Pricing Risk in Construction Tenders
When pricing construction tenders the contractors are faced with assessing risk and uncertainties. If the risk is underestimated or missed, the contractor could face significant monetary loss. Smaller contractors do not necessarily have a risk assessment methodology in place. This article is trying to explain the risk assessment in short form and help with quick implementation.
Published on: Mar 4, 2016
Transcripts - Pricing Risk in Construction Tenders
Risk Pricing Approach
The approach to risk pricing varies with the organization. For the most part,
there are a few basic methods:
1. Risk pricing is an entirely separate activity that follows the base estimate
2. Risk pricing is an integral component of the base estimate preparation,
3. Risk pricing takes place during and after the base estimate preparation.
Additional details are:
1. The risk pricing is conducted by the same parties involved in the base
2. The risk pricing is done by separate individuals from the parties involved in the
base estimate preparation.
While the literature suggests that risk pricing is a separate process that
follows on after the completion of the base estimate, practice shows that this
process is contingent on preferences within each organization.Who is involved
in the pricing of risk? This is dependent on the organization and the size and
type of the project. Ultimately, the risk pricing is a function of the executive
Who is involved in the pricing of risk?
This is dependent on the organization and the size and type of the project.
Ultimately, the risk pricing is a function of the executive management, and it
occurs during the estimate review meeting. Varying with the size and type of
project, the estimate review meeting is attended by those who played a
significant part in the estimate preparation and senior management.
The approval of the final tender sum is always a function of senior
management, regardless of project type and size. The value of the project
usually affects the number of people involved in risk pricing. A typical cost
estimate review group would be the cost estimator, contract manager, site
manager and executive manager. For small construction firms, usually, the
owner is very closely involved with the estimating process and the pricing of
risk. For larger organizations, which bid on more major projects with increased
risk, the tender is reviewed several times by people with increased level of
The risk is usually priced in individual components where the risk is, trade and
non-trade related. Then risk associated with non-trade elements of the project,
such as preliminaries and contractual risk, is priced once the base cost of the
project has been established.
Calculation of risk. There is a wide spread of methodologies for risk
calculation. Some of the most common methods are:
1. Micro. This method involves the identification and pricing of risk on a trade by
trade basis. The contingency for risk is added as a separate line for each
trade. The same approach is applied to calculating risk for all project indirect
costs. The literature on the subject suggests that each major cost element
should be assessed regarding uncertainty, and the appropriate risk value is
assigned. This method of pricing risk is considered more reliable than the
simple application of one overall risk amount to the full base estimate.
2. Macro. This method of risk calculation involves the use of an overall sum to
the whole project. The amount of contingency to cover risk is derived from
previous experience on similar projects and historical data. Some
consideration should be included for adjustments based on current
circumstances: the state of the economy, the location of a project, available
skilled trades, etc.
3. Micro+Macro. This method of risk calculation is a combination of the micro
and macro methodologies. Trade or elemental basis price part of the risk and
some risk is added to the base estimate as a lump sum amount.
4. Construction period. Using this methodology the contractor assesses the
feasibility of construction time stated in the tender documents. Then, if
necessary, they make an allowance per week to cover the liquidated damages
and multiply by the number of extra weeks considered to be required to
complete the project reasonably.
5. Monte Carlo simulation. This methodology uses a probabilistic estimating
technique to determine an overall contingency amount. Contractors very
rarely use this method. It is more common in capital cost estimating.
Above all, the most valuable asset when pricing risk is experience and
intuition. Regardless of the method used to price risk, there is nothing that can
Most common risks. The literature identifies the following risks as most
commonly accounted for when pricing tenders:
1. Tender documentation errors.
2. Availability of resources.
3. Constructability issues.
4. Incomplete design.
5. Subcontractor/supplier availability and quality.
6. Scope changes.
7. Exchange rate.
8. Possible estimating errors.
9. Site access issues.
10. Environmental issues.
11. The complexity of project team.
12. Inclement weather.
13. Subcontractor performance.
14. Owner financial issues.
15. Equipment failure.
16. Unforeseen site conditions.
17. Industrial relations actions.
19. Changes in regulations/legislation.
20. Political uncertainty.
21. Site safety requirements.
22. Low labour productivity.
The significance of each risk is dependent on the type of project, contractor
experience and availability of resources, project location, the design firm,
project owner, project schedule, etc. There is a direct relationship between the
risks the contractors most often encounter and the significance of risks
considered when pricing risk. Some risks have a considerable difference
between their importance and rankings by the contractor. For
example unforeseen site conditions, labour low productivity and scope
changes are considered significant risks but ranked as low ranking. The
reason can be attributed to the fact that based on previous experience,
contractors can mitigate these risks during the project execution.
What is your approach to pricing risk? Please leave your comments below.