Paranha Eng
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Transcript of Paranha Eng
Graduate School of Business (HEC, Ecole des Hautes Etudes Commerciales)
University of Lausanne (Switzerland)
NE-01-004
Negotiation game: Paranha Power Plant
Jean-Claude Usunier prepared this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a business situation. The authors may have disguised certain names and other identifying information to protect confidentiality.
The Institute of International Management of the University of Lausanne (IUMI) prohibits any form of reproduction, storage or transmittal without its written permission. To request permission to reproduce materials, contact IUMI, HEC, BFSH1, CH-1015 Lausanne-Dorigny, Switzerland; phone 00 41 21 692 3310 ; fax 00 41 21 692 3495; e-mail [email protected].
© IUMI/HEC, 2004 Version: (A) 2004-10-06
A consortium, BDH, has been established between a US-based engineering company, a Swiss
company belonging to the same sector and a German firm producing heavy industrial
equipment. This consortium is in the final phase of negotiations to win a contract for building
a turnkey electric power plant. The owner is the National Electricity Authority (NEA), a state-
owned corporation which holds a monopoly on the transport and distribution of electricity in a
Latin America. National Electricity Authority has issued the tender.
The tender procedure was initiated eighteen months ago. At first there were about
twenty potentially qualified contractors which submitted bids. Most of them were engineering
companies originating from the main industrial countries, and some came from newly
industrialized countries such as South Korea and Turkey. After a preselection phase, the
number of potential contractors was reduced to a short list of five companies or consortia. The
final selection process lasted for several months, as bids that were technologically
incomparable had to be taken into account.
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The consortium created by Brown Engineering Corp. (US), Duponval SA (Swiss) and
Horst BauTechnik AG (German) was chosen as the organization with which the final
negotiations would take place. But a Japanese competitor, Chikoda, has also made a very
attractive offer and is equally in a position to supplant BDH, if BDH proves to be too
demanding for National Electricity Authority. In fact BDH has a strong reference list,
supported by similar plants it has built which are working effectively. Moreover, in addition
to its offer, BDH provides a low-rate, long-term financing scheme for the buyer, which has
been created by putting together export credits issued by banking organizations from the
countries of the three members of BDH : US Eximbank for Brown, Swiss Banking
Corporation for Duponval and KfW (Kreditanstalt für Wiederaufbau) for Horst BauTechnik.
The final price has not yet been settled, as there are still some important clauses to be
discussed:
1. The supply of basic materials by the consortium, during the start-up of the power plant.
2. The possibility of signing a 'products in hand' contract. A 'products in hand' contract is a
particular kind of turnkey operation, where part of the payment by the owner to the contractor
is subject to the level of performance reached by the plant. After the start-up phase has been
finished and individual pieces of equipment have been shown to work effectively, a phase
begins where the contractor is assigned to operations. This means that a management contract
has been signed. The variable fee may cover part or all of the turnkey operations as such
and/or the management contract. In this case the consortium would agree to sign a
management contract to run the operation until it reaches 100 per cent of its target capacity
(400 megawatts).
The proposal which served as a starting base for the final bargaining process was
priced at US$105 million. Each one of the partners-to-be has naturally retained its right to
improve its position, either by obtaining a rebate (the buyer) or by increasing this base price
level by astutely negotiating supplementary services (the consortium).
Since the inception of this tender, National Electricity Authority has made it known
that the first power plant will be followed by the construction of two similar plants, all this
being stated in the ten-year plan for the electrification of the country. It seems very likely that
the contractor selected to build the first unit, if effective, will be well positioned for the next
two orders which may possibly be placed by direct agreement between contractor and owner,
that is, without a competitive bidding procedure.
At the negotiating table are three representatives of the buying organization and three
representatives of the BDH consortium, each one an employee of one of the companies:
1. For the buyer:
(a) Mr Melo, who is in charge of project financing for industrial development at the Ministry
of Finance. He might be a useful and even necessary go-between for many red-tape problems
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related to administrative and financial issues which could arise when completing the project:
payments, clearing customs for imported equipment, fiscal and social problems of expatriates,
etc.
(b) Mr Alves, who is the director in charge of energy at the Ministry of Industry. He is
concerned with the coordination of this project with the other industrialization projects being
undertaken in the country. There have been many negative experiences of this in recent years:
two years ago, some ships with a full load of cement were stranded in the main sea port of the
country because there was not enough unloading equipment such as docks and cranes. This
caused severe delay on several projects.
(c) Mr Duran, the third representative, is 38, much younger than both Melo who is about 50
and Alves who is 60. He has been trained in the United States and holds a Master of Science
degree in Electrical Engineering. At National Electricity Authority he is in charge of new
plants and investment project. He is reputed to be ambitious but also capable and hard-
headed. In the long run he is seen as a possible chief executive for National Electricity
Authority. Duran has confidence in the country's development projects and in the capacities of
local managers to run the new plants effectively.
