Procurement Mechanisms for Differentiated Products

Procurement Mechanisms for Differentiated Products

2017Working Paper No. 3450

Part of thesis finalist of 2015 INFORMS George Dantzig Dissertation Award. Second place 2015 M&SOM Student Paper Competition

Problem definition: We consider the problem faced by a procurement agency that runs an auctiontype mechanism to construct an assortment of differentiated products with posted prices, from which heterogeneous consumers buy their most preferred alternative.

Academic / Practical Relevance: Procurement mechanisms used by big organizations often take this form, including Framework agreements (FAs), that are widely used in the public sector.

Methodology: We use tools from mechanism design and auction theory to study the problem faced by the procurement agency and derive concrete practical recommendations.

Results: First, imposing different practical constraints such as linear pricing, we characterize the optimal buying mechanisms, which typically restrict the entry of close-substitute products to the assortment to increase price competition, without much damage to variety. Second, we use these optimal mechanisms as benchmarks to recommend improvements to the Chilean government procurement agency’s implementation of FAs, used to acquire over US$2 billion worth of goods per year.

Managerial Implications: We devote the last section of our paper to explain in detail how our results and insights are changing the way FAs are implemented by the Chilean government.