8 Types of Bonds and Other Types of Surety to be used in Procurement and Supply Chain Management

In general, bonds increase the cost of bidding and tend to reduce competition. The use of bonds does not guarantee financial recovery. Failure of suppliers to meet the performance requirements of a contract can generally be handled by the organization’s legal department.

  1. Bid bonds — Bid bonds bring a third party into the transaction. A bid bond guarantees that if the order is awarded to a specific bidder, that bidder will accept the contract and the contract’s obligations. If the bidder refuses, the extra costs of going to an alternative source are borne by the insurer.
  2. Performance bonds — The supply management professional can, as a condition of doing business, require the supplier to post a performance bond guaranteeing prompt delivery of goods that meet specifications.

In the case of a construction project, a performance bond guarantees the work done will be completed according to specifications and time requirements. If the supplier fails to perform, the buyer is entitled to monetary compensation up to the amount issued in the bond.

  • Payment bonds — A payment bond protects the organization against liens that may be filed against the sourcing organization if the prime supplier does not pay its suppliers, subcontractors or employees (ISM Glossary 6th edition).
  • Deposits — Bid deposits may be requested for certain substantial bids as a device to discourage financially unstable suppliers. A bid deposit generally covers the amount in liquidated damages to which the organization would be entitled should the supplier not perform to the terms of the agreement.
  • Letters of credit — A letter of credit, normally used in international business transactions, is a document that assures the supplier that payment will be made by the bank issuing the letter of credit, upon fulfillment of the terms of the sales agreement (ISM Glossary 6th edition).
  • Real estate — Suppliers may be required to put assets, such as real estate, into an escrow account as a form of surety that the supplier will meet its obligations. If it fails to do so, it will forfeit the asset.
  • Cash — Cash is another asset that the buying organization might require the supplier to set aside to guarantee performance. Normally this would not be a good approach since it may affect the supplier’s liquidity and, hence, its ability to perform, because it may not be able to purchase necessary materials and services.
  • Earnest money — Earnest money represents a security deposit to demonstrate to the supplier that the buyer is seriously interested in the exchange. It is especially used for purchases of large monetary value, such as in real estate transactions, and is held in a trust or escrow account. Once the transaction is finalized, the earnest money is applied to the buyer’s payments to the supplier. If the transaction falls through, the buyer may forfeit the deposit.

7 Ways to Identify Potential Suppliers in Procurement and Supply Chain Management

The third step in the sourcing cycle is to identify potential suppliers to consider. This starts with the buying organization’s existing supply base. Are there suppliers currently being used for other purchases that are qualified and capable of providing a new purchase? Perhaps a supplier is being used by a different division within the organization that should be considered. Maybe a supplier that was used in the past could provide the new purchase. A benefit of this approach is that the organization is likely to have some past or current performance information. This is also consistent with supply base rationalization philosophies because new suppliers are not added to the supply base.

  1. The internet is an excellent tool for identifying potential suppliers. Most suppliers have their own websites that are sources of information. If publicly traded in the U.S., annual reports, 10-K reports, and 10-Q filings can be accessed at www.sec.gov/edgar.shtml or Hoovers (www.hoovers.com). Online directories such as ThomasNet® (www.thomasnet.com) allow you to search for suppliers by category and even have CAD models for many products.
  2. Other ways to learn about suppliers include networking with other supply management professionals and using social media sites such as LinkedIn and Facebook.
  3. Periodic benchmarking of other companies can help to identify new suppliers.
  4. Trade shows and professional magazines or websites are other information sources of potential suppliers.
  5. Identifying international suppliers can be more challenging than finding domestic suppliers. Attending international trade shows is one of the best ways to identify potential suppliers because supply managers can see products and meet face-to-face with supplier representatives. Internet sites provide listings of international trade shows.
  6. Other sources of information about potential suppliers include commercial attachés, large banks, government documents, global trading organizations, and national state departments. Many countries have commerce agencies that can provide assistance to supply management professionals for a nominal fee.
  7. Different types of intermediaries, such as agents, brokers, import merchants, and trading companies can assist supply management professionals with international sourcing. If a supply management professional is inexperienced in sourcing within a country, an agent can be hired. For a commission, an agent acts as the supply management representative in a country. In this role, agents can identify and evaluate suppliers as well as manage necessary documentation. For a fee, brokers can help to bring buyers and sellers together. Brokers do not take ownership of goods, and the purchase transaction occurs between the buyer and the seller (ISM Glossary 6th edition). Import merchants are intermediaries who buy goods in one country and then resell them in another country (ISM Glossary 6th edition). Thus, an import merchant can provide access to international goods without the complexities of direct international sourcing such as managing border crossings. Trading companies have a large network of trading partners and typically offer a wide range of services related to international sourcing and logistics. For example, the Hong Kong-based trading company Li & Fung supplies apparel, toys and other goods to major retailers in the U.S. and Europe from its vast supplier network in Asia.5

The Solicitation Process in Procurement and Supply Chain Management

After potential suppliers are identified, the next step is to develop the appropriate type of solicitations. A solicitation is a “request to suppliers to submit submissions to a procurement organization” (ISM Glossary 6th edition). Suppliers respond to the buying organization’s solicitation with an offer to sell. The buying organization then can decide if it will accept the offer. Valid contracts require an offer and an acceptance.

