Whether you are a market leader or a challenger in a competition for a “franchise” program, pre-emptive pricing strategies are likely to be a factor. It can be an offensive play for the challenger—or a defensive play for an incumbent on a program being upgraded or replaced.
This Winning Insights post is the second article in a two-part series on Rationalizing Pre-emptive Prices. Reflecting on TMI’s 600 engagements over the past 30 years, this article presents insights gained from three additional competitive situations where pre-emptive price was a primary Source Selection determinant (see Part 1 posted on 31 May).
What Is a Pre-emptive Price? Given an acceptable technical offer, it is the “Godfather” offer price—an offer* the customer cannot refuse. It cannot be denied, despite cost realism and risk-based adjustments for Most Probable Cost (MPC), best value trade-off analysis in assessing Total Evaluated Price (TEP), or Value Adjusted Total Evaluated Price (VATEP). (* An acceptable minimum offer requires a technically acceptable product with a low-risk execution plan; relevant or very relevant past performance and a past performance rating of satisfactory or substantial confidence; proven ability in applying the critical program technologies; and credible cost/price substantiation.)
Competitive Situations with Pre-Emptive Prices. The generalized competitive situations described below were selected from dozens of TMI engagements where a pre-emptive price was a primary Source Selection determinant. In June, we presented insights for the following situations:
* Market leader (also incumbent for an airborne BMC2 program) faces the threat of a competitor offering newer technology.
* Challenger beats the axiomatic winner and/or current incumbent on a competitive major upgrade by offering a credibly rationalized pre-emptive price.
* First-to-market “strategic win” of a later generation technology product competing against a competitor (who earlier pioneered and won the prior generation development contract)
This month, we present insights for three additional competitive situations:
* Market leader protects long-term legacy, dominant market position in an open competition for mission recapitalization where the competitor offers a product with greater mission capability.
* Competitor beats the customer’s defacto preferred contractor in a single-up competition between two competitors producing the same weapon in a leader/follower development and production.
* Incumbent, threatened by strong competitor in an OSD initiated competition, defends its position and beats the competitor who offers a rationalized pre-emptive low EMD price.
Market leader protects long-term dominant market position (based on research from open source articles).
KC-135 Replacement. The initial competition was won by the Northrop Grumman and Airbus (NG&A) team with an A-330-based offering having greater capability than the Boeing 767-based offering. NG&A was evaluated to have the lowest Total Evaluated Price (TEP). Boeing protested the award and the protest was sustained. OSD then weighed in and SECDEF cancelled the competition to preclude a reinstitution of the current competition. This decision to start over with a new competition later led to an OSD-approved acquisition plan with modified evaluation factors and a change to fixed price contracting. Upon seeing the new final RFP, Northrop Grumman elected not to bid. This left USAF with a no competition dilemma. After OSD and USAF encouraged EADS-North America (Airbus USA) to bid, the competition was held.
Not winning in the initial competition had shocked Boeing. They realized that if Airbus won, and assembled A-330-based tankers in Alabama, it would not only end Boeing’s 60+ year USAF tanker franchise but would enable Airbus to further dilute Boeing’s share of the U.S. domestic airline market. Thus, there was a Boeing top down imperative to win. In the new competition, if competitors’ offers met over 200 mandatory requirements, government evaluated TEP would become decisive in the source decision. From the USAF debriefing on the initial competition evaluation and other discovery, Boeing was aware of NG&A’s price in its initial offer and thus could analyze and “target” Airbus’s likely price in the new competition and arrive at a price to win.
In a comparison of total program prices of initial offer versus new offer, adjusted for schedule differences and inflation, Boeing’s new offer price on the total package (FPIF RDT&E and the FFP Production) was significantly less than its initial offer price adjusted for the new offer contract terms. For the total package offer, Boeing’s price was approximately 5-6% (net present value) less than EADS’ (Airbus) price on a total program valued at approximately $35 billion.
Boeing must have concluded that the strategic gain was worth the price risk. Also, unlike in the initial competition, Boeing’s top leadership “forged” better cooperation for cost determination and reduction between its Military Aircraft Unit (which bids and delivers the tanker) and its Commercial Aircraft Unit (which provides the 767 platforms for modification to the tanker configuration).
Price risk could be mitigated if the USAF, OSD, and Congress do not deliver, exactly as planned, on their side of the deal for 179 units across the 17-year contract. Constructive and/or programmatic changes could occur. Boeing won and perpetuates its tanker dominance.
[Note: The newer RFP and source selection criteria were prepared to be “bullet proof” to protest. This resulted in a “tilt” toward (de facto) a Lowest Price Technically Acceptable source selection in contrast to the initial Best Value Trade Off selection. NG&A won the 2007 competition with a “Slam Dunk” Offer (Maximum Mission Capability at lowest Total Evaluated Price).]
Competitor beats the likely preferred contractor in a production single-up competition between two contractors producing the same weapon.
