In the second of our procurement series, Simon Rawlinson of Davis Langdon takes a look at two-stage tendering and how to get the best out of the early appointment of the contractor
The objective of contract procurement is broadly to identify an appropriately skilled contractor and to secure an appointment on the basis of the right team, agreed costs, programme and appropriate transfer of risk. This seemingly innocuous objective has become increasingly more difficult to achieve as programmes have accelerated and as both employers and contractors seek, in particular, to strengthen their position with regard to the apportionment of risk.
Historically, clients have mostly chosen contractors on the basis of lowest cost. Although many commentators now recommend the adoption of negotiation and partnering-based arrangements, many clients continue to seek the reassurance of some element of competition in their tendering processes. Indeed, there is evidence to demonstrate that, where lump-sum contracts are in use, this approach can still deliver good-value solutions if the process is not abused. Value and cost certainty still count for a great deal in the overall balance of most clients’ priorities and as a result, some form of competitive tendering will continue to be used on a large number of projects.
So is two-stage tendering a mechanism that enables a more collaborative approach to be adopted by clients and their contractors, while still delivering value for money, or does its use potentially compromise a client’s commercial position? The answer is somewhere in between - in that the main benefit of two-stage tendering, speed of programme, inevitably comes at the price of some degree of cost premium. Furthermore, for clients following a public sector OJEU procedure, limits on their discretion to engage in any negotiation with the preferred tenderer effectively eliminates the opportunity to drive value into the bid.
Where clients need lump-sum cost commitment from their contractor and they have the time available, single-stage tendering continues to be a viable route for obtaining good-quality bids. However, in an increasingly time-driven and consolidated tender market and with a greater transfer of design responsibility to the supply chain, many clients find themselves having little option but to go down the two-stage route. In the final analysis, whether the two-stage route adds value will depend more on the quality of the design information and post-contract relationships than on the basis on which the contract was bought.
An overview of two-stage tendering
Two-stage tendering is a procedure typically used to achieve an early appointment of a contractor to a lump-sum contract. For the first stage, the objective is to competitively appoint, on the basis of limited information, a preferred contractor for further negotiation.
The first-stage competition is typically based on deliverables including a construction programme and method statement, detailed preliminaries pricing, and overheads and profit. The first stage may also include the competitive tendering of some work packages, together with lump sums for pre-construction services, design fees, risk margins for work that will not be tendered in the second stage, and so on. The first stage concludes with the appointment of a preferred contractor either on the basis of the provisions of the contract (such as GC Works) or a separate pre-construction services agreement (PCSA) prior to the completion of a contract at the end of stage two (such as a JCT contract).
The second stage, which is typically managed as a negotiation between the employer and the preferred contractor relies upon competition between second tier contractors for work packages. The second stage is concluded with the agreement of a lump-sum contract sum, typically based upon the competitive tender of between 70 and 80% of the value of work packages.
This process clearly relies upon an element of co-operative negotiation during the second stage. The abuse of a negotiating position during the second stage can have a damaging effect on the conduct of the entire project and cannot be tolerated.
Typical steps in a two-stage process for a conventional lump sum tender are set out in the flow chart attached (See PDF at foot of page - ‘Two-Stage tender process’).
Clients adopt the two-stage tender option for a number of reasons, including:
- Achieving early appointment of the main contractor ahead of the completion of design, and potentially a quicker start on site.
- Securing the involvement of a contractor for pre-contract services on a competitive basis, to obtain input on buildability, sequencing and subcontractor selection.
- Retaining greater client involvement in the pre-selection and appointment of subcontractors.
- Motivating the design and construction team to drive out cost and to drive in value.
- Transferring a greater degree of design and other construction risk to the contractor.
Two-stage tenders are a relatively attractive option to main contractors for a number of reasons, not least because resource requirements and costs of abortive tendering are reduced. The successful second-stage tenderer also has the opportunity to ensure that their costs and profitability are secured through both competitively tendered first-stage deliverables and through risk allowances negotiated during the second stage. In the current market, and for clients in certain business sectors, two-stage tendering is increasingly the only option to secure serious contractor interest and well-resourced project teams.
As a result clients, must take specific steps to strengthen their commercial position in the second stage negotiations. These include securing a portion of the measured work in the competitively tendered first stage and always retaining a get-out route with some leverage on the preferred contractor.
Although two-stage tendering is popular with contractors, there is no guarantee that a contractor’s attitude to a project will remain consistent during an extended tender period. The discovery of an omission in the first-stage bid, the filling of order books or a risk-averse bid adjudication may all result in a less favourable than expected second-stage bid. Unfortunately, the tenderer is under no contractual obligation to submit a competitive second-stage bid. Furthermore, going down the two-stage route is no guarantee of a non-adversarial approach to post-contract relationships with the contractor.
