"Now or later?" when to deploy qualification screening in open-bid auction for re-sourcing

Zhang, W, Chen, Q and Katok, E (2021) "Now or later?" when to deploy qualification screening in open-bid auction for re-sourcing. Operations Research, 69 (6). pp. 1715-1733. ISSN 0030-364X

Abstract

This paper considers a re-sourcing setting in which a qualified supplier (the incumbent) and multiple suppliers which have not yet been qualified (the entrants) compete in an open-bid descending auction for a single-supplier contract. Due to the risk of supplier nonperformance, the buyer only awards the contract to a qualified supplier; meanwhile, the buyer can conduct supplier qualification screening at a cost, to verify whether the entrant suppliers can perform the contract. Conventionally, the buyer would screen entrants before running an auction, i.e., the pre-qualification strategy (PRE). We explore an alternative approach called post-qualification strategy (POST), in which the buyer first runs an auction and then conducts qualification screenings based on the suppliers' auction bids. Our characterization of the dynamic structure of the suppliers' equilibrium bidding strategy enables the calculation of the buyer's expected cost under POST, which is computationally intractable without this characterization. We show analytically that POST is cheaper than PRE when the cost of conducting qualification screening is high, the number of entrant suppliers is large, or the entrants' chance of passing qualification screening is high. To quantify the benefit of POST, we conduct a comprehensive numerical study and find that using the cheaper option between PRE and POST provides significant cost-savings over the conventional PRE-only approach. Furthermore, we leverage a revelation principle for multi-stage games to derive the optimal mechanism as a stronger benchmark for performance comparison. While the optimal mechanism is theoretically optimal, we find that its complexity renders it difficult to implement in practice; but quite strikingly, the simple and practical approach of choosing the cheaper option between PRE and POST captures the majority of the benefit the optimal mechanism can offer over PRE, highlighting the practical benefit of POST.