Bidding Strategy and Markup

Estimation

Objectives

From studying this topic, you will be able to:

 Understand the factors that affect markup decision

 Utilize the data of past bids to analyze the bidding
behavior of key competitors
 Analyze the probability of winning a bid at a given
markup value
 Estimate an optimum markup value as an allowance
for risk and profit

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 Where we are?

Bidders

-Data (site, Quantities,

specs, resources, etc)
-Planning
-Estimating
-Scheduling
-Resource Management

Bidding Strategy &

Markup Estimation

-Cash Flow

CONCEPT DESIGN BIDDING CONSTRUCTION O&M

Accounting for Project Risks

 The bidding strategy is basically a fine-tuning of the
bid by accounting for the level of uncertainty
associated with the project and adding an allowance
for profit.
 Contractors often have two main methods of assessing
and accounting for project risks:
 Estimating a single percentage markup to be added to the
total cost (our topic today);
 Detailed analysis of the risky components in the project, the
probability of risk occurrence, and the expected damages so
that to assign an appropriate contingency allowance for each
of these components.

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 Price/Cost Anatomy
Bid Price

Cost Markup
Profit
Risk contingency
Direct Cost Indirect Cost
Labor
Equipment Project General
Material Overhead Overhead
…

The Final Touches

 We have calculated the direct costs, indirect

costs, calculated project duration, resolved
resource problems, and adjusted the schedule
so that it meets the deadline.

 All these aspects establish a good baseline plan

in terms of time and cost for the project. Now,
it is time to put the final touches for the bid.

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 The Final Touches

 If you are much involved in the construction

business, you must have experienced how
difficult it is to decide on a suitable bidding
strategy against the expected competitors.

 We need to decide on the percentage that

makes the bid low enough to win, at the same
time, high enough to make a reasonable profit.

Estimators Relative Variations

Approximate range
of contribution to Relative Variations
70-90% total cost among estimators

5-20%

3-10%

0-10%

Direct Project General Markup

Cost Overhead Overhead

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 The Challenge

 Despite the importance of these decisions to a

cost commitment, you might have to decide on
them while a lot of information is still lacking and
under the pressure to speed up the bid
preparation.

 Markup needs to be optimally decided.

Analyzing the Bidding Behavior

of Key Competitors

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 Profitability vs. Chance of Winning

 To sustain success in the construction business,

you have to be the lowest bidder for a sufficient
number of projects while the bid price is not too
low in order to make a reasonable profit.

 It is important therefore, to strike a balance

between profitability and the chances of
winning.

Winning Requirements

 To establish a winning bidding strategy we

need to:

 Keep track of our past bids and analyze their

information; and
 Depict any bidding pattern for our key competitors.

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 Required Information
 Information we have:
 Our cost estimate (C = direct + indirect) for any past
bid is known for us.
 Since we cannot know the cost estimate of other
competitors, let’s assume that the cost estimate for
all bidders are the same. This assumption is not true
but can be realistic if we assume that all bidders
have access to the same subcontractors, suppliers,
and follow standard construction technology.
 The bid prices of competitors in past bids are known
to us as a public information published by most
owners after the bid is let.

Bid Price, Cost, & Markup

 The relationship between the bid price and the
cost estimate in any bid is as follows:

 Bid Price (Bi) of competitor i = C x (1+markup)

 Bi / C = 1 + markup
 markup = (Bi / C) - 1

 The Bi / C is a representation of the markup

used by competitor i in one bid.

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 Bid Price, Cost, & Markup
 For Example, in a past bid that we lost, our cost estimate
was $1,000,000. For that project, we submitted a total bid
of $1,150,000 while our key competitor “Company A” bid
was $1,100,000.
 Assuming cost estimate is constant:
 We used a markup of [(1,150,000/1,000,000) -1] = 15%
 “Company A” used a markup of [1,100,000/1,000,000) -1] = 10%

 It is important to analyze if the 10% markup used by

“Company A” is a policy that is repeated in other bids.

