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FACTORS AFFECTING THE CONTRACTORS MARK-UP SIZE DECISION IN
MALAYSIA
TEY KIM HAI
A project report submitted in partial fulfillment of the
requirements for the award of the degree of
Master of Science (Construction Management)
Faculty of Civil Engineering
Universiti Teknologi Malaysia
JUNE 2009
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To my beloved parent, siblings, and friends
Thanks for your never ending love and support
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iv
ACKNOWLEDGEMENTS
First of all, I would like to express my sincere appreciation to my project
supervisor, Assoc. Prof. Dr. Aminah Md Yusof for her generous advice, patience,
guidance and encouragement throughout the duration of my dissertation.
Secondly, I would like to express my gratitude to all participated contractors,
who generously spent their precious time to participate in the questionnaire survey
of this project. Their honest information, opinions and comments are very useful
indeed.
Furthermore, I would also like to express my sincere thanks to my senior and
friends, who has given me a lot of guidance and advice on this project.
Finally, I am most thankful to my parents and family for their continuous
support and encouragement given to me unconditionally in completing this
dissertation. Without the contribution of all those mentioned above, this work would
not have been possible.
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ABSTRACT
Construction industry is a competitive industry and the only possible way for
a contractor to survive is by winning the tenders and making profit. Therefore, a
right mark-up size is essential for contractor which to maximum possible profit, at
the same time keeping its bid at a competitive level. Hence possessing a sound
knowledge of the factors affecting the contractors mark-up size decision is
imperative in identifying the right mark-up size in bidding. Thus, this project is to
investigate the factors affecting the mark-up size decision. It seeks to determine the
factors affecting the mark-up size decision and analyzes the perceived importance of
various factors in different contractor sizes evaluation. The project extent
investigates on the current practices in contractors mark-up size decision.
Questionnaire conducted and distributed to the respondents who are the medium and
large-size of contractors in Johor Bahru, Malaysia. This finding of project shows
that there are top ten important factors affecting mark-up size decision such as
overall economy, competition, need for work, size of project, project cash flow, and
so on. Besides, the ranking of most influence category of factor were followed by
project characteristics, company characteristics, economic situation, project
documentation and bidding situation. Finding also indicates that the different of
perceived important of factors between medium and large-size contractors
evaluation. Seven factors which are degree of difficulty, uncertainly in cost estimate,
need for work, availability of qualified staff, time allowed submitting bids, bidding
document price and risk involved in investment has been highlighted. The finding
shows that the most preference mark-up size is 10 % to 15%. Experience, previous
record and market survey are commonly practiced by contractors in determining
their mark-up size. Unfortunately, the bidding models were not utilized by
contractors since they are not sufficient information to effectively use it and the
complexity of these models.
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ABSTRAK
Industri pembinaan adalah industri yang sangat kompetetif dan satu cara
untuk berjuang terus bertapak dalam industri tersebut adalah mendapatkan tender
dan memaksimakan keuntungan. Saiz mark-up yang sesuai adalah penting untuk
menjaminkan keuntungan yang maksimum dan kompetetif. Shash and Abul-Hani
(1992) menekankan bahawa pengetahuan mengenai faktor mempengaruhi keputusan
saiz mark-up kontraktor adalah sangat mustahak untuk menentukan saiz mark-
up yang sesuai. Kajian ini akan mengenalpasti faktor-faktor yang mempengaruhi
keputusan saiz mark-up dan menganalisa kepentingan faktor-faktor dalam
penilaian mengikut perspektif kontraktor yang berlainan. Penyelidikan ini juga
menganalisa amalan semasa bagi kontraktor dalam menentukan keputusan saiz
mark-up. Soalan penyelidikan ini diagihkan kepada responden iaitu kontraktor
yang bersaiz sederhana dan besar di Johor Bahru, Malaysia. Keputusan penyelidikan
ini menunjukkan 10 faktor utama yang mempengaruhi harga tender seperti ekonomi,
kompetetif, keperluan kerja, saiz projek, aliran tunai projek, dan sebagainya.
Kategori yang paling berpengaruh diikuti cirri-ciri projek, ciri-ciri syarikat, situasi
ekonomi, pendokumenan projek dan situasi bidaan. Keputusan penyelidikan juga
menunjukkan kepelbagaian ketara dalam penilaian kontraktor yang berlainan saiz.
Terdapat tujuh faktor menunjukkan perbezaan yang ketara seperti tahap kesukaran,
ketidakpastian dalam anggaran kos, keperluan kerja, kakitangan yang bertauliah,
jangkamasa penyerahan tender, harga dokumen tender dan risiko dalam perlaburan.
Selain daripada itu, saiz mark-up yang biasa ditentukan oleh kontraktor adalah
10 % hingga 15%. Pengalaman, rekod terdahulu, dan penyelidikan pasaran banyak
diamalkan oleh kontraktor dalam menentukan saiz mark-up. Malangnya, model
bidaan tidak digunapakai sepenuhnya oleh kontraktor disebabkan mereka tidak
mempunyai maklumat yang mencukupi untuk melaksanakannya secara berkesan dan
kerumitan model-model tersebut.
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TABLE OF CONTENTS
CHAPTER TITLE PAGE
DECLARATION ii
DEDICATION iii
ACKNOWLEDGEMENTS iv
ABSTRACT v
ABSTRAK vi
TABLE OF CONTENTS vii
LIST OF TABLES xii
LIST OF FIGURES xiv
LIST OF APPENDICES xv
1 INTRODUCTION
1.1 Introduction 1
1.2 Statement of Problems 4
1.3 Research Aim and Objectives 6
1.4 Research Scope and Limitations 6
1.5 Research Significance 7
1.6 Research Methodology 8
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2 MARK-UP IN BIDDING SYSTEM
2.1 Introduction 11
2.2 Bidding System 122.2.1 Negotiation Bidding 132.2.2 Competitive Bidding 14
2.3 The Challenges of Competitive Bidding System 172.3.1 The Price-Cutter 18
2.3.2 The Bidding Fool 18
2.4Mark-up 192.4.1 Allowance for Overhead 202.4.2 Allowance for Contingencies 22
2.4.3 Allowance for Profit 23
2.5 The Difficulty in Determining a Mark-up Size 24
2.6 Right Mark-up Size 25
2.7 Factors Affecting the Mark-up Size Decision 26
2.7.1 Project Characteristics 30
2.7.2 Project Documentation 32
2.7.3 Company Characteristics 33
2.7.4 Bidding Situation 35
2.7.5 Economic Situation 37
2.8 Summary 39
3 BIDDING STRATEGIC IN THEORY
3.1 Introduction 40
3.2 Bidding Model 41
3.2.1 Friedmans Model 41
3.2.1.1 Bidding Strategy Objective 42
3.2.1.2 Probability of Winning 42
3.2.2 Gates Model 44
3.2.2.1 Bidding Strategy Objective 44
3.2.2.2 Lone-Bidder 45
3.2.2.3 Two-Bidder Strategy 45
3.2.2.4 Many-Bidders Strategy 45
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3.2.2.5 All-Bidders-Known Strategy 46
3.2.3 OPBID 46
3.2.4 LOMARK 48
3.2.5 Carrs Bidding Model 48
3.2.5.1 Impact of Number of Bidders 48
3.2.5.2 Competitive Bidding and Opportunity
Cost 49
3.2.6 Optimum Bid Approximation Model 49
3.2.7 Bids Considering Multiple Criteria 50
3.2.8 Winning over Key Competitors 50
3.2.9 DBID 51
3.2.10 Sequential Competitive Bidding 51
3.2.11 Self-explanatory Artificial Neural Network 52
3.2.12 Average-Bid Method Bidding Model 53
3.3 Utilization of Bidding Models 54
3.4 Summary 55
4 RESEARCH METHODOLOGY
4.1 Introduction 57
4.2 Stage 1: Preliminary Study 57
4.3 Stage 2: Data Collection 58
4.3.1 Primary Data 58
4.3.1.1 Survey Questionnaires 59
4.3.2 Secondary Data 594.4 Stage 3: Data Analysis 60
4.4.1 One-Sample t-Test 60
4.4.2 Chi-Square Test 61
4.4.3 Reliability Analysis 62
4.4.4 Mann Whitney U Test 62
4.4.5 Importance Index 63
4.5 Stage 4: Writing-up 644.6 Summary 64
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5 DATA ANALYSIS5.1 Introduction 655.2 Company Profile of Contractor 67
