http://www.indiandefencereview.com/2010/07/india-pays-dearly-for-poorly-negotiated-arms-deals.html
t has recently been reported in the Israeli press that India paid more than double the amount for the purchase of three AWACS aircraft from Israel in March 2004. These aircraft were earlier being sold to China for US $358 million but the deal had to be aborted under US pressure. Subsequently, India agreed to buy them for US $1.1 billion–a whopping US $742 million more than the price agreed to by the Chinese. There are numerous such instances where India has paid exorbitant amounts for the defence equipment contracted. Coffin deal has already attracted considerable attention for the same reason. Inability to negotiate contracts astutely has been the biggest weakness of the entire defence procurement regime.
Recently, Russia demanded enhanced inflation index for the Sukhoi deal. It also demanded that the rouble be compared with the euro and not with the dollar as agreed to in the original contract. In the case of Gorshkov aircraft carrier, Russia has sought massive upward price revision. Apparently, India had failed to negotiate fool-proof agreements with clearly defined provisions. How else can such lacunae be explained? In almost all contracts, imprecise and flawed provisions lead to multiple interpretations during the implementation stage. Invariably it is India that suffers as vendors exploit ambiguities in the contract language, especially with respect to delivery schedules, warranties, after sales support and penalties for default.
Procurement of new equipment is carried out as per the defence procurement procedure. Once technical appraisal has identified successful vendors, the case enters commercial evaluation phase. A Commercial Negotiation Committee (CNC) is constituted under the Ministry of Defence (MOD) for the purpose. Its members are drawn from the Acquisition Wing, concerned Service headquarters, users, quality assurance directorate and R&D organisation (see box for standard composition of CNC). CNC performs the following functions:-
"¢ Opens commercial quotes of technically successful vendors.
"¢ Prepares a 'Compliance Statement' incorporating the commercial terms offered in the Request for Proposals and those sought by the vendor(s). It helps in analysing discordance, if any, and study the impact of the same.
"¢ Prepares a statement with regard to deviations noticed in the delivery schedule, performance warranty, guarantee provisions, acceptance criteria, Engineering Support Package etc.
"¢ Carries out a comprehensive analysis of the commercial offers and prepares a Comparative Statement of Tenders with a view to determine the lowest offer (L1). It is a highly intricate and protracted process as multi-faceted aspects having commercial overtones have to be factored in. Discounted Cash Flow (Net Present Value) method is used, where applicable.
"¢ Carries out detailed discussions with L1 to ensure product support during the assured life cycle of the product. It entails assured supply of information on product improvements, modifications and upgrades, obsolescence management and life time purchases and fixation of base prices and pricing mechanism for long term.
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As regards price negotiations, CNC has to follow different procedures for multi-vendor and single-vendor cases. In multi-vendor cases, once L1 vendor is identified, the contract is concluded with him without any price parleys. However, price negotiations can be held in exceptional circumstances where valid logical reasons exist. To be in a position to determine whether price negotiations are warranted or not, CNC has to fix a benchmark price prior to opening the commercial bids. Such negotiations are held only with L1.
In case of procurement on single vendor/resultant single vendor basis, CNC has to establish a fair and acceptable price bracket in an internal meeting before opening the commercial offer. In case the quoted price falls within the said bracket, no further price negotiations need be carried out. However, detailed discussions are required to be carried out in all cases with the selected vendor to hammer out other contractual issues in unequivocal terms.
CNC thus performs two critical functions in both multi-vendor and single vendor cases. First, it fixes fair and reasonable price prior to initiating commercial process and, secondly, it negotiates judiciously to safeguard all national interests and obtain best contractual terms. Performance of both the functions is discussed below.
Fixation of Fair and Reasonable Price
As seen earlier, determination of fair and reasonable price has to be carried out prior to opening commercial bids. It is a highly technical, complex and painstaking task. There is no set methodology for it. Countries develop expertise as they gain experience. Generally, the following factors are taken into account while computing fair price of equipment under procurement:-
"¢ Production costs (including development overheads), duly marked up with reasonable profit.
"¢ Competition and related market dynamics – a monopolistic vendor will always charge more.
"¢ Desperation of the vendor to sell – a vendor in pressing need of orders to keep his factories going is likely to offer a more competitive price than a vendor with surfeit of orders.
"¢ Demonstrated urgency and eagerness of the buyer to acquire the product – a shrewd seller is quick to grab it as an opportunity for exploitation.
