# 3.1The Price is Right? (A) Strategic Pricing to Land Air Force Contracts

James Taylor, director of operations at Logistic Specialties, Inc. (LSI), had just hung up the phone. He had extended a supplier an offer to tender a best-and-final offer for the F-16 Strut. The supplier had politely declined, saying, “We’ll have to pass on this one. We can’t go any lower.”

As James sat down, he glanced out his window. The sun was setting on a beautiful April evening, and flickers of light were glistening off the Great Salt Lake. James wasn’t surprised at the supplier’s reaction. He had done the pricing analysis, and he didn’t expect any of the five higher-priced suppliers competing for the right to make the F-16 Strut to beat Touch-and-Go Landing Gear’s (TGLG) quote. The quote was low—perhaps too low. Even so, James always gave each supplier one opportunity to stay in the hunt for business.

It was already 7:30 p.m. Within the hour, James hoped to select the right supplier, finalize the pricing, and submit the final bid to the Air Force. He was already pretty confident who the supplier would be, but he knew that getting the price right would be tricky. Landing contracts gave him a rush. However, tired and hungry, James sometimes wished he could keep banker’s hours.

In 2003, the United States Air Force released a rather distinctive request for proposals (RFP). The Air Force was seeking to build a team of prime contractors to manage the acquisition of almost 2,000 unique landing gear parts and assemblies. Several details made the RFP intriguing:

• Potential primes would have one year to put their proposals together. (However, five years elapsed from initial RFP to the actual award.)

• Each proposal needed to provide pricing and capacity details for the entire and diverse range of landing-gear components for all of the Air Force’s aged aircraft—trainers, fighters, transports, and tankers (see Table 3.1).

• Table 3.1
Aircraft Covered by LGPVC
Name Class
KC135 Cargo
C5 Cargo
C30 Cargo
B52 Bomber
B1 Bomber
B2 Bomber
F15 Fighter
F16 Fighter
F4 Fighter
A10 Attack
E3 AWACS
T38 Trainer
• Companies that earned a landing gear prime vendor contract (LGPVC) would win a 10-year contract. However, because some parts can take up to five years to procure, the actual contract length could actually extend to 14 or 15 years.

• If selected as a prime contractor (frequently just called “prime”), a company would win the right to bid on individual parts contracts as they came to market. Of course, being selected for an LGPVC didn’t guarantee a prime any business. Landing an LGPVC only granted a prime a “hunting license” for the duration of the contract.

• Beyond demonstrating that the prime could deliver on the range of parts, the Air Force required that potential primes include a ceiling price on each and every part. A ceiling price sets the cap on the price for the entire 10-year span of the contract. In other words, regardless of what a part actually costs five or eight years out, the prime can only charge the Air Force its previously quoted ceiling price. None of the primes wanted to win a contract based on its quoted lowest ceiling price.

• Individual parts contracts could be released from any one of five buying centers (see Table 3.2):

• Defense Logistics Agency (DLA)–Ogden

• DLA–Columbus

• DLA–Richmond

• Global Logistics Supply Center (GLSC)

