Indian Defence Review

The Indian defence procurement process consists of two distinct phases – technical and commercial. In the first phase, detailed technical evaluation is carried out of all competing systems to ascertain their compliance with the laid down parameters and to identify the systems considered acceptable for introduction into service. The most important activity carried out in this phase is the conduct of field trials in actual terrain and climatic conditions to validate performance claims. All systems that meet the specified criteria are considered at par and no inter-se merit list is prepared. Technical phase is primarily handled by the concerned Service Headquarters (SHQ), albeit under the close oversight of the Ministry of Defence (MoD). At every step, concurrence of MoD is mandatory to proceed further.

In the second phase, commercial proposals received in respect of all technically successful vendors are examined in detail, financial quotes are compared and the lowest compliant bidder is identified for the award of the contract. Commercial phase is exclusively the domain of MoD. SHQ has no role to play except render advice on issues of technical nature that crop up during the evaluation of commercial quotes and subsequent contractual negotiations with the selected vendor.

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It needs to be recalled here that India’s technical evaluation regime has acquired a reputation for its meticulousness and stringency. It is on record that India has never purchased a sub-standard product. Even the much maligned Bofors guns proved their mettle in operations and have never been faulted for their performance. On the other hand, the commercial process draws flak in every procurement case for numerous inconsistencies and incongruities. It is commonly acknowledged that India’s commercial process is appallingly dismal and flawed. In fact, it is an abject anti-thesis of the technical process.

It is on record that India has never purchased a sub-standard product. Even the much maligned Bofors guns proved their mettle in operations”¦

The commercial phase consists of the two distinct activities – one, ascertaining the lowest compliant bidder and two, negotiating contract with the said bidder. This article restricts itself to the analysis of the functions leading to the identification of the lowest acceptable vendor for the award of the contract.

Organisational Structure

Once the Staff Evaluation Report is accepted by MoD, the case gets transferred from the concerned SHQ to the corresponding Acquisition Manager (AM). A note is initiated by AM proposing constitution of a Contract Negotiating Committee (CNC) to undertake the entire gamut of commercial evaluation activities. The Defence Procurement Procedure (DPP) has laid down standard composition of CNC, as follows:-

Provision has been made in DPP to nominate a service officer or any other officer from the Acquisition Wing as Chairman of CNC for proposals of value above Rs 50 crores, if considered necessary. This can, however, be done only with the express approval of the Defence Minister.

Identification of the Lowest Bidder

Identification of the lowest bidder is by far the most critical, sensitive and complex task that CNC has to perform. There are four distinct steps that precede the final selection.

Fixation of Fair and Reasonable Cost

With a view to obviate need for time consuming price negotiations with the lowest bidder, DPP mandates that CNC must establish a benchmark for reasonableness of price of equipment under procurement in an internal meeting before opening the commercial offers. In case the price quoted by the lowest bidder is found to be within the benchmark fixed, no further negotiations concerning price need be carried out.

Indias commercial evaluation process has been criticised both by domestic and foreign participants for subjectivity”¦

As details of defence deals are never made public by any country, no reference price is available for use as datum. Undoubtedly, fixation of reasonable price of military equipment is a highly specialised task requiring thorough knowledge of the equipment with special reference to the technology involved.

Opening of Commercial Proposals

Once CNC has acquired full knowledge of the equipment under procurement and arrived at acceptable price bracket, it fixes date, time and place for opening commercial offers of the technically accepted vendors. Participating vendors or their authorised representatives are invited to be present. Sealed covers of commercial bids are opened by the Chairman of CNC in front of all present and read out. Thereafter, all members of CNC sign them. Being a procedural step, its execution is easy and smooth.

Preparation of Compliance Statement

Commercial offers are studied by CNC to ascertain their compliance with the terms of reference given in Request for Proposals (RFP). A Compliance Statement is prepared to check if any vendor has sought materially different terms and analyse the impact of the said discordant stipulations. Deviations noticed in the delivery schedule, performance warranty, guarantee provisions, acceptance criteria and Engineering Support Package are also noted. It is a painstaking task and has to be carried out with due diligence. In case of material non-compliance, vendors may be given an option by CNC to make their offers RFP-compliant by dropping unacceptable conditions.

