The bid-winner’s dilemma

Having reached down to the project level, this Part will conclude the Infrastructure Insight series and will do so by examining how a contractor conceptually prices a project.

Let us consider the real case of “Budday,”* who, following an invitation to bid for construction of a hinterland bridge by a regional administration, decided to submit a bid on behalf of his business, Budday’s Construction Enterprise, which has been successful at completing a number of projects. In pricing the tender document, Budday included a sizeable premium in his final price, due to the fact that his business is new to the hinterland location and he wanted to cover for uncertainties. At the bid opening Budday’s price was the lowest and he was awarded the contract for the works.

Judging from the prices of other tenderers, Budday’s price was too low to complete the bridge. However he could not withdraw from the process, and instead hoped that his added premium was enough to carry the project through, and perhaps leave a degree of profit. Budday’s dilemma was that he still did not know if, and how, to proceed as he could make a substantial profit or a heavy loss, and he had no way of assessing his true position. Budday’s bid pricing method was largely determined by the nature and content of the tender document at hand. It is useful to examine the likely methods of pricing.

Bottom-up pricing

Perhaps the most important feature of the classification of contractor pricing is the starting point of the pricing. The traditional ‘bottom up’ approach begins with evaluating the cost factors for each item in a bill of quantities, a contractual document widely used in Commonwealth countries as part and parcel of the received common law of England. To allow certainty in pricing, the work in the bill of quantities is measured off of design drawings and itemised into elementary work packages. Each item specifies both the quality and quantity of the respective work package and must itself conform to an independent, standardised method of measurement. A common misconception is that the bills of quantities are merely passive lists of materials.

The price of a complex structure can then be attained by pricing each elementary work package and building an overall price when all prices are summed up. An amount for desired contractor profit is included, and the total so evaluated is then adjusted for the risk the bidder associates with the project. The usual market risks of which a bidder should be aware are cost inflation and availability of both materials and labour, and the likely bid-prices of others. The importance to the bidder of winning the bid is also important. There are also project risks, which include the competence of design/supervision personnel and the quality of the tender documents. This final adjustment is commonly based on the ‘informed intuition’ of the bidder. However, it may be likened to actuarial calculations made by insurers when pricing risks: for this is the view of John Murdoch et al in their work ‘Construction Contracts’ (Taylor & Francis, 2009). Hence bottom up pricing is always subject to a final adjustment upon review, however, diligently each item has been priced, and this is its main drawback.

Top-down pricing

In contrast, ‘top down’ pricing starts with the total bid price the bidder wishes to submit, including for profit and risks as before. This total is then proportioned against anticipated construction activity duration, rather than work packages, set out in the tender document. An apparent drawback is that the price of each activity is simply an allocated element of the total price, without measureable particulars. Nevertheless top down pricing is applicable where bills of quantities are not provided, either because the works are minor and such value does not warrant the time and expense of bills of quantities preparation, (for example, a modest dwelling house) or a mega-project is at hand where bills of quantities cannot be prepared within a feasible time due to the extensive structure.

Pricing the tender document before work starts may be contrasted with ‘costreimbursement pricing,’ where the price is only ascertainable after the project ends, and only if successfully so. At the same time, the strength of top down pricing is realisable when the top down approach (without measureable details) is combined with the cost-reimbursement pricing and used to establish a “target price”.

Target pricing

David Trench, in his work ‘On Target’ (Thomas Telford, 1991), pointed out that an independent UK survey showed that project time overruns was the largest single cause of cost increase for both construction owners and contractors; with large projects being highly susceptible to uncontrollable costs. He introduced target pricing as a new type of procurement and accounting to mitigate this. First: a proposed project is bid on a ‘top down’ price basis with the successful price being used as a target price. Next: arrangements are made to pay the contractor under a parallel cost-reimbursement account. Finally: where the reimbursed cost is less than the target price, the saving is shared between owner and contractor; where such cost exceeds the target price, the excess cost is also shared. The object is to establish a joint interest in time- and cost-control between the owner and contractor. Trench saw his system pioneered in the construction of the landmark London Millennium Dome, which was successful technically, but dubbed a financial failure (based on the visitor ticket sales) until sold off to a private owner. Over time, target pricing has been extended in use, even to when bills of quantities are provided.

Target pricing presently is limited to use on mega-projects, and to particular countries, but it is mentioned here as there is a nascent international dimension to Guyana’s construction market, and this pricing may emerge. Its drawback is that it demands multiple teams of quantity surveyors and other specialists - for contract documentation, settling of owner/contractor shares, and accounting.

Dilemma extended

Returning to Budday’s situation, a bill of quantities was provided which he priced bottom up, but his business has done badly on the bridge project, so far. He received a normal advance payment but site checks revealed that work was never started, and the advance payment made to Budday’s business remains unrecovered. Also, the defects liability period was not stated in the contract documents. The financial auditor has recommended that the regional administration urge Budday’s Construction Enterprise to complete the works, (even though never started) the advance payment bond be extended (rather than called-in), and the monitoring of work progress be improved (though never evident). Hence Budday’s dilemma of how to proceed continues. Moreover, the situation of non-delivery, notwithstanding the auditor’s recommendation, cries out for investigation of the management and oversight by the local authority concerned. Indeed, the dilemma is now extended to the local authority body which itself is now unsure if and how to proceed with the distressed contract.

*The contractor’s name has been changed above. However, the otherwise real stalled bridge project is another example of construction failure, with obvious economic and social dimensions, beseeching open reporting and confidence-building correction.