Economic and Game Theory
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Developer (D) is developing a power plant and wishes to seek competitive bids for fuel supply. There are five (5) qualified bidders, Companies 1 - 5, all who are capable of supplying fuel. D will be required to risk significant capital to develop the power plant, and would like to find sources of funding to share that risk. Company 1 has offered to provide development funding to D in exchange for the right to negotiate a supply contract based on the most favorable terms received as a result of the competitive process. D will not agree to any arrangement if it makes the fuel supply bidding less competitive (if Companies 2 - 5 would not bid as aggressively).
How will the existence of this right to match affect the behavior of Companies 2 - 5? It is D's current belief that issuance of the right to match will reduce the incentive of Companies 2 - 5 to compete, and therefore, that bids would be less aggressive, knowing that any otherwise successful offer to supply could be taken by Company 1. Company 1 has asserted to D that the process should be unaffected, or potentially made more competitive, by virtue of issuance of the right to match. Company 1's rationale is that Companies 2 - 5 will know that if each were to submit a "fat" offer, that offer is more likely to be seen by Company 1 as attractive, and is more likely to be matched. Therefore, a serious bidder would have incentive only to submit a bid that is at or near its indifference point. If it wins the contract, the profitability will be acceptable, but if it loses the contract, that profitability was at the margin.
Is there a side to this argument that is more likely correct than the alternative?
* The major term on which Companies 1 - 5 would compete is unit price for fuel. All other terms and conditions should be considered equivalent.
* Four bidders will be no less competitive than five bidders.
* The development funding offered by Company 1 is adequate value for the option received (no net creation or diminution of value, just an allocation of risk).
* The cost of bid preparation is not significant. It is an acceptable cost of participating in this business.
* By virtue of its participation in project development, or its right to match, Company 1 will not have access to information beyond what is available to all other bidders.