NATIONAL ASSOCIATION OF SURETY BOND PRODUCERS ...
NATIONAL
ASSOCIATION OF SURETY BOND PRODUCERS
November 1,2003 Introduction Most construction owners have the samegoals: They want projects completed faster, cheaper, and with the highest degree of quality. Federal and state governments sharethese goals, but have many additional goals unique to their size and regulatory complexity, such as wanting to streamline and simplify their procurement methods that often are criticized as cumbersomeand rigid. Therefore, it is commonplace for both public and private owners to be interested in the most current methodology to accomplish their goals.
With advancesin technologyandthe widespreaduseof computersandelectronicsystemsin businessandindustry, it is not surprisingthat projectownerswould look at the useof real time communicationvia the Internetasa possiblemeansto improvethe bidding methodfor construction.Hence,the adventofERAB: electronicreverseauctionbidding. ERAB is of interestto NASBP membersand their contractorcustomers.It is appropriate, therefore,for NASBP to provide informationaboutthis procurementmethodto membersand affiliates,so they maybe of greaterassistance to all potentialbuyersand sellersin deciding whetheror not to participatein reverseauctions. Although construction associationsand other writers have expressedconcerns about ERAB use in the procurement of general contractors' services some individual general contractors may not be averseto using ERAB in purchasing goods and supplies, i.e., items that are interchangeable and indistinguishable and have fixed costs for production and delivery .5,12Some construction contractors even may be interested in using ERAB to purchase subcontractor services, especially for non-complex or routine projects. Much of the literature to date has focused on the impact of ERAB on general contractors, and this white paper will continue in that vein. Professional surety bond producers, however, should be aware that their general contractor customers may have conflicting interests about the ERAB method and need guidance from both the standpoint of being a bidder and a buyer.
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NASBP only canaddressthe ERAB methodas it existsatthe presenttime, andas it hasbeen analyzedto date. The useof technologyin procurementis still evolving. The comments containedin this document,therefore,arerestrictedto the currentmethodanduse. In addition, NASBP supportsthe useof technologyin procurementandsurety,andnoneof the commentsin this white papershouldbe viewedasan indictmentof e-commerce.
Defining What It Is and Who's Using It Accordingto Michael Pearlstein, A reverse auction is an electronic method of confidential bidding... an auction ~s live, online, and the successfulbidder usually is determined by the lowest price submitted to the tendering authority at the close of the auction. 14 Although originally designed to accommodatethe procurement of construction goods or commodities, ERAB now is being considered and in some instancesused in the bidding for construction services. The use of ERAB is a relatively new development that currently is not in widespread use although large industrial firms, e.g. General Electric, and nationwide retailers, including such "big box" companies as Target, Best Buy and Home Depot, are leading the charge in considering its applicability to bidding for construction. I? This interest by the private sectoris causing federal, state, and local governmentsto begin taking notice, as well. For example, as part of a Department 01~ Defense (DoD) 2002 appropriations bill, the Army, Navy, and Air Force were charged with conducting pilot programs to evaluate the use of reverse auctions, primarily for commodities.7 The Army Corps of Engineers' (USACE) is conducting a pilot program to use ERAB in the procurement of construction services for two projects. To date, USACE has conducted 12 auctions, which was a smaller number than originally planned becauseof the number of contractors who withdrew their original intent to participate. This mandateto the military contracting agenciesresulted from the urging of Arlen Specter (R-PA) to authorize these pilot programs in the appropriations bill.7 In addition to military contracting agencies,the Postal Service and the General Services Administration (GSA) are testing the use
ofERAB.7 Some experts argue that federal use of reverse auctions violates the provisions of the Federal Acquisition Re.!JUlations(FAR), "which reflect a clear policy of not disclosing contractor price information."3, For the time being, however, the Office of Management and Budget (OMB), which has jurisdiction over the FAR, is taking a hands-off approachas federal agencies conduct pilot programs and experiment with the reverse auctions process.7 Although some states,e.g., Indiana, Maryland, Minnesota, Maryland and Pennsylvania, already are using electronic procurement for commodities, the road to e-procurement for construction services may be somewhatbumpier. IS This is becauseof the differences between bidding on interchangeable or generic commodities, which have absolute minimum prices, profit margins, and predetermined unit costs for production and delivery, and bidding on construction, which includes such factors as location, site conditions, local codes and permit fees, material
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.. ..
