The total price of a bid consists of the cost and the markup. The cost includes direct and indirect costs. The markup includes profit margin, financial charges (cost of borrowing), and an allowance for risk margin.
Bidders in the construction business know it is very difficult to decide on a suitable margin to make the bid competitively against other bidders. The markup percentage must be low enough to win the bid and at the same time, high enough to make a reasonable profit.
Usually, bidders have a common method of assessing a specific contract markup. That is adding a single percentage markup to the total of direct and indirect costs. It is assumed that this percentage will cover all the components of markup, such as risk allowances, financial charges, and profit. It includes a detailed analysis of the risky components in the project and their impact in terms of increased time and cost. In the meantime, a cash flow analysis must be done to estimate the financial charges before estimating a reasonable profit margin.
The direct costs are associated directly with the contract activities. However, indirect cost and markup are not associated with specific activities but with the whole contract. Therefore, the pricing policy is the method of how the indirect costs and markup be distributed among the work items of the bill of quantities, and to calculate the total bid price before submitting the bid to the client.
Most of the bidders follow this method when calculating the bid price. In this method, the indirect cost and the markup will be distributed among different work items based on their direct cost value. That means, if the direct cost of an item is higher, the share from indirect cost and markup for the particular item is more. The resulting bid price arrived using this method is called a balanced bid.
Example – Assume that the direct cost for an item (a) is LKR 400,000 and that item is included in a contract whose price is LKR 3,500,000 and its total direct cost is LKR 2,800,000. Calculate the price for the item (a) considering a balanced bid.
Unbalanced bid (Loading of Rates)
The bid price is unbalanced if the bidder raises the unit rates on certain bid items (usually the early items on the work programme) and reduces the unit rates on remaining work items so that the bid price remains the same. This process is also called the loading of rates.
The reason for loading the unit rates of the first items is to ensure more cash flow at the beginning of the contract and to reduce the negative cash flow, thereby reducing borrowing of money.
This method of loading rates may be risky to both the contractor and the owner.
For example, when the contractor raised the price for a work item, and then the quantity of this item increased during the construction than what was in the bill of quantities then, the resulting situation is riskier to the client. It will cost the client more money.
On the other hand, if the contractor reduced the price of a specific work item in the bill of quantity and the quantity of that item increased during the construction, the situation is riskier for the contractor.
Therefore, it is better to follow a balanced way of distributing the indirect costs and markup among work items in the bill of quantities.
Example – Consider a contract having five consecutive activities with equal duration. The quantity of work in each activity, the direct cost rate, and the total cost rate for balanced and unbalanced bids are given in the Table below. Determine the influence of unbalanced bid on the contractor’s profit if:
1). Quantity of activity (B) is increased by 50%.
2). Quantity of activity (C) is increased by 50%.
Solution – Here, it seems that the bidder has increased the unit rates of early items (i.e. in Activities A and B) in the unbalanced bid. However, to get the bid price on par with a balanced bid, the bidder has reduced the unit rates of remaining activities.
The Table below shows the effect of the tender price if the quantity of activity “B” increased by 50%.
Then, the price of the unbalanced bid (LKR 7,200.00) is greater than that of the balanced bid (LKR 7,000.00) which means more profit to the contractor and more risk to the owner.
The next Table below shows the effect of the tender price if the quantity of activity “C” increased by 50%.
The price of the unbalanced bid (LKR 7,400.00) is less than that of the balanced bid (LKR 7,500.00) which means less profit and more risk to the contractor.
The decrease in bid price means the profit of the contractor has been decreased representing a risk to the contractor.
From National Procurement Agency (NPA) Guideline in Sri Lanka
Examination of unbalanced bids (lowest evaluated bid) during bid evaluation to minimize the risk
A bid may appear unbalanced resulting from the comparison of unit prices quoted by different bidders and the engineer’s estimate previously prepared by the client.
For Works contracts may be “unbalanced” in several ways.
Unit prices for work items that will be performed early during the construction can be priced high. Or else, the bidders who have reason to believe that the quantities given in the bill of quantities for one or more work items are underestimated will quote high on those items.
In both cases, the unbalanced bids result in higher contract costs. In addition, in the first case, the incentive for the contractor to complete the contract is substantially reduced because the payments he would receive during the latter phases of the contract may be smaller than the costs.
Steps to remedy the situation can, however, be taken in cases where the unbalancing is substantial, i.e. where the unit price quoted for the items involved are, say, 50 percent higher than the average quoted by the other bidders for the same items and where the total amount involved exceeds 5 percent of the total bid.
In the case of very large contracts, say exceeding LKR 500 million:
The present value of all unbalanced items (using the work program as a basis for the timing of payments) can be computed, for over-pricing of the items that will be executed early during the performance. Simultaneously, the present value for such items can be computed using the prices of the engineer’s estimate. The difference between the two present values so computed can be added to the unbalance bid for comparison purposes.
In cases of overpricing, the items that are believed to be underestimated in quantities should be adjusted by the inclusion of clauses in the conditions of contract to limit the mandatory use of existing rates up to a certain percentage rather than evaluating the effects at this stage.
In the case of other contracts, say not exceeding LKR 500 million
For over-pricing early items, the remedial action should be based on the low quoted items rather than the items the bidder has quoted highly.
The bidder shall be requested to prove to the satisfaction of the client /Procurement Entity (PE), how the bidder intends to procure such items/perform the Works/provide the Services as per the quoted rates, for such purposes the bidder may be asked to provide a rate analysis.
If the justification/explanation of the bidder is acceptable, the client/PE should proceed with the evaluation.
If the client/PE is of the view that the justification/explanation provided by the bidder is unacceptable, and hence the bidder would fail in the performance of his obligations within the quoted rates, higher performance security may be requested to mitigate such risks.
If the bidder refuses to provide such additional performance security, his Bid shall be rejected.
For over-pricing high, the items believed to underestimated, rather than evaluating the effects at this stage it may be advisable to include clauses in the conditions of contract to limit the mandatory use of existing rates up to a certain percentage unless justified during the implementation.