Procurement with Bid Preference and Buyer’s Switching Costs

Abstract

Switching costs that arise in repeated purchases of durable goods cause buyers to face conflicting incentives: facilitating competition among potential sellers leads to lower prices while restricting competition among them allows buyers to avoid the disruption associated with introducing a new brand. I study this trade-off in an auction environment with bid preference that allows buyers to favor certain sellers. I construct novel data on fleet renewal by municipal bus operators in Poland who use a common format of scoring auctions to implement bid preference. Consistent with their incentive of avoiding switching costs, the operators favor incumbent bus producers. Motivated by this finding, I develop and estimate a structural model of public procurement with bidder favoritism to quantify the main driving forces of the trade-off. Estimates suggest that bid preference programs can balance the trade-off if an auction attracts sufficiently many bidders, whereas forcibly promoting competition while ignoring the underlying lock-in relationship between buyers and incumbent sellers would lead to counter-productive outcomes. Therefore, the design of public procurement should not only target achieving low prices but also account for other aspects contributing to buyers' welfare.