Graduate School of Business (HEC, Ecole des Hautes Etudes Commerciales) University of Lausanne (Switzerland)

NE-01-004

Negotiation game: Paranha Power Plant

Jean-Claude Usunier prepared this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a business situation. The authors may have disguised certain names and other identifying information to protect confidentiality. The Institute of International Management of the University of Lausanne (IUMI prohibits any form of reproduction! storage or transmittal "ithout its "ritten permission. To re#uest permission to reproduce materials! contact IUMI! $%C! &'($)! C$-)*)+ Lausanne-,origny! ("it-erland. phone ** /) 0) 120 33)* . fa4 ** /) 0) 120 3/2+. email adm.mim5hec.unil.ch. 6 IUMI7$%C! 0**/ *1 8ersion9 (: 0**/-)*-

A consortium, BDH, has been established between a US-based engineering company, a Swiss company belonging to the same sector and a German firm producing heavy industrial e uipment! "his consortium is in the final phase of negotiations to win a contract for building a turn#ey electric power plant! "he owner is the $ational %lectricity Authority &$%A', a stateowned corporation which holds a monopoly on the transport and distribution of electricity in a (atin America! $ational %lectricity Authority has issued the tender! "he tender procedure was initiated eighteen months ago! At first there were about twenty potentially ualified contractors which submitted bids! )ost of them were engineering companies originating from the main industrial countries, and some came from newly industriali*ed countries such as South +orea and "ur#ey! After a preselection phase, the number of potential contractors was reduced to a short list of five companies or consortia! "he final selection process lasted for several months, as bids that were technologically incomparable had to be ta#en into account!

"he consortium created by Brown %ngineering -orp! &US', Duponval SA &Swiss' and Horst Bau"echni# AG &German' was chosen as the organi*ation with which the final negotiations would ta#e place! But a .apanese competitor, -hi#oda, has also made a very attractive offer and is e ually in a position to supplant BDH, if BDH proves to be too demanding for $ational %lectricity Authority! /n fact BDH has a strong reference list, supported by similar plants it has built which are wor#ing effectively! )oreover, in addition to its offer, BDH provides a low-rate, long-term financing scheme for the buyer, which has been created by putting together e0port credits issued by ban#ing organi*ations from the countries of the three members of BDH 1 US %0imban# for Brown, Swiss Ban#ing -orporation for Duponval and +f2 &+reditanstalt f3r 2iederaufbau' for Horst Bau"echni#! "he final price has not yet been settled, as there are still some important clauses to be discussed1 ,! "he supply of basic materials by the consortium, during the start-up of the power plant! 4! "he possibility of signing a 5products in hand5 contract! A 5products in hand5 contract is a particular #ind of turn#ey operation, where part of the payment by the owner to the contractor is sub6ect to the level of performance reached by the plant! After the start-up phase has been finished and individual pieces of e uipment have been shown to wor# effectively, a phase begins where the contractor is assigned to operations! "his means that a management contract has been signed! "he variable fee may cover part or all of the turn#ey operations as such and7or the management contract! /n this case the consortium would agree to sign a management contract to run the operation until it reaches ,88 per cent of its target capacity &988 megawatts'! "he proposal which served as a starting base for the final bargaining process was priced at US:,8; million! %ach one of the partners-to-be has naturally retained its right to improve its position, either by obtaining a rebate &the buyer' or by increasing this base price level by astutely negotiating supplementary services &the consortium'! Since the inception of this tender, $ational %lectricity Authority has made it #nown that the first power plant will be followed by the construction of two similar plants, all this being stated in the ten-year plan for the electrification of the country! /t seems very li#ely that the contractor selected to build the first unit, if effective, will be well positioned for the ne0t two orders which may possibly be placed by direct agreement between contractor and owner, that is, without a competitive bidding procedure! At the negotiating table are three representatives of the buying organi*ation and three representatives of the BDH consortium, each one an employee of one of the companies1 ,! <or the buyer1 &a' )r )elo, who is in charge of pro6ect financing for industrial development at the )inistry of <inance! He might be a useful and even necessary go-between for many red-tape problems

