Construction Bidding Markup Estimation Using a

Multistage Decision Theory Approach

Ibrahim S. Abotaleb, S.M.ASCE 1; and Islam H. El-adaway, M.ASCE 2

Abstract: Determining an optimum bid value maximizes the probability of winning a construction project while realizing proper profit.
Thus, this issue has been one of the important research topics in construction-related research. Various models have provided different
methodological approaches for bid pricing using statistical analysis of competitors’ prior bids. However, the accuracy of these models
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is compromised in cases where the data set of competitors’ historic bids is not complete and/or where such competitors utilize a dynamic
behavior (i.e., having bidding schemes that change significantly with time). Through a multistage decision theory approach, this paper
presents a more advanced model for construction bidding markup estimation that uses a Bayesian analytic framework. To this effect, a
three-stage research methodology was utilized. First, the authors established a systematic procedure to fit competitors’ historical data into
appropriate Bayesian prior density functions while taking the stochastic variability of cost estimates into consideration. Second, the authors
developed stochastic likelihood functions through the most recent observation(s). Third, the authors created the posterior distributions from
which the joint probability of winning and the expected profit can be calculated. To this end, the use of the Bayesian statistics in the model
enables it to draw sound statistical inferences even in cases of data incompleteness and dynamic behaviors of competitors, thus tackling two
important weak spots in the previous models. The proposed model was applied to two case studies from the literature with different scenarios
to demonstrate its use and to illustrate the effect of different parameters on the resulting optimum markup. It was shown that the more recent
bidding strategies of competitors play a significant role in predicting the future ones. Also, as the contractor becomes more certain about its
competitor’s behavior, both its probability of winning and optimum bidding markup increase. This research should be beneficial for the
construction stakeholders to better understand the bidding decision-making processes and consequently help create a healthy contracting
environment. DOI: 10.1061/(ASCE)CO.1943-7862.0001204. © 2016 American Society of Civil Engineers.
Author keywords: Contracting; Construction bidding; Markup estimation; Decision theory; Bayesian statistics.

Introduction
The process of project awarding in the construction industry is
mostly based on competitive bidding. There are many methods
for evaluating and selecting bidders; the typical one in the United
States is the low-bid method, in which the contractor submitting the
lowest bid is awarded the project provided that the contractor pos-
sesses the required technical qualifications. The main advantage of
this method is that it forces bidders to lower their costs by adopting
cost-saving technological and managerial innovations. Accord-
ingly, owners get the best value for money through free competition
(Trickey 1982; Lingard et al. 1998). Other methods, albeit not com-
monly used, include average-bid and below-average-bid selections.
In the average-bid method, the bidder whose price is closest to the
average bid is awarded the contract (Ioannou and Leu 1993). In the
below-average-bid method, the winning bid is the one closest to but
below the average of all bids (Ioannou and Awwad 2010). The
1 profits. But a high Mi means a high bid price Bi , leading to an
Graduate Student, Dept. of Civil and Environmental Engineering,
Univ. of Tennessee—Knoxville, 851 Neyland Dr., 324 John D. Tickle
Engineering Bldg., Knoxville, TN 37996. E-mail: abotaleb@vols.utk.edu
2
Associate Professor of Civil Engineering and Construction Engineering
and Management Program Coordinator, Dept. of Civil and Environmental
Engineering, Univ. of Tennessee—Knoxville, 851 Neyland Dr., 417 John
D. Tickle Engineering Bldg., Knoxville, TN 37996 (corresponding author).
E-mail: eladaway@utk.edu
Note. This manuscript was submitted on December 8, 2015; approved
on May 24, 2016; published online on July 15, 2016. Discussion period
open until December 15, 2016; separate discussions must be submitted
for individual papers. This paper is part of the Journal of Construction
Engineering and Management, © ASCE, ISSN 0733-9364.
scope of this research focuses on the lowest bid method for its
widespread use in the construction market.
It is only logical to consider that all contractors participating in a
bid have the intention to win the bid. Accordingly, each contractor i
attempts to submit the lowest possible bid price Bi . In the process of
bid preparation, each contractor estimates the project’s total costs
Ci that include direct and indirect costs. The critical decision is
which markup percentage M i to select. The markup percentage ac-
counts for the unforeseen risks and the desired profit. The bid price
function is formulated as
Bi ¼ Ci ð1 þ M i %Þ ð1Þ
Bid ratioi ¼ Bi =Ci ð2Þ
Profit ¼ Bi − ðCi þ NCi Þ þ CCi ð3Þ
For a contractor, a high markup value Mi is desired to maximize
increase in the probability of another competing contractor submit-
ting a lower bid. This eventually lowers the chances of winning the
bid. On the other hand, to maximize chances of winning the bid, the
contractor would set a very low M i, which is very risky. A project
might encounter additional noncompensable costs NCi higher than
the additional compensable costs CCi , with a value exceeding the
allocated markup. In this case, the contractor encounters losses.
Determining the optimal bid value that maximizes both the
probability of winning and the profit has been the subject of
construction research for a long time. The different approaches
of researchers are categorized into mainly those abstracted from

© ASCE 04016079-1 J. Constr. Eng. Manage.

