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The Motives for and Consequences of Underpricing for Construction Contractors—Evidence from Australia

Li Liu, Paul L. Bannerman, Xiang Ding, Emma-Jane Elliott, Georgina Ewart, Xiaoying Kong

Abstract


Over the period of 2011-2013, there was a spate of bankruptcies of medium-to-large Australian construction contractors (many of whom were well-established), coinciding with a prolonged decline of the property market. Anecdotal evidence suggests that underpricing played a major role in the collapse of these companies and the financial misfortune of many major Australian construction contractors. On the other hand, anecdotal evidence also suggests that underpricing can be an effective tactic to penetrate markets or weaken competitors when used as part of a strategic mix—a double-edged sword. Because of the political sensitivity of the topic of underpricing, there has been a dearth of research in this area. This study investigates the extent and consequences of the practice of underpricing (in the Australian context), where it is defined as the submission of a tender price at a significantly lower level than the best estimate for the costs, profit margins, and risks of the construction project.

Drawing from the literature on construction tender-price formulation, we develop a framework that separates the motives for underpricing into need-for-work and marketing-based competitive pricing; and predict the consequences of the practice of underpricing in terms of adverse financial consequence or profitability in circumstances driven by the two different motives. The framework is validated through data analysis based on a survey of the members of the Australian Institute of Quantity Surveyors and randomly selected large contractors.

Underpricing was found to be prevalent in construction projects. Contributing to the literature, the results show that when underpricing is primarily driven by a contractor’s need for work to maintain cash flow; underpricing contractors are likely to engage in deceptive practices, such as submission of unwarranted variations or reducing the standard of work. Further, the findings indicate that, although such deceptive conduct could lead to short-term relief of adverse financial outcomes, it does not contribute to the competitiveness of the company in the longer term. By contrast, underpricing driven by deliberate marketing strategies, such as market penetration or to weaken competitors, was found to be linked with long-term financial profitability of the contractor.


Keywords


Underpricing; strategic misrepresentation; deception; tendering; project bidding; pricing strategy; construction

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