Mechanism design for e-procurement auctions: On the efficacy of post-auction negotiation and quality effort incentives

Practical mechanisms for procurement involve bidding, negotiation, transfer payments and subsidies, and the possibility of verification of unobservable product and service quality. We model two proposed multi-stage procurement mechanisms. One focuses on the auction price that is established, and the other emphasizes price negotiation. Both also emphasize quality and offer incentives for the unobservable level of a supplier’s effort, while addressing the buyer’s satisfaction. Our results show that, with the appropriate incentive, which we will refer to as a qualityeffort bonus, the supplier will exert more effort to supply higher quality goods or services after winning the procurement auction. We also find that a mechanism incorporating price and quality negotiation improves the supply chain’s surplus and generates the possibility of Pareto optimal improvement in comparison to a mechanism that emphasizes the auction price only. From the buyer’s perspective though, either mechanism can dominate the other, depending on the circumstances of procurement. Thus, post-auction negotiation may not always be optimal for the buyer, although it always produces first-best goods or service quality outcomes. The buyer’s choice between mechanisms will be influenced by different values of the quality effort bonus. For managers in practice, our analysis shows that it is possible to simplify the optimization procedure by using a new approach for selecting the appropriate mechanism and determining what value of the incentive for the supplier makes sense.