J. Constr. Eng. Manage., 2017, 143(1): -1--1

 game theory, utility theory, and decision theory, which is a broader
form of utility theory. However, there seems to be a consensus
about the superiority of decision theory in tackling the construction
bidding markup estimation quandary (Rothkopf 2007).
Decision theory provides a contractor with an optimum markup
value for a future bid based on statistical inferences from the analysis
of historical bidding patterns of competitors. The earliest decision
theoretic models employed basic assumptions that were not realistic,
and hence their results were inaccurate (Runeson and Skitmore
1999). However, the currently developed models solved many of
the setbacks mentioned by Runeson and Skitmore (1999). The au-
thors have identified two problems that have not been tackled till
now. The first problem is that most of the currently developed models
require extensive historical data about competitors to be able to
provide sound statistical inferences. The second problem is that
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all the current models are based on the assumption that the historical
behavior of competitors, no matter how recent or old it is, governs
their future bidding behavior. Such an assumption is risky and might
produce inaccurate inferences, especially in the following two cases.
The first case is when the available data for a specific competitor are
very old and do not represent that competitor’s current bidding strat-
egies. The second case is when the available historical data are recent
and have good quality, but the competitor decides to shift its bidding
strategy, deeming the available older data misleading. This shifting of
strategy is referred to as dynamic behavior in this paper. A model
that takes into consideration the stochastic variability of historical
cost estimates and the dynamic behavior of competitors, while
reducing the need for extensive information and mathematical
complexities, is hence required.
Goal and Objectives
The goal of this research is to present an advanced model for con-
struction bidding markup estimation. The objective is to draw
sound statistical inferences even in cases of data incompleteness
and dynamic behaviors of competitors, which are two areas iden-
tified for improvement in previous models available in the litera-
ture. The developed model utilizes a multistage decision theory
approach in a Bayesian framework. Ultimately, this research should
be beneficial for the construction stakeholders to better understand
the bidding decision-making processes and consequently help cre-
ate a healthy contracting environment.
Literature Review
Different Approaches to Construction Bidding
Strategies
Researchers have tackled the construction bidding markup estima-
tion problem using different approaches from game theory, utility
theory, and decision theory. All discussions regarding game theory,
utility theory, and decision theory in this paper are in the context of
construction bidding. The terminologies and definitions may not be
the same in other contexts.
The game theory approach in bidding involves finding equilib-
rium strategies in a static noncooperative game model. Such strat-
egies are almost impossible to conclude because no bidder is able to
determine the game model, obtain private values, and estimate the
utility functions of its competitors (Rothkopf 2007). Game theory
works best in open auction, in which two or more competitors con-
tinually bid openly until they reach a value that encourages no one
to bid lower. However, bids in the construction market are closed
bids, in which no bidder knows its competitors’ prices until their
© ASCE 04016079-2
J. Constr. Eng. Manage., 2017, 143(1): -1--1
independent sealed bids are opened. Despite the impracticality of
game theory to provide a solution for optimum markup, it is used
efficiently to estimate the winner’s curse. The winner’s curse is the
situation in which the bidder with the lowest bid price wins the
project contract based on a submitted bid less than the true cost
(Ahmed et al. 2015). In such case, the winner is cursed with
negative profits. Ahmed et al. (2015) utilized the symmetric risk
neutral Nash equilibrium function to assess the winner’s curse in
projects awarded by the California Department of Transportation
in both single-stage and multistage bidding environments. The
other uses of game theory in construction—such as those studied
by Ho and Liu (2004), Ho (2001), Drew and Skitmore (2006), Tan
and Suranga (2008), and Karl (2014)—although beneficial in other
ways, do not directly assist bidders in their selection of optimum
bid prices.
The utility theory approach is based on the assumption that con-
tractors consider numerous criteria in determining the bid markup,
and hence the bid price (Dozzi et al. 1996). Such criteria are a mix
of project-specific factors such as job complexity, duration, level of
competition, completion of designs, and global factors such as the
country’s economic performance and the firm’s need for work. In
utility theory, for a newly tendered project, an expected utility value
is obtained using predetermined criteria and is compared to a
markup utility function to obtain a bid markup (Dozzi et al. 1996).
Noteworthy works utilizing utility theory in the domain of bidding
strategies are those of Ahmed and Minkarah (1987), Hegazy
(1993), Dozzi et al. (1996), Fayek (1998), Liu and Ling (2005),
Dikmen et al. (2007), and Cheng et al. (2011). Utility-theoretic
models are beneficial in capturing the contractor’s knowledge for
simulating its behavior and for applying this knowledge to new
projects recommending appropriate bid markups. However, such
models are not appropriate for calculations of the probability of
winning because the probability of winning is primarily dependent
on the level of competition (Christodoulou 2004a). Accordingly,
the value of markup resulting from such models cannot be consid-
ered the optimum value (Awwad 2015). For that reason, researchers
and practitioners prefer the use of decision theory, which is a
broader form of utility theory, in bid markup estimation.
The decision theory bases the bid markup decision of a contrac-
tor in a future bid on the statistical analysis of historical bidding
patterns of competitors. The main assumption is that bidders can
improve their strategic competitiveness by studying their compet-
itors’ bidding pattern (Friedman 1956; Capen et al. 1971). There is
no fully practical way to validate such an assumption but it is
widely accepted by most, if not all, researchers in this field. In de-
cision theory, the bidder follows two main steps. The first step is to
assess the probability distribution of the competitive bidders’
markup history separately and jointly through statistical analysis.
The classical approach in this step is that a bidder compares its cost
estimates Cj with bidders’ bid prices Bij for previous bids, where i
is the competitor number and j is the historical bid number. Then, it
uses an inverted form of Eq. (1) to obtain the different markup val-
ues of each competitor M ij, eventually characterizing the markup
values of each bidder with a probability density function f i ðrÞ,
where r ∈ M. A more realistic approach is the stochastic one, in
which the cost estimate of each competitor is expected to vary from
that of the firm. Accordingly, the competitors’ bid prices are treated
as density functions, instead of discrete values, to eventually form
fi ðrÞ. The probability Pi ðrÞ of winning competitor i at markup
value r is equal to the probability of that competitor bidding with
a higher r as shown in Eq. (4)
Z ∞
Pi ðrÞ ¼ fi ðrÞdr ð4Þ
r
J. Constr. Eng. Manage.
 In the case of competing against more than one competitor,
which is the case in most projects, the most widely used formulas
for calculating the probability of winning are the ones introduced
by Friedman (1956) and Gates (1967). Friedman’s formula views
the competitors’ bids as independent and hence calculates the prob-
ability of winning against n competitors as shown in Eq. (5)
Y
n
Pwin ðrÞ ¼ Pi ðrÞ ð5Þ
i¼1
On the other hand, Gates’s formula views the competitors’ bids
as dependent. Thus, his calculation for the probability of winning
against n competitors is as shown in Eq. (6)
"  #−1
X 
n
1 − Pi ðrÞ
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Pwin ðrÞ ¼ þ1 ð6Þ
i¼1
Pi ðrÞ
Both the Friedman model and Gates model are widely accepted
in the literature despite the debates about which of them is more
accurate (Crowley 2000). Crowley (2000) did an extensive review
of the literature regarding the different opinions about Friedman’s
and Gates’s models. In the same paper, he also used a third model to
visually demonstrate both similarities and differences between the
models, and he concluded, from a purely statistical point of view,
that “both models are simultaneously correct and incorrect. Fried-
man’s model is theoretically correct, yet the bid problem is incor-
rectly specified. Gates’s model is practically correct, yet the
formula is incorrectly specified.” From a practical point of view,
Sparks (1999) stated that Friedman’s model results in an optimum
bid with lower markup to a project than Gates’s model. As a result,
Friedman’s model helps the contractor win more projects than
Gates’s model. However, because of the low markup, Friedman’s
model does not provide the contractor with as high long-term prof-
its as those of Gates’s model. According to Benjamin and Meador
(1979), a contractor using Friedman’s model would need to obtain
approximately twice the volume of work to attain the same profits
as one using Gates’s model. Based on the previously mentioned
theoretical and practical views, it is not clear which model is better.
What is clear is that the selection of the model depends on the con-
tractor’s situation. To the authors’ best knowledge, both Friedman’s
and Gates’s equations are still currently heavily used in calculating
the probability of winning multiple competitors. Selecting which
one to use depends on whether the contractor views the competitors’
bids as independent or dependent. It also depends on whether the con-
tractor pursues long-term profits or winning more bids. The authors
used both models in this paper to satisfy both schools of thought.
The second step in the decision theory approach is to optimize
the choice of bid value against the assessed competitors given the
calculated probability of winning from Step 1. Such optimization is
straightforward and one-dimensional, and it is abstracted from an
optimality expected value function (Rothkopf 2007; Gilboa 2009).
The expected value is the sum of all possible events multiplied by
their chance of occurrence (Capen et al. 1971). In the case of con-
struction bidding, the expected value is represented by the expected
profit, which is the multiplication of the markup percentage and the
corresponding probability of winning as shown in Eq. (7). The op-
timum markup value r is the one that maximizes the expected profit
EPðrÞ ¼ r · Pwin ðrÞ ð7Þ
The main problem with traditional decision-theory-based mod-
els is that they require an unrealistic amount of data for them to
provide statistically acceptable results (Skitmore and Pemberton
1994). Accordingly, many efforts have been made to provide
© ASCE 04016079-3
J. Constr. Eng. Manage., 2017, 143(1): -1--1
decision-theory hybrid models for deriving markup strategies.
To list a few, Carr (1982) expressed the cost estimate as a normal
distribution instead of a discrete value, and calculated the proba-
bility of winning as an integral over the cost uncertainty. Skitmore
(1991) proposed a model that estimates the statistical parameters
for cost estimates and bid values based on a multivariate approach.
In that approach, Skitmore shifted the data to a logarithmic scale
and expressed the mean of the transformed data by the sum of bid-
ders’ effect and a contract datum parameter that represents the
project size. Skitmore and Pemberton (1994) later extended the
multivariate model to enable the increase of available data by sev-
eral orders of magnitude. More recently, Yuan (2011) devised a
new multivariate methodology that measures the correlation be-
tween bid ratios using probabilistic analysis and Bayesian methods
to estimate optimal markup. A computational approach for opti-
mum markup calculation that attempts to combine decision theory
and utility theory is provided by Christodoulou (2004b). His
approach uses neurofuzzy systems and a multidimensional risk-
analysis algorithm. However, the used model factors have yet to
be statistically validated. Other significant works in the decision-
theoretic approach of bidding strategies are the ones of Stark
(1968), Rosenshine (1972), Dixie (1974), Winkler and Brooks
(1980), Ranasinghe (2000), Lo and Lam (2001a, b), Touran
(1993, 2003), Cooper (2005), Skitmore et al. (2007), and
Yuan (2012).
Despite all of the previously mentioned efforts, the developed
decision-theoretic models so far face one main theoretical problem
and one main limitation from the authors’ point of view. The theo-
retical problem is that the models assume that all historical bidding
strategies have similar weights in determining their future bidding
strategy. In fact, a competitor might shift its bidding strategies; thus,
it would be misleading to give older strategies weights similar to
the newer ones in this case. It also would be misleading to totally
disregard the old strategies since there is a probability that the com-
petitor shifts back to them or close to them. The limitation is that
the current models require extensive historical data to provide
sound statistical inferences. In many cases, the data might be in-
complete, deeming these models unusable. The presented model
addresses the previously mentioned issues throughout a proposed
Bayesian framework. In Bayesian statistics, it is possible to differ-
entiate between the old and recent observations of competitors’
bidding strategies, thus taking the dynamic behavior into consid-
eration. Moreover, the Bayesian framework allows for the inclusion
of educated belief for data points with missing information. Edu-
cated belief is when a contractor hypothesizes certain historical bid-
ding behaviors for a competitor in case such a piece of information
is missing in a solid quantitative manner. Such a hypothesis is based
on the contractor’s experience in bidding and in analyzing the mar-
ket conditions, a skill that contractors usually do not lack. The con-
cept of educated belief, albeit not used in conventional statistics, is
legitimate and reliable in Bayesian statistical approaches (Press and
Press 1989; Stevens 2009; Bolstad 2007). The methodology section
provides further details about how the dynamic behavior and the
educated belief are utilized in the model.
Statistical Background
This section provides a simple description of some of the statistical
methodologies used in this paper.
Bayesian Statistics
The two major domains in mathematical statistics are conventional
(or frequentist) and Bayesian. Bayesian statistics provide a more
J. Constr. Eng. Manage.
 complete paradigm for both statistical inference and decision mak-
ing under uncertainty (Bernardo 2011). Moreover, it makes it pos-
sible to incorporate scientific hypotheses, or educated beliefs, in the
analysis by means of the prior distributions when the available data
are not sufficient to produce sound frequentist statistical inferences
(Press and Press 1989; Stevens 2009; Bolstad 2007). According to
Kelly et al. (2010), “A salient feature of Bayesian inference is its
ability to incorporate information from a variety of sources into the
inference model, via the prior distribution. Done properly, Bayesian
inference integrates old information and new information into an
evidence-based state-of-knowledge distribution.” Bayesian statis-
tics interprets probability as a rational, conditional measure of un-
certainty, where statistical inference about a quantity of interest is
described as the modification of the uncertainty about its value in
light of evidence (Bernardo 2011). Such modification is made ac-
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cording Bayes’s equation [Eq. (8)]
pðθjDÞ ∝ fðDjθÞπðθÞ ð8Þ
In general, two sources of information about the unknown
parameters of interest are collected, not one as in frequentist
statistics.
The first of these is the prior distribution, which represents the
original prior data based on the available information to the inves-
tigator. The second is the likelihood function, which is the sample
data or the observed behavior of uncertainty. If the data are repre-
sented by D, and the set of unknown parameters is represented by θ,
then the likelihood function is fðDjθÞ, which is the probability of
observing the data D being conditional on the values of the param-
eter θ. If the prior distribution for θ is represented by πðθÞ, then the
posterior function is calculated as shown in Eq. (8).
The proportionality symbol ∝ expresses the fact that the right-
hand side of the equation has to be normalized so that its integration
over its full support must be equal to 1. The posterior function
pðθjDÞ provides a weighted compromise between the prior infor-
mation and the likelihood data in a statistically sound environment
(Stevens 2009).
Markov Chain Monte Carlo and the Metropolis-Hastings
Algorithm
It is not difficult, using simple heuristics or simple built-in software
functions, to generate independent and identically distributed (iid)
random variables following a probability density function (PDF) f
of well-known distributions such as the normal, gamma, and beta
distributions. However, this is not the case in ad hoc distributions
following unusual PDFs. In such cases, one of the most widely used
techniques for sampling is the Markov chain Monte Carlo. Markov
chain is a stochastic process in which future states X nþ1 ; X nþ2 ; : : :
are dependent on past states X 0 ; : : : ; X n only through the present
state X n (Serfozo 2009).
Markov chain Monte Carlo (MCMC) is a technique of generat-
ing random variables following any desired PDF, named the target
distribution, throughout simulated draws from an easy-to-sample
PDF, named the proposal distribution. MCMC methods have been
used for almost as long as the original Monte Carlo techniques
(Robert and Casella 2010). For the MCMC to work, the successive
sampling from the proposal distribution has to follow a Markov
chain that abides by the ergodic theorem (Gilks 2005). An ergodic
Markov chain is a one that is aperiodic, irreducible, and positive
recurrent. A Markov chain is aperiodic when it is not repeating an
identical cycle of states. A Markov chain is irreducible when, no
matter the starting value X 0 , the sequence X n has a positive prob-
ability of eventually reaching any region of the state space (Robert
and Casella 2009). Finally, a Markov chain is positive recurrent if
© ASCE 04016079-4
J. Constr. Eng. Manage., 2017, 143(1): -1--1
the expected return time from a state to the same is finite. The dif-
ficulty in applying MCMC is in constructing the Markov kernel
that is associated with the arbitrary density. Such difficulty is
handled through the application of the Metropolis-Hastings algo-
rithm or the Gibbs sampling algorithm.
The Metropolis-Hastings algorithm, named after Metropolis
et al. (1953) and Hastings (1970), is a universal method for deriving
the Markov kernel in MCMC that is theoretically valid for sam-
pling from any target probability density f (Robert and Casella
2009). Such a technique is associated with sampling from a work-
ing proposal density qðyjxÞ that is easy to simulate. The only theo-
retical requirements for q are that the ratio fðyÞ=qðyjxÞ has to be
known up to a constant independent of x and that qð· jxÞ is wide
enough to enable the exploration of the entire support of f (Robert
2015). To construct a Markov transition kernel X 0 ; : : : ; X T via the
Metropolis-Hastings algorithm, given an initial random variable X t ,
generate Y t ∼ qðyjxt Þ, and then obtain X tþ1 , where

