Risk and Uncertainty in Estimating and Tendering

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Contents

Aims and learning outcomes

1. Introduction

2. The nature of the construction business

3. Risk and uncertainty

4. Risk evaluation

5. Aspects of human decision-making

6. Risks and uncertainties to be considered in the estimating process 6.1 Project risk6.2 Risks posed by the client and professional team6.3 Risks and uncertainties inherent in the contractor’s tendering

and estimating process

7. Conclusions

© The College of Estate Management 2002

Paper 0409V1-1

Risk and uncertainty in estimating andtendering


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Risk and uncertainty in estimating and tendering Paper 0409 Page 2

Aims

To introduce you to some basic concepts relating to risk and uncertainty in the preparation of estimates and tenders for construction projects.

After an initial examination of the nature of risk and uncertainty and asuperficial review of some aspects of risk analysis:

To examine the nature of the risks and uncertainties posed by the project and by the professional team, and the risks and uncertainties normally consideredin the estimating process.

Learning outcomes

After studying this paper you should be able to:

Evaluate the risks and uncertainties inherent in the tendering process.

Assess the nature and source of risks and their possible impact on theestimating process.


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1 Introduction

Contractors face two separate problems when submitting competitive tenders forwhich cost is a substantial acceptance criterion:

1. Will the tender be low enough to be accepted by the client?

2. If accepted, will the financial position of the project on completion beacceptably close to the forecasts made in the tender?

This paper examines these questions in the light of the risks and uncertainties posed by the project and by the professional team, and considers the risks and uncertaintiesnormally considered in the estimating process. Other papers consider the problems

posed by the bidding market.

2 The nature of the construction business

By their very nature, all construction projects are economically risky undertakings,and contracts let on the basis of price-competitive tenders tend to be the riskiest of allfor the contractor.

The problems, like so many others in construction, are not new. In 1900 a quantitysurveyor wrote:

‘Responsibilities are sometimes thrown on the builder when estimating, by leavingto his discretion some matter of doubtful yet ascertainable value; a matter which alittle investigation on the part of those arranging the contract would free from anydoubt or uncertainty whatever, and thus enable the competing builders to price it

at fair value instead of allowing a good margin to cover such contingency. Every point on which there is any doubt, and every matter as to which there may be theslightest misunderstanding during the execution of the contract, should, in justiceto all parties, be thoroughly thrashed out before the contract is signed. Anotheroccasional source of injustice . . . is the impracticality of plans and specifications.’

Some indication of how little progress has been made in the last century may begleaned from the fact that many construction contracts are still put out for tender onthe basis of incomplete information. Another quantity surveyor, writing in 1990, said:

‘Over many years the building industry has been aware of the difficulties relatingto the placing and management of contracts. In an attempt to overcome these

difficulties modifications to the established procedures have been introduced fromtime to time since the Banwell report identified where limitations existed . . . .These initiatives have failed.’

Since the 1980s there have been many initiatives to try to resolve some of these problems. The introduction of Co-ordinated Project Information (CPI) in the early1990s was hailed as a new way forward, but commentary by later authors, includingSir Michael Latham in his Constructing the Team report, indicate that it was less thansuccessful. There is, however, a belief among advocates of the CPI system that anyfailings lie not so much with the system as with the fact that the system is not

properly used.


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The years since the Latham report have seen a growth in the popularity of alternative procurement models, such as target cost contracting, in which project cost risks areshared in some way. However, many projects are still let with a heavy emphasis onthe lowest tender price.

No matter how well planned construction projects are, we must recognise that all projects still contain some element of risk – such as the weather, or strikes by workers

or material suppliers. It appears that, in many cases, clients and consultants makingup the demand side of the industry have decided that eliminating uncertainties in thetendering process causes more problems than it solves, particularly since clients areseeking shorter and shorter procurement periods. This being the case, the tendencyhas been to develop more and more complex Conditions of Contract to try to controlthe consequences of the risks and uncertainties inherent in the construction process.

