TECHBRIEF

Research, Development, and 

Technology

Turner-Fairbank Highway 

Research Center

6300 Georgetown Pike

McLean, VA 22101-2296

www.fhwa.dot.gov/research

Performance-Based

Contractor Prequalification

as an Alternative to

Performance Bonds 

FHWA Publication No.: FHWA-HRT-14-035

FHWA Contact: Richard Duval, HRDI-20, (202) 493-3365, 

richard.duval@dot.gov 

This document is a technical summary on a Federal Highway 

Administration (FHWA) project that will be fully documented 

in a separate report under the same title (FHWA-HRT-14-034) 

and will be published in early 2014.

Introduction

State transportation departments must rely on private 

industry construction contractors to build, rehabilitate, and 

replace their infrastructure assets. The FHWA is interested 

in ensuring that State transportation departments select 

contractors that can complete projects cost-effectively. One 

potential method to help select qualified contractors is to 

use a performance-based contractor prequalification process. 

FHWA commissioned this study to evaluate the wisdom 

of expanding the use of this process. This report presents 

the results of this study, which examined relevant 

literature, evaluated the benefits and costs of performance 

bonds and performance-based contractor prequalification, 

and recommended a model performance-based prequalification approach. 

In the highway industry, one of the main methods of prequalifying a contractor is determining whether or not a 

performance bond can be secured. The current performance bonding system does not differentiate between a 

high-performing and marginally-performing contractor, as 

long as the two companies have the same level of financial 

assets. This gives both companies the same opportunity to 

bid on a project, regardless of performance. In a low-bid 

environment, a transportation department concedes 

marginal performance, which in turn reduces the incentive 

for top performers to continue superior performance. 

This research project—which consisted of a detailed literature review; surveys of contractors, State transportation 

departments, and sureties; and State transportation 

department case studies—analyzes the benefits and costs of 
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performance bonds and performance-based 

contractor prequalification and creates a 

performance-based contractor prequalification 

model. The research suggests that the 

minimum contract value that requires a 

performance bond should be raised to somewhere between $1 million and $10 million and 

that the cost of performance-based prequalification is low compared to the cost 

of the premiums for performance bonds.

Last, a three-tiered, performance-based 

contractor prequalification model was 

developed to prequalify a contractor based on 

performance and financials, which rewards 

good performance and encourages improvement of marginal performance. The model is 

general enough so that an individual transportation department will be able to adapt 

the model to its own specific conditions.

This TechBrief presents a performance-based 

prequalification model for the transportation 

industry that includes incentive for good 

performers and encourages marginal 

performers to improve. This model is intended 

to guide State transportation departments in 

making their existing systems more robust 

and to take into account the performance 

of the contractor in the awarding of projects. 

A brief description of the model and its 

three tiers is included in this technical 

brief, as well as some guidance on implementation through the identification of the 

business decisions for each tier.

Proposed Performance-Based 

Contractor Prequalification Model

The proposed performance-based prequalification model combines elements of the 

processes in use by the Florida Department 

of Transportation, Ohio Department of 

Transportation, and Ontario Ministry of 

Transportation and borrows concepts and 

terminology from each. It consists of a 

two-tiered process that is applicable to 

design-bid-build projects and an optional 

third tier for project-specific qualification for 

design-bid-build-best value, design-build, 

construction manager/general contractor, 

public-private partnerships, and other alternate 

project delivery methods.

State transportation departments need to 

undertake the following business actions in 

order to implement this phase of the process:

• Establish a project performance evaluation 

system if one does not already exist.

• Develop an appeals process.

Tier 1: Administrative 

Prequalification

The first tier of the performance-based 

contractor prequalification model consists 

of administrative prequalification, which 

is already used, to varying degrees, by most 

State transportation departments. Administrative prequalification consists of the 

following components:

• Financial analysis conducted by the agency, 

including analysis using audited financial 

statements, bank statements, etc. 

• An optional records check to determine 

whether the contractor has committed 

any major contractual infractions, such as 

breach, failure to complete a punch list,

failure to make good on a warranty, etc. 

An agency may also choose to include 

citations by outside enforcement agencies 

for failure to comply with safety or environmental standards. 

• Assembly of optional external documentary 

information such as bonds, surety verification of the ability to furnish bonds, 

required insurances in the proper amounts, 

etc., as required by law or as desired by the 

agency to validate information developed 

by the contractor. 

The result of tier 1 administrative prequalification is the final contractor financial capacity. 

If the final contractor financial capacity meets 

the minimum required by State transportation 

departments and if the minimum external 

requirements are met, then the contractor 

moves on to tier 2 prequalification; otherwise, 

the contractor is disqualified.
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State transportation departments need to 

undertake the following business actions to 

implement this phase of the process:

• What external validation, if any, is to be 

included in the administrative prequalification? If so, what are the minimum requirements?

• Are contract infractions to be included in the 

administrative prequalification? If so, what 

is the infraction factor scale to be used for 

evaluation?

• What capital modifier or capital modifier 

scale is to be used for the calculation of the 

net working capital?

