Total-Cost Procurement Auctions: Should the Buyer Reveal Suppliers' Quality?

Abstract

We consider sealed and open-bid total-cost procurement auctions where two attributes are used for contract award decisions: price, which is bid by the supplier; and a fixed quality adjustment cost, which is included by the buyer to capture non-price factors such as a supplier's quality and reliability. Suppliers know only their own true production cost and their own quality adjustment cost, and the buyer does not know the suppliers' true production costs but does know all suppliers' quality adjustment costs, which she herself sets in order to make an informed total-cost decision. The buyer, who seeks to minimize her total (price and quality adjustment) procurement cost, can choose to announce the quality adjustment costs of all suppliers by running a descending open-bid auction, or conceal them by running a first price sealed-bid auction. We characterize the buyer's choice between the two formats as a threshold decision over suppliers' quality adjustment costs, and analyze the effect of supplier beliefs on her decision. We also study the impact of additional suppliers on the buyer's decision, the effect of correlation between suppliers' production costs and their quality adjustment costs, and additive as well as multiplicative total cost functions. The results suggest that procurement managers can use their evaluations of suppliers' qualities to make better auction format decisions.