The advice in this section should be read in conjunction with the guidance available in the OGC's Successful Delivery Toolkit (external link verified June 2004)and in particular the guidance within the Requirements Definition and Procurement Strategy (external link verified June 2004) section of this document.

For all procurements over £10,000 in value it is important to determine the most appropriate contract strategy before proceeding to issuing an invitation to tender.

The contract strategy should take into account the following elements:

• how the various stages of the contract (from setting the strategy, right through the various steps to contract management) are to be managed,
• options for procurement - purchase, rent, hire, etc.,
• contractual approaches and types of contract to be used,
• basis of pricing and payment arrangements,
• use of single or competitive tender,
• conditions of contract,
• the impact of Intellectual or Industrial Property and associated rights (see Section D.4 - UK Legislation)

The contract strategy should also take into account relevant aspects of DTI policy, such as:

• policy on the environment (see Section A.7 - Environmental Issues in Purchasing) may affect the way a specification is prepared (defining the product and selecting appropriate standards)
• policy on small firms (see Section A.6 - Small and Medium Enterprises) may affect the make-up of the list of companies invited to bid for work and the way a contract is broken into lots (to enable small firms to bid)
• EU Directives (see Section E.8 - European Union Directives), remembering also that
  
• the possibility of contract renewal needs to be taken into account in assessing the value of a contract for EU procurement threshold purposes and
• R & D procurement can fall within the scope of the EU Services Directive if the Department is retaining intellectual property rights.

The contractual approach and type of contract selected must be appropriate to the procurement. A range of factors needs to be considered, including:

• Departmental policy (see above)
• allocation of risk (see Section E.6 - Gateway Reviews)
• in-house resource availability (e.g. for design and project management)
• importance of timescales
• project complexity and size
• importance of precise requirements and quality
• availability of funding
• availability of standard design or component detail
• market conditions
• lifetime costs.

The paragraphs below describe various contractual approaches, contract types and payment arrangements. Bear in mind that the choice of contractual approach, contract type and basis of payment should represent an appropriate balance between cost, time, control and risk.

In many cases, procurement is a relatively straightforward process. Once the business case has been approved, the end user creates the specification and the procurement staff identifies a suitable supplier and places a contract. However, not all procurement can be effectively managed in this way. For more complex projects it may be appropriate to consider placing a management contract and/or undertaking sequential tendering.

For large and complex projects (typically major works projects but also increasingly for the procurement of a range of contracted-out services) it may be appropriate to award a contract to a specialist contractor to manage the breakdown of the project into suitable packages, to supervise the whole process of tendering for these packages and possibly also to manage the contracts once awarded.

Such an approach can be very effective when specialist contract management skills and knowledge are needed. However, care needs to be taken to ensure that the Department retains sufficient intelligent customer capability to be able to manage the appointed management contractor effectively.

2. Sequential Tendering

Where a project or requirement is too complex to be covered by a fully pre-planned contract, sequential tendering is an alternative.

The overall project is broken down into a series of smaller packages each of which is competitively tendered as and when the detailed requirements are known. This approach should lead to a shorter overall time-scale than a fully pre-planned approach and can provide a better fit to your requirements by leaving some of the detailing until later in the process. This can be particularly important where rapid technological change is envisaged.

A major disadvantage of this approach is that the overall cost remains an estimate until the last package contract is awarded. This factor is particularly important in obtaining overall approval for the project, as approval authorities tend to prefer strategies with a single decision point and closer control over total cost at the outset. This disadvantage is also of relevance to projects that approach the EU Directives thresholds and care should be taken in such circumstances that sequential tendering does not become improper disaggregation.

There are a number of contract types to choose from. Those most likely to be encountered by DTI procurement staff are:

1. Cost-Reimbursement Contracts (time and materials); Cost Plus Contracts

Cost-reimbursement contracts are those in which the contractor is reimbursed for the cost of labour and materials actually used in the contract, plus a fee for supervision, head office expenses and profit. The fee may be a fixed amount or a percentage of total prime cost.

