the risk of collusion in public procurement

Lear - Laboratorio di economia, antitrust, regolamentazione

The Risk of Collusion in Public Procurement

Paolo Buccirossi

Chisinau, December 1 2015

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Issues• Theory of collusion

• How firms collude in procurement

• How to detect collusion

• Leniency programs

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Notions of collusion• Legal notion of collusion: explicit coordination of firms’

market strategies achieved through some form of direct or indirect communication

• Economic notion of collusion: modification of the market equilibrium so that firms charge higher prices or modify other selling conditions to their advantage– Explicit collusion– Tacit collusion

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Two problems

• In order to collude, firms must be able to solve two problems

1. A coordination problem

2. An enforcement problem

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Coordination problem

• Define an acceptable way to share the benefit of collusion

• Find a practical method to achieve the agreed repartition of benefits

• Examples: fix a selling price; set the maximum output; allocate clients or areas to share the market (these are called the “terms of coordination”)

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Enforcement problem• Each firm has a (short run) incentive to deviate (cheat) from

the terms of coordination

• Deviations (cheating) may be discouraged by a mechanism that allow firms to– Monitor the other firms’ market conduct, and– Punish deviators

• Collusion is feasible if the threat of punishment is– Likely– Timely– Sufficient

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How firms collude

There are a number of ways in which firms may collude in procurement. Here the most observed examples:

• Bid suppression • Cover bidding • Bid withdrawal• Non-conforming bids• Bid rotation• Split award• Market allocation

Dynamic collusion

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Bid suppression and cover bidding• Bid suppression: one only firm among the colluders do

participate with a very high price, the other ones do not bid. Thus, the firm that has gained the profit shares with the other ones the ‘cake’. The buyer or the Antitrust Agency may easily understand that some collusive behavior has taken in place if more participation has been observed in the past

• Cover bidding: more bids but one only is valid! More difficult to detect. Abnormal high price and trivial mistakes in the offers may help to detect collusion

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Bid withdrawal and non-conforming bids

• Bid withdrawal: this is the case where a competitor withdraws its winning bid so that an agreed competitor will be successful instead. It is quite easy to detect when the motivation of the withdrawal is clearly faked

• Non-conforming bids: all the conspirators but one submit non-valid bids, inducing the procurement agency to award the contract to the only firm whose bid is still valid. This may be detected by looking at the prices with which the winning firm has awarded the contract. In case it turns out that this price is very high, collusion has probably taken place

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Bid rotation• Bid rotation: suppliers continue to bid, but they agree to take

turns being the winning bidder. The collusive agreement may entail the Firm A winning the contract at time t and the firm B winning the contract at time t+1

• This is a common form of collusion in case of:– Single lot procurements (one only winner at each date), even if it may

work also for multiple-lot procurements– Frequent and regular procurements– When the value of the contract does not change much over the time– Low participation rates

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Split award• Split-award agreement: In case of multi-lot procurement,

firms A and B may agree to split the whole procurement by taking one lot each

– In a two-lot tender (1 and 2), the agreement may require that firm A bids (and wins) always for lot 1 and firm B bids (and wins) always for lot 2

– This is very common in case the goods to procure are complementary or lots are geographic

– When transportation costs are an issue, split-award agreements are more likely

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Market allocation• Market Allocation: In the case of separate tenders, some

firms, potential suppliers for a wide range of goods or services, may split the market by winning some pre-determined procurements each

– Even in case of strong complementarities between different tenders, it is not easy to determine whether some firms are not participating because of collusive intents

– In case of consolidated histories of tenders, changes in participation rates may signal collusive practices

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Detecting collusion: red flags

It is possible to define five categories of warning signs of occurring collusion, each of them referring to a particular moment or characteristic of the procurement mechanism

1. Warning signs involving bid submission2. Warning signs in documents submitted3. Warning signs involving prices4. Warning signs in bidders’ behavior5. Warning signs in suppliers’ statements

