The price is not always right

by William T. Pepoon


THE OLD PROVERB SAYS: “Fool me once, shame on you; fool me twice, shame on me.” When it comes to selecting subcontractors or suppliers, however, project managers are often seduced by the lowest price. The result? Fooled twice.

So what's the lesson here? Just this: If it seems too good to be true, it probably is.

“Hoping for the Best.” A client of mine was pursuing a multimillion-dollar claim against the Federal Bureau of Prisons (FBOP) for design and field delays. While it became apparent that several early delays were “caused” by the FBOP, there was also significant delay toward the end of the project that resulted solely from the poor performance of the kitchen equipment subcontactor.

The project would have been delayed by the kitchen equipment problem anyway; but the same could also be said of the site conditions. Both delays were essentially concurrent in that one had no influence on the other. Under these circumstances my client was still entitled to a time extension for the amount of delay caused by events attributable to the FBOP. The problem was, this time would be noncompensable for the number of days equal to the delay caused by the kitchen equipment subcontractor.

Compensable delays work like this: If the FBOP caused, say; 120 days of delay and the kitchen equipment subcontractor caused 90 days of delay, my client would receive a time extension of 120 days. Only 30 days of delay (120 minus 90) would be compensable. Of course, if the numbers were reversed—the kitchen equipment delay is larger than the FBOP delays—my client would receive a time extension for 90 days, with zero days compensable. The FBOP could then also assess liquidated damages against my client for finishing the project 30 days late.

During my investigation I discovered a startling fact: This subcontractor had caused delays on not one but two other projects my client had built. On all three projects the biggest delay resulted from the equipment being delivered late. Far from being just hapless, the kitchen equipment subcontractor had intentionally misled my client regarding the progress of procurement activities on every project.

William T. Pepoon, PMP, is a senior consultant with Wagner-Hohns-Inglis Inc. in Mount Holly, N.J. He has been providing CPM Scheduling, dispute resolution, and project management services to the construction industry for 15 years. He is also editor of PMI's Design-Procurement-Construction SIG's newsletter, The Project Management Standard.

On the project in which I was involved, my client had sent someone to the kitchen equipment subcontractor's shop to verify the status of procurement. The company president proudly displayed a great deal of stainless steel material being shaped into countertops. ‘All of this,” the project manager was told, “is for your project.” In fact, none of that material was intended for his project. He had been duped.

Naturally, my client cursed the kitchen equipment subcontractor for being unscrupulous. While I agreed that some of the blame certainly should be placed on the subcontractor, I also felt that my client had largely created this situation. Which begged the question: Why hire someone who has hurt you twice before?

The answer: Price! This subcontractor had submitted the lowest price on all three projects, much lower than anyone else. Despite their misgivings after the first project, my client had used this subcontractor on the second project, “hoping for the best.” On the third project, some individuals inside my client's firm had argued against using this subcontractor yet again, but had been overruled by upper management.

Having worked as an estimator, I know the dilemma of receiving an attractive bid from someone unreliable. As my father—the consummate general contractor—used to say, “It's easy to be the lowest bidder; all you have to do is make mistakes.” In many cases these mistakes are unintentional and result from numbers being added or recapitulated incorrectly. Take-off errors and misinterpretation of the plans and specifications are other typical causes of unrealistically low bids.

I will never forget the drywall subcontractor who submitted a price that was nearly half the amount of any other bid I had previously received. Upon further questioning, I learned that his quantities were likewise roughly half of my own figures. Small wonder—he hadn't considered that because the plans he was using were half-scale the published scale was inaccurate. Nevertheless, he refused to change his price. But should we use him?

Our decision was simple. We ignored his bid. His price was less than the cost of materials alone. He wasn't familiar to us, so we had no idea if he could even afford such a mistake. Many of the subcontractors we dealt with on a regular basis did their bookwork at the kitchen table. A loss of just a few thousand dollars could wipe them out. But our biggest concern was that someone who knows they will lose money before the project has even started has a strong motivation to cut corners: substitute cheaper, nonapproved materials; pay workers less than prevailing wages; increase the spacing of studs; whatever.

We realized that other general contractors might choose to use this bid, regardless of whether or not they were aware of the mistake, which clearly put us at a competitive disadvantage. In order to be the lowest bidder we would have to find savings in other areas. Ironically, this drywall bid could have forced us to cut corners if we had used it. We didn't—and didn't get the job.

Returning to the FBOP project: my client hadn't used the lowest kitchen equipment price when preparing their bid. So he was at least successful in getting the work at a reasonable price. The decision to use the lowest price was subsequently made during the buy-out phase, in order to maximize profits. I have had clients tell me they make more money during the buy-out of a project than the line item for profit included in their bids. My opinion is that if you keep cutting, eventually something will fall off.

