Supply Auctions and Relational Contracts for Procurement

We examine the competition between procurement auctions and long-term relational contracts that emerges from the increased usage of electronic marketplaces. Procurement auctions create supply chain efficiencies by selecting the least costly bidder, and long-term relational contracts ensure the quality of the procured products or services when these have nonverifiable attributes. The following two-layer supply chain model is analyzed: Suppliers of an industrial part with nonverifiable quality trade with several manufacturers that utilize that part in the production of an end product. A price-based reverse auction is used for the procurement of low-quality parts, and a relational long-term contract is used for high-quality parts. A formal model of the competition between the two procurement models identifies conditions under which the two coexist, and conditions under which one will push the other out of the market. Market and product parameters that increase the relative economic appeal of the relational contract are determined. It is demonstrated that the competition from the auction market can either facilitate or undermine the relational contract compared with a benchmark case of a monopolist supplier. This implies that competition between the two procurement models plays an important role in the supply of high-quality products.