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Bid submission-1• The same supplier is often the lowest bidder (i.e. the

successful bidder)• There is a geographic allocation of submissions. Some firms

submit tenders only certain geographic areas • Regular suppliers fail to bid on a tender they would normally

be expected to bid for, but have continued to bid for other tenders

• Some suppliers unexpectedly withdraw from bidding• The winning bidder does not accept the contract and is later

found to be a subcontractor

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Bid submission-2

• The winning bidder repeatedly subcontracts work to unsuccessful bidders

• Competitors’ bids are received together • Certain companies always submit bids but never win• Two or more firms submit a joint bid even though one of

them (or both) could have bid on its own

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Documents-1• Identical mistakes in the bid documents or letters submitted

by different companies, such as spelling errors• Bids from different companies contain similar handwriting or

typeface or use identical form or stationary• Bid documents from one company make express reference to

competitors’ bids or use another bidder’s letterhead or fax number

• Bids from different companies contain identical miscalculations

• Bids from different companies contain a significant number of identical estimates of the cost of certain items

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Documents-2

• The packaging from different companies has similar postmarks or post metering machine marks

• Bid documents from different companies indicate numerous last minute adjustments, such as the use of erasures or other physical alterations

• Competitors submit identical tenders or the prices submitted by the bidders increase in regular increments

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Pricing-1• Sudden and identical increases in price or price ranges by

bidders that cannot be explained by cost increases • A certain supplier’s bid is much higher for a particular contract

than the same supplier's bid for another similar contract • Only one bidder contacts wholesalers for necessary pricing

information prior to a bid submission• A large difference between the price of a winning bid and

other bids• Bids from local companies involve similar transportation costs

as non-local bidders

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Pricing-2

• Significant reductions from past price levels after a bid from a new or infrequent supplier, e.g. the new supplier may have disrupted an existing bidding cartel

• Similar (low) quality/price ratio offered by different firms • Anticipated discounts or rebates disappear unexpectedly• Identical (and high) bid amounts

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Bidders’ behavior-1

Sometimes potential suppliers act in a way that suggests past interaction with other suppliers:

• Suppliers meet privately before submitting bids, sometimes in the vicinity of the location where bids are to be submitted

• Suppliers regularly socialize together or appear to hold regular meetings

• A company requests a bid package for itself and a competitor• A company submits both its own and a competitor’s bid and

bidding documents

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Bidders’ behavior-2• A bid is submitted by a company that is incapable of

successfully completing the contract• A firm brings multiple bids to a bid opening and chooses

which bid to submit after determining (or trying to determine) who else is bidding

• Several bidders make similar enquiries to the procurement agency or submit similar requests or materials

• Financial transactions among bidders• Low participation in tenders characterized by high

participation in the past

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Statements (rare)• Use of the same terminology when explaining price increases • Statements that bidders justify their prices by looking at

“industry suggested prices”, “standard market prices” or “industry price schedules”

• Knowledge of competitor’s confidential bid• Spoken or written references to an agreement among bidders• Statements indicating that certain firms do not sell in a

particular area or to particular customers• Statements indicating that a supplier submitted a courtesy,

complementary, token, symbolic or cover bid

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Leniency programs• Finding clear and convincing evidence of explicit collusion may

be difficult• Cartelists can be lured to provide hard evidence if they are

“rewarded”• Leniency programs award immunity from fines to the first

member of a cartel that spontaneously reports information before an investigation of the cartel is opened or that provide hard evidence that is indispensable to prove the infringement

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Leniency programs and incentives• Cartels are sustainable if long-term gains from future collusion

offset short-term gains from a deviation (i.e., submitting a price that is lower than the collusive one!)

• With leniency, a deviating firm can report to the competition authority and protect itself

• In exchange of hard information on a cartel, the deviating firm gets lower fines or complete immunity

• As a consequence, deviator’s short-term gains increase while long-term gains remain stable -> higher incentive to report with respect to the status-quo!

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Leniency programs and rule of law

• Leniency programs are effective only if legal uncertainty is reduced as much as possible

1. Uncertainty concerning enforcement and sanctions

2. Uncertainty about the reward given to the leniency applicant

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Conclusions

• Collusion is a widespread phenomenon• Bid rigging significantly impairs economic growth potentials• Firms are smart: they find effective ways to collude and to

conceal their misbehavior• Competition authorities (and procurement agencies) must be

smart too• Divide et impera: leniency programs may be a smart tool to

fight collusion

the risk of collusion in public procurement

Economy & Finance