5.2.1 Size and Grade of Contractors Company 675.2.2 Years and Project Taken by Contractors 69
5.2.3 Type of Project Usually Undertaken By
Contractors 70
5.3 Factors Affecting the Contractors Mark-up Size Decision 71
5.3.1 Project Characteristics 71
5.3.1.1 One-sample T-Test 72
5.3.1.2 Chi-Square Test 72
5.3.2 Project Documentation 73
5.3.2.1 One-sample T-Test 73
5.3.2.2 Chi-Square Test 74
5.3.3 Company Characteristics 75
5.3.3.1 One-sample T-Test 75
5.3.3.2 Chi-Square Test 76
5.3.4 Bidding Situation 76
5.3.4.1 One-sample T-Test 77
5.3.4.2 Chi-Square Test 78
5.3.5 Economic Situation 78
5.3.5.1 One-sample T-Test 79
5.3.5.2 Chi-Square Test 79
5.3 6 Reliability Analysis 80
5.3.7 Ranking of Significant Factors That Affecting
Mark-up Size Decision 81
5.4 The Importance of the Various Factors in Medium
and Large Size Contractors Evaluation 85
5.4.1 Comparison of Factors between Medium and
Large Size Contractors 87
5.5 The Current Practice in Contractors Mark-up Size
Decision 90
5.5.1 Mark-up Size Taken By Contractors 90
5.5.1.1 Allocation of Components in Mark-up Size 91
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5.5.2 Utilization of Bidding Models in Mark-up
Size Decision. 95
5.5.3 Practices in Determining Mark-up Size Decision 96
5.5.3.1 One Sample T Test 96
5.5.3.2 Chi-Square Test 97
5.5.3.3 Reliability Analysis 98
5.5.3.4 Ranking of Practices in Determining
Mark-up Decision 98
5.5.4 Reason of Non Utilization of Bidding Models 100
5.5.4.1 One Sample T Test 100
5.5.4.2 Chi-Square Test 101
5.5.4.3 Reliability Analysis 101
5.5.4.4 Ranking of Reason for Non Utilization of
Bidding Models 102
5.6 Summary 103
6 CONCLUSION AND RECOMMENDATIONS
6.1 Introduction 1056.2 Summary of Finding 105
6.2.1 Objective No. 1 1066.2.2 Objective No. 2 1066.2.3 Objective No. 3 107
6.3 Conclusion 1086.4 Research Limitation 1086.5 Recommendations For Further Studies 1096.6 Summary 109
REFERENCES 110
APPENDICES 114
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LIST OF TABLES
TABLES TITLE PAGE
Table 2.1 Factors Affecting the Mark-up Size Decision 28
Table 5.1 Size of Contractors Company 68
Table 5.2 One Sample T-Test Result for Factors of Project
Characteristic 72
Table 5.3 Chi-Square Test Result for Factors of Project
Characteristic 73
Table 5.4 One Sample T-Test Result for Factors of Project
Documentation 74
Table 5.5 Chi-Square Test Result for Factors of Project
Documentation 74
Table 5.6 One Sample T-Test Result for Factors of Company
Characteristic 75
Table 5.7 Chi-Square Test Result for Factors of Company
Characteristic 76
Table 5.8 One Sample T-Test Result for Factors of Bidding
Situation 77
Table 5.9 Chi-Square Test Result for Factors of Bidding
Situation 78
Table 5.10 One Sample T-Test Result for Factors of Economic
Situation 79
Table 5.11 Chi-Square Test Result for Factors of Economic
Situation 80
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Table 5.12 Reliability Test Result for Remained Factors 80
Table 5.13 Ranking of Significant Factors That Affecting Mark-up
Size Decision 82
Table 5.14 Ranking on the Importance of Various Factors in Medium
and Large Contractor Sizes Evaluation 86
Table 5.15 Comparison Factors between Medium and Large Size
Contractors 87
Table 5.16 One Sample T-Test Result for Practices in Determining
Mark-up Size Decision 97
Table 5.17 Chi-Square Test Result for Practices in Determining
Mark-up Size Decision 97
Table 5.18 Reliability Test Result for Practices in Determining
Mark-up Size Decision 98
Table 5.19 Ranking of Practices in Determining Mark-up Size
Decision 99
Table 5.20 One Sample T-Test Result for Non Utilization of
Bidding Models 100
Table 5.21 Chi-Square Test Result for Non Utilization of
Bidding Models 101
Table 5.22 Reliability Test Result for Non Utilization of Bidding
Models 102
Table 5.23 Ranking of Reasons of Non Utilization of Bidding
Models 102
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xiv
LIST OF FIGURES
FIGURES TITLE PAGE
Figure 1.1 Flow Chart of Research Methodology 10
Figure 3.1 Friedmans Method of Determining the Probability
of Winning 43
Figure 3.2 Summary Flow Chart for OPBID 47
Figure 3.3 Queuing Model Representation of Flow of Limited
Resources 52
Figure 3.4 Hierarchical Structure of the Artificial Neural Network 53
Figure 5.1 Sequence of Reliability Test 67
Figure 5.2 Size and Grade of Contractors 68
Figure 5.3 Years and Projects Taken by Contractor 69
Figure 5.4 Type of Project Usually Undertaken by Contractors 70
Figure 5.5 Ranking of Significant Factors According To the Category 81
Figure 5.7 Overhead Cost with Different Mark-up Size 91
Figure 5.8 Contingencies Cost with Different Mark-up Size 92
Figure 5.9 Profit with Different Mark-up Size 93
Figure 5.10 Others Cost with Different Mark-up Size 94
Figure 5.11 Utilization of Bidding Models in Mark-up Size Decision 95
Figure 5.12 Practices in Determining Mark-up Size Decision by
Contractors 99
Figure 5.13 Reasons of Non Utilization of Bidding Models 103
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LIST OF APPENDICES
LIST TITLE PAGE
A Survey Questionnaire 114
B Confirmation Letter from Faculty 123
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CHAPTER 1
INTRODUCTION
1.1 Introduction
Construction industry covers a wide range from sub-urban homes to multi-storey
skyscrapers; from sidewalks to dam, tunnel, bridges, highway and rapid transit system
that contributes substantially to the economic growth of country. Therefore, construction
industry is an important economic sector of country and mostly contributes to 3%-6% of
overall Gross Domestic Product. (Fahlin Abdullah, 2004).
In other words, construction industry is stimulated by the economy of the country.
During economic development, it will generate additional demand for construction
activities and construction markets as incomes rise. Construction activity increases as
companies expand their existing facilities or build new premises, more dwellings are
purchased and developers and institutions invest in property. Adversely, the
development of construction industry will recess during the economic crisis and
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recession. (Ofori, 1990). Therefore, construction industry will experience different
structural changes from time to time because the economy develops over time.
In Malaysia, the current economic is more challenging since the global economic
slowdowns which have been associated with the current crisis in the worlds financial
system. The current crisis start from United States as the problems in the credit industry
culminated in the bankruptcy filing of Lehman Brothers. (Levy, 2008). This
phenomenon has left the construction industry facing its toughest challenges and directly
influences the changes in the aspects of construction demands, systems of constructionmarkets, and conditions of competition. Therefore, it is clear that construction industry
in Malaysia today is entering a period of deflation.
Moreover, the rapid expansion of construction works after the economy
recovered from the mid eighties recession led to an increased number of construction
firms in the industry. Especially the implementation of Vision 2020 in 1991 was
enhancing the growth of the construction industry in Malaysia. (Fahlin Abdullah, 2004).
As at January 2008, a total of 63,465 local contractors were registered with CIDB under
various grades. (CIDB, 2008). During this recession period, the construction market will
became more competitive as the increase of construction firms at same time decrease of
construction demand.
As a result, contractors today are facing more challenges in this fiercely
competitive construction industry. Thus, the only possible way for a contractor to
survive in todays highly competitive construction market are winning tenders and
making profit. (Egemen and Mohamed, 2007). But is it possible for a contractor winning
a tender simultaneously making a good profit? It is another new challenges for
contractors since the widely uses of particular bidding method in construction industry,
its competitive bidding.