Capabilities Required
There are a number of scientific tools and techniques available to determine fair price of equipment. To start with, detailed data has to be collected and collated to facilitate development of appropriate methodology for cost estimation. Previous procurements of the same or similar equipment by any government department can provide valuable inputs as regards cost-technology-inflation interrelationship. Such a template, however, can at best be indicative in nature and would require incorporation of numerous other variables to generate meaningful approximations through analogy estimates, parametric estimating, software estimates and so on. Development and application of cost analysis techniques and estimate interpretation require experience, flair and proficiency.
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 acquisition 'Cost as an Independent Variable' (CAIV) management process and other management decision making tools.
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. LCC consists of acquisition costs and sustaining costs. Both are not mutually exclusive. At times, cost of sustaining military equipment is many times the cost of acquisition. It is a tool that helps to choose the most cost-effective alternative available. It facilitates equipment selection based on total costs rather than the initial purchase price. It is also called as 'cradle-to-grave' or 'womb-to-tomb' analysis.
In order to perform the above functions, CNC must possess competence to analyse a contractor's cost proposal and evaluate his pricing justifications with respect to established criteria. Additionally, an understanding of market forces, related commercial issues, cost/price analysis techniques and legal implications of small print is absolutely essential.
Current Mechanism
As is apparent, Indian CNC possesses none of the above mentioned competencies. All functionaries are 'generalists' with no domain expertise. CNC is generally guided by the advice rendered by the Finance Manager. Unfortunately, Finance Managers are totally incapable of providing any worthwhile advice as they possess no knowledge either of the military equipment under procurement or of various cost estimating techniques. Their domain competency is limited to accounting and audit functions only. Despite self-assigned taxonomy, they are least equipped to be defence economists or defence financial advisors. And this deficiency continues to be the biggest limitation of the complete defence procurement process.
LCC consists of deterministic costs (cost of acquisition/development) and probabilistic costs (cost of operation, maintenance and failures). Whereas it is easy to calculate deterministic costs, it requires a great deal of expertise to estimate probabilistic costs which requires necessary vision to forecast long term effect of local terrain/climatic conditions, employment during operations and quality of engineering support. Indian CNC is totally devoid of any such proficiency. Despite repeated claims, LCC analysis has still not been adopted as the standard methodology as there is no expertise available to calculate LCC pragmatically.
In the absence of any other alternative, old files of previous procurements of similar systems are dug out and a standard inflation factor is applied to it. Thereafter, an acceptability factor is assigned to determine a broad range of fair price. The whole process is ad-hoc, irrational and totally bereft of any scientific methodology. This is a naive method and invariably costs the nation dearly.
Negotiating Contracts
Advance planning and development of a well-thought out negotiation strategy are commonly acknowledged to be the key prerequisites for successful negotiations. Hard bargaining can be done only if own and vendor's strengths and weaknesses are known. Different vendors have different negotiating attributes. In single vendor cases, due cognisance must be taken of vendor's known methodology while constituting CNC. Many vendors submit inflated initial quotes to keep adequate allowance for subsequent reduction during negotiations. Special communication skills are required to gauge vendor's approach and develop suitable responses as the negotiations progress.
Competencies Required
Contract negotiation is a highly specialised task and requires specific skills and extensive training. In addition to in-depth knowledge of the equipment, negotiators must be familiar with different tools and tactics to conduct negotiations in a highly demanding world arms market. Negotiators must possess necessary flair and be able to communicate effectively. Communication skills, both verbal and non-verbal, are a must for being a good negotiator as useful bargaining information can be extracted from non-verbal clues as well. Trans-national and trans-cultural negotiations require a thorough knowledge of vendors' sensitivities and dissimilarities in negotiating practices. Bargaining is an essential component of all negotiations. Therefore, strong negotiating skills and optimum utilisation of available leverage are invaluable in striking favourable deals.
Current Dispensation
It may come as a surprise to many that India did not have a standard contract document prior to the issuance of Defence Procurement Procedure – 2005. Vendors were asked to prepare the draft contract document and it was circulated to all members of CNC for review and acceptance. Every member went through his area of concern and commented accordingly. Thus, Indian interests were left to the sincerity and diligence of individual members. Expectedly, vendors always drew contracts safeguarding their interests and the fine print contained provisions inimical to the Indian interests.
In India, officials are authoritarian in functioning and are never required to engage in dialogue. Therefore, they tend to be autocratic and inflexible in attitude. Most adopt 'I am right' or 'take it or leave it' approach. As they lack basic negotiating skills, they are found wanting during negotiations. Worse, little preparatory work is done in advance to evolve a negotiation plan or work out a cogent strategy to cater for contingencies that may arise during negotiations. All functionaries feel confident in the mistaken belief that they can handle trickiest of issues as they crop up and no time need be wasted on elaborate preparatory work. On the other hand, vendors come extremely well prepared and accompanied by a battery of experts.
