Optimal Bid Prices for Unit Price Contract

In this type of contract, the work is broken down by the owner into bid items with an estimated work quantity for each item. In preparing a bid, a contractor estimates the direct cost of each item and then has to spread overhead, profit, and contingency to the bid items, so that these amounts will be recovered when the project is complete. The contractor's bidding strategy is complicated by the uncertainties of the work quantities and which items may be deleted from the contract. To minimize the cash investment required by the contract and maximize the expected profit, it is beneficial to unbalance the bid prices by allocating a larger than proportional share of the margin and overhead to those items performed early in the life of the project and those likely to overrun the owner's estimated quantity. This paper develops an easily implemented model of the preceding problem which permits the calculation of optimal unbalanced bid prices that will maximize the expected net worth of the project for a given desired margin.