendering process for work it intended to subcontract or it may decide after being awarded the contract that it will subcontract some work it had initially intended to perform with its own forces. In these cases, the solicitation, receipt and evaluation of proposals will take place during the project mobilisation phase, using the same guidelines suggested above.
174 The Management of Construction Subcontract negotiation and award
Until the contractor is awarded the job, there is no need to negotiate and award subcontracts. Now, in the project mobilisation phase, these tasks will be carried out. The negotiation process will be conducted by principal officers of the contractor and subcontractor who are skilled in paying attention to the ‘fine print’ in contracts. The contractor’s personnel will be primarily interested in whether the apparent successful subcontractor can do the work, has sufficient financial capability and will be able to meet schedule, safety, environmental and related responsibilities. Until the subcontract is signed, several topics are ‘on the table’ for discussion and resolution; some of these may not have even been thought of during the initial proposal submittal and evaluation. Palmer et al. (1995) provide a checklist of 39 to be considered by those who negotiate and award construction subcontracts. These questions range from ‘Are the names and addresses of the parties correctly stated?’ and ‘To what extent does the subcontractor assume the responsibility to protect the work, the public and the owners of adjacent property from loss or damage?’ to questions involving insurance coverage, jobsite cleanup and payment of legal expenses in case of disputes.
The form and content of the subcontract document varies as much as the work does itself. Standard forms are available from various organisations, such as the Associated General Contractors of America and the F´ed´eration Internationale des Ing´enieurs-Conseils. Many general contractors have developed their own subcontract forms that incorporate their subcontracting policies. Various owner organisations, especially in the public sector, have their own subcontract forms. The subcontract will incorporate by reference the drawings, general conditions, technical specifications and other documents, just as the prime contract does. The standard short form subcontract published by the Associated General Contractors of America is shown in Figure 5.25 (Associated General Contractors of America, 2000). It will be noted that, in addition to various matters pertaining to the particular project on page 1, the document includes three more pages of conditions ranging from safety, time and payment to claims and disputes. Four pages of instructions for using the form are also part of the full document. The wording is typical contract language, whether in a prime contract or a subcontract. In most cases, the subcontract will be signed by all parties prior to the commencement of any work covered by that contract. If such an arrangement is not possible, the general contractor can issue a letter of intent and notice to proceed, to get the work started and to assure the subcontractor that a completed subcontract will be forthcoming.