Negotiation and Its Complexities: A Case Study of Public Sector Negotiation with Vendors
- Subject: Communications
- Citation/Referencing Style: Harvard
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This case is about the negotiation process carried out by the chief procurement officer (CPO) of a leading public sector unit in India. When the company receives an order, the order is materialized by using electric equipment in large quantity. Due to changes in the business situation, the company realizes that it may not be possible to purchase the equipment that they require at the same price as before.
The company has two vendors from whom they buy this equipment. Both the vendors have similar manufacturing policies and same raw material suppliers. Additionally, both the vendors have gone through some management level changes. The CPO who is responsible for the purchase of the electric equipment has to conclude the deal with the vendors and obtain the best possible price which is closest to the amount they had previously paid the vendors.
Aabid, the Chief Procurement Officer (CPO) of NMD Limited, a leading Public Sector Undertaking (PSU), in Navi Mumbai, was confused. NMD Limited, which had recently received an order for Electro Static Precipitator, was in requirement of a transformer which formed the central component of the order. The Chief Executive Officer (CEO) had insisted that the transformer be procured. Aabid had earlier purchased the transformer from one of NMD’s two vendors, Syskateck Industries and Tyco Technocorp, at a ‘dream price’. Aabid was unsure of being able to procure it again at the same price. He was expecting the price to have gone up by a minimum of 40 per cent. However, Aabid observed that the management at both Syskateck and Tyco had undergone changes in the recent past and therefore saw an opportunity to seal the procurement of the transformer at the lowest possible price. He invited suggestions from his team members to minimize the procurement price of the transformer.
Profile of NMD Limited
NMD Limited was an integrated power plant equipment manufacturer and one of the largest engineering and manufacturing companies of its kind in India, engaged in designing, engineering, manufacturing, constructing, testing, commissioning, and servicing of a wide range of products and services. NMD catered to the core sectors of the economy, namely the power transmission industry, the transportation sector (railways), renewable energy, the oil & gas industry, and the defense sector, with over 180 product offerings to meet the needs of these sectors. The establishment of NMD Limited in 1964 brought about an upsurge in India’s heavy electrical equipment industry. Consistent performance in a highly competitive environment enabled NMD Limited to attain the coveted Maharatna status in 2013. Only companies with an investment ceiling ranging from ₹10,000 million to ₹50,000 million were awarded this prize.
The high-quality standards and reliability of NMD’s products and systems were an outcome of its strict adherence to international standards, through acquiring and adapting some of the best technologies from leading OEM companies in the world, coupled with indigenous technologies developed in their in-house R&D centers. Most of the manufacturing units and other entities of NMD had obtained accreditation from Quality Management Systems (ISO9001:2008), Environmental Management Systems (ISO14001:2004) and Occupational Health & Safety Management Systems (OHSAS18001:2007).
NMD had bagged an order for 250 electro static precipitators by quoting aggressively, as the engineering sector was down in the dumps. The transformer, being the heart of the recently obtained order, formed a good percentage of the total value. NMD had procured a similar component in the previous year from one of its two suppliers. NMD had an in-house manufacturing capability for the above discussed component. Information about its manufacturing option and procurement policy is shared below.
In one of the divisions of NMD, spare capacity to manufacture the transformer was available. Sourcing the component from within would have led to capacity utilization at NMD. This was considered to be essential by the corporate management since the company was passing through a lean phase with a dearth of orders especially in the division where the transformer could be manufactured and assembled. Although the technology available within the company was slightly outdated, it could still manufacture marketable products. While the item was made up of two discrete components that were hard-wired externally, there were suppliers in the market who could supply an integrated version (with the two components merged into one product). The high internal cost of manufacture, combined with its old design, led to a towering price of ₹1.04 million per piece.
The procurement policies of NMD were limited as it happened to be a PSU. The company had a written document indicating unified purchasing policy which was followed across various divisions of the company. This procurement policy had its own advantages and disadvantages, both of which have been mentioned below.