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In construction industry, there are two ways through which a contractor may be
awarded a construction project, negotiation with an owner or competitive bidding.
Nowadays, the construction industry becomes more competitive and low profit margin
has great influenced by the widely uses of competitive bidding. Under the competitive
bidding, the clients professional advisers will invite the contractors to submit tenders
for the clients proposed development through the advertisement in the local, national
and technical press. As a result, stack of the interested contractors will participant in the
tender and increase the competitive in getting a job of the contractor. (Clough and Sears,
1994).
Besides, competitive bidding also influences the contractors profit margin due to
the fierce competitive among the contractors in getting a job. According to Shash &
Abul-Hani (1992) and Mohammed & Hong (2002), competitive bidding for construction
projects usually awarded to the lowest responsible bidder. During this recession period,
the lowest bidding prices are driven down by the competitive pressures. (Park, 1979). As
a result, the contractors are forced to reduce their profit margin in bidding and tried to
bid the project as low as possible to getting a job.
In this highly competitive construction business only the strong would survive.
In such situation, contractors are forced to develop a strategy which can improve their
competitiveness. (Shash and Abul-Hani, 1992). Park (1979) stated that even a bad plan
is better than no plan at all. Thus, contractors are encouraged to setting a right mark-up
as the common bidding strategies. This is because a right mark-up plays important role
in competitive bidding in term to maximize the possible profit, at the same time keeping
its bid at a competitive level. (Clough and Sears, 1994). As a result, a right mark-up size
is able enhances the probability of the contractors to winning a tender, yet maximizes
possible profit for the job.
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However, how to determine the right mark-up size is not an easy task. The
complexity of the issue is magnified by many influencing factors and the uncertain
potential outcome of decision. This complexity is the source of the difficulty faced by
many contractors in determining the right mark-up sizes which will assure them of
winning sufficient projects with reasonable profits. (Shash and Abul-Hani, 1992).
1.2 Statement of Problems
In bidding process, the contractors are facing the two crucial decisions. The first
is the decision of whether to bid or not to bid for a project, when an invitation has been
received. If yes, the second decision is associated with the determination of the mark-up
size. The mark-up size may vary from 5 to more than 20 percent of the job cost and
represents an allowance for profit plus other items such as general overhead and
contingency. However, to determine the mark-up size is not an easy task because it is
affecting the probability of getting a job and its chances of making a reasonable profit.
(Clough and Sears, 1994).
In determining a mark-up size, the contractor is facing two seemingly
incompatible and contradictory objectives. He must bid high enough to make a profit yet
low enough to get a job at the same time. It is difficult for a contractor to balance
between both at the same time because a bid low enough to assure getting a job will
invariably is too low to guarantee a profit. On the other hand, a bid high enough to
assure an adequate profit margin usually has only a remote chance of winning the job.
(Park, 1979)
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According to Egemen and Mohamed (2007), right mark-up is the optimum
balance between a bid price that is as practically low as possible to win the tender and
as practically high as possible to maximize profit. But is it possible for contractor to
balance between both at the same time? These unpleasant alternatives place the
contractor in an extremely awkward position.
Since the mid-1950 years, many researchers have tried to eradicate the difficulty
by developing mathematical models as bidding strategy to determine the right mark-up
size. The two best-known and most widely accepted of these bidding strategies areknown as the Friedman Model and the Gates Model. (Clough and Sears, 1994).
However, the utilization of these mathematical models is not widely spread among
contractors to aid them in determining the proper mark-up size while the majority uses
subjective judgment. (Ahmed and Minkharah, 1988).
As discussed in earlier, the determination of the right mark-up is an essential task
of all contractors. However, is it possible to determine the right mark-up that will help
the contractor winning the bidding and at the same time maximize his profit? Neither
mathematical models nor pure subjective judgment proved to be the answer to this
difficult question.
Contractors need to use a more rational way to determine their mark-ups. This
way of thinking is essential for all contractors because the awarding system depends
basically on the lowest bidder criterion. Thus possessing a sound knowledge of the
factors affecting the contractors mark-up size decision is imperative in identifying the
right mark-up size in bidding. (Shash and Abul-Hani, 1992). Hence study should be
carried out to investigate what are the factors affecting the contractors mark-up size
decision.
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1.3 Research Aim and Objectives
This study aims at statistically investigate factors affecting the contractors mark-
up size decision in Malaysia. To achieve the aims, the following objectives are
formulated:
Objective 1: To determine the factors affecting the mark-up size decision by
contractors.
Objective 2: To analyze the perceived importance of the various factors considered in
the mark-up size decision in different contractor sizes evaluation.
Objective 3: To investigate the current practices in contractors mark-up size decision.
1.4 Research Scopes and Limitations
As earlier research, Ahmad and Minkarah (1988) studied the method by which
contractors in the USA to determine the mark-up size. They found that contractors
consider and evaluate many factors subjectively when they decide on mark-up sizes. In
this research, they are identifying 31 factors affecting the bid mark-up decisions made
by the top general contractors in the USA. Shash and Abdul-Hadi (1992) further
developed this research and presented 37 factors affecting the bid mark-up size decision,
with their relative importance to contractors operating in Saudi Arabia. Shash (1993)
revised the questionnaire by Ahmad and Minkarah (1998) and identifying 55 potential
factors affecting in tendering decisions by top UK contractors.
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Shash and Abdul-Hadi (1993) conducted a further research regarding the effect
of contractor size on mark-up size decision in Saudi Arabia. In this study, the 37 factors
same as previous research (Shash and Abdul-Hadi, 1992) but contractor size had divided
into large, medium and small. Thus, this research is initiated to investigate vary
significant of the various factors in the different size of contractors evaluation. Dulaimi
and Hong (2002) further developed this issue which investigated impact on contractor
size on the contractors attitude to mark-up decision. They suggested that 40 factors
influencing the contractor bid mark-up decision of large and medium-size in Singapore.
The author found out that Shash and Abdul-Hadi (1993) and Dulaimi and Hong
(2002) had done the same research related to effect of contractor size on mark-up size
decision. Hence, a similar study will simultaneous conducted by author in Malaysia.
Study wills extent the existing research by investigating into the factors affecting the
contractors mark-up size decision in Malaysia. The scope of this research by is limited
to the medium and large-size contractors in Johor Bahru, Malaysia. Also, emphasis is
given to the competitive bidding method and traditional procurement method in
construction contracting.
1.5 Research Significance
i. Guide contractors to focus their attention on the most important factors thataffecting the mark-up size decision.
ii. Help contractors to enhance their chances of assigning the right mark-up size tothe right job.
iii. Sets the foundation for the development of an expert system that will help acontractor decide on how much mark-up to add his cost estimate.
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1.6 Research Methodology
a) Preliminary Study
This stage includes observations on the current issues and problems on
construction industry. This was done by analysis of documents from various sources
such as text books, journals, electronic media, internet, reports, conference papers and
previous research. Discussion with the lecturers, senior and classmate also carried out ina purpose to gain a better understanding of the issues and problems to be studied. As a
result, the researcher was able to determine the topic, main issues and problems, aims,
objectives and scope of research.
b) Data Collection
This stage includes utilizing the questionnaires to collect the primary data. The
questionnaire will be design which aim to investigate the different factors affecting the
mark-up size decision and sent to medium and large-size contractors in local
construction industry. Besides, the secondary data was gathered from books, journals,
reports, articles, thesis, conference papers and internet.
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c) Data Analysis
All of the data collected will be analyzed using computer software such as
Statistical Package of the Social Sciences (SPSS). Analysis methods will be determined
according to the suitability of each variable. Among the methods to be used are such as
One-sample t-test, Chi-square test, Mann-whithey test, and so forth. As a result, the
research objectives were presented in the form of graphs, charts and tables.
d) Writing-up
This stage includes the process of documentation together with summaries,
conclusion, and some future research recommendations relevant to this topic.
