R E S E A R C H

COBRA 96
The effect of competitive tendering on value in construction

Christine Pasquire and Steven Collins, Loughborough University

ISBN 0-85406-894-5

THE EFFECT OF COMPETITIVE TENDERING ON VALUE IN CONSTRUCTION

Christine Pasquire, Department of Civil and Building Engineering, Loughborough University of Technology Simon Collins, Quantity Surveyor, Taylor Woodrow Construction Ltd
Abstract
This paper reports an investigation into the performance of single stage competitive tendering in terms of delivering value. The research was undertaken because it was indicated that value for money may not be the only outcome of competitive pricing. It examined the three areas of Prequalification, Existing Tendering Practice and Negotiation. The research introduced issues such as the use of cover prices and negative margins and surveyed both contracting companies and client organisations. The analysis revealed surprising attitudes towards value and competition, particularly among client bodies. The work had particular relevance as it was undertaken prior to and just after the release of the Latham Report (1994) and investigated some of the issues scrutinised therein. The main conclusions of the work were that some elements of competition did indeed encourage value for money but that there were many procedures within the competitive tendering process that adversely affect value. Both types of element were identified. Although ostensibly confined to the UK, the work undertaken and findings have implications within any national industry that adopts similar competitive tendering procedures. Keywords : Competitive tendering; value; cover pricing; forced sale pricing; negotiation

1.

Introduction

In 1993 Clive Lewis (RICS President) said "I believe in a competitive UK construction industry, but I do not believe in the sort of competition which drives that industry out of existence. A viable and robust construction industry, operating efficiently and delivering against client requirements on time, price and fitness for purpose, is an essential part of a recovering economy". He added "I know you will look for competitive pricing, but I also know you understand value for money." (Anon 1993) It was understood from this quotation that value for money may not be the only outcome of competition. The primary aim of the research was to investigate the effect that competitive tendering had on the attainment of value in construction and examine the various behavioural aspects. Several behavioural factors were identified and discussed within three specific aspects of tendering. These were :- (a) Prequalification (b) Existing Tendering Practice & (c) Negotiations. The principle methodology used was a questionnaire survey of both contracting and client organisations within the UK, followed up with interviews. A sample of 50 UK contracting organisations, geographically spread and of varying sizes, received the questionnaire, 52% (28Nr) were returned. 25 consultants, Local Authorities and Clients similarly distributed were surveyed, 48% (12) returned the questionnaire. The sample, although small was considered to be indicative of general attitude prevailing in the industry at the time.

Only the most significant aspects of the research are reported here, a much fuller account of the work and the findings will be published by the RICS Research Paper Series later this year.

2.

Prequalification

An early part of selective tendering was the preparation of select lists of contractors for invitation to tender. Turner (1979) recommended as part of this process that "references should be taken up ....., while a visit to completed work or work in progress may be needed for others." This was not an activity mentioned in the NJCC Code. Taking up references as Turner described it, was found to be an increasingly common occurrence known as preselection or prequalification and it was an attempt by clients to further guarantee a satisfactory standard of tenderer. 96% of contractors had been involved in prequalification to get on a tender list. This was echoed by clients, of whom 58% stated that they always required contractors to go through a prequalification procedure, as illustrated in Figure 1. Despite the frequency of prequalification, there existed no authoritative set of recommended procedures even though standardisation was being encouraged throughout the industry. Clients were found to be unrestricted and had a licence to ask any requirement of a contractor. Figure 1 - The Frequency of
NEVER

MAJOR PROJECTS

SOMETIMES

USUALLY

ALWAYS

OTHER

20

30

40

50

60

% of Clients Typical requirements for prequalification were identified and illustrated in Figure 2 - each category being out of a maximum of 25 (the number of contractors who completed the section).

Figure 2 - Prequalification Requirements

Other BS5750 Bank Details Presentations Details of Similar Work Audited Accounts Interviews Questionnaires References
0 10 20 30

Number of Contractors Out of 25

This list, although comprehensive, was not exhaustive and a total of 32 possible prequalification requirements were identified ranging from examples of previous contracts of a similar nature to confirmation of compliance with the Sex Discrimination Act 1975. However, the most extreme example was a client who wished to analyse staff CV's. Prequalification had become an accepted and necessary procedure, however there were times when prequalification procedures were mischievous. For example, one contractor felt that "there are too many detailed and extensive prequalification interviews just to get on the list" and another that "prequalification is costly and treated as a game by some client advisors." (Atkinson 1994). The recovery of prequalification costs was examined and Figure 3 showed where contractors recouped any outlay.

