ECONOMIC PERSPECTIVES OF PROCUREMENT CONTRACTS

PSPTB ANNUAL CONFERENCE

AT AICC, ARUSHA, 6-8 Dec 2015

PRESENTATION BY:

HEDWIG NYALWAL

HEAD OF SECRETARIAT/CEO

KENYA INSTITUTE OF SUPPLIES MANAGEMENT

OBJECTIVE OF PRESENTATION

To assess the nature of contracts for purposes of improved analysis, drafting and

management of contracts.

STRUCTURE OF PRESENTATION

1. Definitions

2. Provision for contract management in procurement law

3. The procurement problem with regards to contracts

4. Contract types and the procurement problem

5. Cases

6. Conclusions

DEFINITIONS

Legal definition of contract contract: “An agreement between two or more parties creating obligations that are enforceable or otherwise recognizable as law.” Black’s Law Dictionary.

Agreement and obligations – means a set of promises exchanged between the parties.

Enforceable – means that if a party fails to do what they promised to do (breach), a court of law will enter an order to remedy the breach, i.e., make the offended party whole.

DEFINITION

Economic definition: A contract is a bilateral coordination arrangement, where two parties make reciprocal commitments in terms of their behavior, this touches on the legal formulation of a contract which creates a meeting of the minds with effect in law, but also transcends it (Brousseau and Glachant,2002). The notion of a contract must therefore be viewed in broad perspective, transcending the legal domain and extending to the social structures that regulate coordination at a bilateral level.

PROVISION FOR CONTRACT MANAGEMENT IN PROCUREMENT LAW

Role of procurement unit – Public Procurement and Disposal Act 2005 (amended 2009), Section 8(2)(t),(u), (bb):monitor contract management by user departments to ensure implementation of contracts in accordance with the terms and conditions of the contracts;report any significant departures from the terms and conditions of the contract to the head of the procuring entity;certify the invoices and payment vouchers to suppliers;

PROVISION FOR CONTRACT MANAGEMENT IN PROCUREMENT LAW

Why monitor? Ensures contractor’s compliance with contract, laws, rules, and regulations.Ensures Program area is getting what it needs and payments are justified.Early detection/prevention of non-compliance Ensures necessary, timely, and appropriate corrective actions are taken.Ensures fiscal responsibilities--costs are allowable, allocable and documented.

PROVISION FOR CONTRACT MANAGEMENT IN PROCUREMENT LAW

Levels of monitoring

Programmatic MonitoringFocus on contract SCOPE, QUALITY and DATA

Contract Monitoring COMPLIANCE with laws and regulations.Provides OVERSIGHT and ensures best practices.Ensures PAYMENTS are within the limits of the contract.

PROVISION FOR CONTRACT MANAGEMENT IN PROCUREMENT LAW

Economic challenge facing contract management:decentralized market and price systems - no unified coordination mechanismgoods and services often traded outside of optimum/equilibrium prices and in a bilateral context neither party has credible information on levels and prices at which other agents are trading or whether these prices clear the market the performance of contracts is not guaranteed by external mechanisms

THE PROCUREMENT PROBLEM WITH REGARDS TO CONTRACTS

Ex-ante asymmetric information – the ADVERSE SELECTION problem or HIDDEN INFORMATION problemThe decision to enter into a contract can be deficient given that either party enters into contract without having full information concerning the engagement e.g. supplier has more information about the product than the procuring entity, and either party may withhold pertinent information prior to signing off on a contract

THE PROCUREMENT PROBLEM WITH REGARDS TO CONTRACTS

Ex-post adaptation - the MORAL HAZARD problem or hidden action problemAfter entering the contract neither party knows with certainty whether the other contracting party will perform – uncertainty over supply of effort after contracting

CONTRACT TYPES AND THE PROCUREMENT PROBLEM

Fixed Price ContractsSupplier is offered pre-specified price for completing the contractSeeks to address the adverse selection problem – ex-ante asymmetric informationRides on assumption of completeness of information ex-ante (prior to contract signing)Bidding process expected to reduce costs ex-ante and corruptionIf information is complete – costs can be high ex-anteIf information is incomplete – costs manifest ex-post and could derail a projectIs the most common/preferred contract in the public sector

