Auctions that are too good to be true

Auctions are supposed to procure the best deal money can buy. Yet, practitioners who procure complex contracts by auction are well aware of some basic pitfalls. One concern is that winning bids may not reflect the quality of the bidder but strategic behavior like low-balling bids or underestimating costs. Such behavior may then lead to demands for contract renegotiation by the winning bidder that are hard to resist. The problem plagues complex contracts for civil works or equipment as well as contracts for various types of public-private partnerships. In 1993 two engineering professors proposed a bidding scheme that aims at preventing excessively low bids. Effectively they developed a way to disqualify bids that are “too good to be true”. Several countries, including Colombia, Italy, China, Chile, Japan, Peru and Taiwan have adopted such auction schemes. However, it turns out that the new auctions give rise to new forms of strategic bidding behavior, which create even bigger problems2. Altogether, the new auctions seem to be “too good to be true”. Using standard procedures like first price sealed bid auctions remains best practice as long as well-established disciplines for pre-qualification and control of post-bid behavior are maintained.