34 Pages Posted: 22 Jul 2011
Date Written: July 20, 2011
We show how repeatedly awarded procurement contracts where unverifiable quality dimensions are relevant can be reinterpreted as relational contracts between a buyer and a contractor that is threatened by a potentially less efficient competitor. We compare two scenarios: 1) Under freedom of choices the (public) buyer freely chooses the contractor, the price and the (unverifiable) quality it should stick to, 2) in a competitive discretionary tendering the buyer evaluates differently the bids of the suppliers by means of a handicap, based on the firm's past performance. We show that, if firms' costs are common knowledge, relational discriminatory tenderings replicates the results of long term contracting (freedom of choice). The handicap ensures the existence of a relational contract under which the buyer selects the more efficient firm and pays it a price higher than its cost, and the firm delivers the required quality. This outcome is an equilibrium when thecost of quality is not too high, and the players' discount factor and the valuation of quality are not small. A self-enforcing relational contract entails an handicap which is closer to the difference between the firms' specific-cost, the lower is the variable cost of quality and the higher is the players' discount factor.
Keywords: public procurement, relational contracts, unverifiable quality, handicap
Suggested Citation: Suggested Citation
Albano, Gian Luigi and Berardino, Cesi and Iozzi, Alberto, 'Relational' Procurement Contracts: A Simple Model of Reputation Mechanism (July 20, 2011). CEIS Working Paper No. 209. Available at SSRN: https://ssrn.com/abstract=1892001 or http://dx.doi.org/10.2139/ssrn.1892001