• What is the minimum final contractor 

financial capacity required to move on to 

tier 2 qualification?

Tier 2: Performance-Based 

Prequalification

Tier 2 (performance-based prequalification) 

qualifies contractors to bid on a specific project 

based on the contractor’s available bidding 

capacity. For a given project, the contractor’s 

available bidding capacity is its bidding 

capacity minus the value of current ongoing 

contracts. The bidding capacity is the result 

of the final contractor financial capacity 

(determined in tier 1) multiplied by the performance modifier or, depending on the 

scale used for the performance modifier, 

a financial factor. This is similar to the 

bonding system except that in place of 

a financial risk factor, a performance factor 

is used to determine the bidding capacity.

The performance modifier is calculated using 

the contractor’s performance rating for the 

past 3 years, as determined by the agency’s 

performance-based contractor evaluation 

system. The latest year’s average performance 

rating carries the most weight, and the 

oldest year’s performance rating carries 

the least weight. This creates an objective 

mathematical process to reward a marginal 

contractor who is committed to improving its 

performance by gradually reducing the impact 

of a year with an adverse rating to the point 

where, after 3 years, it disappears. 

A contractor is qualified if the resulting 

available bidding capacity value exceeds 

the project contract value estimate requirement established by the State transportation 

department for the given contract, which is 

equal to a current engineer’s estimate for the 

project in question.

State transportation departments need to 

undertake the following business actions to 

implement this phase of the process:

• Develop and implement a contractor performance evaluation system.

• Establish how the performance modifier 

is calculated if a performance evaluation 

system has not been in place for at least 

3 years.

• Determine how the contractor performance 

evaluation system integrates with the 

prequalification system.

• Determine the scale for the performance 

modifier and how it is applied to calculate 

the bidding capacity; find out whether a 

financial factor is determined based on the 

performance modifier.

Tier 3: Project-Specific 

Prequalification

Tier 3 is a project-specific prequalification tier 

that is designed to closely evaluate a contractor’s qualifications and experience in 

terms of the specific needs of a given project. 

This final tier is an optional portion of the 

prequalification process and is intended for 

use only on projects delivered by alternative 

project delivery methods or projects having 

specific requirements such as experience.

To implement this phase of the process, State 

transportation departments need to determine 

what project criteria would trigger the use of 

tier 3 project-specific prequalification, such as 

delivery method, technical experience, size, etc.
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Researchers— This study was led by Bill Dye, Dr. Elizabeth Kraft, and Peter Mills of Dye Management 

Group, Inc., and Dr. Douglas Gransberg of Iowa State University.

Distribution—This TechBrief is being distributed according to a standard distribution. Direct distribution is being made to the Divisions and Resource Center.

Availability—This TechBrief may be obtained from the FHWA Product Distribution Center by email to 

report.center@dot.gov, fax to (814) 239-2156, phone to (814) 239-1160, or online at http://www.fhwa.dot.

gov/research.

Key Words—Performance bonds, contractor prequalification, contractor performance, construction, 

default, performance-based prequalification.

Notice—This document is disseminated under the sponsorship of the U.S. Department of 

Transportation in the interest of information exchange. The U.S. Government assumes no liability for 

the use of the information contained in this document. The U.S. Government does not endorse products or manufacturers. Trademarks or manufacturers’ names appear in this report only because they 

are considered essential to the objective of the document.

Quality Assurance Statement—The Federal Highway Administration (FHWA) provides high-quality 

information to serve the Government, industry, and public in a manner that promotes public understanding. Standards and policies are used to ensure and maximize the quality, objectivity, utility, and 

integrity of its information. FHWA periodically reviews quality issues and adjusts its programs and 

processes to ensure continuous quality improvement.

JANUARY 2014 FHWA-HRT-14-035

HRDI-20/01-14(500)E

Conclusion

First, performance bonds are not insurance. 

They do not guarantee against non-completion 

of a contract under all conditions, as insurance 

would (if insurance companies made such a 

product available). Instead, performance bonds 

come into play only when the contractor has 

defaulted on completion of the contract and is 

in financial default (i.e., is unable to provide the 

funds to remedy the situation). Performance 

bonds are more a form of credit than insurance 

in that they are priced like credit and sureties 

have the same rights to monitor and intervene in the affairs of their contractors as do 

other creditors. However, the advanced evaluation and intervention capabilities are limited 

by the nature of performance bonds themselves; performance bonds do not guarantee 

the quality of work, nor do they guarantee that 

the full costs to complete a project in default 

will be covered by the performance bond.

Finally, and most relevant to the objective 

of improving the quality of contracted construction work through the prequalification of 

contractors, performance bonds provide no 

protection against mediocre work. Generally, 

the system does not evaluate contractors in 

terms of the completion of timely, high-quality 

work that satisfies State transportation 

department expectations. Today, data are not 

readily available from State transportation 

departments about contractor performance, 

and even if they could be collected, the low 

rates of default limits obligations or incentive 

to raise the costs of performance bonds in 

order to incorporate contractor performance evaluations. The recently completed 

FHWA research presents a performancebased prequalification methodology that 

could be an alternate approach.