Underbidding: Warning! Highly risky manoeuvre

If you need proof of just how much damage underbidding can do, go to Norwich. This is where the collapse of Connaught last September spelled disaster for a £17.5m housing maintenance contract. When it won the bid, Connaught had been desperately trying to win work to keep its show on the road. Earlier in the year, the bid had been challenged in court by rival bidder Morrison as being “abnormally low”. Morrison’s bid was £5.5m higher.

When Connaught finally fell, the city was rocked. Three hundred jobs were lost, and the council had to draft in replacement firms on emergency contracts, causing disruption to services. “There were much longer waiting lists for repairs,” says Conservative councillor Nikki George. “It was the people of Norwich who suffered.”

Underbidding and trying to claw back costs from the supply chain leads to confrontation, erodes trust, and doesn’t work with a partnering culture

Michael Ankers, Construction Products Association

Of course Norwich was not the only council affected, underbidding was systemic at Connaught and is rife throughout the construction industry. In the end, underbid contracts harm the bidder, the client, the end-users and rival firms that might have been able to do a better job. So why does underbidding continue? And what, if anything, can be done about it?

Almost everyone in the industry agrees that bid after bid is going in at or below the cost of a job, though nobody will admit to doing it themselves. A CIOB survey of its members released in January found that 82% of respondents thought so-called “suicide bidding” existed in the industry but there is precious little hard evidence on how prevalent the practice really is. Paul Sheffield, chief executive of Kier, estimates that at least 10% of bids are loss-making, while James Wimpenny, regional director of Bam in the North-west, estimates the figure is one in four. Another social housing contractor estimates the figure is more like one in five, and that the undercutting is severe. “We have seen quite a few examples where people have put contracts in 20% under [the nearest bidder]. In desperate times people do desperate things,” he says.

Consultants, too, are witness to the practice. Richard Steer, senior partner at Gleeds, says: “In certain circumstances we are seeing very low bids. They can be 20% lower [than the next rival].” He admits underbidding by consultants themselves does go on, but by a smaller margin. Yet the head of one major consultancy privately rages at rivals who offer bids two-thirds lower than his firm’s, barely covering the cost of the equipment that was being installed.

Destroying trust

So why do companies underbid? One reason is, like Connaught, to use it as a temporary way to boost revenue and help the firm - albeit temporarily - stay afloat. Wimpenny says: “People are taking a strategic decision to do it. We know on some bids you just won’t get that money back.” Sheffield adds: “By and large it’s about a surge of costs, and to keep people busy.”

But it is not always simply a way to buy revenue in harsh times. Many contractors do it in the expectation of reclaiming costs by exploiting loopholes in the contract and squeezing suppliers. “I’m not 100% sure that we know we’re underbidding. Instead we’re just saying that the market is falling and we’ll get it back [during the contract],” says Wimpenny. Figures from last year’s Constructing Excellence survey show just 47% of projects finished on price, and the figure has not been above 52% during the last decade. The contract seems to be just the start, rather than the end, of price negotiations.

Some in the industry defend low-bidding as a common sense response to a weak economy. Stan Hornagold, the founder of the
Marstan Group, argues (see box below) that it’s merely a sign of competition at work if a contractor decides to work for no profit. If supermarket brands sell customers loss-leaders, why not construction firms?

Yet this low-bidding strategy looks increasingly risky in 2011 as tender prices stagnate and the cost of materials and energy (in particular oil) rapidly rise. Michael Ankers, chief executive of the Construction Products Association, says that contractors won’t be able to claw back money by squeezing manufacturers. “You’re not going to be able to drive down costs through materials,” he says. Data from the RICS suggests that tender prices will increase by just 0.2% by the end of 2011, well below normal inflation - let alone materials inflation. Copper has risen by 225% since 2009, iron ore doubled in price since last summer, and with Libya now at war, oil is at a two-and-a-half year high.