For example, if RFP allows an advance of up to 15 percent, no vendor can demand 50 percent advance. However, no change in price quote is permitted. Should a vendor insist on unacceptable terms, CNC may eliminate him by declaring his commercial offer to be conditional and non-compliant.

Comparative Statement of Tenders

Once compliance is established, CNC starts the process of determining the lowest acceptable offer (L1 vendor). A Comparative Statement of Tenders (CST) is prepared. It is a highly intricate and protracted process as multifaceted aspects having commercial implications have to be factored in. Discounted Cash Flow (Net Present Value) method is used, where applicable.

Existing Gaps and Infirmities

As stated earlier, India’s commercial evaluation process has been criticised both by domestic and foreign participants for subjectivity due to a complete absence of well-evolved guidelines. Every CNC charts its own course. Lack of standard evaluation criteria makes the whole process ad-hoc, with the result that the environment tends to lose confidence in the credibility and fairness of the system. Major infirmities have been discussed below.

Fixation of Reasonable Price

Establishment of an acceptable price bracket needs expertise in holistic treatment of varied interrelated financial disciplines in acquisition that include earned value analysis; concepts and methodologies needed to develop operating and support cost estimates; total ownership cost reduction studies; and available management decision making tools like ‘Cost as an Independent Variable’ management process.

Although there is no universally accepted standard method to determine fair price of defence equipment, use can be made of a number of scientific techniques that are commonly available. Countries develop expertise as they gain experience and a scientific methodology is evolved through appropriate analogy estimates, parametric estimating, software simulations and technology costing. Production costs (including development overheads) have to be estimated and marked up with reasonable profit. For that, a great deal of data has to be collected and collated. Further, CNC has to consider market dynamics to include extent of competition and degree of desperation of the vendor to sell.

It is obvious that a great deal of proficiency is required to perform the above functions thoroughly. In India, constitution of CNC is purely representative-oriented and not expertise-based. Consequently, CNC are fully devoid of any required qualities. Chairman is nominated due to his official position and not for any special qualifications or skills. As a matter of fact, not a single member of CNC possesses required knowledge and competence. The whole process is ad-hoc and illogical – old files of previous procurements of similar systems are dug out and a standard inflation factor is applied to it. Thereafter, foreign exchange variations are factored in to arrive at a broad acceptable price range. Needless to say, the above methodology is totally unscientific in evaluation, arbitrary in value and subjective in nature. The whole exercise becomes a wasteful sham.

Ascertaining Lowest Bidder

As every major military system has long service life, cost of sustaining it is invariably many times the cost of acquisition. Life cycle cost (LCC) is considered to be the most prudent and realistic way to determine long term cost of ownership. LCC analysis calculates the cost of a system or product over its entire life span in service. It is also called as ‘cradle-to-grave’ or ‘womb-to-tomb’ analysis. It is a tool that helps to choose the most cost-effective alternative available.

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LCC consists of acquisition costs and sustaining costs. Both are not mutually exclusive. Deterministic costs (cost of acquisition/development) can be firm but estimation of probabilistic costs (cost of operation, maintenance and failures) requires great deal of understanding and training. Probabilistic costs of defence equipment also depend on degree of exploitation of equipment in actual operations, war games and field exercises. Knowledge of likely deployment pattern of equipment is essential to be able to estimate long term effect of different types of terrain and climatic conditions. Data regarding past performance of similar equipment provides useful inputs for making realistic assumptions.

Lack of objective professionalism is the main cause for all ToT contracts getting mired in controversies”¦

Availability of extensive teaching aggregates and simulators helps in reducing load on main equipment for training purposes, with resultant lower maintenance costs. Sustaining costs also depend on the quality of engineering support and expertise acquired by indigenous maintenance agencies. Cost implications of actual or planned modifications, upgrades or life extensions are also required to be factored in. In case subsequent indigenous production is planned with technology transfer, LCC analysis has to be tailored accordingly.