changes/availability, procurement. 5
and fluctuating labor conditions, for example, that make it a more complex
In the 2003 state legislative sessions,lawmakers in Minnesota and Arizona considered bills to permit the use of ERAB for construction bidding. Becauseof fierce opposition, these bills were further amended to eliminate the requirement.IS Other states,namely Kansas and Pennsylvania, have enactedlaws prohibiting the use of reverse auctions in construction procurement.IS
Describing How ERAB Works A typical format for conductingelectronicreverseauctionbidding is asfollows: The buyer invites a list ofprequalified bidders to participate. Bidders receive drawings, specifications, and explanations about electronic bidding in advance of the event. A third-party serviceprovider conducts the auction on behalf of the buyer, with all bidders participatin,g simultaneouslywithin a specified start and closing time. The names of all bidders arE~kept confidential during the auction. Bidders submit prices that are ranked and disseminatedto all other bidders. The auction's closing time may be extendedfor a predetermined period of time if one of the top bid ran!kingschanges. The auction serviceprovider notifies the buyer of the bidding results and then initiates the appropriate follow-up with the winning bidder to complete the formal award of the contract. The buyer notifies all bidders immediatelyafter theIJnal bid rankings, with only the dollar value of the winning bid disclosed.5,0,14 ERAB involves a method that is significantly different from the time-tested, traditional sealedbid method in which, ".. .sealed bids are received and opened at a specified time, and the project is awarded to the lowest responsible bidder. Under this method, general contractors submit their bids, or pre-selected general contractors solicit bids from subcontractors,and there is no opportunity for subsequentbidding after the specified time for bid opening.,,1?According to the Associated General Contractors of America (AGC), the sealedbid model is more frequently used by owners on projects in which price and price-related factors are most important, and they do not have a high need to meet with bidders who are competing for the project.4 ERAB also differs from the negotiated procurement method that is used by some owners when non-price factors are important or they have a need to discussthe work with bidders. In this method, relationships and communication are essential, but are absent from the ERAB procurement method. 4
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Discussing the Issues Becauseof the involvementof third party serviceprovidersandrelianceuponthe Internet,the useof ERAB may appearon the surfaceto helpownersand otherbuyersachievetheir goalsof quality, speed,ease,and lower costs. Third-party vendors who provide Internet support and conduct the reverse auctions include consulting flrnls, software providers, or industry-sponsoredexchanges. These vendors are the largest proponents of ERAB for the procurement of both commodities and construction and include such companies as Ariba, CommerceNet, and FreeMarkets.11 One vendor, FreeMarketsInc, has described ERAB as "a safe and transparentmethod to help owners make effective real-time buying decisions.,,2 With the extension of reverse auctions to construction, construction associations' interest in this electronic method has increased accordingly and causedthem to express their concerns about the actual operation of and results from using ERAB. They join businessresearchersand other nonconstruction trade associations that also are expressing concerns about ERAB. All of these concerns may be considered in three distinct areas: (1) cost savings; (2) "bid shopping;" and (3) quality, safety, and relationships. The following discussion elaborates on the features of ERAB along these parameters.
PerceivedCost Savin!!svs. Actual Costs To proponents, the single most attractive feature ofERAB is the appearanceof savings. Buyers can watch the bidding in real time and seethe price of commodities or construction incrementally drop as the bidding goes on. At the conclusion of the auction, buyers of commodities, in particular, may believe that the fmal bid is the absolute lowest price and representsa considerable savings over the final bid price generatedfrom the traditional bidding methods. Attorneys writing for the "Construction Industry Cooperative Council of Minnesota" have taken the position that appearancesmay be deceiving in that the end result of using ERAB may not produce cost savings at all. They go on to say that, ...bidders in the [E]RAB process often do not start at their lowest number as they must do in the traditional sealed bid method. Instead... it is commonfor bidders in an auction to start with a high bid, see what prices their competitors are bidding, and then reduce their bid only if forced to do so bycompetition. Thus, downward movementfrom inflated initial bids should not be viewed as savings.17 The literature on ERAB contains articles by researchersand non-construction associations suggesting that the perceived savings reported by commodity buyers may not be realized if the final costs are examined. After analyzing approximately 12 online reverse auctions, M.L. Emiliani and D.l. Stec of the Center for Lean Business Managementof the Rensselaer Polytechnic Institute reported, "For many companies, the promise of lower unit costs is just an illusion becauseexpensesin other budget categories,i.e., indirect costs, may actually increase. The cost of goods sold will thus be maintained or increased." 11 The reverse auction task force
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of the International Housewares Association reported in its white paper that the savings realized in a buyer's first reverse auction may not be replicated in subsequentauctions, e.g., one company experiencean 11.8% savings in the first auction, which dropped to 2% in the secondauction; another company saw a drop in savings from 6% in the first auction to only .5% in the second.16 Besidesthe expensesinvolved with third-party vendors--computerhardware, software, services, and fees--buyers also may find that fewer bidders than expected register to participate in an electronic reverse auction, or they withdraw from the auction prior to it takinl ~lace. Fewer bidders mean less competition and the possibility of higher costs for owners. ,1