Ankers also warns that underbidding destroys the very trust needed to integrate the supply chain - which the industry has been trying to do since the Latham report in 1994 - because it can require contractors to recoup money through contract loopholes. “They can have lawyers look over the contract to see where they can make costs back. That’s why there’s such a claims culture in the industry. It leads to confrontation; it erodes trust, and doesn’t work with a partnering culture.”

Procurement people in local government are coming under huge pressure from elected representatives to choose the lowest price

John De Souza, Construction Client Group

And Sheffield fears underbidding will ruin any trust built up between clients and contractors over the past decade. “I fear a lot of the good work done in the industry could be thrown out of the kitchen window because when somebody bids on a very low cost then they want that back.” Chief construction adviser Paul Morrell has convinced the government to spare construction the immediate discounts demanded of its other major suppliers, because he thinks the industry can save up to 30% by integrating and collaborating more. Underbidding and trying to claw back costs threatens this very exemption that the industry has fought for.

Product of circumstances

Underbidding, which is difficult to detect, will be even harder to tackle. And what a fragmented industry can do about this mutually assured destruction is unclear. Underbidding is not on the main agendas of any of the major construction groups, and any attempt by contractors to prevent it could smack of a cartel. Sheffield thinks that contractors have been cowed by the OFT’s £129.2m of fines for cover pricing in 2009 (although dramatically reduced since for firms that appealed). “If you look at the OFT it took very draconian measures against something that was quite innocent. So contractors don’t want to act collectively,” he explains.
Clients, particularly in the public sector, are under more pressure than ever to accept the lowest bid. Yet Jon de Souza, head of the Construction Clients Group [CCG] at Constructing Excellence, suggests that even though funds are tight, it’s easier to save money by collaborating on the job than to pick the lowest bid to begin with. “Clearly there are budgetary pressures at the moment,” he says. “The way to take cost out of construction projects is to work with them or use BIM [Building Information Modelling].”

Yet the CCG can only advise, not regulate, and many clients, particularly in local government, seem not to be listening. In January, Building reported that Apollo had heavily underbid its nearest rivals on three council housing contracts in Scotland, one by nearly 20%, although Apollo says it does not bid on loss leaders. West Dumbartonshire council, which accepted two of the bids, says contracts of this kind are “normally awarded to the lowest bidder” as long as they meet minimum standards. Basic standards are set by the OGC, which handles government procurement, but these apply only to central government departments, not local government. “Central government tends to be a very good procurer,” says de Souza. “Local government tends to be a bit more patchy. Procurement people in the [local] authority are coming under huge pressure from elected representatives [to choose the lowest price].”

QSs could have a crucial role to play in combating underbidding. Behind every low bid lurk two QSs - one for the contractor, and one for the client. The RICS says it doesn’t have a policy on underbidding and could not find anyone to talk about the practice. But Steve Newcombe, vice president of quantity surveyors’ group QSi, says that QSs need to be ready to tell uncomfortable truths to clients when presented with low offers. “It’s up to the cost consultant to advise clients of what’s going on, and provide some sense,” he says.

And lawyers can also do their part. Bidding below cost and then recouping money during construction can be rooted out with watertight contracts. Newcombe says: “Contract documents are inadequate when they are sent out. If they were more complete then it wouldn’t be possible.” Chris Hill, a partner at Norton Rose, adds that lawyers can adapt contract terms to cut back the grounds for claiming extensions of time and loss and expense but ultimately clients need to avoid dealing with underbid contractors. “This might be the time for clients to encourage realistic pricing by using hybrid two stage tenders - fixed prices for prelims, profit and overheads and transparent pricing of work packages,” he says.

This would not stop firms that set out to lose money in return for revenue, however. As more insolvencies are a certainty this year, firms secretly in their death throes could be doing untold damage to cash-strapped clients and rival bidders not prepared to put in loss-making bids. One QS at an SME in Scotland wrote to Building in frustration that “below net cost tendering is slowly ruining the building industry and sooner, rather than later, will have to be legislated against.” But with no prospect of this happening, we can expect to see more Norwich-style disasters as the industry races to the bottom.