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Five Common Bidding Methods

by Jim Huston

photos by Tim Rue

There are many methods used to price jobs on the market today. However, they can be reduced to five methods, each of which has its strengths and weaknesses. As we begin our analysis of the five methods, refer to the two jobs in diagram (1), which will serve as examples.

1. The Factoring or "Multiplier" Method:

Diagram 1
Job A
Job B
Materials
$100,000.00
$40,000.00
Labor w/Burden
$15,000.00
$60,000.00
Equipment
$5,000.00
$20,000.00
Subcontractors
$0.00
$0.00
Total Direct Costs:
$120,000.00
$120,000.00
Overhead per hour (OPH)
$7.50
$7.50
Profit per hour (PPH)
$5.00
$5.00
Labor hours
1500
6000

Using the factoring method (Diagram 2), we simply multiply estimated material costs (or estimated material and labor costs) by a "factor". The factor may be based on past profit & loss (P&L) statements or it may be a number "arrived" at as a result of monitoring past competitive bidding situations. Taxes, field labor burden, profit and overhead are all included in the factor used. An added contingency factor may be applied to the job if desired. However, that is not always the case.

Although this method is fast, the flaws in it are almost too numerous to mention, but it is surprising how many landscape and irrigation contractors bid their work using this "material times two" approach.

Essentially, it does not address the multitude of variables (site conditions, profit markup, general conditions, expensive vs. inexpensive plant materials, etc.) that can, and usually do, impact a bid.

2. The Gross Profit Margin (GPM) or the Single Overhead Recovery System (SORS) Method:

Competitive Bidding Formats & Strategies

There are essentially five conventional pricing methods used in the preparation of construction bids. The decision as to which format is used is not always left in the control of the bidding contractor. Rather, the owner or agency soliciting the bid proposal will generally dictate which methodology is employed and bidders must respond in the specified format or risk rejection as a “non responsive” bid.

The various bidding formats in conventional use are as follows:

1. Lump Sum or Stipulated Sum:

When the scope of work is well defined and the quantities of each type of work can be readily determined, the most common bidding technique is that of Lump Sum bidding. In some areas this is known as a Stipulated Sum bid. The bid can be rendered down to a single, all-inclusive dollar value for the work because the plans and specifications are sufficiently clear and complete that the bidding contractor can anticipate virtually all potential risks and arrive at an appropriate pricing strategy to complete the work and assume those risks. In this scenario, all of the implied risk of the project is shifted to the bidding contractor whose bid must be inclusive of all costs. This method is most often used for new construction with complete plans and specifications.

2. Unit Price Bidding:

When the scope of work is well defined, but the quantities are unknown, the most common bidding methodology is to structure a Unit Price bid. In this scenario, the bidder knows enough about each element of work that he/she can propose a price based upon an assumed quantity. Ordinarily, the assumed quantity would be provided by the person soliciting the bid such that the unit prices quoted by each individual bidder, when extended by the specified quantities, provides a common basis by which to compare multiple bidders.

Unit price bidding is generally used for engineering projects such as highway and street improvements, underground utilities, and landfill gas recovery systems. It is also a common practice to use unit price bidding in the production housing market where Owner/Developers may prefer to negotiate fixed unit cost per lot, or per individual irrigation and landscape element. With a catalog of such fixed unit prices, the Owner can add to the contract on an incremental basis as residential communities are built-out in response to market demand.

3. Cost Plus Fee:

When the scope of work is not clearly defined and the quantities of individual work items are not necessarily measurable, the likely bidding scenario is that of Cost Plus Fee. The “Fee” in this instance is the bidding contractors’ overhead and profit for performing the work. The fee may be computed as a fixed sum for the work in it’s totality, or it may be computed as a percentage factor that is to be added to the project’s material, labor, equipment, and subcontractor costs.

Cost plus fee contracting is most frequently used for Fast Track construction projects where there is a limited time for construction and it becomes necessary to begin construction on portions of the work before complete plans and specifications can be prepared for the project in its entirety.

4. Base Bid and Alternate Bid Items:

Situations often occur where the scope of work is well understood and the quantity of work is easily measurable, but the amount of funding available to the project is uncertain. Under such a scenario it may be necessary to request that the bids be structured in a manner that establishes cost values for discreet elements of work that, when combined, equal the total project scope. The bid structure will reflect the relative optimism or pessimism of the Owner or Agency.

For example, a bid for a park might include the general park construction as the base bid, with alternate pricing for individual elements like tennis courts, restroom/concession building, picnic shelters, etc. If the base bid is sufficiently below the available funding, the Owner / Agency can then add one or more of the alternate items back into the project scope.

