Framework Agreements in Procurement: An Auction Model and Design Recommendations

Yonatan Gur (), Lijian Lu () and Gabriel Y. Weintraub ()
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Yonatan Gur: Stanford University, Stanford, California 94305
Lijian Lu: Columbia University, New York, New York 10027
Gabriel Y. Weintraub: Stanford University, Stanford, California 94305

Manufacturing & Service Operations Management, 2017, vol. 19, issue 4, 586-603

Abstract: Framework agreements (FAs) are procurement mechanisms commonly used by buying agencies around the world to satisfy demand that arises over a certain time horizon. This paper is one of the first in the literature that provides a formal understanding of FAs, with a particular focus on the cost uncertainty bidders face over the FA time horizon. We generalize standard auction models to include this salient feature of FAs and analyze this model theoretically and numerically. First, we show that FAs are subject to a sort of winner’s curse that in equilibrium induces higher expected buying prices relative to running first-price auctions as needs arise. Then, our results provide concrete design recommendations that alleviate this issue and decrease buying prices in FAs, highlighting the importance of (i) monitoring the price charged at the open market by the FA winner to bound the buying price; (ii) implementing price indexes for the random part of suppliers’ costs; and (iii) allowing suppliers the flexibility to reduce their prices to compete with the open market throughout the selling horizon. These prescriptions are already being used by the Chilean government procurement agency that buys US$2 billion worth of contracts yearly using FAs.

Keywords: procurement; supply chain management; auction theory; mechanism design (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormsom:v:19:y:2017:i:4:p:586-603

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