During the process of estimating and tendering the contractor must evaluate all theserisks and uncertainties, since the offer submitted at this stage, if accepted, will formthe mainstay of the contractual relationship between the parties and, to a large extent,dictate the contractor’s eventual profit on the job.

In addition to the risks implied by the nature of the project, and those specificallydealt with by the Conditions of Contract, the processes of estimating and tenderingthemselves are subject to considerable areas of uncertainty and risk, even though theyare based on scientific principles.

The process of estimating is, by definition, to do with forecasting the likelycosts of the inputs to the construction process. Since the estimate itself is onlya forecast of the contractor’s expenditure, it must be subject to someuncertainty.

The tendering process is even more uncertain. Under normal circumstancesthe contractor has no way of knowing for certain at the time of tender whether

the bid submitted will be both low enough to be acceptable to the client andhigh enough to enable an acceptable profit to be made.

Understanding the risks and uncertainties inherent in the tendering and estimating process is therefore important for two main reasons:

1. To help the contractor to decide on the level of mark-up that will give the best possible chance of winning the project at an acceptable price.

2. To try to ensure that, if the tender is successful, the completed project willmake an acceptable contribution to profits.

Research shows that contractors deal with risk (sometimes termed ‘quantifiable risk’)and uncertainty (sometimes termed ‘unquantifiable risk’) in different ways. When therisks are quantifiable, the estimator includes appropriate costings for them in the costestimate. When the risks are unquantifiable, the amount added is based onmanagement’s perception of the situation.


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3 Risk and uncertainty

An important first step is to define the meaning of the terms ‘quantifiable risk’ and‘unquantifiable risk’ (uncertainty)’.

Risk arises when the assessment of the probability of a certain event isstatistically possible. Risk is insurable.

Uncertainty arises when the probability of the occurrence or non-occurrence ofan event is indeterminate. Uncertainty is not insurable.

Risk is mathematically assessable, given the availability of sufficient data,whereas uncertainty is not.

Note that there is no hard and fast division between risk and uncertainty. Theoccurrence of some events can be moved from the category of uncertainty (ieconsidered to be indeterminate) to that of risk by the collection of betterinformation. Weather statistics are a good example.

Information that needs to be made available in order to remove an event from therealms of uncertainty and allow the risk to be assessed can be divided into three basictypes:

1. Information that cannot at present be known or discovered.

2. Information that is not at present known but which could, given the necessaryresearch or data collection, be obtained.

3. Information that, although known by someone, is either not available to thedecision-maker or the decision-maker does not have the skills to understand it.

Data that could be obtained by research might include:

The costs to the firm of preparing estimates for various types of project. This isan area of uncertainty until the research has been carried out. Once the researchhas been carried out, the cost of preparing tenders becomes more certain andthe likely cost of preparing a tender for a new scheme moves into the area ofrisk. The more comprehensive the data, the more accurately the cost can beestimated and the more the risk can be reduced.

The risk that the contractor might not be paid on time. A contractor who hasworked many times for the same client is likely to be able to make areasonable assessment of the risk that it will not be paid on time for future

projects. On the other hand, a contractor working for a new client for the firsttime will have no first-hand data on which to base such an assessment. In the

absence of any external data (credit ratings, etc) the possibility of not being paid on time is thus much more uncertain.

In either of the above cases the data are knowable and could be discovered byresearch. Furthermore, it is likely that the contractor will have the necessary skills tounderstand and use them.


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In contrast, consider the question of whether the contractor’s tender for a project will be less than that of its competitors. In the absence of any data documenting thecontractor’s previous success or failure rates against the other contractors bidding forthis specific project, this is plainly an area of uncertainty. Even if the contractor hascollected some data on past tender submissions, he may still not possess the necessaryskills to enable him to use and interpret the data – indeed he may not even realise thatsuch information could be useful at all. One researcher, in calling for an improved setof estimating models, asserts that uncertainty is inevitable in construction projects andthat it must be planned for accordingly:

‘Uncertainty is not ignorance or inadequacy. It is an essential content of our projects. Small amounts of uncertainty do not always cause severe problems, largeamounts do. But we do not yet have a measure that enables us to say where the

boundaries between small and large uncertainties lie, though it is clear that smalluncertainties in large projects seem to behave like large uncertainties in small

projects.’

