Optimizing the Success Rate of Competitive Construction Bidding

Prepared for: Kenneth McGuire, Marketing ManagerOdyssey International

Provo, UT 84602

Prepared by: Joseph McGuire7446 Camby Crossing Cir

Camby, IN 46113

July 25, 2006

Introduction

Odyssey International is consistently failing to accurately estimate and bid construction projects, and they are losing significant profit as a result. Many construction companies share this difficulty. This report documents strategies that will improve the bidding process and success rate of a construction company. According to Baldwin, McCaffer, and Oteifa (1995), “The most common form of awarding construction projects to contractors … is competitive bidding” (p. 1). Construction companies which participate in the bidding process need to submit bids which “give the best chance of winning and making a profit” (Baldwin et al., 1995, p. 2). The information presented comes from various manuals and articles published on this topic. First, the review discusses the preparation that needs to be completed prior to bidding. Second, the review analyzes factors that contribute to the success of a bid. Third, the review examines documented strategies that improve the possibility and profitability of a successful bid.

Basic Bidding Principles

Competitive bidding is the accepted form of obtaining construction contracts. A person or group has the position of estimator for a company, and it is this position’s responsibility to put together an accurate bid for a construction project.

According to Baldwin et al. (1995), a construction bid consists of two components: the direct cost of the construction and the markup (p. 1). The direct cost consists of five factors: labor, plant, materials, subcontracts, and on-cost. The markup covers company overheads, profit, and risk.

The completed bid must strike a delicate balance. To win the project, a bid must be low enough to be low bidder, but must not be so low that no profit can be earned. Essentially, constructing the bid is the job of the estimator (Baldwin et al., 1995, p. 2). Pratt (2004) states that a “systematic approach” is necessary to successful bid planning and execution (p. 18). Without a systematic approach, the bidding preparation and process can become disorganized and chaotic, leading to poor bids.

An inaccurate bid can have several consequences. If too low, the company may win the contract but make no profit. If too high, the company will not win the contract. The profitability of a construction company depends largely on its bidding process.

The systematic approach suggested by Pratt (2004) is shown in Figure 1:

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Figure 1: “The Estimating Process” (Pratt, 2004, p. 19)

Pratt (2004) takes us step by step from obtaining the bid information and deciding whether or not to bid to submitting and completing the bid. He claims that this process will aid the estimator in making an accurate estimate. The most important step is the Decision to Bid. Pratt is careful to point out that, while the decision to bid occurs at the beginning of the process, the decision is not final at this point. As information is gathered and processed, a “yes” decision is reviewed and can be overturned. Changing circumstances can also reverse an initial “no” decision (p. 18).

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Baldwin et al. (1989) give similar bid preparation steps in another flow chart (see Figure 2):

Figure 2: “An Overview of the Bid Preparation Process” (Baldwin et al., 1995, p. 30)

This second flow chart is slightly more detailed than Pratt’s, but it gives the same essential steps to preparing an accurate bid. The process starts again by obtaining the project information and deciding to bid, then going through various estimating steps, and finally submitting the final bid.

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The decision to bid a specific project is the most important decision, as all of the subsequent steps are essentially pricing the parts, labor, and profit.

Factors of Success

A bid is considered successful if it meets three criteria (Baldwin et al., 1995, p. 5). The bid must:

Be the lowest bid Cover all construction costs Earn the required profit

There are several factors that determine a bid’s chance of success. These factors include, but are not limited to, the following (Baldwin et al., 1995, p. 5):

Estimating accuracy The mark-up Market conditions Competition Efficiency and specialization

Estimating Accuracy

Poor estimation leads to unrealistic bids. If these bids are too low, then they will often win the bid but cause the winning bidder to lose money (Baldwin et al., 1995, p. 6). Short (2006) points to recent construction projects that finished far over budget. He states, “The root cause of these problems is that owners, architects and engineers are not using reliable means to obtain correct project numbers.” In other words, bids are based on unrealistic estimates that cause budgets to fail. Short says, “Wishful thinking is driving budgets instead of estimating professionals.” Professional estimators and meticulous, accurate estimates are necessary for successful bids (Short, 2006).

