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Procurement When Price and Quality Matter



swp0000.dvi Procurement when Price and Quality Matter∗ John Asker†and Estelle Cantillon‡ November 10, 2006 Abstract A buyer seeks to procure a good characterized by its price and its quality from suppliers who have private information about their cost structure (fixed cost + marginal cost of providing quality). We solve for the optimal buying procedure, i.e. the procedure that maximizes the buyer’s expected utility. We then use the optimal procedure as a theoretical and numerical benchmark to study practical and simple buying procedures such as scoring auctions and nego- tiation. Specifically, we derive the restrictions that these simpler procedures place on allocations and compare them with the optimal allocations to generate insights about the properties of these simpler procedures and identify environments where they are likely to do well. We also use the optimal procedure benchmark to compare the performance of these procedures numerically. We find that scoring auctions are able to extract a good proportion of the surplus from being a strategic buyer, that is, the difference between the expected revenue from the optimal mech- anism and the efficient auction. Sequential procedures (to which many negotiation processes belong) do less well, and, in fact, often do worse than simply holding an efficient auction. In each case, we identify the underlying reason for these results. Keywords: optimal auction, multi-attribute auction, differentiated product, multidimensional screening, scoring auction, negotiation, bargaining, procurement. JEL Codes: D44, D82, C78, L24, L22 ∗We thank Mark Armstrong, Heski Bar-Isaac, Micael Castanheira, Mathias Dewatripont, Philippe Jehiel, Georg Kirchsteiger, Patrick Legros, Nicolas Sahuguet as well as audiences at the Barcelona workshop on auctions, CEMFI, Paris School of Economics GREQAM, IDEI Toulouse, LSE, UCL, NYU IO Day, and the Duke-Northwestern-Texas IO Theory conference for helpful comments, and Alexis Walckiers for his careful proof

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