In understanding risk and uncertainty it is therefore vitally important, in any particular situation, to identify:

whether the required information is discoverable;

if so, at what cost;

whether, having discovered it, the potential user has the necessary skills to useit effectively.

If the answer to any of these points is ‘no’, then some subjective assessment of theeffects of the residual uncertainty must be incorporated into the tendering andestimating process.

4 Risk evaluation

Once the risks have been identified, some mechanism is required to quantify andevaluate them. Some very sophisticated risk analysis and management techniques areavailable that are apparently widely used in other industries. There is, however, someevidence to suggest that the techniques commonly used in construction are somewhatcruder. It seems that few contractors use any form of statistical analysis to determinerisk, other than on the largest of projects. One American commentator, discussingAmerican construction experience, writes that:

‘Most managers rely primarily on their judgements, rules of thumb, andexpertise . . . . The conventional algorithmic models developed in the past fewyears for risk analysis are not generally accepted by management for decision-making under uncertainty.’

Several techniques might be useful, but perhaps the simplest and most common is toattempt to assess the effects of the particular event occurring in terms of time and costin the context of the probability of occurrence of each of the risk events. These couldthen be summed to give an overall cost assessment. In mathematical terms:

RP = p R + p R + p R + … + p R

where RP is the risk premium p ,p …p are the probabilities of occurrence of each risk (0


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The assessed total cost could then be expressed as a percentage of the net cost.

This model is very simplistic, since it assumes that each of the risk events isindependent of every other, and it has already been shown that in many areas this isnot the case. The model could also be improved fairly easily simply by expressing the

probability of occurrence of each event in terms of a probability distribution andusing a computer to carry out a Monte Carlo simulation.

Many more sophisticated risk modelling techniques have been developed. Berny andTownsend (1993), for example, present a methodology using a software packagecalled VISIER for analysing risks, taking account of time and dependence with therisk event modelled as one of a number of types of probability distribution. Ren(1994) presents the concept of the risk life cycle, including not only the predictedfinancial consequences and the probability of occurrence, but also time properties (iethe time period within which the risk could occur) and the influence of relationships

between different risks. Possible risk relationships are shown in Table 1. Ren goes onto report on a case study using the PREDICT software package which incorporatesthese characteristics.

The simple model outlined above also assumes that it is possible to assign precisenumerical probabilities to each of the risk events. These factors are, however, veryoften assessed subjectively. For example, if the project documentation is poor then itmight be considered that there is a high probability of time and cost overruns.Alternatively, on the basis of past experience we might consider that there is a low

probability of late payment by the client. It may be difficult to assign specificnumbers to this kind of information, and in this case a ‘fuzzy logic’ approach, whichattempts to quantify subjective data, would be useful. One possible approach isreported in Paek et al (1993), but there is plainly a fertile area here for futureresearch.

TABLE 1 Risk relationship

Independent A particular risk event is not affected by any other risks in the system.

Dependent A particular risk event (B) is dependent upon the occurrence of anotherrisk event (A). If A does not occur, then B will definitely not occur, butif A does occur B may occur.

AB

(A) may have more than one risk dependent upon it, ie (A) may giverise to one or more events (B ), (B )…(B )

AB and/or B and/or B … and/or B

Parallel The occurrence of one of a number of risks (Ai, A … A may cause theoccurrence of one or more dependent risk events (B , B …).

A or A …or A B and/or B and/or B

Series The occurrence of a number of risk events together (Ai, A …A ) maycause the occurrence of one or more dependent risk events (Bi, B …B )

A and/or A …and/or A B and/or B …and/or B

1 2 n

1 2 3 n

2 n

1 2

1 2 n 1 2 n

2 n

2 n

1 2 n 1 2 n


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5 Aspects of human decision-making

Research shows that most risk assessment decisions in construction are probablymade intuitively and subjectively. In itself, therefore, the decision-making processduring the estimating stage may give rise to additional risks and uncertainties in thetendering process.

