Contracts vs Purchase Orders

Posted on Wednesday, February 17, 2016 , by Breelyn

If you ever want to flip a coin about a certain topic, just consider purchasing from a Contract versus issuing a Purchase Order (PO). Wait, stop! Put the quarter down slowly and add it to your top-line growth, where it belongs. This feeling of indecision you're having, although warranted, won't help your organization procure with confidence. Good news, though - this feeling is entirely avoidable.

To justify your indecision about ordering from a Contract versus a PO, keep in mind that at first glance they do appear to be confused about their identities. Consider these examples. When accepted by a vendor every PO becomes a contract, but not every contract is a PO. Some (but not all!) people view POs as a kind of one-time contract. Purchase Orders may cross-reference the terms of a negotiated contract. It's a common misconception that the level of detail in a PO is less than that of a contract.

Any licensed medical professional would diagnose this as a variation of Dissociative Identity Disorder, Procurement Division. It's Tradogram's intention to put the 'cure' back in procurement, so here are the top 6 factors to consider when avoiding an identity crisis for contracts and Purchase Orders.

    1. Duration: POs are typically used in the short term (generally less than one year) on a one-time basis, whereas contracts are used for the procurement of items over an extended period of time (generally greater than one year) and may include renewal options.

    2. Legality: A contract is a legal document and a PO is a commercial document. To elaborate, a PO is an offer from the buyer to the supplier. If accepted by the supplier (within a reasonable timeframe) the PO becomes a contract. Logically, this PO will have zero value if it's not accepted by the supplier. It's worth mentioning that POs can be created based on contracts - these are also referred to as Release Orders.

    3. Terms and Conditions: As mentioned, there's a misconception about the level of detail in contracts and Purchase Orders. Specific negotiated terms and conditions are outlined in both, but a contract should be used when these Ts and Cs must include the scope of work, deliverables, performance standards, change management plans, etc.

"A contract is used when there are a complex set of terms associated with the acquisition that go above the standard boilerplate terms associated with PO's. This doesn't mean a PO should not be used, I suggest it should because the value of the PO is to book a commitment in the financial system, allow for a specific record of the spend to supplier and facilitate the matching process for payment". Joseph R. Postiglione Sr. (CMRP)

  1. Level of Risk: As a guideline, when the level of risk is higher, it's wiser to use a contract. Significant risk can indicate the possibility of significant reward, so a legal document is a kind of safety net. Contracts can reduce risk exposure, identify responsibilities, and define performance standards more directly than the terms of a POs. However, since quantities and time of delivery are not defined in a contract, it's recommended that one or more POs be issued referring to the contract in order to commit payment funds for the contracted goods/services. Mitigate risk wherever possible.

  2. Type: There are three types of contracts - a Fixed Price contract, a Cost Reimbursable contract (also known as a Cost-Plus contract), and a Time & Material contract. Similarly, there are different types of POs - you can issue a standard PO, or a blanket order with multiple delivery dates over a period of time. It's critical to know your precise purchasing objectives in advance.

  3. Classification of Items: Purchase orders are commonly used to purchase goods, whereas contracts are more frequently used to purchase services. Although many companies do not follow this protocol, the larger message here is consider what you are purchasing and proceed accordingly. It might not make much sense to draft a contract for that one-time order of blindfolds for your entire procurement department when they go to flip the coin.

If these tips don't provide two separate "identities" for Contracts and Purchase Orders, don't despair - it's not always easy to detect subtleties of character. To make this situation painless, try not to view the coin flip as a choice between a Contract and a PO, but rather a decision between two approaches - a PO that becomes a one-time contract or a Contract that stipulates the parameters of a long term (significantly more complex) relationship with suppliers.

Still confused? We're happy to chat with you! To get more tips about managing Contracts and POs, Contact Us and ask us how Tradogram can help.

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