Once the preferred contractor is appointed at the first stage, the client’s main lever of competitive peer-to-peer competition is lost. Given the diversified nature of contractor workload, few clients have sufficient projects on the books at any one time to use as an effective bargaining chip and as a result, clients need to rely on the way in which the second stage is set up to maintain a strong negotiating position.
Key elements of this negotiating stance include:
- The roles and responsibilities set out in the pre-contract service agreement.
- The client’s advisers’ involvement in the selection of subcontractors.
- The discipline of the client and the design team in preventing scope change and design creep, and in completing the design to a point where the second-stage tender can form the basis of a realistic and achievable lump-sum contract.
- The retention of the client’s ability to withdraw from the second-stage tender at any time, without suffering significant delay or extra cost - through reversion to a single-stage competition or an alternative package-based route.
Taking the above issues into account, two-stage tendering broadly suits the following types of client and project teams:
- Clients that are not driven by the objective of securing an absolute least-cost bid.
- Clients that have a genuine need to follow a two-stage route, either because of programme constraints or a specific requirement to actively involve the contractor in the design and procurement process.
- Projects that are sufficiently well defined at first-stage tender to enable a programme and firm preliminaries to be prepared, together with a client and design team who have the discipline to complete the design to an appropriate level of detail in the second stage.
- Clients and design teams that have the capability and resources to actively engage in negotiations with the preferred contractor during the second stage.
Adapting two-stage tendering for design-and-build
Design-and-build-based procurement has become increasingly widely used on design-team-led schemes where the employer is seeking to transfer both design and commercial risks. Two-stage tendering arrangements should, in theory, be well suited to design-and-build procurement for the following reasons:
- The contractor has the opportunity to work with the client’s designers ahead of novation, enabling relationships to be developed, and giving the contractor the opportunity to contribute to the design process on buildability, sequencing and so on.
- The two-stage tender allows, in theory, further overlapping of the design and procurement programmes.
- The preferred contractor is strongly motivated to ensure completion of the design to an agreed level of definition.
- The procurement of specialist subcontractors with design responsibility should be more effective with the input of the preferred contractor.
- The contractor’s second stage bid should be based on a thorough understanding of the design solution and the client’s requirements.
However, when tendering on a two-stage basis for large and complex schemes the issues raised in the second stage negotiation can be both very wide ranging and also difficult to close-down. As a result, and despite these strong reasons to adopt two-stage tendering on design and build, clients can find themselves facing some nasty surprises at the end of the second stage negotiation. Areas of potential disagreement include allowances for design development during the tender period and risk allowances for the completion of the design. Other risk issues that clients need to be aware of include:
- The design team remains the responsibility of the employer until novation occurs. As a consequence, any design development carried out after the second stage will be a variation for which the client will have some design responsibility. It is a prudent, although possibly impracticable step, to suspend design work during the second-stage bid period, so there is a clear relationship between the contract sum and the novated design.
- Novation can only occur once the second stage is completed and the main contractor appointed.
- The switch to negotiation during the second stage makes it much more difficult for the client to monitor levels of main contractor risk allowances built into subcontractor tenders.
In summary, the adoption of a two-stage tender route on design-and-build jobs gives the employer a great deal of benefit in terms of the balance between client control over design development and the eventual transfer of design responsibility to the contractor. However, there is a premium to pay for this additional risk transfer. The preferred contractor’s role in design development will strengthen its negotiating position, enabling it to drive a particularly hard bargain in the closing stages of the second-stage tender.
Advantages and disadvantages of two-stage tendering
If a proactive contractor is appointed for the second stage, two-stage tendering goes some way towards addressing some of the difficulties experienced with traditional lump-sum tenders that result from the separation of design and construction. In accelerating the appointment of the contractor, the two-stage route provides clients with further potential benefits, but also some significant downsides, which are summarised in the table (see table attached below ‘Advantages and disadvantages of two-stage tendering’).
In summary, the benefits of the two-stage approach are most likely to be secured in circumstances where:
- The client has the bargaining chip of substantial future workload.
- The employer and the design team are disciplined in their completion of the stage two design information.
- The client retains the ability to withdraw from the bid at any time.
- The contractor is proactive in its engagement with the design, buildability and financial aspects of the project, buying into delivery of the project within the client’s cost target.
Recent experience of a number of second-stage tenders, however, suggests that contractors do not always have the design, cost and bid management skills needed to de-risk the project at source, and as a result the stage-two bid may be inflated to include larger than anticipated risk premiums. With the loss of competition after the first stage, clients have only limited options available to renegotiate their preferred contractor’s offer.
Improving the client’s negotiating position on two stage tenders
This section sets out steps that can be taken to improve a client’s negotiating position on a two-stage tender. The starting point for these actions is the assumption that the project is attractive to prospective tenderers, and that the client is able, to an extent, to dictate terms. On complex schemes such as refurbishments, projects for one-off clients, or projects with a very challenging programme, the client may not be in a position to go out to the market on any basis other than conventional two-stage competition.