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First Stage
Second Stage
Third Stage
Final Stage
Figure 1.1: Flow Chart of Research Methodology
Literature Review
Determine Research Topic
Determine Research Aim and Ob ectives
Data Analysis
Data Compilation
Summaries, Conclusion and Recommendations
Data Interpretation
BooksJournals Internal Sources
LecturersSeniorsClassmates
Determine the Research Scopes and Limitations
Preliminary Study
Discussion
Primary Data
Data Collection
Secondary Data
BooksJournalThesisSeminar PapersNewspapers Internet
QuestionnaireDifferent Size of
Contractors
Significance Index
Anal sisReliability Test
Documentation
Writing-Up
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CHAPTER 2
MARK-UP IN BIDDING SYSTEM
2.1 Introduction
There are two methods for contractor obtaining the job; negotiation with an
owner or competitive bidding. Competitive bidding method is more challenging for
contractor because it promotes the competitive and lowest possible profit. Furthermore,
there is no remedy for the rejected bidder to recover its lost profits in competitive
bidding law. (Cementeh, Inc. vs Fairlawn, 2006). Thus the only possible way for a
contractor to survive in highly competitive constructions market is to win the tenders
and making profit. (Egemen and Mohamed, 2007).
However, it is not easy for contractor to win a tender simultaneously making a
fair profit. If the contractor bids low enough and get the job yet he cannot make a fair
profit. On the other hand, if he bids high enough to make a fair profit but he may not be
able to get a job. These unpleasant alternatives place the contractor in an extremely
awkward position.
[Cementech, Inc. vs. Fairlawn, 109 Ohio St.3d 475, 2006-Ohio-2991.]
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Therefore, a right mark-up sizes which assure the win of project with
reasonable profits are concerned by contractor. (Shash and Abdul-Hadi , 1993). Besides,
it is important for the contractor to identify all factors affecting his mark-up size
decision because they will improve the chances of applying and determining the right
mark-up to the right project. (Abdul-Hadi, 1990).
This chapter will look into detail the mark-up in bidding system. There are
several topics that will be discussed in this chapter, including the bidding system, the
challenges of competitive bidding, right mark-up size and factors affecting the mark-up size decision. This discussion will begin with bidding system in following section.
2.2 Bidding System
Bidding is the usual mode of contractor in accomplishing construction work and
enters into a contract with the owner. The contract will describes in detail the nature of
the construction to be accomplished and the services that are to be performed. Therefore,
the contractor is obligated to perform the work in full accordance with the contract
documents, and the owner is required to pay the contractor as agreed. Bidding forms the
preliminary stage in the formation of the contract. Different approaches to bidding have
been practiced in construction. Despite the regulations imposed by authorities, there are
two ways in which the bidding is practiced.
In bidding system, there are two ways which a contractor may be awarded a
construction project; negotiation with an owner or competitive bidding (Clough and
Sears, 1994) and this will be followed by a discussion of different types of bidding.
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2.2.1 Negotiation Bidding
Negotiation bidding is a contract to be negotiated with a single contractor
nominated by the client instead of the competitive tendering. This may be done using
bills of quantities or schedules of rates which instead of the contractor pricing the tender
document on his own and submitting his tender to be accepted or rejected. In negotiation
bidding, the rates and prices are discussed and agreed until eventually a total price is
arrived at which is acceptable to both sides.
According to Clough and Sears (1994), it is common practice for a private owner
to use the negotiated bidding to hand-pick a contractor on the basis of reputation and
overall qualifications to do the job. For negotiation bidding, it is divided into the single-
stage negotiation and two-stage negotiation.
i. Single-stage Negotiation
In single-stage negotiation process, the negotiation usually will be conducted
between the contractors senior estimator and the PQS (either a partner, associate or
senior assistant). To facilitate the procedure, one party will usually price the tender
document first of all, to provide a basis for the negotiation. On the other hand, the other
party will then go through the rates and prices. When agreement on the whole is reached,
a contract will be entered into between the client and the contractor. (Ramus, 1981).
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ii. Two-stage Negotiation
The two-stage negotiation process has involves both competitive stage and
negotiation stage. In the first (competitive) stage, tenderers are informed of the second
stage intention and are asked to submit tender. During this stage, discussions with each
of the tenderers may be conducted in order to elucidate their proposals and to enable the
contractors to make suggestions with regard to design and/or construction methods.
Having selected a contractor at the end of the competition stage, negotiation will follow
on the basis of a detailed tender document, as in single stage negotiation. Again, whenagreement is reached on the whole, the parties will enter into a contract for the
construction work. (Ramus, 1981)
Two-stage negotiation is the method normally used to select a contractor to carry
out a management contract, in which the general contractor does little or none of the
construction work himself but organizes sub-contractors to do the work instead (Ramus,
1981)
2.2.2 Competitive Bidding
In the construction industry, competitive bidding is traditional and is widely used.
This bidding method is normally awarded to the lowest responsible bidder and it is
designed to promote competition in an attempt to ensure the lowest price for the project.
In other words, competitive bidding is used to encourage efficiency and innovation by
the participating contractors, thereby providing the owner with a constructed project of
specified quality at the lowest possible price. (Clough and Sears, 1994).
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A contractor knows that lowering a bid price increases the probability of being
awarded the project. Therefore, they are trying to reduce their profit margin thereby to
increase their competitiveness. As a result, this phenomenon will cause the fiercely
competitive among contractors and lowest possible profit margin of contractors.
It has two different types of competitive bidding are used such as open tendering
and selective tendering. (Ramus, 1981)
i. Open Tendering
Open tendering is initiated by the clients architect or quantity surveyor
advertising in local newspapers and/or the technical press. They are inviting contractors
to apply for tender documents and to tender in competition for carrying out the work.
Usually a deposit is required in order to discourage frivolous applications, the deposit
being returnable on the submission of a bona fide tender. (Ramus, 1981). Nonetheless,
the deposit is no longer practiced in government project in Malaysia.
In open tendering, an opportunity is provided to more participating contractors
and it secure maximum benefit from competition. For advantages, the open tendering
gives the opportunity of a capable firm to submit a tender which might not be included
on a selected list. However, there is a danger that the lowest tender may be submitted by
a firm inexperienced in preparing tenders (particularly if bills of quantities are used) and
whose tender is only lowest as a consequence of having made the most or the largest
errors.
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In addition, there is no guarantee that the lowest tenderer in open tendering is
sufficiently capable or financially stable. Although obtaining references will provide
some safeguard, there may be little time in which to do so. As a result, the total cost of
tendering is increased as all the tenderers will have to recoup their costs eventually
through those tenders which are successful. The result can only be an increase in the
general level of construction costs. (Ramus, 1981)
ii. Selective Tendering
Under selective tendering, a short list is drawn up of contractors who are
considered to be suitable to carry out the proposed project. In the latter case the
contractors may be invited, through suitably-worded advertisements in the press, to
apply to be considered for inclusion in the tender list. The selective tendering gives the
client the opportunity to exclude any firms thought to be unsuitable and to limit the
number of tenderers. At the same time, it gives any firm the opportunity to apply for the
purpose to be considered for the project.
Ramus (1981) recommended that the number of tenderers should be limited
between five and eight, depending on the size of the contract. The tenderers on the list
are reputable, well-established and suitable for the proposed work. The selective
tendering ensures that only capable and approved firms submit tenders. Also, it tends to
reduce the aggregate cost of tendering. In selective tendering, the absence of competition
usually results in a higher price for the project. Therefore, the cost level of the tenders
received will be higher, due to being less competition and also to the higher caliber of
the tenderers. (Ramus, 1981)
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As discussed in earlier, the competitive bidding is designed to promote
competition in an attempt ensure the lowest price for the project. For this reason, it is
more challenge for contractors dealing if compared to the negotiation bidding. In this
research, we are focus to the situation and environment of competitive bidding. To gave
more understand about it, we will further discuss the challenges of the competitive
bidding system in next sections.
2.3 The Challenges of Competitive Bidding System
Major construction work is obtained through competitive bidding. This practice
has been generally criticized by many contractors as the basic challenges of the
construction industry. The competitive bidding is characterized as highly competitive
and lowest profit margin. If the contractor bids low enough and get the job yet he cannot
make a fair profit. On the other hand, if he bids high enough to make a fair profit but he
may not be able to get a job. These unpleasant alternatives place the contractor in an
extremely awkward position. Under these conditions there is little wonder that profit
margins are low in construction contracting if the contractors are sacrificing their profit
margin to win the bidding.
The most challenge in competitive bidding is the degree and type of competition
brought about by the contractors themselves which affecting profits margin in the
competition. There are two kinds of contractors who probably do more harm to the
industry than any other. These are (1) the price-cutter and (2) the bidding fool. (Park,
1979). Each is illustrated further in the following sub-section.