Tools are available to aid the estimating process. Digital libraries and databases give estimators access to thousands of cost tables. Computers perform long calculations and minimize error. Automated estimating systems can count all necessary components of complex projects (Tyler, 1989, p. 10). Whether calculations are done by hand or by computer, all data need to be double checked and careful records kept (Tyler, 1989, p. 28).

The Mark-up

The mark-up covers overhead, profit, and risk in a project (Baldwin et al., 1995, p.7). When several contractors bid on a well-defined project in a fair market, their estimates of cost of materials, parts, and labor should be very close. The mark-up can win or lose the bid all by itself. A high mark-up will earn the contractor the most profit, but lose the bid.

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A low mark-up will make the least money but can win the bid. The contractor must analyze past projects and determine the optimal mark-up (Baldwin et al., 1995, p. 13).

Market Conditions

‘Market conditions’ is a catch-all phrase that encompasses all external factors. These factors include (but are definitely not limited to) (Baldwin et al., 1995, p. 8):

Available projects Economy Legislation (current and future) Competitor activity Price of labor and supplies

There is no way to assign values or numbers to these factors, but they will have an effect on bidding success (Baldwin et al., 1995, p. 8).

Competition

Competition obviously plays a key role in bidding success. When bidding, competitors and their historical bidding trends must be considered. Also, the number of contractors that are bidding a project has to be considered. The more bids that are submitted, the greater the possibility that one of those bids is unreasonably low, thus denying both the company and the winning bidder any chance of a profitable project. The best estimator will not win against an inaccurate bidder, and neither of them will make any money (Baldwin et al., 1995, p. 9).

Competitors will often ask other competitors for information. A competitor may not want a specific project, but needs to bid to keep good relations with the customer. This competitor will ask for information so they can submit a high bid without investing any time in the estimating process. This is common, but may be seen as “limiting competition,” which is a crime (Tyler, 1989, p. 166). Bids should never be discussed with a competitor before the bid is placed. Any secret discussions between competitors about a bid are against the law (Tyler, 1989, p. 166).

Efficiency and Specialization

As a construction company completes projects, it tends to become very skilled in one type of construction. Companies need to recognize what they’ve been successful at in the past and concentrating on this work increases possibilities of success, especially when bidding against contractors without the specialized experience (Baldwin et al., 1995, p. 9). “Bid the type of work your company excels in,” states Tyler (1989, p. 24).

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Bidding Strategies

Construction firms often are very secretive about their bidding strategies. Some estimators simply try to discover the current lowest bid on a project and undercut that bid by a small amount. Others bid low and gamble that they can find ways to complete the project more efficiently by altering the original plans without altering the finished project. The best estimator in the business can lose a job to a company with an aggressive bidding strategy (Tyler, 1989, p. 9). Developing a bidding strategy is necessary. First and foremost, integrity is essential for long term success. A bidder must be “careful, accurate, thorough, and honest,” and “the estimator who violates the trust and confidence of those he deals with won’t survive” (Tyler, 1989, p. 24). Obtaining information unethically or illegally will inevitably damage a business’s reputation and could have serious legal consequences.

The perfect bidding strategy does not exist (McCaffer, 1993). According to Singh & Shoura (1996), bidding is a “scientific game.” Good judgment, skill, and intuition all play a major role and the outcome is uncertain until everything is finished. Nevertheless, several methods of maximizing profits by using specific strategies have been proposed. These methods assume that no unethical business practices are taking place.