In additionto losing the competitivevalueof contractorswho areunwilling to participatein ERAB, the purchaserlosesthe benefitof thosewho areincapableof doing so,becausetheir businesses are not yet automated. OneNASBP membercommentedthat ERAB might unfairly excludesmall and start-upcontractors,in particular. Some ERAB proponents argue that expanding the bidding to broader audiencesmay result in lower costs. Opponents, however, claim that such expansionthreatenslocal companies and may result in bidders, who are unfamiliar with the project location, site conditions, local codes and permit fees, material changes/availability, and the stability and availability of the local workforce, winning the bid and ultimately costing buyers more in the long run.5,8,lO
Smart Business Practice vs. Disl!uised "Bid ShoDDinl!" Pearlsteinindicates that bid shopping occurs when owners (or general contractors seeking bids from subcontractors) selectively disclose competitors' bid information to favored bidders for the purpose of manipulating the bids and shopping for price reductions.14Critics contend that the most significant and serious fault of ERAB is that it is "bid shopping in disguise" and an "electronic version" of a practice that generally is frowned upon by construction associations becauseit is a way for buyers to enhancetheir profits by forcing subcontractors and suppliers to reduce or eliminate their own profits. ERAB proponents staunchly disagree with these criticisms. They mention the confidentiality and impartiality of the method, the development of strict, published protocols to be followed, and agreementsbidders and buyers must sign to guaranteethe validity of their bids and/or contract awards.2 One vendor defends its services by saying that it, ".. .helps full-service clients develop requestsfor qualifications (RFQs).. .monitors log-ons to seeif all bidders are participating.. .and is a "no-cost sales channel to buyers." This vendor claims it is "passionate about integrity, neutrality, and trust." 2 In responseto accusationsof "bid shopping," vendors claim that "bid shopping" generally occurs ~ a contract has been awarded, but if it is "bid shopping," at least it is being conducted in an open environment rather than behind closed doors. I? Opponents counter that even though a settime may be established for the bidding to end, extensions may be granted and frequent overtimes may occur if a bidder submits a low bid within minutes of the closing time, thereby permitting other bidders to re-submit their prices.lOThis kind of a process "can be interpreted as a form of pre-closing negotiation or 'bid shopping.' ,,5
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Others maintain that ERAB "institutionalizes a new form of bid shopping" becausebidders face repeateddemandsto lower their prices or else lose the work. They further contend that this practice often results in poor quality of workmanship to the detriment of the public, customer, or contractor. 10Becauseof the pressureapplied to bidders to shave profit margins and contingency dollars to reduce their bids, some fear that the relationship among the owner, contractor, and subcontractor/supplier may be severely compromised, become adversarial, and create a greater likelihood of disputes and bad faith, along with an increasedrisk of claims and litigation. 17
Built-In Protectionsvs. Com
and Relationshi s
There is no doubt that ERAB provides a more competitive bidding environment as bidders continue to underbid each other to eventually be the lowest bidder. Some claim that the competitive nature of reverse auctions can result in frenzied, cut-throat pricing by bidders, "which can ultimately force them to cut comers and/or submit changeorders to make up the difference between their final bids and what began as their best competitive prices.,,12
ERAB proponentsbelievethat thatthe inclusionof well-draftedprotocols,including clear-cut termsandconditions,specifications,and contractdocumentsto which biddersmustagreeasa conditionof participation,provide safeguardsfor ensuringthe quality and safetyofprojects bid usingERAB. As to the chargethat ERAB compromisesrelationships,onereverseauction vendormaintains,"We're not outto crackrelationships,just give assurances that ownersare gettingtrue marketpricing.,,2 Opponents of ERAB are concernedthat, "The [E]RAB process may induce bidders to reduce labor and supervision to levels that will endangersafety and lessenquality. Many bidders fear that when costs must be reduced, proper site safety is one of the first costs to be cut.,,1? An additional concern is that artificially low bids could affect the training of laborers and lead to a less-skilled workforce for future projects. Some claim that a logical outcome of problems related to safety and quality will be an increase in lawsuits to enforce safety and quality obligations and claims submissions related to performance. Along these same lines, some critics claim that reverse auctions, the pressure on bidders to cut comers or submit change orders, and the lack of communication and dialogue between buyers and sellers that is inherent in reverse auctions, creates difficult projects and leads to problematic relationships between owners and contractors and the destruction of any gains made in increasing partnership in construction. 10 Dave Semerad,CEO of the AGC of Minnesota, concluded in his analysis of reverse auctions that in the end, "The majority of contractors, however, will remain skeptical and will chooseto build collaborative, trusting relationships with their customerswho elect not to use reverse auctions.,,15
AGC maintainsthat,unlike whathappenswhenusingthe negotiatedprocurementmethod, "nonprice factorsthat areof consequence to the buyer, suchas qualityof relationship,past performance,anduniqueneedsarede-emphasized in the auction. As a result,reverseauctionsdo not offer ownersa good way to evaluatenon-pricefactors.,,4
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Somediscussionsof ERAB also point to the negativeeffectsof reverseauctionsin insuringthe continuedquality of materials,supplies,andproducts. Opponentsclaim that reverseauctions work againstthe developmentof bettercommoditiesto achievecompetitiveadvantage.They point out that, "Over time, the buyerinadvertentlyde-skillsits suppliers."ll Some opponents report that ERAB is not suitable for some types of bids. They contend that reverse auctions should not be used to obtain cost-plus or time and material bids in which owners requesthourly labor charges, mark-up on material costs, and billing rates for tools. They contend that these kinds of bids, as opposedto lump sum bids, do not quantify the value ofproductivity-the value of the contractor's supervision and training a more qualified workforce, which can provide a competitive edge in bidding.
