Reference no: EM131003700

NEGOTIATION PLANNING

Review this case carefully and answer the questions at the end of the case in detail

William Pilgrim, Buyer for the Tappan Missile Company, was assigned a procurement requeSt for the modification of 45 optical instruments.

The Gilbert Instrument Company had previously manufactured the item for Tappan and had title to certain special tooling necessary for the modification work. Pilgrim realized that he was faced with a sole source procurement and requested a quotation from Gilbert for the modification work. The following quotation was submitted by Gilbert:

UNIT PRICE

Direct Material Direct Labor Factory Overhead (100%) Total	$        410,00 x 45 1,719.50 x 45 1,719.50 x 45 $3,849.00 x 45	-- = - =	$18,450.00 77,377.50 77,377.50 $173,205,00
G & A (10%)	384.90 x 45	-	17,320.50
Total	$4,233,90 x 45	=	$190,525,50
Special Tooling	329.60 x 45	-	14,832.00
Total	$4,563.50 x 45	=	$205,357.50
Profit (10%)	456.35 x 45	=	20,535.75
Total	$5,019.85 x 45		$225,893.25

Mr. Pilgrim requested a cost analysis and Fred Day, Price Analyst, and Charles Morton, Cost Engineer, were assigned to review the case.

When Mr. Pilgrim received the report from the two analysts, concerning the modification of the optical instruments, he was quite concerned at a substantial difference between the cost breakdown furnished by Gilbert Instrument and the estimate of cost by the Price Analyst. He knew from painful experience that when the Buyer's and Seller's estimate are so far apart, substantial problems would occur in the negotiation. He also recognized the fact that he was in comparatively weak bargaining position since he had no alternate supplier to go to for the modification work, a situation which he knew Gilbert Instrument Company would be well aware.

In his favor, however, was the fact that Gilbert Instrument Company did a large amount of business with the Tappan Missile Company and this procurement was for a relatively small dollar amount.

He called in Mr. Morton and Mr. Day to help him prepare his negotiation plan.

PRICE ANALYST'S REPORT

SUBJECT: ITEM: PROPOSED PRICE: TYPE OF CONTRACT:

Price Analysis, Gilbert Instruments, Inc. Modification of 45 Optical Instruments $225,893,25 Firm-Fixed-Price Contract

1. Supplier's estimate cost submission dated 23 March 20X1 was for the modification of 45 Optical Instruments.

2. Scope of Review

Price Analyst examined the related labor rates, through payroll analysis of all employees for the week ending 21 April 20X1. Overhead and G&A rates for the year 20X0 were computed by the Analyst, who is of the opinion that figures for a complete year are generally of greater value for projection purposes than a shorter period. However, the contractor insisted that the last six months of 20X0 were more representative of current operations, and thus submitted details for that period. The number of persons employed appeared to support the contractor's position.

Price Analyst and Cost Engineer visited contractor's plant on 25 April 20X1 contacting the Chief Estimator and the Comptroller.

Cost Engineer evaluated the estimated direct materials and estimated direct labor hours.

Following are the unit cost details as submitted and accepted:

	Per Contractor	Per Analyst & Engineer	Decreases
Direct Material	$        410.00	$            280.80	$          129.20
Direct Labor	1,719.50	704.00	1,015.50
Factory Overhead (100%)	1,719.50	704.00	1,015.50
Total	$3,849.00	$1,688.80	$2,160.20
G&A (10%)	384.90	168.88	216.00
Total	$4,233.90	$1,857.68	$2,376.20
Special Tooling	329.60	0.00	329.60
Grand Total	$4,563.50	$1,857.68	$2,705.80

3. Below is the Cost Engineer's evaluation of the material and labor hour estimates:

Direct Material: The Cost Engineer allows the following direct material estimates:

Item	Cost Per Unit
Reticle	$ 83.00
Nameplate	10.00
Heat Seal Bag	25.00
Carton	20.00
Selica Gel	7.00
Indicator	1.00
Miscellaneous Packing Materials	15.00
New Instrument Cover	20.00
Miscellaneous Material (alcohol, cement,nitrogen, lens tissues, etc.)	15.00
Miscellaneous Hardware	20.00
	$216.00
30% Allowance for Contingencies	64.80

Direct Labor: The supplier has, to date, failed to substantiate labor estimates on a sound engineering basis. The contractor has submitted general grouping of operations and has placed a time value on each group. Cost Engineer allows 32 hours direct labor.

Per Contractor 54 Hrs. @ 31.8425 $1,719.50

Per Analyst & Cost Engineer 32 Hrs. @ $22.00 $704.00

 

Supplier utilized selected employees while the Analyst utilized a payroll average based upon the latest payroll information available at the time of Analyst's plant visit, namely the week ending 21 April 20X1. Utilization of the plant wide average is consistent with supplier's past policy of using plant wide average rates when diverse personnel are required on a job. Contractor's representative, in the instance indicated, claimed that these key persons may be the only ones available at the time of the award.

