Sunday, December 25, 2011

Breaking Cartel in Government

A decade ago, I worked in Pune looking after a clutch of ordnance factories. Apart from payment and costing, my office was tasked with rendering financial advice to these factories putatively known as the Khadki Group of Factories. Material procurement in factories is a regular job to fulfill production line manufacture. That kept me busy.
One particular item for production involved huge procurement cost. Only two firms had tendered – daintily sharing the quantity in almost equal measure. It gave me an uncanny feel of a cartel; the rates appeared far from market-driven. The prices quoted were about 15% higher than the previous year’s rates.
I mulled over the issue – despairing as I went along. It was a given that most procurement in ordnance factories were essentially cases of monopsony, where one buyer faced many sellers (the opposite of monopoly); hence, in this imperfect competition it’s the buyer who must dictate price rather than the other way around.  Many of the firms who supplied to these ordnance factories had no other market share beyond the factory (ies) under the aegis of the Ordnance Factory Board. Hence, I told myself, I needed to dig deeper. Without much effort, I discerned a trend: the items were being shared by the two firms the past few years, with each year’s rates going up by 10-15% – and in no particular relation with inflation rates!
          But when I went to the meeting, I was confused. The factory needed it to keep going, the lead time was 5-6 months; and obviously I could not stall production. As I sat, my mind caught in cobwebs of procedures, it came to me in a flash. I remembered a conversation I had had during inspection of another factory where a new firm had been given a small order of the same item to establish itself as an “established source”. 
       Back in my office, I got the details. Yes, the firm had been successful. That made it a “semi-established source”. But then it wasn’t enough: it could only be deemed “established” on successful completion of “two” such orders. How was I to leverage this “semi-established source” to break the cartel? Source development orders should not “normally” exceed 20% of annual procurement. I looked at the word “normally” piercingly. Then came the Eureka moment for me.
          In the next meeting, I suggested we try the “new” firm. The General Manager hemmed and hawed, citing the firm’s “semi-established” status. Finally, after long deliberation he reluctantly agreed with me to place 20% on the new firm and the balance 80% on regular suppliers. I suggested we take advantage of the term “normally” and place 40% on the new source. After much persuasion, everyone agreed. We decided to invite tenders from the new source.
       When the rates quoted by the new firm reached us, we were ecstatic: they were unbelievably lower by 58-60% of the established firms’ rates! By now, word had gotten around and the two regular firms without any prompting announced their intention to whittle prices down by 20% from their last purchase rates – effectively down by 35%! Since I wasn’t sanguine about the timely supply by the new firm, I agreed to place 20% on these two.
         We placed 40% on the newly developed source with a tight delivery schedule. That made it 40%+20%=60%. What about the remainder 40%? I kept my counsel close to my chest, hoping things panned out the way I had hoped for and the new firms delivered on its promise – quality and timeline. The firm surprised us by supplying ahead of schedule. Now I suggested repeating the entire ordered quantity. This, too, they supplied on time.
            I was over the moon. We’d broken the cartel; it also meant huge savings; the new rates willy-nilly had become the benchmark for future procurement, thereby cascading savings that ran into crores of rupees. What still rings in my ears are the words of many Doubting Thomases, predicting this was only the penetration rate of the new firm and that it sure will join the ranks of the other two and form cartel at the soonest! The new firm did neither. Instead, the next year round, they further reduced their rates! Touché.


  1. This is true for most of the govt. procurements..application of mind by financial advisors can do wonders..