Analysis of a major type of public tender for IT Infrastructure: the one winner, one catalogue.

BIT decided that  is strategic to develop a balanced scorecard for each tender that has a potential value equal or major of 10 million euro.
In this post, I introduce, as a typical  example,  the tender DIGIT/R3/PO/2016/020 Data Centre Compute Solutions (DCCS) – Lot 1.
Like all tenders issued by the European Institutions, you can find all details in the TED web site.

DCCS – Lot 1 tender: the structure.
Like for all tenders bigger than 5 Million euro, EU law sets minimum harmonised rules.
The procedure chosen for this tender  is an open call, in conformity with Title V of the    Financial Regulation (Art 101-Art 120)  and its Rule of Applications (Art 122- Art.172) .
The scope of this tender is the purchase and leasing of x86 server systems, as specified by the DCCS_Lot 1_Tendering_Specifications.
As an open call tender, all natural and legal persons resident in EUI can answer. However, for the huge amount of necessary working capital and for the extended coverage (all EUI Countries), no organization can bid alone.

This tender is a typical example of what I define “one winner, one catalogue”.  In this kind of tenders, only one winner will be selected. This winner will manage one catalogue of products without future competition for the amount of time established by the tender (in this case, 4 years).
The tender defines in details  the minimum technical requirements  of the offer; no performance tests are necessary.

Only the offers that are able to match this minimum technical requirement will be selected for the financial evaluation .
In this kind of tender the price of the hardware configurations has a very high importance.  A simple and quick simulation on the financial evaluation sheet (using end user price list for hardware and services) shows that the weight of the hardware component is close to 90% (Fig 1).

Fig 1 – The importance to identify the key components in the financial evaluation of the tender.

So, the tenderer depends hugely on the manufacturer price structure and its strategy to answer the tender.
In the financial evaluation sheet, the Volume is predefined. So, the challenge of the vendor and of the tenderer is “simple”: determine the prices of the configurations that will determine the lowest cost of the tender (Fig 2).

Fig 2 – The challenge of “one winner, one catalogue”: estimate the winning bid price of the configurations.

Risk and Recovery Strategy of the tenderer.
To identify the right price structure, the tenderer must estimate the price of the competition.
First, he must identify the configurations that the competition will propose for the tender;  then, he has to estimate the lowest discount on end user price list that the competition usually applies for such a big, public tender.  This is a crucial joint task for the bid and the product management team of BIT.
The manufacturer has then to compare the price identified by the tender with his cost production and his recovery strategy.  BIT inserts all costs (including risks) in the financial evaluation of the tender. However, there are also expected opportunities that must be calculated, This is done through the so called “recovery strategy”.  In practice, BIT quantifies the expected opportunities (in the same way that risks are quantified) in an internal  profitability analysis (that is different, of course, of the financial evaluation document of the tender).

The prices of reference determines the value of the offer and the “theoretical” margin for the manufacturer and for the tenderer.  It is a “theoretical” as the quantities indicated in the tender are theoretical.

Fig 3 – Theoretical margin on the configurations of the tender

In their internal profitability analysis, they  might estimate different volumes for each configuration.   In this sense, we can talk about an “estimated” margin.

The margin of Fig 3 is not just an estimation as the quantity of each configuration is estimated. It is also an estimation as it is an average of the margin on the four years.
It is quite normal that the margin increases with time; this is fundamental concept of the recovery strategy of the vendor.  The margin is increasing as the manufacturer cost is expected to decrease for a specific category during the time and the manufacturer is expecting also to introduce new configurations (with higher margin) during the life of the contract.  However,  the change process (described at pag 31 of   DCCS Lot 1 Annex 4 – Service Level Requirements ) will limit the possibility for the manufacturer  to introduce configurations with  an higher price of the ones contained in the  initial catalogue.
Normally the tender purchase the equipment at a fixed Special Bid Price by the manufacturer; however, the manufacturer might agree to share with the tenderer the (eventual) decrease in costs.