Table 3.2
Customer Volume by Order

2,015 Orders
Volume by Dollar

James, however, viewed small-dollar RFOPs as a great opportunity. He took pride in winning and performing on contracts that none of the other primes felt were worth handling. One time, an Air Force contractor had commented, “You guys took 150 orders last year that were only $300. I don’t know how you make money on orders that small.” James smiled every time he remembered that conversation. He hadn’t told the contractor that LSI couldn’t do it profitably. Those skinny orders were one reason he worked late so many nights. James wasn’t just interested in making money; he also wanted to earn goodwill. 5. Zero-Margin Orders. A second classic rule is to go hard after the high-margin orders. James understood the logic: if you’re going to sweat to earn every contract, you might as well be compensated for it. Even so, James was willing to take a lot of orders at zero margin. In fact, during an audit of 2012’s orders, the audit team discovered that over three percent of all the orders LSI had won and executed were at zero margin. When the audit team reported this result, some of James’s colleagues shook their heads in dismay and grumbled, “That’s no way to run a profitable business.” James hadn’t argued the point, but he was confident that the goodwill LSI was earning was worth the investment. What was LSI’s reward for working so strenuously to rewrite the rules? For the previous year, LSI had won about 50 percent of the orders—and almost 45 percent of the dollars spent on the landing-gear program (see Figure 3.1). When asked about LSI’s success, James responded, “Everyone works for low margins almost all of the time. The difference is who is willing to work the most. We win so much because we are willing to do the work.” Figure 3.1: LSI’s Winning Track Record ## Winning an Order Once the Air Force issued an RFOP, James and his team had 10 days to put a winning proposal together. The preparation process consisted of three main phases: 1. Day 1—Sourcing Strategy. The first task on James’s radar each morning was to check how many RFOPs had been released by the Air Force. On average, he expected five RFOPs to be waiting for him. However, he wouldn’t be surprised to see anywhere from 0 to 25. Once, he found an astonishing—almost unmanageable—49 RFOPs demanding action. For each RFOP, James’s team needed to build a sourcing strategy. The team would send an RFQ to every supplier identified on the Air Force’s attached qualified supplier list. However, out of the up to 150 suppliers typically listed, James expected only four to six suppliers to really go after any specific part order. His job was to identify the preferred suppliers, gauge their ability to put together a winning bid, and decide whether or not to bring in new supplier through the SAR process. 2. Days 2–9—Homework. After sending out the RFQs, LSI’s workload broke down into two distinct activities: • Following Up. Given the compressed timing, LSI aggressively followed up with its preferred suppliers, asking questions like, “How is it looking?” or “What questions do you have?” It wasn’t uncommon for a supplier to respond, “We’ve looked at the data package. On note 17, it says to heat treat the spec from standard 129. It used to be 130, and we think the tensile strength is too soft. We’re a little nervous about that.” LSI's job was to follow up with the Air Force to obtain an engineering review and clarification. This query-and-clarify process could happen multiple times for a single part. • Pricing. As the suppliers were setting up their supply chains and preparing their bids, James’s team was digging into the bidding history on the part. How many times had the Air Force put this part out to bid? Which prime had won the bid? Who were the lead subcontractors? What were the volumes? What was the winning price? Developing an accurate pricing profile was the key to a productive Day 10—and to winning the bid. 3. Day 10—Decision. Although it was possible for suppliers to come back with their bids earlier in the timeline, they almost always pushed into the 10th day. As busy as LSI was during Days 2–9, the suppliers had a far more difficult and hectic job. They had to resolve all technical issues, assess materials availability, verify capacity, schedule production, and come up with a firm price. The result: almost all the suppliers’ quotes came in on Day 10 (sometimes very late in the day). With the quotes lined up, James’s Day 10 was drawing to a close. After reviewing each package to make sure it was valid, James was ready to initiate the final delicate step in the selection process. He would call each of the high-bid suppliers and say, “On this part, you are not the lowest price. You’ve got an hour to bring back your best and final offer.” James was always very careful never to divulge rivals’ pricing information to suppliers during this “best-and-final offer” process. James wanted to give everyone a fair shot, but he did not want to drive an artificial feeding frenzy (a practice often pursued by rival primes). He was sure that although sharing pricing information might drive price down, it would undermine trust, reducing supplier willingness to respond to future RFQs. Suppliers needed to know that their prices were safe with LSI! This was one reason LSI received more quotes per part than rival primes. If one of the higher-priced suppliers came back with a lower bid than the previous low-price supplier, James would have to make one last best-and-final offer call to that supplier. Every supplier deserved one chance to improve its bid. With the right partner selected, the time had come for a final phone call. James would call the winning supplier and say, “Here’s the deal: I have your price, you’re the lowest, and we’re using you. Now, let’s talk about what we need to do to win this contract.” One of three conversations could ensue. • Too High. “The last seven times this part has come out, Héroux has won it and built in-house. You’re$35 higher than I think you need to be based on the pricing history. So, I’ll bid the way you have it written up, or you can drop the price. If you really want to win this part, I think you will need to drop your price by $35—and then it will be close. What do you want to do? Of course, if you think my pricing analysis is wrong, I’d appreciate any feedback. We don’t just want to win this, we both want to make a little money.” • Too Low. “We’ve done the price analysis going back 15 years on this part, and I think you are about$60 too low on a per-unit basis. To double-check, we took one of the bids from a rival supplier who consistently quotes us 20 percent higher than its preferred partner, HTI. Working backward from its bid, your price is $63 below market. I see two possibilities. One, maybe you need to go back and check your quote and make sure you caught all the requirements. For example, are you sure you accounted for two forgings on this part and didn’t price it with just one? Two, maybe you are that efficient. If so, I’m telling you that you can raise your quoted price. Just to be on the safe side, I’m going to bid this$55 higher. I’ll give you half the difference. You deserve to keep some of your efficiency.”

• Just Right. “We’ve done the price analysis going back 15 years on this part, and I think your price is right on target. I’ll get the paperwork done and get this submitted. We’ll know in a few days if we’ve done our homework well.”

To reliably win parts contracts, LSI had invested in leading-edge information systems. Given the fact that Day 1 for one part could be Day 10 for another, accurate and comprehensive data were needed to keep the details straight. James remembered a few times when LSI had to juggle 50 RFOPs in a single day (25 Day 1s and 25 Day 10s). Beyond systems, a strong team of loyal subcontractors was also vital. By law, LSI could not lock in a subcontractor via contract. Trust and the ability to be partners in profit was all that kept many subs as consistent members of LSI’s hunting party. Of course, a culture of meticulously doing the homework didn’t hurt!

