Case Text: Purchasing at an Airlines and Its Struggles with Reciprocity Recently
ID: 421423 • Letter: C
Question
Case Text:
Purchasing at an Airlines and Its Struggles with Reciprocity
Recently, a major airline was in the process of searching for an IT provider for a specific service. The business was worth about $50 million in spend. The purchasing group sent out RFQs to several qualified suppliers and reviewed the responses. Three of the suppliers met their purchasing criteria but varied in cost by 1 to 3 percent. Before awarding the contract the procurement team met with their sales organization to discuss the findings. The airlines sales group also contacted the suppliers to discuss who currently had the major contract for their airline business travel. Two of the suppliers stated that they were locked into their current contract and the contract was with another airline. One of the companies, the one with the highest price, noted that they were not under contract but were going to sign a contract with another airline. The contract was worth $50 million in revenues with a significant profit margin. The sales team fed this information back to purchasing and based on TCO analysis, purchasing determined that the company with the highest price would provide the most overall value to their internal customers, and the business overall.
Is this a legal contract? And what is the best value for the airlines? It depends. If the criteria is “overall value to the airlines,” the choice is clearly the company with the highest IT bid that is willing to commit to a contract with the airline for flying its corporate staff. An effect of this kind of reciprocity is a reduction in degrees of freedom. Assuming that ceteris paribus (other things being equal) applies here (in that the service level of each of the three IT suppliers are equal), it is possible to imagine down the road that the service levels provided by the highest bidder will deteriorate, but that the contract cannot be terminated for fear of its impact on airlines sales. However, there is also a question of how these two IT companies were bound under the current contracts to other competing airlines and the method of award. If these contracts were due to expire in the not too distant future it is possible that purchasing should have awarded the contract to the lowest bidder and still get the sales impact when their contracts with another carrier expires. This is of course a difficult dilemma to solve. If purchasing and sales were completely separate functions, the decision as to who to award the IT contract to would be different than if the sales function influenced purchasing. In this case, purchasing was very concerned about being locked into an IT supplier based on sales impact. Quite obviously, reciprocity is at the heart of this issue. One purchasing person noted that “If purchasing is locked in by sales impact to a less preferred supplier, I wonder whether several such contracts could have accumulated negative effects on the efficiency of our airline? Also, could other suppliers, that may have had lower costs, accuse us of giving preferential treatment to the other supplier?”
What is your statement describing your reaction to Handfield’s interview conclusions in 100 words?
Explanation / Answer
I strongly agree to the fact that the highest bidder should be awarded the contract for a variety of positive reasons. The IT company who is asking the highest price in the market would be delivering the best quality services to the customers and airlines as a whole would grow. The company should wait for the contract of top companies to get over and then should award the contact and should not in a hurry award it to a lower quality supplier. Also this should be done at the cost of lower bidders thinking that the company is biased and is not treating equally because we are in the business world and at the end of the day quality and productivity matters more.