In continuation to my previous question

NORTHERN DRILLING

Northern Drilling was a subsidiary of InterDrilling Corporation, the worlds third largest exploration drilling contractor, headquartered in Europe. Northern began in 2006, when Peter Bremner was hired to build the division from the ground up. Since then, the company had acquired several other drilling companies across Canada, such as Cass Drilling Ltd., based in Kamloops, British Columbia. Northern was considered to be a full-spectrum services company, with superior technical capability and high safety standards. Of Northerns 34 drill rigs, 12 were deep diamond drills, the type of drills required in the Mond Nickel RFP. Northerns year-to-date revenue was Cdn$43 million with 26 per cent earnings before interest and taxes (EBIT) (see Exhibit 4). Current utilization rates were approximately 75 per cent across all drill types. Deep diamond drills were fully utilized. Northern prided itself in its treatment of employees: We treat our drillers like people, not numbers; explained Peter. We pay attention to their needs and give them a level of job security far above our competitors. Although the company had several jobs that were running smoothly, Northern was struggling to be competitive in the market. Management believed these difficulties were the result of being too expensive relative to some of the commodity-type drillers5 and owner-operators. The companys growth strategy was to secure long-term specialized work. Because of the cyclical nature of the mining industry, long-term work mitigated some of the risk associated with investing in drilling equipment.6 Specialized work allowed Northern to differentiate itself in the highly competitive Canadian industry, helping Northern to secure contracts with higher margins.7 Generally, management preferred to avoid investing in new equipment unless absolutely necessary. However, when investments were assessed, they were benchmarked against a 20 per cent hurdle rate. Peter Bremner Peter Bremner had worked in the exploration drilling industry for more than 30 years. After graduating from Queens University with a degree in mining engineering in 1981, Bremner began working for Boart Longyear, the worlds largest exploration drilling contractor. He had held several senior management positions, including Regional General Manager (Asian Pacific) and Vice President of Drilling Services. As a result, he had personally developed excellent relationships with many of the worlds largest mining companies and was in an excellent position to begin InterDrilling Corps Canadian operations in 2006. The Mond Nickel Contract The proposed Mond contract involved drilling over a span of three years for poly-metallic deposits near Sudbury, Ontario. The RFP was divided into two individual jobs: a deep job with 3,000-metre holes, and an intermediate job with 1,800-metre holes. The work was to be charged as a fixed cost per metre, regardless of speed, unless the contractor entered poor geological conditions (which would be compensated on an hourly basis). If any costs and delays occurred due to the negligence of a Northern employee, Northern was to bear the cost. The proposed contract was for a total of 231,500 metres (see Exhibit 5). Direct costs per shift would be roughly $2,450 for the intermediate job and $2,800 for the deep job. Because the contract required that Northern invest in new drills and drilling equipment, Bremner needed to consider the cost of securing the equipment and the potential return on investment. The number of drills required for each job varied depending on the year (see Exhibit 6). Each drill cost Northern $550,000. A bulldozer or skidder per drill was also required to move the rigs, costing $150,000 each. Additional support equipment of $200,000 per drill was also necessary. Overhead costs amounted to 8 per cent of sales, but synergies equal to 2 per cent would be realized if Northern won both jobs. The deep job involved drilling deeper than Northern was used to, and the work was complex. Geological conditions were expected to be poor in some areas, and these issues were compounded by the fact that the holes were so deep. As a result, Mond had made it clear that the contract was to be prioritized by the winning bidder. All bidders were required to include a detailed profile of each employee that would be working on either job. Bremner wondered whether he would be able to put together a team capable of doing the work. He would need to find 24 additional drillers8 to staff both jobs, but he knew that drillers found long-term contracts to be appealing. Bremner also considered Northerns existing client base. Although he wanted to grow the company, he wanted to do so without affecting Northerns other clients. In particular, Noranda Nickel, the worlds fourth largest nickel producer, had been a loyal Northern client for several years and had historically represented 60 per cent of Northerns revenue. Bremner wanted to maintain their excellent relationship. Northern was running seven drills for Noranda Nickel in Sudbury, next to Monds property. The contract with Noranda, however, was up for renewal at years end. Bremner was unsure whether Noranda wanted to maintain the current contract or scale down the number of drills, given that he had heard the geological results had been less than favourable. However, Noranda had only one mine left in Sudbury with only eight years of production life remaining. Noranda had the infrastructure to support three more mines. On average, it took seven years from discovery for a new mine to go into production. Competition for the Contract Bremner was concerned about three drilling contractors that would be bidding for the Mond contract: Boart Longyear (Boart), Major Drilling Group International Inc. (Major) and Orbit Garant Drilling Inc. (Orbit). Boart, the incumbent contractor, was the worlds oldest and largest drilling exploration service provider. Boart had an excellent reputation, but had been struggling in recent years in Northern Ontario. Service had been on the decline a result of management issues and, because of the industry shortage, personnel issues. Boart had lost the Mond contract due to underperformance. Major was the worlds second largest drilling contractor. It was more experienced and more technically capable than Northern. With global training camps in place for new drillers, it was likely that they were well equipped to handle the Mond job. However, the company was constrained by capacity and had performed little work for Mond in the past. Bremner suspected that the Mond contract would not be a strategic job for Major, and, as a result, it would bid high. Orbit was a major drilling contractor based out of Val-dOr, Quebec. Orbit was typically known as a discount contractor. Bremner expected it would bid for the contract aggressively. However, Bremner didnt think Orbit performed such deep work, and it did not perform technical work on a regular basis. DECISION Bremner wondered what steps he should take before sending a proposal, or whether he should send one at all. Although Northern was only at 75 per cent utilization, it had no diamond drill rigs available for the upcoming year. However, Bremner anticipated that up to four drills would be made available through the renegotiation of the Noranda contract. Utilizing these drills on the Mond job could save on capital costs and allow Northern to potentially outbid competitors. On the other hand, Bremner knew that Noranda was likely to eventually ramp up its exploration efforts given the urgency of its situation he just didnt know when. He had worked hard to develop a good relationship with Noranda in particular, so he wondered whether to approach someone at Noranda and explain his situation with Mond, Norandas direct competitor. Bremner considered the alternative: investing in new diamond drill rigs. Would such an investment be too risky given current industry conditions? Could Northern meet its target hurdle rate and make a satisfactory return on investment (ROI)? Could Northern afford to invest in eight new drills, or would it make more sense to bid on only one of the two jobs? If Bremner decided to prepare a proposal, he needed to take into account the actions of his competitors. Should he bid aggressively and give Mond a discount, or should he rely on Northerns reputation and bid at a level consistent with the traditional 30 per cent target gross margin? Bremner knew that even if Northern was successful in winning the bid, he would need to ensure that the company was capable of performing the job. If the company underperformed, Northern would compromise its relationship with Mond and could lose any chance of repeat service. However, if the deep job was won and executed properly, Northern would be established as one of Canadas most technically competent drilling contractors. With only three weeks before the proposal deadline, Bremner needed answers quickly.