1. Auctions and Competitive Bidding
Chapter 19
Auctions and Competitive Bidding

2. Types of Auctions Types Characteristics Winning Bid English auction
Types
Characteristics
Winning Bid
English auction
 Most common form; price is successively raised until only one bidder remains
The highest bid
Dutch auction
 Auctioneer calls an initial high price, and then lowers the price until one bidder accepts the current price
 The highest bid, but the winner pays the lowest winning price
First-price sealed bid auction
Competitors submit bids secretly, or sealed.
 The highest bid when competing for goods; the lowest bid when competing to offer a service

3. Types of Auctions Types Characteristics Winning Bid
Types
Characteristics
Winning Bid
Second-price sealed bid auction
Competitors submit bids secretly, or sealed
The highest bidder, but pays the price of the second-highest bidder
Reserve-price auction
A reserve price is set by the seller
The highest bidder, if above the seller=s reserve price
Reverse-price auction
The price declines at a regular interval
The first bid during the price decline

4. Types of Auctions The English auction
The most common form, the one in which the highest bidder among potential buyers, or the lowest bidder among potential sellers is the winner
Can be closed or open
Requires bidders to be present, susceptible to rings of bidders

5. Elements of Auctions Participants
A seller offers a right or an object to prospective buyers who are invited to bid
The auctioneer or auction house conducts the auction and receives a commission from the seller based on the price paid; the auctioneer also receives a commission paid by the winning bidder (buyer’s premium)

6. Elements of Auctions Scarcity
Typically there are limited quantities of the object available for sale
Auctions provide an opportunity to determine the market value of scarce objects, in contrast to mass-produced and mass-merchandised goods and services that are offered for sale at a fixed price

7. Why Auctions Work Reasons for holding auctions
Uncertainty as to what price to post, or the value that buyers may place on an asset
Occurs when products are not standardized or market prices are not stable
The formality of the procedure provides a perception of legitimacy that may not be obtained in other forms of asset transfer

8. Why Auctions Work Information asymmetry
The sellers do not know who will attend and bid in the auction, or what each bidder’s value and price limit is for the object
The bidders do not know if the seller has set a reserve price that reflects the seller’s value for the item, or what the competitor bidders have set as their caps for the item
Auction houses are most successful when they can find the largest number of bidders who value the objects to be auctioned more than other bidders

9. Fixed-Price Competitive Bidding
The theory of fixed-price competitive bidding covers such situations as
1. Deciding what price to bid when the number of competitor bidders is known and when the identity of the competitors is known
2. Deciding what price to bid when the number and identity of competitors are unknown
3. Deciding whether to submit a bid at all
4. Deciding how many contracts to bid on simultaneously when a company cannot afford to win them all

10. Fixed-Price Competitive Bidding
The decision problem is to submit a bid that will help the firm achieve its objectives and be lower than the competing bids
What to bid depends on the objectives of the firm
Assumes the bidder’s objective is to maximize expected immediate profits

11. Fixed-Price Competitive Bidding
The firm must estimate
The probabilities of winning the contract at various prices
The number of bidders submitting a bid since the probability of winning a bid is a function of this number
What competitors are likely to bid since competitors will keep their intentions secret

12. Fixed-Price Competitive Bidding
Prebid analysis
By being selective in its bidding, a company can save time and money that would be spent on bid activities such as cost estimation, engineering proposals, purchasing, and printing the bids
Determine bid objectives
The objective may be the typical economic objective of profit maximization, either in terms of return on investment or absolute profits, or it may be to keep labor busy, gain an entree into a new business, or overcome a survival crisis

13. Fixed-Price Competitive Bidding
Developing evaluation criteria
Necessary labor skills and engineering capability
Available plant capacity
Possibility of follow-up orders
Amount of the job’s design content
Number and identity of probably competitors
Degree of familiarity the firm has with the bid project
Ability to deliver the project on time
Possibility of cost savings due to experience curve

14. Fixed-Price Competitive Bidding
Develop a screening procedure
Assign a weight to each of the evaluation criteria, quantify these values, and then compare the score to other previous bids or to a predetermined minimum acceptable value
Cost estimation
The firm should avoid arbitrary cost-estimating formulas, and instead prepare careful cost estimates based on realistic activity levels

15. Fixed-Price Competitive Bidding
Estimating the probability of winning
The winning bid approach simply uses the history of competitors' winning bids
The average-opponent approach uses the history of competitors' winning and losing bids to represent the bidding behavior of an average opponent
The specific-opponent approach uses the past bidding behavior of specific competitors

16. Fixed-Price Competitive Bidding
Problem of determining reasons for a winning bid
The bid-taker may be attempting to maximize the perceived value of the decision by trading-off price with other product service attributes
Conjoint analysis
The salespeople involved with the buying company need to try to determine reasons why the bid was lost; or the firm can conduct interviews with clients to elicit information about the bid selection and the reasons for the selection of the winning bid

17. Fixed-Price Competitive Bidding
Determining the best bid
The optimal bid is the bid that offers the highest expected contribution to profit and overhead
The expected contribution of a bid E(B) is determined by multiplying the probability of winning with a bid, P(B), by the difference between the bid price and the estimated direct costs (B-C):
E(B) = (B - C) x P(B)

18. Fixed-Price Competitive Bidding
Contingent contracts
Contingent contracts are used when neither the bidding firm nor the bid-taking organization has complete information about either the costs of performing the service or developing and providing the product or the value to be derived from receiving the service or using the product
Cost-plus contract- used to determine the amount of “guaranteed” profit for the performing organization
Incentive or risk-sharing contract
Contingency-value contract- the bidding firm uses the amount of the incentive they build into the bid as a signal of their performance capabilities

19. Fixed-Price Competitive Bidding
Bidding with capacity constraints
When operating at or near full capacity, the firm is in a position to allocate its resources to maximize contributions per resource unit
When capacity constraints exist, the bidding firm should substitute the contribution per resource unit criterion for contribution margin in the analytical procedures developed in this chapter and then proceed as usual