Who is the L-1?

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ASMAN01

Who is the L-1?

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Posts: 6

(01/28/08 01:28:47)

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Many times on the basis of recommendations of RDSO or other bodies, tenders for implementation/Up gradation of new /existing technology (e.g. SCADA) are floated in the divisions. Since these technologies are sophisticated and generally Railways do not have the necessary expertise to maintain such technology. Therefore the tenders are floated on TURNKEY basis i.e. Installation of the new / upgraded technology and its maintenance for a sufficiently longer period. Also many times the tenders for AMC for a period of relatively longer duration say 5 years are more are invited. The problem in such tenders is how to decide L-1.

As known in the Financial Management, value of money goes on diminishing as the time elapses. (Time value of money). In simple terms, value of a rupee 2 years hence will not be same as of today because of inflationary and various other factors. Therefore from finance point of view, the offers received in tenders with longer period must be adjusted with the discounting factor so as ascertain the exact cost to railways. Let me explain with the following case:

In a tender for installation and maintenance of a technology related to IT project two tenderers have participated. The scope of the work was to provide the hardware and to maintain the same for a period of 5 years. The rate offered by both the firms are as under:-

Sr.no.	Particulars	Rate offered by M/s. ABC Ltd.	Rate offered by M/s. XYZ
1	Supply of hardware	15,00,000/-	12,00,000/-
2	Supply of software	05,00,000/-	04,00,000/-
	TOTAL	20,00,000/-	16,00,000/-
3	AMC
	I st year	02,00,000/-	2,00,000/-
	2 nd year	02,00,000/-	2,50,000/-
	3 rd year	02,00,000/-	3,00,000/-
	4 th year	02,00,000/-	3,50,000/-
	5 th year	02,00,000/-	4,00,000/-
	GRAND TOTAL	30,00,000/-	31,00,000/-

From the above table, one would easily draw the conclusion that M/s. ABC Ltd. has quoted lower overall value and hence he is L-1. But if we analyze the yearly CASH OUTFLOW adjusted to discount rate, the position becomes much different:-

	M/s. ABC Ltd.			M/s. XYZ
	Cash outflow	PV factor	Present value	Cash outflow	PV factor	Present value
INITIAL YEAR	20,00,000	1.000	20,00,000	16,00,000	1	16,00,000
END OF I st year	2,00,000	0.935	1,87,000	2,00000	0.935	1,87,000
2 nd year	2,00,000	0.873	1,74,600	2,50,000	0.873	2,18,250
3 rd year	2,00,000	0.816	1,63,200	3,00,000	0.816	2,44,800
4 th year	2,00,000	0.763	1,52,600	3,50,000	0.763	2,67,050
5 th year	2,00,000	0.713	1,42,600	4,00,000	0.713	2,85,200
	30,00,000		28,20,000	31,00,000		28,02,300

Thus the position of L-1 changes if we discount the cost quoted by the tenderers with a discount rate of 7% (notional rate).

So shall we adopt the Discounted Cash Flow technique while evaluating the inter-say position? What are the practices followed in different railways in this regard?

Manoj Asawa

DFM /BSL

subbu98

Discounting factor is important

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Posts: 147

(01/28/08 03:49:49)

Arriving at a reasonable discounting factor is the key. In the example cited the discounting factor seems to have been taken as 6.5% (not 7% as mentioned). One presumes that the premise used for the same is that Railways pays 6.5% dividend to the General Exchequer. Such a premise may not necessarily be a correct one. This is a critical area and there will be an element of subjectivity. A better way to tackle the problem would be to ask for the AMC for the 1st year and provide a pre-determined PVC (based on some index like WPI if the consumables of AMC are difficult to ascertain or any other index or weighted average of several indices if the elements of AMC are known) for the subsequent years. That way the playing field would be the same for all the bidders. The likelihood of a firm becoming L1 despite a higher cost of main items (as in case of ABC in example) because of low AMC would be marginalised. Similarly, the confusion regarding awarding the contract to a firm whose cost of main item is less but overall cost is more (as in case of XYZ) can be avoided. In any case, either way the AMC as a matter of principle should not decide the contract.

Subhashisha Nath

Dy FA&CAO/COFMOW

scmitra

DCF

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Posts: 542

(01/28/08 07:39:10)

The mental gymnastics in the above example need not be resorted to if in the tender document the evaluation criteria of L1 is mentioned. If it has been made clear to firms that DCF technique with x% discounting factor would be used, everybody is on a level playing field. But if the same was not mentioned in the tender document and has been used by the committee to evaluate the tender and the inter se position changes as in the above example, motives can be and will be imputed. Afterall a different discounting factor and a different L1 will be the result!

