EFFECTIVE BID PRICING FOR UNIT PRICE CONTRACTS

ABSTRACT

The task of submitting a competitive bid for the production of a specific product or performance of a particular job is a requirement of firms in many different types of industries, such as construction, manufacturing, and government contracting. In this paper we provide a general model from which to derive a deterministic bid price on a unit price contract. The solution is derived in a capital budgeting context, first for a single bid item contract and then extended to the case of a multiple bid item contract. The specification of a completely general model allows us to examine the sensitivity of the solution to the firm's fixed and variable costs. The sensitivity of the bid price is shown to be independent of the level of cost, but highly dependent upon the delivery schedule of the contract. A form of the winner's curse dilemma is also examined. We show how the conditional distribution of project net present value (NPV), given a winning bid, is adversely affected, and provide a means to incorporate a correction to the firm's bid price. A brief numerical example is included to illustrate the models.