Theory and practice of how contractors approach risk in the tender process

Here's a piece about my PhD that Will and I wrote for publication in the newsletter of the Civil Engineering Contractors Association (CECA)

Theory and practice of how contractors approach risk in the tender process

Samuel Laryea and Will Hughes
School of Construction Management and Engineering, University of Reading, UK

Many formal and analytical risk models that contractors can incorporate into the bidding process for pricing risk have been proposed by academic researchers in recent years. Indeed, a comprehensive survey of the construction management literature showed that more than 60 such models have proliferated since 1971. However, several empirical studies of contractors’ tendering processes have indicated that contractors rarely used them in practice.
In February 2006, a major study began to ascertain how contractors price risk in practice. The main question was: If contractors do not approach risk according to the contingency allocation theory proposed by academic researchers, then what do they actually do about risks when they put a bid together? The aim was to compare the analytical approaches proposed in the construction management literature to what contractors actually do, in order to identify whether there are areas of significant differences.
Altogether, about a dozen national contractors in the UK were initially involved in the study through interviews and documentary analysis. To probe for a deeper understanding, the whole tender process was shadowed in some of the firms. The researcher participated in all activities of the particular bid teams, from the time when tender documents were first received in the contractor’s offices until tender submission. The purpose was to capture how risk analysis influences pricing levels, and how it is taken into account at an operational level (also summarized in Laryea and Hughes, 2008[2]).
The study found that risk allowances of around 1-2% of project cost were included in some bids. However, the main mechanisms used by contractors for approaching risk, particularly the risk of getting the tender price wrong, were a commercial review; commercial and planning review meetings; and the use of assumptions, qualifications, and clarifications in the tender programme and price to mitigate risk. The two main risks of concern were identified as commercial and operational risk. Most of the contractors would carry out a commercial analysis of the proposed conditions of contract, through their commercial managers, and depending on the degree to which the conditions were considered to be ‘onerous’, they would decide on the best way to approach risks: either to avoid bidding at all, or qualify (or clarify) the risks as part of the tender submission for post-tender negotiations with the client ‘if the tender price is of interest’. Operational risk related to the perceived difficulty in carrying out the actual job under physical conditions such as access, location, and ground. In relation to these, most of the contractors tended to state clear assumptions upon which their offer (tender programme and price) was based.
Thus, it became clear that instead of pricing in risk allowances that will inflate their tender price, and probably cause them to be uncompetitive, strategies and tactics were developed to help offer the best (lowest) price for ‘getting a foot in the door’ and then to negotiate risks with the client at the post-tender stage. This was found to be one reason why risk may not be approached according to the contingency allocation theory suggested in the 60+ analytical approaches proposed by academic researchers.

Acknowledgement:
We are grateful to CECA (Southern) Ltd for the help in finding companies to study in the second phase of the research project.

Reference:
[2] Laryea, Samuel and Hughes, Will (2008) How contractors price risk in bids: theory and practice, Construction Management and Economics, 26: 9, 911- 924.