Researchers examining the tendering and estimating processes have concluded thatthe risks and uncertainties arising out of human decision-making are subject to twosets of influences:

1. Risks and uncertainties arising from the cognitive processes of human beings,the use of common approximations, and the individual’s attitude towardstaking risks.

2. The extent to which decision-makers attempt to reduce uncertainty, and tosome extent risk, by making simplifying assumptions that may be unrealistic –in other words, the tendency to assume away those real world uncertainties thatwe cannot objectively quantify.

These two groups are very difficult to separate, and both may be present in typicalhuman decision-making. It is therefore useful, in understanding the estimating andtendering processes, to consider briefly some aspects of human decision-makingunder conditions of uncertainty.

Research shows that people make decisions primarily on the basis of largely unstated beliefs and preferences, bearing in mind the context in which the decision is beingmade:

‘People rely on a limited number of heuristic principles which reduce the complextasks of assessing probabilities and predicting values to simpler judgementaloperations.’

In other words, people tend to assume away what they either do not understand orcannot objectively quantify.

Three major types of heuristic knowledge typically used in subjective decision-making have been identified:

1. Representative heuristics. Probabilities are evaluated according to how farthe problem matches other relevant experience.

2. Availability heuristics. Probabilities are assessed based on the ease withwhich similar events are brought to mind – in other words, recent relevantexperience has a strong bearing on current decision-making.

3. Adjustment and anchoring heuristics. People ‘anchor’ their estimates tosome starting value, which they then use to make future estimates byadjustment from the anchor value. The adjustments are usually insufficient,

because people tend to try to rationalise new events to fit their existing framesof reference. In other words, they make simplifying assumptions to tie newevents into things which they already understand.


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It is also likely that people’s attitudes towards taking decisions that involve risk anduncertainty, such as forecasting a construction price, will change over time,depending upon factors such as the penalty or reward resulting from an incorrectforecast and their own ‘built-in’ psychological attitude towards uncertain events.

There is a considerable body of management research looking at the psychologicalfactors that affect personal decision-making, from which it would appear that people

are very inconsistent in the way they make decisions. There is some evidence tosuggest that forecasts of time and cost made in the estimating process largely dependupon the estimator’s attitude to the risks involved – in other words, the estimator’stendency to gamble. It follows that a contractor attempting to fix the mark-up toconvert an estimate into a tender will need some knowledge of how the risks in theestimating process have been handled by the estimator – ie how much of a gamblerthe estimator is.

A number of techniques for analysing personal risk attitudes have been developedthrough research in psychology, business and management. The best known involvethe use of utility theory to construct a graphical representation of personal riskattitude. The process basically works by asking the subject to choose between trading

a guaranteed sum now for some larger uncertain sum in the future. For example, ifyou have a lottery ticket with a 50 percent chance of winning £100,000, how muchwould you sell it for? Someone who is ‘risk neutral’ might not be prepared to sell forless than £50,000. A ‘risk taker’, on the other hand, might want more; and someonewho is ‘risk averse’ might be prepared to take less. The results from a number of suchquestions are used to calculate a range of ‘utility values’, which are then plotted on agraph to show degrees of risk aversion.

Although research seems to show that the majority of business decision-makers are‘risk averse’ – that is, conservative in their decision-making – it may be useful formanagers in the tendering process to know just how risk averse their estimators are.

The decision-making process can be improved by the application of formal decisionanalysis techniques. A full discussion of this topic is beyond the scope of this text, butthe best known technique may be summarised as:

‘The spirit of decision analysis is divide and conquer. Decompose a complex problem into smaller problems, get your thoughts straight in these simpler problems, paste them together with logical glue and come out with a program foraction for the complex problem.’

