Anda di halaman 1dari 8

International Journal of Construction Management

ISSN: 1562-3599 (Print) 2331-2327 (Online) Journal homepage: http://www.tandfonline.com/loi/tjcm20

The Winners Curse in the Sri Lankan Construction


Industry

Willie Tan & Himal Suranga

To cite this article: Willie Tan & Himal Suranga (2008) The Winners Curse in the Sri Lankan
Construction Industry, International Journal of Construction Management, 8:1, 29-35, DOI:
10.1080/15623599.2008.10773106

To link to this article: http://dx.doi.org/10.1080/15623599.2008.10773106

Published online: 10 Feb 2014.

Submit your article to this journal

Article views: 19

View related articles

Full Terms & Conditions of access and use can be found at


http://www.tandfonline.com/action/journalInformation?journalCode=tjcm20

Download by: [Jordan Univ. of Science & Tech] Date: 16 February 2016, At: 21:44
The International Journal
The of Construction
Winners Curse Management (2008)
in the Sri Lankan 29 - 35
Construction Industry 29

The Winners Curse in the Sri Lankan


Construction Industry
Willie TAN1 and Himal SURANGA2
1
Department of Building, School of Design and Environment, National University of Singapore. Email: bdgtanw@
nus.edu.sg
2
corresponding author, Department of Building Economics, Faculty of Architecture, University of Moratuwa, Sri
Lanka. Email: suranga@becon.mrt.ac.lk

Abstract
Downloaded by [Jordan Univ. of Science & Tech] at 21:44 16 February 2016

This paper presents a study on the size of winners curses in the Sri Lankan construction industry. The
study is interesting because the existence of large winners curses is an indicator of information and other
types of inefficiency. Large winners curses are detrimental to the development of the industry and for
individual clients as well. The winning margin and the distribution of bid prices are used in detection
of possible winners curses. Based on 389 bids in 64 private sector projects, the study finds evidence of
the existence of large winners curses in the Sri Lankan construction industry.

Keywords
Winners Curse, Tendering, Bidding, Construction Industry, Sri Lanka

Introduction

This paper presents a study on the size of winners curses in the Sri Lankan construction
industry. The study is interesting because existence of large winners curses is an indicator of
information and other types of inefficiency (for example, inexperience or poor training on the
part of the cost estimator) and is therefore detrimental to the development of the industry.

Background

The winners curse story begins with Capen, Clapp, and Campbell (1971). They claimed
that oil companies suffered unexpected low rates of return in the 1960s and 1970s on outer
continental shelf lease sales. They argued that these low rates of return resulted from the fact
that winning bidders ignore information on the consequences of winning. That is, bidders
naively base their bids on their own estimates of value which, although correct on average,
ignores the fact that you only win when your estimate happens to be the highest (note that in
construction tenders, the winning bid should be the lowest) among bidders. But winning
against a number of rivals following similar bidding strategies implies that your estimate is
an overestimate of the value of the lease conditional on the event of winning. Unless this
effect is accounted for in formulating a bidding strategy, it will result in winning a contract
that produces below normal or even negative profits. The systematic failure to account for
this adverse effect is commonly referred to as winners curse: you win, you lose money, and
you curse (Kagel and Levin, 2002).
30 Tan and Suranga

In the construction industry, most clients still favour competitive bidding (Murdoch and
Hughes, 1992; Dawood, 1994; Holt et al., 1995). It is believed that competitive bidding gives
the client value for money through free and fair competition (Trickey, 1982; Lingard and
Hughes, 1998). Contracts are usually awarded to the lowest bidder (Merna and Smith, 1990).
Awarding the contract to the lowest bidder is usually practised in the public sector particularly
because of its greater accountability (Rankin et al., 1996; Turner, 1979). Many private clients
also award contracts to the lowest bidder for cost reasons. Sri Lanka has not changed from
this traditional procurement practice. Therefore, the lowest bidder is typically the price setter
in the Sri Lankan construction industry.

