Supplier rating

Supplier rating is one of the subindicators used for zIndex contracting authorities evaluation.

This indicator identifies the following supplier characteristics that may imply increased inefficiency or corruptions risks:

• public procurement share on total revenue exceeds 75%
• more than 50% of the contract value is subcontracted
• non-disclosure of financial statements in the Commercial Register
• non-standard demise
• supplier's insolvency
• supplier was founded less than a six month prior to the contract notice
• supplier's donations to political parties

A necessary prerequisite for the optimal supply of public investment is the effective management and monitoring of the supply chain (OECD, 2009). According to anti-corruption organizations the Czech contracting authorities have significant reserves particularly in the supervision over the selected contractor's performance and delivery. Our chosen set of subindicators identifies the supplier risk characteristics, which may partly serve either as warning signs of potential corrupt conduct, or may cause difficulties with the contracted work delivery or enforcement of guarantees.

We evaluate the supplier (i.e. the winning bidder) of each contract by the following subindicators:

• Public procurement share on total revenue in the reference period (typically 3 years). Abnormally high value is common for suppliers that do virtually no business with the private sector. These are usually exposed to much weaker competitive pressures, are more technologically rigid and may thus deliver less added value for the contracting authority. And finally, the absence of other sales channels solidifies an existential dependence on public procurement, which leads to higher risks of corruption and a vendor lock-in. Only subjects that existed and published financial statements for the whole span of three years are evaluated, as there is timeline long enough for the reliable assessment to make (suppliers non-disclosing their financial statements are penalized by another subindicator).

• Subcontractors' share of the contract value: The proportion of subcontracting should not be overly high, as such contract is more difficult to supervise in terms of subject-matter performance, corruption and collusion practices, transparency, cash-flows traceability and possible conflicts of interest. At the same time it is more likely that the contracting authority pays the supplier unnecessary extra margin for the mere resale of goods. Best practice thus recommends splitting such contract into lots and procure each of them separately (even a „coordination and management of other supplies“ lot can be created if necessary).

• Period of time since the supplier's establishment is a number of months since the supplier company was founded. We regard companies established right before the public procurement as less credible, since there is a considerable risk that such company was founded with the sole purpose of rent-seeking. Six months limit is the critical point in our calculation - suppliers established (i.e. entered in the Commercial Register) less than six months before the winning of the contract are penalized.

• Regular disclosure of financial statements in the Commercial Register is a legal obligation of most legal entities. Non-disclosure of annual reports significantly reduces supplier's transparency and integrity. We consider it an error if at the date of the contract award the supplier had not yet disclosed the obligatory financial statements for the year before last (e.g. When awarded a contract anytime in 2013 the supplier should already have disclosed the annual report for 2011, provided he existed at the time).

• Company's demise subindicator is a number of months between the contract award and the supplier's eventual wound up. We penalize companies that closed not long after they won the contract, the crucial limit being 18 months. Penalized are only companies that closed in a non-standard manner, excluding such as mergers and divisions. In terms of the Czech Statistical Office's classification we consider non-standard these manners:
  • 00 Undetermined
  • 01 Dissolution of business corporations with liquidation
  • 04 Dissolution of business corporations without liquidation with no legal successor
  • 05 Notification of natural person on the termination of activity
  • 06 Authorized body's decision on the cancellation of natural person's trade authorization
  • 10 Misregistration

• Supplier's insolvency jeopardizes the supply of goods or services and may result in a waste of public funds. We penalize the suppliers who were insolvent at the time of the contract award or during one year both before and after that. We specifically penalize suppliers in the following states of insolvency proceeding (more description here):
  • Debt relief
  • Bankruptcy
  • Decline
  • Reorganization
  • Moratorium
  • Annulment of bankruptcy
  • Renewed proceeding

• Supplier's donations to political parties indicate its connections with the political class and thus potentially with the contracting authority. A company doing business with the state should not financially support political parties. A study conducted at Charles University shows a significant correlation between political donations and the volume of contracts awarded. We penalize the suppliers that made a donation to a political party in the year prior or after the respective contract award (e.g. contract awarded in 2012 is affected by possible donations made in 2011, 2012 or 2013).

All subindicators are binary - they assume either the value of 0 (in case of a negative effect, e.g. the supplier went into liquidation or failed to disclose an annual report in the Commercial Register) or 1 (if the respective condition was fulfilled).

Each supplier is then evaluated in the following manner:

• value of 1 in case no negative effect occurred
• value of 0.75 in case of a single negative effect
• value of 0.5 in case of two negative effects
• value of 0.25 in case of three negative effects
• value of 0 in case of four or more negative effects (out of the total seven observed)

Average rating of all its suppliers is then computed for each contracting authority in the form of a squared value of the weighted average, with the weights being the volumes of contracts awarded to individual suppliers. The purpose of the square in the formula is to increase differences between the highly rated and the lowly rated contracting authorities.

Unlike other indicators, this one serves more as a feedback for contracting authorities regarding the riskiness of suppliers they select. Low rating does not necessarily means a wilful breach of best practice, but rather may be a sign of poorly drawn up specifications. Even though a well prepared procurement may still produce an inadequate winner, it is much less likely. It is however still questionable to penalize a contracting authority for facts that are beyond its control (non-disclosure of supplier's financial statements, its liquidation or insolvency, donations to political parties). The same applies to the supplier side: new companies, companies with a large volume of subcontracting, companies supplying only the state (particularly in sectors, where it is common, e.g. road maintenance) - their negative rating implies only a higher risk of corruption and inefficiency - not a certainty of it.

• Select companies able to perform the contract professionally - prohibit a major use of subcontracting where appropriate in order to prevent reselling and dilution of responsibility. Even the basic references should not be proved through subcontractors and should reflect the scope and purpose of the contract. At the same time the competition should not be overly restricted - the contracting authority should have conducted a preliminary market research showing that there is a sufficient number of companies able to compete for the contract.

• Aim for the quality, eliminate „garage companies“ - use qualification and evaluation criteria in order to deter risky companies (usually professionally inadequate, unable to compete in terms other than price) from participating. Using non-price criteria related to the quality of a tender is recommended. It is now also possible to evaluate the implementation team, whose subsequent participation in the contract, however, should be checked. It is important not to confuse the risky companies with the small companies as a rule - it is advisable to require fewer references, but quality ones - and check them thoroughly.

• Supplier supervision - management and supervision of the supplier chain must be an integral part of the public investment management. Good knowledge of subcontracting companies may facilitate a future use of contract splitting into lots (and elimination of middleman company margins), potential supplier replacement and reduction of a vendor lock-in risk. Finally, the routine monitoring of financial results of a bidder or a supplier may help to avoid losses related to its prospective bankruptcy or a closure.

• Minimize the conflict of interest risk - political parties should not accept donations from the public procurement bidders in the first place. Such companies should in turn abstain from any form of support for political parties. A contracting authority can only take preventive measures in this matter: consider all representatives of a political party receiving donations from a potential bidder as subjects to a conflict of interest and as such do not let them participate in the contract specifications preparation and tender evaluation.