In industries where customers buy substantial projects, each contract is effectively a case of type-1 rivalry – either we win it, or a competitor does. Examples include construction projects in civil engineering or process industries, IT projects for government departments, and large consultancy studies. Customers usually ask possible suppliers to submit bids for a project, issuing “invitations to tender” (ITTs) or “requests for proposal” (RFPs). Although suppliers would prefer a continuing relationship, to enjoy a steady stream of all of a customer’s project needs, the high cost of big projects motivates customers to seek the best bid on each occasion.
A supplier may decline to bid on an ITT for various reasons, e.g. if a particular project is not of a kind they especially want, if the customer is difficult to deal with, or if the supplier is already overloaded. A key question for contractors is therefore how many of the possible ITTs to bid for, and how much effort to devote to preparing bids. It can be hard to say “no” to potential work, so contractors often respond to more ITTs than they could possibly deal with, knowing that they will only ever win a small fraction.
In Figure 1, we compete for a steady stream of 50 potential large projects per quarter, each taking four quarters to complete. Better quality bids win more projects, and this quality depends on putting enough staff time onto preparing each bid. One particular competitor is virtually identical to our business, with the same staff of 40 on bid preparation, the same price and cost per project, the same overhead, and the same performance on actually doing the projects. Just over a year into the situation shown, we saw a sharp fall in the number of projects won each quarter. As a result, our stock of active projects fell, as the larger numbers previously won worked through the system, to be only partly replaced by the fewer new projects we won. Operating profits also fell until the stock of active projects bottomed out.
Figure 1: How bidding for more projects can lead to fewer successes. (Click image to view larger)
Why did we do so badly? Initially, we and our rival were bidding on the same number of cases, and putting the same, limited effort into those bids. In the fourth quarter, our competitor decided it was losing too many bids through the poor quality of its proposals, and decided to focus its efforts on producing better bids for fewer projects. The quality of its bids increased substantially, allowing it to win most of the projects for which clients invited us to tender. Our response was precisely the opposite of what was needed. We went for a larger fraction of project opportunities, so our bid-preparation staff had still less time to give to each proposal, reducing the quality of those bids and thus reducing our win-rate.
Until next time…
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Cyclicality in project-based industries
Many project-based industries are notoriously cyclical – going through periods of rapidly escalating demand, followed by near-total collapse. This happens for two reasons. First, relatively small changes in demand for final products – packaged consumer goods, for example – produce big swings in the supply-demand balance for intermediate and up-stream suppliers (producers of packaging and plastic raw materials). A switch from plentiful supply to shortage therefore means that more capacity is needed, so projects get started. This pressure is made worse because everyone in the supply chain sees rising prices and the chance of rising sales at the same time, so all may rush to build new capacity at the same time. In 2008, for example, charter rates for large ships hit an all-time high of $300,000 per day, compared with just $15,000 in 2003, resulting in a 4-fold increase in ship-building. Similar issues arise in industries as diverse as commercial real-estate, petrochemicals, memory chips and insurance.
This briefing summarises material from chapter 7 of Strategic Management Dynamics, pages 450-452.
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