Procurement Mechanisms for Assortments of Differentiated Products.

Many procurement agencies around the world construct assortments of differentiated products from which consumers can buy from. A leading example is framework agreements, a type of procurement mechanism commonly used by governments. This type of practice is studied head on. The authors introduce a mechanism design formulation of the procurement agency's problem and solves it under progressively more realistic implementation constraints. The results show how restricting entry of close-substitute products into the assortment can increase price competition, reducing spending significantly, without much damage to the variety offered to consumers. Furthermore, the results have practical implications that can be used by procurement agencies to increase consumer surplus and have already been used to redesign FAs in the Chilean government. We consider the problem faced by a procurement agency that runs a mechanism for constructing an assortment of differentiated products with posted prices, from which heterogeneous consumers buy their most preferred alternative. Procurement mechanisms used by large organizations, including framework agreements (FAs), which are widely used in the public sector, often take this form. When choosing the assortment, the procurement agency must optimize the tradeoff between offering a richer menu of products for consumers and offering less variety, hoping to engage the suppliers in more aggressive price competition. We formulate the problem faced by the procurement agency as a mechanism design problem, and we progressively incorporate more complex and often more realistic implementation constraints, including that the allocations should be decentralized (that is, consumers choose what to buy) and that payments must be implemented through linear pricing (in particular, no up-front payments are allowed). We characterize the optimal buying mechanisms that highlight the importance of restricting the entry of close-substitute products to the assortment as a way to increase price competition without much damage to variety. Motivated by the implementation of the Chilean FAs, which are being used to acquire around US$3 billion in goods and services per year, we leverage our characterization of the optimal mechanism to study the design of first-price-auction-type mechanisms that are commonly used in public settings. Our results shed light on simple ways to improve their performance. [ABSTRACT FROM AUTHOR]