Bid Compensation Theory and Strategies for Projects with Heterogeneous Bidders: A Game Theoretic Analysis

Abstract

Practitioners involved in large-scale, complex projects have long been searching for strategies that encourage bidders to invest more effort in project planning and schematic design during the bid preparation process. According to conventional wisdom, one of the strategic alternatives for encouraging bidders to make extra efforts in the early stage is to offer bid compensation to unsuccessful bidders. However, although the argument for using bid compensation is intuitively sound, rigorous investigations on the effectiveness of bid compensation are scant. In this study, game theoretic analysis is applied to analyze strategic interactions among project bidders. In large-scale, complex projects, it is not unusual to have one or two bidders who have stronger competitive power than other bidders do, such as reputation, specialties, and financing capability. Thus, a more general scenario is examined where the bidders are heterogeneous in terms of their competitive advantages. Through the analysis, the authors show that, under certain conditions, the offering of bid compensation can effectively encourage the stronger bidders to make extra efforts in the early stage. Conditions for the effective use of bid compensation are identified. Strategic implications for practitioners are derived and suggested accordingly.