Y t with probability ρðxt ; Y t Þ
X tþ1 ¼ ð9Þ
X t with probability 1 − ρðxt ; Y t Þ
 
fðyÞ qðxjyÞ
ρðx; yÞ ¼ min ;1 ð10Þ
fðxÞ qðyjxÞ
The resulting chain can be considered a sample, albeit a depen-
dent sample, that is distributed from f with resilient approximation.
Because of the Markovian nature of the simulation, the first values
are highly dependent on the starting value X 0 and usually removed
from the samples as burn-in. The burn-in is for the purpose of en-
suring, in theory, that the Markov chain is intrinsically equivalent to
a standard iid simulation from f (Robert 2015). There is no defini-
tive measure of estimating the number of burn-in variables that it
takes for the chain to reach stationarity; however, the effect of initial
values diminishes if the chain is long enough. See the work of
Hobert and Robert (2004) for suggested burn-in estimation
methodologies.
Gibbs sampling is another famous methodology for forming the
Markov transition kernel and has its advantages, especially in high-
dimensional multivariate analysis. However, the authors only
focused on the Metropolis-Hastings algorithm in this paper for two
reasons. First, to use a Gibbs sampler to sample from a joint dis-
tribution pðθ1 ; : : : ; θk Þ, full conditional distributions for each
parameter have to be calculated. The full conditional distribution
is the distribution of the parameter conditional on the known infor-
mation and all the other parameters pðθj jθ−j ; yÞ. Many times, such
as the case in this paper, the full conditionals do not follow a stan-
dard distribution with known density functions. Second, if the tar-
get function does not follow a standard distribution, Gibbs
sampling will not be practical for the lack of conjugacy (Gilks
2005). In short, the Metropolis-Hastings algorithm is more flexible,
generic, and best fits the type of data in the scope of the research.
Kolmogorov-Smirnov Test
The one-sample Kolmogorov-Smirnov test, referred to as the K-S
test, is a statistical nonparametric test for comparing a sample with
a reference probability distribution. In the scope of this research,
the K-S test is used to measure the goodness of fit, which is a valid
and widely employed use of the test (Wilcox 2005). Given N-
ordered data points X 1 ; : : : ; X n , an empirical cumulative distribu-
tion function ECDF is formed using EN ¼ nðiÞ=N, where nðiÞ is
the number of points less than X i and the X N are ordered from
smallest to largest value (Marsaglia et al. 2003). The ECDF is plot-
ted and compared to the reference cumulative distribution function
J. Constr. Eng. Manage.
 RCDF and the maximum distance between these two curves is
measured and considered the basis of the test. The null hypothesis
H 0 is that the sample data points are drawn from the reference dis-
tribution. The test statistic D is obtained using Eq. (11)
 