Figure 3 - Recovery of the Cost of Prequalification

General Overheads

Contractual Claims

On Other Contracts

In Tender Sum

Nowhere
0 10 20 30 40

% of Contractors Only 23% of contractors recouped the costs through the tender sum, whereas 77% of clients thought that was the method of recoupment. As 30% of contractors tended to recoup through general overheads and 35% did not specifically account for the costs (ultimately these would be added into the general overhead or deducted from profit) clients may find themselves reimbursing the cost of prequalification schemes implemented by other clients rather than paying their own costs.

2.1

Prequalification And Value For Money

The overall trend of opinion for both contractors and clients was that prequalification did improve value for money. This was not taken to mean that the prequalification process could not be improved to further enhance value for money. Under the existing system there was found to be a great deal of duplication because of clients requiring contractors to submit similar (but not identical) documentation. Such activity increased contractors overheads and subsequently tender prices. However, should a single qualification document for public sector bodies be implemented on a widespread scale (Latham 1994), a decrease in costs and increase in value for money would surely be the outcome. It was unclear what effect an upturn in the market would have on prequalification. A swing in power towards contractors could possibly lessen the frequency and extent to which clients could call for prequalification, although one contractor commented that "prequalification is here to stay" no matter what the future holds. If prequalification did improve value for money as much as the results of this research indicated then standard procedures should be developed to the benefit of all parties concerned.

3. 3.1

Existing Tender Practice Tender Lists

The NJCC Codes (1985 & 1989) recommended that the maximum number of tenderers should be three - four and six respectively. This was partly agreed to by Sir Michael Latham (1994), who advised that tender lists for design and build works should be shortened. The research showed that 83% of contractors believed tender lists were too long, but only 17% of clients believed them to be. The reasons for long lists were unclear, but an overwhelming 75% of clients did not consider longer tender lists gave better value for money. Indeed, they were unable to say what benefit they received from long tender lists. The 25% of clients who did think longer lists gave better value thought so for the reasons shown in Figure 4 below :Figure 4 - Prequalification and the Reasons for a Change in Value for Money 9%

35% High Standard of Contractor Bona-Fide Tenders No Unsuitable Contractors Increased Tender Prices

53%

3%

3.2

Cover Pricing

Cover pricing was the procedure of submitting prices high enough to ensure the contract would not be won or if it was, at a comfortably high profit margin. A total of 65% of contractors admitted they would submit a non-competitive price. Seeley (1984) claimed that a preliminary invitation to tender would guaranteed a bona fide tender. These results suggest that this was not the case and what Seeley had not considered was the reason cover prices were submitted - prejudice. When work was scarce, marketing departments worked overtime to secure tender opportunities, the result being an influx of chances to tender for poor quality work. If the terms of tendering for this work were generally unfavourable, a cover price was likely to be considered an optimum solution. The submission of a cover price would avoid the prejudice of future opportunities with the same client. 77% of contractors thought that refusal to submit a price could prejudice those opportunities.

These findings made an interesting comparison with those for clients, of whom only 15% said that refusal would prejudice future tendering opportunities. However attention must be drawn to the rider attached by the majority of the 77% of clients who claimed no resultant prejudice "as long as good reason and sufficient notice are given." This was a procedure acknowledged by several of the 23% of contractors who felt refusal did not mean rejection. To offer an explanation for divergence of opinion, the principle of value for money was again questioned. A slight majority (54%) of contractors agreed that cover pricing did reduce client value for money for reasons illustrated in Figure 5. (based on points not percentages). Although clients had no idea how the tender sum was derived and consequently little idea of the level of competitiveness included, that their value for money could be adversely affected by explained why clients preferred to hold no prejudices. Especially as contractors had little to lose in submitting a cover price - after all, they did not want the contract and even if it was awarded it would be done so inclusive of a comfortable profit margin. Figure 5 - Why Cover Pricing Reduces Clients' Value for

Other

Good Company off Select

Contractors Overheads Increased

Wrong Contractor

Competition Reduced
0 10 20 30

Points Scored

3.3

Buying Work

Under the terms of perfect competition the success of one tenderer over another could never be guaranteed and each would have an equal chance of winning. In construction there were so many variables in the motivation to tender, it was impossible for perfect competition to exist and for six similar contractors to arrive at six similar tender totals.

