Why some firms count on bid rigging to survive

Good news. No less than 112 contractors, who form much of the core of the construction industry, have been named for colluding.

At last there is a major, albeit confidential, report on the building industry that “reveals” what really occurs and how contractors operate. The Office of Fair Trading (OFT) has announced its report (or Statement of Objections, to give it its official title), on collusion in construction, but unfortunately, the EU competition rules under the EC Treaty which established the European Community and the UK Competition Act 1998 prevent the report itself from being published.

Nevertheless, if proven, this news is like a breath of honesty and realism against a background of much misleading discussion about the industry and its methods of working. The Latham and Egan reports of 1994 and 1998 respectively initiated the most unrealistic debates within construction circles, creating partnering, demonstration projects and key performance indicators, and much more and claiming great improvements had been achieved. No doubt there have been changes. Now, thanks to the OFT, we have an opportunity to shift the discussion away from wishful thinking and on to a more realistic approach.

Firms in construction must meet their clients’ requirements not their own preferred output levels.

Unfortunately, from what little has been released, this widespread attack by the OFT on the construction industry does not mention the nature of the construction market, how it operates and how the firms in the construction industry work. This is important because it is what construction firms do and how they cope.

Contractors compete to provide an identical service, namely the construction of a building or structure. With the exception of design and build, whoever wins the tendering process, the end product is expected to be the same regardless of who the main contractor may be. Because they all offer the same thing, construction firms have to survive in a high risk market with low profit margins. It is not surprising that firms take measures to reduce and manage the risks they face.

At the tendering stage the client has unrestricted power. In reaction to that power, firms respond covertly and informally. Should contractors not determine what they do? How else can they manage their own workloads efficiently and profitably? Firms in other industries can adjust their levels of output. Firms in construction must meet their clients’ requirements not their own preferred output levels. One method of controlling the type and quantity of work especially when operating without any spare capacity, is to tender a cover price in order to remain on a tender list for future projects.

However, tendering is not costless for contractors. Losing contractors lose their costs of tendering. These losses cannot be ignored by contractors.

Until recently many clients have conveniently tended to ignore the cost of tendering. However, tendering is not costless for contractors. Losing contractors lose their costs of tendering. These losses cannot be ignored by contractors.

For example, if profit margins are, say, 2% of turnover, not an unreasonable margin in the construction industry, then for every £20,000 lost in unsuccessful tender bids, the firm must generate £1m worth of business. It then carries out that construction work only to sacrifice the profits from that effort in lost tenders. Compensation payments are rational, if companies have paid out to participate in the tendering process and the compensation agreement is seen as a method of mitigating bidding risk.

The construction market is not like the airline market or the mobile telephone market or the supermarket market, where a few firms sell to millions of customers with no power to influence or negotiate prices with these overwhelmingly large companies. Each construction deal is an individual bargain.

is the OFT also unwittingly accusing the quantity surveying profession of failure to identify costs?

If local authorities, the NHS or private sector developers decide to reject the lowest bid in a tender competition, they could withdraw, re-tender or negotiate with another contractor. In the labour market, employers do just that, when jobs are re-advertised if there are no suitable candidates. If clients limit their options and commit themselves to select one of the tenders before having had sight of the submissions, then that is the client’s choice.

At the tender stage contractors must therefore assess the willingness of clients to pay. Each party to a construction project only enters into a contract after the tenders have been offered. The key point is that clients have to be willing to pay. They are, after all, advised by an army of professionals. Or is the OFT also unwittingly accusing the quantity surveying profession of failure to identify costs? In the end both parties to a contract must come to an agreement for work to commence.

Government is repeatedly criticised, when it does not accept the advice of its own experts. If excess payments have indeed been made as a result of construction firms’ collusion, this would appear to be an example of the advice of experts given to clients being systemically wrong. This, in spite of the fact that building costs are kept under constant surveillance throughout the process by quantity surveyors, project managers, accountants, architects and lawyers, all professionals in their fields.

If excess payments have indeed been made as a result of construction firms’ collusion, this would appear to be an example of the advice of experts given to clients being systemically wrong

After all, the tender process is only a construction industry ritual. It is the method whereby clients choose the main contractor. After the building process begins, the actual costs of construction become apparent, especially if clients or architects alter designs from the original concept. Indeed often detailed drawings are not available and problems arise after contracts have been signed.

There can be variations, unexpected delays and late deliveries, bad weather and accidents. All raise costs after contracts have been signed. In the construction industry it is not tender prices that matter but final building costs.This is the actual cost of building work.

Contractors invariably subcontract the work to specialist firms. Plant and labour are hired on an ad hoc basis. The actual cost of carrying out the construction work is roughly similar, regardless of who wins a particular contract to be the main contractor. The tender price becomes notional.

It is right not to be complacent but it is important to keep a sense of perspective. While not wishing to whitewash activities that may have been against the public interest, undoubtedly, the OFT report will do much long lasting damage to the reputation and image of the construction industry. It may even deter many, who might otherwise have considered it as a career.

Nevertheless, this report sheds important light on the mysteries of the tendering process. Pointing out the nature of the construction market is not a case of special pleading. It is a matter of understanding the economics of the building industry. This is not to suggest that the construction industry is a garden tea party, but if the conditions in the construction business environment are not mitigating circumstances, what is?