Competition and Cost Overruns in Procurement

UPF Economics and Business Working Paper 772

34 Pages Posted: 15 Nov 2005

See all articles by Juan-José Ganuza

Juan-José Ganuza

Universitat Pompeu Fabra (UPF) - Faculty of Economic and Business Sciences

Date Written: October 2003

Abstract

Most cases of cost overruns in public procurement are related to important changes in the initial project design. This paper deals with the problem of design speciffication in public procurement and provides a rationale for design misspeciffication. We propose a model in which the sponsor decides how much to invest in design speciffication and awards competitively the project to a contractor. After the project has been awarded the sponsor engages in bilateral renegotiation with the contractor, in order to accommodate changes in the initial project's design that new information makes desirable. When procurement takes place in the presence of horizontally differentiated contractors, the design's speciffication level is seen to affect the resulting degree of competition. The paper highlights this interaction between market competition and design speciffication and shows that the sponsor's optimal strategy, when facing an imperfectly competitive market supply, is to underinvest in design speciffication so as to make signifficant cost overruns likely. Since no such misspeciffication occurs in a perfectly competitive market, cost overruns are seen to arise as a consequence of lack of competition in the procurement market.

Keywords: Cost overruns, procurement contracts, strategic ignorance

JEL Classification: L51, H57, D44

Suggested Citation

Ganuza, Juan, Competition and Cost Overruns in Procurement (October 2003). UPF Economics and Business Working Paper 772, Available at SSRN: https://ssrn.com/abstract=848487 or http://dx.doi.org/10.2139/ssrn.848487

Juan Ganuza (Contact Author)

Universitat Pompeu Fabra (UPF) - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(34-93) 542 27 19 (Phone)
(34-98) 542 17 46 (Fax)

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