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A Comparison of Unit Price and Fixed Price Contracts for Infrastructure Construction Projects

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Abstract

Today’s dominant mechanism for infrastructure project tendering is the Unit Price Contract (UPC). While the winning bidder retains risk related to the unit price bids submitted, the Principal carries all risk related to misspecification of the activities required for having a project build. This paper reviews the microeconomic foundations for this contracting procedure and identifies situations where an alternative mechanism, Design – Build (DB) contracts, may be preferable. DB leaves the bulk of project risk with the agent and therefore requires bidders to hedge against unpleasant surprises in the implementation by increasing the demand for compensation for undertaking the job. It is argued that DB should not be used if the number of bidders is expected to be large; this is a means for reducing the duplication of design costs. Moreover, DB projects should be complex with respect to the number of sub-tasks required for construction and it should be feasible to substitute one input for another. This is a way for society to benefit from the agent’s superior information about alternative implementation techniques and relative input prices. The projects should moreover not include too many unobservable quality features and the risks for geotechnical problems should be manageable.

Suggested Citation

  • Mandell, Svante & Nilsson, Jan-Eric, 2010. "A Comparison of Unit Price and Fixed Price Contracts for Infrastructure Construction Projects," Working Papers 2010:13, Swedish National Road & Transport Research Institute (VTI).
    • Handle: RePEc:hhs:vtiwps:2010_013
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    File URL: http://www.transportportal.se/SWoPEc/UPC_vs_DB_(WP)_Mandell_dec2010.pdf
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    Citations

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    Cited by:

    1. Svante Mandell & Johan Nyström, 2013. "Too Much Balance in Unbalanced Bidding," Studies in Microeconomics, , vol. 1(1), pages 23-35, June.
    2. Nilsson, Jan-Eric & Odolinski, Kristofer & Nyström, Johan, 2023. "Using a self-selection mechanism for tendering in the construction industry: A case study of railway renewal contracts," Working Papers 2023:10, Swedish National Road & Transport Research Institute (VTI).
    3. Nilsson, Jan-Eric, 2012. "Procurement and contract design in the construction industry: … not one size fits all," Working papers in Transport Economics 2012:26, CTS - Centre for Transport Studies Stockholm (KTH and VTI).
    4. Mandell, Svante & Nyström, Johan, 2011. "Why are bids not more unbalanced?," Working papers in Transport Economics 2011:13, CTS - Centre for Transport Studies Stockholm (KTH and VTI).
    5. Borg, Lena & Lind, Hans, 2014. "Framework for Structuring Procurement Contracts," Working Paper Series 14/9, Royal Institute of Technology, Department of Real Estate and Construction Management & Banking and Finance.

    More about this item

    Keywords

    Procurement; Unit Price Contracts; Design build; Infrastructure;
    All these keywords.

    JEL classification:

    • H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
    • L98 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Government Policy
    • R42 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Transportation Economics - - - Government and Private Investment Analysis; Road Maintenance; Transportation Planning
    • R48 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Transportation Economics - - - Government Pricing and Policy

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