Introduction

The distinction should not be between the service and manufacturing industries, but rather between the process of buying services and buying goods. Manufacturing purchasing organizations focus on buying goods (their bread and butter) and often (by policy or by ignorance) leave others to do service purchasing. The service purchases are there, even though they are often awarded and administered in an all too often “unprofessional manner” by every organization in the company other than the purchasing department. Unfortunately most organizations deal with service purchases in a “decentralized manner”. This of course makes them fertile ground for cost savings through centralization within the purchasing department. Companies in service industries also buy goods as well as services, but most of their purchases are incidental to their main focus, providing their in-house services to others.

With that in mind, I have borrowed from my book “Service Purchasing” (Van Nostrand, 1994) to draw some comparisons between purchasing goods and purchasing services.

Comparisons: Service and Goods Purchasing

We will include in our comparison not only pre-award (procurement) functions but post-award (administration) functions as well.

Individuals making the transition from supply purchasing to service purchasing are often struck first with the differences between the supply and service industries. To begin with most supply vendors have been obliged to invest substantial sums for plant and equipment before commencing operations, whereas some service vendors can operate with little investment in facilities. One result of this situation is that most service businesses are small (according to Small Business Administration standards). Many can also qualify as small-disadvantaged (minority) or women-owned. Because of the large concentration of small and small-disadvantaged businesses among service providers, both public and private sector purchasing departments often try to further certain socio-economic goals by setting service purchases aside exclusively for small or small-disadvantaged businesses. The combination of a heavy concentration of small and small-disadvantaged businesses with socio-economic setasides has resulted in most organizations buying their services from smaller, less sophisticated firms. Such purchases often present more problems for the buyer.

The depth of competition present in service purchasing also surprises new buyers, particularly if they have come from a Government or public sector supply purchasing background. Although many Government (particularly DOD) supply purchases are sole source or limited source because of their specialized requirements, most service purchases are heavily competitive. The author has witnessed service purchases with as many as 20 or 30 offers, even for modestly-sized contracts. One might question the economic efficiency of so many firms bidding on a job which only one can win. Even the FAR accepts two (or more) offers as "adequate price competition".

New service buyers may also be confounded by funding rules that differ from those they are accustomed to. Supply purchases are almost always fully funded and obligated. Service purchases, on the other hand, often span fiscal years. Government agencies in particular attempt to relate work effort closely to fiscal year funding and hence generally fund only the work needed in the current fiscal year. Service buyers and vendors are normally very familiar with "Availability of Funds for the Next Fiscal Year" provisions which tell the service vendor he will have a contract for the next fiscal year only the necessary funds are appropriated.

Another arena of differences between service purchasing and supply purchasing is the make-or-buy decision. Both private and public sector organizations tend to have highly formalized make-or-buy decision-making procedures for supplies. This is often not the case for service purchases. Although the Federal Government has a very formal system for analyzing in-house versus contract services, the services for which it hires contractors are often incremental services it cannot perform in-house because of funding or personnel ceiling limits. This creates situations where most of a service function is performed in-house, with an incremental piece of the function performed by contract. Federal Government employees may be sitting side-by-side with contractor employees performing the same task. When one of the factions earns more than the other, conflict and ill-will results. In contrast, most non-Federal public and private organizations do not have any program for analyzing in-house versus contract service operations and often undertake contract operations irrespective of the comparative economics of the two alternatives.

Service purchasing also provides an interesting contrast with supply purchasing in the area of labor laws, especially in the Federal Government arena. In Federal supply purchasing, buyers must be familiar not only with the Fair Labor Standards Act but also with the Walsh-Healey Public Contracts Act. This latter act contains, in addition to requirements for working conditions, restrictions against dealing with vendors that are not either manufacturers or regular dealers. (This latter aspect of the law is probably a good business practice for all buyers to follow even though the law is applicable only to the Federal sector.) Walsh-Healey places both pre-award and post-award requirements on the Federal Sector supply buyer. On a pre-award basis, the Federal Sector buyer must obtain certifications from vendors on their status as manufacturers or regular dealers (and deal with protests from other firms who allege the low bidder fails to qualify under this criterion). On both a pre-award and post-award basis, the Federal Sector buyer must process suspension and/or debarment actions against vendors which have been proven to have falsified their manufacturer or regular dealer status.

In contrast, Federal Sector service buyers, must invoke the Service Contract Act and the Contract Work Hours and Safety Standards Act (the latter act is designed primarily for construction-related work) in addition to being familiar with the ubiquitous Fair Labor Standards Act. The Service Contract Act places a greater administrative burden on the Federal Sector buyer than does the Walsh-Healey Public Contracts Act. On a pre-award basis, the Federal Sector service buyer cannot award a covered service contract until that contract contains a contract and area-specific wage determination. The Department of Labor (DOL) in Washington , D.C. rarely issues such a determination before 90 days have elapsed from the date of initial request. On a post-award basis, the Federal Sector service buyer is held to strict Service Contract Act requirements for a new wage determination if he/she intends to extend the contract. In addition, the Service Contract Act limits the elements of cost that can be adjusted on an extension to direct labor and related costs, excluding material, overhead, G&A, or profit increases. The Federal Sector service buyer must assist DOL in administration of the law on his/her contract and, if suspension or debarment action is warranted, initiate the action. A lengthy explanation of the impact of this law is available at Appendix A.

