Two-stage tenders are increasingly common in the construction sector – largely because traditional construction tenders, where the client sets out its requirements and a number of contractors compete for the contract on the basis of price, often suit neither party.

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Contractors don’t like the one-stage process because the cost of bidding is high and the chances of success, where they’re tendering against a number of competitors, are relatively low. Plus, pricing so definitively at such an early stage exposes them to unwanted risk. Clients don’t like them because of the scope for dispute over such risks at a later date, as well as their vulnerability to problems such as price fixing.

By contrast, in the first stage of a two-stage construction tenders, the client tenders to an outline project design. Contractors then compete for preferred contractor status and the two parties enter into detailed negotiations over the technical and financial commitments in the final contract.

This approach has a number of advantages. Contractors can be involved in the design process, contributing their own expertise. Final pricing should be more realistic, because the preferred contractor has a good understanding of the project and risks can be properly explored, and sub-contractors, where necessary, can be jointly appointed. However, there are also potential risks with two-stage construction tenders:

  • The preferred contractor may have the upper hand in negotiations – once the contractor knows it is no longer battling with rivals for the business, it has less incentive to price competitively. Negotiations may therefore be difficult, with considerable scope for price escalation.
  • A two-stage process may be more time-consuming – the two-fold process in itself may take longer, but the potential for protracted negotiations means there is scope for further delay.
  • The preferred contractor may go out of business – there is a danger of the chosen contractor suffering financial distress before the final contract is agreed. Official statistics show there were more insolvencies in the construction sector than in any other industry during the final quarter of 2015.
  • Clients are vulnerable to contractors colluding with suppliers – with no final price for the contract agreed, contractors may be able to profit from undeclared arrangements with sub-contractors and suppliers, with the client picking up the bill.
  • It isn’t always clear whether clients and their preferred contractors are legally bound to sign a final contract – unless the initial agreement sets this out in detail, neither party can be confident a deal will be struck.
  • EU procurement laws can cause difficulties – the law firm Macfarlanes warns that where a construction tender is covered by European Union directives on procurement, special arrangements will be needed to ensure a two-stage process doesn’t contravene the legislation.

All of these risks carry the potential for unexpected expense, delay and even reputational damage during project tender processes. For this reason, it’s crucial that clients seek to mitigate the dangers at an early stage.

A number of practical steps will help – early advice on EU legislation, for example, and financial due diligence on contractors making stage-one submissions. Above all, it will be crucial to get as much detail as possible into the pre-construction services agreement signed with the preferred supplier.

The aim should be for the client to seek to manage some of the variables that may lead to price escalation and delay, by setting out a detailed and clear brief that covers issues such as:

  • key dates and durations
  • the production of quality information
  • cost targets
  • a realistic design and procurement programme
  • engagement of the supply chain
  • pre-construction activities
  • both parties’ respective roles and responsibilities.

It will also be important to agree the circumstances under which either side may exit the initial agreement – if costs hit certain thresholds, for example, or the timetable stalls. The agreement may specify, for example, that at this stage the project will revert to a single-stage tender.

In some circumstances, clients engage two preferred contractors for the second stage, on the understanding that only one will proceed to the project. This can be expensive, since the client will have to cover both contactors’ costs, but it is one option for maintaining a sense of competition. Alternatively, large clients appointing contractors to a number of different projects may be able to use this as a bargaining tool.

Against that, however, successful two-stage construction tenders are founded on trust and ongoing collaboration – and clients and contractors should seek to work together closely from the earliest stage of the process.

Projects that begin in an adversarial frame of mind are much less likely to proceed smoothly. By contrast, says Alan Woolston, a partner at law firm Fladgate: “used correctly, two-stage tendering could be a potent tool to not only meet the challenges of today’s construction market, ensuring high levels of interest in a project, but perhaps to also realise the ambitions of efficiency, value and a better end product”.

That’s a worthwhile goal – and by managing the risks outlined above, clients will have a better chance of achieving it.

TAKEAWAYS

  • Two-stage construction tenders carry significant benefits but bring new risks.
  • It is possible to manage the risks of two-stage tenders with detailed agreements at an initial stage.
  • Two-stage tenders work best when the parties trust one another and work together, rather than engaging in an adversarial relationship.

Find out more about risk management in construction. Download: 7 Inherent Risks of Construction Projects and How to Manage Them





7 Inherent Risks of Construction Projects and How to Manage Them