III.  Negotiated Bid

II.  Performance Based              High performance            Minimized management            Professionals design, contractors construct            Contractor quality control

I.  Low-Bid              Commodity            Low price            Minimum standards            High risk

IV.  Unstable Market

Low

High

Value

High

Low

Competition

 Figure 1: Construction Industry Structure 

Industry stability is defined as (Kashiwagi, 1991): 

1. The ability to continuously provide a performing product.
2. The ability to continuously improve the performance of the product.

By definition, stability infers sustainability. If one of the parties in the industry loses, that party is non sustainable and threatens the sustainability of the entire industry. Therefore, sustainability can be defined as a “win-win” relationship. The CIS identified the performance-based sector as the most stable environment (Figure 2) and that the construction industry is stabilized by moving to a performance based sector instead of a price based sector (Kashiwagi & Parmar & Savicky, 2003a). 

II.  Performance Based   Win-Win Relationships Stable environment Sustainable

I.  Low-Bid   Adversarial Win-lose Unsustainable environment

Low

High

High

Low

Value

Competition

 Figure 2: A Stable Industry 

The CIS model by definition identifies that the cost of delivering construction in the price-based environment as higher than a performance-based environment (due to non-value added functions, poor quality, and the cost of rework). The price-based sector is an environment that does not use performance information.  In this environment, construction professionals deliver construction as a commodity (Figure 3). 

II.  Performance Based   Non-Commodity Information based “win-win”

I.  Low-Bid   Commodity No information “win-loose”

Low

High

High

Competition

Value

Figure 3: Commodity vs. Non-Commodity 

The professional uses minimum standards to describe the commodity. When competing to deliver a commodity, contractors do not get credited for higher quality or performance. The lowest acceptable quality option is favored and will be awarded the bid (Figure 4). This function increases the risk to the project since contractors are motivated to lower quality to save on costs. This is clearly understood by realizing that the owner’s minimum requirements are translated into maximum requirements by contractors and vendors (Figure 5). A price based environment forces manufacturers who have systems that are above the minimum standard to minimize their performance if it will make their products less expensive. 

Contractor 1

Contractor 2

Contractor 3

Contractor 4

Low

High

Spec

Contractor 2

Contractor 3

Spec

Contractor 4

Contractor 1

High

Low

A

B

Performance / Price

Performance / Price

High

High

Low

Low

Risk

Risk

 Figure 4: The Impact of Minimum Standards

Low

High

Spec

Owners: Perceive a minimum level of quality

Contractors: View standard as a maximum level of quality

Low

High

Spec

A

B

Performance

Performance

Figure 5: “Win-Lose” Relationship 

The CIS model identifies the performance-based environment as the most efficient environment. This environment uses performance information to minimize owner management, minimize inspection, and increase performance. In this environment the client hires the best construction professional to design and the best performing constructor to construct (Figure 6).  

II.  Performance Based   Use of performance information Minimized management Efficient Best value

I.  Low-Bid No performance information Minimum standards High management & inspection Inefficient Most expensive

Low

High

High

Low

Value

High

Low

Efficiency

Competition

 

 Figure 6: An Efficient Environment 

The Performance Information Procurement System 

The Performance Information Procurement System (PIPS) was developed to form the performance-based environment. PIPS uses performance information and considers both performance and price in determining best value. The performance information creates a performance environment. Contractors must identify their own performance in relation to other contractors, provide best value, and continuously improve to stay competitive. Over 350 tests of PIPS have been performance resulting in the following (Kashiwagi & Savicky, 2003, Kashiwagi et la, 2003b):           

1. 96% performance (on time, no contractor generated cost change orders, and meeting clients’ expectations)
2. Minimization of construction inspection from 40 to 80%
3. Minimized first cost of delivery.

The price-based environment identifies the construction professional as a critical requirement. The performance-based sector identifies the performing designer and constructor as critical factors. Management is only required when performance is not meeting expectations. A high performance environment minimizes management. The most efficient environment will provide the best performance and the best value (best performance for the lowest cost).   

