Sensitivity Analysis of Construction Contract Prices Using Spreadsheets

Abstract

“Bad profits” have been identified as the cause of more than one‐half of all business failures in construction. To improve the profitability of the construction contractors, the Fair and Reasonable Markup (FaRM) is defined as the smallest markup that satisfies the Required Rate of Return (RRR) of the contractor for the particular (or at least the general risk class of the) project at hand. The microcomputer‐based FaRM Pricing Model provides a systematic and efficient framework for analyzing the forecast cash‐flow stream of the project and for estimating the Minimum Acceptable Price (MAP). The model utilizes LOTUS 1‐2‐3 spreadsheet and can be implemented on most IBM or compatible microcomputers. The computerized model delivers speedy responses to a variety of what‐if questions investigating the sensitivity of FaRM and MAP to the billing policy and the Required Rate of Return (RRR) of the contractor and to the payments time lag and the retainage policy of the owner. Once the FaRM Pricing Model has been implemented, contractors should bid lower on projects which are more attractive; thereby, they should become more competitive. This should result in lower costs to owners while satisfying the RRR of the contractors. Conversely, contractors can maintain their RRR on the less attractive projects by submitting higher bid prices