Preferred Suppliers and Vertical Integration in Auction Markets

This paper examines a symmetric first-price procurement auction in which one supplier is preferred by the buyer. Preference takes the form of a right-of-first-refusal which allows the preferred supplier to accept or reject the contract at the lowest bid of the other competing suppliers. We first characterize a strictly monotonic bidding function for the competing suppliers. We then show that the buyer can benefit from selling preference to one of the suppliers. The sale of preference allows the buyer to extract the differential expected profits from becoming the preferred supplier. Preference can also arise from a vertical merger between the buyer and one of the suppliers. We also show that the joint surplus of the buyer and one supplier increases after the vertical merger. * Martin would like to acknowledge the financial support of the Instituto de Analisis Economico (IAE, Institute for Economic Analysis) and the Institucio Catalana de Recerca i Estudis Avancats (ICREA, Catalan Institute for Research and Advanced Studies) in Barcelona Spain. Roberto would like to acknowledge financial support of FEDER and the Spanish Ministry of Science and Technology, project SEC 2002-02506 and CREA. In addition, we would like to acknowledge Maria Lauve and Ying Zhang, Martin’s research assistants at Rutgers University, for their help on various aspects of this paper. Finally, we would like to thank Richard McLean, Martin’s colleague at Rutgers University, for his careful suggestions on several theoretical issues.