Understanding Purchase Orders, Service Orders, Contracts, and Master Agreements

This is usually communicated in writing through one of several different awarding documents, all of which are a form of commercial contract. The terminology used to describe these contracts and the complexity of these contractual documents varies depending on the type of procurement being conducted (for example, strategic procurement versus spot procurement or goods versus services), the value of the procurement and payment terms, and the complexity of fulfilment and after sales support required from the supplier.

Common terminology

Procuring goods and physical products

When procuring goods or physical products that are clearly defined, a simple purchase order may be sufficient. This will simply specify the exact item or items being procured, their price and quantity. In the case of very expensive goods, the terms and conditions of the purchase order may be lengthier, but the overall document remains relatively simple in structure.

Procuring services or works

When procuring services, instead of a bill of quantities or item list, there is usually a longer description of the scope and nature of services. Depending on the complexity of the services, the award may be in the form of a service order, which is the equivalent of a purchase order for services, or it may be a longer form contract, with warranties, representations, completion milestones, and other clauses.

When to use a purchase order or service order

Purchase orders and service orders should be used if the required items can be generally be listed in the form of a bill of quantities with, at minimum, the item name and description, quantity and price clearly defined. Put differently, a purchase order or service order should be used under the following conditions:

1. The item or items requested are commodity type items or can be clearly defined and measured in terms of exact specifications, such as make, model, quality, size, dimensions, color or other similar attributes in the case of goods and scope / desired output in the case of services

2. The items / services requested can be clearly quantified

3. The individual line items can be easily costed – that is, the cost is not dependent on unclear or ambiguous conditions, such as the number of hours worked.

If any of the above conditions are not met, then it is better to go with a contract or a service agreement.

When to use a contract

When purchasing services (or very expensive goods or very large quantities of goods), the risk is higher and there is much more that needs to be defined beyond simply item description, quantity and price.

In many cases, there may not even be a clear price or quantity. The existence of one or more of following conditions will tend to require a contract:

1. Greater need to detail exactly what the vendor is being hired to provide

2. Timeline of delivery is an equally important element of fulfilment as quantity, quality and price

3. Delivery is in milestones

4. Payment is in parts or against milestones; (there is no single payment term—one payment may be in advance, another on a milestone, a third within X days of completion of milestone)

5. There are specific clauses that outline responsibilities of both parties, breach of which can nullify the agreement, even if services are provided and invoiced.

When to use a master agreement / framework agreement

A master agreement is utilized in the event a buyer plans of having repeat orders of an item or service, but does not have exact visibility on when each order will be placed and what quantity / scope will be required each time.

Master agreements are mainly utilized for strategic procurement, and help provide the cost and time savings of bulk procurement without incurring the immediate cash outflow of procuring everything all at once. The master agreement sets out terms and conditions for procurement over time and is designed to minimize re-work on repeat orders of the same item or service from a supplier. In the contract, a framework is defined to allow future incremental purchase or service orders to be issued at the price and terms agreed to in the master agreement.

The master agreement will set out overarching terms and conditions and parameters of purchase, including price, overall quantity to be procured over a period of time, and delivery and payment terms. The buyer will then issue sub-orders for smaller quantities at the pre-agreed price and terms, without having to renegotiate each time.