ORIE Colloquium, 2014-12-15 - Daniela Saban: Procurement Mechanisms for Differentiated Products

We consider the problem faced by a procurement agency that runs an auction-type mechanism to construct a menu (assortment of products with posted prices), from a set of differentiated products offered by strategic suppliers. Heterogeneous consumers then buy their most preferred alternative from the menu as needed. Framework agreements (FAs), widely used in the public sector, take this form; the central government runs the initial auction and then the public organizations (hospitals, schools, etc.) buy from the selected assortment as required. This type of mechanism is also relevant in other contexts, such as the design of medical formularies and group buying. We develop a mechanism design approach to study this problem, and provide a characterization of the optimal menus. The optimal mechanism balances the trade-off between product variety and price competition, in terms of suppliers' costs, products' characteristics, and consumers' characteristics. We then use the optimal mechanism as a benchmark to evaluate the performance of the FAs run by the Chilean government procurement agency, used to acquire US\$2 billion worth of goods per year. We show how simple modifications to the current mechanism, which increase price competition among close substitutes, can considerably improve performance. (Joint work with Gabriel Weintraub)