Performance Bonds – Why the Bid Spread Matters

Looking at the bid spreads is one of the underwriting considerations of the surety company when approving a performance and payment bond.  One would think that in this highly competitive market that it is impossible to have a bid spread more than 5%.  While this is true for most hard bid public works jobs it is not always the case.

Recently one of our contractors was lucky enough to be the low bidder on a public works project.  Everybody was excited about the win in this most competitive market.  That was until we reviewed a copy of the bid results.  Our contractor was 30% lower than the next lowest bidder.  Our contractor felt good about his number and didn’t understand why the surety company had a problem approving the performance and payment bonds.

There are several reasons why there is a large bid spread, some of which is perfectly acceptable from the surety perspective.  One recent example is a medium sized job that was going to take place two miles from the contractor’s place of business.  He did not have to pay per diems and he owns his own equipment.  The contractor also showed a past history of completing jobs consistently within his original estimate.  This simple explanation is more than enough to satisfy the surety underwriter.

A large bid spread is also perceived as a warning sign to a potentially larger issue.  It is a warning sign of a desperate contractor trying to “buy” a job.  There is a saying in our business; the only thing worse than not having work is having unprofitable work.  There is a difference between lower margins and irresponsible bidding.  We have seen an example of this recently on a roofing job where the winning bidder’s price was only about 20% more than the specified material cost.  That is fine if you don’t have labor or overhead.  When considering the size of the job and the mandatory use of prevailing wages the job was clearly bid at a net loss.

Another warning sign for a large bid spread is inadequate costing systems.  The surety will look at past jobs to see if the jobs were completed close to the original estimate.  If there is a history of fading profit from past jobs the surety will take a dim view of the accuracy of this project.

Mistakes can happen.  In most cases a reasonable obligee will allow a contractor to pull their bid if a mistake was made.  Most owners do not want a contractor on site that is in a position to scramble for every nickel.  If the obligee is not willing it may make sense then to just pay out on the bid guarantee.  It could be less financially devastating to pay out of the known loss than actually entering into a contract.

In conclusion, if you find yourself a low bidder by a margin greater than 10%, be proactive in your approach.  Review your numbers to make sure you did not make a mistake. You will want to re-read the bid specifications.  Document your findings for the surety company in a clear and concise manner.  Last of all, GOOD LUCK!