The lowest bid may come from a firm that badly under estimates the cost of the project
Downloaded by [Jordan Univ. of Science & Tech] at 21:44 16 February 2016

(McCaffer and Pettitt, 1976). There is evidence that large winners curses exist in construction
(Dyer and Kagel, 1996). Hence, some contracts carry losses to contractors. This is detrimental
to the industry for at least two reasons. First, some firms may become insolvent or they could
abandon the project (Holt et al., 1995). Second, firms may adopt illegitimate survival strategies.
They may divert funds from other projects, make numerous claims to receive extra payments,
or breach the contract. In addition, it results in poor quality and time overruns that are costs
to the client (Ho and Liu, 2004; Lingard and Hughes, 1998; Kumaraswamy and Yogeswaran,
1998; Crowley and Hancher, 1995; Zack Jr., 1993). The effect could be exaggerated by other
inefficiencies that exist in the Sri Lankan construction industry such as payment delays, and
errors in contract documents.

Firms may voluntarily bid with low or negative profits to win projects, seeking other benefits
such as prestige, track record, and to reduce excess capacity. However, most underbids are
due to errors in bids (Lange and Mills, 1979; Beeston, 1983; Kaka and Price, 1993; Chapman
et al., 2000). These can be random or systematic errors and/or blunders.

The current literature does not clearly pinpoint the types of errors found in construction bids.
However, a combination of these three types in varying degrees can be expected to exist.
Random errors are statistical in nature and occur with certain probability. They occur due to
chance variation in the process. Systematic errors are unintended biases in basic prices and
in the schedule of rates that lead to estimated values being consistently too high or too low.
However, experienced construction firms tend to have smaller biases than newer firms as
they learn from previous tenders. Unlike physical measurements, systematic biases in tender
estimates cannot be calibrated with high precision because there is no such thing as the true
bid. The winning bid is merely the bid that wins the contract. It is neither true nor false.

A blunder may be caused by faulty perception, misinterpretation of tender documents, arithmetic


mistakes, carelessness, poor communication among estimators, and shortcuts (Thomas, 1991).
Unlike random and systematic errors, blunders can be quite large such as having the incorrect
decimal point in rates or quantities.

Detection of winners curse

The difference between the lowest and second lowest bids is often referred as winners
curse. Another definition is that the winners curse is the difference between the right price
of the project and the winning bid (Thaler, 1992). The right price is, of course, unknown.
Theoretically, the right price should be the total cost plus a fair profit to the contractor. In
practice, this figure is difficult to ascertain. Cost differs from one contractor to another because
The Winners Curse in the Sri Lankan Construction Industry 31

of the differences in their efficiencies, and is also related to quality and workmanship. The
level of fair profit is also debatable. The second lowest bid is therefore not the right price.
For consistency, we will use the term winning margin to represent the difference between
the lowest and second lowest bids.

The winning margin alone does not tell much about the existence of the winners curse,
especially when the second lowest bid is also a large underestimate. Therefore, it becomes
necessary to study the distribution of all bids of a tender.

Methodology
Downloaded by [Jordan Univ. of Science & Tech] at 21:44 16 February 2016

A total of 389 bids from 64 projects were used to study the winning margin and distribution of
bids. A stratified random sample was used to collect necessary data for the study. The sampling
population consists of all construction projects in Sri Lanka tendered in 2003 and 2004, and
categorised M6 or above. The stratification was according to the project size categories: large
(M1 & M2), medium (M3 & M4) and small (M5 & M6).

Since the winning-margin () is not comparable across the projects, the percentage winning-
margin () is used in the analysis. These are mathematically represented by

(1) = (P1 - P0), and


(2) = ( / P0)(100%)

where P0 is the lowest bid and P1 is the second lowest bid.