4. Factory Overhead and G&A: Contractor utilized 100% of direct factory labor as factory overhead and 10% of total factory costs as G&A in its submission.

The Analyst is accepting the rates on the basis of prior to Analyst's report of 12 January 20X1, utilizing figures for the calendar year 20X0 as well as the first three months of 20X1. The trend appears to be upward with continued increases in overhead and G&A percentage. The last six months of 20X0, as adjusted, indicates higher rates than those utilized in contractor's submission. Contractor's business has decreased considerably.

5. Special Tooling: Contractor has estimated 212 hours as the time required to remove
the necessary special tooling from storage and return same to lay-away condition upon completion of the specific mission.

The following estimates were submitted by the Contractor:

Remove tooling from storage and clean                  64 hours

Set-up of Coolimators                                             38 hours

Subtotal                               102 hours

Put back in storage                                                110 hours

Total                                    212 hours

The supplier refused to furnish a cost breakdown for the special tooling. Using the same labor and overhead rates as used in the rest of the proposal, the following approximation was furnished:

212 hours	@ $32.40	$ 6,868.80
Overhead	@ 100%	6,868.80
G&A		1,094.40
		$14,832.00

The Chief Estimator for Gilbert Instrument, Mr. Peterson, stated that his estimate was very rough since this work is performed by maintenance personnel who are usually carried as an indirect charge.

6. Type of Contract: Ordinarily, a cost-type contract would be recommended; however, subject contractor's lack of a desirable cost system precludes such a contract. Thus, a fixed price contract is contemplated. Contractor's cost trend upward is such that a redeterminable contract would not be beneficial to the Government's interest.

(SELLER'S POSITION)

The Gilbert Instrument Company manufactures optical instruments. They had manufactured 45 instruments for the Tappan Missile Company and delivered them in 19X9. Tappan is one of Gilbert Instrument's biggest customers. In March, 20X1, they received a Request for Quotation for the modification of the 45 instruments which they had delivered in 19X9.

When the Request for Quotation for the modification of the 45 optical instruments came into the Gilbert Instrument Company, it was turned over to John Peterson, Gilbert's Chief Estimator. He frowned when he saw it because he knew from previous experience that modification contracts were very difficult to estimate. He much preferred preparing estimates for new items to preparing estimates for modification contracts.

Direct Material Direct Labor

$ 244.00 1,064.50

He assigned one of his more experienced estimators and within a short time the estimator furnished him with the following estimate of direct costs:

Direct Material Direct Labor Overhead @ 100%	$ 244.00 1,064.50 1,064.50 $2,373.00 237.30   $2,610.30
G&A @ 10%

Peterson then went to Bruce Jones, the Comptroller, and asked him for the most recent projected rates for the period of performance of the contract. He found that there was some discussion in the accounting group regarding the overhead rate to be used for bidding purposes. Peterson and the Comptroller, Mr. Bruce Jones, finally agreed that they would use the current rate of 100% and a G&A rate of 10%. Apply these factors, Mr. Peterson came up with the following estimate:

Peterson then considered tooling costs. While the Company had all the special tooling required for the job, considerable effort had been spent in storing the tooling. However, this work had been performed by maintenance personnel whose time was charged to overhead on an available time basis. These costs were charged to overhead and therefore he had no historical costs to fall back on. He developed a rough estimate of 150 hours at a labor charge of approximately $25.00 per hour to put the tooling in operation and to clean and store it at the conclusion of the contract.

Peterson then talked to John Gobel, the Marketing Manager. Gobel, after looking at the figures that Peterson showed him, asked him how much confidence he had in his estimate. Peterson stated that while he had done his best, his past experience with modification contracts showed that the actual cost of such work could vary widely from the estimated cost. Gobel agreed and asked him what was the extent of the variation he had encountered in similar modification work. Peterson replied that the actual cost could vary as much as 100% over the estimate due to unforeseen difficulties. Gobel then stated that Tappan Missile Company could not have the work performed anywhere else, and that the modification work was only a small percentage of the value of the instruments involved, and that, in his opinion, the price quoted

should be based on the most pessimistic cost estimate. The two men then put their heads together and developed the following cost estimate:

Direct Material                                             $ 410,00

Direct Labor                                                        1,719.50

Factory Overhead @ 100%                1,719.50

$3,849.00

G&A @ 10%                                         384.90

$4,233.90

Special Tooling                                                       329.60

$4,563.50

Profit @ 10%                                                          456.35

$5,019.85

The quotation was furnished to Tappan Missile Company. Approximately one week after the quotation was submitted to Tappan Missile, Mr. Fred Day, the Price Analyst for Tappan, called and requested an appointment with Mr. Peterson to review the quotation for the modification work. Mr. Peterson was concerned as to the extent of the review contemplated. His worst fears were confirmed when Mr. Day, the Price Analyst, arrived accompanied by Charles Morton, a Cost Engineer, and stated that their purpose was to review the basis for Peterson's estimate.

