Competitive bidding on construction projects involves decision making under uncertainty where one of the greatest sources of the uncertainty for each bidder is due to the unpredictable nature of his competitors. Each bid submitted for a particular job by a contractor will be determined by a large number of factors, including an estimate of the direct job cost, the general overhead, the confidence that the management has in this estimate, and the immediate and long-range objectives of management. So 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.
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 labor costs, material costs, equipment costs, and direct filed supervision; and (2) the markup or return, which must be sufficient to cover a portion of general overhead costs and allow a fair profit on the investment. A large return can be assured simply by including a sufficiently high markup. However, the higher the markup, the less chance there will be of getting the job. Consequently a contractor who includes a very large markup on every bid could become bankrupt from lack of business. Conversely, the strategy of bidding with very little markup 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 markup” 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.
From all indications, most contractors confront uncertain bidding conditions by exercising a high degree of subjective judgment, and each contractor may give different weights to various factors. The decision on the bid price, if a bid is indeed submitted, reflects the contractor’s best judgment on how well the proposed project fits into the overall strategy for the survival and growth of the company, as well as the contractor’s propensity to risk greater profit versus the chance of not getting a contract.
One major concern in bidding competitions is the amount of “money left on the table,” of the difference between the winning and the next best bid. The winning bidder would like the amount of “money left on the table” to be as small as possible. For example, if a contractor wins with a bid of $200,000, and the next lowest bid was $225,000 (representing $25,000 of “money left on the table”), then the winning contractor would have preferred to have bid $220,000 (or perhaps $224,999) to increase potential profits.
Some of the major factors impacting bidding competitions include:
- Exogenous Economic Factors
- Characteristics of Bidding Competition
- Objectives of General Contractors in Bidding
- Contractor’s Comparative Advantages