Aside from allowing contractors sufficient time to properly consider the pricing of risk, clients need to be able to assess the extent to which contractors' tender prices are based on well-founded willingness to take on project risk. A useful 'transparent pricing' strategy is for the client to require fixed price bids to be broken down into a price for expected project costs and risk premia for various risks. Supporting documentation could also show the contractors' perceptions of risk on which the risk premia were based. As in insurance contracts, pricing based on broad categories of risk rather than related to small details is a realistic approach. An important consideration in performing risk analysis is the identification of factors that can have a major impact on project performance. However, detailed risk analysis may be necessary to determine the relative significance of project risks. Pricing need not consider all project risks in detail, but it does need to be related to major sources.
An important benefit of a transparent pricing strategy to both client and contractor is clarification of categories of risk remaining with the client despite a fixed price contract. For example, there may be project risks associated with exogenous factors, such as changes in regulatory requirements during the project, that are not identified or allocated by the contract. Such factors are unlikely to be allowed for in bids, because tenderers will consider such factors outside of their control and the responsibility of the client.
A further benefit of transparent pricing is that it helps to address an important, potential 'adverse selection' problem. Contractors who can provide honestly stated, good-quality risk pricing may price themselves out of the market in relation to those who provide dishonestly stated, poor-quality risk pricing at low prices, if sufficient clients are unable to distinguish between good and poor quality, honesty and dishonesty. As Akerlof (1970) argues in a paper entitled 'The market for ''lemons'': quality uncertainty and the market mechanism', poor quality and dishonesty can drive good quality and honesty out of the market. Clients can address this problem by requiring transparent pricing of risk in tenders and by requiring tender submissions to include plans for managing risk. In this way comparisons between tenderers in terms of the extent of well-founded willingness to bear risk can be made on a more informed basis.
In practice, tenderers experienced in risk management may be able to demonstrate well-founded willingness to bear risk and submit lower tender prices than competitors. In such cases transparent pricing should help to consolidate their advantage over less experienced contractors.
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What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.