Peterson at first tried to restrict their analysis to overhead and G&A factors; however, the two men insisted on reviewing the complete cost estimate.

Peterson consulted with John Gobel, the Marketing Manager, for advice. Gabel told him that while he did not have to provide the information the men had requested, since the procurement was for a small amount considering the total business done by Gilbert and Tappan Missile Company, it would be in the overall interest of the Company to cooperate with the Buyer's Representatives. Peterson agreed to cooperate.

The following items were discussed by the Analyst:

Material

Peterson was able to show Charles Morton, the Cost Engineer, invoices for the following items that would be needed in the modification work. These represented approximately 85% the material costs.

Item	Cost Per Unit
Reticle	$ 83.00
Nameplate	10.00
Heat Seal Bag	25.00
Carton	20.00
Selica Gel	7.00
Indicator	1.00
Miscellaneous Packing Materials	15.00
New Instrument Cover	20.00
Miscellaneous Material (alcohol, cement, nitrogen, lens tissues, etc.)	15.00
Miscellaneous Hardware	20.00
	$216.00

The Cost Engineer asked him for an explanation for the difference between these material costs and the material costs included in the cost estimate which he had furnished with his quotation. Peterson replied that while this was the bulk of the material required for the modification, that in modification work, many problems arose which could not be anticipated. To illustrate, he cited problems of spoilage in the new items required, the possibility that in removing the parts of the instruments which required modification, other parts might be damaged or destroyed and require replacement. Peterson stated that since this was to be a fixed price contract, provision had to be made for these costs.

Direct Labor

Mr. Morton, the Cost Engineer, did not tell Mr. Peterson what his estimate of the amount of direct labor required was, but he strongly inferred that Peterson's estimate of 54 hours of direct labor for the modification of each unit was considerably higher than it should be. Mr. Day, the Price Analyst, questioned the rate of $31.80 per hour used by Mr. Peterson in his estimate on the basis that Gilbert Instrument had consistently used a payroll average in bidding on previous proposals and if they followed the same practice in this quotation, the labor hour rate used should be $22.00. Mr. Peterson told Mr. Day that the $31.80 rate which he had used in his estimate was developed on the basis of the actual labor cost of the type of employees which he contemplated using; that he was forced to use his top instrument repair men on this job since they would be the only ones available during the period in which the modification work would take place. Mr. Day did not seem convinced by this argument. Mr. Day, the Price Analyst, discussed with Mr. Bruce Jones, the Comptroller, the overhead and G&A rates used by the Company in the quotation. Mr. Jones showed them the basis for the projection of both rates. Amer examining the information that Mr. Jones had furnished, Mr. Day made no further comments and left.

In the meantime, Mr. Morton, the Cost Engineer, had been discussing with Peterson the basis for the estimate for the special tooling costs included in the proposal. Peterson explained that he had no historical cost information or experience to back up his estimate of the cost associated with taking the tooling out of storage and returning it to storage at the conclusion of the contract. He stated that the time estimate was based on his long experience with this type of work. Mr. Day, the Price Analyst, questioned Mr. Peterson concerning possible duplication of the tooling charge in overhead.

Peterson supplied the following estimate of the tooling hours:

Remove tooling from storage and clean                 64 hours

Set-up of Coolimators                                             38 hours

Subtotal                              102 hours

Put back in storage                                                 110 hours

Total                                   212 hours

He refused to supply a detailed estimate of tooling costs but did provide the following approximates:

212 hours	@ $32.40	$ 6,868.80
Overhead	@ 100%	6,868.80
G&A and Material		1,094.40
		$14,832.00

The representatives of Tappan Missile Company thanked Mr. Peterson for his cooperation and told him that he would probably next hear from Mr. William Pilgrim, the Buyer.

Approximately one week later, Mr. Gobel, the Marketing Manager, was contacted by Mr. Pilgrim, the Buyer for the Tappan Missile Company, and requested him to come in to negotiate the contract. Mr. Gobel decided that since Mr. Peterson was most familiar with the estimate, he would be the Chief Negotiator, and that he, Gobel, and Bruce Jones, the Comptroller, would assist him. The three men then sat clown to discuss their approach to the coming negotiations.

QUESTIONS:

1. Prepare separate written analysis of the procurement situation for both parties.

2. Prepare separate written negotiation plans for each party to include cost element objectives.

3. Are there any major misconceptions in the way the parties perceive each other's positions? Elaborate.