Cost-plus is a pre-dominant pricing model we use in bids. How can we make it more competitive?
One of the most important decisions in developing the bid response is the Price. Whether it is a L1 deal or a QCBS, price always plays a key role in determining the outcome.
One of the easiest ways to price a bid is to link it to the cost of delivery. You find out the costs involved in delivering the scope defined by the client, add component costs and overheads such as cost of bought out components and management overheads, and add target gross margin on top of that.
If you are a systems integrator or a turnkey projects vendor, you may have different margin targets for bought out components and for your own services that create the solution. Put all of this together and you are almost done.
The cost-plus contracts became popular during the first and second world wars. Governments procured large quantities of varied war supplies from private sector on cost-plus basis, thus assuring a market and profit margin, which were big incentives in war times.
Cost plus contracts continue to be popular for government procurement and with many private sector players such as systems integrators and turnkey projects vendors.
Cost-plus contracts tend to pass on the risk of increase in material and labour costs, variance on account of any inefficiencies, and the cost of fixing defects to the customer. If the customer has an upper hand in negotiation, the contract is worded such that no increase in prices is allowed during the tenure of the contract. A penalty is prescribed for delay, and at times, there is no incentive for early completion.
Yet, cost-plus pricing continues to be in vogue because it is simple to understand, explain, implement, and improvise upon.
While bidding though, bidders must carefully consider contract terms such as those that forbid increase in prices and levy penalties for non-compliance, in addition to client’s budget and competition.
Here is a list of top 10 measures systems integrators and turnkey projects vendors can implement to ensure that the cost-plus pricing works for them as well as for the customers.
1) Identify the scope for re-use of existing solutions capabilities – frameworks, processes, and tools – that can be leveraged in delivering the customer solution
• Ensure that the respective COEs are involved in the bid response
2) Identify the capabilities built in delivering the solution to the customer, that can be subsequently leveraged for other customers, by productizing those
• Ensure that the respective COEs are involved in the bid response process.
3) All of us have defined target margins for (a) bought-out components, (b) outsourced services, and (c) own components, solutions, and services. Develop different thresholds for different territories or bid types.
• If any deviations are required, ensure that all the internal stakeholders – finance, procurement, COEs, delivery and sales – are on the same page regarding the margin expectations. Get this reviewed and capture the final approvals.
4) Most bids include penalties for unsatisfactory performance. Can we introduce incentives for better performance? While this is not easy it is worth a try. It also gives client the benefit for better or early delivery. To the least it creates another trade-off lever for you during the negotiations.
• Ensure that the legal and finance teams are involved in the discussion and have signed off on the terms.
5) Link incentives and performance guarantees signed in the contract, back to back with the component vendors and sub-contractors. Again, not straightforward. But most vendors/OEMs/sub-contractors willing of long-term relationship will look at this in the right spirit.
• Ensure that the procurement team is involved in the deal so that they can work back to back with the vendors and sub-contractors.
6) Spell out in clear terms the customer’s oversight in monitoring progress and costs.
• Ensure that the audit and compliance teams sign-off on the responsibility of monitoring the costs incurred in execution, with reasonable degree of accuracy.
7) Identify how the potential scope variations will be handled so that change management is transparent and exercisable without any ambiguity.
• Ensure that the sales and delivery teams are in complete alignment on the customer’s scope and expectations.
• Spell it out clearly in your proposal.
8) Review previous bids with the customer and similar bids for the other customers for identifying (a) solution design, (b) re-use opportunity, (c) lessons learned, (d) our pricing and (e) competition pricing.
• Ensure that all the bids and proposals data and artifacts are in a single repository, appropriately classified and tagged for ease of access and retrieval.
• Analyze competition based on the territory, offering, industry, and account.
9) Build alternative solutions based on likely scenarios and select the most suited solution. Many customers value this effort and realize that the solution provider has indeed thought thru the solution before arriving at the final one. It also brings in new dimensions to the solution/offering which the customer may not have thought of before helping, you to demonstrate more value.
• Ensure that the alternative scenarios are shared with all stakeholders and their inputs are consolidated in a single place for selecting the most appropriate solution.
• Create 3 pricing scenarios to arrive at your price-to-win.
10) Try to change the game by proposing other pricing models proactively, such as - outcome based, value- driven and ROI based options. This will help you differentiate your offering and benefit both the parties.
• Ensure that the pricing team spends adequate time to explore and innovate pricing models appropriate for the deal and the customer.
Not all deals are same. So, you may continue to follow a standardized approach for the run-of-the-mill deals. However, where a deal demands taking a non-standard approach to the cost-plus pricing, the measures you take to design and deliver the deal are often the deciding factor.
This post has been written by our guest author Mr Shailendra Marathe. Shailendra is a senior finance professional, with 25 years' experience in business finance, financial markets, FinTech and risk management. Shailendra currently runs CFO Axis which is a virtual CFO service. He is a Chartered Accountant and an alumnus of IIM Bangalore. He is also author of the book – Price to Profit.
Comments and observations welcome at firstname.lastname@example.org.