CONTRACT TYPES AND THE PROCUREMENT PROBLEM

Cost Plus ContractsSupplier is offered stipulated fee and reimbursed costs incurred on a projectSeeks to address the moral hazard problem – ex-post uncertainties and costsRides on the assumption of incomplete information tIncentive to reduce costs ex-ante is eliminated, but the process of adaptation is smoother – the reimbursement process and fees are clearly defined and there is limited space for hagglingRarely used in public sector procurement

CONTRACT TYPES AND THE PROCUREMENT PROBLEM

Comparing Fixed Price with C-plus Contracts

(Holstrom and Miligrom, 1991)

  Fixed Price Cost Plus

Risk allocation mainly on Contractor Buyer

Incentives for quality Less More

Buyer administration Less More

Good to minimize Costs Schedule

Documentation efforts More Less

Flexibility for Change Less More

Adversarial relationship More Less

CASES

Parliamentary Service CommissionRemodeling of Senate Chamber and Offices for Parliament - cost Kshs.2,209,173,479.35 Contract period 72 weeks from 1 October, 2012 to 16 February, 2014. Project delayed - not completed as at December 2014 Contract does not stipulate who should bear cost of delaysBy 30 June 2014, Commission had paid Kshs.2,380,593,751.22 since inception of project, which includes a variation of Kshs.171,420,273.22.no evidence available to show that the Tender Committee approved variations as required by Section 47(a) of Public Procurement and Disposal Act, 2005.

Controller and Auditor General 2013/14

CASES

Laisamis Police Station- Local company awarded contract to construct Laisamis Police Office Block and a staff apartment at a cost of Kshs.105,365,422.00 on May 2012. - Contract period 78 weeks from the date of the contract agreement. - Audit inspection undertaken on 14 December 2014 revealed that the project had stalled and the contract period had elapsed by 120 weeks, - Explanation from the Officer in Charge of the Police Station - stoppage of works due to the death of the contractor in road accident on 26 September 2012.

Controller and Auditor General 2013/2014

CASES

Masai Technical Institute- A tender for erection and completion of a food and beverage unit awarded in 2010 for a contract sum of Kshs.28,976,992.56 and signed on 1 March 2011 for a period of fifty two (52) weeks. - As at 30 June 2014, the Institute had paid Kshs.25,628,901.00 or approximately 88% of the contract price.22 August 2014 the building was still incomplete and no latest progress report by the quantity surveyor was availed for audit review.- No evidence of extension of the completion period was availed for audit review.

Controller and Auditor General 2013/2014

CASES

Embakasi Police Training College- contract for construction of warehouse awarded, through restricted tendering method, at Kshs.39,880,000.00, agreement signed 9 August 2012. Completion date 18 Sept 2013- an approved programme of work required under Section 13 of the contract was not availed for audit verification. -contract incomplete as at 26 November 2014. - No evidence show that liquidated damages were recovered from the contractor as required under Section 27 of the conditions of contract. Contractor has been paid Kshs.22,504,000.00 or 56% of the contract sum,

(Controller and Auditor General 2013/2014)

CONCLUSIONS

Public procurement is guided almost exclusively by Fixed-Price contracts

Fixed-price contracts provide strong incentives for cost reduction ex-ante. However if the design/information are left incomplete – then costs for renegotiating the fixed price contract is high

Cost-plus contracts allow adaptation with ease, to changes in the contract by the parties i.e. there are no costly delays

Fixed price contracts are suitable to simple projects with complete or near complete information/designs

Cost price contracts are suitable to complex projects with incomplete information/design e.g. in huge construction

TIPS FOR EFFECTIVE PROGRAM MONITORING

Determine monitoring requirements, methods, tools, etc.. Ideally, this should be done during the RFP and contract development process.

Maintain regular, effective contractor dialogue and review contractor performance and progress on a regular basis.

When possible, conduct on-site reviews and interview contractor staff to determine their understanding or contractual requirements, review key documentation and observe operations.

If applicable, conduct client surveys to determine service delivery quality and satisfaction and require the contractor to resolve complaints.

Document monitoring results and ensure that appropriate corrective action is taken for any deficiencies.

Follow-up to ensure that deficiencies have been timely and satisfactorily corrected.

PROVISION FOR CONTRACT MANAGEMENT IN PROCUREMENT LAW

END – Q & A