Abstract
First-Price-Sealed-Bid (FPSB) are widely used in both the public and private sectors. In a FPSB procurement common value auction, a seller must first estimate their cost to provide the product requested by the buyer and then determine a bid amount by adding a markup to the cost estimate. This markup must consider desired profits as well as informational uncertainties regarding the cost estimates since actual costs of production are known only after the product is produced. In this paper, we investigate the impact of better cost estimates on firm profitability and bidding strategy in a two- and three-bidder auction. Based on field data from over 1000 procurement auctions, we assume that errors in cost estimation follow a normal distribution. This assumption greatly complicates the analysis such that finding an analytical solution is unlikely. Therefore, using a numerical solution approach, we find the equilibrium solution for each type of seller under a variety of parameter settings. We find that advantaged sellers will be more profitable yet submit more aggressive bids. These results depend on the number of advantaged and disadvantaged sellers competing. Indeed, if there is more than a single advantaged seller competing, they will submit very aggressive bids resulting in profits that may actually decrease as each gets better at estimating costs. Our results provide a clear understanding as to the importance of accurate product cost estimates and extends the research on the effects of cost estimation accuracy in procurement auctions.
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