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Massive Procurement Failure

 

The procurement phase of any large transaction must be transparent, fair, ethical and have a clear audit trail giving every bidding vendor equal opportunity to win the engagement. As was recently reported the Department of Transport (DoT) manage to get it wrong. The West Coast Mainline franchise went off the rails, with a reversal estimated at costing the tax payer over £50 million. Louise Ellman, chairwoman of the committee reported "Embarking on an ambitious perhaps unachievable reform of franchising, in haste, on the UK's most complex piece of railway, was an irresponsible decision for which ministers were ultimately responsible”.

 

Virgin Rail challenged the government’s decision to award the West Coast rail contract to FirstGroup at £5.5 billion citing their growth projections as wildly optimistic. FirstGroup’s offer was considerably more than that offered of Virgin Rail but their ownership rights were revoked after an inquiry found multiple failures by the DoT. Virgin Rail will run the service for the next 23 months until 2014.

 

A report by Sam Laidlaw reviewed the project and highlighted some areas of concern.

 

Among the failures made by DoT, there were transparency issues faced by bidders who were unable to forecast the size of the risk capital they were required to commit to for a subordinated loan facility (SLF). This was due to the build and assumptions supporting the DoT’s modeling of SLF sizing and its challenging nature in regards to bidders.

Another failure was made in the way of technical modeling flaws. The DoT used an elasticity factor of 1.4 but advised bidders to use an elasticity factor of 1.8 to carry out revenue risk adjustments. This caused the SLF number generated by bidders to be higher than the understated number generated by the DoT’s own model. Hence the inconsistent information prevented bidders from determining the correct level of SLF required and the optimal capital structure for their bids.

Bidders were treated inconsistently as a result of the Contract Award Committee (CAC) disregarding the guidelines set out by the DoT. Instead, the CAC based their final reported numbers on their personal view that took into account extraneous factors resulting in the bidder bias, this lead Virgin Rail to challenge FirstGroups winning bid.

If vendors are not aware of accurate information, their proposal will reflect this causing unnecessary elimination of worthy competitors. The information used by each vendor will naturally vary depending on their understanding of the information gathered from the client. That being said, the requirements of the clients may not be effectively communicated to vendors, which in this case caused confusion. Meeting with vendors earlier in the sourcing stage will ensure each candidate is fully aware of the client’s requirements allowing them to submit information/proposals detailing their best ability in line with client requests. By making vendors aware of all the terms and conditions earlier in the process will further reduce the amount of confusion during later stages, reduce the possibility of a late project completion and the risk of additional charges being added to the final cost.

 

This leads to another possible problem faced in the procurement phase not necessarily experienced in the West Coast Mainline incident. Vendors may charge a high rate for their service depending on the client or knowing the rates of other vendors. Rates may increase during the course of the project due to unforeseen circumstances, additional service requirements or unknown terms and conditions. Vendors may also charge below their ‘omega price’ (the lowest price a vendor will charge while still 100% committed to delivering on a deal; http://www.goxglobal.com/publications/omega_price) in order to secure a contract which can cause a lack of productivity, diminishing quality of service and less incentive to spent time serving the client’s needs.

 

 

In order to combat over aggressive pricing and encourage efficiency, an auction process can be used to find the omega price of each vendor. Paying just above the omega price will ensure productivity and reliability in the vendor’s service. Make vendors aware of all the terms and conditions at the beginning stages so additional charges are not added to the final cost, but above all the people running the competitive tender must ensure the process is transparent with unyielding integrity. 

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