Lowest cost pricing - end of an era?
Social landlords running procurement exercises in the economic downturn have been poorly served by traditional lowest cost pricing evaluation strategies. Recent criticism in the Hackitt Report about lowest price tendering suggests the need for a radical rethink in assessing price.
Lowest price tendering results in competitive prices that allow clients to demonstrate they have obtained good value at the point of procurement. However, the downside of this approach often outweighs the financial savings secured, resulting in poorly-performed contracts, disputes and claims as the contractor attempts to recoup costs, or, in extreme cases, contract termination and contractor insolvency. Put bluntly, relying on lowest price can result in a flawed and adversarial contractual relationship.
The Hackitt Report on the building industry has been highly critical of lowest cost tendering, and made a number of recommendations for improved procurement practice in this area. The report identifies the procurement process as the process that "kick-starts the behaviours" seen throughout the design, construction, occupation and maintenance stages, and "sets the tone and direction" of relationships between construction and design team members. Poor procurement creates a "race to the bottom" culture which prioritises "doing things as quickly and cheaply as possible rather than delivering quality homes which are safe for people to live in."
In relation to price, the report states that procurement processes should aim "to obtain best value, rather than lowest cost". The report criticises contracts with low margins for contractors, which it says leads to contractors pushing technical and contractual risk to its supply chain, and risks being handled by people who are unable to mitigate them appropriately.
The report's key recommendations are for clients to aim to construct buildings that have a long life cycle, and consider full life cycle costs at procurement stage. This cultural change needs to be embedded from the outset and, so with this in mind, the tender process should prioritise building safety, and balance upfront capital cost against quality and effectiveness. Safety requirements should be tested effectively during the tender process. Best value should be achieved by establishing collaborative relationships between the construction team, and by encouraging efficiency and productivity, not by using cheaper and unsuitable materials.
So how can contracting authorities put the report's recommendations into practice?
The current public procurement regime already provides flexibility in relation to assessing price. The Public Contracts Regulations 2015 allow contracting authorities a broad margin of discretion when structuring evaluation exercises, which may comprise a price-only assessment or a split between price and quality. Courts are unlikely to interrogate this selection unless the contracting authority makes a manifest error in adopting a particular pricing formula.
Many procurement exercises in the UK favour the "standard differential model", regardless of the price/quality split, in which the lowest price is awarded full marks and the other prices are scored in relation to the lowest score. This practice incentivises bidders to price as low as possible, continuing the "race to the bottom" culture criticised in the Hackitt Report. This approach also creates a higher risk of abnormally low tenders, which contracting authorities are now required to investigate. Although the Regulations empower contracting authorities to reject suspected abnormally low bids where the bidder cannot satisfactorily account for its low prices, in practice this seldom happens, leaving contracting authorities to deal with low-margin high-risk contracts.
The Regulations also provide for an alternative "life cycle costing" model, in which the contracting authority considers all the costs over the life cycle of a building, including (without limitation) energy consumption, maintenance, collecting and recycling and pollutant emissions costs. Though life cycle costing has been available since February 2015, its uptake in the UK has been quite low, suggesting that UK contracting authorities lack the inclination or experience to adopt alternative pricing models.
There are a number of other pricing models that incentivise sustainable pricing behaviours. One such model is the "optimum pricing" model, where the contracting authority sets out the optimum price that it considers appropriate for the contract, based on its market research and consideration of its budgetary constraints, and the tender closest to the optimum price receives the highest marks. As with the life cycle costing model, this requires contracting authorities to undertake market research about the true price of the contract, rather than simply ranking the prices received and giving full marks to the lowest score.
Moving away from a lowest price tendering system requires contracting authorities to explore efficient working practices through the life of the contract. The use of partnering contracts such as PPC2000 and TAC-1 can encourage collaborative working practices, as recommended in the Hackitt Report. However, this requires clients to commit to long-term contract management, rather than assuming that a low upfront price will deliver the best result.
Given the high profile of the Hackitt Report, the link between lowest price tendering and safety risks will continue to be debated.
With this in mind, UK contracting authorities should be encouraged to review their current price evaluation models, and consider different procurement methods that achieve best value without compromising safety.