i−1 i
D ¼ max1≤i≤N FðX i Þ − ; − FðX i Þ ð11Þ
N N
where F = theoretical cumulative distribution of the ECDF. The
null hypothesis is rejected if the test statistic D is greater than a
critical value obtained from K-S tables. However, computer statis-
tical software can directly generate the p-value. Accordingly, the
null hypothesis is rejected if the p-value is less than the desired
significance level α. The most commonly used number for α in
these cases is 0.05 (Nuzzo 2014). Simply, a p-value more than
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0.05 means that there is not enough evidence to reject the null hy-
pothesis that the tested sample follows the reference probability
distribution.
Methodology
A three-stage research methodology was utilized in this research.
First, the authors established a systematic procedure to fit compet-
itors’ historical data into appropriate Bayesian prior density func-
tions while taking the stochastic variability of cost estimates into
consideration. Second, the authors developed the stochastic likeli-
hood function through the most recent observation(s). Third, the
authors created the posterior distributions from which the joint
probability of winning and the expected profit can be calculated.
The General Structure
To clarify the sense in which the Bayesian framework is used in the
context of construction bidding, the historical bidding data of com-
petitors are not going to be treated equally and fitted in probabilistic
densities as usually treated in the frequentist statistical approach.
However, recent observations are going to have a significant role
in shaping the statistical inferences more than the role of the less
recent ones in the following manner. In simple words, less recent
historical data are the ones forming the prior distribution πðθÞ.
Even if such data are not available, contractors can incorporate
the concept of the average bidder described by Friedman
(1956). The most recent observation or set of observations of com-
petitors is the one forming the likelihood function fðDjθÞ. Of
course the different prior and likelihood functions take the stochas-
tic variability and uncertainty of each single data point for each
competitor into consideration. Statistical inference about future
bid strategies of competitors is then made from a series of posterior
functions that modify the uncertainties about the different posterior
values in light of evidence presented by the likelihood function.
Fig. 1 details the methodology utilized in developing the proposed
model.
The following paragraphs detail the aforementioned three-stage
research methodology as related to calculating prior, likelihood,
and posterior functions within the Bayesian framework. The first
stage is concerned with fitting of the historical data of competitors
into probability density functions forming the prior distribution.
The second is concerned with forming the likelihood functions. Fi-
nally, the third stage is concerned with forming the posterior dis-
tribution, calculating the probability of winning, and determining
the optimum markup value at which the expected profit is at its
highest. For simplicity to readers, each stage is organized into steps.
Stage 1 is performed in Steps 1 to 4, Stage 2 is performed in Step 5,
and the last stage is performed in Steps 6 to 8.
© ASCE 04016079-5
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Step 1: Forming the Preliminary Distribution Density
Functions
It is only logical that contractors seeking bid winning keep records
of the bid values of their competitors in all previous bids. The best
quality of data is where a contractor knows its competitor’s histori-
cal markup percentages, M ij , directly, where M ij is the markup per-
centage of contractor i in historical bid j. However, this is not the
case most of the time. In reality, a contractor would only be able to
collect information about its competitors’ previous bid prices Bij .
Such bid prices are functions of the competitors’ cost estimates and
their markup percentages. A contractor x does not know the cost
estimates of its competitors for any given bid. Accordingly, the bid
function has two unknowns: the competitors’ cost estimates and
their markup percentages. It is statistically inappropriate to obtain
the probability density of competitors’ markup behaviors throughout
a simple function of dividing their bid values by the cost estimate of
contractor x. This is so because it assumes that the cost estimate is the
same for all competitors, including the studied contractor.
In the proposed model, instead of fitting the competitors’
markup density functions from points directly obtained from dis-
crete bid ratios, the density functions are fitted from points sampled
from a preliminary distribution density function pdi ðrÞ. In the
pdi ðrÞ, bid ratios are considered as density functions themselves
to take the stochastic variability of cost estimates into consideration
[Eq. (12)]
ni   

X  Bij × 100
pdi ðrÞ ∝ N r − 100; σij ð1 − ∅ij Þ
j¼1
Cj

þ Γðrjαij ; β ij Þð∅ij Þ ð12Þ
where r ∈ ð0; ∞Þ; ni = total number of available bid value data
points for competitor i; Nðrja; bÞ = normal distribution probability
density function with mean a and standard deviation b, calculated
as shown in Eq. (13); and Γðrja; bÞ = gamma distribution proba-
bility density function with shape a and rate b, calculated as shown
in Eq. (14)
1 ðr−aÞ2
−
Nðrja; bÞ ¼ pffiffiffiffiffiffi e 2b2 ð13Þ
b 2π
ba
Γðrja; bÞ ¼ R ∞ ra−1 e−br ð14Þ
0 ra−1 e−r
A preliminary density function is calculated for each competitor.
For each historical bid j, a contractor knows its cost estimate Cj and
the bid value of each of its competitors Bij . The stochastic variance
in the cost estimation between a contractor and its competitors is
represented by σ. The generic nature of the model allows for a dif-
ferent σ in each historical data point. Thus, σij reflects the contrac-
tor’s perception of variance between its cost estimate for bid j and
the cost estimate of its competitor i for the same bid. Each historical
data point is represented by a normal distribution with mean equal
to the estimated markup and a standard deviation of σij . The normal
distribution is widely accepted as a measure for stochastic uncer-
tainty in similar cases (Carr 1982; Ioannou and Leu 1993; Ioannou
and Awwad 2010). The value of σij is project dependent. Every
project has unique circumstances. For example, in a simple instal-
lation project with complete drawings and specifications, the vari-
ance of cost estimates of competitors is less than that in a more
complex project. There are no validated generic values that can be
used for σij found in the literature. The contractor can obtain σij
either from statistical analysis of historical cost estimates of its
J. Constr. Eng. Manage.
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Fig. 1. Methodology utilized by the proposed model

© ASCE 04016079-6 J. Constr. Eng. Manage.

J. Constr. Eng. Manage., 2017, 143(1): -1--1

 competitors or from its expert judgment taking into consideration
the project complexity, the competitors’ behavior, and other factors
that are not in the scope of this paper. Higher values of σij represent
cost estimates with high variability.
The binary variable ∅ij acts as a switch between the real his-
torical observations and the data points obtained through the
concept of educated belief. If ∅ij ¼ 0, then the first term in
Eq. (12), corresponding to real historical observations, is active,
and the second term in the same equation, corresponding to
the educated belief factor, is inactive. On the contrary, if
∅ij ¼ 1, the first term in Eq. (12) becomes inactive and the sec-
ond term becomes active. What determines the value of ∅ij is the
Bij =Ci ratio. If Bij =Ci is less than or equal to 1, then ∅ij ¼ 1.
Oppositely, if Bij =Ci is greater than 1, then ∅ij ¼ 0. The follow-
ing paragraphs discuss the reasoning behind using the gamma
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distribution for the second term to represent the educated belief

factor and behind using ∅ij to switch between the two terms
of Eq. (12).
In some infrequent cases, a contractor’s cost estimate for a
project might have a value greater than a competitor’s bid value
of that project. Accordingly, Bij =Ci would have a value less
than 1. This means one of two scenarios: either the contractor’s
cost estimate is much higher than the competitors’ cost estimate,
or the competitor submitted a very low bid price with negative
markup. Each scenario has its valid roots. However, the first
scenario has a much higher probability. The proposed model
is constructed on the assumption that the markup value of com-
petitors cannot be less than zero, meaning that no competitor will
desire to take a project at loss. Although in some rare cases, for
unusual reasons, firms might accept to be awarded projects at
loss, the model is built to simulate normal rational contractor
behaviors.
For any historical data point where the contractor’s cost estimate
is more than the competitor’s bid value at any given historical bid,
i.e., Bij =Ci < 1, the contractor shall assume that (1) his cost esti-
mate for that bid was overestimated, or the competitor had a certain
advantage that enabled him to estimate much lower costs; and
(2) the competitor’s markup in such a bid is a number in the positive
range following a stochastic gamma distribution that fits the con-
Fig. 2. Effect of shape and rate on the gamma distribution
tractor’s educated belief about the competitor in that bid. Such as-
sumptions are taken care of automatically by the binary variable
∅ij . The corresponding gamma distribution Γ should have appro-
priate parameters, namely shape αij and rate β ij , where αij and β ij
are nonzero, nonnegative values. Both the α and β parameters col- the competitor’s markup in that bid. The educated belief is based
lectively control the skewness, location of peak, and width of peak on the contractor’s experience in bidding and in analyzing the mar-
of the gamma probability density function. Fig. 2 provides some ket conditions, skills that contractors usually do not lack. As men-
examples of the effect of α and β on the gamma density function. tioned earlier, such educated belief is legitimate and reliable in
Generally speaking, as shown in Fig. 2, α contributes more to the Bayesian statistical approaches. So, the contractor might opt to
location of the peak and β contributes more to the width of the use αij ¼ 6 and β ij ¼ 5 if the contractor’s analysis and experience
peak. The gamma distribution is selected in this case because of led the contractor to hypothesize that the competitor was risk averse
two main reasons: first, the gamma distribution is a shape shifter in that bid. The contractor also might opt to use αij ¼ 1 and β ij ¼ 8
that can assume a range of shapes, from exponential to normal for a risk-taking competitor.
(Hazewinkel 2001). Such flexibility is abstracted from the fact that In this step, historical projects are those that precede the latest
the gamma distribution is controlled by two different parameters. common bids. The latest common bids are defined in Step 5. If such
Second, the support of the gamma distribution extends in the data are missing for a given competitor, then this step and the fol-
positive real number range only from 0 to ∞ (Hazewinkel lowing step are not required for that competitor. The right-hand side
2001). Accordingly, this ensures that the pdi ðrÞ function does of the equation has to be normalized so that its integration over its
not have values in the negative r region. full support must be equal to 1, hence the proportionality symbol ∝.
Selection of the appropriate α and β parameters is project and If the user has sufficient statistical background, then the user could
competitordependent and should be based on the contractor’s ver- replace the gamma term in the equation with an alternative appro-
dict. For example, if the contractor observes that the bid price for priate distribution with a positive support such as beta or Weibull.
competitor i in bid j is less than the contractor’s cost estimate of The alternative distribution should have proper parameters that re-
the same bid, i.e., Bij =Ci < 1, then the contractor should select flect the hypothesized competitors’ behavior in such cases where
αij and β ij for that data point based on his educated belief of Bij =Ci < 1.