Furthermore, it was possible for contractors to go one step beyond the confines of competition and increase their chances of winning. Based on the assumption that the contract will be awarded to the lowest tenderer as recommended in the NJCC Code, then if a tenderer was able to ensure that their bid would definitely be the lowest the probability of a successful tender was significantly increased. This process was commonly known as "buying work" and was achieved in one of three ways :1. Including only a nominal profit margin.; 2. Pricing at cost; or 3. Including a negative profit margin. Being a technique implemented during difficult times, buying work has been a frequent occurrence during the recession years. The survey found that 65% of contractors said they would consider tendering at tight or negative margins. If contractors were buying work, how then did they intend to ensure profitability was maintained? Although the interest from cash flow was utilised, the extent to which this could be used to fund future growth was strictly limited as was the amount of interest available .Figure 6 illustrated the percentage of interest on turnover for six major contractors. Figure 6 - Construction Profits Breakdown (Contracts Journal 15.10.94)
3

Percent

Interest as % of Turnover Operating Profit

1

0
Balfour Beatty AMEC Wimpey Costain Laing Mowlem

Contractor What was most alarming about this was the extent to which it showed profit margins to be depressed, with five of the six contractors not even making 1%. To counter this contractors could not sit back and accept the tendered lack of profit or indeed loss. Figure 7 showed the importance placed on the various methods available for enhancing contract profit. Again a points system was utilised to measure the response. From this it could be seen that "vigorous financial control to recoup maximum entitlement" was considered to be the best way of increasing profit. The wording of this phrase was intentionally broad and purposefully avoided the sensitive issue of contract claims - however, it would be surprising if contractors considered that claims were to be excluded from such a category especially since the advent of the position of "Claims Surveyor" on many construction sites.

Figure 7 - Relative Importance of the Methods of Enhancing Contract Profit

Other Nothing

Use Top Management Use Cheaper Resources

Reduce Contract Overheads

Vigorous Financial Control

0 1 20 30 40 50

Points Scored

Clients were not oblivious to the level of profit margins and the practice of buying work, 91% of those clients contacted recognised that a contractor who had little work on at the time of tendering was more likely to submit a price with a decreased profit margin to secure the work. What was more surprising was that only 8% of clients consider such activity likely to decrease their value for money, which was in direct contrast to 58% of contractors. Furthermore, 50% of clients considered that value for money would increase and 42% thought that value for money would be unaffected. The thinking behind this difference was of particular interest with 48% of clients arguing that a low tender ultimately reduced the contract cost and contractors emphasising that the actual final cost tended to increase as a result of claims. As Sir Michael Latham (1994) warned-"When contracts are won on a price which can only produce a loss for the main contractor, the likelihood of a contract dominated by claims, and of disputes between main contractor and subcontractors, is extremely high. Clients, with their professional advisors, need to be able to reject an apparently financially advantageous tender because it is uneconomic." Clients were apparently saying that when the market was depressed and buying work was rife, their value for money improved. This was partly reflected in a market where it was cheaper to build now than 5 years previously. However, value for money was not based purely on price and the fixation with cost was something to be considered in greater detail.

4. 4.1

Tender Negotiations Negotiated Reductions

Negotiation gave flexibility to single stage tendering as the tender sum need not necessarily become the contract sum. The NJCC (1989) stated negotiation as being the recommended procedure "should the tender under consideration exceed the employer's budget". This arrangement meant it was possible for contracts to be let on the basis of competition but include an element of negotiation.

The frequency of tender negotiations, illustrated in Figure 8, was based on what contractors considered to be the number of times negotiations were entered into as a percentage of tenders for which Bills are called i.e. those tenders which have been under consideration. Figure 8 - Frequency of Tender 30

20

% of Contractors 10

0 - 5%

5 - 10%

10 - 20% 20 - 30% 30 - 50%

50%+

Frequency When combined with the 55% of clients who said that they "sometimes" went to negotiations, it was concluded that tender negotiations were an aspect of competitive tendering procedure that was encountered on a regular basis. The remaining 45% of clients stated that negotiations were never required.

4.2

Time, Cost And Quality

Figure 10 showed what contractors and clients respectively, considered to be the main areas for negotiation.

