Auctions versus Negotiations in Procurement: An Empirical Analysis

Should the buyer of a customized good use competitive bidding or negotiation to select a contractor? To shed light on this question, we offer a framework that compares auctions with negotiations. We then examine a comprehensive data set of private sector building contracts awarded in Northern California during the years 1995-2000. The analysis suggests a number of possible limitations to the use of auctions. Auctions may perform poorly when projects are complex, contractual design is incomplete and there are few available bidders. Furthermore, auctions may stifle communication between buyers and sellers, preventing the buyer from utilizing the contractor's expertise when designing the project. Some implications of these results for procurement in the public sector are discussed.