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Misconceptions About Tendering

Tendering is a formal process in which a company (or organization) evaluates and selects a banker on the basis of information provided in a Request for Proposal (RFP) document. The tendering process is competitive, and typically involves the solicitation of RFP’s from several pre-qualified banks.

Tendering has two rationales:
  1. Tendering is used when there is a need to demonstrate that the bank selection process is rigorous and fair.
  2. Tendering is used when there is a need to introduce auction dynamics into banking negotiations.

In spite of its obvious advantages, the only organizations that systematically tender their banking relationship are those that operate in the public or quasi-public arena. Governments, crown corporations, school boards, hospitals, charities, etc. all tender to satisfy a public accountability requirement. They report that tendering results in more competitive pricing.

Why don’t more companies tender their banking relationships? Because while tendering costs are known and understood, tendering benefits are ambiguous.

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The Cost Benefit Relationship

Companies struggle when it comes to forecasting savings that will result from tendering their banking arrangements. Why so? For starters, most CFO’s believe that there’s little difference between competing financial institutions from a pricing viewpoint and that the price reduction advantage to switching banks is nominal.

It’s easy to understand the rationale for this opinion. In banking, tender driven price reductions are usually small and spread across the banking interface. Although their aggregate impact can be worth pursuing, it’s difficult to see where one bank has a clear-cut price advantage over another. Without assurance that tendering will yield substantially better pricing, the lack of benefits objection to tendering becomes circular and self fulfilling. Most treasury personnel view the cost saving rationale for tendering as a benefit that should happen, but may not.

If the cost reduction benefits from tendering are unclear, the costs associated with tendering are not. CFO’s recognize that the cost of tendering, in both time and resources, can be substantial. They are rightly reluctant to invest time in a task where returns are uncertain. The lack of a clear cut economic case for tendering is further complicated by treasury’s overreaching concern about the credit relationship. The perceived penalty for tendering and failing on the relationship side is substantial. If a company changes banks and the new credit relationship sours, then the tendering decision will be viewed as a mistake – no matter what the cost savings.

Breakthrough Pricing

While the tendering of banking relationships is a fixture in the public sector and is seen, on an irregular basis, in the private sector, it has not delivered the break-through cost reductions seen in non-banking supplier-customer relationships. Why?

It’s a matter of numbers. Think of an industry where a significant number of contracts are awarded on a tender basis.

Suppose a company has to respond to RFP’s for 60% of its revenues – a statistic that would be quite normal in industries like advertising or automotive parts manufacturing. Unless the company wins its fair share of these tenders, its customer base will erode quickly and significantly. If tender losses are high the company will face difficult times and tough choices.

A company’s ability to manage the cost consequences of significant tender losses has limits. Not all customer costs are variable or even step-variable. A company that experiences significant customer losses will be forced to downsize. The short term price of a failed tendering policy is one-time costs associated with downsizing and higher ratio of fixed costs relative to revenue. Both factors point to a less competitive cost structure.

Costs are only the starting point of problems for a company with a failed tendering program. Few companies that lose tenders are able to entice these customers back at pre-tender price levels. The competition will act aggressively to frustrate “return to the fold” overtures. Companies in industries where tendering is the norm recognize that benefits of a successful tendering program – a larger customer base and scale economies associated with size – are points of competitive advantage going forward.

The company’s former customers are a second stumbling block for a company that tries to buy back its customer base. Old customers develop new loyalties surprisingly quickly. To them, talk about re-establishing relationships will ring hollow and will sound self serving. In many cases a customer will use “welcome back” pricing to wring more pricing concessions out of its new supplier, but will stop short of changing back.

Companies that are intent on replacing customers they lose in tender competitions inevitably find that they have to discount prices substantially to win back enough customers to make the buy-back strategy worthwhile. Unfortunately, buy-back price levels are usually too low to let the company return to its previous profitability level. In companies that tried this strategy, the residual unrecovered costs are usually referred to as an “expensive lesson”.

In industries where a significant portion of business is tendered, most companies price aggressively so tender losses don’t occur. This pre-emptive approach to tender pricing creates strong and sustained downward pressure on prices.

Now suppose our company only has to respond to RFP’s for a small segment of its business. Here the auction dynamics surrounding tendering are quite different. In industries where tendering is the exception not the rule, there is still downward pressure on pricing but it lacks intensity. These industries typically don’t experience the cycles of deep discount and claw back pricing seen in industries where tendering is the norm. Without the pressure of large share-of-market losses the motivation to price aggressively is blunted. Tendering will force pricing down, but only so far. Pricing floors are the norm in industries where tendering is not widespread.

Banking is such an industry. Tendering occurs primarily in the public sector and although tender pricing is often public knowledge, this information is not widely disseminated. Few businesses, for example, know what prices municipalities or school boards receive or the basis on which their pricing is predicated.

Companies that tender their banking relationship can expect price reductions, but only to a point. Once floor pricing levels are reached, the cost reduction benefits of tendering tend to fall off sharply. The auction dynamics of tendering a banking arrangement preclude the breakthrough price reductions that are commonplace in industries where most business is awarded on a tender basis.

Tendering and Benchmarking

If companies can’t expect to achieve breakthrough pricing by tendering their banking arrangements, should they bother to pursue the tendering option? The answer is sometimes. Benchmarking provides companies with a good indication of floor pricing for companies with different credit and volume profiles. If face-to-face negotiations don’t deliver pricing that’s competitive in relation to this standard, then tendering is the only tool that will break the pricing logjam.

Companies considering tendering should subscribe to six simple guidelines to maximize the usefulness of the tendering process:
  1. Include target pricing with the RFP.
  2. Communicate the company’s willingness to change bankers. This sends an important message to the banks being asked to tender – including the incumbent bank. It says the tender isn’t tire-kicking. The business is really “up-for-grabs” and serious responses are in order.
  3. Make the tender a two step run-off process. The second step should give the two finalists a last chance to fine tune their pricing before the decision to award the business is made.
  4. Do not disclose winning tender pricing to the losers. A simple “your pricing wasn’t aggressive enough” is sufficient comment if the issue of pricing is raised.
  5. Lock-in pricing and the relationship for a two or preferably three year period. This gives the winning bank time to realize efficiency gains on the account.
  6. Make use of variable rate pricing to fix pricing floors and pricing ceilings. Make the pricing rates dependent on financial performance. Properly done, this yields pricing that caps price increases and provides appropriate incentives for improved financial performance.
In normal bank negotiations, principled negotiating and the use of benchmarking information should approximate the results that could be expected by tendering the relationship. However, as in all negotiations, matters don’t always turn out as they should. When a CFO finds himself or herself dealing with an intransigent banker, the option of tendering is almost always better than capitulation.

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After completing the review, Jack was able to make specific recommendations to provide significant savings and increased interest earnings for HSFO.

Heart and Stroke Foundation of Ontario
William J. Thomas
Chief Financial Officer and President
Finance, Systems and Business Solutions