The bidding behavior of contractors in private and public sector construction projects

Abstract

This study investigates the behavior of contractors when submitting bids under different institutional arrangements. Construction projects under the private and public sectors in Hong Kong operate under two distinct contractual and bidding arrangements giving different degrees of risk and uncertainty to the contractors. First, private sector projects in Hong Kong invariably adopt conditions of contracts that shift more risk to the contractor. A typical example is private sector projects do not normally allow fluctuation adjustments, thereby shifting the risks of future increase in prices of construction resources to the contractor. Public sector construction projects include fluctuation clauses for projects of duration over 21 months (Later extended to all contracts via Circular DEVB(PS)107/3 dated 18 July 2008). Second, it is common practice for private sector clients to negotiate with the contractors after they have submitted their bids. Although in some cases, private sector clients may also simply accept the lowest tender, bidders would normally anticipate that they are likely to negotiate with them after the bids are opened. This practice, however, is not allowed in public sector projects. For reasons of public accountability, Government tendering procedures do not allow changes to the bid price after the tenders have been submitted and the time for return lapsed (except for specifically approved cases). This requirement basically bars any price negotiation as in the case of private projects. We conjecture that these two differences in institutional arrangements have significant impact on bidders’ behavior, which would be characterized by the distribution and pattern of the submitted bid prices.

Based on records of bid prices for 105 contracts tendered during the period 1997 and 2007, we found that public sector bids are more skewed to the left (or have a longer tail towards the left) than private sector bids, ceteris paribus. This means that low bids for public sector projects are more scattered than those of private sector projects. This result is consistent with the hypothesis that bidders attempt to hide their true bid prices by submitting higher bids when the client is not bound to accept the lowest tender.

The empirical results also suggest that the bid-spread, as defined by the percentage difference between the lowest and second lowest bid, is higher when post tender negotiation is prohibited. Bidders would tend to submit more aggressive bids for public sector projects, knowing that they would not have a second chance to adjust their bid prices at a later stage. This suggests a higher probability of winner’s curse for public sector projects.

For private sector projects that do not include fluctuation clauses, the bid-spread is also affected by the expected risk of future increase in the prices of construction resources. When such risk is high, bidders will become more cautious when submitting their bids and thus resulting in a lower bid-spread.

The bid distributions for public sector project have thicker tails on both ends compared to those of private sector projects due to its prequalification system and the practice of acceptance of the lowest bid. The empirical evidence in this study confirms this. In addition, market conditions, number of bidders, contract size and the proportion of prime cost and provisional sum as a percentage of the contract sum are also important determining factors of biding behavior.

The results of this study show that institutional arrangements matters in determining bidding behavior. Previous studies that attempt to estimate the distribution of bid prices for construction projects have largely ignored the importance of institutional arrangements, which may therefore lead to biased results. The results of this study contribute to our understanding of bidder’s behavior when bidding for construction projects under different institutional arrangements. The understanding will be useful in handling bidding exercises for new construction projects and the advancement of studies on bidding strategy models.