A bid spread is simply the difference between the lowest bidder and the second lowest bidder. For example, If Bidder 1 submitted a bid of $100,000 and Bidder 2 submitted a bid of $110,000, the bid spread is $10,000 or 10%. The formulas for calculating a bid spread are as follows:
Bid spreads are important for evaluating how competitive a bid letting was. In most instances, contractors have similar job costs such as materials, fuel, etc. Differences occur because of different overhead, profit and subcontractor costs. Therefore, hard bid contracts tend to have close bid results. Small bid spreads are an indication that the project was bid competitively.
For surety bonding, a large bid spread is generally any spread that is more than 10% between the lowest and second lowest bidder. When a bid spread is more than 10%, the surety bond company will generally ask the contractor to justify their bid. 10% is considered the margin of difference for a contractor’s gross profit. Since costs should be similar for all contractors, 10% variance for overhead and gross profit is considered an industry standard.
Bid spreads can occur for a variety of reasons including a contract advantage, mistake or omission, poor or incomplete plans, project location or scope, subcontractor pricing, timing or a limited number of bidders.
Large bid spreads can occur when a contractor has a significant contract advantage over another contractor. For example, a large highway contract next to a contractor’s quarry would provide them a significant cost advantage. Where other contractors may incur significant cost to transport rock and material to the site, the close contractor would not incur such costs.
Mistakes and Omissions are the worst reason for large bid spreads and the reason that surety bond companies are concerned about them. Common examples include leaving out a scope of work, or under estimating quantities. Mistakes can also occur mathematically by adding up costs incorrectly or transposing numbers incorrectly.
Another common reason for bid spreads are Incomplete or poor plans and drawings. When plans or drawings are bad or incomplete, contractors are forced to interpret the project to some degree. This can lead to wide bid spreads. Bidding such documents is dangerous to contractors and increases the chances that they will leave out important details for the project.
The location or scope of a project could lead to significant bid spreads. For example, a large oversea project could have large bid spreads because of the uncertainty of the project, or the limited number of bidders for the particular project.
Large bid spreads can occur because of subcontractor pricing. Subcontractors pricing and performance presents a significant risk to general contractors. A cheaper price could be an advantage to the general contractor, or it could mean that the subcontractor made a mistake in their pricing. Contractors can protect themselves from subcontractors by getting multiple sub bids, obtaining subcontractor bonds, or alternatives such as subcontractor default insurance.
Timing can lead to large bid spreads. If competing contractors have full backlogs, they may “pad” their bids and put more profit in the bid. This can lead to large spreads between the low bidders and their competitors, even when their estimate is accurate.
When a project only has a couple of bidders, there may be large bid spreads between the numbers. For this reason, many bid lettings require at least 3 bids for the letting to be awarded.
Surety bond companies are very interested in bid spreads. They generally want their customers to justify bid spreads over 10%. The first they will generally ask is whether the contractor is comfortable taking on the project as bid. From there, they will generally ask the following:
Bond underwriters will ask the contractor if they have reviewed the bid again carefully to see if any mistakes, errors or omissions occurred. Did the contractor leave something out? Did they check subcontractor pricing? Are the quantities correct? Contractors should check and recheck their bids when a large spread occurs.
Surety bond underwriters will also compare the bid amount to the engineer’s estimate. An Engineer’s Estimate is the expected cost of a construction project, which is established before it is put out to bid.There is more concern for the bond company if there is a large bid spread and the bid came in under the engineer’s estimate.
Surety bond underwriters will also compare the bid spread to the contractor’s net worth and financial strength. For example, consider a $1,000,000 bid spread on a project. Suppose the spread was a 15% bid spread. For a contractor with a $2,000,000 net worth, this would be a significant spread.
Failure to properly evaluate the bid could lead to a bond claim or financial disaster for the company. On the other hand, this bid spread is probably of little concern to a contractor with a $20,000,000 net worth.
Finally, surety bond underwriters look at a contractor’s bidding history. Does the contractor normally have good bids and profitable work, or is their strategy to bid low and try to make profit through change orders. The latter is a risky strategy that may lead the bond company to re-evaluate their support.
Bid spreads are normally easy to identify by looking at bid results. Public projects normally release the results of the bid letting to the public. Private projects do in some cases, but not always. These bid results can be difficult or impossible to obtain, making it difficult to determine if a bid spread exists. The same can be said for subcontractor bids to the general contractor. Some GCs will release bid results and some will not. It is still common practice for the surety bond company to ask to obtain the results. Technology and subscription services have also made obtaining bid results easier. Services such as ConstructConnect, and Dodge have made obtaining bid results simple.
There is a difference between a bad bid and leaving money on the table. While every contractor would love to have the smallest bid spread and make the most money possible, there are many times when good, profitable jobs have a large bid spread. Those jobs should still be performed and completed.
However, there are also bad bids and mistakes. In my experience, contractors may be better off leaving those projects and forfeiting their bid security than taking a losing project. Below is an example:
Keep in mind that a surety bond company does not have to write a performance bond or payment bond, even when they issued a bid bond. A large bid spread may keep them from wanting to do so. The best case is to always talk to the owner when an error is made. Try to withdraw the bid if possible.
While rare, I have seen surety bond companies send out engineers to review a project when there is a large bid spread. This will likely only occur if the contractor wants to stay on the project and the bid spread is significant. This gives the contractor and the engineer an opportunity to convince the surety it is a good idea to move forward.
Bid spreads are a normal part of construction. Large bid spreads can be concerning, but there are legitimate reasons that they occur. Reviewing your bid and communicating with the project owner and surety bond company are the best ways to ensure the project still goes smoothly. Contact Axcess Surety today for all you surety bond questions and needs.
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