That is a common question, which requires some rephrasing to be answered with anything other than ‘It depends’
‘How much should I invest to increase my chances of winning that tender’ is a better question.
Would you spend 20k to have a 50/50 chance of a $5 million contract?
How about if your chances of success were only 20%. Would you still spend the 20k?
There is a continuum here, one that should change with your circumstances, and your judgement of your chances in the tender process. The management challenge is quantifying the level of risk tolerance that exists at that time.
‘How much should I spend’ is a form of question that implies a short term is involved, ‘How much should I invest’ implies a longer term. It may only be a semantic difference, but there is a great difference in the manner in which you approach the tenders preparation.
Quoting on tenders has two elements, the first is that now it is a tender, the implication is always that you are just one of several to tender, so it is an auction, of sorts.
The second is that there is never a sure fire thing, even when you have the inside running for any one of a large number of reasons, the most usual being incumbency of some sort. The fact that there has been a tender made public is an indication that the tenderer is not only looking for a price, they are looking for ideas.
To some questions you should be asking yourself:
- How valuable is the tender to me? If the tenderer is your biggest customer, and you are an incumbent for this sort of job, the answer would probably be very valuable, not just for the job being tendered, but for the ongoing relationship and flow of further work.
- What is the strategic value of the customer? This will often be a similar answer to the previous question, but your largest customers always started as a new, much smaller customer, and grew, so considering how ‘strategic’ they may be is important. An acquaintance of mine has what he calls a ‘green-keeping’ business that specialises in public spaces. He will do everything possible to win tenders put out by public bodies, councils, schools, and the like, as each one he wins is strategically important not just to the current cash flow, but to the position he holds in the competitive field.
- How unique is my solution? When you can do something none of your tender competitors can do, price becomes less important. Following the above example of the green-keeping business, he owns a tractor towed machine that ‘cores’ a surface, an important factor for vigorous grass growth on areas like football fields. All of his competitors need to hire such a machine (sometimes from him) as the need arises which adds a significant cost to maintenance and a resulting reluctance, which often enables him to get a superior outcome.
- How close is the strategic fit of the tenderer to the profile of my ideal customer? Every successful business has an idea of what their ideal customers look like, and the closer to the ideal profile a tenderer is, the more important it will be to win a tender that arises from them.
- How does the job fit into the existing workflow? When you have a ‘hole’ in your work flow, filling it becomes more urgent, the alternative being to cover the overhead costs from reserves or remove them. When the latter course is taken, it can be hard to resource back up when the work flows in again.
- How does the job fit my capability mix? A key part of having a profile of the ideal customer is that the mix of capabilities you can deliver exactly matches what is required by the tenderer. Having to buy in a capability you do not have is a strategic decision, and should be made carefully.
- What is the net cash flow from the project over the life of the project? To do any sort of financial calculation, this forecast is an absolute necessity. It should be done in any case, as you are bidding for the contract, and therefore should have calculated your costs and the financial benefits and risks. This is all that is needed for a financial calculation.
Having determined how important the job may be to win, the task is to increase your chances and decide how much to invest in winning.
There are two variables, the amount you invest, and the chances of winning the tender. To do a financial calculation on the options, you could use a function called ‘Net Present Value’ or NPV. We all recognise that a dollar today is worth more than a projected dollar tomorrow. The value of tomorrows dollar being reduced by the amount of inflation, and the certainty of the projected cash flow from the project.
To do an NPV calculation, you need to have projected the cash flows to which you are applying the formula.
The NPV formula is simple in principal: Assume an amount of $20,000 is outlaid with the projection that in the following 3 years the project will deliver 100k/year positive cash flow in current dollars, and the discount rate is 5% to allow for 5% inflation.
The cash flow looks like:
$20,000 initial investment, followed by year 1 net cash flow of $100,000, plus year2 100,000 X .95 = $95,000 plus discounted year 3 of $90,250.
The net cash flow from the project is therefore $285,250.
Therefore the net present value of the initial investment at the end of the project is $285,525 – $20,000, or $265,525. In this case, it would seem that the investment of 20k in winning the tender would be a very good investment indeed.
The discount rate can be changed to reflect not just the future value of current dollars, but to also reflect the risk of not winning. This can be a more complex calculation, but relatively easily done with a formula called Internal Rate of Return (IRR) available in every spreadsheet package.
These two calculations, NPV and IRR are routinely done in tandem by accountants to calculate a risk adjusted return from an investment.
When considering the question ‘how much should I spend on this tender‘ they will together be very handy tools.
Cartoon credit: Scott Adams and Dilbert.