NASBP's Considerations About ERAB One ofNASBP's policies (GA-16; adopted 05-05-2002) statesthat, NASBP supports the developmentand use of innovative alternative project delivery methods that improve efficiency and competition as long as these methodsdo not adverselyaffect contractors, owners,fair and open competition, or the ability to provide the required surety bondsfor theproject... Although this policy relates to another issue, it applies to the emergenceof ERAB. It also reflects the Association's concerns about certain construction principles, such as efficiency, open competition, fairness to all stakeholders,and the use of surety bonds to protect stakeholders' interests.
The May 2003issueof Pipelinecontaineda descriptionofERAB andrequestedreaders'input aboutits use.I3A few membersrespondedto this requestandprovidedcommentsandreports aboutthe useofERAB. Additionally, membersofNASBP's ConstructionIndustryCommittee who formeda subcommitteeon ERAB consideredmembers'input andprovidedtheir own opinionsandcommentsin the drafting of this white paper. With members' observations and concerns in mind, the subcommittee developed considerations that professional surety bond producers can provide to stakeholdersin construction, and considerations producers may want to take into account for protecting the surety companies they representand the customers they serve. These considerations are contained in Attachment I.
ForemostamongNASBP members'concernsis the prequalificationprocessand whetherany form of bid securityis required. Theyrecognizethatbid bondswould addressbothof theseconcerns.In addition,they maintainthatthis kind of methodis a perfectexampleof where suretybonds,and especiallybid bonds,would be of the utmostimportanceandrecommendthat theybe an essential componentof ERAB.
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Other Associations' Considerations About ERAB On September15,2003,the AssociatedGeneralContractorsof America (AGC) issuedits latest discussionof reverseauctions,andconcludedthat, Each construction team member must decide whether to participate in such [reverse] auctions. However, AGC believes that reverse auctions are an unproven methodfor selection of construction contractors, specialty contractors, subcontractors, and suppliers. At best, reverse auctions raise significant issuesfor owners and construction team members including thefollowing: .Reverse auctions do not guarantee the lowest price .Reverse auctions mayencourage imprudent bidding .Negotiated procurements allow thorough evaluation of value .Sealed bidding assuresthat the successfulbidder is responsive and responsible .Reverse auctions may contravenefederal procurement laws and certain state laws. 4
The boardof directorsof the AmericanSubcontractors Association(ASA) approvedits position on reverseauctionsat its meetingon September 21,2003, which said, ASA believes that electronic reverse auctions are aform of "bid shopping." ASA reaffirms its abhorrence of "bid shopping" and "bid peddling" as unethical practices. Thus,ASA supports legislation and regulation that would prohibit the use of reverse auctions on public and . k ,,] przvate wor . As evidence of its position, ASA is supporting legislation in Congress,HR 1348, that would prohibit all forms of "bid shopping" on federal construction projects, including the use ofERAB. The Surety Association of America does not have a fomlal policy or statementregarding ERAB; however, in a letter dated April 21, 2003, to David Semeradof the Minnesota chapter of the Associated Contractors of America (AGC), Robert Duke wrote: Although the concept of bid auctioning is primarily a contractor related issue, It has ramifications with respect to bid and performance bond guarantees ...A bid auctioning system may lead to haphazard bidding procedures in which the bidder lowers its bid price simply to beat the current low bid; with no relation to the estimated costs of the project. Without the assurance that the contractor has developed its bid price based on a careful review of estimated construction costs, a surety may be reluctant to provide a bid bond. 18
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Conclusion As with anychangein a long-standingindustrywith well-definedmethodsandprocedures,some considerERAB to be a "radical departurefrom the principlesof [traditional] construction practices."s As with other new alternatives that have appearedin the procurement system, however, dismissing ERAB as a "fad" is not in the best interest of any of construction's stakeholders, including the surety industry. Instead, surety bond producers need to consider the various issues involved in ERAB, educatethemselves and their customers about these issues, and explore ways the method can uphold the principles of fair and competitive bidding and maintain the use of surety bonds. At the presenttime, the fate of electronic bidding auctions for construction services is unknown. Yet to be tested is whether ERAB can meet the needsof all stakeholders. Ultimately, the pros and cons of the viability of ERAB as an efficient meansof achieving the lowest price, or even best value, will undoubtedly be a function of its successin the marketplace. The decision as to whether NASBP should be a proponent or opponent ofERAB, therefore, is both premature and inappropriate at this point in time.