For the manufacturer and the tenderer, the most important  element of the recovery strategy is the estimation of the quantity of options that will be purchased in the tender that  are not quoted as upgrade kit or part of the configuration.  For these options the manufacturer (and the tenderer) has the possibility to quote a price that is not evaluated in the value of the tender and by consequence it can assure a very high margin.

The tenderer has also its own recovery strategy. In part, this is linked to the recovery strategy on the purchase price (as far this is shared by the vendor) with him.  Another important component is linked to the action of continuous improvement that in four years of contract should allow a decreasing of costs.

Fig 4 – Recovery Strategy of BIT.

One risk that the manufacturer or the tenderer (or both if they decide to share the risk) is the exchange rate risk for the purchase of the hardware and how much is it possible to include this risk in the price of the offer and/or in the recovery strategy.
In annex III the prices must be expressed in euro, but the cost of the hardware is in dollar.   The risk can be covered but it has a cost.  The cost depends of the time length that it necessary to cover and the expected value of purchase in that length of time.   In this tender the European Institutions can purchase hardware for 4 years and the expected time (at least in this first simulation) is 128.301.812. If you ask your bank how much it would cost to cover 100% the risk of exchange of 128 million euro for 4 years, you might be surprised of the answer.
For this tender, BIT decided to cover 100% of the risk exchange for one year and manage the fluctuation of the exchange rate monthly during the execution of the contract.

The risk of liquidate damages is related to the delivery of the items and the execution of the maintenance.
A quick comparison of the liquidate damages related to delivery (pag 23 of DCCS Lot 1 Annex 4 – Service Level Requirements) with the liquidated damages related to services (see section 6.1.1 of DCCS Lot 1 Annex 4 – Service Level Requirements) shows that the highest risk is related the delivery of the items.  A delay in the delivery might be link to mistakes made in the presales activity, during the delivery from the manufacturer to the tenderer, during the delivery from the manufacturer to the European Institutions.
Normally the tenderer is covered on the risk related to a long delay during the delivery from the manufacturer by a back to back agreement.

Even if the risk of liquidate damages is concentrated in the first four years of the contract, the European Institutions have the right to claim them until the end of the contract.    Some Institutions are pushed by their financial services to claim liquidate damages as soon as they appear. Other Institutions instead prefer to claim them only if the tenderer is negligent in the execution of the contract (not only in the delivery phase).    Based on the knowledge of the behaviour of the European Institutions participating at the tender, their estimated purchase and the SLA required, the tender must make a difficult estimate of the risk of liquidate damages and include it in the offer price (Fig 5).

Fig 5 – BIT estimation of the risk for liquidate damages on late delivery.

Space of negotiation for the tenderee.
With this kind of tender, the tenderee is sure to obtain the best bid price at the time of publication for the techncial requirements specified in the tender.

Fig 6 – Recovery strategy of the manufacturer on the production cost.

The bid price is fixed.
If the recovery strategy of the vendor is correct (decreasing costs in time for the initial configurations), the ratio of the bid price toward the end user price list will decreased in time.

Contractually, the tenderee might ask for a benchmarking of the prices at any time (pag 12 of DCCS Lot 1 Annex 5 ).
So, in this example, at time T2 the tenderer might initiate this procedure.  Normally this doesn’t happens for two reasons:
1) This is a complex and expensive procedure for the tenderee;
2) If this should happen, it is sure that in future all the tenderers will not include a cost reduction in their recovery strategy and the ration between the bid price and end user price list at time T0 will be higher.
It makes more sense for the tenderee to use this clause (why not with the possibility to ask for the liquidate damages matured during the contract) to negotiate better conditions during the life of the contract.
For example, during the 4 years, the tenderee might want to introduce a configuration very different from the 4 identified in Fig 3.   In this case he has no contractual way to push the tenderer to propose a very competitive price on the new configuration; the tenderer, at this point, has no competitive pressure as he is the only owner of the catalogue. So, the tenderee might use some of the tools specified before to negotiate competitive prices.
Anyway, this kind of tender suits an IT strategy of the tenderee  based on a mature (not innovative) technology in which it is relatively easy to identify at the time of the announcement of the  tender a limited set of configurations for which it is as well easy to identify their technical replacement during the life of the tender.

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