© ASCE 04016079-7 J. Constr. Eng. Manage.

J. Constr. Eng. Manage., 2017, 143(1): -1--1

 Step 2: Sampling From the Preliminary Density
Functions Using MCMC
In this step, for each competitor, iid random variables are sampled
from its preliminary density function using the MCMC Metropolis-
Hastings algorithm. The resulting Markov kernel will form the
prior distributions. Since the computing powers of standard com-
puters are very powerful, the number of simulations S for each
competitor is suggested to be 10,000, where the first 1,000 simu-
lations are not taken into consideration because they are considered
the chain’s burn-ins. The initial random variable X 0 is proposed to
be a number within the range of the markup percentages. But even
if it is not in that range, the chain will still converge, but slower
(Robert 2015). The proposed value for X 0 is 1. The target function
is pdi , which is obtained from Step 1.
To simplify the part concerning the candidate function, the
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random walk Metropolis-Hastings algorithm is used, where the
random variable Y t is generated as shown in Eq. (15)
Y t ¼ X t þ εt ð15Þ
where εt = random perturbation with distribution g. In this case, g is
a normal distribution with mean = 0 and standard deviation = 2. So
for each simulation, a random variable εt is generated from g
[Eq. (16)] and added to the preceding X t [Eq. (15)]
εt ∼ Nð0,2Þ ð16Þ
The random walk allows for local exploration of random vari-
ables all over the support of the target function while maintaining
the ergodic properties of the chain. The values of Y t can then be
used in Eq. (9). Moreover, the use of such a symmetric function for
g simplifies the acceptance probability previously shown in
Eq. (17)
 