Analyzing “Company A” Bidding

Behavior

 Let’s expand our analysis of “Company A” by

retrieving all our records of past bids in which
we competed against them. Let’s assume we
found 31 past bids and we have all the
information regarding our cost estimates and
the bid prices.

 We can create a histogram as follows:

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 7
6 6 No. of past bids against
the competitor

3 3

Below 2 2
cost
1 1

Competitor’s Bid (B)

1 1.1 1.2 1.3 1.4 B/C=
Our Cost Estimate (C)

0% 10% 20% 30% 40% markup= B/C -1

Answer the following Questions

 If the B/C ratio used by “A” in a past bid was

1.25, it means the company used a markup
of ____%
 If we decide to use a 10% markup in a new
bid against “A”, how many times in the past
did they underbid us at this level of markup?
 What is our chances of winning “A” using
25% markup?

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 Answer the following Questions

 If we bid right at cost (no profit), then your

B/C becomes?
 How many times did company “A” bid below
cost?
 What is the average markup used by
“Company A” and how much it varies?

 Mean = 1 x 1.375 + 2 x 1.325 + 3 x 1.275 + 6 x 1.225

+ 7 x 1.175 + 6 x 1.125 + 3 x 1.075 + 2 x 1.025
+ 1 x 0.975 ) / 31 = 1.175

 Standard Deviation = Σ(X-µ)2 = 0.0931

(n-1)

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 Assume Normal Distribution
(m, s)
Probability table for Probability of winning
standard normal using markup (m) =
distribution shaded area

B/C

Desired markup = (m) m

Then, B/C = (m+1)

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 Estimating Optimum Markup

What is to Optimize?
 We have two conflicting objectives: to reduce
markup to improve the probability of winning,
and to increase markup to improve profitability.
 The probability of winning is unit-less and profit
is in dollars.
 We multiply the two components to get the
Expected Profit that is to be used as a measure
for optimality.

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 The Expected Profit

 Expected Profit of a given markup =

Probability of winning
Profit
x all competitors using
value $
the specified markup

1. Calculate the probability of winning individual

Markup % x Cost competitors, then
2. Combine these probabilities to determine the
probability of winning all of them
simultaneously.

Winning a Single Competitor

 Example: You have kept good records of the bidding
behavior of one competitor “Company B”. The mean
and standard deviation of the company’s B/C ratio are
calculated to be 1.1 and 0.1, respectively. Answer the
following:

a) What is the probability of winning “Company B” in a new bid,

using a 20% markup? Your cost estimate for the new project is
$1,000,000.
b) What is the expected profit at this markup?

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 Winning a Single Competitor
 Solution:
a) At 20% markup, B/C = 1 + markup = 1.2
Using the standard normal distribution table,
B/C
z = (X-µ) / σ = (1.2-1.1)/0.1 =1.0 1.1 1.2

From the table (provides left side area), Probability = 0.8413, then the
probability of winning “Company B” at 20% markup = 1 - 0.8413 =
0.1587 (the shaded area)
b) Expected profit = Probability of winning x Profit
= Probability of winning x Cost x markup
= 0.1587 x $1,000,000 x 0.2 = $31,740

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 Winning All Competitors
Simultaneously
 How to combine: Pwin(A), Pwin(B), Pwin(C), … @ a certain
markup level, to get Pwin(All), at that markup
 Two models are available:
 Friedman (1956): The basic assumption is that different
competitors’ probability distributions are mutually independent.
Accordingly, he suggested a multiplicative model to combine the
probabilities; i.e., Pwin(All)= Pwin(A) x Pwin(B) x Pwin(C) x …
 Gates (1967): criticized the independence of Friedman and offered
his model as follows: 1
Pwin(All)=
1 - Pwin(A) + 1 - Pwin(B) + 1 - Pwin(C) + …+[1]
Pwin(A) Pwin(B) Pwin(C)

