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Public Policy: Using Market-Based Approaches Factors that facilitate collusion Economists have found that the following market features help firms to reach and sustain a collusive agreement. 189 These are: ● High concentration: the lower the number of potential firms in a market, the easier it is to reach an agreement between them; ● Symmetry of firms: it is easier for firms to reach an agreement when they are similar as their interests are more likely to be aligned; ● Transparency: a transparent market makes it easier for firms to reach an agreement and to monitor that the agreement is being maintained; ● Homogenous contracts: if contracts are similar, it is easier for firms to share them amongst themselves; ● Regularity and frequency of orders: if there are frequent, regular orders it is easier for firms to sustain a collusive agreement. It may not be worth deviating and undermining the agreement for a small contract. Moreover, punishing cheating firms is easier when the next contract comes soon; ● Multi-market contacts: these can help collusion by increasing the symmetry of firms (as one may be strong in one market, and one strong in another) and by increasing the regularity of orders. Where firms have a ‘natural territory’ this can also make it easier to agree on an initial allocation of contracts; ● Stable demand: stable demand makes it easier for firms to determine whether prices have fallen due to a firm cheating on an agreement or a genuine fall in demand; ● High barriers to entry: this makes it less likely that collusion will be undermined by new entrants; and ● Absence of buyer power: a strong buyer can make collusion more difficult through the design of the sales process. Factors that make public procurement vulnerable to collusion A number of the factors listed above are often found in public procurement processes, increasing the potential for collusion. Although governments should often be in a position to exercise buyer power, the design of some procurement processes has on occasions created conditions ideal for fostering collusion among bidders. For example, standard contracts are often awarded by many local authorities on a local basis, resulting in a high degree of regular, standard contracts and repeated interaction among firms. In addition, many public tender processes can require a past track record by a firm, creating barriers to entry and reducing the pool of potential firms. Risk-averse government agencies, such as those involved in the provision of frontline services, are likely to favour procurement through a steady and predictable flow of demand. Stable demand 189 Motta (2004), Competition Policy: Theory and Practice, Cambridge University Press. 174
allows suppliers to plan more effectively to meet demand and thus ensures sufficient capacity is available to deliver these services, but also makes collusion easier to sustain. An illustration of how a badly designed public procurement process can create conditions ideal for collusion is provided by Pesendorfer (2000) who examined a cartel for school milk contracts in Florida and Texas. 190 The market was characterised by many small contracts (in total several hundred a year between the two states). In each school district contracts were awarded independently of one another and at different dates. Each school district also published details of all bidders for the contract and the price bid by each. The transparency created by this system made it easy for bidders to collude on a market outcome (either in terms of price or by sharing contracts) and to detect when any firm had cheated on a contract. The frequency of contracts deterred firms from cheating, both as the gains from cheating on any individual contract were likely to be low and as any deviation could quickly be punished on the next contract. Ways to reduce the risk of collusion The potential for collusion can be restricted through appropriate auction design, bearing in mind the features that are likely to support a coordinated outcome in the first place. Making the process less transparent, reducing the frequency and similarity of contracts and reducing barriers to entry can all help in undermining collusion. For example, in the school milk example cited above, collusion would have been less likely if information on bids and bidders were not published and if the authority had aggregated together groups of contracts into large contracts. Fewer and larger contracts reduce the frequency of interaction, introduce an element of volatility to demand and increase the cost of losing. However, this must be balanced against incumbency advantages and the resulting impact on long-term market structure. Similarly, making bidding processes less transparent may limit the potential for collusion, but implies a trade-off in terms of the increased risk of regulatory capture that will also result. Auction design Section 12 – Issues in the implementation of market mechanisms As many competitive tenders are allocated through an auction process, care needs to be taken to ensure that the auction design does not create conditions for collusion. Auctions can be either open or sealed bid. In open auctions, bidding proceeds in stages, with bidders acting simultaneously and independently in each round. At the end of the round, bidders observe the outcome and adjust bids accordingly. Under a sealed-bid auction, bidders submit bids simultaneously and independently. Bids are then opened and the auction outcome decided 190 Pesendorfer (2000) as quoted in Motta (2004), Competition Policy: Theory and Practice, Cambridge University Press. 175
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DTI ECONOMICS PAPER NO.14 Public Po
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DTI ECONOMICS PAPER NO.14 Public Po
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Contents Acknowledgements vi Forewo
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Contents Section 11 Emissions Tradi
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Foreword There is increasing intere
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SECTION 1 Introduction and summary
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Public Policy: Using Market-Based A
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SECTION 2 Using market mechanisms U
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SECTION 3 Lessons for the design an
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SECTION 4 Introduction This part of
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SECTION 7 Market-Based Mechanisms W
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SECTION 8 Framework for assessing m
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Part IV Case Studies 73
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● the Green and White papers behi
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A prison failing to deliver on its
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Table 9.3 Companies providing priso
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Section 9 - Competitive Tendering o
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detect any deviation from a collusi
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at HMPS began as an equal mix of th
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(e.g. lighting). This impact could
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MARKET POWER The full benefits of c
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However, it should be noted that te
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on competition is uncertain. The ab
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Controlling for problems of asymmet
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Procurement process design One way
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however, financial deductions are m
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The Independent Monitoring Board at
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Figure 9.1: Difference between the
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‘While there were staff in the pu
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design the invitation to tender and
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and demand conditions. Second, we d
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DEMAND Anyone can apply to a local
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● Rent deposit guarantee by the l
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The Green Paper stated the Governme
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It was not an objective of ODPM or
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