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ASSOCIATION OF SURETY BOND PRODUCERS
November 1,2003 Introduction Most construction owners have the samegoals: They want projects completed faster, cheaper, and with the highest degree of quality. Federal and state governments sharethese goals, but have many additional goals unique to their size and regulatory complexity, such as wanting to streamline and simplify their procurement methods that often are criticized as cumbersomeand rigid. Therefore, it is commonplace for both public and private owners to be interested in the most current methodology to accomplish their goals.
With advancesin technologyandthe widespreaduseof computersandelectronicsystemsin businessandindustry, it is not surprisingthat projectownerswould look at the useof real time communicationvia the Internetasa possiblemeansto improvethe bidding methodfor construction.Hence,the adventofERAB: electronicreverseauctionbidding. ERAB is of interestto NASBP membersand their contractorcustomers.It is appropriate, therefore,for NASBP to provide informationaboutthis procurementmethodto membersand affiliates,so they maybe of greaterassistance to all potentialbuyersand sellersin deciding whetheror not to participatein reverseauctions. Although construction associationsand other writers have expressedconcerns about ERAB use in the procurement of general contractors' services some individual general contractors may not be averseto using ERAB in purchasing goods and supplies, i.e., items that are interchangeable and indistinguishable and have fixed costs for production and delivery .5,12Some construction contractors even may be interested in using ERAB to purchase subcontractor services, especially for non-complex or routine projects. Much of the literature to date has focused on the impact of ERAB on general contractors, and this white paper will continue in that vein. Professional surety bond producers, however, should be aware that their general contractor customers may have conflicting interests about the ERAB method and need guidance from both the standpoint of being a bidder and a buyer.
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NASBP only canaddressthe ERAB methodas it existsatthe presenttime, andas it hasbeen analyzedto date. The useof technologyin procurementis still evolving. The comments containedin this document,therefore,arerestrictedto the currentmethodanduse. In addition, NASBP supportsthe useof technologyin procurementandsurety,andnoneof the commentsin this white papershouldbe viewedasan indictmentof e-commerce.
Defining What It Is and Who's Using It Accordingto Michael Pearlstein, A reverse auction is an electronic method of confidential bidding... an auction ~s live, online, and the successfulbidder usually is determined by the lowest price submitted to the tendering authority at the close of the auction. 14 Although originally designed to accommodatethe procurement of construction goods or commodities, ERAB now is being considered and in some instancesused in the bidding for construction services. The use of ERAB is a relatively new development that currently is not in widespread use although large industrial firms, e.g. General Electric, and nationwide retailers, including such "big box" companies as Target, Best Buy and Home Depot, are leading the charge in considering its applicability to bidding for construction. I? This interest by the private sectoris causing federal, state, and local governmentsto begin taking notice, as well. For example, as part of a Department 01~ Defense (DoD) 2002 appropriations bill, the Army, Navy, and Air Force were charged with conducting pilot programs to evaluate the use of reverse auctions, primarily for commodities.7 The Army Corps of Engineers' (USACE) is conducting a pilot program to use ERAB in the procurement of construction services for two projects. To date, USACE has conducted 12 auctions, which was a smaller number than originally planned becauseof the number of contractors who withdrew their original intent to participate. This mandateto the military contracting agenciesresulted from the urging of Arlen Specter (R-PA) to authorize these pilot programs in the appropriations bill.7 In addition to military contracting agencies,the Postal Service and the General Services Administration (GSA) are testing the use
ofERAB.7 Some experts argue that federal use of reverse auctions violates the provisions of the Federal Acquisition Re.!JUlations(FAR), "which reflect a clear policy of not disclosing contractor price information."3, For the time being, however, the Office of Management and Budget (OMB), which has jurisdiction over the FAR, is taking a hands-off approachas federal agencies conduct pilot programs and experiment with the reverse auctions process.7 Although some states,e.g., Indiana, Maryland, Minnesota, Maryland and Pennsylvania, already are using electronic procurement for commodities, the road to e-procurement for construction services may be somewhatbumpier. IS This is becauseof the differences between bidding on interchangeable or generic commodities, which have absolute minimum prices, profit margins, and predetermined unit costs for production and delivery, and bidding on construction, which includes such factors as location, site conditions, local codes and permit fees, material
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.. ..