Figure 8 - The Subject Matter in Tender

80

60

40 % of Respondents

Contractor Client

20

Time

Cost

Quality

Other

There was a difference of opinion over this issue. Overall, the emphasis on time, cost and quality was fairly evenly distributed among clients, contractors clearly considered cost to be the main issue. Several possibilities were offered in explanation for the incongruous results but the research findings lead to the conclusion that clients had not answered this question honestly. Had cost not been a major consideration then more than 8% of clients would have recognised that the practice of buying work ultimately adversely affected value for money. The survey went on to ask clients what they felt the benefits of negotiation were. 50% felt that getting the job done for the price they required was the main advantage and yet only 32% claimed to concentrate on price in the negotiations. An element of prevarication must be applied somewhere. There was found to be growing concern generally about the assessment criteria applied to the selection of competitive tenders (see Forced Sale Pricing) and it was possible that clients talked themselves out of selecting the cost option involuntarily to avoid scrutiny. However, it was unequitable to believe that clients were solely responsible for the deviance in results shown in Figure 10, a more representative figure for the emphasis placed on cost was likely to be somewhere in-between the responses.

4.4

Forced Sale Pricing

The process used to enable clients to get the job done for the price they required was known as forced sale pricing. Essentially this involved the client pushing down the tender sum at the negotiation stage so that the tender sum either met the client's budget or was below the set figure. i.e. emphasis placed on cost. Contractors were asked what they considered to be the main consequences of forced sale pricing.

This indicated that forced sale pricing did not provide much good spirit between contractor and client and the benefits it afforded either party on an individual basis were questionable. For example, increased contractual dispute was the factor contractors considered to be the most likely consequence. However, to counter this, 50% of clients still maintained that the job was done for the required price. This finding gave more credence to the contention that clients were not correct in their claim that quality was the governing factor in negotiations Figure 11 - The Effects of Forced Sale

Increase Client Value Less Contractor Profit Increased Disputes WeakerClient/Contractor Team Inflated Tenders Other
0 10 20 30 40

Weighted Point Score A greater emphasis on quality would be achieved by not allowing price to dictate the choice of successful tenderer. The American system of automatically discarding the lowest tender was use as an example in the survey. Figure 12 showed what contractors thought would be the effects of this system.

Figure 12 - The Effects of Accepting the Second Lowest

Cost Less Important in Tender Increased Tenders Less Client Value No Buying Work Fewer Disputes Truer Cost at Tender Other
0 10 20 30 40 50

Weighted Point Score This identified a method by which the practice of buying work could be removed, although if clients fail to see any detrimental effects caused by buying work it was unlikely that acceptance of the second lowest tender would be adopted. The other options favoured by contractors in their assessment of the possible advantages would surely be of benefit to clients as well, in that there would be fewer contractual disputes and a better idea of contract cost at tender stage. Notably the latter point came out on top when clients were asked for their opinion on the practice of accepting the second lowest tender, although in this case it did so just ahead of increased tender prices and a reduction in value for money. If other apparent advantages were willingly ignored in favour of price then we have come once again to the myopic view on cost. Although 17% of clients would consider accepting the second lowest tender as a policy. What appeared to be missing in tendering practice was a system of tender analysis which allowed an assessment of quality as well as price. This was a notion supported by Sir Michael Latham (1994) who argued that, "it is not necessary to choose the lowest tender. The best tender should be accepted." One such system identified was the "Value Assessment" method recommended by the Construction Industry Council. Such a system allowed flexibility in that as many quality factors may be included as were thought applicable and price given a high or low weighting in accordance with the complexity of the work.

4.5

Tender Negotiations And Value For Money

Value for money was defined in terms economy, efficiency and effectiveness. Further to this, economy was defined as "minimising the cost of resources. . .having regard to appropriate quality."(DoE 1992) Price was obviously an essential part of the value for money concept, but it could only be so if the element of quality was appreciated to the extent that it became relevant. Clients who continued to force price down in tender negotiations on the basis that cost was the critical factor when selecting a contractor, were effectively pushing aside their own value for money.

Perhaps if just a few clients had the confidence to try value assessment and reported success, then it may inspire other clients to do likewise. Quality would then become standard to the construction industry and general improvements all round could be anticipated. As Geoff Brewer (1995) says, "Many of the current ills of the construction industry can only be cured by improving our general standards of professionalism."

