Promoting a Flourishing Society
 

Tuning Up Ontario's Economic Engine: A Cardus Construction Competitiveness Monitor Brief

April 9, 2015

PROJECT LEAD 

Brian Dijkema 

Brian Dijkema is Program Director, Work and Economics at Cardus. Prior to joining  Cardus, Brian worked for almost a decade in labour relations in Canada after completing  his master’s degree with Cardus Senior Fellow, Jonathan Chaplin. He has also done work  on international human rights, with a focus on labour, economic, and social rights in Latin  America and China. 

Contact: 

Brian Dijkema: bdijkema@cardus.ca 

Cover Photo: Annie Ling 

EXECUTIVE SUMMARY

Toronto rightly calls itself the economic engine of Ontario. But Toronto's performance is hampered by legislation which prevents it from getting the best value for its construction projects. Why?

One of the reasons can be found in a 2008 Toronto city staff report which studied the cost implications of closed-tendering in Toronto. This paper reviews that staff report and finds significant methodological problems with it that lead to faulty conclusions. Particularly, the report failed to account for the variety of ways in which competition works. Instead, it focused on one small segment of competition: labour costs. The fact that the City's fair wage policy specifically restricts competition on labour costs makes the report's conclusion misleading. Further, the report focuses too heavily on the unionization or non-unionization of firms, rather than examining a wider range of variables which would affect competition and cost.

We suggest that these factors should compel Toronto to revisit its construction procurement practices with a view to providing a clear signal to the market that it is open for  business. One way to do this would be to commission an independent review by leading  competition experts to evaluate the competitiveness of Toronto’s construction procurement  market. Another would be to join other leading municipal organizations like the Association of Municipalities of Ontario and the Large Urban Mayors Caucus in supporting a fair, open, and transparent procurement regime.  

INTRODUCTION: 

Cardus has produced a series of papers that examine the issue of restricting qualified con tractors from bidding on public construction projects. These papers were produced as a series under the heading “Cardus Construction Competitiveness Monitor.” The monitor  proceeds from the assumption that public contracts should not be restricted to a subset of  private companies because of the choices of their workers; rather, all qualified contractors,  regardless of the private affiliations of their workers, should be allowed and encouraged to  bid on public projects.  

The first of these papers, Ontario Municipal Construction Markets, described how Ontario  construction labour law has effectively created statutory oligopolies in vast swaths of its  public construction markets. These statutory oligopolies exist in a variety of public construction markets, which include municipal construction markets, but also other public  markets like school boards, other crown agencies, and corporations.  

This paper surveyed the number of municipal taxpayers affected by restricted bidding, pro vided estimates on the amount of public monies affected by these restrictions, and surveyed  the available estimates provided by a variety of stakeholders on the overall impact of these  restrictions on the public purse. The cost estimates were spread over a wide range from a  minimum estimate of 1.7% in additional costs (from a City of Toronto report) to a maximum estimate of 40% additional costs (from consultants hired by the City of Hamilton).  

A number of other iterations of this paper were published in response to developments in  Ontario, particularly the restriction of bidding in the Region of Waterloo, and to provide  estimates to the way in which restrictive bidding affects other jurisdictions, including Manitoba, British Columbia, and the Government of Canada. 

An open, competitive bidding environment in which all qualified companies can bid is more likely to achieve best value for public money than an environment marked by restrictions.

Last year, Cardus produced a paper entitled Hiding in Plain Sight: Evaluating Closed Tendering in Construction Markets, which focused particularly on the policy frameworks in Ontario, Canada, and the around the world that support maximizing competition in public  procurement systems. The intent of this paper was to show that there is virtually unanimous consensus from economists and governments around the world that competitive bid ding environments provide the best value for taxpayers and that reducing competition leads  to distortions in public procurement processes that not only increase costs but tend towards  more corrupt environments. A variety of papers – both empirical and theoretical across a  wide array of sectors – suggest that shrinking the bidding pool in ways similar to that of  Ontario’s largest municipalities results in cost increases ranging from 20% to 30%.  

This consensus is backed up by government policies and directives that are structured  to reap the benefits of fair and open competition on publicly funded projects. And it is  supported by a federal bureau, the sole purpose of which is to ensure that markets are not distorted by monopolies, collusion, bid-rigging, or other negative market behaviours.  

In short, there is general consensus that maintaining an open, competitive bidding environment in which all qualified companies can bid is more likely to achieve best value for public  money than an environment marked by restrictions. 

But there continues to be some disagreement on the extent to which closed tendering in creases costs in construction. 

Competitive markets are better for those purchasing goods and services.

CITY OF TORONTO – HOW DOES COMPETITION CREATE VALUE?  

One source of the lack of consensus on the cost implications in Toronto is a report entitled Labour and Training Costs in Construction Procurement and produced by the city in 2008. This  report suggested that closed tendering for Toronto led to cost increase of 1.7%.  