5. Combination Bids:

Many times the nature of the work may dictate that the proposal incorporate a combination of several of the above items. It is not uncommon for an Owner or Agency to base the bid selection upon a Lump Sum bid amount, but require the bidders to include a schedule of stand-along unit prices (not extended by quantities or included in the bidding total). The purpose of the unit price schedule is to establish at the time of bid unit pricing for any incidental additions or deletions to the work.

Similarly, a project may suggest that portions of the work be bid as a lump sum, with portions of the work bid as a unit price bid, in addition to which bidders are required to provide alternative pricing for separate elements of work. The possibilities are almost without end and are all intended to structure the proposal in a manner that will provide an equitable distribution of risk and reward for the participants.

Conclusions:

The method and structure of bidding a project is all determined by the need to provide an equitable distribution of risks and rewards. Careful determination of the format for receiving or for submitting bid proposals can help to quantify the risk and then distribute it proportionately. When a project’s inherent risk is appropriately distributed through the bidding format, bidders can focus more on the cost of the work and less on the cost of the risk. The resulting bids will generally represent a win-win scenario where the contractor’s reward and the Owner/Agency’s value are appropriate to the project.

by Kelly F. Duke

Director of Pre-Construction Services, Valley Crest

There are a number of popular derivatives of the GPM/SORS (Diagram 3) approach to pricing, and there is often some historical basis for using these adaptations. Although it has some merits and applications, virtually all of these positives are only useful when they are incorporated into other, more accurate and flexible, estimating methods.

Although the specific fractions may change, their use is the same. The estimator, after reviewing past P&L statements (or recollecting from past experience--either his own or that of a trusted "source"), determines that material costs have comprised approximately 33.3% of gross sales (plus or minus a percent or two). Labor with burden, and possibly equipment costs, accounts for another 33.3% (+/-). The remaining 33.3% covers equipment costs (if not combined with labor), overhead, and profit.

Using our two jobs as an example, bidding results would be as follows:

The pitfall of the GPM method is what happens to direct costs once they are calculated and identified. Our two examples will help us to understand the inherent error.

Jobs "A" and "B" both have the same direct costs. Assuming that our company field payroll is $15,000 per month (including labor burden), "Job A" consists of one month of payroll, while "Job B" consists of four months of payroll.

"Job B" should have four times the overhead as "Job A" because it lasts four times longer.

The GPM/SORS method has a serious flaw in this area because it does not adjust overhead recovery to accurately reflect the duration of the job.

3. The Market-Driven Unit Pricing (MDUP) Method:

All photos provided courtesy of Valley Crest, an Environmental Industries company, based in Calabasas, California. All photos were taken during the construction phase of the Queensway Bay-Rainbow Harbor project in Long Beach, California. Valley Crest specializes in commercial projects.

Do not make the mistake of assuming that there is something inherently wrong with organizing and presenting an estimate in a unit price format. The format is not the issue. The issue is the process (or the lack of a process) used to arrive at your unit price(s).

Contractors, who use this method, first break a job into units commonly priced on the market. They then take prices from the "market" and apply them to these units without analytically considering the numerous variables which might drive these prices up or down.

Contractors who rely solely upon the MDUP method seriously short-circuit their business systems. Key information and data that is needed to direct and to control individual jobs (as well as the entire company or division) is just not available. As a result, meaningful job costing is not possible, and the company lurches forward in a fog.

4. The Multiple Overhead Recovery System (MORS) or the "Traditional" Method:

Diagram 2
Job A
Job B
Material Costs
$100,000.00
$40,000.00
Factor
x 2.0
x 2.0
Price
$200,000.00
$80,0000

This method of pricing projects has gained popularity in recent years and is being taught in estimating workshops throughout North America. In fact, I taught it in workshops for over two years in the late 1980's while I was employed at another consulting firm.

This method can have distinct advantages over the previous ones IF used properly and IF key information used to bid is kept current. However, herein lies its chief disadvantage. It is overly complex, and it is difficult to adjust to compensate for varying market conditions. This becomes a particular liability in periods of rapid market change.

The MORS estimating method actually cost one of my clients $500,000 in sales one year (sales that he should have gotten) because he did not know how to adjust his bidding methods to reflect changes in his company and the market.

The MORS method is essentially the same as the GPM/SORS method except when it comes to overhead and profit. Instead of using a "single" percent on all direct costs, four different (multiple) percentages are used, to recover overhead. These four percentages are applied to materials, labor & burden, equipment and subcontractors. The percentages usually applied are 10%, a range of 30-100%, 25% and 5%, respectively. Profit is then added to the job as deemed appropriate. Diagram (4) displays implementation of the MORS method and how it attempts to compensate for the differences in the duration of the two jobs.

