Public Policy: Using Market-Based Approaches - Department for ...

educe the level of participation, and therefore competition, in the tendering
process. Where lack of competition is not a concern, the incentive benefits of
transferring risk to the private sector are more likely to outweigh any short-run
increase in costs.
The second situation, where some potential service providers have less
information than others, can give rise to a ‘winner’s curse’ problem. This arises
when bidders do not know the true costs of providing the service and make
different forecasts. The bidder that wins the contract will be the one with the
lowest forecast, which is most likely to be below the true cost of providing the
service. It might be expected that this will be a good result for the public sector,
but it can result in firms feeling under pressure to cut quality, raising their
bidding price in order to compensate for this risk or deciding not to participate
since they expect the contract to prove unprofitable for the successful bidder.
In general, the winner’s curse problem can be minimised by providing bidders
with more information so that they can make accurate forecasts of their costs.
An open auction can also assist this process since bidders can use information
on competitors’ bids to adjust their own forecasts. A smaller number of bidders
will also reduce the likelihood of a winner’s curse. However, as explained above,
all these factors can increase the risks of collusion.
CONCLUSION
Competitive tendering allows the government to retain ownership of public
assets whilst harnessing the sharper incentives for efficiency and innovation
offered by the private sector. We have set out above a number of factors that
could influence the way in which this is implemented. Clearly, there are tradeoffs
to be made here – decisions which address concerns over asymmetric
information may increase the likelihood of collusion between participants, for
example. Nevertheless, by considering the weight that should be attached to the
risks identified above in any particular circumstance, it will be possible to
identify which approaches are most likely to be successful in that particular case.
The case study on competitive tendering of prison services in Part IV assesses
the evidence on how competitive tendering in that case affected cost efficiency
and innovation, and looks at whether the potential problems highlighted by
theory have been encountered in practice. Specifically, we have examined
whether problems of market power and incumbency advantage arose in the
market for prison management services, and whether costs were cut at the
expense of quality. We also considered how problems of asymmetric
information have been overcome in the design of incentive contracts to avoid
both ‘winner’s curse’ and ‘hold-up’ problems.
User choice
Section 7 – Market-Based Mechanisms
In some cases, full competitive tendering of a service may not be considered an
option. For example, quality may be difficult to control or competitive tendering
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