The final steps in the contractor selection phase involve decisions about the size of the markup to be added to the net project cost, the submittal and opening of all tenders, the selection of the successful contractor and, at last, the notice to proceed, which directs the contractor to begin work.
Turning the estimate into a tender
Pilcher (1992) defines tendering as the process whereby a contractor, given the net cost, converts this to the sum that will actually be submitted to the client, together with any qualifications that are seen to be required. At this stage the principal discussions are concerned with the profit and the risk, together known as the margin or the markup.
Although we have already illustrated the addition of markup, or profit and contingency, to net project cost in the determination of total tender price, it is important that we consider some of the issues involved in determining the markup amount. Also, the separation of the rather mechanical process of determining the net project cost from the judgment-based setting of markup is an important part of the thought process. Furthermore, while the estimating staff will perform most or all of the assembly of net project cost, the setting of markup is the responsibility of upper management. If the net project cost estimate is a relatively accurate prediction of what the project will cost, the decision about markup will make or break the project. For those reasons, we set this section apart from the cost estimating section in this presentation.
Hendrickson and Au (1989), in their discussion of the principles of competitive bidding, state that most contractors exercise a high degree of subjective judgment in the setting of markup. The process is far from exact. In a competitive tendering situation, two opposing objectives are at work: (1) the desire to be selected as the winning tenderer and (2) the desire to make a decent profit from the project. The lower the markup, the higher will be the probability of the contractor having a sufficiently low price to be selected. On the other hand, the higher the markup, the greater will be the profit if the contractor is selected, other things being equal. It is upper managements responsibility to set an optimum markup that balances these two objectives for any particular tender.
The factors that may be involved in setting the markup amount have some resemblance to the factors the contractor considers in making the decision whether to spend the effort to prepare the tender, discussed earlier in this chapter. The factors are related to the contractors potential risk if the project is won, the degree of need and desire to win the project and the expected competition. Among all the factors a contractor might take into account are the following.
The owner and design professional and the likelihood they will cause difficulties for the contractor.
Stipulations in the contract documents for delays in payments or retention of moneys owed to the contractor.
Disclaimer clauses that place on the contractor most or all of the risk for unknown physical conditions at the site, especially underground conditions.
Clauses making the contractor responsible for any delay in the project, even if not caused by the contractor.
Other clauses providing for procedures the contractor may believe to be unreasonable, for such matters as change orders (variations), contract claims and the rendering of binding decisions in case of disputes.
The extent to which the contractor may be liable for any worker safety-and-health problems or labour law violations.
The projects location, size and complexity.
The amount of work to be done by the contractors own forces in comparison to work to be done by subcontractors. In general, contractors believe that more risk is associated with doing the work yourself; some apply a higher markup percentage to that work than to subcontracted work.
How hungry the contractor is, based on the number of projects the contractor already has under contract and the potential for other new projects. This degree of desire to win the project can be a major influence on markup.
The expected competition, including the number of tenderers and the characteristics of each.
In general, the competition will be more intense as the number of tenderers increases and the contractors will need a smaller markup to have a high chance of success. Also, if some of the other contractors have reputations for offering low-priced proposals, this fact may influence our contractors markup decision. Of course these other tenderers are considering the same factors when pricing their proposals, including their current and future workloads, so attempts to analyse their potential competitiveness will be inexact at best.
Most of these factors are quite intangible, which is why the evaluation of these risks and the decision on markup is the responsibility of those personnel with considerable experience and judgment skills. In our two examples earlier in this chapter, we used markups of 9.6% and 10.5%, before adding taxes and bond costs. In good times, these may be reasonable percentages, but it is well known that some contractors add only a few per cent for profit and contingency when the competition is intense and they are highly desirous of obtaining the work. One other comment is in order with regard to markup. Sometimes this term is defined to include general overhead, as well as profit and contingency. In that case, of course, a higher percentage would be used. Clough et al. (2000) suggest that markup may vary from 5% to more than 20%, especially if it includes general overhead.
