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Procurement When Price and Quality Matter

  • John Asker
  • Estelle Cantillon

A buyer seeks to procure a good characterized by its price and its quality from suppliers who have private information about their cost structure (fixed cost + marginal cost of providing quality). We solve for the optimal buying procedure, i.e. the procedure that maximizes the buyer's expected utility. We then use the optimal procedure as a theoretical and numerical benchmark to study practical and simple buying procedures such as scoring auctions and negotiation. Specifically, we derive the restrictions that these simpler procedures place on allocations and compare them with the optimal allocations to generate insights about the properties of these simpler procedures and identify environments where they are likely to do well. We also use the optimal procedure benchmark to compare the performance of these procedures numerically. We find that scoring auctions are able to extract a good proportion of the surplus from being a strategic buyer, that is, the difference between the expected revenue from the optimal mechanism and the efficient auction. Sequential procedures (to which many negotiation processes belong) do less well, and, in fact, often worse than simply holding an efficient auction. In each case, we identify the underlying reason for these results.

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File URL: http://pages.stern.nyu.edu/~jasker/AskerCantillonProcurement2006.pdf
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Paper provided by New York University, Leonard N. Stern School of Business, Department of Economics in its series Working Papers with number 06-24.

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Date of creation: 2006
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Handle: RePEc:ste:nystbu:06-24
Contact details of provider: Postal:
New York University, Leonard N. Stern School of Business, Department of Economics, 44 West 4th Street, New York, NY 10012-1126

Phone: (212) 998-0860
Fax: (212) 995-4218
Web page: http://w4.stern.nyu.edu/economics/

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  1. Steven Tadelis, 2009. "Auctions Versus Negotiations in Procurement: An Empirical Analysis," Journal of Law, Economics and Organization, Oxford University Press, vol. 25(2), pages 372-399, October.
  2. Jehiel, Phillipe & Moldovanu, Benny & Stacchetti, E., 1997. "Multidimensional Mechanism Design for Auctions with Externalities," Sonderforschungsbereich 504 Publications 97-04, Sonderforschungsbereich 504, Universit├Ąt Mannheim;Sonderforschungsbereich 504, University of Mannheim.
  3. Alejandro M. Manelli & Daniel R. Vincent, 1992. "Optimal Procurement Mechanisms," Discussion Papers 999, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Wilson, Robert, 1997. "Nonlinear Pricing," OUP Catalogue, Oxford University Press, number 9780195115826, July.
  5. Bajari, Patrick & Tadelis, Steven, 2001. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 387-407, Autumn.
  6. Fernando Branco, 1997. "The Design of Multidimensional Auctions," RAND Journal of Economics, The RAND Corporation, vol. 28(1), pages 63-81, Spring.
  7. Ganuza, Juan-Jose & Pechlivanos, Lambros, 2000. "Heterogeneity-promoting optimal procurement," Economics Letters, Elsevier, vol. 67(1), pages 105-112, April.
  8. Asker, John & Cantillon, Estelle, 2004. "Properties of Scoring Auctions," CEPR Discussion Papers 4734, C.E.P.R. Discussion Papers.
  9. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August.
  10. Armstrong, Mark, 1996. "Multiproduct Nonlinear Pricing," Econometrica, Econometric Society, vol. 64(1), pages 51-75, January.
  11. repec:oup:restud:v:67:y:2000:i:3:p:455-81 is not listed on IDEAS
  12. Laffont, Jean-Jacques & Tirole, Jean, 1987. "Auctioning Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 921-37, October.
  13. Alejandro M. Manelli & Daniel R. Vincent, 2004. "Multidimensional Mechanism Design: Revenue Maximization and the Multiple-Good Monopoly," Working Papers 2004.153, Fondazione Eni Enrico Mattei.
  14. Asker, John & Cantillon, Estelle, 2005. "Optimal Procurement When Both Price and Quality Matter," CEPR Discussion Papers 5276, C.E.P.R. Discussion Papers.
  15. Mathias Dewatripont & Lars Peter Hansen & Stephen Turnovsky, 2003. "Advances in economics and econometrics: the eighth world congress," ULB Institutional Repository 2013/9557, ULB -- Universite Libre de Bruxelles.
  16. repec:oup:restud:v:65:y:1998:i:2:p:295-305 is not listed on IDEAS
  17. Border, Kim C, 1991. "Implementation of Reduced Form Auctions: A Geometric Approach," Econometrica, Econometric Society, vol. 59(4), pages 1175-87, July.
  18. Mark Armstrong, 2000. "Optimal Multi-Object Auctions," Review of Economic Studies, Oxford University Press, vol. 67(3), pages 455-481.
  19. repec:ste:nystbu:06-22 is not listed on IDEAS
  20. Yeon-Koo Che, 1993. "Design Competition through Multidimensional Auctions," RAND Journal of Economics, The RAND Corporation, vol. 24(4), pages 668-680, Winter.
  21. Dasgupta, Sudipto & Spulber, Daniel F., 1989. "Managing procurement auctions," Information Economics and Policy, Elsevier, vol. 4(1), pages 5-29.
  22. Yeon-Koo Che & Ian Gale, 2003. "Optimal Design of Research Contests," American Economic Review, American Economic Association, vol. 93(3), pages 646-671, June.
  23. Taylor, Curtis R, 1993. "Delivery-Contingent Contracts for Research," Journal of Law, Economics and Organization, Oxford University Press, vol. 9(1), pages 188-203, April.
  24. Bulow, Jeremy & Klemperer, Paul, 1996. "Auctions versus Negotiations," American Economic Review, American Economic Association, vol. 86(1), pages 180-94, March.
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