changes/availability, procurement. 5
and fluctuating labor conditions, for example, that make it a more complex
In the 2003 state legislative sessions,lawmakers in Minnesota and Arizona considered bills to permit the use of ERAB for construction bidding. Becauseof fierce opposition, these bills were further amended to eliminate the requirement.IS Other states,namely Kansas and Pennsylvania, have enactedlaws prohibiting the use of reverse auctions in construction procurement.IS
Describing How ERAB Works A typical format for conductingelectronicreverseauctionbidding is asfollows: The buyer invites a list ofprequalified bidders to participate. Bidders receive drawings, specifications, and explanations about electronic bidding in advance of the event. A third-party serviceprovider conducts the auction on behalf of the buyer, with all bidders participatin,g simultaneouslywithin a specified start and closing time. The names of all bidders arE~kept confidential during the auction. Bidders submit prices that are ranked and disseminatedto all other bidders. The auction's closing time may be extendedfor a predetermined period of time if one of the top bid ran!kingschanges. The auction serviceprovider notifies the buyer of the bidding results and then initiates the appropriate follow-up with the winning bidder to complete the formal award of the contract. The buyer notifies all bidders immediatelyafter theIJnal bid rankings, with only the dollar value of the winning bid disclosed.5,0,14 ERAB involves a method that is significantly different from the time-tested, traditional sealedbid method in which, ".. .sealed bids are received and opened at a specified time, and the project is awarded to the lowest responsible bidder. Under this method, general contractors submit their bids, or pre-selected general contractors solicit bids from subcontractors,and there is no opportunity for subsequentbidding after the specified time for bid opening.,,1?According to the Associated General Contractors of America (AGC), the sealedbid model is more frequently used by owners on projects in which price and price-related factors are most important, and they do not have a high need to meet with bidders who are competing for the project.4 ERAB also differs from the negotiated procurement method that is used by some owners when non-price factors are important or they have a need to discussthe work with bidders. In this method, relationships and communication are essential, but are absent from the ERAB procurement method. 4
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Discussing the Issues Becauseof the involvementof third party serviceprovidersandrelianceuponthe Internet,the useof ERAB may appearon the surfaceto helpownersand otherbuyersachievetheir goalsof quality, speed,ease,and lower costs. Third-party vendors who provide Internet support and conduct the reverse auctions include consulting flrnls, software providers, or industry-sponsoredexchanges. These vendors are the largest proponents of ERAB for the procurement of both commodities and construction and include such companies as Ariba, CommerceNet, and FreeMarkets.11 One vendor, FreeMarketsInc, has described ERAB as "a safe and transparentmethod to help owners make effective real-time buying decisions.,,2 With the extension of reverse auctions to construction, construction associations' interest in this electronic method has increased accordingly and causedthem to express their concerns about the actual operation of and results from using ERAB. They join businessresearchersand other nonconstruction trade associations that also are expressing concerns about ERAB. All of these concerns may be considered in three distinct areas: (1) cost savings; (2) "bid shopping;" and (3) quality, safety, and relationships. The following discussion elaborates on the features of ERAB along these parameters.
PerceivedCost Savin!!svs. Actual Costs To proponents, the single most attractive feature ofERAB is the appearanceof savings. Buyers can watch the bidding in real time and seethe price of commodities or construction incrementally drop as the bidding goes on. At the conclusion of the auction, buyers of commodities, in particular, may believe that the fmal bid is the absolute lowest price and representsa considerable savings over the final bid price generatedfrom the traditional bidding methods. Attorneys writing for the "Construction Industry Cooperative Council of Minnesota" have taken the position that appearancesmay be deceiving in that the end result of using ERAB may not produce cost savings at all. They go on to say that, ...bidders in the [E]RAB process often do not start at their lowest number as they must do in the traditional sealed bid method. Instead... it is commonfor bidders in an auction to start with a high bid, see what prices their competitors are bidding, and then reduce their bid only if forced to do so bycompetition. Thus, downward movementfrom inflated initial bids should not be viewed as savings.17 The literature on ERAB contains articles by researchersand non-construction associations suggesting that the perceived savings reported by commodity buyers may not be realized if the final costs are examined. After analyzing approximately 12 online reverse auctions, M.L. Emiliani and D.l. Stec of the Center for Lean Business Managementof the Rensselaer Polytechnic Institute reported, "For many companies, the promise of lower unit costs is just an illusion becauseexpensesin other budget categories,i.e., indirect costs, may actually increase. The cost of goods sold will thus be maintained or increased." 11 The reverse auction task force
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of the International Housewares Association reported in its white paper that the savings realized in a buyer's first reverse auction may not be replicated in subsequentauctions, e.g., one company experiencean 11.8% savings in the first auction, which dropped to 2% in the secondauction; another company saw a drop in savings from 6% in the first auction to only .5% in the second.16 Besidesthe expensesinvolved with third-party vendors--computerhardware, software, services, and fees--buyers also may find that fewer bidders than expected register to participate in an electronic reverse auction, or they withdraw from the auction prior to it takinl ~lace. Fewer bidders mean less competition and the possibility of higher costs for owners. ,1
