Risk and Need‐for‐Work Premiums in Contractor Bidding

Abstract

Contractors add significant premiums, on the order of 3%, to their bids when they have a low need for work or projects have high risk. An empirical study of the effect of need‐for‐work and project risk on contractor bid markups was conducted by assessing and analyzing utility functions obtained from construction contractors in a bid‐simulation exercise. Thirty New England contractors participated in the study. The statistical analysis of utility data indicates, with a high level of confidence, that need for work and risk significantly affect contractor bid markups. A revised model of bidding is presented. The paper also discusses the implications of these need‐for‐work and risk premiums for owners, contractors, and the insurance industry. Specifically, project managers should seriously consider investing at least 1% of the project cost in studies that reduce the risk perceived by contractors.