The major disadvantages were:
- Procurement of materials could be through tender system
- Orders could be placed only with the bidder who was ranked the lowest (L1) in the
- Negotiations, if any, could only be an
- Negotiations could be conducted only with the L1
The third and fourth limitations were as per the guidelines issued by the Central Vigilance Commission (CVC) of India to which all PSUs were subjected.
The major advantages of this policy were:
- Each division of the company had a well-organized database of suppliers (with records of the supplier performance measured and recorded for each order executed).
- Purchase enquiries could be limited to the suppliers in the approved material directory of the
- Provision was also available for the company to resort to buying through Reverse Auction (RA), which was considered to be a transparent mechanism for conducting negotiations (electronically), with all the participants in a tender
The company’s vendor base essentially had only two strong contenders, Syskatech Industries and Tyco Technocorp. Both these firms had their products built on the same design philosophy.
Supplier of Vendors
One key and major ingredient of the equipment was a special type of oil, which was supplied by only one supplier in the world located in the USA. Therefore, the price element of the equipment with respect to this major item which they had to import was at par since the US based supplier had uniform worldwide pricing for all its customers. The other major raw materials that went into the equipment were copper windings and sheet metal steel. While the price of the copper fluctuated highly, the price of steel had been stable over the past one year. Thus, the overall price of the inputs remained constant for both firms (Syskatech and Tyco Technocorp).
Manufacturing Process of Vendors
The manufacturing processes adopted by both parties (Syskatech and Tyco Technocorp) were similar and therefore the costing structure for both remained quite similar. The annual (financial) turnover of both these competitors (Syskatech and Tyco Technocorp) was also comparable. However, both the parties competed fiercely in the market to secure the available orders for themselves.
In the year 2013–2014, NMD resorted to buying about ₹392 million worth of transformers. The procurement was made through the RA process. There was stiff competition in the RA. The RA yielded NMD a saving of about ₹31.63 million. The average unit price obtained then was ₹400 thousand. This was what Aabid termed as the ‘dream-price’. The RA produced about 30 ‘hits’ with both suppliers vying with each other for taking the order.
The market condition was such that both contenders were starving for orders and an order of ₹392 million would form a major portion of their order book. Syskatech, one of the contending firms, had a turnover of ₹531 million in the last year, of which ₹392 million was from the single order that they had bagged from NMD.
Although Aabid was very happy at the price he got during the previous year, he was apprehensive about the quoted price, feeling that Syskatech might end up making a loss in executing the order and therefore he personally and carefully monitored the progress of the supplies which stretched throughout the year. The supplies were slow, but nevertheless it did not affect the operations at NMD. To some extent, in the course of the year, Aabid found the supplies were received on a start-stop-start manner, as Syskatech made a ‘lot’ of supply and waited for the release of payment by NMD before taking up the manufacture of the subsequent lot. Syskatech was unable to mobilize the necessary working capital for maintaining an uninterrupted flow of supply to NMD. At one point, Aabid had to intervene by talking to a funding agency to extend monetary support (credit) to Syskatech based on the strength of the order placed. The contracted payment term between NMD and Syskatech was 45 days of credit from the date of receipt of the goods.
While preparing the quote for the new orders, the Chief Marketing Manager (CMM) of NMD, Mr. Chowdary, had a discussion with Aabid as to what price the marketing department should factor in for the transformer. It was Chowdary who shared the data of internal costs of in- house manufacture with Aabid. Chowdary also informed Aabid that, in consideration of the high cost of in-house manufacturing, he had taken a special dispensation from the Divisional CEO to outsource the manufacture of the transformer by buying the item through the purchasing department.