The major obstacle in modelling the general distribution of bids is that there are not enough
bids in any given project to produce a sensible probability distribution. The number of bids per
project varied from two to sixteen. Figure 1 provides a simple illustration of this limitation.
It shows the histograms for two projects having 15 and 8 bids respectively. The distributions
appear erratic, and frequencies for certain bid prices were missing.

Figure 1 Histograms of bid prices


32 Tan and Suranga

As a result, it is necessary to merge the raw data for all projects. Since raw bid prices varied
substantially across projects, normalization was required. The standard score (Z) transformation
was rejected because it fixes the standard deviation at unity, which is undesirable. Hence, the
following transformation is used for normalising the jth bid in ith project (Beeston, 1983):

(3) pij = (Pij /mi)100%

where Pij is the original bid price, and mi is the mean bid price of ith project. In essence,
normalization scales the bids by average project size. All normalized prices (pij) were pooled
to obtain a single sample with sample size n = 389.
Downloaded by [Jordan Univ. of Science & Tech] at 21:44 16 February 2016

Results

The results of descriptive analysis of the percentage winning margin are given in Table 1.
Table 1 Descriptive analysis of percentage winning-margin ()
Percentage winning-margin () Statistic
Mean 9.32
Std. Deviation 9.12
Minimum 0.12
Maximum 35.18
Range 35.06
Inter-quartile Range 11.60

The average percentage winning margin is 9.32%, that is, the second lowest bid is, on average,
9% higher than the lowest bid but it can range from as low as 0.12% to as high as 35.06%. This
shows that the winners curse in the Sri Lankan construction industry is a serious issue.

The descriptive statistics of normalised bid prices are shown in Table 2 and the distribution
is plotted in Figure 2.

Figure 2 Normalised Bid Prices Histogram


The Winners Curse in the Sri Lankan Construction Industry 33

Table 2 Normalised bid prices: Descriptive Statistics


Statistic Standard Error
N sample size 389
Mean 100 0.8180
Std. Deviation 16.13
Minimum 52.44
Maximum 206.48
Downloaded by [Jordan Univ. of Science & Tech] at 21:44 16 February 2016

The distribution is symmetrical and close to a normal distribution. This may be explained as
follows. Let pi be a random variable representing bid prices in the ith project. Then

(4) E[pi] = 100 for all i,

and, from Equation (3), using Taylor series expansion,

(5) var(pi) = 1002var(Pij /mi)


1002[sPP(g/Pij)2+ smm(g/mi)2 +2sPm(g/Pij)(g/mi)]
= 1002[sPP /mi 2 + smm Pij 2/mi 4 - 2sPm Pij /mi 3]
where

g(.) = Pij /mi, and


sPP, smm and sPm are variances and covariance respectively.

The last two terms in square brackets in (5) are small relative to the first term because of
higher powers of mi. Hence,

(6) var(pi) 1002[sPP /mi 2] = i 2 (say) < .

The variances are therefore bounded, and

(7) lim max(i /i 2) = 0.


n

That is, the maximum value of the ratio i /i 2 as n tends towards infinity is zero. This means
that the variance from any project does not dominate, and by Lindeberg-Feller Central Limit
Theorem, the distribution of the normalized bid prices tends towards a normal distribution as
n tends towards infinity.

Since our sample size of 389 bids is relatively large, the observed normal distribution in Figure
2 is not surprising, based on the Central Limit Theorem discussed above. The distribution
may then be described by the mean and standard deviation, the two parameters of the normal
distribution. What is disturbing is that the standard deviation of 16.13 in Table 2 is relatively
high, implying large winners curses in the Sri Lankan construction industry.
34 Tan and Suranga

Conclusion

This study provides evidence of the existence of large winners curses in the Sri Lankan
construction industry. This is detrimental to the development of the industry and for individual
clients as well. Apparently, bid prices varied substantially.

