Ch4_Feb08_CUP - CHAPTER 4 Procurement Contracting...

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1 CHAPTER 4 Procurement Contracting Strategies G. L. Albano, G. Calzolari, F. Dini, E. Iossa, and G. Spagnolo 4.1 Introduction Well designed supply contracts are essential to effective procurement. 1 By fixing obligations and promises, contracts protect each party in a procurement transaction against the risk of unexpected changes in the future behaviour of business partners, thereby allowing to safely and efficiently plan, invest, and produce in decentralized supply chains. Contract obligations ensure, for example, that a buyer will receive the right service or good when and as needed, as promised by her supplier; and that the supplier’s investment specific to a particular procurement will not be ‘wasted’, in the sense that the buyer will indeed buy what she ordered at the agreed terms. There are several types of contracts and very many dimensions along which apparently similar contracts differ, so that choosing the right contracting strategy is not always easy for a buyer. And a bad choice of contract can have very negative consequences for a buyer in terms of cost and quality of supply. However, economists and practitioners would agree on considering contract flexibility, the incentives for quality and cost reduction, and the allocation of procurement risk as the most important dimensions influencing the buyer’s choice of the procurement contract. In this Chapter we offer simple and practical indications on how to choose among different types of procurement contracts. We focus on situations where the needs of the buyers are unlikely to change during the execution of the contract, so that renegotiation of the initial contract specifications, which is generally costly for the buyer, is unlikely to occur. 2 In these situations, contract flexibility plays a limited role in the choice of the procurement contract whilst incentives for quality and cost reduction as well as procurement risk allocation remain central. The issue of contract flexibility will be analyzed in depth in Chapter 5. Also, we will discuss only briefly how the choice of the procurement contract can affect the characteristics of the suppliers that decide to participate in the procurement process. For an in-depth discussion of issues related to how to select the most efficient supplier, see Sections 2 and 3 of this Handbook. The present Chapter is organised as follows. In the first part we focus on explicit contracts ; that is, on written and legally binding contracts that can be enforced by courts of law and therefore can govern dimensions of the procurement that can be monitored and verified by a court at a reasonable cost. Within this framework, in Section 2 we explain the importance of choosing the allocation of
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2 procurement risk and the relevance of creating incentives for quality provision and for cost reduction. In Section 3 we describe the features of the most frequently used contract types. We discuss how these contracts differ in the allocation of procurement risk and in the provision of incentives on cost and quality dimensions that are hard to contract upon explicitly. We also discuss
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Ch4_Feb08_CUP - CHAPTER 4 Procurement Contracting...

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