The Federal Sector buyer of construction services has perhaps the greatest administrative burden of all in that he/she must administer the Davis-Bacon Act and its related acts for DOL. A great number of pre and post-award responsibilities and duties must be performed. A full discussion of these laws is beyond the scope of this lesson. A lengthy explanation of the impact of this law is available at Appendix B.

Descriptions of requirements also differ in supply and service purchases. In supply purchases, item usually of "off-the-shelf". The same specifications (with minor updates as necessary), can be used from purchase to purchase. The buyer rarely gets involved in the preparation of the specification. In service purchasing the specifications, called statements of work and including construction specifications and drawings, tend to be contract-specific and tailored to the circumstances. Moreover, statements of work generally require a technical/contracting team approach . Because they are contract-specific and developed under severe time constraints, statements of work tend to be less comprehensive and reflect less depth of understanding than supply specifications. This is particularly true where the organization has never performed the service in-house and has never contracted for similar services before. Some organizations take the easy way out of this dilemma by asking the service contractor to write the statement of work. They do so, of course, at their own peril.

A related issue is that of the in-house estimate. Although it is a good business practice to prepare such estimates for all purchases, service purchases demand the preparation of detailed in-house estimates. They are often awarded on technical as well as cost considerations and are awarded after technical and/or cost negotiations. In many instances, a detailed in-house estimate (supplemented by an audit of records, if appropriate) is all that stands between the service contractor and the organization's bank vault. Construction contracts, although rarely negotiated, likewise depend heavily upon detailed estimates, not only as a basis for reviewing and verifying bid errors, but also as a means of establishing and verifying schedules of prices used in pricing contract changes and for making payments.

Buyers of services generally find the process paper-laden. In addition to tailored statements of work, service purchases generally require written solicitations built around those statements of work. Tailored statements of work must be accompanied by tailored schedules and other terms and conditions. Buyers of services rarely have the luxury (enjoyed by their supply buyer associates) of using time-saving oral solicitations to obtain quotations and proposals for their services. This administrative detail generally lengthens the lead-time for service purchases. In the author's experience the procurement lead time for services is about two or three times longer than that for supply purchases. Advance purchasing plans for services should not disregard this difference.

Buyers of services must be adept in using various types of contracts, whereas the buyer of supplies can often spend his/her entire career awarding firm-fixed-price (lump-sum or fixed price line item) contracts. The indefiniteness of service requirements provides many circumstances where indefinite quantity-indefinite delivery, requirements, or time and material/labor hour contract types are necessary and appropriate. The service contracting situation may, in fact require combination or composite contract types, with certain clearly defined contract services falling under a firm-fixed-price line item and other less clearly defined contract services falling under a requirements or time and materials line item(s). The application of firm-fixed-price contract type thinking to all service contracts is courting disaster that will manifest itself in problems with contract administration.

Unlike the majority of supply contracts, most service purchases (other than construction) will consider technical approach and experience to be at least as important as low price. A&E firms are, in fact, selected solely on technical qualifications: contract is awarded based upon negotiation of a fair and reasonable price with the best technically qualified firm. Other service purchases generally select the successful firm based upon technical and cost proposal submittals, with lowest being price only one of the factors used in selection. Some organizations even assign price such a low weight that it has little effect on the selection results. In the public sector, these purchases are considered negotiated procurements, and discussions will generally be held on both technical and price/cost matters.

Unlike supply deliverables, which are usually of a tangible personal property nature, service purchase deliverables can take many forms. Good purchasing would call for packaging services into discrete deliverable work units in order to avoid the appearance of personal service contracting. Unless the purchased service is measured in discrete work units, contract administration personnel tend to deal with contractor personnel as if they were working directly for the buyer organization, thus creating the problems associated with personal service contracting.

Examples of discrete work packages would include square feet of interior or external masonry wall painted; square meters/yards of lawn mowed; numbers of guard posts manned; etc. This type of work line item could be readily priced either as a lump sum or a fixed price line item. If unable to define requirements as discrete work packages, writers of statements of work should develop time and material or labor hour line items. The process involved uses estimated manhours against which loaded labor rates (including base hourly rate, benefits, overhead, G&A, and profit) can be developed and applied. Total dollar estimates for material usage (excluding labor, overhead, G&A, and profit) are normally added to the total labor estimate to derive a total cost estimate for the work. Unlike discrete work package deliverables, which are usually amenable to measurement and review for quality, the output of time and material/labor hour contracts is delivered as expended man-hours. It is considerably more difficult to measure the quality of man-hours than it is most discrete work items.

