Procurement with Cost and Non-Cost Attributes: Cost-Sharing Mechanisms

Published in Operations Research. DOI: https://pubsonline.informs.org/doi/10.1287/opre.2020.2060

Posted: 5 Mar 2018 Last revised: 29 Sep 2022

See all articles by Shivam Gupta

Shivam Gupta

University of Nebraska Lincoln - College of Business

Shouqiang Wang

University of Texas at Dallas - Naveen Jindal School of Management

Milind Dawande

University of Texas at Dallas - Department of Information Systems & Operations Management

Ganesh Janakiraman

University of Texas at Dallas - Naveen Jindal School of Management

Date Written: November 26, 2018

Abstract

A buyer faces a two-dimensional mechanism design problem for awarding a project to one among a set of contractors, each of whom is privately informed about his cost and his estimate of an a priori random non-cost attribute. The winning contractor realizes his non-cost attribute upon the project’s completion and may “manipulate” it in a costless manner (if such a manipulation is beneficial to him). The non-cost attribute inflicts a disutility cost on the buyer. This procurement problem arises in situations such as highway construction projects, where completion times are a major concern. We establish the significance of incorporating the possibility of manipulation in two ways: (1) Using an optimal mechanism obtained by ignoring the possibility of manipulation can generate perverse incentives for the winning contractor to engage in manipulation. (2) The privacy of the non-cost estimates can generate information rent only due to the possibility of contractors’ manipulation. We further study the family of cost-sharing mechanisms as a nonmanipulable, easy-to-implement and near-optimal solution to the buyer’s procurement problem. In a cost-sharing mechanism, the winning contractor is selected via a second-price auction and needs to reimburse a pre-specified fraction – referred to as the cost-sharing fraction – of the buyer’s disutility cost upon completion of the project. We show that the cost-sharing fraction plays an unequivocal role in capturing the essential tradeoff between allocative inefficiency and information rent. We also characterize the optimal cost-sharing fraction and offer prescriptive guidelines on the choice of this fraction based on the second-moment information of the buyer’s belief distribution. Finally, we establish the theoretical performance guarantees for the optimal cost-sharing mechanism.

Keywords: procurement, non-cost attribute, mechanism design, cost sharing

Suggested Citation

Gupta, Shivam and Wang, Shouqiang and Dawande, Milind and Janakiraman, Ganesh, Procurement with Cost and Non-Cost Attributes: Cost-Sharing Mechanisms (November 26, 2018). Published in Operations Research. DOI: https://pubsonline.informs.org/doi/10.1287/opre.2020.2060, Available at SSRN: https://ssrn.com/abstract=3132220 or http://dx.doi.org/10.2139/ssrn.3132220

Shivam Gupta (Contact Author)

University of Nebraska Lincoln - College of Business ( email )

P.O. Box 880491
Lincoln, NE Nebraska 68588

Shouqiang Wang

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Milind Dawande

University of Texas at Dallas - Department of Information Systems & Operations Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Ganesh Janakiraman

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

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