I have had numerous conversations this year with both owners and contractors related to the amount of risk being passed on to the contractors in RFPs.
It is getting to the point that, as a contractor or subcontractor, many RFPs from specific owners are just not worth bidding. To cover all the risks that are being imposed on the contractor, some bids could be double the cost from the original estimate to cover all the unknown risk factors.
No municipality wishes to pay more than the market price for what it buys, but insufficient thought concerning what risk factors are put into the RFP or tender documents can have an overwhelming cost implication.
Contract terms always have price implications.
In general, construction prices directly affect the costs incurred in completing the proposed project, plus allowances for the specific risk associated with the contract, the general business risk and profit.
The allocation of risk under a contract largely flows from the terms in which the contract is drafted.
The more risk assigned to the contractor, the more the quoted price will be.
Owners need to do a better job assessing what risks can be absorbed by the municipality and which ones should be passed down to the contractor.
Simply unloading all the risk to the contractor not only escalates the original budget, but has the secondary negative outcome of attracting less bidders and additional unnecessary cost to the project.
I have always said the risk factors should be delegated to the organization best able to handle them in the most cost efficient manner and should not just passed down to the contractors to deal with.
However, risk can only arise from uncertainty. When the document terms are vague or otherwise confusing, they create additional costs to the owner. The more uncertain the meaning of the contract, the higher the quoted price will be.
High-risk documentation increases the price in two ways.
First, it encourages contractors to hedge their prices to offset any risk that they have identified. Second, as I have mentioned, it encourages most potential contractors not to bid at all.
A smaller contractor is not going to risk the entire company on a one-sided contract that could put them under should anything go wrong.
The importance of the second problem is easily underestimated. Generally, the bidders who decide not to bid are the top contractors in the field, who are able to offer the best prices.
Such entities usually have their choice of work because they are known to be highly stable, properly capitalized, offer good quality products and have an experienced and professional staff. These companies do not need to bid for high-risk work.
Risk can also relate to a wide range of factors which neither party is in a position to control.
The enormous risk presented to a contractor by a fixed price agreement raises sharply in line with the length of the term of the agreement.
Asking a contractor to assume the risk that the price for commodities such as fuel will remain stable is not realistic. If a contract is drafted on this basis, either a prospective contractor will drastically increase the bid price to account for the risk assigned or refuse to bid at all. Asking for a fixed price for goods and services of an undefined nature is equally unrealistic.
A sound and comprehensive system of risk allocation can play a critical role in problem avoidance when undertaking a major capital project.
The term “risk management” describes a formal management process that helps ensure the financial stability and safe operation of any organization.
It entails a planned and systematic process to monitor and control any risk exposure that arises inherently to the conduct of a particular line of business or the management of the affairs of an organization.
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.
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