Risk and need-for-work premiums in contractor bidding

Contractors add significant premiums, on the order of 3%, to their bids when they have a low need for work or projects have high risk. An empirical study of the effect of need-for-work and project risk on contractor bid markups was conducted by assessing and analyzing utility functions obtained from construction contractors in a bid-simulation exercise. Thirty New England contractors participated in the study. The statistical analysis of utility data indicates, with a high level of confidence, that need for work and risk significantly affect contractor bid markups. A revised model of bidding is presented. The paper also discusses the implications of these need-for-work and risk premiums for owners, contractors, and the insurance industry. Specifically, project managers should seriously consider investing at least 1% of the project cost in studies that reduce the risk perceived by contractors.