The two-tier prices issue

Whenever doing a project in construction, the main question will almost always revolve around how much it will cost. There are two general ways how to budget a project: find a constructor from the start and define the project costs together with him (one tier budgeting), or let the planners prepare the project documentation alone. Basing on it the constructors then in the second step define the final project expenditure (two-tier budgeting). The second system is the predominant way in construction projects, even though it has its flaws. I would like to briefly discuss it, pointing out the flaws and suggest possible solutions. 

 

Planers prices Vs Market Prices

A quick review. The two-tier system. The investor sets the budget, the planner prepares the project documentation, the list of works and the costs estimate for each work category. In the next step the investor asks the constructors for bids to the given project, based on the list of works (without the costs estimates, of course). These bids can alter to the planner’s costs estimates in both ways, as only they know for how much money they are willing to do a specific job. The investor can then decide for a bidder of their preference (usually the cheapest one).

This system is a two-tier system because there are two prices for any given work: the planner’s price and the constructor’s price. They can differ and they usually do. Normally the planner’s price is set higher, because they are motivated to do so. On one side they do it to keep good relations with the investor, as it is bad if the contractors are demanding more money as they planned for. But it also give them leverage during the construction. If there are unexpected changes or costs on the project, they have some extra money reserves set in the budget.

Planners do not gain anything from making the project cheaper. It is the role of the investors to push the prices  down, which can be a problem. If the investors are not experienced enough, constructors can take advantage of them. In general investors tend to be overly optimistic about the project costs, especially the unexperienced ones (in my experience many projects tend to go over budget).

These two extremes: planners setting the prices to high and investors setting them two low – give the constructors a lot of room for defining the price for the project. If the investor sets the initial budget too low and the planer use too high prices, they have a wide window of setting the prices for a specific task. Sometimes they can speculate in order to make their bid more appealing. They can set the prices too low, hoping for additional contracts during the construction. Their only opponent are the other constructors, who can use different prices for the same work. They are the most experienced side involved in setting the prices and know on which works they can make a profit.

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The problem

This system is the best we have, as it offers a good solid neutral ground for finding the best bidder for a job. It is very useful for public projects, as it forces the constructors to push the prices down. Quite often the cheapest bidder wins. But the system has its flaws. It is a knowledge problem and affects all three parties:

  • It is a problem for investors, as they can be played if they don’t have enough knowledge about the prices to push them down.
  • It is a problem for planers as they are unnecessarily inflating the project value.
  • And it is a problem for the constructors. As they  are competing against each other – if anyonen has any price advantages, he can exploit them, thus hurting other competitors.

Could the prices at one point converge towards one?

A more stable pricing system would benefit everyone. Could the right solution be more transparency in the process? I think yes, but until one point. I see the prices slowly converging towards one, real price. For this to happen, the work type description and the price must be more freely shared in between the constructors and planners. Knowing the mean/median price for a specific job in a specific region could be beneficial for all three parties. The investor could adjust the planned budgets, constructors could compare their costs with the industrial average, and planners could adjust their prices for more realistic ones.

But for this to happen, a universal database should be created. To that, contructors should share their costs and works database. But the chance of that to happen are quite low, as (big) contractors will be very hard to convince to share, well, trade secrets. Project prices are, after all, their market advantage and thus their try to protect them.

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But everything is not bad. Constructors are willing more and more to share their work descriptions, and collaborate tightier with the planners. But to protect their interests, they are creating “lockdown” systems: a product or technology so specific, that only they can install it. No substitutes are availbale. This way they technologically eliminate the competition, not just with prices anymore.

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