Supplier Selection—Auctions and Negotiations

A good test of whether a firm has the right number of suppliers is to analyze what impact deleting or adding a supplier will have. Unless each supplier has a somewhat different role, it is likely that the supply base is too large. In contrast, unless adding a supplier with a unique and valuable capability clearly adds to total cost, the supply base may be too small. 

An excellent discussion on auctions can be found in Krishna (2002) and Milgrom (2004). Much of our discussion summarizes some of their ideas. 

From the buyer s perspective, the purpose of an auction is to get bidders to reveal their underlying cost structure so the buyer can select the supplier with the lowest costs. A commonly used mechanism that achieves this outcome is the second-price (Vickrey) auction. In this type of auction, each potential suppher submits a bid and the contract is assigned to the lowest bidder— but at the price quoted by the second-lowest bidder. In general, it is in the buyer s interest to 

A significant factor that must be accounted for when designing an auction is the possibility of collusion among bidders. Second-price auctions are particularly vulnerable to collusion. If there is collusion and all bidders but the lowest cost bidder raise their bids, the contract goes to the lowest-cost bidder, but at a high price. Firms must take care to ensure that no collusion occurs when using an auction. 

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