Despite repeatedly avowed intention to apply LCC analysis to all major deals to identify lowest bidder, India continues to bank on acquisition costs. As no effort has been made to acquire the necessary expertise, LCC continues to be a statement of intent and nothing more. Not a soul in the whole acquisition regime has mastered the LCC technique. Every CNC follows the easy path of tabulating and totalling initial procurement costs of main items, training aids, spares, tools and test equipment to arrive at the cheapest option. Invariably, India is taken for a ride by smart vendors who quote low for the main equipment in their commercial quotes but hike up cost of follow up support to unreasonable levels.

Further, fair comparison of commercial offers demands that different payment terms, including advance payments and progressive stage payments to the vendors be brought to a common denomination. Discounted Cash Flow (DCF) method with a discounting rate in consonance with the existing government borrowing rate is considered to be an ideal vehicle for the same. DCF method is also useful in cases where entering into AMC for period in excess of one year is part of the required bid. Unfortunately, India has to still master DCF technique. Consequently, DCF method is rarely applied and initial quotes are evaluated by all CNC.

Costing of Transfer of Technology Improbabilities

Proposals that include ToT provision for indigenous manufacture of bulk quantity of equipment pose additional problems. As per DPP, each vendor is required to submit undertaking with ‘not to exceed’ budgetary price for ToT in their commercial proposals. ‘Not to exceed’ budgetary price is used for commercial evaluation. ToT cost has to cover licence fee, documentation, technical assistance, training, materials, spares, tooling, ground support items, test equipment, programme management and other necessary facilities for indigenous production.

Notwithstanding the fact that India has been negotiating ToT for decades, there is no system in place to carry out inter-se evaluation of competing technologies and cost them accordingly. There are no set guidelines. Every CNC follows different yardsticks. Lack of objective professionalism is the main cause for all ToT contracts getting mired in controversies, invariably to India’s disadvantage.

The Way Forward

As seen, CNC consists of ‘generalist’ functionaries whereas the tasks assigned to CNC are highly technical in nature needing domain expertise. It will not be incorrect to state that CNC is a motley grouping of officeholders representing different agencies and totally devoid of the required competencies. The members are selected because of the appointments they hold and not for any expertise acquired. Worse, many agencies detail officers who can be easily spared without reference to their suitability. In some cases, a new officer represents an agency at every meeting. CNC has no financial experts well versed with international trade practices, foreign exchange transactions and contractual legalities. And these deficiencies continue to be the biggest limitation of the complete defence procurement process.

Despite repeated claims, LCC analysis has still not been adopted as the standard methodology as there is no expertise available to calculate LCC pragmatically. The problem gets compounded where technology transfer is sought as an essential part of the package and has to be compared and priced.

It is time attention is paid to rectify existing deficiencies in commercial evaluation process. First of all, all concerned organisations should ensure that their representatives in the CNC possess adequate knowledge and can participate in the deliberations in a fruitful manner. Members once nominated should not be allowed to be changed. Importantly, their mandate should not be limited to safeguarding the interests of the organisation they represent but to contribute to the provision of collective counsel for national good.

CNC should be constituted well in advance to give it adequate time to acquaint itself with the details of the equipment under procurement and understand intricacies of the procedure. Once a rough model of methodology to be followed emerges, competencies required would get identified. Thereafter, CNC should be allowed to co-opt experts as additional members to fill voids. Finally, an exhaustive data bank should be created to ensure that required inputs are readily availability to CNC.

As every single deal for major procurements is getting mired in acrimonious discordance, there is an urgent need to impart professionalism to the commercial evaluation process. Commercial evaluation culminates in signing contract with the lowest bidder. Therefore, deliberations of CNC have a profound effect on contractual provisions and poorly negotiated deals can cost the country dear. Commercial evaluation is too critical a process to be handled in an ad-hoc, unscientific and amateurish manner.