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Game Theory and the


Construction Bidding
Process
AreYouBeingPlayed?
Published:September2016
ByJohnKellamis

ontractorsaregamblersbynature.Theyrisk
ClickToViewFullSize
theirlivelihoodonamultitudeoffactors,many
ofthemuncontrollable,suchastheweather,
commoditypricesandtheactionsofothers.Nowhereisthisriskbetterdemonstratedthanduringthe
competitivebiddingprocess.

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Aconstructionestimatesaccuracyiscontingentupontheamountofinformationpresentduringbidtime.
Determinationofscope,estimationofquantitiesandassumptionsofproductivityareallformulatedtoproduce
acost,exclusiveofoverheadandprofittocompletetheproject.Becausetherearemanysimilaritiesbetween
contractorsintakeoffmethods,laborunitsutilizedbyestimatingprograms,andmaterialpricing,thelargest
projectsseesurprisinglyclosebidnumbers.Mosttimestheyarenot,butthesedifferencescanbeattributedto
companyexperience,laborsavingmethodsandtheamountsallocatedforoverheadandprofit.
Thisarticledealswithoverheadandprofitallocationandthedecisionsthataremadewhenputtingthefinal
numbertoabid.

An estimator's job
Iaskyoungestimatorswhattheirjobis,andmanytimestheyanswerthatitistowinthebid.Anybodycanwin
thebid.Bymakingpoorassumptions,ignoringthetruecostofoverheadandleavingoutprofit,anyfirmcan
besuccessfulatbidtime.Unfortunately,thatsuccessdoesnotalwaystranslatetothebottomline.
Itellestimatorsthatitistheirjobtodeterminethelowestnumbertheirfirmcanperformtheworkandearn
enoughextratocoveroverheadandprofit.Dependingonthecircumstances,thisnumbercanberaisedto
becomethehighestbidthatwillstillgetthejob.Thisrangebetweenlowandhighiswherecrucialdecisions
aremade.

Game theory
MerriamWebsterdefinesgametheoryastheanalysisofasituationinvolvingconflictinginterestsintermsof
gainsandlossesamongopposingplayers.Itwasdevelopedfrommathematicalmodelsbymanyscientists,
includingJohnNash,whowaspopularizedinthemovie,ABeautifulMind.Gametheorylooksattheconflict
andcooperationbetweenrationaldecisionmakers.AclassicexampleisAlbertTuckers"PrisonersDilemma."
InthePrisonersDilemmatwosuspectsarebeinginterrogatedinseparateroomsforacrimetheyare
suspectedofcommitting.Eachisgivenanopportunitytoconfessandbetraytheirpartner,somethingwhich
willresultinfreedomshouldtheirpartnernotconfess.Bothprisonersconfessingresultsinalongprison
sentenceforboth,andbothprisonersremainingsilentresultsinashortprisonsentenceforboth.Ifviewed
fromanoptimaloutcomestandpoint,noprisontermisbest,andthus,eachsuspectshouldconfess,butgame
theoryhastodowiththecooperationandconflictofparties.Inthissituation,bothsuspectsrealizethat
keepingsilentisbestandwillaccepttheirshortsentenceasareward.
Gametheoryhasbeenusedinthestudyofconstructionbiddingpractices.Thisisnottosaythatbidders
cooperateasintheaboveexample.Cooperationinabidsituation,otherwiseknownascollusion,willhaveits
ownPrisonersDilemmashoulditoccur.Biddingismostdefinitelydonebetweenconflictingparties,anditis
thisconflictthatbringsmanyofthefactorsthatgointothedecisionofthefinalbidnumberintoplay.
Ifcontractorsspendsomucheffortobtaininganaccurateestimateofthecostsinvolvedforthecompletionof
aproject,howcananyendupunderbiddingandlosingmoney?Ignoringtakeofformathematicalerrors,it
comesdowntoassumptionsandthelackofinformation.Itisassumedthattruechangesinscopewillbe
handledthroughthechangeorderprocessorthroughlitigation.Everythingelseislookedatasarational
decision.

