Chapter 2

CONSTRUCTION PRICING AND

CONTRACTING

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 2.1 TENDERING POLICY AND PROCEDURE

The construction contract price includes the direct
project cost including field supervision expenses which
are often referred as site overhead costs plus the
markup imposed by contractors for general overhead
expenses and profit.

For any firm to operate its business in a satisfactory
manner, it is necessary for its policy directors to
establish a clear objectives or a strategy.
2.1 TENDERING POLICY AND PROCEDURE...


to have a continual process of determining the missions

and goals of an organization within the context of its
external environment that create opportunities and
threats, and its internal environment which are
expressed as strengths and weaknesses.

This strategy often depends upon many factors which
the management body of the contractor has to make a
thorough analysis of the situations at hand and take up
appropriate competitive advantage.
2.1 TENDERING POLICY AND PROCEDURE...

Factors that need to be considered in construction

pricing

• Work at hand,
• The geographical areas in which the firm will operate,
• Type of client the organization is to favor, ( private, local authority,
community services, )
• Projected risks and uncertainties of the project,
• Form of the bid: (open, short-listed, pre-qualification, etc)

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 Bid Qualification
Procedure

Competitive Bid Negotiated Bid

Short listed Open Bid

One Stage Procedure Two Stage Procedure

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2.1.1 BIDDING STRATEGY
In a competitive tendering situation, the
contracting firm is constantly facing a tradeoff of
submitting a high price for getting profit and the
resulting shortage of work, with that of a low
price for winning the contracts, but allow little
profit margin.
Develop a bidding strategy to
determine the OPTIMUM BID

 First step: MAP THE BIDDING

PATTERN OF KEY
COMPETITORS
2.1.2 TENDERING PROCEDURE
Procedure for tendering: Ministry of Infrastructures
i) Decision to Tender
• Production workload,
• Future commitments,
• Market,
• Capital,
• Associated risk,
• Prestige, reputation
• Estimating workload,
• Time for preparation of
tender,
ii) Collection of Information
iii) Preparation of Estimate
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iv) The Tender
v) Action with Tender Results
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2.1.3 Firm’s Mark-Up
-To determine firm’s mark-up target, it is required establish:
i) Return on Capital Employed (ROCE), which is made to account the
following costs:
• The average weighted cost of capital ( Interest of capital employed)
• Profit margin (dividends, capital reserves...)
• Corporate obligations such as taxations and deprecation costs.
• Contingencies to cover uncertainties ( Risks)
ii) Annual Turnover on contracts. This can be obtained from
short-term plan committed or planned for execution in the current
year.

iii) General overhead costs (off-site administration)

General overheads

Costs entailed in administering the company and

providing off-site administration
The general overheads vary with individual firms,
but a broad list may include:
• Rent, rates on office ,
• Fees, salaries and wages for directors and office staff,
• Office equipment, stationary, postage, telephones, cars
• Office heating and lighting
• Insurances on office and staff
• Interest on capital borrowed
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 Express
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these Costs as a percentage
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of previous year’s turnover
Example
Assumptions
Capital Employed: Birr 2,000,000
Turnover on contracts for year: Birr 4,000,000
General overheads: Birr 160,000
Return on Capital Employed 17%
Target: Contracts must contribute (Head office Mark-up)
General overheads Birr 160,000
Return ( ROCE) 17% ( 2,000,000 ) Birr 340,000
Head office Mark-up = Birr 500,000

Production Costs = 4,000,000 – 500,000 = Birr 3,500,000

Mark-up on contracts = (500,000 / 3,500,000) x 100 = 14.3%

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2.2 CONTRACT PROVISIONS FOR
RISK ALLOCATION
All Pricing arrangements have some common
features in the form of the legal documents
binding the owner and the supplier (s) of the
facility.
Common types of Pricing arrangements are:
1) Competitive Bidding 2) Negotiated Contracts
• Final bid • Reimbursement is
submitted on lump direct project cost
sum or unit price plus the contractor’s
basis fee
 All forms of construction pricing
arrangements pose differed level of risk to the parties
in the contract. Hence, it is
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important to identify the provisions for risk
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in contracts
PARTIAL LIST OF RESPONSIBILITIES
ASSIGNED TO DIFFERENT PARTIES IN A
CONTRACT
 Force major : "Acts of God" and other external
events such as war, etc
 Indemnification: third party liability transfers
 Differing site conditions,
 Delays and extensions of time,
 Liquidated damages,
 Occupational safety and health of workers,
 Permits, licenses, laws, and regulations,
 Equal employment opportunity regulations,
 Termination for default by contractor,
Warranties and guaranties,
 zY:i ed(B
) M Price variation adjustments,
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RISKS AND INCENTIVES ON CONSTRUCTION QUALITY

Most claims and disputes arise most frequently from

lump sum and unit price contracts for both public
and private owners, the following factors associated
with lump sum contracts are particularly
noteworthy:
 Unbalanced bids
 Change orders subject to negotiated payments
 Changes in design or construction technology
 Incentives for early completion
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2.3 TYPES OF CONSTRUCTION CONTRACTS
In addition to serving as a means of pricing
construction, contracts also structure the
allocation of risk to various parties involved:
1. Lump Sum Contract
All risk assigned to the contractor
1. Unit Price Contract
The risk of inaccurate estimation of uncertain
quantities for some key tasks has been removed from
the contractor
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Problem: Unbalanced Bid
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Cost + Contracts
 Cost Plus Fixed Percentage Contract
Purpose: for new approach/technology yet to be
analyzed
 The owner takes all the risks of cost
overruns

•Cost Plus fixed fee contract

•Cost plus variable percentage contract

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•Target Estimate Contract

1. Actual costs measured against target estimates of

the contractor.

•Guaranteed Maximum Cost Contract

Suitable for turnkey operations

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THANK U!