Maintain an exit strategy. Negotiation on two stage tenders relies on a good deal of 11th-hour brinkmanship. To be fair to the contractor, the source of this problem is very often rooted in the fact that the contractor’s overall risk exposure will only be known when the design is completed to the required stage and when subcontract bids are received. Key attributes of the exit strategy are that bidders must know that it exists, it must be credible and its operation must have a negative consequence for the preferred tenderer. Exit options include:
- Retain the option to proceed to full single tender in competition after the completion of the first stage. This option is particularly effective if some work packages have already been secured ahead of the completion of stage one.
- Use the client’s not-to-exceed (NTE) budget as a cost threshold that will trigger a separate, single-stage competitive tender process. Where a target cost threshold is being used, the preferred second-stage contractor should be advised that they will be barred from submitting a revised single-stage tender offer on the basis that they have already submitted their best price.
Both of these options would inevitably incur a time penalty if enacted, but their prime intention is to strengthen the client’s negotiating position. The client should allow some programme float at the end of the second stage for this eventuality.
Don’t start too early. The first-stage tender must be based upon a sufficiently representative firm design so that the contractor’s programme and preliminaries are not subject to renegotiation in the second stage. The earliest practical date for the issue of stage-one tenders is therefore the end of RIBA stage C. At the same time, the client’s design team must detail the design so that it can be procured securely during the second stage. Clearly there is no benefit to the client in going down the two-stage route unless a viable firm price tender can be secured. Where the design team is not to be novated, these deliverables will need to be driven by the client. A recent court case, Plymouth and South West Co-op vs ASM, involved a project where more than 85% of the second-stage tender was let as provisional sums. Damages awarded to the client exceeded £1.5m. The case demonstrates the importance of the client keeping on top of design team performance as well as contractor procurement if the second stage is to be successful.
Don’t start on site under the direction of the main contractor prior to the agreement of the second stage tender. Instructing work on the basis of a letter of intent is a high-risk option on any project, and will undermine the client’s exit strategy on a two-stage scheme.
Maintain the quality of the design information. Avoid the acceleration of the production information programme to meet the timescale for the second stage if this will compromise the issue of complete design information.
Early procurement of tender packages. Include works packages in the first-stage tender in order to ensure that they can be priced on the basis of a competitive rather than a negotiated tender. Clients need, however, to be confident that the scope of work will not change significantly during the second stage. Package contractors can also tender directly to the client for later novation to the successful contractor. High-value contractor-designed packages that require substantial input from the project team such as external cladding provide opportunities to procure specialists on this direct appointment basis.
Establish clear roles and responsibilities for the tenderers. No pre-construction services agreement can compel a contractor to submit a competitive bid. However the PCSA can clarify the contractor’s role with regard to the continuing development of the design, their responsibility for the management of the design team during the second stage and the targets that need to be met to complete the second stage. In effect the PCSA should aim to set out the basis on which the client can revert to a plan B without penalty.
Agreement of design development risk allowances as part of the first stage tender. One of the major problems with the second-stage negotiation on design-and-build contracts is the “below the line” risk allowances for design development and so on that contractors add to second-stage package tenders. These main contractor costs are usually included within the gross costs of the package tenders and are not subject to any form of benchmarking.
They are potentially a significant source of loss of cost control during the second stage. Pricing of risk allowances can be included as part of the first stage bid, but other than the adoption of a wholly open-book approach to pricing, there is no way of guaranteeing that these additional allowances are not subsequently included in subcontractors’ costs in the second stage.
Greater client involvement in the second stage procurement of subcontractors. Active involvement by the client’s consultants in the procurement of subcontractors helps to ensure that the negotiation proceeds on an even-handed basis. Areas where the project team can contribute include the shortlisting of the subcontractors, the preparation of the tender documents and the opening of tenders.
Maintenance of competition into the second stage. Competition can be extended into the second stage through the retention of two preferred contractors. The employer will be liable for the second stage costs of both tenderers and as a result will need to be confident that the additional costs incurred by both contractors and the project team can be offset by savings achieved in the second stage. Running second-stage tenderers in parallel is practicable only when there is a limited transfer of design responsibility to the contractor. It would not be appropriate to follow this option on design-and-build projects, for example, where the aim of the second stage is to get the preferred contractor and design team to collaborate in the production of a firmed-up set of contractors’ proposals.
Incorporation of gainshare arrangements. Contractors can be incentivised to improve on the client’s NTE budget during the second-stage tender using a shared savings arrangement. The downside of this approach is that the NTE must have some fat in it for the contractor to secure savings to share. Alternatively they may adopt a pricing strategy to meet the NTE - retaining the full value of the value of the contract rather than returning some to the client.
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