Procurement Perspectives: Government contracting departs from the norm

It is a common fact that government contracting departs from the norm, but the factors that influence government suppliers are nevertheless similar.

Although the world of municipal contracting might seem at first blush to stand a very good distance from the world of price theory, in fact price theory plays itself out every day in the world of municipal contracting in ways that are both predictable and almost uniform in consequence.

The relative size of governments allows them a degree of market influence.

Thus, governments have a limited ability to dictate contract terms to the market — provided it is understood that in doing so, the effect will be to adjust the cash price that must be paid under the contract.

More generally, the consequence of departing from prevailing market practice and terms is that any such departure will be reflected in a higher contract price.

The prevailing market price for goods and services will reflect the normal allocation of risk between supplier and customer, the normal customer’s service needs and delivery expectations.

It seems fairly obvious that when a customer insists on delivery to some remote location, then the price charged by the supplier to that customer must necessarily increase by a corresponding amount to reflect the higher costs incurred by a supplier in dealing with the customer.

Similarly, any adjustments of risk that departs from the allocation of risk prevailing within the market will also result in a corresponding increase in price.

In a world of perfect information, since all buyers and sellers know what price currently prevails in the market, any effort by a seller to secure more than the market price will fail; any effort by the buyer to get less than the market price will also fail.

Contract terms that ask contractors to take a shot in the dark — in terms of assessing the magnitude and probability of risk — invariably result in a disproportionate increase in price. Such terms are encountered quite frequently in the construction context.

For instance, a city may engage an environmental consultant to carry out tests of the conditions of a property. Nevertheless, the city will stipulate that the contractor will bear the risk of any unidentified environmental condition.

Axiomatically, the contractor must include a hedge in the price to reflect the additional risk assumed.

Usually there is an asymmetric distribution of information between the city and the contractor. The city will know more about the property than the contractor possibility can. As a result, the contractor’s adjustment to the price will almost certainly err on the high side.

It is worth observing that in practice, provisions of this kind have currently come into vogue among Canadian governments, particularly in the construction field.

The following offers a brief description of contract stipulations that tend to result in a disproportionate increase in the cost of obtaining a supply of goods and services.

Requiring atypical bid security: For many years, it has been common for municipalities to require the delivery of a bid bond at the time of submitting a bid tender (at least where the dollar value of the tender is substantial). In recent years, some municipalities have concluded it is too difficult to enforce bid bonds as a security.

Consequently, they have begun to seek alternate forms of security.

Some municipalities now require bidders to deliver a certified cheque for a stipulated amount (e.g., $250,000 as security against the risk of supplier default).

Certified cheques have an adverse impact on the supplier’s cash flow, as do cash deposits, and may also increase its aggregate borrowing requirements.

Any resulting increase in cost will also be passed along to the municipal customer.

These and many other factors influence government contracts differently than those in the private sector.

Stephen Bauld is a government procurement expert and can be reached at swbauld@purchasingci.com.

Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.