Sustainable Public Procurement: Towards a lowâcarbon economy

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40 Sustainable Public Procurement: Towards a low carbon economy Procurement choices and Asset Specificity Procurement choices made by companies may give rise to asset specificity 25 . This refers to the extent to which a party is locked into a two way or multiple business relationship. Such a lock in may arise when a company procures goods and services from a supplier over a long time that requires investments by the seller in physical (specialized tools or systems) and human (skills) asset specificity and/or dedicated assets (investments in plants). In such a scenario the procurer purchases items from suppliers over a long term and does not want to invest time in procuring the same assets from other alternative suppliers. One of the reasons is that the procurer is certain about the quality of the material procured from the specific suppliers over a longer period of time. The uncertainty of information on the quality of items from other suppliers could increase the transaction cost of the procurers while procuring items from them. This motivates the procuring firms to purchase goods and services from a single or a few suppliers over a long period of time. The buyer is also motivated to continue with this dependency because of the exit costs of searching and time involved in moving away to new suppliers. 26 This generates a long term dependency between the suppliers and the procuring firms by means of procurement of specific items over a long period of time. The supplier of items would also like to maintain this long term relationship with the procurer and would invest in the dedicated assets Such investments by the suppliers would maintain the quality of the items and would help in maintaining a market for such products. This trend is typically observed in the procurement decisions of companies like NTPC, IFFCO, and BHEL who have got into long term supply contracts with some specific set of suppliers who supply certain specific items to these companies. The suppliers invest in specific assets so to be able to supply the items which are being procured by companies like NTPC, IFFCO and BHEL. 25 Williamson O.E. (1971), “ The Vertical Integration of Production: Market Failure Considerations ”, American Economic Review 61, p.112-123. Also Williamson O.E. (1979), “ Transaction-Cost Economics: The Governance of Contractual Relations ”, Journal of Law and Economics 22, p.233-262. Williamson, O. E. "Credible Commitments: Using Hostages to Support Exchange", American Economic Review, 1983, pp. 519-38. 26 Joskow, P. L. "Asset Specificity and the Structure of Vertical Relationships: Empirical Test of Transaction Cost Analysis", Journal of Law, Economics and Organization (4), Fall 1988, pp. 121-139. T E R I Report No. 2007GL01
41 Sustainable Public Procurement: Towards a low carbon economy Case Study IV NTPC Procurement process in NTPC has similarities with that in IFFCO. NTPC procures a large variety of items starting from heavy machinery items of a plant to small stationary items. Procurement of high value needs clearances from head office and small items are procured at procurement departments of the project sites. Procurement of items is made once engineering and other relevant departments of the company give specification. Competitive two-stage bidding is followed in NTPC. The steps and the process of procurement is similar to that of IFFCO. 40% of the total procurement budget of NTPC is being spent on coal. This is spent on a coal of ash content less than 35% which is transported for 1000 km based on government of India notifications. Coal is imported from Australia, Indonesia as well as procured from Coal India Limited. The delegation of power for procurement is based on the ISO certified contract manual. Energy efficiency standards, social clauses like child labour are built in the procurement contracts. Tenders for procurement are often published in newspapers. The valuation of such documents are Rs.7100 for each set. Spare parts, sundry items may be procured at specific sites. Duty drawback clauses and clauses of excise duty cuts are also built in the tenders. The evaluation of the foreign bids and domestic bids differ in the procurement process. The users of the items specifies the needs that are then procured. Bulk procurement of items is carried out through the corporate centre. Apart from this procurement is also done through specific project sites. Certain parameters of energy efficiency like heat rate, auxiliary consumption are mentioned in the bids. In the past environmentally benign items have been given preference in the procurement process of NTPC. For instance, NTPC has procured replaced procurement of asbestos gas kits with rubber gas kits. This is also guided by the environmental management policy of the company. NTPC’s main procurement is coal followed by heavy machineries for power plants from BHEL. Small procurement contracts are given to the suppliers to create employment. Big contracts of procurement deal with the procurements of equipment, items of civil construction. In BHEL, dependence on a single supplier over a long term holds for supply of heavy items, which are of very specific use and have high monetary value. The study also found out that that larger the complexities in the specification of a capital good, greater is the trend of a company to procure those items from specific set of suppliers. In Railways this pattern has been seen in the procurement of complicated heavy machinery items with finer specifications. In Railways, many engineering, machinery items have been procured from specific set of suppliers [NAME] from Germany since mid 1970s till now. Railways has not invested in producing these items themselves as that would have raised their transaction cost and sunk costs within the firm beyond the optimum level which could be borne by them. The uncertainty of the quality (in terms of the life cycle of the produced item) of the material produced from such investments within Railways has also pushed the organization towards long term procurement of these items from Germany. Some companies like IFFCO do not rely on one dedicated supplier in case of procuring items that are not required frequently. For instance, it has not got into a long-term supply contract with the suppliers of small items. The decision of procuring these small items are taken at the local project sites which has a larger access to information about these small items in comparison to the material purchase department at the office headquarters. This is done to reduce the transaction cost incurred within a firm for procuring even small items through the purchase section at the office headquarters not located close to the project sites. As the local project sites and the head quarters are well connected, information regarding procurement at the local project specific sites is easily transmitted to the headquarters. In this case a stronger vertical integration within the firm reduces the transaction costs of the firm through procuring of small items at local project specific sites and subsequent easy transmission of information to the headquarters from the project sites. The same trend has been observed in case of companies like BHEL where standard small items like lights are procured at local project specific sites. In case of BHEL, the frequency of procuring these small items is guided by a company manual which details out how many times these small items could be procured. The company manual also provides guidelines on how the quality of these procured small items would be reviewed by the purchase and material section in the headquarters. In BHEL, it has been observed that small items are procured from many suppliers at the local project units. T E R I Report No. 2007GL01
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