fðyÞ
ρðx; yÞ ¼ min ;1 ð17Þ
fðxÞ
Roberts et al. (1997) specifies that an acceptance rate of 23.4%
or more provides a good indication on the convergence of the chain
and the suitability of the candidate function. The flow chart of
the random walk Metropolis-Hastings algorithm was shown in
the right part of Fig. 1. The generated Markov chain for each
competitor, which is the output of this step, is referred to as
½X 1,001 ; X 1,002 ; : : : ; X 10,000 i . The numbering starts from 1,001 be-
cause the first 1,000 points are eliminated for the chain’s burn and
ends at 10,000 because the total number of simulations (draws)
is 10,000.
Step 3: Fitting Proper Distribution to the Preliminary
Density Functions
In this step, the Markov chains from Step 2 are processed to form
prior distributions to be used in the Bayesian framework. Each of
the random variables ½X 1,001 ; X 1,002 ; : : : ; X 10,000 i is named M ij ,
where M stands for the markup percentage, i stands for the number
of competitors, and j stands for the number of generated random
variables in the Markov chain of each competitor. The purpose of
this step is to fit a parametric distribution to the set of Mij .
Fitting distributions to data consists of selecting the best-fitting
probability distribution from a predefined family of distributions. It
requires judgement and expertise and generally needs an iterative
process of distribution choice, parameter estimation, and quality of
evaluation (Pouillot and Delignette-Muller 2010). This step pro-
vides a systematic and objective approach to distribution fitting.
© ASCE 04016079-8
J. Constr. Eng. Manage., 2017, 143(1): -1--1
A histogram of M ij of each competitor is plotted. From visual
observation of the histograms, for a histogram with one significant
peak, plot the Cullen-Frey graph. The Cullen-Frey graph displays
the relationship between the square of skewness and the kurtosis of
standard parametric distributions, superimposed with skewness
and kurtosis values estimated from the used data sets (Pouillot
and Delignette-Muller 2010; Cullen and Frey 1999). Simply, the
Cullen-Frey graph shows which parametric distribution best fits
the data set. Different software packages have the ability to easily
plot the Cullen-Frey graph. The one used in this research is R pro-
gramming language in R-studio’s software environment.
After determining the closest parametric distribution(s) that fit
the data set of each competitor, several heuristic steps can be fol-
lowed to perform the actual fitting and obtain the suitable distribu-
tion parameters. However, several software packages are available
to find the best parameters for any selected distribution to fit the
data set. For example, assume that in a hypothetical case, the
Cullen-Frey graph shows two suitable distributions, namely normal
and Weibull, fitting a certain data set. Then assume that the best
parameters for those distributions are mean = 4.52, SD = 3.33
for the normal distribution and shape = 1.42, scale = 4.99 for
the Weibull distribution. One indicator to judge which distribution
best fits the data set is the plotting of the histogram against
each of the parametric distributions and selecting by visual
inspection the one that best matches the histogram. Another indi-
cator is the plotting of the quantile–quantile (Q–Q) plots and
probability–probability (P–P) plots of the theoretical and empirical
probabilities, and taking the decision based on visual inspection of
the plots. To minimize subjectivity in evaluating the quality of
fitness, the one-sample Kolmogorov-Smirnov test is performed.
The distribution that results in a p-value higher than 0.05 is selected
as the one that best fits the data set.
For a histogram with significant multiple peaks, the previously
mentioned procedure will not be of benefit because the traditional
parametric distributions mostly have one peak. Thus, fitting inap-
propriate density functions to data sets leads to low K-S test p-
values, deeming the output statistically questionable. In cases of
data sets with two or more peaks in their histograms, the logspline
fitting is recommended. The logspline fitting forms a function from
a space of cubic splines that have a finite number of prespecified
knots and are linear in tails (Kooperberg and Stone 1991). A de-
tailed mathematical description for fitting a set of points into a logs-
pline density is given by Kooperberg and Stone (1991). There are
software packages that can automatically fit logspline densities of
data sets such as the package logspline in R.
Step 4: Developing the Prior Functions
The fitted distribution for each competitor i from Step 3 is recorded
as the competitor’s prior distribution πðθÞi . πðθÞi should be normal-
ized with a positive support.
For competitors with little accurately recorded previous histori-
cal bid data, the corresponding πðθÞi of such competitors would be
obtained based on the expert judgment of the bidding firm or based
on the concept of educated belief, discussed earlier in the paper, or
the concept of the average bidder. The concept of average bidder
was proposed by Friedman (1956) and acknowledged by other re-
searchers later (Hanssmann and Rivett 1959; Capen et al. 1971).
The average bidder is a composite of all bidders that the contractor
has faced in the past (Sparks 1999). If the user has very limited
information about the competitor’s history and intends to form
its corresponding prior distribution without sufficient information
to form a good educated belief, the authors encourage the user
to use a probability distribution with parameters that result in a
J. Constr. Eng. Manage.
 minimally informative prior. This is a traditional practice in Baye-
sian statistics (Carlin 1996; Kelly et al. 2010). A minimally inform-
ative is one with an insignificant peak, such as a normal distribution
with a large standard deviation, a gamma distribution with a small
rate, or even a uniform distribution. A minimally informative prior
ensures the avoidance of the often-voiced criticism of subjectivity
in the choice of prior (Kelly et al. 2010). The advantage of Bayesian
statistics in this regard is that it allows for such incorporation with-
out jeopardizing the statistical integrity of the solution. Despite
that, still having complete and accurate data is much better and
much more credible than having incomplete data.
Step 5: Developing the Likelihood Functions
The likelihood function for each competitor is formed by first re-
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cording its latest common bid value(s) and then using such values
to form the likelihood function. Latest common bids are those bids
that are very recent and share a commonality. Such commonality
can be in the recency, meaning that the bids were made within a
short period of time. It can also be in factors affecting the bidding
behavior such as the management team, project type, project loca-
tion, cost range, risk, and so on. No matter what the commonality
is, the recency commonality has to exist. Such commonalities
strengthen the statistical significance given the conditional proper-
ties of the Bayesian statistics. If no commonalities are found, then
only the latest bid value is sufficient to form the likelihood function.
The likelihood function is formed as shown in Eq. (18)
X   
K  Z × 100
fðDjθÞi ∝ N r ik − 100; σik ð18Þ
k¼1
C k
where fðDjθÞi = likelihood function of competitor i; Nðrja; bÞ =
normal distribution probability density function with mean a and
standard deviation b, calculated as shown in Eq. (13); K = number
of latest common bids considered for the likelihood function; Zik =
bid value of competitor i in bid k; Ck = firm’s cost estimation of bid
k; and σik = estimated standard deviation representing the stochas-
tic uncertainty of the difference between the firm’s cost estimate for
bid k and the cost estimate of its competitor i for the same bid. The
right-hand side of Eq. (18) should be normalized and with a pos-
itive support.
Step 6: Calculating the Posterior Distribution
The posterior distribution pðθjDÞi for each competitor is calculated
in accordance with Eq. (8) throughout the multiplication of the cor-
responding prior distribution πðθÞi and likelihood function fðDjθÞi
and normalization of the result. Inferences about future bidding
strategies are made from the posterior distributions in the preceding
steps. Of course all such inferences are probabilistic given the dif-
ferent historical and recent bidding behaviors of competitors.
Step 7: Calculating the Probability of Winning
(Separate and Joint)
For each competitor, set f i ðrÞ ¼ pðθjDÞi and then use Eq. (4) to
calculate the probability of winning against each contractor i at the
different markup values r on the support of f i . Then for the prob-
ability of winning against all competitors in the bid, Friedman’s or
Gates’s equations are used [Eqs. (5) and (6)]. The firm has the free-
dom to select any of them, depending on its assumption of the bid-
ding price dependence. The firm can also use both and make a
comparison.
© ASCE 04016079-9
J. Constr. Eng. Manage., 2017, 143(1): -1--1
Step 8: Calculating the Expected Profit and Selecting
the Optimum Markup
This is the final step. After calculating the probability of winning
against all competitors, Eq. (7) is used to compute the expected
profit EPðrÞ. The optimum markup is the one that corresponds
to the maximum expected profit. Obtaining an optimum markup
does not guarantee a winning bid. A competitor might bid lower
and win the bid. In this case, such a result is not totally undesirable
because a lower bid price would have decreased the profits in the
case of winning, hence increasing the risk.
Some previous works in the literature assume that historical
data of direct markups, not bid values, are available. However,
the rest of the works are based on the assumption that the histori-
cal bid values are available because it is very difficult, almost
impossible, to obtain data about competitors’ markups directly.
No competitor would reveal its markup. The model in this paper
is flexible enough to incorporate both assumptions. In the case of
the availability of historical markup data directly, such as in the
first case study, Steps 1 and 2 are not required, but the rest of the
steps are essential. In the case that historical markup data are not
available directly, which is the more reasonable case, the full
steps are required to obtain the optimum bidding markup as
demonstrated.
Assumptions
The proposed model is built on the following underlying as-
sumptions:
1. It is presumed that the firm using the model is targeting one
objective, which is expected profit maximization. In reality, con-
tractors consider many criteria when it comes to deciding on the
markup such as the market conditions, the client’s reputation,
the job complexity, and others. However, no matter what the
criteria are, the governing attribute for winning the bid is still
the bid price relative to the competitors.
2. In many cases, it is unlikely that a firm knows the identity of
its competitors when bidding in a newly advertised project.
The model assumes that the firm knows the number of com-
peting bidders and their identities, even if it doesn’t have
proper historical data of one or more of them. Such assump-
tions can be valid to an extent by assuming that usually a
firm knows its competitors in a certain work specialty
(Boughton 1987). If no knowledge at all is present, then
neither this model nor any of the models in the literature can
be applied.
3. It is assumed that a firm keeps track of the bid prices of its com-
petitors for past bids. This information is available, especially in
public bids, where the bid prices of all bidders are announced
publicly after the bid-opening session (Awwad 2015). Indeed
the firm should have its cost estimates for such previous bids
so the bid ratios can be obtained.
4. The values of σij and σik are assumed to be known by the
firm through either some simple statistical analysis or
through experience. The same also applies for the values
of αij and β ij .
5. Each project is unique; however, some projects are more unique
than the others. The model will work best in cases where the
future bid has similar properties to those of historical ones and
lies within the same domestic market. International projects or
diversification into other work domains involve the input of
other conditionals that are not incorporated into the conditionals
of the posterior distributions, hence not allowing for a strong
output.
J. Constr. Eng. Manage.
 Case Studies
The proposed model was tested on two case studies from the liter-
ature. The first case study was a case where historical data of direct
markup values of competitors were available. The data were ob-
tained from Christodoulou (2004a) and the results were compared
to those of Christodoulou’s model. The second study was a case
where historical data of bid prices of competitors were available.
The data were obtained from Skitmore and Pemberton (1994). The
same data were used by Yuan (2011). So the results of the second
case study were compared to those of Skitmore and Pemberton
(1994) and Yuan (2011). The comparisons are not made to show
the superiority of the proposed model, but rather to demonstrate its
use, observe the differences between its results and those of other
models to deduct behavior patterns, and illustrate the effect of dif-
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ferent parameters on the resulting optimum markup.
In the first case study, the total number of competitors was 3. For
each competitor, there were 30 direct markup percentages avail-
able. So the available data points were in the form of M ij , where
i ∈ f1,2; 3g, J ¼ 30, and j ∈ f1,2; : : : ; Jg. Steps 1 and 2 were not
required in this case study since the data were already in the form of
direct markups.
In the second case study, the total number of competitors con-
sidered was 4. The gathered data were for actual bids entered by a
firm. The firm recorded the bid prices Bij of each of its competitors
(including other participants than the considered 4) and its own cost
estimates Cj . Each competitor had a code, namely 1, 55, 134, and
221. So, i ∈ f1,55,134,221g. There are different data points for
each competitor, where J i ∈ f33,20; 12,6g.
The data available in the case studies did not provide sufficient
information about the dates and conditions of the bids because the
previous statistical models did not require such information. Ac-
cordingly, some assumptions were made regarding the stochastic
variability in cost estimates, the selection of data points that provide
the likelihood function, and the distribution parameters in cases
where certain bid ratios were negative. In reality, when the pro-
posed model is used, the assumptions will be minimal because
the firm using the model will have all the proper information.
Fig. 3. Cullen-Frey graph for Competitor 1, Case Study 1
© ASCE 04016079-10
J. Constr. Eng. Manage., 2017, 143(1): -1--1
For each of the case studies, two scenarios were simulated. In
the first scenario, the likelihood function was formed by the last
observation, assuming that the preceding observations were less
recent. Accordingly the preliminary distribution forming the prior
function used j observations, where j∀f1,2; : : : ; J i − 1g. In the
second scenario, the likelihood function was formed by the latest
two observations instead. Thus, J∀f1,2; : : : ; J i − 2g in this sce-
nario. In both scenarios, it was assumed that the standard deviation
σij resembling the variability of the firm’s cost estimate and the
competitors’ cost estimates in the calculation of pdi ðrÞ was 2%
in a normal distribution form. This standard deviation was used
for all i and j. In reality, a firm knows the conditions of each i
and each j, which in return enables it to input a more accurate
σij for each data point. In the second case study, the following as-
sumptions were made with regards to the gamma distribution
parameters αij and β ij in the cases of negative bid ratios. For
i ¼ 1, the value of αij was 3 and the value of β ij was 1.3; for
i ¼ 55, the value of αij was 3 and the value of β ij was 2; and
for i ¼ 134, the value of αij was 5 and the value of β ij was 2. There
were no cases of negative bid ratios in bids related to competitor
221 so the gamma distribution part is not used for that competitor.
In each scenario, several values of σik were simulated to provide
some kind of a sensitivity analysis for the effect of σik on optimum
markup selection and the corresponding probability of winning. A
higher σik means a higher variability between the firm’s cost esti-
mate and the competitors’ cost estimate in the bids considered in
the likelihood function. Lastly, σik ¼ σ for all i and all k, where
σ ∈ f1,2; 3,4g. The case studies were programmed in R-language.
Results of Case Study 1
Since the data provided the historical direct markup values, the
Cullen-Frey graph of each competitor was plotted directly from
the data points. Fig. 3 shows the Cullen-Frey graph of Competitor
1 (as a sample), indicating that the normal, lognormal, and Weibull
distributions are possibly good fits for the corresponding markup
data. The MASS package in R was used to obtain the optimum
parameters for each of the three nominee distributions throughout
J. Constr. Eng. Manage.
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Fig. 4. Fitting the markup data of Competitor 1 to Weibull distribution, Case Study 1

the maximum-likelihood fitting routine. Afterward, the K-S test
was conducted to select the most suitable fit throughout the
p-values. For Competitor 1, the best-fit distribution, eventually
forming the prior function, was the Weibull distribution with the
parameters scale = 10.575 and shape = 2.147. This distribution
was also visually compared to the data points throughout the histo-
gram Q–Q, cumulative distribution function (CDF), and P–P plots
for verification as shown in Fig. 4. The same steps were conducted
for the rest of the competitors. The resulting prior function of the
second competitor was obtained from a uniform distribution with
parameters min = 0.4 and max = 19.4. The histogram of the third
competitor showed two significant peaks, so the logspline approxi-
mation was used to obtain its prior function using the logspline
package in R. The Cullen-Frey graph and distribution fitting figures
for Competitors 2 and 3 are not shown for the sake of the paper’s
length.
The likelihood and posterior functions were calculated in accor-
dance to the model’s methodology and the aforementioned stated
assumptions. The probability of winning against each contractor
was obtained and the combined probability of winning against
all competitors was calculated once using Friedman’s formula
and once using Gates’s formula. The expected profit and probabil-
ity of winning curves for each σ in the two scenarios are shown in
Figs. 5 and 6. The optimum markup and its corresponding prob-
ability of winning for each σ in the two scenarios are shown in
Table 1.