In other words, isolate each of the risks and uncertainties, understand the relationship between them, and solve them one at a time. Note, however, that there may be adefinite limit for the decomposition; that is, there comes a point at which it is not

productive to break the problem down any further.


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6 Risks and uncertainties to be considered in theestimating process

The risks and uncertainties faced by the contractor in the estimating process may bedivided into three distinct groups:

1. Risks posed by the project itself.2. Risks posed by the professional team.

3. Risks implicit in the contractor’s own estimating process.

The first two groups may be to some extent unique to each project, but the third grouphas an effect on every estimate the company prepares.

6.1 Project risk

A number of different risks are posed by various aspects of the project and theassociated procurement and contractual approaches. All these risks are interrelated

and must be considered together. Risks posed by the project might include thosedescribed below.

1 Procurement methodology and proposed contractual arrangement

Different procurement methodologies and contractual arrangements pose differentdegrees of risk for the contractor. The contract documents normally spell out andallocate the balance of risks between the parties in an attempt to control theconsequences of risky and uncertain events. Indeed, some lawyers contend that the

principal purpose of the contract is to define how the risk is to be shared betweenclient and contractor.

Unfortunately, most attempts by the commonly used Standard Forms of Contract to provide contractual mechanisms that control and limit the effects of risky events haveresulted – largely because of developments through the courts in the law of contract –in the forms becoming increasingly complex and bulky. This approach has been seen

by some as an exercise in damage limitation, in that it simply tries to provideremedies for an increasingly large number of events within the framework of thecontract rather than through the courts. It is an attempt to close the legal door after thecontractual horse has bolted, rather than a positive strategy to improve both parties’

prospects for success, particularly for major projects.

Some legal commentators have argued powerfully for over 30 years that theunderlying problems of long-term contracts can only be solved by a completely newapproach to the construction of contracts for major projects. This would be aimed atdeveloping a partnership between the client and the contractor based on a ‘win/win’scenario, rather than the confrontational approach adopted in the past. Contemporaryattempts to address some of these issues include contracts such as the Engineeringand Construction Contract, which was substantially rewritten to reflect the concernsexpressed in Constructing the Team, and the recently introduced PPC2000 StandardForm of Contract for Project Partnering produced by the Association of ConsultantArchitects.

Be that as it may, the main problem from the contractor’s point of view is that, for perhaps the majority of competitively tendered projects, the procurementmethodology and contractual conditions are established unilaterally by the client long

before the contractor becomes involved, and are often aimed at minimising theclient’s risk. Since all projects, no matter how well planned, will always contain someelement of risk, minimising the risk for the client can all too easily mean placing themain share of the risk with the contractor.


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As far as individual procurement routes are concerned, it is difficult to be preciseabout which are more risky than others, and to what extent, simply because of all ofthe different risks involved. Generally, however, a contractor is almost certain to befaced with less risk on a cost reimbursement project than on a project based on unitrates; and less risk on a project including a fluctuations adjustment clause than one

based on a fixed price. In the case of projects based on the design and build model,the contractor carries considerable risk for the design, price and timescale, but at leasthas control of all the inputs.

As far as lump sum contracts are concerned, it has been pointed out that:

‘The maximum possible risk to the contractor occurs in the lump sum contract inwhich the extent of the work is only moderately well specified and the cost of thework is tendered for without possible change. If prices rise due to inflation, or ifthe time of construction is significantly lengthened due to industrial action, poorweather or shortage of materials, the contractor is severely disadvantaged.’

2 Adequacy of project information on which tender is to be based

Pressure of time, often imposed by the client, means that the great majority ofconstruction projects are put to tender before all the drawings and schedulesnecessary for construction are complete. (Note that this does not refer to minor piecesof information. Even for the best projects it will not, for example, be expected thatcolour schedules will be completed at tender stage.) Items falling under this headingare substantial pieces of missing information likely to have a significant effect on thecontractor’s price. It is not unknown for contractors to be expected to tender for quitecomplex works on the basis of little more than 1:100 scale plans and elevations.