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2.3.1 The Price-Cutter
According to Park (1979), the impact of the low-mark-up cause the millions of
dollars in profits sacrificed each year. The price-cutter can be defined as a job taken at a
price closely approaching the direct job cost and not benefits. The contractor who gets
the job makes nothing at his minimal price, and those who bid the job without getting
the additional costs are synonym to preparing the unsuccessful bids. The effect on the
construction industry as a whole is worse than if the jobs were never offered in so low
bid prices, for it results only in additional costs with no compensating profits. (Park,1979). This phenomenon affects the competitiveness among the bidders and it is
impossible mission of contractor to tendering the project with compensating profits.
2.3.2 The Bidding Fool
The bidding fool is contractors who feel obligated to bid every job. Such
situation will contributed to the profit squeeze by increasing the intensity of competition
on each job they bid, thereby lowering the price at which the job is finally let. It is not
only possible, but often happens, that as total construction volume increases and the
number of contractor decreases, competition becomes even more intense than before.
(Park, 1979).
Only the average numbers of bids per job need increase to bring about this
situation, the result of each contractor increasing the number of bids he submits. The
intensity of competition encountered on a job depends solely on the number of bids on
that one job, not on the total number of contractors in business. (Park, 1979). As a result,
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this phenomenon affects the competitiveness among the bidders due to solely on the
number of bids.
As mentioned in this section, its very challenging of the competitive bidding
system in construction industry. To be competent in this fiercely competitive, the
contractor must dealing with the mark-up that determined the success or failure of
bidding. (Adrian, 1982). Thus, next section discusses mark-up in detail.
2.4 Mark-up
During the estimating process, a contractors estimating staff is responsibility to
establish the direct costs which represent the largest cost component of the project. The
direct costs were including the job-site labor costs, equipment costs and temporary or
put-in-place materials costs. (Adrian, 1982). Then the mark-up will be added to the
estimated direct cost of construction at the close of the estimating process. (Clough and
Sears, 1994).
The definition of mark-up is an amount added to the cost price to determine the
selling price. Also, the amount added by a seller to the cost of a commodity to cover
expenses and profit in fixing the selling price. In construction industry, the mark-up
added in term to bidding a project contract. The mark-up size is representing the
different between his winning or losing the project contract in the competitive bidding
procedure. (Adrian, 1982).
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According to Clough and Sears (1994), the mark-up is customarily determined as
a percentage of the cost and it may vary from 5 to more than 20 percent of the job cost.
The mark-up usually contains three elements; an allowance for company overheads, an
allowance for contingencies and an allowance for profit. (McCaffer and Baldwin, 1984).
Mark-up = Overheads + Contingencies + Profit
2.4.1 Allowances for Overhead
Most overhead costs relate generally to the firms overall operations rather than
to specific jobs or work functions. A portion of overhead costs will be relatively stable
and other overheads may vary according to the firms capacity to do business, the
amount of work bid, or the sales volume achieved. And still other overheads can be
related to the combination of two or more different factors.
Overhead costs are largely independent of the amount of work actually done or
the total sales volume actually achieved. The amount of overhead cost incurred is
determined by the decisions of management; these costs are then accumulated with time,
according to the obligations that management has established. (Park, 1979).
Overhead costs may be defined generally as all costs incurred by the contractor
that cannot be attributed directly to specific functions; these usually include all costs
other than direct labor, materials, and equipment. According to Park (1979), overhead
costs fall into two categories:
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1. Job overheads or indirect expenses.
2. General overheads.
i. Job Overheads or Indirect Expenses
Job overheads are the indirect expenses that are caused directly by individual
jobs, but are not directly chargeable against any specific phase of the work. These job
overheads typically include items such as welfare fund payments, apprentice training,
social security, workmens compensation, unemployment taxes, miscellaneous payroll
related expenses, surety bonds, direct supervision, building permits, tool and equipment
expenses, temporary buildings and enclosures, sanitary facilities, utilities, sales taxes,
and many others.
Job overheads can be handled in different ways. Many contractors add job
overheads to their estimates as some percentage of the estimated direct job costs. For
contractors who perform essentially the same type of work all the time, and who
maintain a stable work load, this method is generally satisfactory.
However, most contractors are confronted by varying workloads and different
types of jobs, and a percentage add-on simply adds another element of uncertainty to the
job. As long as costs can be identified and attributed directly to certain jobs, these job
overheads should be estimated with the same care and accuracy as the other direct job
costs and included as such in the bid. (Park, 1979).
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ii. General Overheads
General overhead expenses are those which cannot be charged directly to a
single job. These include the costs of maintaining an office or shop, such as rent,
telephone and other utilities, property taxes, interest, insurance, salaries of office
personnel (such as secretaries, bookkeepers, and estimators), association dues, sales and
promotion expenses, office supplies, depreciation and management salaries.
Most of these general overhead costs must be paid regardless of the amount of
work done or contracts received, although their magnitude may vary somewhat with the
amount of business done or with the number and size of the contracts. Such expenses are
continuous and can be controlled only through managements decisions to curtail them.
General overhead costs can be either fixed or variable in nature. In general, the
fixed elements of overhead involve the resources for obtaining, or trying to obtain, jobs.
The variable or semi-variable elements are related to the actual amount of work that the
firm either gets or tries to get. (Park, 1979).
2.4.2 Allowances for Contingencies
In construction industry, contractors are required to assess cost and price of a
product before production and this process involves high risks due to the uncertainties of
the national construction market, the national and international economies, the weather,
ground conditions, and so on. (Kwakye, 1994). When the assessemnt places the risk of
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the uncertainties entirely on the contractor, consideration must be given to the
inclusion of a contigency allowance in the mark-up amount to be included in the bid.
(Clough and Sears, 1994).
Contingency is an amount added to an estimate to allow for additional costs for
the uncertainities thing. Contingecy cost cover the costs that may result from
incomplete design, unforeseen and unpredictable conditions, or uncertainties within the
defined project scope. The disccusion of allowances for profit will be discussed in next
sections.
2.4.3 Allowances for Profit
The profit in a job bid represents the minimum acceptable return on the
contractors investment. Profit more linked with the risk and uncertainty. Typically, the
more risk there is in a business venture or industry, the higher the potential profit. In
construction industry, the contractor is asked to take a significant risk so that his profit
margin should be relatively high. However, this potential is tempered by the relatively
fierce competition that exists between contractors. As an industry approaches perfect
competition, the potential profit margin of the industry diminishes. (Adrian, 1982).
As mentioned in earlier, the mark-up are consists of the overhead cost,
contingencies cost and profit. But it is difficult to balance each other element of mark-up
in order to determine a right or appropriate mark-up size. Therefore, the difficulty in
determining a mark-up size is going to be discussed in next section.
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2.5 The Difficulty in Determining a Mark-up Size
According to Park (1979), overhead costs and contingencies cost as the cost for
some contractors feel can be reduced and simply reducing their prices on jobs. This
thought is a dangerous illusion because as these costs reduced, they are reducing the
price bid for a job cuts profit, not overhead and contingencies costs. (Park, 1979).
That mean, overhead and contingencies cost are inevitable to changes thus onlyprofit margin will first considered changes in mark-up size. In other words, change of
mark-up size is the major factor affecting the profit margin of contractor. As we know
that the objective of contractors is to maximize the profit margin as the return of their
investment. (Clough and Sears, 1994). This scenario places the contractors in the
dilemma situation which change the mark-up size in order to change profit margin which
contrary their objective.
A contractor can increase his mark-up size but by doing this the contractor is
minimizing his chances of being the lowest bidder. On the extreme, the contractor can
minimize his mark-up size so that his chances to win are maximized; however, this
situation may and will cause loss which is not the objective of the contractor. (Abdul-
Hadi, 1990). That means if the contractor includes too large profit, the bid may not
qualify to win the project. On the other hand, if he/she includes too low profit in his bid
to ensure winning the contract, this may be unprofitable which actual costs may exceed
the contractors estimated costs to the extent that they exceed his profit. Such a situation
would result in the contractor losing money on the project. (Adrian, 1982).
