FACTORS AFFECTING THE CONTRACTOR’S 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

iii

To my beloved parent, siblings, and friends

Thanks for your never ending love and support

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 size’s 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 12

2.2.1 Negotiation Bidding 13

2.2.2 Competitive Bidding 14

2.3 The Challenges of Competitive Bidding System 17

2.3.1 The Price-Cutter 18

2.3.2 The “Bidding Fool” 18

2.4 Mark-up 19

2.4.1 Allowance for Overhead 20

2.4.2 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 Friedman’s 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 Carr’s 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 59

4.4 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 64

4.6 Summary 64

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5 DATA ANALYSIS

5.1 Introduction 65

5.2 Company Profile of Contractor 67

5.2.1 Size and Grade of Contractor’s Company 67

5.2.2 Years and Project Taken by Contractors 69

5.2.3 Type of Project Usually Undertaken By

Contractors 70

5.3 Factors Affecting the Contractor’s 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 Contractor‘s 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 105

6.2 Summary of Finding 105

6.2.1 Objective No. 1 106

6.2.2 Objective No. 2 106

6.2.3 Objective No. 3 107

6.3 Conclusion 108

6.4 Research Limitation 108

6.5 Recommendations For Further Studies 109

6.6 Summary 109

REFERENCES 110

APPENDICES 114

xii

LIST OF TABLES

TABLES TITLE PAGE

Table 2.1 Factors Affecting the Mark-up Size Decision 28

Table 5.1 Size of Contractor’s 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 Size’s 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

xiv

LIST OF FIGURES

FIGURES TITLE PAGE

Figure 1.1 Flow Chart of Research Methodology 10

Figure 3.1 Friedman’s 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

xv

LIST OF APPENDICES

LIST TITLE PAGE

A Survey Questionnaire 114

B Confirmation Letter from Faculty 123

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

2

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 world’s 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 construction

markets, 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 today’s 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.

3

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 client’s professional advisers will invite the contractors to submit tenders

for the client’s 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 contractor’s 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.

4

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)

5

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 are

known 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 contractor’s mark-up size

decision.

6

1.3 Research Aim and Objectives

This study aims at statistically investigate factors affecting the contractor’s 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 size’s 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.

7

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 contractor’s 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

contractor’s 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 that

affecting the mark-up size decision.

ii. Help contractors to enhance their chances of assigning the right mark-up size to

the right job.

iii. Sets the foundation for the development of an expert system that will help a

contractor decide on how much mark-up to add his cost estimate.

8

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 in

a 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.

9

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.

10

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 Objectives

Data Analysis

Data Compilation

Summaries, Conclusion and Recommendations

Data Interpretation

• Books • Journals • Internal Sources

• Lecturers • Seniors • Classmates

Determine the Research Scopes and Limitations

Preliminary Study

Discussion

Primary Data

Data Collection

Secondary Data

• Books • Journal • Thesis • Seminar Papers • Newspapers • Internet

• Questionnaire � Different Size of

Contractors

Significance Index Analysis

Reliability Test

Documentation

Writing -Up