This report’s primary flaw derives from its baseline assumption that the only, or primary, cost  savings on construction procurement come as a result of wage differentials between competitors. 

This assumption is shown in the methodology by which the report calculates the cost implications of closed tendering. These are outlined on page 14 of the City’s report: 

Roughly half of the work on a typical project will relate to work and expenses that fall  outside of the jurisdiction of the City’s nine unions. This percentage fluctuates from  project to project based on the work that is to be performed. As approximately 33.5%  of projects relate to labour costs, a typical project will result in approximately 17%  of total cost being attributable to the payment of wages to union workers in the nine  unions. If one could assume that all of the remaining wages paid on such projects  would be paid at the Fair Wage rate (approximately 10% less than unionized rate),  as opposed to the collective agreement union rates, and assume that these savings  would be passed on to the City in the form of lower bid prices, it is possible that there  might be a savings of approximately 1.7% of the total project costs. However, as the  construction industry is highly unionized (as the experience in the non-ICI sectors  demonstrates), it is unlikely that all the work would be performed by non-union forces. As a result, the savings to be realized by the City may be significantly lower.  

For clarity, the City’s assumptions are as follows:  

a) Labour costs in construction = 33.5% of total project costs. 

b) 50% of the work on a particular ICI project is i) open to competitive tendering and  ii) will attract bids from non-union companies. 

c) The wages on the portion of work which is open to competitive tendering are 10%  less than those paid to unionized workers.  

The City’s report assumes that a modest cost increase of 1.7% is as simple as ABC.  

PRECISION ≠ ACCURACY 

The trouble is that the effects of competition on price are not that simple. The result is that  the City’s 2008 report suffers from precision bias; that is, the belief that because the figures  are precise they are also accurate. They are not, and the reason this report does not provide  an accurate picture of the costs associated with closed-tendering can be found in assumptions  

that are made but not clearly articulated in the City’s report.  

The City’s report assumes: 

a) That labour costs are the only, or primary, means by which firms compete when bid ding on public construction projects.  

b) That closed tendering can be boiled down to union vs. non-union discussion.  

c) That the complexity of placing bids which involve the simultaneous management of  multiple labour pools has no negative affect on attracting bids on City work.  

d) That policy signals have no effect on market participants.

These assumptions are incorrect, and should cause City officials to revisit the report and its  conclusions. Here we address each of these assumptions in turn.  

COMPETING ON LABOUR COSTS IN A MANDATED WAGE  ENVIRONMENT?  

The City’s 2008 report notes that “there are a large number of factors which go into bid prices  received by the City for construction work.”1 It goes on to list four of these factors: 

1. The overall state of the economy 

2. The state of the construction industry specifically  

3. The amount of competition between firms 

4. The ability to negotiate on access to and prices for 

a. Equipment 

b. Materials 

c. Labour  

Closed tendering forces an unnecessary reduction of  qualified firms that can compete for public works. In doing so it unnecessarily eliminates firms which would otherwise  bring a competitive edge on cost, quality, time, and  innovation to Toronto’s construction market.

Further, the City goes on to report that “a particular interest for the City is to ensure there is a  sufficient degree of competition amongst companies bidding for City work.”2

Yet while all of these factors have implications for the price the City pays for its construction,  the report does not address any of these factors in its report. It assumes equality between all  bidding firms on everything other than labour costs. This is a significant gap, especially in an  environment like Toronto whose fair wage policy attempts to reduce or eliminate competition on labour costs by mandating the wages that firms pay to employees. In short, the City  focused on the one area that was least likely to have an impact on the price of bids and created  an entire report around that factor. It’s generally accepted that firms compete on many factors  beyond cost and that competing on cost involves a wide variety of factors other than labour.  As noted by Kale and Arditi: 

The construction industry calls upon construction companies to adopt an approach  that attaches great emphasis to the combined effect of four modes of competition— cost, quality, time, and innovation. It is this simultaneous emphasis on exploiting  the current competencies for being efficient in transforming inputs into outputs and  exploring new ways of competing that makes the difference among competitors’  offerings significant, which in turn promotes competitive success.3 

As we note in previous Construction Competitiveness Monitor papers,4 closed tendering  forces an unnecessary reduction of qualified firms that can compete for public works. In  doing so it unnecessarily eliminates firms which would otherwise bring a competitive edge on  cost, quality, time, and innovation to Toronto’s construction market. This reduction of firms  prevents the City from taking advantage of the competitive positioning of the firms that are  disallowed from participating in the market.  

COMPETITIVE TENDERING IS NOT A UNION V. NON-UNION  ISSUE 

The City’s 2008 report breaks down the value of contracts that have gone to union and  non-union firms, and notes that even in the ICI sector (the sector most affected by “construction employer status”) non-union firms are able to win work.  