As Aabid felt that the previous price was a one-time ‘dream’ price, he informed Chowdary that the next price would be about +40.5 per cent on the previous price, which Aabid noted, would still have been about 50 per cent lower than the in-house manufacturing price. Chowdary did not agree with Aabid about the raise in the price and insisted that he could only take the current price in his estimates. Since Aabid and Chowdary were not in agreement, Aabid privately approached the CEO. To his dismay, the CEO also insisted that NMD had to acquire the orders somehow. The CEO took sides with Chowdary and overruled Aabid’s objections.
However, the CEO conceded to the fact that Chowdary would not take into consideration the previous price in his estimates but would escalate it by 20 per cent. Aabid was unhappy, but he could not do anything in the face of the insistence of the CEO who went to the extent of saying that Chowdary should be a part of the team and that he was paid to contain the material costs which alone could increase the competitiveness of the company in the market and also led to the profitability of NMD. Knowing it to be a difficult task, as a matter of caution, Aabid had a separate discussion with the Engineering Manager to contain the cost. The Engineering Manager assured Aabid that he would concentrate on reducing the material content (steel) while making the detailed design, so that the anticipated price increase of the transformer could be off-set with lesser steel material input for the overall system.
With this verbal assurance from the Engineering Manager, Aabid shared his thoughts with his team and instructed them to keep the price increase to a minimum. He also assured his team that he would be a part of every step of the purchasing process.
In the team meeting Aabid recalled that the Chief Operating Officer (COO) of Syskatech had been replaced. The COO was eased out of the company on account of the loss-making order that he had booked with NMD during the previous year. At that point in time, the order book of Syskatech was very lean and the action was taken by the COO with the intention to augment the top-line. However, the management was not pleased with the loss booked by the COO of Syskatech and therefore had asked the COO to leave.
Aabid had a gut-feeling that Syskatech would have booked a loss of around 15 per cent during the previous order and shared the same with his team. During discussions, Aabid had a hunch that the management at Tyco Technocorp would also have undergone changes, since both the suppliers were aggressively competing in the market.
Supplier Current Status
Aabid shared his hunch with Mr Roberto, the Senior Buyer at NMD. Roberto revealed that Tyco Technocorp did not only replace its COO but also the Regional Representative (RR) of its firm. Roberto informed that the replacement had been affected two years back at the top and six months back at the region level as a fall-out of a loss-making order booked by the COO in a government contract. With such management changes at Syskatech and Tyco, NMD’s buying team felt that the current COOs would be cautious and circumspect in quoting their prices for the fresh requirement of the company.
Options With CPO
Aabid invited ideas from his team members for the best approach that should be adopted for the present purchase so that the company could get the material at the optimum price.
He said that the options available were:
- Insist with Syskatech to take a repeat order at the same rate, terms, and
- Proceed with tendering and the adoption of the RA
- Go ahead with tendering on paper-mode bidding with the first lowest price taking the order and follow it up with face-to-face negotiations, if
- Place an order with Tyco Technocorp on nomination basis subject to their acceptance to supply the material at the current price levels.
In this scenario, Aabid wanted the team to adopt the buying process which would allow NMD to get the best price.
Referring to the above case study, answer the following questions: (Total words count for all questions is 2000 words as minimum).
- What is the main problem/ challenge that NMD Limited was facing? What were the NMD Limited’s expectations about the price change from the suppliers?
- While relying on your analysis of the CPO’s embraced strategies regarding their procurement approach with suppliers, what type (s) of negotiations (Distributive or integrative bargaining) NMD is likely to focus on? Justify your answer. What tactics can Aabid exercise to achieve distributive bargaining? What tactics can Aabid exercise to achieve integrative bargaining?
- Assume now that both suppliers had a meeting with Aabid before the tender to negotiate the price Suppose that Syskatech followed integrative bargaining while the other supplier followed the distributive bargaining. What tactics would each of these suppliers follow to achieve their goals?
Part B: (Total words count for all questions is 1000 words as minimum and maximum 2000 words). Discuss 3 obstacles of a negotiation between 2 conflicting parties? Giver examples to support your discussions. Propose strategies to overcome them.
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