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 Optimum Markup Estimation

Expected
Profit

1% 3% 5% 7% 9% markup

Optimum markup

Optimum Markup Estimation

 Initialization: m = 0%, increment j = 1%
 LOOP
 m=m+j
 LOOP
 Calculate P win (competitor i) @ markup m

 DO LOOP for all competitors

 P win (all)
 Profit = m x Cost
 Expected Profit (EP) = Profit x P win (all)
 j= j+j
 DO LOOP till m = M (e.g. 20%)
 m optimum @ EP maximum

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 Example
 A contractor wants to determine the optimal bid to
submit for a job with estimated cost $1,000,000,
bidding against 3 key competitors with the following
historical data.

Competitor B/C (mean µ) B/C (standard

deviation σ)
A 1.081 0.052
B 1.032 0.044
C 1.067 0.061

Solution
 At markup = 1%
 Probability of winning the 1st competitor, “A”
 X = B/C = 1+markup = 1+0.01 = 1.01
 ZA = (X-µA)/σA = (1.01 -1.081)/0.052 = -1.365
 From normal Distribution table - value = 0.086
 Then Probability P win A =1 – 0.086 = 0.914
 Probability of winning the 2nd competitor, “B”
 X = B/C = 1+markup = 1+0.01 = 1.01
 ZB = (X-µB)/σB = (1.01 -1.032)/0.044 = -0.500
 From normal Distribution table - value = 0.309
 then Probability P win B = 0.691
 Probability of winning the 3rd competitor, “C”
 X = B/C = 1+markup = 1+0.01 = 1.01
 ZB = (X-µC)/σC = (1.01 -1.067)/0.061 = -0.934
 From normal Distribution table - value = 0.175
 then Probability P win C = 0.825

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 Solution
 Probability to win All @ 1% markup:
 Friedman Model:
 P win All-F = 0.914 x 0.691 x 0.825 = 0.521
 EP-F (expected profit) = $1,000,000 x 0.01 x 0.521
= $5,213.3
 Gates Model:
 P win All-G = 0.571
 EP-G (expected profit) = $1,000,000 x 0.01 x
0.571 = $5,705.9

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 Solution

14000 4.2%
12000
3.2%
10000

8000 EP-F
6000 EP-G

4000

2000

0
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0%

 Friedman’s and Gates’ models give different results, and

debate over the years has not been able to resolve this
conflict.
 There are many studies that concluded that:
 Freidman’s model is more correct when variation in bids is only
due to markup,
 Gates’ model is more correct when variation in bids is only due
to variation in cost estimate
 Gates model gives higher markups, i.e., Freidman model can
present a pessimistic approach while Gates model presents an
optimistic approach

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 Important Bidding Relationships
 When σ of B/C ratio of a competitor is small, it indicates
this competitor uses a consistent markup policy (easy to
win)
 in case of high project risk, it is wise to use higher
markup as an allowance for unforeseen conditions. The
use of Gates model in this case is more advisable.
 When the level of competition is high (large number of
bidders) and the economic conditions are not favorable,
winning bids becomes difficult and bidders reduce their
bids.

Important Bidding Relationships

 In construction, an average bidder behavior is

exhibited as having B/C ratio mean of 1.06 and
standard deviation of 0.065. For building construction,
markup may vary from 2 to 10%, while in highway
and heavy civil construction, it can reach up to 20%.
The average number of competitors bidding for a job
is around 6. (can be used in case of no information)

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 Important Bidding Relationships
 The correlation between markup and number of
competitors and between markup and project size has
been studied and results are as follows (can be used
in negotiations):
 m2/m1 = (n1/n2)0.7
 m2/m1 = (s1/s2)0.2

 With Friedman and Gates models being viewed as

pessimistic and optimistic a moderate bidding strategy
is to consider the average of their optimum markups.

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