It also notes the number of unionized firms in the GTA and Ontario and draws two conclusions:  

1. “That there are a significant number of companies for general contractors to choose  from, which would appear to suggest that there is a competitive marketplace.”5

2. “[That the City] cannot be certain […] whether further competition would in turn  have the effect of lowering prices by general contractors.”6 

While there may be a significant number of unionized companies this does not imply  that the market is efficient, or that it is likely to produce the public value that comes from  healthy competition. After all, even a duopoly can be competitive. The issue is not whether the Toronto public construction market meets a minimal definition of competitiveness  among unionized firms, but whether it has a competitive marketplace that brings best value  for public dollars spent on construction projects.  

The City would have done a better job of advising its government if it were to provide a comparison of qualified unionized firms as a proportion of all qualified firms in the market,  regardless of their union affiliation. Without that it is difficult to gauge the extent to which  their market is truly competitive.  

The issue is not whether the Toronto public construction  market meets a minimal definition of competitiveness among unionized firms, but whether it has a competitive marketplace that brings best value for public dollars spent  on construction projects.

The City’s 2008 report does not provide any data on: 

1. The number of firms competing for public projects. 

2. The number of bids its receives on projects. 

3. The range of those bids, and a comparison of that range to the market as a whole. 4. The proximity of the bids it does receive to its estimates. 

5. The relation of its own estimates to other municipalities in the province.  

6. How these data points compare to other Canadian and international jurisdictions.  

This type of granular data is what is needed to provide an accurate empirical picture of the  exact cost implications of closed-tendering on Toronto.  

The defining question is whether or not qualified contractors, regardless of their union  affiliation, are able to bring their respective competitive advantages to the market place to  compete for work that is paid for by the public.  

And, as we show in Hiding in Plain Sight, Canada, Ontario, and Toronto have a robust  series of laws and regulations which are in place to ensure competition because there is near  universal consensus that competitive markets are better for those purchasing goods and  services, including construction.7 This is borne out both by theoretical economic models,  empirical studies, and the recent experience of Ontario municipalities such as the City of  Hamilton.8 And, likewise, there is a high degree of consensus that government regulation  that prevents qualified contractors from entry into markets is likely to increase prices.9

One of the urgent challenges for  Toronto, and indeed our cash and  infrastructure-strapped province as a whole, is to communicate that it is open to business

A less noticeable assumption made in the City’s 2008 report is that companies will not be  deterred by the complexity involved in managing multiple labour pools when bidding on  public projects. The City’s report assumes that companies will not change their prices even if it means having to alter their business model and labour structure to meet the City’s  labour obligations.  

However, the complexity of bidding does affect the price that companies place on their  services. As noted by Clive Thurston, president of the OGCA, last year,  

The majority of my members don’t like to bid the city, and those that do have  learned how to play the game so they charge a premium,[…] Throw in another  10% to 15% [...] I call it the aggravation factor.10 

The City report’s assumption that requiring firms to alter the organization of their work force because the City is designated as a construction employer will not increase the bid  price for is highly unlikely. This is one reason why Cardus’s estimates of the work affected  by closed tendering are higher than the City’s.11 The City’s numbers only account for the  portions of work that are required to be subcontracted to unionized firms, and they assume  that there will be no effect on how general contractors submit their bids. However, as noted  by the OGCA and other actors, many firms will either not bid on such work or will add a  premium to account for the extra effort in managing multiple labour pools.  

One of the best ways to signal that you are open to business is to remove any barriers that stand in the way of healthy competition.

RECOMMENDATIONS: TIME FOR TORONTO TO SIGNAL THAT  IT’S OPEN FOR BUSINESS 

There is no doubt that Toronto suffers from a number of significant challenges in its  procurement of construction projects. One of the urgent challenges for Toronto, and  indeed our cash and infrastructure-strapped province, is to communicate that it is open for  business. And one of the best ways to signal that you are open to business is to remove any  barriers that stand in the way of healthy competition. Strategically it makes sense to remove  barriers that are obvious, that can be changed easily, and that have a direct effect on the  price for services that would enhance the competitive environment.  

Closed tendering is one of these barriers. It not only adds costs to cities and the province, but  it stands in the way of securing the removal of another of Ontario’s competitive barriers: its  infrastructure deficit.12 

To move forward, Toronto could undertake two small steps that, even in the absence of a  just law on competitive tendering in the province, will signal their commitment to an open,  fair, and transparent procurement process.  

1. Toronto should support the Association of Municipalities of Ontario, and the Large  Urban Mayor’s Caucus of Ontario’s call for competitive bidding in the province.  

2. Toronto should commission an independent report by leading competition experts  to review the current competitive environment in Toronto.  

It’s time for Ontario’s leading City to remove the road-blocks and get itself and our province running again. 

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