In additionto losing the competitivevalueof contractorswho areunwilling to participatein ERAB, the purchaserlosesthe benefitof thosewho areincapableof doing so,becausetheir businesses are not yet automated. OneNASBP membercommentedthat ERAB might unfairly excludesmall and start-upcontractors,in particular. Some ERAB proponents argue that expanding the bidding to broader audiencesmay result in lower costs. Opponents, however, claim that such expansionthreatenslocal companies and may result in bidders, who are unfamiliar with the project location, site conditions, local codes and permit fees, material changes/availability, and the stability and availability of the local workforce, winning the bid and ultimately costing buyers more in the long run.5,8,lO
Smart Business Practice vs. Disl!uised "Bid ShoDDinl!" Pearlsteinindicates that bid shopping occurs when owners (or general contractors seeking bids from subcontractors) selectively disclose competitors' bid information to favored bidders for the purpose of manipulating the bids and shopping for price reductions.14Critics contend that the most significant and serious fault of ERAB is that it is "bid shopping in disguise" and an "electronic version" of a practice that generally is frowned upon by construction associations becauseit is a way for buyers to enhancetheir profits by forcing subcontractors and suppliers to reduce or eliminate their own profits. ERAB proponents staunchly disagree with these criticisms. They mention the confidentiality and impartiality of the method, the development of strict, published protocols to be followed, and agreementsbidders and buyers must sign to guaranteethe validity of their bids and/or contract awards.2 One vendor defends its services by saying that it, ".. .helps full-service clients develop requestsfor qualifications (RFQs).. .monitors log-ons to seeif all bidders are participating.. .and is a "no-cost sales channel to buyers." This vendor claims it is "passionate about integrity, neutrality, and trust." 2 In responseto accusationsof "bid shopping," vendors claim that "bid shopping" generally occurs ~ a contract has been awarded, but if it is "bid shopping," at least it is being conducted in an open environment rather than behind closed doors. I? Opponents counter that even though a settime may be established for the bidding to end, extensions may be granted and frequent overtimes may occur if a bidder submits a low bid within minutes of the closing time, thereby permitting other bidders to re-submit their prices.lOThis kind of a process "can be interpreted as a form of pre-closing negotiation or 'bid shopping.' ,,5
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Others maintain that ERAB "institutionalizes a new form of bid shopping" becausebidders face repeateddemandsto lower their prices or else lose the work. They further contend that this practice often results in poor quality of workmanship to the detriment of the public, customer, or contractor. 10Becauseof the pressureapplied to bidders to shave profit margins and contingency dollars to reduce their bids, some fear that the relationship among the owner, contractor, and subcontractor/supplier may be severely compromised, become adversarial, and create a greater likelihood of disputes and bad faith, along with an increasedrisk of claims and litigation. 17
Built-In Protectionsvs. Com
and Relationshi s
There is no doubt that ERAB provides a more competitive bidding environment as bidders continue to underbid each other to eventually be the lowest bidder. Some claim that the competitive nature of reverse auctions can result in frenzied, cut-throat pricing by bidders, "which can ultimately force them to cut comers and/or submit changeorders to make up the difference between their final bids and what began as their best competitive prices.,,12
ERAB proponentsbelievethat thatthe inclusionof well-draftedprotocols,including clear-cut termsandconditions,specifications,and contractdocumentsto which biddersmustagreeasa conditionof participation,provide safeguardsfor ensuringthe quality and safetyofprojects bid usingERAB. As to the chargethat ERAB compromisesrelationships,onereverseauction vendormaintains,"We're not outto crackrelationships,just give assurances that ownersare gettingtrue marketpricing.,,2 Opponents of ERAB are concernedthat, "The [E]RAB process may induce bidders to reduce labor and supervision to levels that will endangersafety and lessenquality. Many bidders fear that when costs must be reduced, proper site safety is one of the first costs to be cut.,,1? An additional concern is that artificially low bids could affect the training of laborers and lead to a less-skilled workforce for future projects. Some claim that a logical outcome of problems related to safety and quality will be an increase in lawsuits to enforce safety and quality obligations and claims submissions related to performance. Along these same lines, some critics claim that reverse auctions, the pressure on bidders to cut comers or submit change orders, and the lack of communication and dialogue between buyers and sellers that is inherent in reverse auctions, creates difficult projects and leads to problematic relationships between owners and contractors and the destruction of any gains made in increasing partnership in construction. 10 Dave Semerad,CEO of the AGC of Minnesota, concluded in his analysis of reverse auctions that in the end, "The majority of contractors, however, will remain skeptical and will chooseto build collaborative, trusting relationships with their customerswho elect not to use reverse auctions.,,15
AGC maintainsthat,unlike whathappenswhenusingthe negotiatedprocurementmethod, "nonprice factorsthat areof consequence to the buyer, suchas qualityof relationship,past performance,anduniqueneedsarede-emphasized in the auction. As a result,reverseauctionsdo not offer ownersa good way to evaluatenon-pricefactors.,,4
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Somediscussionsof ERAB also point to the negativeeffectsof reverseauctionsin insuringthe continuedquality of materials,supplies,andproducts. Opponentsclaim that reverseauctions work againstthe developmentof bettercommoditiesto achievecompetitiveadvantage.They point out that, "Over time, the buyerinadvertentlyde-skillsits suppliers."ll Some opponents report that ERAB is not suitable for some types of bids. They contend that reverse auctions should not be used to obtain cost-plus or time and material bids in which owners requesthourly labor charges, mark-up on material costs, and billing rates for tools. They contend that these kinds of bids, as opposedto lump sum bids, do not quantify the value ofproductivity-the value of the contractor's supervision and training a more qualified workforce, which can provide a competitive edge in bidding.
