Tey Kim Haim Fka 2009

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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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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



5.3.3 Company Characteristics 75



5.3.4 Bidding Situation 76



5.3.5 Economic Situation 78



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


5.5.3.3 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


5.5.4.3 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


Table 5.17 Chi-Square Test Result for Practices in Determining


Table 5.18 Reliability Test Result for Practices in Determining


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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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.



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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.


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

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