Secrets of Bonding #16: Bid Spreads

They can be full of fat or skinny. Sometimes they’re yummy, but they never go on crackers.

A Bid Spread is important to contractors and their surety.  Let’s find out why.

What is a bid spread? 

When a contractor is pursuing a new project, they may be required to submit a written proposal which the project owner then compares to offers made by other firms.  It is a competition based on capabilities, credentials and price.  In the case of public projects such as federal, state or municipal, the bid results are normally published – meaning everyone gets to see the full list of bidders and their amounts.  These dollar figures are the prices the contractors will charge to perform the work.

The bid spread is the difference in dollars and percentage between two of the bidders.  The “apparent low bidder” is the company with the least expensive price on bid day.  The bid spread for the low bid is based on the difference between bids # 1 and 2.  It is an indication of the adequacy of the low bid amount.  

How to calculate the bid spread

Suppose the low bid is $100,000 and the second bid is $150,000. In this case it may be obvious that the second bid is 50% more than the first.  But what is the calculation method?  You subtract the difference between the bids and divide the number into the low bid:

150,000 – 100,000 = 50,000

50,000 / 100,000 = 50%

Therefore the bid spread is 50%.  (The difference in bids equals 50% of the low bid amount.)

It is not correct to divide the 1st bid into the second, such as 100,000 / 150,000 = .33 or 33%. This indicates that the second bid is 33% larger than the first – which is not the question at hand.

What does the bid spread tell us?

The purpose of determining the bid spread is to evaluate the adequacy of the low bid.  For example, if the 2nd, 3rd and 4th bids are clustered with the 1st bid far less, one may conclude that there was a calculation error by the low bidder.  Maybe they left out an element, misread the plans or made a calculation error.  All the bidders wanted the work, so how could one be significantly less?

For the low bidder, a large bid spread demands an immediate review.  If an error or omission is found, usually the bid can be withdrawn with no penalty if acted upon promptly.

For the surety, there is a reluctance to bond an inadequately priced project.  The absence of profit could cause the contractor to abandon the work or they could be forced into default by the financial pressure.  They may be tempted to cut costs resulting in shoddy workmanship.  This too can be grounds for a bond claim.

The only thing worse than a bond claim is a defaulted project requiring completion by the surety where the remaining funds are insufficient to complete the project.

How low is too low?

The rule of thumb is 10%.  If the low bid is $100,000 and the second is more than $110,000, than the spread is over 10% and warrants evaluation before a performance bond is issued.

The surety will ask if the bid estimate has been double checked.  What was included for profit and overhead? Are subcontractors dependable at their prices – and bonded? Did the low bidder have some advantage over the other contractors that enables them to perform the work profitably for a lower price?

Alternative calculation method

When faced with a spread of more than 10%, analysts will also calculate the bid spread to the average of the second and third.  In this case they hope to find a spread not in excess of 15%.

Try the analysis on these numbers: 1st: $100,000, 2nd: $112,000, 3rd: $114,000.

Other facts about bid spreads

In most cases, the surety that provides a bid bond is not obligated to provide the Performance and Payment bond.  An exception to this would be situations in which a Consent of Surety was required with the bid bond.  Such consent does promise to issue the P&P bond.

With no consent in play, a large bid spread could cause the surety to refuse the P&P bond, even though it could result in a bid bond claim – if the contractor cannot quickly locate a replacement surety.  (Refer to Secrets #8: Bid Bonds).  A bid bond claim is a much smaller problem to deal with than a defaulted contract.

A new surety that is offered the P&P bond on a project that apparently required a bid, will naturally ask for details.  They know the incumbent surety must have had good reason to forego the production and face a possible bid bond claim. Producers can expect this to be a difficult placement.

Bid spreads are revealing! A tight bid spread validates the low bidder’s amount.  Large spreads require further scrutiny.

In cases where bid results and bid spreads are not known, such as on private contracts (or in cases where the contract amount is negotiated) it makes approval of the P&P bond a bit harder for the surety.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s