NASBP's Considerations About ERAB One ofNASBP's policies (GA-16; adopted 05-05-2002) statesthat, NASBP supports the developmentand use of innovative alternative project delivery methods that improve efficiency and competition as long as these methodsdo not adverselyaffect contractors, owners,fair and open competition, or the ability to provide the required surety bondsfor theproject... Although this policy relates to another issue, it applies to the emergenceof ERAB. It also reflects the Association's concerns about certain construction principles, such as efficiency, open competition, fairness to all stakeholders,and the use of surety bonds to protect stakeholders' interests.
The May 2003issueof Pipelinecontaineda descriptionofERAB andrequestedreaders'input aboutits use.I3A few membersrespondedto this requestandprovidedcommentsandreports aboutthe useofERAB. Additionally, membersofNASBP's ConstructionIndustryCommittee who formeda subcommitteeon ERAB consideredmembers'input andprovidedtheir own opinionsandcommentsin the drafting of this white paper. With members' observations and concerns in mind, the subcommittee developed considerations that professional surety bond producers can provide to stakeholdersin construction, and considerations producers may want to take into account for protecting the surety companies they representand the customers they serve. These considerations are contained in Attachment I.
ForemostamongNASBP members'concernsis the prequalificationprocessand whetherany form of bid securityis required. Theyrecognizethatbid bondswould addressbothof theseconcerns.In addition,they maintainthatthis kind of methodis a perfectexampleof where suretybonds,and especiallybid bonds,would be of the utmostimportanceandrecommendthat theybe an essential componentof ERAB.
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Other Associations' Considerations About ERAB On September15,2003,the AssociatedGeneralContractorsof America (AGC) issuedits latest discussionof reverseauctions,andconcludedthat, Each construction team member must decide whether to participate in such [reverse] auctions. However, AGC believes that reverse auctions are an unproven methodfor selection of construction contractors, specialty contractors, subcontractors, and suppliers. At best, reverse auctions raise significant issuesfor owners and construction team members including thefollowing: .Reverse auctions do not guarantee the lowest price .Reverse auctions mayencourage imprudent bidding .Negotiated procurements allow thorough evaluation of value .Sealed bidding assuresthat the successfulbidder is responsive and responsible .Reverse auctions may contravenefederal procurement laws and certain state laws. 4
The boardof directorsof the AmericanSubcontractors Association(ASA) approvedits position on reverseauctionsat its meetingon September 21,2003, which said, ASA believes that electronic reverse auctions are aform of "bid shopping." ASA reaffirms its abhorrence of "bid shopping" and "bid peddling" as unethical practices. Thus,ASA supports legislation and regulation that would prohibit the use of reverse auctions on public and . k ,,] przvate wor . As evidence of its position, ASA is supporting legislation in Congress,HR 1348, that would prohibit all forms of "bid shopping" on federal construction projects, including the use ofERAB. The Surety Association of America does not have a fomlal policy or statementregarding ERAB; however, in a letter dated April 21, 2003, to David Semeradof the Minnesota chapter of the Associated Contractors of America (AGC), Robert Duke wrote: Although the concept of bid auctioning is primarily a contractor related issue, It has ramifications with respect to bid and performance bond guarantees ...A bid auctioning system may lead to haphazard bidding procedures in which the bidder lowers its bid price simply to beat the current low bid; with no relation to the estimated costs of the project. Without the assurance that the contractor has developed its bid price based on a careful review of estimated construction costs, a surety may be reluctant to provide a bid bond. 18
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Conclusion As with anychangein a long-standingindustrywith well-definedmethodsandprocedures,some considerERAB to be a "radical departurefrom the principlesof [traditional] construction practices."s As with other new alternatives that have appearedin the procurement system, however, dismissing ERAB as a "fad" is not in the best interest of any of construction's stakeholders, including the surety industry. Instead, surety bond producers need to consider the various issues involved in ERAB, educatethemselves and their customers about these issues, and explore ways the method can uphold the principles of fair and competitive bidding and maintain the use of surety bonds. At the presenttime, the fate of electronic bidding auctions for construction services is unknown. Yet to be tested is whether ERAB can meet the needsof all stakeholders. Ultimately, the pros and cons of the viability of ERAB as an efficient meansof achieving the lowest price, or even best value, will undoubtedly be a function of its successin the marketplace. The decision as to whether NASBP should be a proponent or opponent ofERAB, therefore, is both premature and inappropriate at this point in time.
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