An information-based environment quickly identifies performance and risk of nonperformance. It forces performers to minimize risk instead of hiring low performers (who increase risk) that move the risk back to the client, building owner, or insurance company. 

The CIS model identifies the following solutions to improving construction value and performance, and minimizing cost and risk: 

1. Increase the use of performance information.
2. Minimize the use of minimum standards.
3. Minimize management and inspection.

The construction industry has proposed to increase performance and minimize the risk by more construction and project management. This solution is just moving the risk from one party to another. The performance in the low bid sector has shown that the risk has not been minimized (Egan,1998, Post, 1998, Post, 2001, CIB, 2000). To move to a performance-based environment, the owner must hire a performance-based contractor to minimize the risk. 

Cost of Risk 

The construction industry has been one of the most risky businesses in the United States in terms of business failures (Construction Chart Book, 2002). It has had difficulty providing construction on time, on budget, and meeting the quality expectations of building owners. Each year, thousands of companies fail, leaving behind billions of dollars in liabilities (SIO, 2003). Of the contractors who went out of business in 1997, 37% had been in business for over 10 years (Ames, 2002). Owners have attempted to minimize the risk of their loses by requiring that contractors carry specific types of bonding and insurance.  Owners believe that moving the risk to the bonding and insurance companies will manage and minimize their risk.   

Risk is defined as exposure to the chance of injury or loss (Websters, 1994). Although owners have successfully transferred the financial risk of failure to bonding and insurance companies, the owner’s risk (not on time, no contractor generated cost change orders, and meeting the owner’s expectations) has not been minimized. This is manifested by the increase of insurance and bond rates for contractors.   

Insurance and Bond Rates 

Surety loses over the years has been considerable. From 1990 to 1997, over 80,000 contractors failed, leaving behind unfinished projects with liabilities costing over $21 billion (Construction Chart Book, 2002. SIO, 2003). Losses have not faired any better in recent years.  In 2000, the industry reported $1.6 billion in loses, and $2.7 billion in 2001. The ratio of losses to surety (bonding) premium jumped from 42% in 2000, to 82% in 2001 (Korman, 2002, Brown, 2002). 

The substantial amount of loses has caused bonding and insurance companies to rethink the way they do business.  Companies that have not gone out of business due to the failures are (Korman & Illia, 2003, Brown, 2002, Korman, 2001, Grenier, 2001, Wheeler, 2000): 

1.      Increasing the rates (bonding and insurance) they charge contractors

2.      Requiring more personal guarantees

3.      Canceling policies with certain contractors

4.      Limiting coverage (listing exclusions)

5.      Limiting the number of bonds that they issue 

In the past, contractors that have good performance records were given lower rates (since the bonding and insurance companies risk is lower).  However, the large financial loses has forced the bonding and insurance companies to raise their rates throughout the industry.  Contractors that are able to get coverage are noticing large increases in the cost of insurance and bonding premiums. Performance bonds that usually ranged from 0.5%-3% of the contract have increased by 10%-30% (Brown, 2002, Krizan & Ichnniowski & Rubin, 2002). Other insurance premiums have increased 2-3 fold, and some have even jumped up by five fold at the high end (Korman, 2004, Grenier, 2001, Krizan, 2002). The increases in premiums will ultimately be passed along to the owners. Owners that believed they were managing their risk by moving the risk to insurance companies will pay for the risk in lower value construction.   

Conclusion 

As financial risk increases, insurance and bonding companies (that deal with the risk) are forced to increase rates.  The increased insurance and bonding rates validate the CIS model concept that the price based sector is: 

1. Inefficient.
2. Transfers risk instead of minimizing risk.
3. Decreases value of construction.
4. High risk due to the low price and minimal standards.
5. Win-lose, creating an adversarial and bureaucratic environment.

The impact of moving the risk is shown in (Table 1). The conclusion is that the price-based environment is not cost effective, sustainable, or stable.     

Table 1  

Unsustainable Price Based Environment

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