Contractors are by nature optimists. If a contractor contemplated everything that could go wrong he wouldn't get any work. Using an unrealistically low price is always a risk: the greater the potential savings, the greater the risk. As my client finally learned after three tries, wishful thinking is not very effective in managing risk.

The “Successful Bid.” I was preparing a delay claim for “Mike,” project manager for a general contractor in the northeastern United States. I knew Mike's company was bidding on a very promising project and inquired as to its status. He replied, “We were the successful bidder.” “So you got the job?” I asked. He just smiled. “No. We were the successful bidder—we didn't get it.”

I knew exactly what he meant. Mike's company had submitted a very competitive price, but someone else was willing to do it for a lot less money. Mike's company was wise enough to realize that getting the job at the wrong price is much worse than not getting the job at all. Letting go of the “win at any cost” mentality made them the successful bidder.

Even though we're adults, we often find ourselves being influenced by peer pressure. If everyone else is getting work at insanely low prices, there must be a way to make money at those prices, right?

Wrong! Many companies will price a service at a rate that is acceptable to their clients. They either don't know or don't care to find out what price will allow them to make a profit. Their biggest fear is that raising the price too high may result in no demand whatsoever. So be it. If the market won't pay you what you need to survive, you need to get out of that business.

I know you're thinking: “This guy doesn't know what he's talking about. Nobody I know goes around bidding projects at prices that will cause them to lose money!” Oh, really? I've seen some big players admit to some pretty silly thinking. One of my overseas clients initially wanted to pursue a “total cost claim” against the owner, meaning that all cost overruns were attributable to the owner. But after further contemplation they asked me to provide four alternatives in my cost analysis: (1) assume a 40 percent error in the original bid; (2) assume a 50 percent error in the original bid; (3) assume a 60 percent error in the original bid; (4) assume a 65 percent error in the original bid.

Think about it: My client was willing to concede that its original bid may have been as much as 65 percent below what it should have been. That's more like a confession than a concession! What my client might characterize as “bad assumptions” I would simply call “mistakes.” More importantly, when such variances exist they tend to reflect underestimating rather than overestimating a project. The truth is, it will take my client several successful projects in the same price range to recover those losses.

For project managers in the construction industry, getting work often means competing against many other firms, mostly (or solely) on price. Reputation helps when the numbers are close, but only in the private sector. Public owners really have no choice—they must take the lowest price. But this doesn't mean a contractor has to submit a bid that makes no sense internally, or accept a subcontractor's bid that appears ridiculously low.

Unfortunately, bid prices seem to be inversely proportional to how badly you need the work. When times are tough there is considerable pressure to take liberties. Plans and specifications are viewed in a “favorable” light, meaning that the interpretation that costs the least amount to implement is the correct one. If subcontractor or supplier costs aren't as low as had been expected, a more acceptable (lower) price will be penciled in with the expectation that “we'll beat it out of them later.” Conditions that could be foreseeable will be classified “unforeseeable” and therefore subject to an adjustment in price after the project has been awarded.

You Know What They Say About “Assume.” Let's spend more time finding creative ways to do the work for less money without breaching the plans and specifications. As soon as you find yourself making assumptions regarding the project scope, stop. Submit your assumptions in writing to the owner prior to submitting your bid. This is standard protocol on public projects, but many contractors choose not to because: (a) the owner will share this information with the other bidders, or (b) the owner might say “no.” Either way, the contractor loses whatever competitive advantage lies in making these assumptions.

I'm speaking of good assumptions, of course. Contractors rarely assume the worst unless they have very little interest in the project. But why make assumptions at all? The plans and specifications are supposed to explicitly describe the scope of the project. Assumptions should only be made when the scope is undefined. That is to say, the architect/engineer might make certain assumptions during the project development phase, when scope is still being influenced by cost and schedule concerns. Not so during the procurement phase. If a contractor isn't sure exactly what the scope is, he shouldn't submit a bid!

A certain level of uncertainty exists in every project, but this does not legitimize making assumptions. Risks can be analyzed by a neutral party—albeit with somewhat different results—whereas assumptions are highly personal. Taken to the extreme, a person can assume just about anything. Assumptions, for that matter, tend to project one person's opinions onto someone else. How often have you heard, “I thought this would be acceptable to you” or “How was I supposed to know that you'd have a problem with this”?

WISHFUL THINKING AND assumptions make poor foundations for a proposal. The price is right only when it can withstand close scrutiny. Don't worry about what your competitors are willing to do to get the work. Your competitors aren't going to build this project for you or assume its risks. Even under the best of circumstances you will make mistakes; the only way to not make mistakes is to do nothing at all. The smart person, however, never makes the same mistake twice. images

Reader Service Number 049

May 1999 PM Network



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