The Effect of Winner’s Curse on Contract Management

Following the evidence that, there is high probability for large winner’s curse to exist in the Sri Lankan construction industry (please read this first), we moved forward to identify how it could challenge the contract management of a project. This is a synopsis of a paper I published with Ruwandika Uhanowitage at the International Conference on Building Education and Research: Building Resilience, held at Kandalama Hotel in 2008.

Large winner’s curse means that the winning contracts shall either carry losses with below average profits or even negative profits. This can lead to cash flow problems for the contractor, who may try to compensate by submitting numerous claims or reducing time and quality performance. As a result, post-contract management difficulties may arise, requiring extra effort for corrective measures from the client and consultants. One of the key impacts of this scenario is the elevated aggressiveness of the contractor in claiming.

We used two variables to assess the winner’s curse: Winning Margin and Winning Bid Range. The Winning Margin quantifies the difference between the winning bid and the second lowest bid, offering a measure of the perceived winner’s curse. The Winning Bid Range measures the gap between the average bid and the lowest bid, providing an estimate of the theoretical winning margin, assuming the average bid reflects the normal market price.

The contractor’s claim attitude index was a new measure we identified through our study to represent the level of contract management difficulties because the contractor’s aggressiveness of claiming is a key factor to aggravate difficulty of contract management. The index was calculated as the ratio between the amount claimed for the contractual claims such as variations, fluctuations, and cost headings under time extensions by the contractor, and the actual amount approved for payment. The formula used to calculate the claim attitude index is as follows:

Claim attitude index = Quoted amount by contractor / Approved amount

The research was designed as a correlation study based on a survey of 20 building projects. The study revealed a significant positive correlation between the winner’s curse and post-contract management difficulties. The higher the winner’s curse, the higher the contractor’s claim attitude index, which signifies greater contract management challenges. Moreover, the research indicated that while both the winning margin and winning bid range are positively correlated with the contractor’s claim attitude index, it was the winning margin that displayed the strongest correlation. These findings imply that contractors with a pronounced perceived winner’s curse are more likely to claim aggressively, resulting in increased paperwork, negotiations, and potentially strained relationships.

The study’s implications for the construction industry are noteworthy. Clients should exercise caution when awarding projects to bidders with a substantial winner’s curse. Instead of relying solely on bid prices, clients should take into account other critical factors, including the contractor’s experience, reputation, and track record when making their decisions.

Citation to Original Paper (click on the title to open the paper)

Jayasena, H. S., & Uhanowitage, R. (2008). The Effect of Winner’s Curse on Post-Contract Management. International Conference on Building Education and Research, Building Resilience (pp. 284-285). Kandalama, Sri Lanka: CIB.

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