## The Right Pricing Strategy for Part XYZ

As the last light faded from the mountains, James swung his chair around to his desk. The last best-and-final offer on the F-16 Strut had just come in. No one had come close to Touch-and-Go Landing Gear’s original bid of $3,142 per unit (see Table 3.5). James smiled, wondering whether the bid team at TGLG knew what it meant when he never called to ask for a best-and-final offer. Table 3.5 Bids for the F-16 Left Strut Current Opportunity for 146 Units Supplier Supplier Notes Approved Quoted Each Price Delivery Time TGLG In production now, gives LSI a 20% discount Y$3,142 1,050 days
Bemsco Not in production, no discount to any prime Y $3,456 1,000 days MSI Not in production, no discount to any prime Y$3,242 1,500 days
Johnson Not in production, gives other primes a 20% discount Y $4,100 1,000 days Alpine Not approved, submitting an approval request—only bids LSI N$3,885 1,100 days
Notes: Allowed to bid an unapproved source with an alternate bid. Alternate bid will be used in the event that the approval request is denied.
Requirements: Price per part cannot exceed 12,000 and delivery time cannot exceed 1200 days.

James glanced at the pricing history on the F-16 Strut (see Table 3.6 and Table 3.7) as he picked up the phone and began dialing. Smiling, he said to himself, “This should be a fun conversation.”

A moment later, James heard a familiar voice say, “Hello?”

Table 3.6
Price History: Panel A—Left Hand
Part Number Description AMSC Code
200143-118 F-16 Strut LH C
Purchase History
Prime Quantity Total Price Award Date
HDI 1 $6,425.87 6/20/2013 ES3 3$17,700.00 11/7/2012
LSI 133 $424,378.00 12/22/2010 LSI 120$356,690.00 8/4/2010
ES3 94 $382,612.00 3/1/2010 LSI 206$765,423.00 12/22/2009
LSI 32 125,466 9/29/2009
Non LGPVC History
Vendor Quantity Total Price Award Date
TGLG 75 $270,000.00 8/3/2008 TGLG 88$301,300 9/20/2007
Eagle 25 $113,800 6/29/2007 Eagle 7$46,680 6/5/2006
Eagle 8 $38,708 6/1/2006 MSI 40$164,000 1/31/2006
Cagas 7 $29,260 2/15/2000 DAF 7$31,822 4/24/1996
Lockheed 1 $12,042 1/29/2009 DAF 11$50,721 1/29/2009
Lockheed 7 $48,669 5/1/1983 Lockheed 6$30,970 11/1/1982
Table 3.7
Price History: Panel B—Right Hand
Part Number Description AMSC Code
200143-117 F-16 Strut RH C
Purchase History
Prime Quantity Total Price Award Date
LSI 1 7,000.00 4/4/2013
LSI 3 23,868.00 3/29/2013
LSI 111 314,130 9/15/2011
HTI 177 470,542.11 4/14/2011
LSI 120 333,240.00 1/11/2011
LSI 139 341,349.25 8/6/2010
LSI 44 127,379.56 6/9/2010
LSI 156 430,630 2/12/2010
Non LGPVC History
Vendor Quantity Total Price Award Date
TGLG 126 428,600 9/6/2007
Kellstrom 13 89,570 8/16/2006
MSI 125 472,500 6/6/2005
MSI 12 68,800 4/15/2005
SP 15 80,790 12/2/2002
Cummins 39 141,774 8/21/2002
Kellstrom 8 59,640 4/19/2002
Kellstrom 2 14,720 2/22/2001
SP 3 13,194 7/30/1996
DAF 11 48,378 4/24/1996
Goodrich 1 8,020 11/1/1995
Lockheed 1 11,557.46 10/1/1992
Lockheed 8 38,888 6/1/1990
Lockheed 10 60,611.18 5/1/1983
Lockheed 6 30,970.26 11/1/1982

## Questions

1. Which conversation should James pursue? How vigorously should he press his point? What are the potential outcomes of this conversation?

2. For what price would you write the bid? Remember, you want to win the bid. You also want to make money.

3. What are the pros and cons of each of LSI’s four initiatives to rewrite the rules of the bidding environment? Why would LSI take small-dollar or zero-margin orders?

## Action Activity

Imagine you are in James’s chair. Script your conversation. Consider the following:

• How would you begin?

• What evidence would you use to support your discussion and make your point more powerfully and convincingly?

• How would you expect your counterpart to respond?

Sit down with a team member and role-play this scenario.