Vickrey (1961) has suggested that contracts may be awarded based on the second lowest bid
rather than the lowest bid. The rationale is that bidders will bid properly by taking into account
that desperate or suicide bids may not win the contract. However, the Vickrey solution
considers only rational bidding strategies and not the problems arising from the errors in prices
and quantities identified in this paper. Much remains to be done to minimize such errors through
Downloaded by [Jordan Univ. of Science & Tech] at 21:44 16 February 2016

measures such as better drawings, greater estimation skills, and better price information.

References

Beeston, D. T. (1983). Statistical methods for building price data. London: E&FN Spon.
Capen, E. C., Clapp, R. V. and Campbell, W. M. (1971). Competitive bidding in high risk situations.
Journal of Petroleum Technology, 23, 641-653.
Chapman, C. B., Ward, S. C., and Bennell, J. A. (2000). Incorporating uncertainty in competitive bidding.
International Journal of Project Management. 18, 337-347.
Crowley, L. G., and Hancher, D. E. (1995). Risk assessment of competitive procurement. Construction
Engineering and Management, 121, 238-245.
Dawood, N. N. (1994). Developing an integrated bidding management expert system for pre cast concrete
industry. Building Research and Information, 22, 95-102.
Dyer, D., and Kagel, J. H. (1996). Bidding in common value auctions: how the commercial construction
industry corrects for the winners curse. Management Science, 42(10), 1463-1475.
Ho, S. P., and Liu, L. Y. (2004), Analytical model for analysing construction claims and opportunistic
bidding. Journal of Construction Engineering and Management, 130(1), 94-104.
Holt, G. D., Olomolaiy, P. O., and Harris, F. C. (1995). A review of contractor selection practice in UK
industry. Building and Environment, 30, 553-561.
Kagel, J. H. and Levin, D (2002). Bidding in common value auctions. In J. H. Kagel. and D. Levin (Ed.),
Common value auctions and winners curse, 1-84. New Jersey: Princeton University Press.
Kaka, A. P., and Price, A. (1993). Modelling standard cost commitment curves for contractors cash flow
forecasting. Construction Management and Economics, 11(4), 271-83.
Kumaraswamy, M. M., and Yogeswaran, K. (1998). Significant sources of construction claims.
International construction law review, 15(1): 144-60.
Lange, J., and Mills, D. Q. (1979). The Construction Industry: Balance Wheel of Economy. Lexington
Massachusetts: Lexington Books.
Lingard, H., and Hughes, W. (1998). The impact on contractor selection method on transaction costs:
a review. Journal of Construction Procurement, 4(2), 89-95.
McCaffer, R., and Pettitt, A. N. (1976). Distribution of bids for buildings and roads contracts. Operational
Research Quarterly, 27(4), 835-843.
Merna, A., and Smith, N. J. (1990). Bid evaluation of UK public sector construction contracts.
Proceedings: Institution of Civil Engineers, 88: 91-105. Quoted in Lingard and Hughes (1998).
Murdoch, J. R., and Hughes, W. P. (1992). Building Contract Law. London: Longman.
Rankin J. H., Champion, S. L., and Waugh, L. M. (1996). Contractor selection: qualification and bid
evaluation. Canadian Journal of Civil Engineering. 23, 117-123. Quoted in Lingard and Hughes
(1998).
The Winners Curse in the Sri Lankan Construction Industry 35

Thaler, R. (1992). The winners curse: paradoxes and anomalies of economic life. New Jersey: Princeton
University Press.
Thomas, P. I. (1991). The contractors field guide. New York: Prentice Hall.
Trickey, G. G. (1982). Does the client get what he wants? Quantity Surveyor, 38, 86 87.
Turner, D. F. (1979). Quantity Surveying practice and administration (2nd Ed). London: Godwin.
Vickery, W. (1961). Counterspeculation, auctions, and competitive sealed tenders. Journal of Finance,
16(1), 8-37.
Zack, J. G., Jr. (1993). Claimsmanship: current perspective. Journal of Construction Engineering and
Management, 119(3), 480-97.
Downloaded by [Jordan Univ. of Science & Tech] at 21:44 16 February 2016