In some cases, such as for low-volume commodity items, the sourcing process may be simple: Items can be selected from suppliers’ catalogs or websites, often by the internal customer, at prices that have been negotiated in advance by supply management professionals. In other cases, with low-value items below a defined monetary limit, informal quotations may be requested by email or phone. For larger-value purchases a formal solicitation process is used. To determine the appropriate type of solicitation, supply managers must decide if negotiation or competitive bidding will be used to select the suppliers.

Deciding Between Competitive Bidding and Negotiation. In competitive bidding, solicitations are sent to qualified suppliers to get the maximum number of supplier proposals. In the public sector, supplier selection is normally based on the lowest price. In the private sector, price and other important factors are typically considered when selecting the supplier. If specifications are not fully developed, a two-step bidding process can be used. Technical proposals are requested in the first step, followed by a request for an updated bid with pricing from suppliers with acceptable technical proposals. According to the ISM Glossary (6th edition) negotiation is “an exploratory and communication process (identifying interests, walk-away alternatives, and options) internally and externally to reach a mutually satisfactory agreement.”

Supply market conditions, the type of contract desired, industry standards, and the time available influence the choice of competitive bidding or negotiation. When the market consists of many willing, qualified suppliers that can provide the same quality, delivery, and service, competitive bidding is often preferred. If there are few suppliers that can provide a product or service, if the specifications are not clear or may change, or if early supplier involvement in product development is needed, typically negotiation is used. The type of contract desired is another determinant of whether to solicit bids or negotiate. For example, fixed-price contracts are based on a price that will not differ from that agreed upon at the time of the ordering. This type of contract is a good candidate for competitive bidding. Cost-reimbursable and indefinite delivery quantity contracts, also called blanket contracts, are better candidates for negotiation, as the costs are more uncertain and often the terms need to be changed after the contract is created.

Industry norms and standards are other important considerations. Products that are manufactured to the same general specifications by all producers are commonly referred to as “industry-standard products.” Because of the competitive nature of the markets for these products, competitive bidding rather than negotiation is ordinarily used for acquisition. Custom-made products and especially services, by contrast, may not have sharply defined specifications or many capable suppliers. In these situations, negotiation is preferred.

The time available to obtain the product or service must allow for competitive bidding. This includes time for supply management professionals to develop and send or formally advertise solicitations, as well as time for suppliers to respond to them, and time for bids to be evaluated. If adequate time is not available, negotiation should be used. If the dollar value of the item is relatively low, the time and expense of competitive bidding is probably unjustified for both the buyer and supplier. A product or service that is purchased frequently is generally a poor candidate for competitive bidding because of the time requirements. Blanket orders, systems contracts, or procurement cards are alternatives for frequent purchases. The choice of competitive bidding or negotiation affects the type of solicitation method that is used.

Developing an RFI, RFQ, RFP, or IFB. An important part of the sourcing process is to gather information using requests for information (RFI) and writing and issuing formal solicitations that inform suppliers of the opportunity to sell products or services to the buying organization. Three types of formal solicitation documents are used: 1) request for proposal (RFP), 2) a request for quotation (RFQ), and 3) an invitation for bid (IFB). A comparison of when to use each method, potential benefits, and potential problems are shown in Figure 4-2.

Figure 4-2: Information and Solicitation Methods

RFIBefore developing specifications when market information is neededGathers new ideas and supply market understandingNot a solicitation, thus is not binding on either party

Suppliers do not respond if used too frequently
RFPWhen specifications are not clear or are uncertain, or when several solutions may be feasibleLeverages supplier’s expertise to generate new ideas and solutionsDifficult to clearly communicate needs

Challenging to compare supplier responses
RFQWhen specifications are clear and unambiguous and price is the only selection criterionEfficientSpecifications are not clear or can be misunderstood

There may be differences in suppliers’ offerings other than price
IFBIn government procurement with sealed bidding when specifications are clear and unambiguous and price is the only selection criterionEfficientSpecifications are not clear or can be misunderstood

There may be differences in suppliers’ offerings other than price

Leave a Comment

Your email address will not be published.