Under these conditions, it seems that contractors are faced with two extremely
unpleasant alternatives: (1) an excellent chance of making no profit with a low bid, or (2)
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no chance at all of making a high profit with a high bid.These unpleasant alternatives
place the contractor in an extremely awkward position. (Park, 1979). Therefore, the
contractor should make a trade-off between the mark-up size and the probability of
winning the contract. (Abdul-Hadi, 1990). This will be followed by a discussion of the
right mark-up size in next section.
2.6 Right Mark-up Size
According to Egemen and Mohamed (2007), a contractor who intends to survive
in this competitive construction business is competent to making a right mark-up size
in their bidding. Without right mark-ups, selecting right projects will be
meaningless. (Egemen and Mohamed, 2007). That mean the mark-up size which
profitability are important in bidding whatever projects are selected. Therefore, right
mark-up size was very important in bidding in term of profitability at the same time high
competitiveness. (Clough and Sears, 1994). There are many explanation and definition
of the right mark-up size as discuss below:
Egemen and Mohamed (2007) explain that right mark-up size is the optimum
balance between a bid price that is as practically low as possible to win the tender and
as practically high as possible to maximize profit. Park (1979) determines the right
mark-up size is the result in the highest possible profit obtainable under the existing
competitive situation.
According to Clough and Sears (1994), right mark-up size is potential to
maximum possible profit, at the same time keeping its bid at a competitive level. Shash
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and Abdul-Hadi (1993) said that right mark-up sizes which will assure them of
winning sufficient projects with reasonable profits.
As briefly discussed in above, all of the right mark-up size has similar
explanation and definition. It can be summary that right mark-up size is the highest
profitability in bidding at the same time under the highest competitive level. However,
determining the right mark-up size is not an easy task.
According to Abdul-Hadi (1990), if a contractor can determine and identify all
the factors that affect his mark-up, then the chances of applying the right amount of
mark-up to the right project will be much improved. Therefore, there should be
considered concern by contractor in determining the right mark-up size. Next, the factors
affecting the mark-up size is going to discusses.
2.7 Factors Affecting the Mark-up Size Decision
Ahmad and Minkarah (1988), Shash and Abdul-Hadi (1992) and Shash (1993)
suggested that at thorough investigation of the underlying factors affecting the bid mark-
up decision is essential before attempting to develop a realistic bidding strategy.
Therefore, many factors must be considered by contractors in deciding a mark-up figure,
and each can have an influence on the value chosen. The size of the project and its
complexity, its location, provisions of the contract documents, the contractors
evaluation of the risks and difficulties inherent in the work, the identity of the owner
and/or the architect-engineer, and other intangibles can have a bearing on how a
contractor marks up a particular job. (Clough and Sears, 1994).
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As earlier research, Ahmad and Minkarah (1988) identified 31 factors affecting
the bid mark-up decisions made by the top general contractors in the USA. Shash and
Abdul-Hadi (1992) further developed this research and identifying 37 potential factors
affecting a contractors decision on proper mark-up size. These factors are classified into
five categories such as project characteristics, project documents, company
characteristics, bidding situation and economic situation.
Shash (1993) revised the questionnaire by Ahmad and Minkarah (1988) and
identifying 55 potential factors affecting in tendering decisions by top UK contractors.In this research, the result of 10 most important factors affecting the mark-up decision is
followed by: degree of difficulty, risk involved owing to the nature of the work, current
work load, need for work, contract conditions, anticipated value of liquidated damages,
owner/promoter client identity, past profit in similar projects, completeness of the
documents and project size.
Recently, Dulaimi and Hong (2002) suggested that 40 factors influencing the
contractor bid mark-up in Singapore. These factors have been grouped under five broad
categories describing project characteristic, project documentation, company
characteristics, bidding situation and economic environment. Table 2.1 is shows the
listing of all of the factors affecting mark-up size decision which determined by several
researchers.
Table 2.1: Factors Affecting the Mark-up Size Decision
Factors Affecting Mark-up Size DecisionShash & Abdul-Hadi Shash Dulaimi & Hong
(1992) (1993) (2002)
Project Characteristics
Size of contract/project
Project type
Duration
Project cash flow
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Type of equipments required
Location of project
Identity of owner
Degree of difficulty
Degree of hazard/safety
Job related contingency
Risk involved nature work
Job start time
Type and number supervisory person required
Project DocumentsType of contract
Completeness of documents
Contract condition
Use of nominated subcontractor
Anticipated value of liquidated damages
Contractor involved design phase
Design quality
Qualification requirements
Insurance premium
Owner special requirement
Designer (A/E)
Company Characteristics
Availability of required cash
Uncertainty in cost estimate
Confidence in work force
Strength in industry
Availability of qualified staff
Need for work
Experience in such projects
Establishing long relationship with client
Past profit in similar jobs
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General overheads
Current workload
Reliability of subcontractors
Portion subcontracted to others
Public exposure
Bidding Situation
Required bond capacity
Competition
Number of competitors
Identity of competitors
Tendering method
Tendering duration
Time allowed for submitting bids
Time of bidding (season)
Reliability of company cost estimate
Availability of other project
Risk in fluctuation in material prices
Risk in fluctuation in labour prices
Bidding document price
Prequalification requirements
Economic Situation
Risk involved in investment
Availability of equipment
Overall economy (availability of work)
Quality of available labor
Availability of labour
Rate of return
Government division requirements
Tax liabilities
Policy in economic use of building resources
Policy in production cost savings
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2.7.1 Project Characteristics
According to Shash and Abdul-Hadi (1992), project characteristics includes all
qualities that describe the project such as size, owners identity, duration, project cash
flow, type of equipment required, location, and job start time. However, it is slightly
different from Dulaimi and Hong (2002) who suggested that project characteristics has
included the degree of difficulty and degree of safety.
The size of a project is found to be the most heavily contemplated factor among
the project characteristics. It seems that the larger the size of project is, the more
attractive it is to contractors. The attractiveness of a large size project may arise from its
big contract price and long construction duration. The large project size will contribute
positively and substantially to annual business volume and al1ows sizeable monthly cash
inflows to a contractor. (Shash and Abdul-Hadi, 1992).
Besides, the project cash flow also considered heavily the mark up size decision.
Project cash flow reflects the contractors need for cash. Monthly cash inflow will help a
contractor to pay the monthly wages of the contracted imported work force and other
permanent employees. Also, the monthly inflow will increase cash availability to a
contractor giving him an economic leverage to compete for other projects. (Shash and
Abdul-Hadi, 1992). Therefore, contractors can reduce the mark-up size because they not
to rely on borrowed funds to make up the shortfall of cash flow.
The duration of a project also should be considered in the determination of a
mark-up size. Given two projects of equal value but different expected duration, the
project with the longer duration should have a higher total profit due to the time value of
money and opportunity costs. (Adrian, 1982). Also, the long construction duration will
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allow a contractor to keep his resource in revenue generating state for, at least, a period
extending over the project duration, hoping that a more prosperous economy will
emanate before the completion of the project. (Shash and Abdul-Hadi, 1992).
In addition, equipment required by a project and equipment availability also
plays a heavy role in determining the mark-up size for the project. A contractor who is
deciding on a mark-up size evaluates equipment required by the project against
equipment available in his own. In a situation where a contractors own equipment make
up a major portion of the required equipment, he may trade off high mark-up size withsetting his available equipment in a revenue generating condition. On the other hand,
this factor might have heavier weightage on the mark-up size decision in a situation
where the majority of the contractors equipment are inactive in the storage yard. (Shash
and Abdul-Hadi, 1992). Therefore, contractors need to raise the required loan to
purchase or rent the equipment required by the project. (Kwakye, 1994).
The project location also plays a heavy role in mark-up size determination. The
heavy importance is given to the project location may originate from its potential effect
on a contractors competitive strength. A contractor bidding for a project that is located
outside his business area is assumed to be in a weak competitive position. He/she has to
compete against local contractors who have already established good business
relationship with local suppliers. Also, he may have to reflect the cost of transporting
and accommodating his imported work force in his bid price. Thus, project location has
heavier influence on a contractors mark-up size decision. (Shash and Abdul-Hadi,
1992).
