Extensions of bidding theory: Concealed bidding, optimal number of bidders, and follow-on contracts (original) (raw)

Procurement bidding with restrictions

Quantitative Marketing and Economics, 2007

In many procurement situations with simultaneously offered projects, firms face participation restrictions and can bid only on a subset of the projects. This phenomenon is prevalent in a variety of observed situations such as bidding for private label supplies, business to business procurement or government projects. We show that for the case of n bidding firms where each is restricted to bid on a subset of the offered projects, there exists a symmetric equilibrium in which each bidder has a positive expected equilibrium profit. Prices are bounded away from marginal costs even if all the bidders are homogenous. this results from the fact that there is a positive probability that each firm will find itself in the position of being the sole bidder on a project. While the equilibrium probability of bidding on a project increases with its value, it is interesting to note that the bidding probability on the projects approaches an equiprobable one as the number of bidding firms increases. We find that the equilibrium profits decrease as firms are able to bid on more of the available projects. In contrast, bidder commitment to bid on specific projects increases the equilibrium profits of all firms. We also examine the effect of heterogeneity on equilibrium profits. Greater heterogeneity in the project valuations leads to lower firm profits. On the other hand, heterogeneity among bidders in terms of the number of projects that they are constrained to bid on leads to greater profits for the firms that can bid on more projects (regardless of the mix of the firms in the industry.) Finally, we analyze the effect of uncertainty in project valuations and show greater uncertainty in project valuations (as represented by a mean preserving spread) decreases the equilibrium profits. We conclude with an empirical analysis of bidding behavior that tests the predictions of the theory. We find that the probability of bidding on a particular project is increasing in its value, decreasing in the other projects values and decreasing in the number of bidding subjects. Furthermore, the value of the bids on a project increase with its valuation and decrease with the total number of bidders.

Optimal Auctions of Procurement Contracts

Organizational Economics Proceedings, 2014

We consider tenders/auctions for the procurement of items that do not exist at the time of the tender. The cost of production is subject to ex-post shocks, i.e. cost overruns, which cannot be contracted away or insured at the time of tender. The contractors may default due to the cost overruns once the project is underway. We consider a simple contract that speci…es the payment in case of default and the award that is paid upon successful project completion. This contract is allocated at the tender and the award part is determined by competitive bidding. We characterize bidding behavior of contractors in standard tenders and derive the implications for the buyer's expected cost minimization.

Optimal Bid Price in Competitive Bidding under Risk Aversion

This paper presents a quantitative model to determine the optimal bid price in the lowest bid procurement model under the framework of expected utility theorem. The contractor is assumed to behave as a risk averse individual with his utility expressed as an exponential utility function. The model aims at maximizing the expected utility of uncertain profit rather than the expected value of uncertain profit. Incorporating the contractor's risk attitude into a bid decision results in a lower firm's optimal bid-to-cost ratio. The worked example demonstrates that the more tolerable the contractor to risk, the higher will be the his optimal bidto-cost ratio. The optimal bid-to-cost ratio is more sensitive at lower risk levels. A Monte Carlo Simulation with 500 trials adopted in the study also reveals that there is no substantial change in the contractor's expected utility as the construction cost uncertainty changes. A venue for future research works is presented in the paper.

Bidding for Incomplete Contracts: An Empirical Analysis

2006

Procurement contracts are often incomplete because the initial plans and specifications are changed and refined after the contract is awarded to the lowest bidder. This results in a final cost to the buyer that differs from the low bid, and may also involve significant adaptation and renegotiation costs.

Optimal procurement mechanisms: bidding on price and damages for breach

Economic Theory, 2013

We study the optimal procurement mechanism when contract breach and abandoning a project may be efficient, either because of completion costs higher than anticipated, or new and more lucrative opportunities for the contractor. When contractors have private information about their costs, the procurer finds it optimal to set damages above expectation damages. There is a lock-in effect, or status-quo bias; the agent that has won the award will complete the project even in situations when it would be efficient to abandon it. If the cost types of all agents are above a threshold, the optimal bidding procedure assigns the project by lottery. The optimal mechanism cannot be implemented by standard auction formats. However, the larger the number of agents bidding for the project, the closer auctions with a liquidated damage clause approximate the optimal mechanism.

Procurement with costly bidding, optimal shortlisting, and rebates

Economics Letters, 2008

We consider the procurement of a complex, indivisible good when bid preparation is costly, assuming a population of heterogeneous contractors. Shortlisting is introduced to implement the optimal number of bidders, and we explore whether the procurer should reimburse the nonrecoverable cost of preparing a bid in whole or in part. We find that a reimbursement policy is profitable for the procurer only if performance and bidding costs are negatively correlated. Moreover, negative rebates (entry fees) always dominate positive rebates.

Risk and Price in the Bidding Process of Contractors

Journal of Construction Engineering and Management, 2011

Formal and analytical risk models prescribe how risk should be incorporated in construction bids. However, the actual process of how contractors and their clients negotiate and agree on price is complex, and not clearly articulated in the literature. Using participant observation, the entire tender process was shadowed in two leading UK construction firms. This was compared to propositions in analytical models and significant differences were found. 670 hours of work observed in both firms revealed three stages of the bidding process. Bidding activities were categorized and their extent estimated as deskwork (32%), calculations (19%), meetings (14%), documents (13%), off-days (11%), conversations (7%), correspondence (3%) and travel (1%). Risk allowances of 1-2% were priced in some bids and three tiers of risk apportionment in bids were identified. However, priced risks may sometimes be excluded from the final bidding price to enhance competitiveness. Thus, although risk apportionment affects a contractor"s pricing strategy, other complex, microeconomic factors also affect price. Instead of pricing in contingencies, risk was priced mostly through contractual rather than price mechanisms, to reflect commercial imperatives. The findings explain why some assumptions underpinning analytical models may not be sustainable in practice and why what actually happens in practice is important for those who seek to model the pricing of construction bids.

Optimal Bidding Policies For Civil And Mechanical Engineering Contracts

INFOR: Information Systems and Operational Research, 1986

In certain industries contracts are awarded on the basis of price bids submitted by a set of competing organizations. This study reports on an application of existing bidding theory in determining optimal bidding policies in the civil and mechanical engineering sectors of the economy. RESUME Dans certaines industries les societes attribuent leurs contrats en tenant compte des devis soumis par un certain nombre d'autres societes concurrentes. Dans la presente etude nous analysons la mise en pratique d'une theorie courante des devis pour determiner la politique des devis la plus rentable dans les secteurs civil et mechanique de l'economie.

Fundamental research in bidding and estimating

1988

Since Friedman, fundamental research in construction contract bidding and estimating has been concerned with the full problem definition, formulation and calibration. The general problem definition is now virtually complete in that bidding involves sequential and simultaneous decisions to be made over time, under conditions of uncertainty, and with multiple, conflicting objectives. Problem formulation has been rather haphazard and many ad hoc models have been used, often with very little empirical support.