2. For the consortium:
(a) Mr Smith, a project manager aged 42, who has worked for many years at Brown, the US
member of the consortium. Brown will take charge of the boiler part and the plant monitoring
system. Brown is ranked among the leading US engineering companies. It has a high
reputation for technical excellence as well as for cost control. Project managers at Brown are
partly compensated with a bonus based on the profit generated by the project. A sophisticated
cost accounting system monitors actual and forecast costs and margins regularly during the
project. When projects are completed after two to three years or more, final costs are
calculated, with a minimal deviation from target costs.
(b) Mr Robin from Duponval SA, a Swiss engineer who has worked for this company for the
last ten years. Duponval has already formed several joint ventures with Brown, and Robin
knows Smith because they have already worked together. Duponval SA is in charge of civil
engineering and the total coordination of the work. This firm has established a good
reputation world-wide for meeting delivery times.
(c) Mr Dietermeyer, a Doctor of Law, aged 55, has worked for the last twenty years for Horst
BauTechnik. Although he has not been formally trained in engineering, he has built up a good
knowledge of industrial engineering on the job. In addition to this he has attended many
training sessions which have provided him with an in-depth knowledge of the technologies of
a large variety of turnkey plants. He is considered in his company a skilful, experienced and
effective business negotiator. His law background is very useful in discussing precise clauses,
understanding what is at stake and the possible legal consequences of a specific clause. Horst
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is in charge of supplying and installing turbo-alternators and all the electrical parts in the
plant.
BDH consortium has been chosen as the contractor with which National Electricity Authority
is willing to negotiate the final agreement under the supervision of the Ministry of Finance
and the Ministry of Industry. A sum of US$105 million is the starting point for the discussion;
until now it has been considered a lump sum for a turnkey operation contract. But things have
not yet been fully settled.
The Latin American team wishes to negotiate either a rebate on this price level,
arguing that there will be future projects which could be awarded to BDH, or complementary
services or guarantees, which could be granted for free. These might possibly be the
following:
1. The free supply of materials required for production during the start-up phase, which will
last one month.
2. Free technical assistance for the industrial management of the power plant, in order to be
able to serve consumers and to manage the electricity distribution network properly.
3. A commitment from BDH to subcontract part of the job locally, especially the less
sophisticated part of the civil engineering work.
BDH naturally prefers to maintain its price, for which it had been selected from harsh
competition. In fact there were some cheaper competitors, sometimes $15 million less. But
neither their reference lists nor their financing deals matched BDH's bid.
To tell the truth, BDH is somewhat worried about the delay penalty clause which National
Electricity Authority wants to include. The fine is supposed to be 1 per cent of the total price
for each construction month beyond the standard completion time. The consortium foresees
that there could be some delay. It fears that it might be difficult to assign clear responsibilities
to either the contractor or the owner (or the state authorities of the country, or a large
subcontractor, especially if it was a local business). Usually turnkey contracts include a
customs franchise for all the equipment imported in order to build the plant. But it is not that
rare for customs officers not to apply these rules immediately, and it may delay the customs
clearance of these components and equipment, thereby delaying the completion of the plant.
The parties have agreed to discuss the issue of transforming this pure turnkey
operation, paid for by a lump sum, into a 'B.O.T.' contract ('Build-Operate-Transfer'). Under
the B.O.T. scheme, part of the payment will be subject to a variable scale related to the level
of capacity reached during the management contract period after the plant has been completed
and started up. The possibility of a management contract has been discussed. It will probably
be added to the turnkey contract (which includes the construction start-up phase, but no
more). This management contract will encompass handling the industrial management
procedures, the accounting system, setting salaries, customer service and providing training
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programmes for local executives. Progressively, local management is supposed to take over
the management of the project. The basis on which the variable payment would be calculated
has not been clearly settled up to now. This basis could be: the whole amount of the
management contract, part of it, or the whole amount of the management contract plus part of
the $105 million turnkey project.
The Latin American proposal for this final negotiation includes the following
elements:
1. The price of the management contract plus US$10 million (on top of the turnkey price) to
become a variable and conditional payment, subject to the capacity level reached within a
certain time span. This scheme would extend throughout the total thirty-six months of the
management contract period.
2. For this variable part the proposed payment scheme is as follows:
(a) 15 per cent after six months if the output reaches at least 50 per cent of the target capacity;
(b) 15 per cent after twelve months if the output reaches at least 60 per cent of the target
capacity;
(c) 15 per cent after eighteen months if the output reaches at least 70 per cent of the target
capacity;
(d) 15 per cent after twenty-four months if the output reaches at least 80 per cent of the target
capacity;
(e) 20 per cent after thirty months if the output reaches at least 90 per cent of the target
capacity;
(f) 20 per cent after thirty-six months if the output reaches 100 per cent of the target capacity.
3. The management contract may grant decision-making powers to the consortium in the
following matters: recruiting personnel (workers, not the management), operating the plant
and choosing supplies of appropriate quality and price. The selling price of the output as well
as the operating costs are to remain the sole responsibility of National Electricity Authority.
The negotiation takes place at the headquarters of National Electricity Authority in
Port Paranha, where the power plant will be built. The talks simply aim at finalizing an
agreement for beginning the construction as soon as possible. No detailed agenda has been
prepared for the negotiations.
Discussion begins....
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