Defence ministry official questions whether Pilatus was cheapest trainer

MoD finds Pilatus' demands for additional money for "follow on support" not in line with original bid

By Ajai Shukla

Business Standard, 14th Feb 2015

The purchase of seventy-five trainer aircraft from Swiss company Pilatus was fundamentally flawed, a key defence ministry official has discovered.

In a detailed note that the official has requested be “brought to the notice of RM (Raksha Mantri, or Defence Minister Manohar Parrikar)”, he shows that additional money being demanded by Pilatus, over and above the contracted price of Swiss Franc (CHF) 557 million (Rs 3,870 crore), makes the PC-7 Mark II trainer far more expensive than was assessed while awarding Pilatus the contract.

Business Standard has reviewed the six-page note. This suggests that Pilatus was not the lowest bidder (L1) and was awarded the contract incorrectly.

Contacted for comments, Pilatus cited “confidentiality agreements with both the GOI [government of India] and HAL.” The MoD has not responded to an emailed request for comments.

The Pilatus contract has been in the news from the start. On May 16, 2011, when the ministry of defence (MoD) opened the commercial bids for 75 basic trainers, Pilatus’ closest rival, Korea Aerospace Industries, strongly protested that Pilatus had submitted an incomplete bid and should be disqualified. South Korea’s defence minister personally wrote to his Indian counterpart, AK Antony, requesting a “high-level review”. Overruling these objections, the MoD awarded Pilatus the contract.

Now the note dated January 9, 2015 and signed by AR Sule, the ministry’s “Finance Manager (Air)”, who handles the financial aspects of military aircraft purchases, shows that the Korean protest was valid.

This was the first MoD tender decided on the basis of “life cycle cost” (LCC). It instructed all vendors to specify the costs of buying, maintaining and flying their respective aircraft over a 30-year service life. The winner --- termed the “L1 vendor” --- would be the company whose trainer had the lowest LCC.

The actual LCC of the PC-7 Mark II is significantly higher than Pilatus’ commercial bid; it now emerges from detailed calculations in the MoD note.

“The actual Life Cycle Cost could be much higher than the one used for L1 evaluation and may invite audit objections subsequently”, the note observes.

According to the MoD official’s noting, Pilatus was declared L1 vendor based on its declared LCC of Rs 4,160 crore. With the exchange rate at that time being 1 CHF = Rs 51.95, Pilatus’ cost breakdown (see graphic) was: CHF 557.39 million (Rs 2,896 crore) as the “direct cost of acquisition”, or purchase price; CHF 36.44 million (Rs 189 crore) for spare parts; Rs 5.5 crore for servicing and maintenance; CHF 114.36 million (Rs 594 crore) for depot-level overhaul; and Rs 476 crore as operating costs over its 30-year service life.

Serial No	Item	Cost (in million CHF)	Cost (in Rs crore)
a	Direct acquisition cost of aircraft, equipment, systems and services	557.39	2,896
b	Cost of spares and reserves	36.44	189
c	Cost of scheduled servicing	-	5
d	Cost of depot overhaul	114.36	594
e	Operating cost	-	476
f	Total cost of acquisition (TCA)		4,160

(Source: defence ministry noting, dated January 9, 2015)

These figures, however, have been rendered invalid by Pilatus’ demand for more money. The MoD note states the Indian Air Force (IAF) has moved a proposal for Pilatus to be paid CHF 72.95 million (Rs 507 crore @ current exchange rate of CHF 1 = Rs 69.50) for a “Follow On Support Contract” (FOSC) to cover repair and maintenance over the five years that follow the initial two-year warranty period.

“This is almost three times of repairs and maintenance cost presumed at the time of L1 evaluation”, points out the MoD note. It complains there is no way to enforce a price on the vendor.

The calculation in the note are as follows: in Pilatus’ commercial bid, the cost of repair and maintenance over the PC-7 Mark II’s 30-year service life adds up to CHF 150.80 million (36.44 million + 114.36 million). Therefore, the cost over 5 years should work out to CHF 25.13 million, i.e. one-sixth of the 30-year figure.

However, going by Pilatus’ FOSC demand, the aircraft’s LCC would be consumed in less than a decade, even in constant 2012 prices. The MoD note observes: “88.89% of TCA [total cost of acquisition] (excluding operating cost) will be incurred at the end of 07 years period (02 years warranty + 05 years of FOSC) as against Rs 3,684 crore for lifetime evaluation arrived at the time of L1 evaluation.”

The MoD official also notes that numerous other expenses that Pilatus has now demanded in the FOSC --- such as supply chain administration, publication updates, etc --- “were not factored into TCA (total cost of acquisition).”

The note also observes, “There is no independent validation of information provided by the vendor to validate the claims made by them for TCA…”

“It thus defeats the basic objective of LCC”, he notes.

With about 55 aircraft already delivered by Pilatus, the contract for 75 aircraft can hardly be cancelled. But the defence minister will find it difficult to okay the IAF’s proposal to buy more 106 PC-7 Mark II trainers.

To buy 106 additional Pilatus trainers, the IAF wants Hindustan Aeronautics Ltd (HAL) to scrap its project to develop and build 106 indigenous trainers, called the Hindustan Turbo Trainer – 40 (HTT-40).

With the LCC model being seriously questioned, Pilatus is not the only major contract in the firing line. A similar model was followed to declare Dassault the lowest bidder in the proposed $18-20 billion purchase of 126 medium multi-role combat aircraft (MMRCA).

The MoD official has this in mind when he writes that “the issue may be brought to the notice of the RM (Raksha Mantri) as two high value cases of IAF based on LCC model are at CFA (competent financial authority) approval stage.”