Advantages and disadvantages of competitive bidding?

Answer 1

THE COMPETITION MYTH

Why Competitive Tendering Fails to Deliver

author's email - competitivetendering@hotmail.com

Abstract.

Competitive tendering (bidding) is a widely used procurement method. The idea behind competitive tendering is that it forces suppliers to compete and consequently the purchaser will gain better "value for money". This paper challenges that belief and shows why competitive tendering is rarely an efficient and effective procurement method.

Introduction.

This paper will explain why the result of competitive tendering is often inferior, poor quality product or service. It will:

1. List the perceived advantages of competitive tendering.

2. Outline the disadvantages of competitive tendering.

3. Discuss who is generally blamed when competitive tendering produces bad results.

4. Propose a better procurement model.

5. Discuss potential barriers to implementation of the improved procurement model.

Dr Deming wrote important sections on customer supplier relationships. This paper aims to build on that work.

Most relevant is Dr Deming's comment in The New Economics that states "The idea of several suppliers for any one item, competing with each other for lower prices (as advocated by some authors), makes good talk, but as a practical matter it is only talk, even under long term contracts. It destroys any possibility of a good relationship between customer and supplier. The losses would be one of those unknowable figures".

Competitive tendering (what is it?)

Competitive tendering involves a purchasing organization advertising business and requesting tenders to supply that business. In some countries the tendering process is called "bidding". Competitive tendering can be broken into two main types:

1. Open competitive tendering is where the invitation to tender is publicly available for all interested suppliers to respond. This method is most commonly used in government organizations.

2. Closed competitive tendering is where the invitation to tender is issued to a predetermined, or restricted number of suppliers.

In some countries the use of competitive tendering is mandatory for government agencies. For example, most Australian Government agencies are required to go to tender if they intend to make purchases over eighty thousand Australian dollars(1). Some exceptions apply. Tenders are generally advertised via an on-line website called Aus-tender.

The advantages of competitive tendering.

Competitive tendering is often considered to have the following benefits:

1. It promotes competition between suppliers, resulting in best "value for money" for purchasers and users. This point will be extensively challenged in this paper.

2. It "offers a kind of transparency that helps mitigate favoritism and corruption"(2).

3. In the case of open tendering, it gives all suppliers the opportunity to win the business that is advertised.

The author acknowledges that points 2 and 3 above are notable benefits of competitive tendering. These benefits need to be considered and weighed against the factors raised later is this paper.

The disadvantages of Competitive Tendering.

Competitive tendering has many disadvantages. Because there are different types of competitive tendering, not all the disadvantages outlined below will apply in every situation. Factors such as whether open or closed competitive tendering is used; or whether competitive tendering is being used by a private or government organization will determine if these disadvantages apply. The disadvantages include:

1. Leading suppliers may not tender.

Most Australian government procurement guidelines only allow suppliers who actually tender to be considered for a procurement decision. If the leading supplier or suppliers do not tender, the purchaser can only consider bids from suppliers who do tender. If leading suppliers are not considered, the purchaser may end up buying inferior product or service.

There are several reasons leading suppliers may not submit a bid. These include:

1. The expense of the tendering process. Some complex tenders can involve huge costs that are not reimbursed to the bidder.

2. Suppliers may not believe that the tendering process is fair.

3. Suppliers may already be heavily committed to other customers and may not need the business that is being advertised by the purchaser. The supplier may be so popular that he has a waiting list.

2. Barriers to communication between supplier and customers.

When making significant purchases, frank and open communication between potential supplier and customer is crucial. Competitive tendering is not conducive to open communication.

"Practitioners have recognized that competitive tendering stifles valuable coordination between the procurer and potential supplier before the plans and specifications are finalized. To see this, note that the primary information that the procurer receives from suppliers in a competitive tender is their bid. A supplier has no incentive to offer the procurer advice on how to improve the plans or avoid certain pitfalls. In fact, the supplier would have the incentive to keep any findings of this kind to himself as they offer him a competitive advantage over his rivals in a competitive tendering process"(2).

However, when more effective procurement methods are used "the procurer and supplier typically spend a good deal of time discussing the project before the work begins. During such negotiations the procurer can elicit the supplier's views about where the designs and specifications can be improved".(2) Potential problems and pitfalls with the proposed work can also be discussed.

3. The cost-plus phenomena.

Competitive tendering often results in strictly worded contacts between supplier and procurer. Deviations to contractual terms can be extremely expensive. This can create a situation that is sometimes referred to as "cost-plus".

Dr Deming describes the situation in Out of the Crisis - "There is a bear-trap in the purchase of goods and services on the basis of price tag that people don't talk about.

To run the game of cost plus in industry a supplier offers a bid so low that he is almost sure to get the business. He gets it. The customer discovers that an engineering change it vital. The supplier is extremely obliging, but discovers that this change will double the cost of the items.

It is too late for the customer to try and make other arrangements. Production is under way and must be continued without interruption. The vendor comes out ahead".

4. Use of cheaper, poor quality materials and/or labor.

A supplier forced to play the competitive tendering game may come under pressure to keep costs down to ensure he gets a satisfactory profit margin. One way a supplier can lower costs is by using cheaper labor and/or materials. If the cheaper labor and materials are poor quality, the procurer will often end up with inferior, poor quality product or service.

5. Safety shortcuts.

Another area where suppliers may be tempted to lower costs is safety standards.

The British film "The Navigators" provides an example of a safety short cut taken as a result of competitive pressures. To keep costs down the tendering group reduces costs by cutting back on manning. In this case, the manning reduced is a safety critical role. The result is the death of a co-worker.