Diagrama 3
Job A

Job B

Material Costs
$100,000.00
33.3%
$40,000.00
33.3%
Labor, Burden, & Equip.
$100,000.00
33.3%
$40,000.00
33.3%
Subtotal
$200,000.00
66.6%
$80,000.00
66.6%
Overhead & Profit
$100,000.00
33.3%
$40,000.00
33.3%
Total price
$300,000.00
100.0%
$120,000.00
100.0%

The advantage that the MORS method has over the GPM/SORS one is that it adjusts overhead recovery according to the duration of the job. However, it does have serious disadvantages.

The main disadvantage of the MORS method is that it is simply too complex and cumbersome a system for the contractor who is already overloaded. Adjusting the MORS method to account for "T & M" work, prevailing wage rates, rapidly changing markets, recessions, etc. is extremely "tricky" and time consuming.

Another serious drawback of the MORS method is the "traditional" markups applied to materials, equipment and subcontractors (10%, 25%, and 5% respectively); which have absolutely no clear analytical basis. Another shortcoming of the MORS method is that overhead recovered on jobs is not easily accumulated, tracked, and compared to actual financial statements.

Basically, the MORS method is just too complex and intrinsically inflexible. Fortunately, there is an easier method...

5. The Field-Labor Hour Recovery or the Overhead and Profit per Hour (OPPH) Method:

Although not a panacea, the OPPH pricing method provides considerable advantages over all of the previous methods discussed.

Diagram 4
JOB A
Direct Costs
Overhead %
Overhead $
Materials (w/Tax)
$100,000
10%
$10,000
Labor (w/burden)
$15,000
36%
$5,400
Equip. (w/rentals)
$5,000
25%
$1,250
Subcontractors
$0
0%
$0
Total overhead applied to job

$16,650
total direct costs

$120,000
total costs (break-even point)

$136,650
Profit (10%)

$15,183
Price for job

$151,833

JOB B
Direct Costs
Overhead %
Overhead $
Materials (w/Tax)
$40,000
10%
$4,000
Labor (w/burden)
$60,000
36%
$21,600
Equip. (w/rentals)
$20,000
25%
$5,000
Subcontractors
$0
5%
$0
Total overhead applied to job

$30,600
total direct costs

$120,000
total costs (break-even point)

$150,600
Profit (10%)

$16,733
Price for job

$167,333

However, it is necessary to have a clearly identified overhead amount on a company/division basis to recover for the year. This amount is then divided by the number of field-labor hours to determine the overhead per hour (OPH) dollar amount. OPH ranges from $2-5 for large commercial companies up to $10-14 for smaller ones.

Overhead is then allocated to projects on the basis of the number of field-labor hours estimated in each bid. For instance, a project that had 1,000 field-labor hours in the bid would be marked up $6,000.00 for overhead (1,000 hours x $6.00 OPH) if the OPH was $6.00. There may be some slight variations to this process, but this is essentially how the OPPH method recovers overhead. Profit is then added either as a percent of the total costs of the job or on a per hour basis similar to overhead. Diagram (5) shows how the OPPH method is applied to the sample jobs.

There are two critical requisites and a caveat attached to the OPPH method. First, projected field-labor hours must be reasonably accurate (within plus or minus 10%) to actual hours for the year. Second, overhead must be correctly calculated and not include any direct costs such as field equipment or labor burden items.

Contractors should be cautious when first using the OPPH method. They should compare prices it produces with ones produced from their previously used estimating methods. Otherwise, they might underprice jobs and "leave money" at the bid table.

Diagram 5
Job A
Job B
Total direct costs
$120,000
$120,000
Overhead ($7.50 x 1500)
$11,250 ($7.50 x 6000)
$45,000
Total costs (BEP)
$131,250
$165,000
Profit ($5.00 x 1500)
7500 ($5 x 6.00)
$30,000
Total price for job
$138,750
$195,000

In conclusion, all five pricing methods have their strengths and weaknesses. At best, factoring and the MDUP methods are all but useless for determining consistent, accurate prices for your work; at worst, they can cause serious errors. While the GPM/SORS and the MORS methods have some merit, they should also be used with caution. I recommend that contractors estimate their jobs using the OPPH method and then compare its results to their present method of bidding. The OPPH system will not only provide you with more accurate and consistent pricing, it can also be easily monitored and compared to your company's actual P&L statement performance. LCM

This article was adapted from James Huston’s book, Estimating for Landscape & Irrigation Contractors. The author is president of Smith Huston, Inc. which specializes in construction and services management consulting to the Green Industry. Mr. Huston is a member of the American Society of Professional Estimators and he is one of only two Certified Professional Landscape Estimators in the world. For further information on the products and services offered by Smith Huston, call 1-800-451-5588, e-mail SHI at shi@smith-huston.com, or visit the Smith Huston web page at http://www.smith-huston.com.


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September 18, 2019, 7:46 am PDT

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