For complex projects the contractor needs to plan the construction carefully beforesubmitting a tender. In particular, calculation of Preliminaries costs requires the

preparation of detailed method statements and operational plans. Obviously, the lesscomplete the project information, the more difficult it is for the contractor to plan thework in such a way that the final estimate bears a reasonable relationship to the out-turn costs if the tender is successful. Incomplete information at tender stage alsoimplies a high risk of variations during the course of the work – generally regarded as

bad news for a contractor working to a tight programme. Variations are disruptive andexpensive, and sometimes consultants’ interpretation of Conditions of Contract causecontractors to complain that they are not fully reimbursed for the true costs.

Contractors therefore need to look closely at the information provided by the architectand engineers. Beware of the bills of quantities. Remember that they can only be asaccurate as the information provided to the quantity surveyor. If projects are not fullydetailed when the quantities are prepared, the quantity surveyor is likely to includesome measured items for work not shown on the drawings but which he thinks may

be required, to try to make sure that the tender sum is high enough to cover the cost ofthe work. There is nothing inherently wrong with this approach, provided that the billmakes clear that this is what has been done by marking the items as‘PROVISIONAL’. In other words, the contractor should be made aware that theseitems have not been accurately measured because sufficient information is notavailable.

Unfortunately, it is not unknown for some architects to expect quantity surveyors tomake up their own details for items yet to be designed, and to pass this informationoff as fact. One recent commentator is splendidly eloquent on this point:

‘For some reason QSs see it as part of their job to produce a convincing 100-page bill of quantities from a sketch on the back of a table napkin, and then wonderwhy so many projects end in dispute, late and over budget.’


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Alternatively, the bills may include ‘PROVISIONAL SUMS’ – ie lump sums whichall contractors are required to include in their tenders to cover work which has yet to

be designed.

3 Project timescale and penalties for non-completion

Contractors need to assess available project timescales, both for preparation of thetender and for completion of the works. The construction time allowed by the client

should be compared with the contractor’s proposed programme, and an assessmentmade of the likelihood of the project being completed on time, together with thelosses and penalties in the event of failure. For most construction contracts the

potential consequences of failure to complete on time include payments by thecontractor to the client in the form of liquidated and ascertained damages. Therelevant figures will be set out in the bill of quantities, and the contractor cantherefore make an assessment of the likely consequences of late completion.

In some Forms of Contract the client has discretion as to whether or not to invoke theliquidated damages clause. The contractor must therefore also assess the likelihood ofthe client applying them.

Some contracts include a bonus for early completion, and this will also need to beconsidered.

Some contracts require that the contractor should not only complete the whole projecton time, but also achieve predefined programme milestones. Failure to hit themilestone dates may incur severe financial penalties, which may then cause thecontractor difficulty with the rest of the project. A good understanding of the ContractConditions is required for reliable assessments of the risks to be made.

4 Fixed or fluctuating price

Construction contracts may be let on either a ‘fixed price’ or a ‘fluctuating price’

basis.

Fluctuating price means that the contractor is required to submit a bid basedon prices ruling at the date of tender, and the contractor will be reimbursed forany price rises that occur as a result of inflation during the course of thecontract.

Fixed price means that the contractor is required to make an assessment of thelikely effects of price inflation, generally excluding increases caused by taxand levy changes, during the contract period and to make due allowance in the

price.

Note that both fixed price and fluctuating price contracts are adjustable for the costsof any variations. Fixed price contracts therefore impose an additional risk on thecontractor, in that the tender must include a forecast of the likely effect of future priceincreases during the contract period. The extent of the risk obviously increases withthe length of the contract period, and also in times of high inflation.