Moreover, the identity of client and professional advisers of project also need
considered in the determination of a mark-up size. If the contractor has had previous
dealings with the client and clients professional advisers, then he or she may be in a
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better position to predict the level of risks that may confront him or her. If experience
has shown that the client does not pay promptly and clients professional advisers are
noted for the late issue of project information or disruptive variations, the contractor
may decide to increase the project overhead costs in his mark-up size in order to mitigate
this risk. (Kwakye, 1994).
The degree of difficulty or complexity job also should be considered in the
determination of a mark-up size. (Dulaimi and Hong, 2002). If the complexity of the
project requires more technical and managerial input, contractors may consider eitheremploying or hiring consultants to undertake some of the technical and managerial
functions. In such situation, contractors will determine the high mark-up size in his bid
price. (Kwakye, 1994). Besides, the degree of safety and hazard risk also need to be
considered in determination of mark-up size. According to Smith (1986), the greater the
degree of risk and uncertainty involved in the job, the greater the profit margin that will
be expected by the management. Thus, contractors have heavier weightage on the mark-
up size decision in the highest risk of safety and hazards.
2.7.2 Project Documentation
According to Shash and Abdul-Hadi (1992), the project documentations
category constitutes all factors and characteristics of the bidding documents such as type
of contract, design quality, owner special requirements and designer (A/E). Besides,
Dulaimi and Hong (2002) suggested that the project documentation includes the type of
procurement method, completeness of document, owners special requirement, use of
nominated subcontractor, anticipated value of liquidated damages, risk in fluctuation in
materials price and percentage of insurance premium.
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In project documentation, type of contract plays an important role to determine
the mark-up size. According Shash and Abdul-Hadi (1992), the lump sum and the unit
prices contracts are usually used in competitive bidding. This type of contract is rigid
and inflexible for changes. As we know that changes are very expensive for the owner
and they usually bring extra cash to the contractor. Also, both types of contracts transfer
the construction risk from an owner to the contractor. (Shash and Abdul-Hadi., 1992).
Therefore, contractors are deciding to increase the contingencies costs in their mark-up
size in order to mitigate these risks and uncertainties.
2.7.3 Company Characteristics
Company characteristics include factors relevant to the company such as need for
work, current work load, availability of required cash, confident in work force,
reliability of subcontractors, portion subcontracted to other, and so on. (Shash and
Abdul-Hadi, 1992). However, Dulaimi and Hong (2002) suggested that company
characteristic should include the experience in similar project and established long
relationship with clients.
The current work load and the need for work are taken into account
interdependently in determining the proper mark-up size for any project. These factors
should be considered by contractor with the surrounding economic situation through the
availability of work condition. It looks as though in a depressed economy where the
availability of work is very scarce, the need for work may be considered the dominating
factor on mark-up size decision. However, in a recessive economy where a contractors
current load is low, he puts less weight on the need for work in the mark-up size
decision. The weightage of the need for work may he reduced to minimal when the
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contractors current work load is high and work is available. (Shash and Abdul-Hadi.,
1992).
In addition, availability of required cash of company also should be considered in
the mark up size decision. If the required cash is available to a contractor, he will have
the control in setting the interest rate for using the money. But, if the required cash is not
readily available, the contractor will approach a bank for a loan. In this case the interest
rate is dictated by the bank. In addition, obtaining a bank loan may freeze a contractors
short and/or long term assets that are held against the loan as collateral. (Shash andAbdul-Hadi, 1992).
The availability of qualified staff also need considered during mark-up size
decision. This factor is not considered by large and medium contractors in the
determination of the mark-up size, but for small contractors it is a major input to their
mark-up decisions. Large contractors may attract qualified staff to join their
organizations for the better pay, benefits and recognition they offer. It seems that small
contractors cannot compete with large ones in attracting qualified staff to join their firms.
Consequently, they may hire less qualified staff and recognize this in the determination
of their mark-up. (Shash and Abdul-Hadi, 1993).
The experience of a contractor in similar projects also needs to be considered in
the determination of the mark-up size. The contractors past experience may provide an
ability to foresee the project requirement more clearly which will help the contractor in
putting proper estimate, plans and schedule. (Shash and Abdul-Hadi, 1992). In such case,
the contractor can determine an optimum mark-up size with easily. However, if a
contractor inexperienced in new project, he or she will evaluate the project as risky and
therefore increase the mark-up size as a contingency cost. (Adrian, 1982).
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Moreover, confidence in work force also considered when deciding mark-up
sizes for projects. For large and medium contractors do not consider this factor when
deciding on their mark-up because they have established successful programmes for
selecting, orienting, training and motivating their expatriate work force. These
programmes may have created a sense of commitment and loyalty in the attitudes of the
work force towards the organization. On the other hand, small contractors may not have
such programmes. The absence of such programmes may have caused them to develop a
work force that could be characterized as dissatisfied and incompetent in their jobs. The
small contractors may find it is easier to make up for their level of confidence in their
work force in the mark-up size rather than seeking remedial actions. Such situationindicates that small contractors accentuate the influence of this factor on their mark-up.
(Shash and Abdul-Hadi, 1993).
Another consideration to determine the mark-up size is the past profit in similar
job. By considering past profit rates, the contractor may be able to formulate his desired
future profit rate. (Adrian, 1982). That means that the contractor can determine the best
and optimum mark-up size which maximize the possible profit and at competitive level.
Besides, establishing long relation with clients is also considered by contractors when
they want to determine the mark-up size. This factor may be taken into account to satisfy
a contractors long term business plan. (Shash and Abdul-Hadi, 1992).
2.7.4 Bidding Situation
According to Shash and Abdul-Hadi (1992), bidding situation includes all factors
operating in the awarding of contract situation. This category includes factors such as
competition, required bond capacity, time of bidding, bidding document price,
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prequalification requirements and time allowed for submitting bids. Besides, availability
of other project, identity of competitors and number of competitors also need identify in
this factor. (Dulaimi and Hong, 2002).
Competitive nature of the construction industry especially in the competitive
bidding situation should be considered by contractors when deciding the mark-up size.
According to Adrian (1982), the lowest bidder prices decreases as the number of
competitors on a project increases. In such competitive situation, contractors need to
minimize his or her mark-up size so that the chances being lowest bidder are maximized.Latter, he or she just can winning over the competitors and success biding the project.
(Abdul-Hadi, 1990).
The required bond capacity is need to be considered in the mark-up size decision.
The bond is usually in the form of cash or a bank guarantee. In any case the contractor
should commit an amount equal to the bond capacity until the expiration of the warranty
period. The commitment of cash reduces the contractors economic leverage. Therefore,
this factor may have heavier influence on a contractors mark-up size decision when
availability of cash in a contractors account is limited. (Shash and Abdul-Hadi, 1992).
Besides, the bidding document price also needs to be considered in mark-up size
determination. Project drawings and specifications are usually sold to the interested
contractors for non-refundable consideration. Only the contractor who wins the contract
is able to recover the document price given that they incorporate it as a cost item in the
bid. As we know that the amount paid for bidding documents for projects undertaken by
large and medium contractors is high enough to influence the mark-up size decision. For
small contractors, this factor has no influence on the determination of mark-up size.
(Shash and Abdul-Hadi, 1993).
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The pre-qualification requirement also needs to be considered when deciding on
their mark-up. The pre-qualification requirements may provide these contractors
valuable information in evaluating the level of competitiveness. If the pre-qualification
requirements limit the contractors who can bid for the project to a certain class or grade,
contractors may have the ability to reasonably estimate the number of bidders and their
identity. This information may help them in setting the optimum mark-up that
maximizes expected profit and the chances of winning the project. (Shash and Abdul-
Hadi, 1993).
In addition, the time allowed for the preparation of bids has a great importance in
the determination of the large contractors mark-up. It appears that large numbers of
these contractors believe that the period allowed for submitting bids is not enough to
prepare an accurate estimate. Therefore, they are aware of the likelihood of producing an
inaccurate estimate so that they consider this factor when determining their mark-up.
(Shash and Abdul-Hadi, 1993).
2.7.5 Economic situation
Shash and Abdul-Hadi (1992) and Dulaimi and Hong (2002) stated that the
economic situations category involves all economic indicators that may operate on the
project. Indicators such as overall economy, labor and equipment availability,
government regulation, risk of investment and anticipate rate of return on project are the
elements of this category.