6. Competitive tendering can be extremely slow.

When government agencies use competitive tendering it can take several years to choose a successful bidder. The result is the customer can wait incredibly long periods for product or service that may be required quickly. By comparison, the use of direct sourcing procurement can take a fraction of that time.

7. A Supplier who wins the tender, but is unable to meet the contractual requirements.

A problem that compounds the problem of competitive tendering's lengthy time frame, is when a selected supplier is unable to meet the requirement that he has contracted for. To the procurer's frustration, the lengthy competitive tendering process may have to begin again.

8. The 300% mess around tax.

Sometimes private sector companies will go to tender simply to determine if the price they are paying is a fair market price. Companies with a reputation for doing this are often the recipients of what a colleague in the mining industry referred to as a "300% mess around tax". Because the bidder knows the "purchaser" is not genuinely interested in making a purchase, he submits a heavily inflated bid with a 300% loading added. In this type of situation, the supplier's time is being wasted.

9. Insufficient profit margin to allow for investment in research and development, new technology or equipment.

Many companies have made important contributions to society by investing wisely in research, development and technology. In many cases, these advances were possible because the organization made a healthy profit.

As previously mentioned, competitive tendering can force a supplier to accept a very slim profit margin. These low margins can result in a supplier having little or no money to spend on research and development, new technology and equipment. The result - society loses out.

Who gets the blame when competitive tendering produces bad results?

When the results of competitive tendering are bad for the purchaser, a scapegoat is often found. Someone will claim that the "Statement of requirements" were written poorly. The "Statement of Requirements" is the document that defines the product or service that is being put to tender. The claimant may argue that critical information was omitted or that the requirements were poorly worded.

This scapegoating generally shows a misunderstanding of several crucial points.

Dr Deming stated in The New Economics that "Any supplier worthy of consideration possesses specialised knowledge about his products - more than the customer can hope to have, even though the customer will be the user of the supplier's product". As it is the purchaser who writes the "Statement of requirements" (often without the input of potential suppliers); it shouldn't be a surprise that these requirements are not written as well as they could be. As previously mentioned, crucial communication between supplier and purchaser is already stifled or prevented as part of the competitive tendering process.

Furthermore, Dr Deming pointed out in Out of the Crisis, that from his experience "94 percent of the problems come from the system, rather than the worker". Blaming the person who writes the "Statement of Requirements" is a case of blaming the worker, instead of working to improve the system.

A better procurement model.

The type of solution to competitive tendering will vary depending on several factors. These factors may include; the type of industry, the complexity of the product, the price of the purchase, whether the purchase is a one-off or a long-term supply relationship. The following key principles however, can apply to the majority of procurement decisions.

· Thorough research of the purchasing requirement and/or alternatives.

· Open communication with current or potential suppliers.

· Purchasing decisions based on a strong relationship of trust.

· Developing a long-term and healthy relationship with a reputable supplier or suppliers.

· Paying the supplier a fair profit margin.

Despite some recent quality problems that have occurred in the United States, a supply system that is held in high regard is the Toyota Production System.

Jeffrey Liker states in the Toyota Way that "Even when Toyota became a global powerhouse, it maintained the early principal of partnership. It views new suppliers cautiously and gives only small orders. They must prove their sincerity and commitment to Toyota's high performance standards for quality, cost and delivery. If they demonstrate this for early orders, they will get increasingly larger orders. Toyota will teach them the Toyota way and adopt them into the family. Once inside, you are not booted out except for the most egregious behavior". "Simply switching supplier sources because another supplier is a few percentage points cheaper (a common practice in the auto industry) would be unthinkable".

Bringing about improvement in procurement methods will be different depending on the type of organization. In private sector organizations it may simply take a change in view from top management. In the Public sector it would mean changing Public Sector procurement policy. Before this could happen, the government of the day would have to approve those policy changes.

Potential barriers to implementation of the improved procurement model.

The biggest barrier to implementing improved procurement methods in government agencies is convincing the relevant decision makers that it is acceptable to move from a system which is "open to everybody to tender" to a system which is not.

In government organizations, procurement methods are influenced by politicians. For a politician, transparency is incredibly important. If a procurement process produces a poor result, a politician can say "the organization conducted a thorough and transparent procurement process. All suppliers that tendered were carefully considered." Allowing every supplier the opportunity to tender for a contract could be compared to a government job being advertised and all members of the public having the opportunity to apply for the job.

Convincing politicians to adopt a system with less transparency and which does not allow all potential suppliers to tender will be challenging. However, this is what must occur if improved procurement methods are to be implemented. The potential beneficiaries include users, purchasers, suppliers and taxpayers.

Conclusion.

Competitive tendering rarely produces what is best for the customer. It is not efficient and is rarely effective. The exact amount of damage done by this procurement method is unknown and unknowable. To bring about improvement; organizations' requirements for effectiveness and efficiency will need to outweigh their requirements for their procurement business to be open and available to all suppliers.

This paper recommends abolishing competitive tendering. Where possible, long term, mutually beneficial relationships should be developed with trusted and reputable suppliers. Selection of these suppliers should be based on thorough research. The selected suppliers should be paid a fair profit margin for the quality product or service they provide.

Footnotes

(1) Commonwealth Procurement Guidelines Page 26, Paragraph 8.4 (2008). Commonwealth of Australia.

(2) Tadelis, S. and Bajari, P. (2006). Incentives and Award Procedures: Competitive tendering vs. Negotiations in Procurement.

References

Deming, W,E. (1982). Out of the Crisis., MIT Press.

Deming, W.E. (1994). The New Economics for Industry, Government, Education, 2nd Ed., Cambridge: M.I.T. Center for Advanced Engineering Study.

Liker, K. Jeffrey (2004). The Toyota Way, McGraw Hill.

Loach, K. (2001). The Navigators (film).