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The aim of this report is to research and discuss the term 'bidding' within the construction industry. Within this piece the writer will look at various theories that demonstrate how bidding is adopted within the construction industry along with the various formats and approaches companies can take when it comes to bidding for a particular project. In conclusion the writer will show his understanding of Mechanism Design Theory and speculate if this particularly new theory is adaptable to the construction industry currently and whether this theory will be beneficial to the industry for years to come.
Within a construction contract price includes the direct project cost including field supervision expenses plus the mark-up imposed by contractors for general overhead expenses and profit. Many factors are involved that it is impossible for a particular bidder to attempt to predict exactly what the bids submitted by its competitors will be.
In the private sector, the owner has considerable latitude in selecting the bidders, ranging from open competition to the restriction of bidders to a few favoured contractors. In the public sector, the rules are carefully delineated to place all qualified contractors on an equal footing for competition, and strictly enforced to prevent conspiracy among contractors and unethical or illegal actions by public officials.
The final bids are normally submitted on either a lump sum or unit price basis, as stipulated by the owner. The contractor is permitted to submit a list of unit prices for those tasks, and the final price used to determine the lowest bidder is based on the lump sum price computed by multiplying the quoted unit price for each specified task by the corresponding quantity in the owner's estimates for quantities. However, the total payment to the winning contractor will be based on the actual quantities multiplied by the respective quoted unit prices.
An alternative to competitive bidding is negotiated contracts. Private owners often choose to award construction contracts with one or more selected contractors. A major reason for using negotiated contracts is the flexibility of this type of pricing arrangement, in particular projects of large size and great complexity. An owner may value the expertise and integrity of a particular contractor who has a good reputation or has worked successfully for the owner in the past. If it becomes necessary to meet a deadline for completion of the project, the construction of a project may proceed without waiting for the completion of the detailed plans and specifications with a contractor that the owner can trust.
In a unit price contract, the risk of inaccurate estimation of uncertain quantities for some key tasks has been removed from the contractor. However, some contractors may submit an "unbalanced bid" when it discovers large discrepancies between its estimates and the owner's estimates of these quantities. Depending on the confidence of the contractor on its own estimates and its propensity on risk, a contractor can slightly raise the unit prices on the underestimated tasks while lowering the unit prices on other tasks. Should the contractor be correct in its assessment, it can increase its profit substantially since the payment is made on the actual quantities of tasks; and if the reverse is true, it can lose on this basis. Furthermore, the owner may disqualify a contractor if the bid appears to be heavily unbalanced.
It is useful to think of a bid as being made up of two basic elements: (1) the estimate of direct job cost, which includes direct labour costs, material costs, equipment costs, and direct filed supervision; and (2) the mark-up or return, which must be sufficient to cover a portion of general overhead costs and allow a fair profit on the investment. Consequently a contractor who includes a very large mark-up on every bid could become bankrupt from lack of business. Conversely, the strategy of bidding with very little mark-up in order to obtain high volume is also likely to lead to bankruptcy. Somewhere in between the two extreme approaches to bidding lies an "optimum mark-up" which considers both the return and the likelihood of being low bidder in such a way that, over the long run, the average return is maximized.
Exogenous factors such as the history of a contractor and the general economic climate in the construction industry will determine the results of negotiations. However, the skill of a negotiator can affect the possibility of reaching an agreement, the profitability of the project, the scope of any eventual disputes, and the possibility for additional work among the participants. Thus, negotiations are an important task for many project managers. Even after a contract is awarded on the basis of competitive bidding, there are many occasions in which subsequent negotiations are required as conditions change over time.
In conducting negotiations between two parties, each side will have a series of objectives and constraints. The overall objective of each party is to obtain the most favourable, acceptable agreement. A two party, one issue negotiation illustrates this fundamental point. Suppose that a developer is willing to pay up to $500,000 for a particular plot of land, whereas the owner would be willing to sell the land for $450,000 or more. These maximum and minimum sales prices represent constraints on any eventual agreement. In this example, any purchase price between $450,000 and $500,000 is acceptable to both of the involved parties. This range represents a feasible agreement space.
Hatush and Skitmore (1997 a) identified five main elements as common factors in the contractor selection process for all types of procurement arrangements. These are project packaging, invitation, prequalification, short listing and bid evaluation. Hatush and Skitmore (1997a) defined pre-qualification as a pre-tender process used to investigate and assess the capabilities of contractors, hence providing the client with a list of potential contractors to invite to tender. Bid evaluation despite involves similar process it is different in two aspects; it occurs at the post tender stage and it considers both bid amount and the contractors' capabilities. Russel and Skibiniewski (1988) defined bid evaluation as a decision-making process that involves the development and consideration of a wide range of necessary and sufficient decision criteria used to assess the contractors' capabilities.
Holt et al. (1993) have proposed a modified quantitative model for selecting contractors. This model comprises a three-stage process requiring the calculation of what is called P1 scale index to investigate the more general areas surrounding potential bidders. A P2 scale index is calculated for the second stage to assess the contractor further in the light of specific factors. Finally a P3 scale index is calculated to compare the bid prices amongst the invited bidders.
Bid evaluation is used to denote the procedure for strategic assessment to tender bids submitted by pre-qualified contractors. The strategy used for bid evaluation should reflect the client's objectives (Hardy, 1978). Hardy's (1978) criterion, for example, prioritises bids considering the return on the client's investment. Thus bidders should submit a projected cash flow so that clients can determine the present value of bids. Herbsman and Ellis (1992), on the other hand, proposed a time/cost approach to determine the winning bid in the highway construction contracts. By converting the contract time to cost, a straightforward comparison can be made on a single criterion.
Maskin and Myerson have heavily contributed. The problem is to decide how to allocate some objects among potential bidders when the value of the object(s) to a bidder is only known to a bidder. The government uses auctions to allocate spectrum, airport slots, oil drilling rights, timber or land. They also use reverse auctions to produce goods/services from the private sector.