Investment obligations under municipal contracts

Moscow authorities will hold major tenders in healthcare and transport until the end of the year to select the investor for the new medical devices factory and to make contracts for the supply of sophisticated medical equipment and electric buses. In an interview, Leonid Kostroma, Director of the Moscow City Investment Agency, described the procurement tools that the capital city employs when interacting with suppliers.

In early autumn, the Moscow City Government announced a new investment project of constructing a medical devices factory. What exactly will be produced there and how much will be invested?

– To date, a tender has been announced for the right to make an offset contract, which envisages launching Russia’s first large-scale production of medical devices for ostomy patients.

The investor will be named subject to the results of competitive procedures by the end of this year. An offset contract with such an investor is to be signed for 10 years. The project will be funded by the supplier’s own or borrowed funds and will require an investment of at least RUB 1 bln ($ 15.4 mio) over the next three years to set up domestic production of modern medical devices. The investment will be made in two stages, taking into account the varying degrees of complexity of products manufacturing.

What is the difference between an offset contract and a regular public procurement?

– An offset contract involves a long-term supply of goods for public needs an the supplier’s investment obligations to localize their production in the region. The main goal of this mechanism is to stimulate businesses to invest in new enterprises or to modernize existing facilities.

Under the law on contract system, offset contracts are made for a period of up to 10 years with a bottomline investments of RUB 1 bln, while the delivered goods must be of Russian origin, that is, with a high degree of localization.

The municipal authorities will thus make the third offset contract. It turns out the mechanism has proven its effectiveness and has taken root as a tool for interacting with business.

– Offset contracts signed earlier have shown efficiency in terms of saving budget funds since their initial (maximum) prices as a result of competitive procedures were reduced by a total of 36%. At a tender, Biocad, for instance, made a bid which was half of the initial price ($ 215.4 mio instead of $430.8 mio), whereas R-Pharm’s bid was 18.5% below the initial price.

Could it be that the final contract price is significantly lower than the market price? Could a business suffer a loss through such substantial reductions?

– The initial (maximum) offset price is calculated according to the same procedure as for ordinary government contracts. So, when determining the initial price for the purchase of medicines, the reference price is used which is a per unit price of the purchased goods, formed on the basis of data on the prices of such goods for previously concluded government contracts, executed without applying penalties to the supplier. Suppliers (investors) enter the tenders and set contract prices ensuring project profitableness since no one would work at a loss for 10 years. So, the ultimate prices set within the offset procedures can be viewed as market prices meeting a real profitability expectations of the companies. At the same time, an investor’s manufacturing is not restricted by procurement contract’s scope, hence the products can also be distributed through other market mechanisms.

In general, the offset contract mechanism is a win-win principle as both parties benefit. The city enjoys imports substitution in socially sensitive areas, saving budget funds on procurements since due to competitive procedures the price of purchased products, as a rule, decreases, at the same time expanding taxation base and creating new jobs. An investor gets in turn a guarantee of long-term supply of localized products, high customer reliability, since the capital city is one of the largest state customers, the inclusion, once contractual obligations are fulfilled – in the regional register of sole suppliers.

What are the criteria for selecting an industry for making offset contracts?

– When choosing industries, we first of all analyze products that may be most in demand for municipal needs. The priority is given to industries with a large volume of purchases and a big share of imported goods, as it is important to ensure maximum supply of high-quality domestic products at reduced prices.

The first two offset contracts with Biocad and R-Pharm, for example, relate to pharmaceuticals. The contracts envisage localization in the city of production and the subsequent supply of oncological, cardiological, endocrinological medicines and immunomodulators. The aggregate investment in the two offsets is RUB 8.8 bln ($135 mio), the anticipated supply scope is RUB 32.4 bln ($496 mio). The contracts provide for import substitution for more than 50% of medicines as 27 out of 53 international nonproprietary names are not produced in Russia at the moment.

As for the third offset contract, it provides for almost a hundred percent import substitution in medical devices.

We intend to make further offset contracts in such sectors as transport, machinery and materials for housing and public utilities, IT equipment, and food.

Since 2013, Moscow authorities have been making life cycle contracts in public transportation. What are the specifics of this mechanism and why it was decided to extend it to other areas?

– A life-cycle contract (LCC) envisages procurement of goods subject to their further maintenance and repair by the supplier over a certain period of time (usually the entire useful life of the goods). Due to the long-term nature of the transaction, LCC provides for an opportunity to get the best price/quality ratio for equipment purchase and maintenance, to evenly and predictably distribute budget expenses. The municipal authorities do not pay for the servicing of equipment per se, but for ensuring its operability. For a supplier, a LCC ensures a long-term capacities exploitation and generates income for the entire contract term. Over the past five years, LCCs in Moscow amounted to $7.2 bln.

Indeed, earlier local authorities only made LCCs in public transportation for acquiring machinery for Moscow metro, buses, trams, and electric buses. This fall, LCC practice was expanded into public utilities and four contracts worth $486.2 mio for installation of metering devices in apartment buildings and at public facilities, were made. The winners of open tenders will not merely supply smart meters for municipal needs, but will also be contracted to ensure their maintenance and operability throughout the entire technological cycle.

How do you see the future of such contracts and what other goods are to be purchased through this mechanism?

– In the near future, municipal authorities will make LCCs in healthcare and transportation. An open tender for supply and servicing of 16 angiographs to medical institutions in Moscow took place and its winner will supply the medical equipment and ensure its adequate performance for 10 years.

By the end of this year, online auctions for supply and servicing of a total of 300 more electric buses will be held. Machinery maintenance will be required for 15 years since the date of delivery of the first batch. Starting in 2021, Moscow will no longer purchase diesel-powered buses but only electric buses instead.

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