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Auction design and risk of collusion

February 2009

Economic Focus

In order to award a procurement contract, a buyer may choose between entering into negotiations and running a procurement auction. The theoretical economic literature suggests choosing a procurement auction, because under certain conditions it induces competitive bidding resulting in the best possible price for the buyer.

This suggestion is based on the assumption that bidders do not collude. However, in practice, bidders may collude and therefore procurement auctions do not necessarily guarantee the best prices for the buyers. It is a common belief that auctions allow for generating the highest possible revenue even though suppliers may collude. For example, in its decision concerning collusion in the market for electric cables, the French competition council suggested that as compared to negotiations the introduction of a procurement auction had a goal of increasing competition in the market. In fact, auctions may not succeed in eliminating collusive behavior.

The present article discusses collusion in auctions and indicates the measures that the auctioneer could adopt to prevent collusive behavior. In particular, it reviews the standard factors related to collusion and links them with auction rules. These standard factors include cartel’s ability to (1) generate extra profits, (2) divide the surplus in such a way that all the colluding parties are satisfied, (3) detect deviations and (4) punish detected deviations.    

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