Procurement when Price and Quality Matter

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 and marginal cost of providing quality). We characterize the buyer's optimal buying mechanism. We then use the optimal mechanism as a theoretical and numerical benchmark to study simpler buying procedures such as scoring auctions and bargaining. Scoring auctions can extract a significant proportion of the buyer's strategic surplus (the difference between the expected utility from the optimal mechanism and the efficient auction). Bargaining does less well and often does worse than the efficient auction.

Reference

John Asker, and Estelle Cantillon, “Procurement when Price and Quality Matter”, The RAND Journal of Economics, Spring 2010, pp. 1–34.