Two-stage tendering is slowly being recognised in the Middle East as a potential way to achieve an employer’s objectives and reduce risk, writes EMILY LAWRENCE*.

THE key objective of employers when tendering any form of construction contract is the appointment of an appropriately-skilled and experienced contractor on the basis of the right price, programme and risk allocation.

In a market where the balance of power between contractors and employers is shifting, this objective is increasingly hard to achieve.
Two-stage tendering is a process that is being used with increasing frequency in the UK and is slowly being recognised in the Middle East as a potential way to achieve an employer’s objectives.
Set out below is a brief outline of the process of two-stage tendering and the potential benefits and risks associated with this approach.

Two-stage tendering centres on the engagement of a contractor on the basis of a preliminary design and concept, at a very early stage in a project.
The intention of the parties is then to work together to develop the design and detail of the project, and seek to agree a fixed price for and enter into a design-and-build contract at a later date.
At stage one, a contractor is appointed by way of a competitive tender procedure, with the employer selecting a contractor on the basis of skills, experience and resources rather than price1 to carry out services, such as collaborating with the design team to agree a final design, agreeing a programme and cost plan and tendering early and long-lead sub-contract packages.
Traditionally, the contractor will enter into a separate pre-construction services agreement for the purposes of stage one and will perform those services on a fixed-fee or cost-reimbursable basis.
At stage two, the contractor and employer will seek to agree and enter into a lump-sum, guaranteed maximum price or target price design-and-build contract.
The conversion from pre-construction services agreement to design-and-build contract will typically occur when the contractor has successfully tendered 70 to 80 per cent by value of the sub-contract packages for the project. In the traditional UK two-stage model, this conversion is often effected by way of a ‘conversion mechanism’ in the pre-construction services agreement.
This mechanism dictates the stage two price, based in part upon an aggregation of the value of sub-contract packages already tendered and the price for preliminaries and percentage for overheads and profit proposed by the contractor at the start of stage one.

The potential benefits to an employer of adopting the two-stage approach can be divided into two broad categories:
• Cost certainty/accuracy; and
• Time saving.
From a cost-certainty perspective, by tendering the project in two distinct parts, the employer is able both to engage the contractor early and to achieve a fixed price for the main works — in circumstances where due to the absence of specific information he may not otherwise have been able to do so.
With regard to cost accuracy, it is generally accepted that as up to 80 per cent of sub-contract packages will already have been tendered when the parties seek to agree a fixed price for stage two, the parties will have greater comfort as to the probable cost of the project going forward. Also, the contractor should be in a position to bid a more competitive, realistic and accurate price.
Equally, the pre-construction services agreement may be used to require the contractor to tender all sub-contract packages (including those to be self-performed) on a competitive and fully open-book basis, ensuring that value for money is achieved and that there is little opportunity for the contractor to inflate its stage two price artificially.
From a project programme perspective, there is no doubt that appointment of the contractor before the design for the project has been fully developed may potentially provide for a quicker and more efficient start on site. Ideally, a collaborative approach will be adopted between the contractor and design consultants and they will work together to develop a design that takes account of the contractor’s views in relation to buildability, sequencing and sub-contractor selection – the intention being that any potential problems are identified and avoided at the outset.

Risks & mitigants
While early engagement of the contractor is one of the perceived advantages of two-stage tendering, it also represents one of the key risks to the employer.
The pre-construction contractor will be in-situ and heavily involved in the project by the end of stage one – and in the absence of direct competition, it will have significant leverage in negotiation of the terms and price of the stage two contract. Many contractors will seek to use this leverage to inflate the stage two price and/or delay the conversion from a low risk cost-reimbursable pre-construction services agreement to a fixed-price contract under which it is required to take all design and construction risk2.
One method of mitigating these risks and achieving greater cost certainty and savings is to require the contractor to bid a guaranteed maximum price for the whole of the project, as part of stage one.
The contractor and employer may then seek to agree a fixed price for stage two. However, in the event that the contractor attempts to price stage two above its original guaranteed maximum price, the employer has an ‘exit route’ and is able to return to the market to tender for an alternative contractor1.
This approach lends itself to the hybrid two-stage model that is emerging in the Middle East.
Although a separate pre-construction services agreement is not entered into, a contractor may be required to bid a guaranteed maximum price for a project and enter into a staged EPC (engineering, procurement and construction) contract that provides for the performance of early services and early works, as well as the main construction works.
Based on the parties’ increasing knowledge and experience as the project progresses, the parties agree to negotiate a fixed price during the course of the contract, which is below the guaranteed maximum price bid by the contractor.
However, in the event that they are unable to agree a fixed price, the contract will proceed on the basis of the guaranteed maximum price with an appropriate shared saving mechanism to ensure that the contractor is incentivised to minimise costs.

There are some very real advantages to be had by adopting the two-stage tendering approach, and in the Middle East where scheduling constraints are increasingly an issue in developments, a move towards two-stage tendering or a hybrid form of the same may prove to be a useful tool going forward.
The key question is whether or not the benefits of engaging a contractor for stage one outweigh the potential loss of commercial leverage in stage two.
The answer to this question is one that can only be addressed on a case-by-case basis.
However, it can be said with some certainty that the opportunity is there for employers to mitigate the risks they face and implement a transparent and robust two-stage process.

1. C Davis and P Dornan, “The Rise and Rise of Two-Stage tendering”, The International Construction Law Review, Volume 25 Part 4, October 2008, 511-517.
2. K Fenton, “Two Stage Tendering — An Open Approach” (2006): Builtenvironment/Constructionmanagement/Procurementandtendering/fenton001.htm.

Gulf construction

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