Sealed bid auctions: An application to the building industry

This paper examines some of the theory and practice of competitive tendering in the building industry. Allocation of building contracts by means of competitive tendering is one type of sealed bid auction. Two main strands of the theory of sealed bid auctions are developed. The first strand identifies optimal mark-up given that each tender competition occurs in isolation. The second strand treats explicitly the sequential nature of tendering and resource constraints of tenderers. It emerges that the first strand is a special case of the second. A simple optimal bid price rule is identified, which indicates that bid price for any one contractor will be affected by the resources available to the contractor and general market conditions. It is shown that bid prices will be more competitive the better the information available to tenderers, the more carefully is the tender list constructed and the greater the number of firms invited to tender. It is further shown, however, that little is gained by having more than five firms on the tender list. Some empirical evidence is examined in the light of this theory and is shown to be consistent with it.