Supply purchasing, (unless it is accomplished in a JIT environment), invariably involves a "one shot" ordering process. Service purchasing, conversely, often necessitates the use of requirements or other indefinite quantity contracts which rely heavily upon ordering "as needed". Most time and materials/labor hour contracts are also of this nature. Although most statement of work preparers attempt to develop lump sum requirements, the probability of their being able to do so decreases as the complexity of the required services, size of the contract, and the period of time covered by the contract increases. Multiple ordering generally adds to the administrative workload, and inability to develop lump sum requirements leads either to complicated composite-type contracts or to multiple ordering.

The frequency with which bonding is required is another difference between supply and service purchasing. Although bonding is rarely employed in supply purchases, construction contracts are almost always bonded. Bonding of non-construction service contracts represents somewhat of an "in between" situation, with many buyers invoking bonding requirements on a business judgement basis.

Inspection procedures also differ somewhat for supplies and services. Supplies of a non-critical nature are normally inspected at destination. Supplies of a critical nature will often warrant inspection at origin, before the items are shipped to the buyer's manufacturing facility. Services must always be inspected at the performance site. Suppliers that fail to deliver conforming items subject themselves to rejection or return of the items purchased. Service contractors which fail to perform timely or at the required level of quality are all-too-often paid for their shoddy workmanship. This does not mean that service contracts cannot be written so as to assure adequate quality. It is the challenge of every statement of work writer to interject clear, unambiguous standards of quality and methodologies for measuring conformance. Contracts written with effective quality requirements facilitate the buyer's ability to demand quality performance through either reperformance or reduction in payment for work not performed or below the requisite quality standard.

Contract terms of performance often vary between supply and service purchases. Significantly sized supply purchases of a non-systems nature generally terminate upon successful delivery or (heaven forbid) default in delivery. Service purchases of significant size and scope, unless they are terminated for convenience or default, will generally either terminate at project completion (often years in the future), or be extended at the option of the buyer. Although utility service contracts will often have a ten year term, the standard term for many service contracts is one base year and four one year options. Use of service contract renewal options facilitates annual schedule price adjustments around either economic price adjustment escalators/deescalators or pre-priced additions to the work. In Government service contracting, the Fair Labor Standards Act and Service Contract Act limits annual adjustments in labor and labor-related cost changes indicated by a new Service Contract Act wage determination. Although renewal options are not unheard of in supply purchasing, their use is much more pervasive in service purchasing.

Final payment for supply purchases is invariably made after receipt, inspection, and testing of merchandise and receipt of an acceptable invoice. Although final payment in construction contracts is made upon project completion, service purchases generally call for monthly invoicing and payment through buyer choice (contract requirement). This is generally true whether the service is priced on a lump sum or indefinite quantity basis.

The administration of service contracts is highly resource intensive. Service contracts are more likely to have a cost reimbursement compensation structure than supply contracts, which are invariably some type of fixed-price arrangement. Cost reimbursement contracts require significantly more administration than fixed-price contracts. Even fixed-price service contracts demand inspection and contract management surveillance at higher levels than supply contracts, however. The combination of the added labor law requirements, the multiple provisions needed to implement the various indefinite quantity contract types, the option pricing provisions, and the detailed quality assurance requirements that even fixed price service contracts require adds to service contract administration complexity.

What Service Purchasers Can Learn From Manufacturing Purchasers

It is important to remember that purchasers in service industries buy from manufacturers and that manufacturing companies buy from service businesses (albeit often on a “decentralized basis” as explained above). Purchasers in all industries buy “goods” and as such must be familiar with the manufacturing processes that were used in production of those “goods”. Purchasers in all industries must be proficient with the “learning curve”, breakeven analysis/cost-volume-profit analysis, manufacturing cost accounting, value engineering, value analysis, and the whole panoply of things we learn in our basic purchasing courses. Most purchasing curricula (my own Federal procurement training included) concentrate on purchase of goods and supplies and then branch out into service purchasing, and that is an appropriate approach to learning the business of purchasing, for the reasons stated above.

Manufacturing Purchasing Practices and Procedures Appropriate Purchasers in Service Industries

As far as traditional manufacturing purchasing “practices” are concerned, the purchaser in service industries would be advised to put some of his suppliers of “goods” on a “just-in-time” delivery schedule. In addition, that service industry purchaser should liberally use blanket agreements/contracts for both goods and services and consider approaching some of his suppliers of goods to consider “consignment” of their goods to the service business. Office supplies and other G&A inventory items are excellent candidates for consignment whether the business is a manufacturer or service business. Purchasers in service industries (as well as purchasers of services everywhere) should consider for adoption all the current world class purchasing practices no matter where they are used and rule them out only if they have been evaluated to promise a less than a favorable benefit to cost ratio.

Staying Current

All purchasers need to stay current with developments in the field of purchasing. The best way is of course continuing education. Next Level Purchasing, the American Certification Institute, the American Purchasing Society, and the Institute of Supply Management all have excellent procurement courses designed to keep the purchaser current on developments. Another excellent way is to establish a professional reading program. A professional purchaser should read 3-5 new purchasing books per year in order to stay current. Amazon.com is a good place to start to see what is current.

 

 

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