As the protracted countdown for release of a production single up slipped to the right, Contractor B, the customer’s likely preferred contractor, was pushing for an early single up. More than 10 years earlier, Contractor A won the original RDT&E and the lead producer role in the subsequent leader/follower production program (competed annual split buys). Subsequent to winning the RDT&E, Contractor A had competed against B (production follower) and had lost two important engineering support programs for the acquisition customer. One contract was critical for the weapon’s Mission Planning. The other was a Weapon System Engineering contract to help the acquisition customer in its role of integration across the broad set of contractors and government labs involved in the program. Thus, Contractor B became the likely preferred contractor for the single up. This preferred posture was enabled by the continuing daily interactions of Acquisition Program Office personnel with Contractor B’s system engineering personnel, who were co-located with the Acquisition Program Office. Even though the single up source selection would be stated as best value award, both contractors knew that all up round average unit production price would be decisive in winning.
Contractor A projected that the customer would also buy several thousand more units after the single up production run was completed. In effect, at stake was a franchise program for the next 30 years.
Contractor A’s consulting firm estimated Contractor B’s average unit cost advantage to be 10-12% based on bill of material (BOM) cost differences, manufacturing cost differences, and rate differences. Also, if the customer needed to use a best value premium to “reach” for Contractor B that premium would not exceed more than 4-5% since both contractors had been producing the same weapon for years. Thus, Contractor A had a cost/price problem of 14-17 %. This set the stage for Contractor A to rationalize a pre-emptive price by engineering cost out of its in-house tasks and out of the BOM, which represented 80% of all up round unit cost. Focusing on the cost leverage in the BOM and benefitting from the added time due to the customer announcing a one year delay, Contractor A set ‘gamey” buy to goals for the major cost items in the BOM. Setting the goals was the easy part. The hard part entailed implementing, for each of the largest cost items comprising 85% of the BOM, a team consisting of an engineer with functional responsibility for the subsystem being procured, a senior buyer with negotiation experience, and a cost analyst to work with each supplier. In each team’s collaboration with suppliers, costly but non critical specs, invented by Contractor A in the initial proposal, were scrubbed and unnecessary, but costly below the line data, etc., was eliminated to significantly reduce supplier prices in the “all (winning) or nothing (losing)” scenario. Further, a recently retired Contractor A Vice President of Procurement, who earlier worked as an engineering manager, was called back to active duty for a year to manage the BOM cost reduction efforts.
Contractor A won with a pre-emptive price they rationalized and worked exhaustively to implement. Contractor A’s all up round price was less than the Contractor B’s BOM. This became the basis for Contractor B’s protest, which was not sustained. Contractor A continues to enjoy its franchise program.
Incumbent, threatened by strong competitor in an OSD initiated competition, defends its position and beats competitor who offers a rationalized pre-emptive low EMD price.
Targeting Sensor Upgrade Program (TSUP). The incumbent, through its comprehensive pre-RFP situation and competitive assessment efforts, concluded that the challenger could credibly rationalize a pre-emptive EMD price. The challenger, claiming its later technology and production programs as leverage, prompted OSD to intervene and direct the acquisition customer to open the TSUP Pre Planned Improvement upgrade for the incumbent’s targeting sensor to a full and open competition. The challenger’s claim to OSD and USAF was “why spend several hundred million dollars to upgrade the incumbents’ sensor to the capability we already have in production? Also, we can adapt ours and integrate it on USAF’s fighter for an EMD cost of less than $100 million and deliver two years sooner than the incumbent.”
The incumbent knew it could match or better the technical capability the challenger recently developed for two fighter sensor programs for other customers. But the incumbent did not have the rich menu of NDI and qualified components the challenger enjoyed. This prompted an effort to re-engineer how the incumbent designed, procured its subsystems, and manufactured its sensors. Further, the incumbent’s Business Unit General Manager decided to forge commonality into it three new sensors (TSUP and two others being developed for other platforms) to reduce the TSUP’s NRE cost and get cost saving from common IRAD investments, etc. In spite of commonality savings and capital investment for Engineering Development Models and other clever EMD cost saving initiatives, the incumbent’s EMD cost would exceed the challenger’s by tens of millions.
Thus, the incumbent concluded that it could not win a head-to-head EMD competition given the cost lift enjoyed by the challenger. The incumbent then decided to change the game by pushing to expand the scope of the offer to include an NTE unit cost for LRIP and an average unit cost estimate for Full Rate Production (FRP) units. This would broaden the scope of the offer, extend the contract horizon, and raise the cost base (EMD plus LRIP plus FRP) to be evaluated. Further, the challenger would be burdened with actuals from its recent LRIP deliveries wherein unit cost significantly exceeded original estimates. This prompted the incumbent to initiate a comprehensive Design To Unit Production Cost (DTUPC) effort driven by a “gamey” top-down goal that would be out of reach for the challenger. The Program Technical Director was charged with managing and realizing the DTUPC goal.
Additionally, the incumbent knew USAF would ultimately task the platform prime to host the competition and make the source selection. Thus, the incumbent decided to monetize the integration risk that it and the platform prime had already mitigated in three earlier integrations of TSUP-A, B, and C on the platform. This monetized risk of $90 million actual cost gave meaning to a theme: “incumbent’s fourth time integration versus challenger’s first time integration.” Then later in source selection, the prime used the monetized risk in arriving at the challenger’s most probable cost. Also, fortune smiled on the incumbent when USAF and the platform prime delayed the competition for a year. This helped fix the incumbent’s schedule problem. Thus, the incumbent “checkmated” the challenger’s pre-emptive EMD price and retains its major program.
Our Winning Insights series will continue with next month’s article: Opportunity Creation in the 2016-2020 Competitive Environment.