related to administrative and financial issues which could arise when completing the pro6ect1 payments, clearing customs for imported e uipment, fiscal and social problems of e0patriates, etc! &b' )r Alves, who is the director in charge of energy at the )inistry of /ndustry! He is concerned with the coordination of this pro6ect with the other industriali*ation pro6ects being underta#en in the country! "here have been many negative e0periences of this in recent years1 two years ago, some ships with a full load of cement were stranded in the main sea port of the country because there was not enough unloading e uipment such as doc#s and cranes! "his caused severe delay on several pro6ects! &c' )r Duran, the third representative, is =>, much younger than both )elo who is about ;8 and Alves who is ?8! He has been trained in the United States and holds a )aster of Science degree in %lectrical %ngineering! At $ational %lectricity Authority he is in charge of new plants and investment pro6ect! He is reputed to be ambitious but also capable and hardheaded! /n the long run he is seen as a possible chief e0ecutive for $ational %lectricity Authority! Duran has confidence in the country5s development pro6ects and in the capacities of local managers to run the new plants effectively! 4! <or the consortium1 &a' )r Smith, a pro6ect manager aged 94, who has wor#ed for many years at Brown, the US member of the consortium! Brown will ta#e charge of the boiler part and the plant monitoring system! Brown is ran#ed among the leading US engineering companies! /t has a high reputation for technical e0cellence as well as for cost control! @ro6ect managers at Brown are partly compensated with a bonus based on the profit generated by the pro6ect! A sophisticated cost accounting system monitors actual and forecast costs and margins regularly during the pro6ect! 2hen pro6ects are completed after two to three years or more, final costs are calculated, with a minimal deviation from target costs! &b' )r Aobin from Duponval SA, a Swiss engineer who has wor#ed for this company for the last ten years! Duponval has already formed several 6oint ventures with Brown, and Aobin #nows Smith because they have already wor#ed together! Duponval SA is in charge of civil engineering and the total coordination of the wor#! "his firm has established a good reputation world-wide for meeting delivery times! &c' )r Dietermeyer, a Doctor of (aw, aged ;;, has wor#ed for the last twenty years for Horst Bau"echni#! Although he has not been formally trained in engineering, he has built up a good #nowledge of industrial engineering on the 6ob! /n addition to this he has attended many training sessions which have provided him with an in-depth #nowledge of the technologies of a large variety of turn#ey plants! He is considered in his company a s#ilful, e0perienced and effective business negotiator! His law bac#ground is very useful in discussing precise clauses, understanding what is at sta#e and the possible legal conse uences of a specific clause! Horst

is in charge of supplying and installing turbo-alternators and all the electrical parts in the plant! BDH consortium has been chosen as the contractor with which $ational %lectricity Authority is willing to negotiate the final agreement under the supervision of the )inistry of <inance and the )inistry of /ndustry! A sum of US:,8; million is the starting point for the discussionB until now it has been considered a lump sum for a turn#ey operation contract! But things have not yet been fully settled! "he (atin American team wishes to negotiate either a rebate on this price level, arguing that there will be future pro6ects which could be awarded to BDH, or complementary services or guarantees, which could be granted for free! "hese might possibly be the following1 ,! "he free supply of materials re uired for production during the start-up phase, which will last one month! 4! <ree technical assistance for the industrial management of the power plant, in order to be able to serve consumers and to manage the electricity distribution networ# properly! =! A commitment from BDH to subcontract part of the 6ob locally, especially the less sophisticated part of the civil engineering wor#! BDH naturally prefers to maintain its price, for which it had been selected from harsh competition! /n fact there were some cheaper competitors, sometimes :,; million less! But neither their reference lists nor their financing deals matched BDH5s bid! "o tell the truth, BDH is somewhat worried about the delay penalty clause which $ational %lectricity Authority wants to include! "he fine is supposed to be , per cent of the total price for each construction month beyond the standard completion time! "he consortium foresees that there could be some delay! /t fears that it might be difficult to assign clear responsibilities to either the contractor or the owner &or the state authorities of the country, or a large subcontractor, especially if it was a local business'! Usually turn#ey contracts include a customs franchise for all the e uipment imported in order to build the plant! But it is not that rare for customs officers not to apply these rules immediately, and it may delay the customs clearance of these components and e uipment, thereby delaying the completion of the plant! "he parties have agreed to discuss the issue of transforming this pure turn#ey operation, paid for by a lump sum, into a 5B!C!"!5 contract &5Build-Cperate-"ransfer5'! Under the B!C!"! scheme, part of the payment will be sub6ect to a variable scale related to the level of capacity reached during the management contract period after the plant has been completed and started up! "he possibility of a management contract has been discussed! /t will probably be added to the turn#ey contract &which includes the construction start-up phase, but no more'! "his management contract will encompass handling the industrial management procedures, the accounting system, setting salaries, customer service and providing training

programmes for local e0ecutives! @rogressively, local management is supposed to ta#e over the management of the pro6ect! "he basis on which the variable payment would be calculated has not been clearly settled up to now! "his basis could be1 the whole amount of the management contract, part of it, or the whole amount of the management contract plus part of the :,8; million turn#ey pro6ect! "he (atin American proposal for this final negotiation includes the following elements1 ,! "he price of the management contract plus US:,8 million &on top of the turn#ey price' to become a variable and conditional payment, sub6ect to the capacity level reached within a certain time span! "his scheme would e0tend throughout the total thirty-si0 months of the management contract period! 4! <or this variable part the proposed payment scheme is as follows1 &a' ,; per cent after si0 months if the output reaches at least ;8 per cent of the target capacityB &b' ,; per cent after twelve months if the output reaches at least ?8 per cent of the target capacityB &c' ,; per cent after eighteen months if the output reaches at least D8 per cent of the target capacityB &d' ,; per cent after twenty-four months if the output reaches at least >8 per cent of the target capacityB &e' 48 per cent after thirty months if the output reaches at least E8 per cent of the target capacityB &f' 48 per cent after thirty-si0 months if the output reaches ,88 per cent of the target capacity! =! "he management contract may grant decision-ma#ing powers to the consortium in the following matters1 recruiting personnel &wor#ers, not the management', operating the plant and choosing supplies of appropriate uality and price! "he selling price of the output as well as the operating costs are to remain the sole responsibility of $ational %lectricity Authority! "he negotiation ta#es place at the head uarters of $ational %lectricity Authority in @ort @aranha, where the power plant will be built! "he tal#s simply aim at finali*ing an agreement for beginning the construction as soon as possible! $o detailed agenda has been prepared for the negotiations! Discussion begins!!!!