PMP Procurement – Rent vs Buy Decisions
PMP Procurement – Rent vs Buy Decisions
As students prepare for the Project Management Professional (PMP) Certification, one of the areas upon, which there is an intense focus, perhaps we’ll call it a volume of questions is Procurement. In the classroom, I teach the Procurement as a great way to think about project management, by simply taking your ball cap and turning it slightly to the side.
Before we start projects, we have a cost/benefit analysis done by the Business Analyst. That cost/benefit analysis helps us justify why we’re going to take on a project, why the business is going to issue a charter to assign a project manager, the charter or the responsibility to do the project. That’ the starting point.
After we work through all of the knowledge areas, as provided by the Project Management Body of Knowledge (PMBOK), we realize sometimes, as we look at our triple-constraint, that we can’t handle aspects of the Scope, the Time, or the Cost.
We potentially choose to outsource either the entire project or a subcomponent of the project. Acquiring a widget that goes into a larger assembly that we don’t have the skill sets to do in the most effective time or cost for our project.
When we talk about Procurement, we talk about making Make vs Buy decisions. That’s effectively, “Can we afford to make it or gain the skillsets that are materially equivalent to make it ourselves most cost efficiently, or do we outsource it?”
There will be a Make vs Buy cost/benefit and triple-constraint types of questions on the exam. One of the subareas, associated with Procurement is this concept of Rent vs Buy, as opposed to Make vs Buy. The decisions that you make will have some math associated with them.
There are few math oriented questions associated with Procurement. This one particular area, although likely one, maybe two questions on the entire exam, maybe none, because students get concerned about this math. I thought I would take enough time here to do this video blog to give you an overview of the Rent vs Buy decisions.
We’re talking here about comparing the cost of a purchase, that’s the buy, versus in this case, the cost to rent or lease it. It’s not the same as I’m going to make or I’m going to buy it, but amongst my buy or acquisition options, which one of the multiple buy or acquisition options do I have?
Remember that projects are temporary. The students that get challenged by this question on the test fail to put into context that we’re talking about isolating the time period associated with the project.
If we take a look at that, and the project is 12 months long. We’re only talking about a 12‑month rent versus the cost of purchasing the entire item permanently, at least most of the time. We’re not going to talk about interest rates, annual percentage rates, or net present value of money.
At least on the Project Management Professional PMP exam, they’re going to have you do straight comparisons. Let’s look at a direct comparison of the cost of making a purchase versus the cost of renting.
To look at the solution, the way we want to look at it is. Let’s look at the period for the project. I said 12 months, but it could be six months. It could be years, depending on that temporary fixed time frame duration of the project. You’re going to multiply whatever the cost per period is times the number of periods to figure out a value and compare that to the direct cost of the purchase
Let’s take a look a little further here and give an actual couple of math problems that you could see on the exam. Let’s say you’ve got project and one of the things that you need to do is to clear a plot of land. You’re going to hire somebody to do it, rent a tractor or lease a tractor to do it.
A lease versus purchase for the tractor, to purchase this little teeny tractor to do your plot of land is $100,000. You say, “Wow! Let’s rent it or lease it instead.” You’ve got to make the decision. How long will you have the tractor? What its cost per day?
In this simplest of equations, renting the tractor is $2,500 a day. If the project’s duration is 45 days, that’s the time in which you have to get that field cleared. You would multiply 45 days times the $2,500 a day, and you would compare that to the $100,000 purchase. If I multiply 45 times 2,500, I come up with a value of $112,500.
In this particular situation, it does mathematically identify that the purchase of the trailer is more cost effective than renting the tractor. The purchase is better than the rent. Don’t overthink the questions, should you see them on PMP exam. We know for a fact, if we talk about the product life cycle, we’ve got operation cost and maintenance cost, etc…
In the real-world, those would be our considerations, but on the test you’re doing a direct comparison of lease or rent versus purchase. Let’s go further, because they could ask you a question that includes other costs. Let’s take a look at another one of rent versus purchases, where they give you daily operational cost.
This is where they’re paying attention to that Product Lifecycle effect. They’re giving you specific information to incorporate into your evaluation. In this particular instance, we’re talking about renting a copier for $50 a day on your project and that rental includes the supplies.
From whomever you’re renting the copier, they’re providing paper, toner, maintenance of the copier until they retrieve it back at the end of the rental period versus an $8,000 purchase for this copier, where they $2 per day, pay per toner cost estimated, based on your study. Accept the numbers they give you on the exam.
You’re talking about a project, in this case, will run six months. Since you don’t know the months, we can go between 28 and 31 days, we’ll use six months is 180 days, rounding it to 30. They’re not going to play a day on or off for you. They’ll give you a number that’s easier for you to use.
They’ll give you instead of a per-day cost, they’ll give you a per-month cost. That it’s easier to calculate. We’re trying to compare what’s the cost of purchase plus operations versus the cost of rent. I got to calculate what my rental cost is for this 180 day period. $50 times $180, that’s the rental cost per day, for a 180‑day period versus a purchase price times the money.
If we take a look at this, and I put a number on here, we set a purchase cost of $8,000. 50 times 180 is $9,000. We said the purchase price is $8,000. $8,000 plus $2 a day, $2 a day times 180 days. Two times 180 is $360. Our actual cost for purchase plus operations would be $8,360, compared to a rental of 9,000 for the period at $50, including those supplies.
In this case, the lower of the two costs would be the purchase plus operations. You simply want to do the math to figure out what the two different cost would be. The rent option versus the purchase option or purchase plus operations. Whichever is lower, that’s what you’d pick.
Remember, when you’re making project decisions, everything is within the banded time frame of your project between beginning and end, not ongoing cost. If you are looking in the real world, you think about the ongoing operations, maintenance, disposal cost.
Let’s give you one more example here, as we go through this. We get the pen out of the way here. In this last one, they might talk about a renter lease versus purchase and resale.
Now, we’re now talking about renting a facility, renting a building to do some production, renting a studio to do a video production like this, and you’re going to have it for a period of time where you could buy everything. At the end, sell it off.
We’re not looking at that present value. What they would have to do is tell you what the value you’d get at the end. For instance, purchasing a building that you own and hoping that the economy neither goes up nor down very dramatically. At the end of the project, you have the ability to resell it. They’re going to tell you what that resale cost might be.
If we walk through the math of this equation should you see it on the exam. Here we’re talking about a two‑year project, because we’re talking renting a facility where you got to have a contract. The monthly lease for this facility that you’re going to rent is $3,500. The purchase price for that facility is $500,000.
At the end of the project, you can sell this facility for 400,000. How do we come up with an equation, basic math to try to compare the two options? The first one is a monthly lease for $3,500 per month, and we said it’s two years. I’m going to multiply it by 24 months. I have 24 times the 3,400. If I do the math on that. I come out to $84,000.
In this instance, I’m taking a look at purchase price of $500,000, and at the end of the project, two years later. I’m able to sell the facility back, or sell it to a third party.
In the process of that, I get a return of $400,000. 500,000 ‑ 400,000 is…It’s going to cost me $100,000 to purchase and resell the facility versus a cost of $84,000 to rent it. Clearly, renting would be better than purchasing.
This is a basic overview of how you would work through Rent vs Buy, lease versus buy, lease versus buy and sell‑back options. Should you see these math questions on the Project Management Professional PMP certification exam.
Steve teaches PMP: Project Management Fundamentals and Professional Certification, Windows 7, Windows 8.1 and CompTIA classes in Phoenix, Arizona.
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