Theory in practice

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Theory in practice
Assumptionsbeyondthoseaffectinglaborcanincludetheamountofworkafirmcurrentlyhas,theeconomic
outlookforfuturework,andafirmsdesiretopursueworkforacustomer.Dofirmslowertheirbidtokeep
peopleworking,tostockupontheirbacklogortokeepacustomer?Absolutely.Shouldtheylowerthembelow
theirtruecost?Absolutelynot.Yetitisdoneeveryday.Theexamplesabovecanbeemotionalissues,and
thisisapartofgametheoryaswell.Myonlyadviceistoalwayshaveaworkingknowledgeofyourtruecost
andthefactorsplayingonyoureventualdecision.Sometimessteppingbackfromanimportantdecisiontosee
whatisinfluencingitcanbebeneficial.
Thisarticlehighlightsgametheorynotbecauseitisbeingstudiedbyelectricalsubcontractors,theones
playingthegame,butbecauseitisbeingutilizedbyownersandconstructionmanagers,theoneswhorunthe
game.Thereareseveralscholarlypapersontheinternetcoveringthistopic,andtobehonest,theybecome
veryconfusingfromamathematicalstandpointasmoreplayers,orbidders,andfactorsareadded.
Thinkofyourresponsestotheabovequestionsandassigningapercentagethatyouwouldraiseorloweryour
bidtocoverforthem.Thencharttheseagainstyourbestguessofhowyourcompetitionwouldanswerthem.
Gametheoristswithknowledgeofallpartieswouldcomputearesultantpercentagethateachfirmshould
apply,butthisisimpossiblefromthestandpointofaplayerguessingatitscompetitionsresponses.However,
thereisawaythoughthatafirmcanenhanceitsdecisionmakingforfuturebids.
Thelackofinformationatbidtimecancauseafirmtoraiseitspriceinfearoftheunknownortounwittingly
loweritspriceinitsignorance.Thereisatermcalled"thewinnerscurse,"originallyappliedtoauctions,that
appliestotheconstructionbiddingprocess.Investopedia.comdefinesthewinnerscurseasatendencyfor
thewinningbidinanauctiontoexceedtheintrinsicvalueoftheitempurchased.Becauseofincomplete
information,emotionsoranyothernumberoffactorsregardingtheitembeingauctioned,bidderscanhavea
difficulttimedeterminingtheitemsintrinsicvalue.Asaresult,thelargestoverestimationofanitemsvalue
endsupwinningtheauction.
Doesthissoundfamiliar?
Aconstructionbidisalsoinfluencedbythelackofinformation.Inthisinstancethelackofinformationshould
belimitedtoonesnotdealingwithscopebutwithfactorsassociatedwiththeowner,constructionmanageror
thefirmscompetitors.Howwelldoyouperformversustheestimateforaparticularowner?Docertain
constructionmanagersaffectyourbottomlineadversely?Shouldyoutrackthisinformation?Absolutely.Do
youdropyourbidaftercomparingittoapublishedbudgetnumber?Shouldyoudropyourbidwhenoffereda
lastlook?
Theseareyourdecisions,butyoushouldbeawareofyourtruecost,orintrinsicvalue,checkyouremotions,
andchartyourdecisionsforfuturereference.Theonesrunningthegamedothis.Asaplayer,youshould,too.

How low can you go?


Onediscouragingprocurementmethodintheindustryhasbeentheuseofonlinereverseauctionsfor
constructionservices.Thispracticeisstraightoutofthegametheorybook.Whenconfrontedwithdroppinga
smallincrementtosecureabid,likereceivingmultiplelastlooks,thetendencyisforthelowbidderto
eventuallygobelowthelevelitwouldhaveinaclosedbidsituation,perhapslowerthanitstruecost.
Governmentsandlargecorporationsthatspendbillionsonconstructionservicesrealizethisandhave
institutedtheseauctionsincertaincircumstances.Understandingallofthefactorsthatareconfrontinga
bidderinsuchapressuredsituationmaymakesomefirmsdecidethatthebestplayisnottoplay.
Whilegametheoryhasbeenstudiedsincethe1940s,thepracticeofpittingoneplayeragainstanotherhas
beenaroundmuchlonger.Theconstructionbiddingprocess,withitscompetingplayersinconflict,separated
andnoncooperating,isaperfectexample.Manyexperiencedcontractorshaveagutfeelingwhilebidding,
andthereissomethingtosayaboutintuition.Manyothersagonizeovereverybid.Theonesthatareconfident
intheircost,rationallylookatthefactorsinfluencingtheirdecisionsandkeepacoolheadwhenthegames
beginwillhavethebestchanceoflastingthelongest.Longmayyouplay.
Estimating, GameTheory, Bidding, Contracts, Agreements

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