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5 Level of prime cost sums

The contractor has virtually no price risk associated with work for which prime costsums are included in the bills. Prime cost sums – which all contractors are required toinclude in their tender – are for works to be carried out, or materials to be supplied,

by specialists appointed by the client and its advisers, and for which the client willeffectively carry the price risk. In other words, if the prime cost sums fail to cover theactual costs of the work, the difference will effectively be paid by the client, not bythe contractor. The level of prime cost sums is therefore of interest to the contractor inassessing its price risk. Generally, the higher the proportion of prime cost sums in the

project, the lower the risk to the contractor as far as the overall price is concerned.

On the other hand, the contractor does have the responsibility for controlling and co-ordinating the work of all specialist subcontractors working on the project, includingall work covered by prime cost sums. At the time the tender is prepared, many of thespecialists will not have been appointed. The contractor therefore has the difficulttask of including in the programme possibly large amounts of work, some of whichmay be on the critical path, to be carried out by unknown specialists.

The various Conditions of Contract have different provisions for letting work which

is the subject of prime cost sums, giving the contractor varying degrees of control.For example, the JCT98 Standard Form of Building Contract makes provision for themain contractor and the nominated subcontractor to agree relevant programme datesas part of the subcontractor’s tendering process. In other forms the nominatedsubcontractor is simply appointed by the architect, often on the basis of the architect’s

perception of when the work is required to be done, and the contractor has to cope as best he can. From this point of view, therefore, a high level of prime cost sums may be a distinct disadvantage. It is therefore not only the level of prime cost sums that isimportant, but also the Conditions of Contract and the degree to which the specialistfirms have been appointed at the time of the main contractor’s tender.

6 Degree of technological difficulty

The contractor needs to consider factors such as how difficult the project will be toconstruct, whether the technology is new or well-tried, and how serious theconsequences will be if things do not go as planned. In general, the newer thetechnology the higher the risk. Unfortunately, it appears that these risks are frequentlyunderestimated.

For major projects with a high degree of technological innovation, contractors arewell advised to conduct a formal risk assessment and evaluation. Risk assessment atthis level is intimately connected with the preparation of project planning studies andmethod statements. Good computer-based planning systems give the opportunity toinclude at least three durations for each activity – most likely, most optimistic, andleast optimistic. The use of simulations using packages of this type can be very useful

in assessing technological risks.

6.2 Risks posed by the client and professional team

As far as the client is concerned, the contractor’s main problem arises fromuncertainty as to whether or not he will be paid on time.

Cash flow is of fundamental importance to any contractor. Late payment by the clientwill mean that the contractor must finance the works to a greater extent thanenvisaged when the tender was submitted. This has potentially serious effects on the

profitability of the contract.


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Although the Conditions of Contract will include clear and unambiguous provisionsfor interim payments, the contractor is largely reliant on the client for prompt

payment, and if the client is consistently late with payments there is in reality not a lotthe contractor can do. Once construction work has been completed it cannot easily bedisassembled again. Where the contract conditions permit, the contractor candetermine the contract, or sue for breach, or even, in extreme cases, abandon theworks, but none of these options is likely to recover outstanding monies quickly, andfew contractors will want to take such radical steps unless it appears that the client isnever going to pay at all. It is therefore important that the contractor evaluates thisrisk carefully before submitting a tender.

A further uncertainty arises in the stringency with which members of the professionalteam are likely to interpret the Conditions of Contract. Although the wording of thecontract may be perfectly clear, it may be subject to varying interpretations bydifferent consultants. Some of the major problems faced by the contractor aredescribed below.

1 Interim valuations not reflecting the true cost of the work

Consultant quantity surveyors sometimes see themselves as guardians of the client’s

financial interest, and there is therefore a temptation to keep interim valuations low inorder to make sure that the client will not be financially exposed if the contractor goesinto liquidation. Whilst the shortfall might not appear large on a particular contract,and the under-valuation will in any case sort itself out once the contract is completed,an under-valuation in interim certificates of, say, 2.5 percent on all the projects thecontractor is working on can pose very serious cash flow problems.

