Pass-Through of Cost Reductions in Open Auction Markets with Application to Merger Effects

Abstract

Here we analyze how, in an open procurement auction, cost reductions among suppliers bidding to sell to a buyer affect the payoffs to the buyer and suppliers. When a single supplier enjoys a reduction in cost, its increase in expected payoff is equal to the expected increase in total surplus from the cost reduction. The buyer benefits not by capturing a portion of the increase in surplus but instead gains at the expense of the suppliers who do not enjoy the cost decrease. The buyer's benefit from a cost decrease, increases in the concentration among the suppliers who do not enjoy the cost decrease. These results have implications for vertical integration and merger analysis. Increases in concentration increase the incentive of buyers who are integrated upstream to make cost reducing investments in the supply of the good while the investment incentives of non-integrated suppliers remain unchanged. In terms of merger analysis these results suggest that pass through of merger specific cost savings will be higher if the non-merging firms in the market are more concentrated. In addition, mergers increase the incentives for vertically integrated sellers to make cost reducing investments, which may serve to mitigate the anticompetitive effects of a merger.