Fig. 5. Expected profit and probability of winning against all competitors in Scenario 1, Case Study 1

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J. Constr. Eng. Manage., 2017, 143(1): -1--1

Downloaded from ascelibrary.org by Budi Atmoko on 05/09/17. Copyright ASCE. For personal use only; all rights reserved.

Fig. 6. Expected profit and probability of winning against all competitors in Scenario 2, Case Study 1

Table 1. Optimum Markup Determination and Corresponding Probability of Winning, Case Study 1
Scenario 1 Scenario 2
Bidding
σ ¼ 1% σ ¼ 2% σ ¼ 3% σ ¼ 4% σ ¼ 1% σ ¼ 2% σ ¼ 3% σ ¼ 4%
against
competitor M Pwin M Pwin M Pwin M Pwin M Pwin M Pwin M Pwin M Pwin
number (%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%)
1 7.6 0.86 7.3 0.80 7.2 0.75 7.2 0.71 8.5 0.94 8.2 0.85 8.2 0.79 8.1 0.75
2 12.6 0.92 11.9 0.87 11.4 0.82 11.1 0.76 13 0.96 12.1 0.92 11.6 0.86 11.1 0.81
3 9.9 0.92 9.4 0.89 9.2 0.84 9.1 0.79 10.9 0.61 9.8 0.55 8.9 0.57 8.6 0.59
Winning alla 7.5 0.87 7.1 0.80 6.7 0.75 6.4 0.69 8.5 0.60 7.6 0.56 7.1 0.57 6.7 0.58
Winning allb 7.5 0.87 7.1 0.81 6.9 0.74 6.7 0.68 8.8 0.59 8.2 0.55 7.6 0.56 7.3 0.56
a
Based on Friedman’s formula.
b
Based on Gates’s formula: M (%) = optimum markup; Pwin = probability of winning corresponding to M (%).

In Scenario 1, where the likelihood function is formulated from
the latest observation, the optimum markup for winning against all
three competitors in a future bid ranged from 6.7 to 7.5% as shown
in Table 1. The 7.5% corresponded to the lowest σ and the 6.5%
corresponded to the highest σ. The probability of winning in such
markups ranged from 87 to 64% depending on σ. There were no
significant differences between the results of Friedman’s and
Gates’s formulas in this scenario.
In Scenario 2, where the likelihood function was formulated
from the latest two observations, the optimum markup for winning
against all competitors ranged from 6.7 to 8.8%. These markup
values were higher than those of Scenario 1 because the corre-
sponding observations, especially for Competitors 1 and 2, pro-
vided stronger evidence that the competitors’ current bidding
scheme was more risk inclined. In this scenario, the differences be-
tween Friedman’s and Gates’s formulas increased but were still not
very noteworthy. The gaps between them increased in higher values
of markups, where the probability of winning was lower.
As the variability, or the belief of variability, between cost
estimates (represented by σ) decreased, the optimum markup in-
creased and the probability of winning also increased, as shown
in Fig. 7. This means that if a firm has high certainty that its cost

Fig. 7. Effect of σ on optimum markup selection and the corresponding probability of winning, Case Study 1

© ASCE 04016079-12 J. Constr. Eng. Manage.

J. Constr. Eng. Manage., 2017, 143(1): -1--1

 estimate is within a small range of its competitors’ cost estimates, it
can bid with a higher value of markup and at the same time with a
higher probability of winning, up to a certain level, of course.
Results of Case Study 2
In this case study, all eight methodological steps were performed
because the available data were in the form of competitors’ bid pri-
ces and the firm’s own cost estimates. The preliminary distribution
of each of the competitors was calculated based on Eq. (12). The
MCMC sampling was performed for competitors to sample from
their preliminary functions. The left side of Fig. 8 shows the con-
vergence of the Markov chains of competitors 55, 134, and 221.
The MCMC acceptance rate ranged from 77.8 to 88.1%, which
is acceptable because it is above 25%. The right side of Fig. 7
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The best-fit prior functions for competitors 55 and 221 followed
the following density functions, respectively: Weibull distribution
with parameters shape = 1.503, scale = 4.22 and Weibull distribu-
tion with parameters shape = 2.106, scale = 7.181. The histogram
of competitor 134 showed two significant peaks, so the logspline
approximation was used to obtain its prior function using the logs-
pline package in R. All of the bid ratios of Competitor 1 were in the
negative range, so the preliminary distribution function of that com-
petitor mainly utilized the gamma distribution part of the function,
which was based on the firm’s experience rather than objective
numerical operations. For that reason, no MCMC sampling was
required for that competitor because the preliminary distribution
was already a parametric one that had a known density function.
The used gamma parameters for Competitor 1 are shape = 3, rate =
1.3. The authors assumed that Competitor 1 was a risk taker so its

shows the histograms of the resulting points and their fitted prior markups were in very low ranges. Such an assumption was made
distributions after performing the K-S tests on them. for demonstration of the effect of belief on the results. In reality, if

Fig. 8. MCMC convergence of competitors and the resulting prior distributions, Case Study 2

© ASCE 04016079-13 J. Constr. Eng. Manage.

J. Constr. Eng. Manage., 2017, 143(1): -1--1

 data are not available, the firm can form a more educated belief
from its experience in the market.
The likelihood and posterior functions were calculated in accor-
dance with the model’s methodology and the aforementioned stated
assumptions. The probability of winning against each contractor
was obtained and the combined probability of winning all compet-
itors was calculated once using Friedman’s formula and once using
Gates’s formula. The expected profit and probability of winning
curves for each σ in the two scenarios are shown in Figs. 9 and 10.
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The optimum markup and its corresponding probability of winning
for each σ in the two scenarios are shown in Tables 2 and 3.
As shown in Tables 2 and 3, the optimum markup and proba-
bility of winning were calculated for bidding against six combina-
tions of the competitors. For example, the first combination was for
bidding against competitors 1, 55, and 134. The rest of the combi-
nations are stated in the aforementioned tables. The combinations
were selected this way to provide a comparison between the pro-
posed model and the models of Skitmore and Pemberton (1994)

Fig. 9. Expected profit and probability of winning against all competitors in Scenario 1, Case Study 2

Fig. 10. Expected profit and probability of winning against all competitors in Scenario 2, Case Study 2

Table 2. Optimum Markup Determination and Corresponding Probability of Winning, Scenario 1, Case Study 2
Combined probability based on Friedman’s equation Combined probability based on Gates’s equation
Winning against
σ¼2 σ¼3 σ¼4 σ¼2 σ¼3 σ¼4
the following
competing bidders M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%)
1 þ 55 þ 134 1.20 62.4 1.24 61.4 1.26 59.9 1.33 59.5 1.41 57.7 1.46 55.7
1 þ 55 1.57 64.5 1.55 62.5 1.51 61.4 1.58 64.4 1.61 61.4 1.62 59.3
1 þ 134 1.21 62.1 1.29 61.4 1.35 61.3 1.33 59.7 1.43 58.6 1.5 58.2
55 þ 134 1.67 62.4 1.81 61.0 1.9 59.7 1.69 61.9 1.90 59.9 2.12 56.4
55 þ 221 2.41 66.7 2.55 63.4 2.58 60.4 2.47 65.9 2.78 61.0 2.9 57.1
All 1.12 62.5 1.17 61.5 1.2 60.6 1.28 58.6 1.36 57.1 1.41 56.1

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J. Constr. Eng. Manage., 2017, 143(1): -1--1

 Table 3. Optimum Markup Determination and Corresponding Probability of Winning, Scenario 2, Case Study 2
Combined probability based on Friedman’s equation Combined probability based on Gates’s equation
Winning against
σ¼2 σ¼3 σ¼4 σ¼2 σ¼3 σ¼4
the following
competing bidders M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%) M (%) Pwin (%)
1 þ 55 þ 134 1.32 63.7 1.32 62.0 1.32 60.7 1.45 60.7 1.49 58.4 1.51 55.9
1 þ 55 1.53 65.0 1.51 63.5 1.58 61.3 1.56 64.3 1.60 60.6 1.61 58.7
1 þ 134 1.35 63.6 1.41 62.2 1.45 61.6 1.47 60.1 1.53 59.9 1.57 59.4
55 þ 134 2.19 62.4 2.16 60.7 2.2 58.3 2.32 60.4 2.41 57.4 2.57 53.6
55 þ 221 2.57 68.2 2.57 63.1 2.57 59.9 2.72 66.4 2.84 60.1 2.89 56.5
All 1.25 64.0 1.26 62.0 1.25 60.5 1.4 60.6 1.44 58.2 1.47 56.5
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Fig. 11. Effect of σ on optimum markup selection and the corresponding probability of winning, Case Study 2