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The overall economy is important in determining the mark-up size decision. A
study of the economic indicators will enable the contractor to forecast whether the
economy is heading toward a boom or recession. If the indications are that recession is
imminent, which may slow down construction activities, and then the contractor would
price keenly to win the contract. In such case, determination to win means lower
percentage mark-up and hence reduced profit margin. (Kwakye, 1994).
In addition, anticipate rate of return on project also affecting the mark-up size
decision. If a project has a high anticipate rate of return, the contractors may minimizetheir mark-up size to winning the project. In such case, they are considering the long
term profit margin incurred on the project in future.
The risks involved in investment also need to consider in mark-up size decision.
After the contractual and construction risks assessed, the contractors are expects to be
rewarded for accepting such risks with a reasonable return and mark-up size. Generally,
the greater the degree of risk and uncertainty involved in the project, the greater the
profit margin that will be expected by the management. As a conclusion, where an
element of risk is attached to an investment, it follows that a higher rate of return would
be required to make it worthwhile.
According to Shash and Abdul-Hadi (1992), the availability of the labor force is
low contributed to mark-up size decision. A contractor may obtain the required work
force from his own imported labor and or from other contractors imported labor. It is
because contractor who does not win a contract functions as a labor supplier, supplying
surplus labor, for other busy contractors.
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2.8 Summary
This chapter had discussed the challenges of competitive bidding, right mark-
up size and factors affecting mark-up size decision. In competitive bidding, to
determine a right mark-up size is not an easy task because it is two unpleasant
alternatives place the contractor in an extremely awkward position. If the contractor bids
low enough and get the job yet he cannot make a fair profit. On the other hand, if he bids
high enough to make a fair profit but he may not be able to get a job. Therefore, all
factors affecting the mark-up size decision should be considered concern by contractorin order to improve the chances of applying the right mark-up to the bidding.
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CHAPTER 3
BIDDING STRATEGIC IN THEORY
3.1 Introduction
As briefly discussed in the previous topic, mark-up is important in determining
the success or failure of competitive bidding. (Adrian, 1982). However, to determine the
right mark-up is not an easy task. Furthermore, competitive bidding is characterized as
highly competitive in construction industry. As Park (1979) said that the more
competitive an industry, the greater the need for making sound strategic decisions. The
need is greater in construction contracting especially competitive bidding, where
competitive pressures are probably more intense that in any other industry.
According to the Park (1979), even a bad plan is better than no plan at all.
Thus, contractors are encouraged to use the bidding strategies to improve their bidding
effectiveness, thereby to assist them in selecting the right mark-up figure that will
maximize its profits over the long term determine. Therefore, this chapter will look into
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detail in bidding model as the bidding strategies in theory. This discussion will begin
with bidding model and thereafter utilization of bidding model in following section.
3.2 Bidding Model
Since the mid-1950 years, many researchers tried to eradicate the biddingdifficulties in construction industry by developing mathematical or statistical models.
The two best-known and most widely accepted of these bidding strategies are known as
the Friedman Model and the Gates Model. The Friedman Model is the simplest of the
two and assumes that all bidders are acting independently of one another. This means
that the probability of underbidding a group of competitors equals the product of the
probabilities of underbidding each competitor separately. The Gates Model assumes that
bids from competing contractors are not totally independent of one another and
procedures are applied to take this into account. (Clough and Sears, 1994). Also, other
approaches of bidding models will be briefly discussed in the following section.
3.2.1 Friedmans Model
Friedman's competitive bidding strategy is the pioneering work in the study of
competitive bidding. In this bidding model, the lower limit of bids is generally set by the
estimated direct cost of a given project. The relationship between the bid price and the
estimated cost depends on several factors, such as the contractors need for work, the
minimum acceptable markup, and the maximum he thinks he can get. In addition, every
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contractor should realize that his chances of being low bidder have a direct relationship
to his bid. (Park, 1979). Therefore, the bidding strategy of Friedmans Model should be
well understood as discussed in following section.
3.2.1.1 Bidding Strategy Objective
There are several objectives in the Friedmans model such as to maximize the
total expected profit, minimize the total expected losses, or to obtain the project even at
a loss. One of the objectives that chose as the basis of his bidding strategy is to
maximize the total expected profits. This objective is the common one for any company
and because it is "one of the easiest to handle in a bidding situation of this type".
(Friedman, 1956)
3.2.1.2 Probability of Winning
To determine the probability of winning can be quite difficult. In Friedman
model, one way to determine the probability of winning is to examine the bidding
patterns of the competition in relation to the contractor's own bidding pattern. Any
competitor's bidding pattern can be understood by examining the ratio of the
competition's bid to the contractor's cost for past projects. (Friedman, 1956)
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A probability distribution of that ratio can be constructed and determine the
probability of winning with a bid of x. The probability of winning is equal to the area
under the distribution curve greater than the ratio of x for the current project to C for the
current project. For more than one competitor, the probability of winning with a bid x is
the product of the probability of defeating each of the competitors as shown in Figure
3.1. (Friedman, 1956)
Figure 3.1: Friedman's Method of Determining the Probability of Winning
In Friedmans concept, if all the competitors are not known then the probability
of winning should be determined as average bidder. The probability distribution of the
ratio of the average competitor's bid to the contractor's costs is determined by fitting a
curve to the set of ratios of the opposition's bid to the contractor's costs for past projects.
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3.2.2 Gates Model
Gates model is dependent on the pioneering work of Friedman. The basic
assumptions of both models are the same, but they are differing on two points. The first
point of disagreement is the assumption of independence. Gates model does not assume
that bid-to-cost ratios are independent. It does, however, assume that outcomes of
different competitors are dependent. This assumption is more realistic, but when applied
to the bidding model it ignores a very important aspect of bidding in real practice.
(Sparks, 1999).
In this model, Gates assumes that if there are seven competitors the chance that
any one of them will be the winner is 1/7. The study of bidding behavior in reality
assures us that this assumption is not valid because the lowest bidder is not randomly
selected, as implicitly assumed by Gates. Therefore, the bidding strategy of Gates
Model should be well understood as discussed in following section.
3.2.2.1 Bidding Strategy Objective
This model is same with Friedman' model which based on the main objective of
maximizing the profits for a job. There are six different strategies for use by contractors
in different situations. All the strategies are calculates the expected value of the project
for different bid amounts in determining the probability of winning. (Gates, 1967).
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3.2.2.2 Lone-Bidder
In the situation that the contractor finds that he/she is the only bidder, the
contractor just only estimates the probability of winning. The probability of winning will
be based on the contractor's estimate of the highest bid that the owner will accept. The
bid with the greatest expected value should be submitted, thereby maximizing the profits
for bidding situation. (Gates, 1967).
3.2.2.3 Two-Bidder Strategy
If the contractor is one of two bidders for a project, the contractor should
carefully estimate the probability of winning with certain bid amounts. After discovering
that there are only two bidders, a contractor might raise his bid because there is less
competition. Using the game-theory approach, the contractor can determine what bid
amount to submit to maximize the profit for the job. (Gates, 1967).
3.2.2.4 Many-Bidders Strategy
An average bidder will be representing all the other competitors in this situation.
Using historical data, the contractor studies his bid in relation to the low bidder by
subtracting the ratio of the low bid to the contractor's bid from one. This percentage
implied how much the contractor would have needed to reduce his bid in order to be the
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low bidder. Then, a cumulative probability distribution can create to determine the
probability that certain ratios of his bids to the low bids will occur in the future. From
that distribution, the contractor can develop a relationship between the probability of
winning and the amount of the bid. (Gates, 1967).
3.2.2.5 All-Bidders-Known Strategy
This strategy would be used when the contractor is familiar with and has
historical bidding information for all the other bidders for a project. It is very similar to
the many-bidders strategy. The difference is that the historical bidding data is sorted by
which competitor was the low bidder. Then, a separate analysis, like the one done for the
many-bidders strategy, is done for each opponent. (Gates, 1967).
3.2.3 OPBID
The OPBID program is basically a computerized version of Friedman's bidding
model. The OPBID program uses the same goal as Friedman which to maximize the
total expected profits. OPBID improves on Friedman's model by taking in to account
that competitors bid differently for different class of work and by giving more recent
data more weight in the calculations. By weighting more recent information, OPBID is
recognizing that bidding strategies and the market environment can change over time.
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OPBID processes the information and advice the contractor the optimum mark