Overcoming Cost Disadvantages in Procurement Auctions

Abstract

An increasingly studied auction format is the asymmetric procurement auction, which features an advantaged bidder selling a good or service to a buyer. Such asymmetric setups, while generally believed to be more realistic, are also more complex. We investigate one such setting where one bidder has a cost advantage. Our central question is whether bidders who are cost-disadvantaged can overcome their inferior cost position. In a design that mirrors real construction procurement auctions, our laboratory experiment tests whether two information asymmetries (more precise cost estimates and knowledge about the cost estimating abilities of a competitor) allow cost-disadvantaged sellers to better compete. We begin by testing bidder performance in a procurement auction where the only asymmetry is due to a cost. In this setting, analytical benchmarks are known. We find – consistent with other studies – that all bidder types submit aggressive bids well below the Nash equilibrium predictions. Over time, subjects submit less aggressive bids, moving closer to what theory would predict. We then extend our experiments to include our novel, multiple asymmetry setup. We find that endowing cost-disadvantaged bidders with higher cost estimate precision benefits the bidder, as one might expect. Notably, providing market knowledge about a rival’s ability to estimate costs may not provide a benefit; in fact, it seems bidders are not able to use this information effectively and performance suffers. Finally, we show how bidders behave myopically when making these decisions. These implications raise important questions about how asymmetries interact in complex auction settings.

Keywords: procurement auction, asymmetric information, cost, experiment

JEL Classification: D44, C91, M2