Life Cycle Cost An Imperative For Public Procurement

Public procurement can be a key facilitator of India’s small and medium manufacturing sector by providing the necessary demand for its goods.

In their ordinary course of business, governments purchase vast amounts of goods and services through public procurement. Such spending by public agencies contributes significantly to domestic demand, encourages manufacturing, and can incentivize private sector participation in key manufacturing sectors such as defence equipment, railway supplies, and others where Governments are typically the major, and often sole, buyer.

It is therefore necessary that such procurement of goods adheres to the principles of efficiency, competitiveness, and transparency, while being fair and equitable to suppliers and promoting competition in the market. The Life Cycle Cost (LCC) of procurement becomes a necessary component of high-value Government purchases, and its usage in India should extend to all procurement above a certain cost threshold.

According to a recent report by the World Bank, developing countries spend about $820 billion annually of tax-payer funds on Government requirements for different purposes, amounting to about half of total public spending. In India, various estimates place such expenditure at about 20-30 per cent of GDP, including on defence equipment. Between 1980 and 2010, public procurement increased 58 times, bearing significant implications for the overall growth of the manufacturing sector.

With the ‘Make in India’ policy in place, procurement plays a key role in developing India as a global manufacturing, technology and design hub. This is all the more critical at a time when India aims to achieve self-sufficiency in the defence sector and build its capital goods manufacturing capabilities. In addition, public procurement can be a key facilitator of India’s small and medium manufacturing sector by providing the necessary demand for its goods.

Government procurement is conducted under the 1947 General Financial Rules (GFR) of the Ministry of Finance, updated in 2005. The Manual on Policies and Procedures for purchase of goods, 2006, provides the basis for procuring goods of the required quality at the most competitive price in a fair, equitable and just manner. In computing the costs offered by various bidders as per the tender documents, the Government adopts a single-stage two-bid system of technical and financial bids submitted together. The evaluation ranks total cost from lowest to highest, and decides on the offer with the least cost or L1.

A drawback of this system for high-value procurement is that it evaluates only the cost at the time of procurement. Typically, capital goods and defence equipment have long operation periods, and it is important to examine the costs of operation, maintenance, spare parts, and others over the entire period that the equipment is in use. Better design and higher technology content can, over the long run, make a piece of machinery more efficient and less expensive to run and service. For example, we often go in for more expensive cars or consumer durables, keeping in mind the servicing costs, access to repairs, and cost of running.

Life cycle cost, or the total expenditure over the entire duration of the product, takes into account costs of its design and technology, as also procurement, installation, operation and maintenance. For India, a country that aspires to emerge as a technology leader, public procurement that takes into account the entire LCC can serve as a potent instrument to boost indigenous R&D and high-tech manufacturing of equipment, systems and sub-systems. Currently, such an approach has been used only a few times in some defence tenders.

There are several benefits to considering the LCC approach to arriving at L1. First, the cost to the Government over the full life of the equipment would be arrived at in a rational manner, thus lowering its expenditure over the longer term. This would also boost quality and efficiency of the product, bringing in higher gains and saving tax-payer money. Second, producers would be incentivized to spend more money on R&D if it is likely to be recouped through an advantage in procurement. Better design and technology content would be ensured. Third, a wider set of enterprises would be encouraged to participate in bidding processes.

Essentially, a proactive approach to Government procurement designed to promote Make in India would ensure that India receives the highest levels of technology and quality available globally and appropriate for Indian conditions. Prior track record should not be a criteria for disallowing bidding and norms for qualification must undertake an evaluation of capabilities of Indian companies to enable them to participate in tender processes. Further, speedy procurement demands that the time-lag between request for quotation (RFQ) and request for proposal (RFP) should be stipulated at a maximum of 3 months. The Government needs to include a price variation clause in the project order to ensure that unplanned cost escalations due to foreign exchange fluctuations are taken care of at a later stage.

It is time that the GFR is amended to incorporate life cycle cost of procuring high-value capital equipment for Government needs. This would align the country’s procurement practices with its manufacturing objectives, and thus turn procurement from a mundane process to a valuable tool to be harnessed for development.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house