Optimal Design of Split-award Auctions with Economies of Scale and Multiple Periods
The rapid growth of donor funded markets for medicines, vaccines, and healthcare products for low income countries builds the need for effective procurement mechanisms. In many instances, these markets are characterized by homogenous goods, economies of scale in production, and cost advantages of generic suppliers. Clearly, in the short term (i.e. one period procurement) consolidating volume to one supplier reduces procurement cost because the buyer benefits from the pooling effects. However, in case of multiple periods the buyer may want to prevent a monopolistic market from increasing prices (in the future) by contracting a second supplier today. In this case, the buyer forgoes some of the single sourcing benefits in the short term to ensure long-term low procurement cost. One way to achieve this long-term market health is a split-award auction.
We study the (repeated) procurement of a homogenous good in a two period environment in the presence of economies of scale and possible market withdrawal of a supplier (i.e. the occurrence of a monopoly). The model consists of two suppliers, one more cost effective than the other, bidding for a variable share of a procurement contract, both in a first-price and a second-price auction setup. We identify the factors that influence the volume share that the buyer awards to each supplier and if the buyer should prefer an auction format. We find that in some situations the buyer can benefit from split-awards and reduce prices compared to single-sourcing and that the auction format can have an impact, too.
Lauton, F. (2013) Optimal Design of Split-award Auctions with Economies of Scale and Multiple Periods (more)