1

Appendix 2: Bid Evaluation and Contract Award Systems.

Overview: To develop an understanding of the alternative bidding

and contract award systems used internationally, and their relative advantages.

Summary: A2.1. Introduction

A2.2. Bidding Strategies

A2.3. Relative Merits of Alternative Contract Selection Methods.

2

A2.1 Introduction

Two basic methods of contractor selection:

competitive bidding

negotiation

Other methods are variationsor a hybrid in between.

lowest bid wins

Price negotiated withselected contractor

For example, other methods designed to overcome shortcomings of two extremes include:

• negotiation with low bidder;• invitation for bids from pre-qualified/pre-selected group.

3

Basic types of contract award systems:

1. competitive low-bidding (sealed submissions);2. competitive average bidding (sealed submissions);3. competitive bidding based on price and other

factors (possibly sealed);4. competitive negotiated bidding (possibly sealed);5. non-competitive negotiated bidding (unsealed

submissions).

4

1: Competitive Low-Bidding:

1. The qualified bidder who submits the lowest bid wins;

2. Most widely used method;3. Purpose is to obtain lowest possible price;

5

2: Competitive Average Bidding:1. Based on the principle that the best bid is that nearest to the

average, not the lowest;2. Lowest is considered to be under-priced (problems);3. Termed “European methods”, and derived from the “Danish”

system:• lowest and highest bids are rejected;• NewAverage = (NewLow + 4xNewAverage + NewHigh)/6• the first bid above this value wins;• there are many variations on this, for example:

– Italy: nearest to average of all bids;– Korea: reject low and high, then nearest to

average of all bids;– Pakistan: lowest within 80% of engineers

estimate;– Peru: bids 10% of average are rejected, then the nearest bid above new average wins.

6

These methods are designed to:• avoid contractor failure; and• reduce disputes and claims;

7

Determine the winner from the following bids:

Bidder A: $15,760,000Bidder B: $16,093,000Bidder C: $15,505,000Bidder D: $17,990,000Bidder E: $14,120,000Bidder F: $15,980,000Bidder G: $15,400,000Bidder H: $12,885,000

For:1. Danish method2. Italian method3. Korean method4. Pakistani method (Engineer’s estimate = $17,600,000)5. Peruvian method

8

3: Competitive Bidding Based on Price and Other Factors:

1. Multi-Parameter Bidding Method:• cost + others;• time to complete;• quality (measured by materials used for example);• safety record;• etc…

2. Evaluated Total Cost Method:• The project is awarded to the bidder offering the lowest

total project cost, including:– construction price;– overhead to the owner (function of project duration);

3. Subjective Rating Method:• based on (1) technical proposal and (2) price proposal.

9

4: Competitive Negotiated Bidding:

1. Request For Proposal Method (RFP):• proposals accepted from pre-qualified teams;

2. Request for Qualification Method:• a method for pre-qualifying bidders prior to issuance of

an RFP.

5: Non-Competitive Negotiated Bidding:

Enter into negotiation with a single/sole source.

10

A2.2 Bidding StrategiesThe optimal bid price is a function of:

1. Probability of winning at the bid price2. Profit we will make at the bid price

The product of these two factors is the expected profit (that is, the average profit we would make bidding at this price over many similar projects)

Typically, will go for maximum expected profit, as it maximizes profit over many projects.

11

Probability of Winning against One Competitior

0

0.2

0.4

0.6

0.8

1

1.2

Series1

Assume 1 competitor, equally likely to bid between$55M (giving $0 profit) and $65M (giving $10M profit).

First, consider the lowest bidder wins approach:

12

Expected profit

0

0.5

1

1.5

2

2.5

3

bid value

exp

ecte

d p

rofit

($M

)

Expected profit

Expected profit for different bid values, for one competitor.

13

Probabilities of Winning for Different Numbers of Competitors

0

0.2

0.4

0.6

0.8

1

1.2

bid price

pro

bab

ility

of

win

nin

g

1 competitior

2 competitors

3 competitiors

4 competitors

5 competitors

Range of 1 to 5 competitors, equally likely to bid between$55M (giving $0 profit) and $65M (giving $10M profit).

14

Expected profit for different bid values, for multiple competitors.

Expected Profit (multiple competitors)

0

0.5

1

1.5

2

2.5

3

1 competitor

2 competitors

3 competitors

4 competitors

5 competitorsExp

ecte

d pr

ofit

($M

)

Bid value

15

Probability of Winning for Average Bid Wins(many bidders)

0

0.1

0.2

0.3

0.4

0.5

bid value

pro

ba

bili

ty

Series1

Assume multiple competitors, equally likely to bid between$55M (giving $0 profit) and $65M (giving $10M profit).

Next, consider the average bidder wins approach:

16

Expected Profit for Average Bid Wins(multiple bidders)

0

0.5

1

1.5

2

2.5

Bid value

Ex

pe

cte

d p

rofi

t ($

M)

Series1

Note, curve is slightly skewed, making it worthwhile bidding slightly above what you believe will be the average.

Expected profit for different bid values, for multiple competitors.

17

A2.3 Relative Merits of Alternative Contract Selection Systems

1: Competitive Low-Bidding:

Advantages:• Saves owner (client) money on price of work;

Disadvantages:• promotes inferior quality work;• furthers adversarial relationships;• can cause delays to progress through disputes;• more likely to lead to failure of contractor;• above problems more likely with an increase in the number of

bidders increases (more likely to select a bidder that has made a mistake);

• can increase overall cost of the project;• prone to corruption via collusion (notable in certain countries);• excludes contractor from design stage;

18

2: Competitive Average-Bidding:

Advantages:• avoids unrealistically low bids and bids with gross mistakes;

Disadvantages:• does not necessarily provide the best realistic price;• contractors could still cut corners;• the success of this approach also requires general contractors to

select their subcontractors using the average bid method (otherwise still get low quality work and adversarial relationships forming);

• collusion is still possible;• in some countries, watch out for companies setting up dummy

companies that bid similar prices to the affiliated company, pulling the average price towards this value - if a dummy company wins, it asses the job to the affiliated company;