Dual Sourcing with Price Discovery

with J Alcalde, CeDEx Discussion Paper 2016-03

Revise and resubmit at Games and Economic Behavior

Click here for longer summary.

Reverse auctions are considered a fast and inexpensive price discovery tool to award procurement contracts and it is often desirable to award contracts to more than one supplier. We propose a new procurement procedure that is based on a reverse auction. Shares are allocated endogenously, depending on the suppliers’ bids. The procedure obtains dual sourcing by assigning positive shares to the two most competitive bids and uses discarded bids to endogeneize the reserve price. In equilibrium the two most competitive suppliers are awarded contracts. Surprisingly, when discarded suppliers are competitive enough, the procedure not only allows taking advantage of dual sourcing but also generates lower procurement expenditures than a standard auction for sole sourcing. We also show that providers reveal their costs truthfully and that the procurement procedure can be used in different scenarios concerning what providers know about each others’ costs, provided the assumption of private values holds.