Endogenous asymmetry in a dynamic procurement auction

Abstract

This paper analyzes a typical procurement market where a few firms compete repeatedly over a sequence of first price auctions. In practice, such firms have been found to experience capacity constraints whereby their costs increase with their capacity utilization. As a result, since a firm's capacity utilization can change over time, the firms can endogenously become asymmetric in terms of their costs. We model this setting as an infinite-horizon dynamic procurement auction and numerically solve for its Markov Perfect Bayesian Equilibrium. We find that the procurer is best off scheduling frequent auctions for small project sizes. The alternative, having fewer auctions but for larger contracts, tends to make the firms more asymmetric and more capacity-constrained; this softens competition, and increases bidder profits and procurement costs. We also find that forward-looking bidding dampens the competition-softening effects of asymmetry; farsighted firms compete more intensely than myopic ones. We show that this undermines the intended goal of a bid preference style affirmative action program: the more farsighted the firms are, the greater the rate of bid preference needs to be.

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