The contractor is entitled to the full value of all work properly completed at the timeof each valuation, less only the retention percentage stipulated in the contract. Inextreme cases of under-valuation the contractor can probably sue the relevantconsultant (quantity surveyor, engineer or architect) for professional negligence. In

practice, of course, this will only be a very last resort, and most contractors will try

other means to influence the valuation.

One common way in which a contractor will try to ensure that the valuation includesthe full value of all work completed is to offer to prepare the valuation himself andsubmit it to the consultant for checking. JCT98 now legitimises this process by givingthe contractor the right to submit his valuation of the works in advance of the date forinterim payments. Final responsibility for the valuation still rests with the quantitysurveyor, but he must respond to the contractor’s approach within laid-downtimescales.

Although many contracts make it clear that it is the quantity surveyor’s responsibilityto carry out the valuation, some consultants are still prepared to allow the contractoreffectively to prepare the valuation for them, and for their contribution to amount to achecking of the contractor’s ‘claim’.

2 Payment for variations not fully reflecting the true cost of the work

All Standard Conditions of Contract include clear rules for the valuation of variations.In most standard forms of building contract the contractual philosophy is to try toensure that the additional payment for variations reflects the pricing level in theoriginal tender. The principal method of achieving this is to require, wherever

possible, variations to be priced at rates either set out in the tender bills or derivedfrom them. Most contracts provide for alternative methods of valuation if it can beshown that the varied work is executed under special conditions. However, it is

usually clear from the contract wording that the main basis for valuation is intendedto be the rates in the tender bill, and quantity surveyors vary greatly in theirwillingness to move away from these.


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Decisions made by estimators are affected partly by their confidence in their own professional competence, and also by their own personal attitudes to risk. It istherefore totally unrealistic to consider an estimator’s prediction of likely cost as asingle-point figure, although this is apparently what management wishes to do. Anestimator’s prediction is in fact only one value drawn from a probability distributionof possible costs, and that single-point value will depend largely upon the estimator’sown psychological state at the time the decision is made.

The estimator will be heavily influenced by, among other things, a personalassessment of reprimand or reward if the figure is not accurate. If, for example, theestimator believes that censure will follow if the project is won but the estimate isshown to be low, he will tend to choose a value from the high end of the likely rangeof cost. If the estimator has been told to ‘sharpen your pencil’, then the choice may befrom the low end of the range. These perceptions are personal and will change overtime.

The key therefore is to try to reduce the estimator’s consideration of reprimand orreward, in order to ensure, firstly, that estimates are consistently produced on thesame basis, but, secondly, that the estimator always gives the most unbiased

assessment of likely project cost, backed up by lowest practical and highest likelyvalues.

7 Conclusions

Clearly the processes of tendering and estimating are subject to considerable degreesof risk and uncertainty. It is also evident that contractors can both increase theirchances of winning competitive tenders and remove some of the uncertainty involvedin making the required profits if they have a better understanding of the causes andeffects of the uncertainties involved.

Perhaps the most important lesson to learn is that it is totally unrealistic for managersto continue to consider estimates for construction work in terms of single-pointfigures. Evaluation and quantification of risk and uncertainty should involveconsideration of the probabilities that various outcomes may occur. The use of rangeestimates incorporated in a probability distribution may therefore lead to betterdecision-making at the tender stage.

Business and management research has developed a range of tools to aid risk analysisand decision-making, and these are well documented in the literature. However, thereseems to be little evidence of their use in construction at present. The risks and

uncertainties identified here fall into several different groups, and the evaluation ofeach might require the use of different tools.

REFERENCES

Berny J and Townsend P R F (1993) ‘Macrosimulation of project risks – a practical way forward’, International journal of Project Management , vol.11, No.4, pp.201–8.

Paek J H, Lee Y W and Ock J H (1993) ‘Pricing construction risk: fuzzy setapplication’, Journal of Construction Engineering and Management , vol.119, No.4.

Ren H (1994) ‘Risk life cycle and risk relationships on construction projects’, International Journal of Project Management , vol.12, No.2, pp.68–74.

Documents

Risk and Uncertainty in Estimating and Tendering