and Yuan (2011), given that they used the same combinations ex- range or not does not make the proposed model any more or less
cept for the last one. Figs. 5 and 6 show the expected value and validated because Christodoulou’s model works in an entirely dif-
probability of winning graphs for the last combination only, which ferent methodological approach. However, it surely substantiates
is bidding against all four competitors. the abilities of the proposed model in generating sensible results.
Similar to Case Study 1, as σ decreased, the probability of win- In the second case study, for bidding against competitors 1, 55,
ning increased. However, as σ decreased, the optimum markup in- and 134, Skitmore and Pemberton (1994) suggested an optimum
creased as shown in Fig. 11, which is contrary to what is in Case markup of 13.47%, while Yuan (2011) suggested an optimum
Study 1. Also, as the value of σ increased, the gap between the markup of 2.79% (Table 4). The proposed model suggests an op-
outcomes of Friedman’s and Gates’s formulas increased. Further timum markup ranging from 1.20 to 1.46%, with a winning prob-
discussion is available in the next section. ability ranging from 55.7 to 62.4%, given the assumption of the
first scenario. For the second scenario, where the likelihood func-
tion is formulated from the latest two observations, the optimum
Discussion markup ranges from 1.32 to 1.51% with a winning probability that
ranges from 58.4 to 63.7%. The values of optimum markups and
In the first case study, the optimum markup for winning against all the winning probabilities within each range depend on the value of
competitors ranged from 6.4 to 8.8% and the corresponding prob-
σ and on the decision whether to use Friedman’s or Gates’s
ability of winning ranged from 55 to 87%, depending on the sce-
formula.
nario and the value of σ. To compare, the neuro-fuzzy model
For bidding against competitors 55 and 134, Skitmore and
developed by Christodoulou (2004b) suggested an optimum
Pemberton (1994) suggested an optimum markup of 7.7%, while
markup of 7% for the same data, which is within the range of op-
Yuan (2011) suggested an optimum markup of 3.29%. The pro-
timum markup resulting from the proposed model. Being within the
posed model suggests an optimum markup ranging from 1.67 to
2.12%, with a winning probability between 56.4 and 62.4%, given
the assumption of the first scenario. For the second scenario, the
Table 4. Optimum Markup Values Obtained by Skitmore and Pemberton
proposed model suggested optimum markup ranging from 2.16
(1994) and Yuan (2011), Case Study 2
to 2.57% with a winning probability between 53.6 and 62.4%. The
Competing Skitmore and Yuan (2011) values of optimum markups and the winning probabilities within
bidders Pemberton (1994) (%) (%) each range also depend on the value of σ and on the decision
1 þ 55 þ 134 13.47 2.79 whether to use Friedman’s or Gates’s formula.
1 þ 55 10.98 3.69 Generally in the second case study, the optimum markup values
1 þ 134 12.06 3.74 suggested by Yuan (2011) are much lower than those suggested by
55 þ 134 7.70 3.29 Skitmore and Pemberton (1994). Although both of their statistical
55 þ 221 6.62 —
models employ correlation analysis of historical bids, the differences

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J. Constr. Eng. Manage., 2017, 143(1): -1--1

 between their results emerge from the calculation of the expected
profit. Skitmore and Pemberton take the cost estimation error into
consideration in an augmented way in the expected profit calcula-
tion. The probability of winning in the model of Skitmore and Pem-
berton is 15–20 times lower than that of Yuan (2011) and the
proposed model. To this end, the authors believe that Yuan’s model
is more accurate than the one presented by Skitmore and Pember-
ton. However, both of these models do not employ the idea that
competitors change bidding behaviors.
The proposed model resulted in optimum markups that are
even less than those of Yuan (2011). Such low values are caused
by the assumption that was made for Competitor 1, that it is a
risk taker, and thus its markup values are always low. Another
assumption would have changed the results. The difference in
results between the proposed model and Yuan’s model is a result
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of two factors. First, both models have totally different method-
ologies. Second, the proposed model takes the dynamic behavior
of competitors into consideration, so it is more dependent on
recent observations. In the case study, the most recent observa-
tions had low bid ratios. The authors believe that the proposed
model produces accurate results because it takes the dynamic
behavior of competitors into consideration. The model’s accu-
racy increases when the user is knowledgeable about competi-
tors. If such knowledge is available, the assumptions will be
minimal.
The proposed model requires some additional information about
historical bids other than just bid prices of competitors. Because
such additional information was not available in the data provided
in the literature, the authors simulated different scenarios with dif-
ferent likelihood approaches and different values of σ. The output
was a set of different values of optimum markups and probabilities
of winning. However, in reality, the assumptions will be minimal
and there will be only one value for markup and one for probability
of winning. Also, a firm that opts to use the proposed model can do
its own sensitivity analysis and scenarios. It might add a stochastic
term in the σ parameter itself, where σ itself would follow a certain
distribution.
In both case studies, as the variability, or the belief of variability,
between cost estimates (represented by σ) decreased, the probabil-
ity of winning increased. This means that if a firm has high
certainty that its cost estimate is within a small range of its com-
petitors’ cost estimates, it can bid with a higher value of markup
and at the same time with a higher probability of winning. Accord-
ingly, the accuracy of cost estimation is an important factor in
deciding the allocated markup, which is in alignment with the dis-
cussion of Capen et al. (1971). A high certainty of the cost estimate
is always desired. On the contrary, there is no agreement between
the case studies on the general effect of σ on the optimum markup.
In other words, there is a relationship between σ and the optimum
markup, but this relationship is different for each project and each
set of competitors. In cases, σ and the optimum markup might have
a positive correlation and in other cases they might have a negative
correlation.
Although different values of σ result in different optimum mark-
ups and winning probabilities, such differences are not significant.
This means that the optimum markup is not very sensitive to σ. So
the firm does not have to put a lot of effort into estimating the σik of
the likelihood. However, it should do so in estimating the σij of the
historical data. Obtaining credible values of σij should not be dif-
ficult throughout some statistical analysis of the historical bids. To
this end, a high probability of winning does not guarantee winning.
Nothing in life is guaranteed. This is why all bidding models are
stochastic, not deterministic.
© ASCE
J. Constr. Eng. Manage., 2017, 143(1): -1--1
Conclusion
This paper utilized a multistage decision-theory-approach bidding
model embedded within a Bayesian framework for contractors to
estimate the optimum markup in future bids. The optimum markup
is the one corresponding to the highest expected profit, where the
expected profit is the multiplication of the probability of winning
and profit. The model was developed in an attempt to tackle two
gaps in the current body of knowledge. First, the model takes the
dynamic behavior of competitors into consideration. Accordingly,
if a competitor has changed its bidding strategy, such a change is
reflected in the model and the optimum markup is estimated ac-
cordingly. Second, the model is able to produce sound statistical
inferences, leading to optimum markup decisions in cases of
incompleteness of competitors’ historical data. Such abilities are
obtained through the innovative combination of decision theory
and Bayesian statistics.
The proposed model was compared to three bidding models
from the literature that utilized two historic case studies. Each case
study had its own set of data. Since the data available did not have
all of the required information, reasonable assumptions were made
for the missing information. The purposes of the case studies were
to demonstrate the use of the model and to illustrate the effect of
different parameters on the resulting optimum markup. The model
showed that the more recent bidding strategies of competitors play
a significant role in predicting the future ones. Also, as the contrac-
tor becomes more certain about its competitor’s behavior, both its
probability of winning and optimum bidding markup increase. In
the first case study, the results of the proposed model were close to
those of Christodoulou (2004a, b). In the second case study, the
proposed model suggested a markup that is less than that of Skit-
more and Pemberton (1994) and Yuan (2011). In both case studies,
the probability of winning decreased when the variability of cost
estimates between competitors increased. This highlights the im-
portance of high accuracy in cost estimating. The authors believe
that the proposed model produces statistically accurate results,
especially when good quality data are available. This belief is sup-
ported by the widely credible Bayesian approach and the multi-
staged approach that accurately simulates the competitors’
dynamic behavior. One important assumption is that the number
of competitors competing in the given bid is known. Most of
the models in the literature make such an assumption as well. This
research should be beneficial for the construction stakeholders to
better understand decision making in bidding processes and con-
sequently to help create a healthy contracting environment.
For future work, the authors recommend testing the model on
further case studies and automating the process using a user-
friendly software tool to run the model. It is recommended to test
the implementation of a hybrid model that utilizes both the multi-
staged Bayesian approach and a multivariate analysis approach
under the umbrella of decision theory. The authors intend to further
extend the research to include hybrid game theory concepts that
would add the ability to predict the winner’s curse and to grasp
the effect of learning in bidding. Such an interdisciplinary frame-
work will provide a more holistic and comprehensive understand-
ing of construction bidding that will enable better decision
making.
Acknowledgments
The authors would like to sincerely thank the anonymous reviewers
whose comments and suggestions helped improve and clarify this
paper.
04016079-16 J. Constr. Eng. Manage.
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