Past Performance and Procurement Outcomes

Reputational incentives may be a powerful mechanism for improving supplier performance and limiting the perverse effect of price competition on contract execution. We analyze a unique experiment run by a large utility company in Italy which introduced a new vendor rating system scoring its suppliers' past performance and linking it to the award of future contracts. We study responses in both price and performance to the announcement of the switch from price-only to price-and-rating auctions. Average performance improves from 25 percent to 90 percent of the audited parameters. Improvements involve all parameters and suppliers, are long-lasting (for at least 10 years after the initial experiment) and are reflected in higher service quality by the utility. Contract prices do not significantly change overall, but we find evidence of lower prices right after the announcement when suppliers compete to win contracts to get scored, and of higher prices, once they have established a good reputation. We then argue that supplier moral hazard is the main force behind our findings. The main takeaway from this study is that the gains from curtailing supplier moral hazard may be higher than those from always bolstering price competition, and that a reputational mechanism based on objective past performance can be a powerful tool to achieve this goal.