This is a sticky territory and in my opinion any stand, even if bona fide, but lacking in transparancy will be looked down upon.

scmitra
sredpm/ccg

rahuliras

evaluation criteria

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Posts: 4

(01/29/08 22:31:56)

Normally the evaluation criteria is not mentioned in the tender document so as to accord manegerial flexibility to the tender deciding authority. Use of DCF or any other moethod for evaluation of the offer would be the discretion of the Tender committee.The TC has to weigh the pros and cons of each technique in deciding upon the method adopted by them for evaluation. For instance, a different result would be obtained if a different discount rate is chosen while using the DCF technique. Hence justification for using a particular rate should be clearly mentioned in T C proceedings if DCF is used for evaluation.
I agree with Mitra sirs view that whatever decision is taken, transparency and application of mind should be reflected in the decision making process.

R Kapoor
DFM/RNC

Govindu96

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Posts: 3

(02/01/08 04:08:03)

To the extent of my knowledge, Works contracts are decided on absolute value of the OFFER and not by the various Financial techniques. As such you may go ahead with defined L1-Valid, Eligible and Technically Suitable. As such Tender Committee has limited role and everything can not be decided by TC. TC can not go beyound defined rules. Finance officer may know the DCF technique but not other officers of TC/TAA. Basic rules are decided at the time of Tender Notice itself duly incorporating all rules, regulations and instructions duly keeping the tender document open for incorporating further changes in rules, instructions from time to time during execution of work. Tenders are personal resposibility of the member and no other person can give advise. These are only the views. All the best.

Govindu.
SrDFM/ HUBLI

abhishek

DCF

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Posts: 20

(02/01/08 09:38:33)

hi

Most of us will agree that tenders are means of discovering reasonable cost of a work/service not an investment decision.Costs are real and Cash outgo are not dependent on any financial techniques or ratios instead they are real cheques.So L1 should be based on least cash outgo alternative.

No harm in putting evaluation criteria like DCF in NIT as long as providing level playing field and transparency in evlauation of tender is concerned.But how good a financial decision it will be is an different issue altogether.

At the time of planning an investment we might have assumed costs and benefits and applied DCF as per F1 (true only for a miniscule of proposals that end up in tenders) .By applying DCF to offered rates we may be rightly discounting costs(which are more realistic now than what was assumed at propsal stage).But thats only one side of story.What about discounting future benefits?and the way earning estimates are made to arrive at a predecided irr putting effort to arrive at realistic discounted net (benefit minus cost ) value of a proposal will be an exercise in futility,if not in toto certainly at tender finalisation stage.Tenders come at execution stage when investment decisions are through.Costs are real and have to be assessed more realistically (at any point of time accuracy with which cost can be predicted will be much higher than the accuracy of predicting earnings) at propsal stage and at tender stage we can only hope that value offered by L1 is close to our estimates of costs

Abhishek
DFM/DNR

Vivekanup

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Posts: 30

(02/03/08 22:16:05)

Manoj:
Rather than calculating the DCF, or NPV, somewhere in your tender document it would be written that the overall value of the tender will be the criteria. This would be near the paragraphs which metiones about consideration of taxes and other ancillary costs. I am not sure how the tender you are dealing with has been drafted. Thats the simplest way to go.

Second, if you check the NPV at various discouting rates, this is what we get:
M/s. ABC Ltd. M/s. XYZ
Supply of hardware INR 1,500,000.00 INR 1,200,000.00
Supply of software INR 500,000.00 INR 400,000.00
Total of H/w, s/w INR 2,000,000.00 INR 1,600,000.00
1st year amc INR 200,000.00 INR 200,000.00
Total outgo in 1s yr. INR 2,200,000.00 INR 1,800,000.00
2 INR 200,000.00 INR 250,000.00
3 INR 200,000.00 INR 300,000.00
4 INR 200,000.00 INR 350,000.00
5 INR 200,000.00 INR 400,000.00
Total: INR 3,000,000.00 INR 3,100,000.00
Discouting rates %
5 INR 373,328.19 INR 308,654.84
6 INR 319,045.64 INR 263,289.11
7 INR 278,570.56 INR 229,589.84
8 INR 247,221.80 INR 203,558.06
9 INR 222,222.00 INR 182,839.00
10 INR 201,818.06 INR 165,954.26
11 INR 184,848.41 INR 151,928.21
12 INR 170,512.78 INR 140,090.71

Further more, if we have decide to go this far, why not consider the rate of Borrowings. If this is capital expenditure, then probably this would have been borrowed at 9% by railways from GOI and then they will be paying dividend at 7.5% . This assumption is based on the fact that these are not strategic lines or somthing similar. So the truth shall lie somewhere between 7-8 % of discount.
Let test it against Financial propriety (116-F).

116. Standards of financial propriety.

In the exercise of their financial powers, the sanctioning authorities must pay due regard to the following principles:-
(1) The expenditure should not prima facie be more than the occasion demands, and that every Government servant should exercise' the same vigilance in respect of expenditure incurred from public moneys as a person of ordinary prudence would exercise in respect of the expenditure of his own money.
.....................

So you see that NPV's get you better picture. But the bottom line, is this calculation acceptable to (Vigilance and) accepting authority.

I believe what you are saying is true and should be followed. But this remains a large gray area.

Vivek Tripathi
IRAS 98

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