Currently, the public sector tends to procure goods and services on a fixed priced basis. As inflation continues to rise and organisations grapple with significantly higher costs than anticipated, there are certain ways procurement processes may need to change to best manage and support suppliers in the changing economy and ensure a competitive procurement process, to secure best value across the life of the contract.
For public sector organisations, the benefit of fixed pricing has always been to provide cost certainty, meaning that the cost of the goods or services remained within the contracting authority’s allocated budgets and approvals.
However, fixed pricing is challenging for suppliers to provide in the current market. Indeed, it may be difficult for a supplier to properly estimate the cost of the goods or services across the whole contract period, and many may be reluctant to do so with further price rises in the back of their minds.
If fixed pricing remains a hallmark of public sector tenders, there are a few potential responses that bidders may submit, and each one bears its own risk to both parties.
Starting with more cautious bidders, these suppliers are most likely to incorporate the risk of fluctuating prices within their costs. Since the risk is largely unknown, that risk allowance is likely to add a significant margin to the price. While this could result in the buyer paying an artificially inflated price for the product, it could also result in the bidder losing the tender because of the approach to pricing, even if they have otherwise scored highly on quality.
At the other end of the spectrum, there are bidders who may not price risk into quotations at all. These bidders will either be gambling on a fall in future prices or hoping to persuade the authority to then vary the contract later, once the risk materialises.
The risks for both the supplier and buyer in this circumstance could be significant. For the supplier, this approach could make the actual cost of providing the goods or services too high to fulfil the contract at the tendered price. To try and salvage their bottom line, they might cut corners on service delivery which could impact public services and delivery of community benefits. It could also add management time on the behalf of the public sector body in order to ensure the contract is fulfilled as required. There is also the knock-on effect down the supply chain to consider as smaller suppliers are squeezed.
In more severe circumstances, particularly where the public sector is a large portion of the company’s income, it could force the supplier to cease trading, as their profit margin disappears. Supplier insolvency will have a significant impact on the purchasing authority, and delivery of public services, also causing a ripple effect through the supply chain. Taking this risk-hungry approach leaves much to wishful thinking on costs which is not beneficial to either party.
If the authority is procuring a framework agreement, it should beware of the risk of "bed-blockers" who price keenly to secure a place on the framework, but are unable to bid at the call-off stage, when the true cost risk is known. This could result in the process becoming uncompetitive at call off stage and affect the authority's ability to achieve value for money.
A final consideration is a “nil return at tender”, where some or all of those in the market deem the contract simply too risky or unprofitable to submit a bid. This would leave the authority with the possibility of having to retender, with knock-on cost and time implications, during a time when costs are rising further.
While fixed pricing in the current market brings clear risks for the specific contract, the approach could also have longer-term impacts on the public sector marketplace.
Thinking in extremes, businesses could shut up shop, or withdraw from the public sector market altogether, severely impacting long-term competition in the future. This is of particular concern since the public sector has a responsibility to transact fairly with bidders in order to preserve a competitive market.
An important way for authorities to ensure they are transacting fairly is to understand the context of the market they are purchasing in. Inflation is not homogenous – certain materials and sectors are under more pressure than others. If the authority understands where suppliers are most under pressure, it can help to set realistic project budgets and ensure affordability through benchmarking exercises.
Authorities are recommended to carry out a thorough pre-market engagement process, within the scope of the procurement regulations. Failing to do this might lead to unaffordable bids being returned with the authority either having to abandon the project or seek approval for additional budget, leading to further delay, during which time costs will have risen further.
Market knowledge gained through the pre-market engagement must be reflected in the tender process and the resulting contract documentation. Authorities should consider their pricing requirements, their evaluation mechanism, the length of the contract, as well as their terms and conditions of tendering. This will ensure an appropriate risk allocation between the public and private sector, making it an attractive opportunity for the private sector and preserving healthy competition.
Public sector organisations should also consider the impacts of unanticipated rises mid-contract. If it is considered appropriate, authorities can draft in provisions for price changes, such as adding in a price adjustment or a risk sharing provision to the contract. Authorities should remember that any review clauses have to be written in a "clear, precise and unequivocal" way, so as to comply with the requirements of the procurement regulations. Doing so should support suppliers in providing the most competitive response possible but also protect the authority by clearly setting out the parameters for any future changes.
Inflation has risen at pace and continues to climb. It is critical for public sector organisations to consider rising costs as part of their procurement processes, both to ensure a competitive tendering process, but also to provide a fair risk allocation between the public and private sectors.
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