4.5

Negotiated Contracts

The frequency of the use of negotiated contracts was found to be restricted. Only 20% of contractors stated that 20 - 50% of their tenders were negotiated. The remaining 80% said that contracts were negotiated on less than 20% of their tenders. This was echoed by clients of whom 92% stated that only up to 5% of their contracts were awarded on a negotiated basis. It was apparent that negotiated contracts were not favoured by clients to the construction industry.

4.6

Negotiated Contracts And Value For Money

When the effect of negotiated contracts on value was examined, only 18% of clients felt that negotiated contracts improved their value for money. However, contractors were of almost exactly the opposite opinion as a substantial majority of 81% considered that value for money would increase. The reasons contractors felt negotiated contracts increased value for money were illustrated in Figure 13 and highlighted that no single element was perceived as being vastly more significant than another. Contrasting these results with the reasons clients considered value for money not being enhanced was particularly revealing. It was apparent that cost showed itself to be the most significant factor in their minds once again, with 88% citing a reduction in price competitiveness as the main reason for the negative impact on value for money. This was further evidence to support the argument put forward over the reliability of the client response to the relative emphasis on time, cost and quality in tender negotiations. The remaining 12% of clients claimed increased lead in time was the major factor which adversely affected value for money.

Figure 13 - The Reasons Negotiated Contracts Increase Clients' Value

Less Dispute

Better Idea of Cost at

Contractor not Chosen on Cost

Other

10

20

30

40

% of Contractors

5.

Conclusions

The most significant finding, although not surprising, was the wide divergence of opinion between clients and contractors, most notably prejudice over non-submission of a tender, the effect of cover pricing on value for money, the methods of recouping the cost of prequalification, the basis for tender negotiations and the effect that negotiated contracts would have on value for money. It was hard to imagine parties of such differing views becoming the cohesive team that Latham (1994) described. It was only to be expected that the notion of value for money meant different things to the two parties as they had distinctly different motivation for building. What was worrying was the perception that cheapness meant value amongst the client population. It appeared that clients (or more significantly their representatives) were deceiving themselves into believing they were adequately balancing the time:cost:quality triangle through the existing methods of tendering. It was clear that contractors were striving to move clients towards more negotiation and longer term relationships. Negotiated contracts provided an acceptable alternative but even contractors agree that they were only an alternative to competition and it was unlikely this relationship would be reversed. The concern over price and the misinterpretation of value for money as described previously would prevent this.

6.

Recommendations

In order to develop tendering strategies which enhance value for money, full consideration should be given to the following ;1) Standardised prequalification procedures with clear definitions of the information required from the contractor. The amount of information required should be as concise as possible. Such procedures would streamline prequalification practices, ultimately reducing their cost to the industry. 2) Shorter tender lists would be advantageous especially where contractors have already pre qualified for the project. A maximum of four tenders should be sought for Design and Build projects with six being the maximum number for traditional projects. 3) The practice of cover pricing will be hard to eliminate, but increased communication, especially about prejudice, between the client and the contractor will move towards achieving this. 4) The research findings indicated that the practice of buying work encouraged contractors to recoup in other ways and that this could adversely affect the client's value for money. Buying work will continue whilst there is over capacity in the industry and accepting the lowest tender is common practice. Accepting the second lowest tender and an increased use of negotiated contracts would remove this practice. 5) The practice of forced sale pricing following post-tender negotiations created a mistaken belief among clients that value for money was being achieved. It was argued that where ever quality was sacrificed in favour of cost, then true value for money would never be achieved. A process of quality assessment in tender analysis would be a step towards redressing the cost : quality : time balance.

References
Anon. (1993) September Need for a Sane Construction Industry; Chartered Surveyor Monthly, Anon, (1994) 15 September Builders' Margins Collapse. Contracts Journal, Atkinson, (1994) 5 May J. Abuses of Power, Contract Journal, Brewer, G. (1995) 23 February Come on Down....The Price is Right. Contract Journal, Department of the Environment, (1992)Value for Money in New-Build Housing HMSO Latham, Sir M. (1994) Constructing The Team, HMSO NJCC, (1985) Code of Procedure for Selective Tendering for Design and Build, NJCC, (1989)Code of Procedure for Single Stage Selective Tendering, NJCC, (1994)Code of Procedure for Two Stage Selective Tendering, Seeley, I H. (1984) Quantity Surveying Practice, Turner, D F. (1979) Quantity Surveying Practice and Administration. Second Ed, George _Godwin Limited.