Author's Personal Copy Split-award Contracts with Investment ☆

In most cases authors are permitted to post their version of the article (e.g. in Word or Tex form) to their personal website or institutional repository. Authors requiring further information regarding Elsevier's archiving and manuscript policies are encouraged to visit: a b s t r a c t a r t i c l e i n f o JEL classifications: C72 D44 L14 Keywords: Split-award Generalized second-price auctions Investment This paper studies procurement contracts where a buyer can either divide full production among multiple suppliers or award the entire production to a single supplier. We examine the effect of using multiple suppliers on investment incentives. In a framework of generalized second-price auctions with pre-auction investment , we show that the optimality of split-award depends on the socially efficient number of firms at the investment stage. When that number is greater than one, sole-sourcing is buyer-optimal. When that number is one, split-award lowers the buyer procurement cost. The practice of employing a contractual format that allows for a split-award is widely observed. In Japan's telecommunications industry, as reported in Fransman (1995), " Competition between the suppliers is not of the 'winner-take-all' variety. Rather, it involves controlled competition insofar as, contingent on reasonable performance as judged and monitored by NTT, each supplier can expect to receive a sizable share of NTT's order. " China Mobile, the world's largest mobile carrier, regularly conducts several rounds of supplier tournaments in each year, where large chunks of equipment and mobile handset contracts are divided among a few vendors. The practice is also very common in the private sector. Wal-mart's vitamin business adopts a multiple-source model, relying on several of its vendors in China for supply contracts. Similarly, companies such as Sun and HP that use online auctions to procure products worth hundreds of millions of dollars frequently opt for multiple sourcing, as documented in Tunca and Wu (2009). The issue of sole-sourcing versus split-award has been extensively researched. Some, for example Beltramo (1983), argues that split-buy competitions often increase costs to the government since they fail to achieve efficiency in production. Others, for example Gansler and Lucyshyn (2009), argue that with careful planning, this barrier (of achieving efficiency in production) can be overcome. The latter cites example of Lockheed Martin which was able to reduce the D-5 Sea-Launched-Ballistic-Missile production rate from 60 a year to 12 a year, while reducing the cost at the …