Pricing and price competition in shipbuilding

Pricing and price competition in shipbuilding

Alexander Neygebauer
Vice President for Economics and Finance, USC

It is a pleasant thing to note that USC’s financial and economic indicators over the past five years suggest that the consolidated revenue jumped by 40-plus percent from 237.2 bln. RUR to 336.3 bln. RUR, IFRS reports.

However, this quite impressive gain, amounting to 19-odd bln. RUR, notwithstanding, the financial and economic indicators in shipbuilding from the point of view of return on revenue by all means paint a rather poor picture. Profitability averaged just 1.3 percent in the past five years.

The analysis of the problem, affecting the financial indicators of USC and all its subordinate enterprises, revealed a number of the most prominent issues in the sector.

Opening the list is pricing. A large chunk of USC’s income (let us not consider the foreign trade aspect with all its components of specific nature), coming from the state armament procurement program, is generated through cost-plus pricing. According to Decree No. 1465 of the Russian Government of December 2, 2017 ‘On the State Regulation of Prices for Products, Delivered under the State Armament Acquisition Program,’ the profit margin breaks down as follows, 1 percent of contributed costs + 20 percent of the enterprise’s own expenses.

Hardly it is a secret that in shipbuilding shipyards contribute 30-35 percent to the manufacturing cost. This means that a shipyard can count on a margin revenue of 6-7 percent. However, in fact the manufacturer gets less, putting the undertaking on the profitability threshold.

This falls short of the target even to think of investing into the modernization of the operation and often does not cover the suppliers’ cost build-up risks. Thus, when it comes to implementation of the state armament procurement program, the head contractor bears full and undivided responsibility for the quality of components, as well as failures to timely supply the required amount of items, taking on itself all risks, triggered by changes in the microeconomic environment of Russia, since the major job of the enterprise is a long-term manufacturing operation.

In shipbuilding shipyards contribute 30-35 percent to the manufacturing cost. This means that a shipyard can count on a margin revenue of 6-7 percent

The current pricing system in shipbuilding has failed to encourage manufacturers to improve labor efficiency and operation output. It has long been overdue to amend the situation by creating real labor efficiency stimulating mechanisms and integrating innovative solutions. This said, it is worth factoring in internal capacities of enterprises with due account of modernization and production diversification issues.

USC’s enterprises are run in different conditions of price competition. A comparative analysis of generation of manufacturing costs at shipbuilding facilities in Russia’s Far North, as well as other areas, where similar conditions prevail and equal operations run in western and central Russia, indicated a range of reasons, denying the former the ability to take part in the armament procurement program on par with the latter.

The financial and economic indicators in shipbuilding from the point of view of return on revenue are modest at best

Apart from the geographic factor, including the distance to the ship equipment and material manufacturing centers, as well as unfavorable climatic conditions, the far eastern enterprises have to shoulder a heavier social security burden under federal laws, dictating that those employed in far northern areas and other zones with similar conditions are entitled for extra guaranties and compensations in the form of allowances, extra vacation days, etc. Being part of manufacturing costs as per laws and regulations, these result in a price tag higher than that pinned to equal products constructed in western districts of Russia.

The burden that shipbuilders in Russia’s Far North, as well as other such areas have to shoulder, particularly guaranties and compensations, which have to be extended to the employees, automatically puts them in unfavorable conditions, when it comes to tenders and trade competitions.

To render competitive conditions of the enterprises engaged in the shipbuilding sector equal, it is essential to consider granting price benefits in state procurement programs similar to those enjoyed by the facilities catering to the needs of the penitentiary system and organizations of people with disabilities, amending laws and regulations governing the state procurement contracts accordingly.