Guest Commentary

November/December 2008

The Project-Delivery Debate: Risk Analysis Begins with Initial Bids

Contractors should carefully validate potential bids to help make better choices about which projects to pursue and which ones to let go

Richard Sappé Market Manager Richard Sappé is A/E/C industry market manager for Primavera Systems, a project, program and portfolio management software company based in Bala Cynwyd, Pa. Website: www.primavera.com

In the industry, a debate rages over which project-delivery method is the best to deliver projects on time and on budget. There is, however, another important debate that should not be forgotten—the one about how an owner best decides who will receive a contract.

The most crucial decisions and assumptions about a project often are made during the bidding process before a contract is awarded. With a low-bid mentality still widespread in the industry, project owners too often award contracts on the sole factor of lowest price.

Because owners usually do not require contractors to verify their bids as to revenue and profit, unscrupulous bidders can spoil the contract-award process by lowballing bids to win contracts even though they know they can never make a profit at that number. After the project is under way and the owner is locked in, the low bidder can increase its revenue and profit through change orders. Costly litigation often follows as well.

On any project, the bidding process is the only truly competitive phase among contractors, and it is often a tough situation for ethical contractors that set a realistic price for the job. When unscrupulous competitors undercut everyone else with unreasonable bids, it is difficult for others to compete on the basis of streamlined operations and economies of scale. It also is harder for contractors to propose new methods, technology and techniques that can help deliver quality projects at a lower price because they know they can be undercut by unrealistic low bidders.

One major concern for project owners is project risk—knowing what they are getting into and exactly how much it will cost—especially today as many sources of project funding dry up. Contractors can stand out from the pack without sacrificing ethics by verifying their bid to owners through risk analysis. Many organizations already are applying risk analysis to evaluate potential bids so they can make better choices. Contractors that verify their bids hold a powerful advantage because they can demonstrate to the owner that its risk level is sufficiently low and that the contractor is able take the job and deliver it profitably without relying on change orders. An owner is much better off choosing a bidder that is 10% higher than the lowest but delivers the project within budget, than it is in choosing a low bidder that may increase a project’s cost by 25%. As with anything else, quality and reliability are not always consistent with the lowest initial cost.

When contractors verify their bids, the three key factors to consider are:

> Revenue potential. Estimate the long-term total revenue gained from a project investment. Revenue potential is used to indicate the potential size of the opportunity.

> Contract type. Examine the structure of the contracts and determine which party is liable for what. This will have an enormous impact on risk.

> Portfolio-capacity planning. Evaluate the firm’s capacity and expertise to execute and deliver the project to completion.

These three points have to be considered and resolved as part of the go/no-go decision-making process of capital-investment planning, and all three factors encompass a great deal of uncertainty.

The process of project scheduling and estimating can, to an extent, minimize this uncertainty and assert a level of control. But, without continued risk assessment and reduction during the actual project, this process is like relieving symptoms rather than understanding and preventing the root causes of an illness. Performing a risk analysis on each bid can reveal its integrity and viability.

Through bid validation and risk analysis, contractors not only can avoid presenting unnecessarily risky bids, they also can add another weapon to their marketing arsenal and demonstrate to owners that they are credible, responsible and ultimately the best value for the money.