Local Cost Synergies in Reverse Auctions: An Application to Road Salt Procurement

Abstract

We develop a structural econometric model of simultaneous first-price auctions with cross-auction linkages, and apply it to Minnesota Department of Transportation's (MnDOT) annual road salt procurement auctions. We begin by demonstrating that North American and Cargill, the two largest firms in MnDOT's auctions, enjoy substantial local cost synergies. Specifically, their bids are about 9 percent lower than what they would be absent these synergies. Then, we examine local cost synergies' interaction with auction competitiveness and efficiency. We estimate that: (i) in a representative sample of auctions, (a) the small firms' probability of winning is about half what it would be absent large firms' local cost synergies, and (b) the simultaneous auction assigns all depots in an area to a single large firm about one-quarter as often as the efficient auction would; (ii) to alleviate the large firm--small firm asymmetry generated by local cost synergies, MnDOT would have to institute a small-firm bid preference of at least 12 percent; (iii) on average, North American's and Cargill's per-ton bids are 0.5 percent and 6.4 percent lower than they would be if MnDOT bundled depots (storage facilities) by area to increase efficiency, respectively. Overall, we find that cross-auction linkages can be economically significant in simultaneous auctions, and that they can substantially moderate the tradeoff between auction competitiveness and auction efficiency.

Keywords: reverse auction, structural estimation