CORY ELECTRIC

“Frankly speaking, Jeff, I didn’t think that we would stand a chance in winning

this $20 million program. I was really surprised when they said that they’d like to

accept our bid and begin contract negotiations. As chief contract administrator,

you’ll head up the negotiating team,” remarked Gus Bell, vice president and general

manager of Cory Electric. “You have two weeks to prepare the data and line

up your team. I want to see you when you’re ready to go.”

Jeff Stokes was chief contract negotiator for Cory Electric, a $250-million-a year

electrical components manufacturer serving virtually every major U.S. industry.

Cory Electric had a well-established matrix structure that had withstood

fifteen years of testing. Job casting standards were well established, but did include

some “fat” upon the discretion of the functional manager.

Two weeks later, Jeff met with Gus Bell to discuss the negotiation process:

Gus Bell: “Have you selected an appropriate team? You had better make sure

that you’re covered on all sides.”

Jeff: “There will be four, plus myself, at the negotiating table; the program manager,

the chief project engineer who developed the engineering labor package; the

chief manufacturing engineer who developed the production labor package; and

a pricing specialist who has been on the proposal since the kickoff meeting. We

have a strong team and should be able to handle any questions.”

Gus Bell: “Okay, I’ll take your word for it. I have my own checklist for contract

negotiations. I want you to come back with a guaranteed fee of $1.6 million for

our stockholders. Have you worked out the possible situations based on the negotiated

costs?”

Jeff: “Yes! Our minimum position is $20 million plus an 8 percent profit. Of

course, this profit percentage will vary depending on the negotiated cost. We can

bid the program at a $15 million cost; that’s $5 million below our target, and still

book a $1.6 million profit by overrunning the cost-plus-incentive-fee contract.

Here is a list of the possible cases.” (See Exhibit I.)

Gus Bell: “If we negotiate a cost overrun fee, make sure that cost accounting

knows about it. I don’t want the total fee to be booked as profit if we’re going to

need it later to cover the overrun. Can we justify our overhead rates, general and

administrative costs, and our salary structure?”

Jeff: “That’s a problem. You know that 20 percent of our business comes from Mitre

Corporation. If they fail to renew our contract for another two-year follow-on effort,

then our overhead rates will jump drastically. Which overhead rates should I use?”

Gus Bell: “Let’s put in a renegotiation clause to protect us against a drastic

change in our business base. Make sure that the customer understands that as part

of the terms and conditions. Are there any unusual terms and conditions?”

Jeff: “I’ve read over all terms and conditions, and so have all of the project office

personnel as well as the key functional managers. The only major item is that

the customer wants us to qualify some new vendors as sources for raw material

procurement. We have included in the package the cost of qualifying two new raw

material suppliers.”

Gus Bell: “Where are the weak points in our proposal? I’m sure we have some.”

Jeff: “Last month, the customer sent in a fact-finding team to go over all of our

labor justifications. The impression that I get from our people is that we’re covered

all the way around. The only major problem might be where we’ll be performing

on our learning curve. We put into the proposal a 45 percent learning

curve efficiency. The customer has indicated that we should be up around 50 to

55 percent efficiency, based on our previous contracts with him. Unfortunately,

those contracts the customer referred to were four years old. Several of the employees

who worked on those programs have left the company. Others are assigned

to ongoing projects here at Cory. I estimate that we could put together

about 10 percent of the people we used previously. That learning curve percentage

will be a big point for disagreements. We finished off the previous programs

with the customer at a 35 percent learning curve position. I don’t see how they

can expect us to be smarter, given these circumstances.”

Gus Bell: “If that’s the only weakness, then we’re in good shape. It sounds like

we have a foolproof audit trail. That’s good! What’s your negotiation sequence going

to be?”

Jeff: “I’d like to negotiate the bottom line only, but that’s a dream. We’ll probably

negotiate the raw materials, the man-hours and the learning curve, the overhead

rate, and, finally, the profit percentage. Hopefully, we can do it in that

order.”

Gus Bell: “Do you think that we’ll be able to negotiate a cost above our minimum

position?”

Jeff: “Our proposal was for $22.2 million. I don’t foresee any problem that will

prevent us from coming out ahead of the minimum position. The 5 percent change

in learning curve efficiency amounts to approximately $1 million. We should be

well covered. “The first move will be up to them. I expect that they’ll come in with an offer

of $18 to $19 million. Using the binary chop procedure, that’ll give us our

guaranteed minimum position.”

Gus Bell: “Do you know the guys who you’ll be negotiating with?”

Jeff: “Yes, I’ve dealt with them before. The last time, the negotiations took three

days. I think we both got what we wanted. I expect this one to go just as

smoothly.”

Gus Bell: “Okay, Jeff. I’m convinced we’re prepared for negotiations. Have a

good trip.”

The negotiations began at 9:00 A.M. on Monday morning. The customer

countered the original proposal of $22.2 million with an offer of $15 million.

After six solid hours of arguments, Jeff and his team adjourned. Jeff immediately

called Gus Bell at Cory Electric:

Jeff: “Their counter offer to our bid is absurd. They’ve asked us to make a counter offer

to their offer. We can’t do that. The instant we give them a counter offer,

we are in fact giving credibility to their absurd bid. Now, they’re claiming that, if

we don’t give them a counter offer, then we’re not bargaining in good faith. I think

we’re in trouble.”

Gus Bell: “Has the customer done their homework to justify their bid?”

Jeff: “Yes. Very well. Tomorrow we’re going to discuss every element of the proposal,

task by task. Unless something drastically changes in their position within

the next day or two, contract negotiations will probably take up to a month.”

Gus Bell: “Perhaps this is one program that should be negotiated at the top levels

of management. Find out if the person that you’re negotiating with reports to a

vice president and general manager, as you do. If not, break off contract negotiations

until the customer gives us someone at your level. We’ll negotiate this at my

level, if necessary.”

1. What is the major problem with this case study?

2. How do you think Cory Electric will handle this dilemma?

3. What do you think is wrong with the estimates provided by Cory Electric?