Strategy 1: Optimize the Estimate

Generally 90% of a bid is the estimate, and the remaining 10% is mark-up (McCaffer, 1993). The estimate is, by far, the largest part of the bid, and therefore has the greatest impact on success of the bid, according to McCaffer. He states, “Estimating inaccuracy is one of the main reasons why bidding strategies can be destroyed” (1993). In other words, no matter how good one’s bidding strategy is, if the estimator can’t estimate correctly, he is doomed to fail. If the estimator can estimate perfectly and optimize the project design to save money and time, then the mark-up makes less difference because the estimate will win the bid.

Strategy 2: Optimize the Mark-up and Bid

Computer models using complex calculations have been developed to aid estimators and bidders. The goal of these software packages is to calculate the optimal mark-up and bid for a project. The optimal bid is one which makes the most profit but will win the bid (Seydel, 2003, p. 285). These packages require various inputs and historical data and attempt to use that data to optimize the bids. Seydel reviews and analyzes three such techniques:

unconditional model regression-based model neural network model.

The descriptions of these models are lengthy, and according to Seydel’s analysis, the neural network model does the best job of mathematically optimizing bids. The calculations are very complex and computer software is necessary, but Seydel believes

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that this is a helpful tool (p. 290). Most bidders have avoided computer optimization tools but the accuracy of these tools is steadily increasing. If enough historical data is available, then these tools can be effective (Seydel, 2003, p. 291).

Singh and Shoura (1996) present a different mathematical approach with the same objective. Their specific research was conducted on airport construction in French Polynesia, but their methods are simpler than those set forth by Seydel (2003) and can be applied to any kind of construction project. Marzouk and Moselhi (2003) developed a software package that they call a “decision support tool.” This software tool helps estimate mark-up and evaluate bid proposals. The designers claim that this tool combines the best aspects of the aforementioned methods into one accurate tool (Marzouk & Moselhi, 2003). The user is able to choose quantity and importance of many factors and the program assists the decision making.

No strategy will ever work perfectly 100% of the time, and McCaffer (1993) and Pratt (2004, p. 32) both say that these tools are to be used only as aids and should not replace good judgment or take over the process. The backbone to any bidding strategy is an extensive knowledge of historical bids, knowledge of competitors, and practice. However, tools such as those listed have been shown to improve profits over time.

Conclusions

This report reviews the construction bidding process, factors that can affect the success of a bid, and strategies and tools that are available. Construction estimators and bidders have intense pressure to submit extremely accurate bids on huge projects, and they must be well prepared. After an accurate bid is completed, contractors competitively bid for the projects. In order to both win the bid and make a profit, the bidder must have a method of determining how to mark up the estimate and submit a bid that has the best chance of winning a profitable contract. There are no foolproof solutions, but there are aids that can help and prepare a bidder. This report has briefly discussed this process and given valuable resources to the bidder.

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References

Baldwin, A., McCaffer, R., & Oteifa, S. (1995). International bid preparation. Geneva: International Labour Office.

Marzouk, M., & Moselhi, O. (2003). A decision support tool for construction bidding. Construction Innovation, 3(2), 111. Retrieved July 19, 2006, from the Business Source Complete database.

McCaffer, R. (1993). Construction bidding (book). Construction Management & Economics, 11(4), 309. Retrieved July 20, 2006, from the Business Source Complete database.

Pratt, D. J. (2004). Fundamentals of construction estimating (2nd ed.). Clifton Park: Thompson Delmar Learning.

Seydel, J. (2003). Evaluating and comparing bidding optimization effectiveness. Journal of Construction Engineering & Management, 129(3), 285. Retrieved July 19, 2006, from the Business Source Complete database.

Short II, D. (2006). Some estimates are wishful thinking. ENR: Engineering News-Record, 256(8), 63-63. Retrieved July 19, 2006, from the Academic Search Elite database.

Singh, A., & Shoura, M. (1996). Optimizing bidding success and profitability in airport runway construction in French Polynesia. Construction Management & Economics, 14(6), 507-530. Retrieved July 20, 2006, from the Business Source Complete database.

Tyler (1989). Estimating electrical construction. Carlsbad: Craftsman Book Company.

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