July 01, 2018
Competitive Bidding Not Especially Effective for Reducing Contract Costs
Competitive bids among potential suppliers is supposed to reduce costs and minimize collusion. However, new research demonstrates that such benefits of increasing competition are smaller when a buyer has the opportunity to negotiate contract terms with suppliers.
“Winning by Default: Why Is There So Little Competition in Government Procurement?” — coauthored by Karam Kang, assistant professor of economics, and Robert Miller, Richard M. Cyert and Morris DeGroot Professor of Economics and Statistics — analyzes 2,203 contracts awarded by the federal government between 2004 and 2012.
Of these contracts, just 26 percent were awarded following a competitive process. The study revealed that while mandating competitive bids to select a supplier with the lowest bid without negotiations would increase the number of bids by 0.6 to 2, it would also increase the average price per contract by about $35,800, or 3 percent of the average price. “Our results indicate that allowing discretion to procurement agencies is valuable, especially when increasing competition is costly,” Kang said.
During a bidding process, potential suppliers and a buyer negotiate contract terms, which determines the final price of the contract, after accounting for contract outcomes such as delays. This negotiation helps the buyer lower the contract price even with one supplier bidding. The study finds that negotiations effectively reduce the average price by about the same amount as one extra bidder, which is important because each additional bid increases the administrative costs for the buyer.
To best reduce procurement costs, the faculty members recommend allowing buyers discretion during the procurement process, rather than requiring competitive bidding in all cases.
Read more in the summer 2018 Tepper Magazine.