Inability to determine realistic range of fair price hampers CNC's ability to question costing of the main equipment and support systems. Therefore, reduction in cost is sought by demanding discounts as a percentage of the quoted price, which is generally considered to be the most imprudent method. It conveys an impression of non-professional and amateurish approach. In the absence of a negotiation plan, some negotiators lose focus and tend to get mired in procedural minutiae. At times they trivialise serious issues with their officious behaviour and irresponsible remarks, thereby weakening their position during hard bargaining.
Selection of CNC Members
Instead of tailoring CNC as per the complexities of the system under procurement, it is constituted in a routine manner and members are detailed to represent different departments without reference to their suitability. The thrust is towards ensuring that all concerned departments are on board rather than pooling talent. The members are neither selected for any demonstrated capability nor for any displayed talent. Members have often been found wanting both in knowledge of the equipment and basic communication skills. The concerned departments detail the officers who are available and can be spared. In some cases there is no continuity at all as at every meeting a new officer appears. Worse, the leader is nominated purely due to the appointment he holds in the set-up rather than for any special expertise or competence. India, perhaps, is the only country in the world where a weapon purchase committee is headed by a functionary who is totally ignorant of the weapon-system under procurement and is awfully deficient of financial expressions and negotiating skills.
India wants to switch over to LCC methodology of evaluating offers but has developed no expertise at all. As most members are unaware of the anticipated employment and exploitation of equipment, application of LCC continues to be ad hoc, selective and inept. The problem gets compounded where technology transfer is sought as an essential part of the package and has to be priced. CNC has no financial experts well versed with international trade practices, foreign exchange transactions and contractual legalities. Functionaries trained in account-keeping and auditing are roped in as financial advisors. They fail to render any meaningful advice and are generally seen to be concentrating on irrelevant and peripheral issues.
Lack of Data Base
As a certain degree of secrecy shrouds all arms deals in the world, there are no ready reckoners or well-evolved guidelines for the costing of high-tech weapon systems. Every country has to develop its own methodology. A well-maintained data bank can provide useful details of previously negotiated contracts of similar equipment to facilitate preparation of acceptable price bracket. There is also a need to verify that there has been no downward trend in the world market since the previous purchase.
Additionally, banked data provides clues to the behaviour and conduct of a vendor during negotiations and implementation of previous contracts. Records of earlier negotiations also reveal degree of flexibility displayed by the vendor during price-fixation. It helps in devising own approach. It is equally important to maintain a data base of the feed back of earlier contracts to identify weaknesses and gaps, if any.
Although the defence procurement procedure mandates that the Acquisition Wing should maintain necessary data bank, little attention has been paid to it. There is no free flow of information between the three Services. The Comptroller and Auditor General of India (CAG) in his report has pointed out instances when different services paid different prices for the same item from the same vendor. Another issue relates to quantification of spares required and their cost. In the absence of any supporting data, these are generally left to the vendor. In numerous instances, India has purchased disproportionate quantities of spares at enormous cost without carrying out a realistic estimate of their wastage rate.
Conclusion
CAG, in his report placed in the Parliament in 2007, faulted the existing system of acquisitions being handled by unspecialised personnel posted for three-year tenures. The Kelkar Committee also noticed this deficiency and recommended that suitable training courses on tendering and contracting be conducted for Acquisition Managers by the College of Military Management, Hyderabad.
Popular Military Books
Insurgent Crossfire: North-East India
Wellington's Campaigns in India
Negotiation of contracts worth millions of dollars requires dexterous handling. To obviate mistakes which may prove inimical to own interests subsequently, a panel of experts should be associated with CNC to provide commercial and procedural advice. Requirements of all the three Services must be collated to obtain advantages of economies of scale and achieve best possible commercial terms for the country. Contracts involving transfer of technology and provision of subsequent upgrades need to be negotiated by experts who could be drawn from the industry as well. In the earlier defence procurement procedure, there was a provision that all contracts over 300 crore rupees would necessarily have a pre-contract process and procedures audit by an independent eminent persons group. For unknown reasons, this provision has since been dropped from the revised procedure promulgated in 2005. It must be restored.
Competent and well-equipped negotiating staff can save enormous funds by adopting a scientific and methodical approach. India must ensure that its functionaries who negotiate defence deals are fully trained and equipped to strike best possible bargains for the country during contract parleys. They must do detailed preparatory work to formulate a suitable negotiation strategy and make judicious use of available leverage to clinch most favourable defence deals for the country. And most importantly, care must be taken to ensure that the small print does not contain provisions detrimental to Indian interests.
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