Cost-plus contracts may be appropriate if the work is very urgent or if it is hard to decide how much work is required. However, as there is no risk to the contractor and no financial incentive to work efficiently or to seek ways to save money, it can be difficult to ensure that best value for money is obtained. They should, therefore, be avoided whenever possible.

2. Fixed Price Contracts

These are considered to be the most effective type of contract. They benefit both parties. They give an efficiency incentive to the contractor and the Department knows from the total cost from the outset.

A fixed price contract is one where the Contractor bids a fixed price for undertaking the work. This is usually shown as a single sum, rather than as a day rate with a total number of days. Such a sum will be clearly indicated in the contract. The Contractor is then bound to satisfactorily complete the task for this quoted sum. He assumes the risk for failing to do, but equally will benefit if he can complete it within his own estimated timescale.

Fixed price contracts are of two main types:

• Lump Sum Contracts and
• Measured Contracts.

In lump sum contracts, a single total price (the lump sum) covers the whole contract. This is considered suitable for major works if they can be precisely defined and described in detail in the contract documents, and also for minor works and alteration and repair jobs. However, fixed price contracts can be applicable in a range of circumstances when the scale and nature of a procurement can be clearly defined in advance.

In measured contracts, price is fixed in the sense that bidders quote itemised prices for doing work and supplying materials, using a bill of quantities, but the total price payable is determined by measuring the amount of work done and materials supplied, multiplying by the agreed price for each item and totalling.

3. Capped Price Contracts

These will be the most familiar types of contracts found in the Department, particularly for procuring professional and consultancy services. They are similar to cost re-imbursement contracts, in that a daily fee is agreed at the outset. However, the fee will include any profit element and the total number of days will also be fixed at the outset.

Such a contract will be along the lines of, as an example, "£400 per day at a maximum of 20 days" and, in this example, is capped at £4,000 for the total contract price. This cap must be clearly indicated in the contract/purchase order. If the contractor is able to complete the task within the stipulated number of days then his bill will be less than the capped amount. If, however, he needs additional days to complete the task, he has to make the case for the cap to be increased. There may be good reasons for so doing, but they need to be investigated, and the reasons for extending the cap recorded.

Contracts should never be let solely on the basis of an agreed daily (or other period) fee, without including a cap on time or cost.

4. Incentive Contracts

Incentive contracts give the supplier an incentive for success. They have been widely adopted in the construction industry as an alternative to cost plus contracts in cases where the cost can be estimated roughly, so that a figure for target cost can be agreed, but not with sufficient accuracy to arrive at a fixed contract price. They are intended to motivate a supplier to achieve target cost by sharing with them any savings they manage to make, while obliging them to stand part of the expense if costs are above target.

Multiple incentive contracts extend this by including in the contract monetary incentives for achieving other targets, such as delivery performance and quality performance (e.g. customer satisfaction). With multiple incentive contracts, there can be a problem balancing one desirable objective, such as high performance, against another desirable objective, such as early delivery or low prices. Care needs to be taken in setting and balancing the monetary rewards embodied in the incentive clauses to ensure the contractor optimises on a balance of objectives which is in the Department’s interest rather than his own.

5. Framework (Call-Off) Contracts

Framework, or call-off, contracts set the terms on which the Department will make future purchases of supplies or services. For details on the use of such contracts see Section E.9 - Frameworks.

Payments can only be made when goods or services have been satisfactorily supplied in accordance with the terms of the contract. For straightforward purchases this will mean payment on satisfactory completion of the contract.

For some contracts it can be appropriate to agree payment at predetermined stages, often referred to as "milestones". This can also be used as an alternative to regular re-measurement of the quantities of work and materials expended or the percentage completion level of a contract.

By setting various "milestones" along the path towards completion of a contract the need for re-measurement is avoided and payments can be tied to stages of partial completion. Careful selection of "milestones" can also be used to minimise risk to the DTI by ensuring that payment is only made at stages where it would be feasible for a contract to be taken over by another contractor, if necessary.