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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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The winner’s curse is a phenomenon that occurs when the winning bidder in an auction or bidding process ends up paying more for the item or project than it is actually worth. This concept is explained in the book “The winner’s curse: paradoxes and anomalies of economic life” by Richard Thaler. The explanation primarily focuses on the buyer’s perspective, as the concept of the winner’s curse was originally introduced in the context of auctions in the oil drilling industry. In these auctions, buyers often place bids without having a precise understanding of the potential oil reserves they can extract.

In the construction industry, the dynamics differ from traditional auctions because, in construction tenders, bidders present proposals to provide their services at a specific price to the client, rather than bidding to purchase a product. Each bid specifies the price a contractor is willing to accept from the client in exchange for completing the construction project. In this context, the winner’s curse can occur when a contractor secures a bid but later realizes that the actual project costs exceed their initial estimates during the pricing phase. This miscalculation can result in reduced profits or even financial losses, thereby negatively impacting the overall profitability of construction projects.

The study conducted by us in Sri Lanka from 2003 to 2005 revealed strong evidence of significant winner’s curses in the Sri Lankan construction industry. The research employed the winning margin and the distribution of bid prices to identify potential winner’s curses. Analysing 389 bids across 64 private sector projects, the study observed considerable variability in bid prices, with a standard deviation of 16.13% from the average bid. This indicates that the winning bids consistently fell significantly below the average price, as the winning bid tended to be closer to the lower end of the price spectrum, not near the average.

The winning margin represents the difference between the lowest (i.e., winning) bid and the second lowest bid. It essentially quantifies “the money left on the table,” as the winner could have secured the bid by offering just one rupee less than the second lowest bid. On average, the winning margin was 9.32%, meaning that, on average, the second lowest bid was approximately 9% higher than the lowest bid. However, this winning margin could range from as low as 0.12% to as high as 35.06%.

The significant price variability and substantial winning margin emphasize the gravity of the winner’s curse issue within the Sri Lankan construction industry. The presence of substantial winner’s curses serves as a indicator of inefficiencies, including issues related to information, inexperience, or inadequate training among cost estimators. These inefficiencies are detrimental not only to the industry’s growth but also to individual clients. Given the compelling evidence, it is vital that we collectively address and confront this issue.

This article provides an overview of the paper titled “The Winner’s Curse in the Sri Lankan Construction Industry,” which was a part of my master’s study at the National University of Singapore. Associate Professor Wille Tan supervised the study. I am grateful to his guidance and insights.

Cite the original article

Willie Tan & Himal Suranga (2008) The Winner’s Curse in the Sri Lankan Construction Industry, International Journal of Construction Management, 8:1, 29-35, DOI: 10.1080/15623599.2008.10773106

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